BUS 591 Week 1 Discussion 1&2

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Financial Accounting: Tools for Business Decision Making

Eighth Edition

Kimmel ● Weygandt ● Kieso

Chapter 1

Introduction to Financial Statements

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Financial Accounting: Tools for Business Decision Making

Chapter Outline:

Learning Objectives

Identify the forms of business organization and the uses of accounting information.

Explain the three principal types of business activity.

Describe the four financial statements and how they are prepared.

L O 1: Identify the Forms of Business Organization and the Uses of Accounting Information

Forms of Business Organization

Users and Uses of Financial Information (1 of 7)

Internal Users

Accounting Across the Organization (1 of 3)

Owning a Piece of the Bar

The original Clif Bar® energy bar was created in 1990 after six months of experimentation by Gary Erickson and his mother in her kitchen. Today, the company has almost 300 employees and is considered one of the leading Landor’s Breakaway Brands®. One of Clif Bar & Company’s proudest moments was the creation of an employee stock ownership plan (E S O P) in 2010. This plan gives its employees 20% ownership of the company. The E S O P also resulted in Clif Bar enacting an open-book management program, including the commitment to educate all employee-owners about its finances. Armed with basic accounting knowledge, employees are more aware of the financial impact of their actions, which leads to better decisions.

Users and Uses of Financial Information (2 of 7)

External Users

Accounting Across the Organization (2 of 3)

Spinning the Career Wheel

How will the study of accounting help you? A working knowledge of accounting is desirable for virtually every field of business. Some examples of how accounting is used in business careers include the following.

General management: Managers of Ford Motors, Massachusetts General Hospital, California State University–Fullerton, a McDonald’s franchise, and a Trek bike shop all need to understand accounting data in order to make wise business decisions.

Marketing: Marketing specialists at Procter & Gamble must be sensitive to costs and benefits, which accounting helps them quantify and understand. Making a sale is meaningless unless it is a profitable sale.

Accounting Across the Organization (3 of 3)

Spinning the Career Wheel

Finance: Do you want to be a banker for Citicorp, an investment analyst for Goldman Sachs, or a stock broker for Merrill Lynch? These fields rely heavily on accounting knowledge to analyze financial statements. In fact, it is difficult to get a good job in a finance function without two or three courses in accounting.

Real estate: Are you interested in being a real estate broker for Prudential Real Estate? Because a third party—the bank—is almost always involved in financing a real estate transaction, brokers must understand the numbers involved: Can the buyer afford to make the payments to the bank? Does the cash flow from an industrial property justify the purchase price? What are the tax benefits of the purchase?

Users and Uses of Financial Information (3 of 7)

Ethics In Financial Reporting

United States regulators and lawmakers were very concerned that the economy would suffer if investors lost confidence in corporate accounting because of unethical financial reporting.

Recent financial scandals include: Enron, WorldCom, HealthSouth, A I G, and others.

Congress passed Sarbanes-Oxley Act (S O X).

Effective financial reporting depends on sound ethical behavior.

Users and Uses of Financial Information (4 of 7)

Solving an Ethical Dilemma

Recognize an ethical situation and the ethical issues involved.

Use your personal ethics to identify ethical situations and issues. Some businesses and professional organizations provide written codes of ethics for guidance in some business situations.

Identify and analyze the principal elements in the situation.

Identify the stakeholders—persons or groups who may be harmed or benefited. Ask the question: What are the responsibilities and obligations of the parties involved?

Users and Uses of Financial Information (5 of 7)

Identify the alternatives, and weigh the impact of each alternative on various stakeholders.

Select the most ethical alternative, considering all the consequences. Sometimes there will be one right answer. Other situations involve more than one right solution; these situations require you to evaluate each alternative and select the best one.

Ethics Insight Dewey & LeBoeuf L L P (1 of 2)

I Felt the Pressure—Would You?

“I felt the pressure.” That’s what some of the employees of the now-defunct law firm of Dewey & LeBoeuf L L P indicated when they helped to overstate revenue and use accounting tricks to hide losses and cover up cash shortages. These employees worked for the former finance director and former chief financial officer (C F O) of the firm. Here are some of their comments:

“I was instructed by the C F O to create invoices, knowing they would not be sent to clients. When I created these invoices, I knew that it was inappropriate.”

“I intentionally gave the auditors incorrect information in the course of the audit.”

Ethics Insight Dewey & LeBoeuf L L P (2 of 2)

I Felt the Pressure—Would You?

What happened here is that a small group of lower-level employees over a period of years carried out the instructions of their bosses. Their bosses, however, seemed to have no concern as evidenced by various e-mails with one another in which they referred to their financial manipulations as accounting tricks, cooking the books, and fake income.

Source: Ashby Jones, “Guilty Pleas of Dewey Staff Detail the Alleged Fraud,” Wall Street Journal (March 28, 2014).

Do It! 1: Business Organization Forms

In choosing the organizational form for your outdoor guide service, you should consider the pros and cons of each. Identify each of the following organizational characteristics with the organizational form or forms with which it is associated.

Easier to raise funds.

Simple to establish.

No personal legal liability.

Tax advantages.

Easier to transfer ownership.

Solution

Corporation.

Sole proprietorship and partnership.

Corporation.

Sole proprietorship and partnership.

Corporation.

Users and Uses of Financial Information (6 of 7)

Review Question

Which of the following did not result from the Sarbanes-Oxley Act?

a. Top management must now certify the accuracy of financial information.

b. Penalties for fraudulent activity increased.

c. Independence of auditors increased.

d. Tax rates on corporations increased.

Users and Uses of Financial Information (7 of 7)

Review Question

Which of the following did not result from the Sarbanes-Oxley Act?

a. Top management must now certify the accuracy of financial information.

b. Penalties for fraudulent activity increased.

c. Independence of auditors increased.

d. Tax rates on corporations increased.

L O 2: Explain the Three Principal Types of Business Activity

All businesses are involved in three types of activity —

financing,

investing, and

operating.

The accounting information system keeps track of the results of each of these business activities.

Financing Activities

Two primary sources of outside funds are:

Borrowing money (debt)

Amounts owed are called liabilities.

Party to whom amounts are owed are creditors.

Notes payable and bonds payable are different types of liabilities.

Issuing (selling) shares of stock for cash (equity).

Common stock is the term used to describe the amount paid by stockholders for shares they purchase.

Payments to stockholders are called dividends.

Investing Activities

Purchase of resources a company needs to operate.

Computers, delivery trucks, furniture, buildings.

Resources owned by a business are called assets.

Investments are another example of an investing activity.

Operating Activities (1 of 2)

Once a business has the assets it needs, it can begin its operations.

Revenues - Amounts earned from the sale of products and other sources (sales revenue, service revenue, and interest revenue).

Inventory - Goods available for sale to customers.

Accounts receivable - Right to receive money from a customer as the result of a sale.

Operating Activities (2 of 2)

Once a business has the assets it needs, it can begin its operations.

Expenses - cost of assets consumed or services used. (cost of goods sold, selling, marketing, administrative, interest, and income taxes expense).

Liabilities arising from expenses include accounts payable, interest payable, wages payable, sales taxes payable, and income taxes payable.

Net income – when revenues exceed expenses.

Net loss – when expenses exceed revenues.

Do It! 2: Business Activities

Classify each item as an asset, liability, common stock, revenue, or expense.

Solution

Cost of renting property.

Expense.

Truck purchased.

Asset.

Notes payable.

Liabilities.

Issuance of ownership shares.

Common stock.

Amount earned from providing service.

Revenue.

Amounts owed to suppliers.

Liabilities.

L O 3: Describe the Four Financial Statements and How They Are Prepared

Companies prepare four financial statements from the summarized accounting data:

Income Statement

Retained Earnings Statement

Balance Sheet

Statement of Cash Flows

International Note The primary types of financial statements required by International Financial Reporting Standards (I F R S) and U.S. generally accepted accounting principles (G A A P) are the same.

Financial Statements (1 of 12)

Income Statement

Financial Statements (2 of 12)

Reports revenues and expenses for a specific period of time.

Net income – revenues exceed expenses.

Net loss – expenses exceed revenues.

Past net income provides information for predicting future net income.

▼ Helpful Hint The financial statement heading identifies the company, the type of statement, and the time period covered. Sometimes, another line indicates the unit of measure, e.g., “in thousands” or “in millions.”

Financial Statements (3 of 12)

Income Statement

Retained Earnings Statement

Net income is needed to determine the ending balance in retained earnings.

Financial Statements (4 of 12)

Statement shows amounts and causes of changes in retained earnings during the period.

Time period is the same as that covered by the income statement.

Users can evaluate dividend payment practices.

Retained Earnings Statement

▼ Helpful Hint The heading of this statement identifies the company, the type of statement, and the time period covered by the statement.

Financial Statements (5 of 12)

Balance Sheet

Retained Earnings Statement

Ending balance in retained earnings is needed in preparing the balance sheet.

Financial Statements (6 of 12)

Balance Sheet

Reports assets and claims to assets at a specific point in time.

Assets = Liabilities + Stockholders’ Equity.

Lists assets first, followed by liabilities and stockholders’ equity.

▼ Helpful Hint The heading of a balance sheet must identify the company, the statement, and the date.

Financial Statements (7 of 12)

Balance Sheet

Statement of Cash Flows

Financial Statements (8 of 12)

Statement of Cash Flows

Provides answers to:

Where did cash come from during the period?

How was cash used during the period?

What was the change in the cash balance during the period?

▼ Helpful Hint The heading of a balance sheet must identify the company, the statement, and the date.

Financial Statements (9 of 12)

Review Question

Net income will result during a time period when:

a. assets exceed liabilities.

b. assets exceed revenues.

c. expenses exceed revenues.

d. revenues exceed expenses.

Financial Statements (10 of 12)

Review Question

Net income will result during a time period when:

a. assets exceed liabilities.

b. assets exceed revenues.

c. expenses exceed revenues.

d. revenues exceed expenses.

Financial Statements (11 of 12)

Review Question

Which of the following financial statements is prepared as of a specific date?

a. Balance sheet.

b. Income statement.

c. Retained earnings statement.

d. Statement of cash flows.

Financial Statements (12 of 12)

Review Question

Which of the following financial statements is prepared as of a specific date?

a. Balance sheet.

b. Income statement.

c. Retained earnings statement.

d. Statement of cash flows.

People, Planet, and Profit Insight

Beyond Financial Statements

Should we expand our corporate reports beyond the income statement, retained earnings statement, balance sheet, and statement of cash flows? Some believe we should take into account ecological and social performance, in addition to financial results, in evaluating a company. The argument is that a company’s responsibility lies with anyone who is influenced by its actions. In other words, a company should be interested in benefiting many different parties, instead of only maximizing stockholders’ interests. A socially responsible business does not exploit or endanger any group of individuals. It follows fair trade practices, provides safe environments for workers, and bears responsibility for environmental damage. Granted, measurement of these factors is difficult. How to report this information is also controversial. But many interesting and useful efforts are underway. Throughout this textbook, we provide additional insights into how companies are attempting to meet the challenge of measuring and reporting their contributions to society, as well as their financial results, to stockholders.

Do It! 3a: Financial Statements (1 of 7)

C S U Corporation began operations on January 1, 2017. The following information is available for C S U on December 31, 2017:

Accounts receivable	1,800	Retained earnings	?
Supplies expense	200	Accounts payable	2,000
Equipment	16,000	Cash	1,400
Rent expense	9,000	Insurance expense	1,000
Dividends	600	Notes payable	5,000
Service revenue	17,000	Common stock	10,000
Supplies	4,000	Blank	Blank

Prepare an income statement, a retained earnings statement, and a balance sheet.

Do It! 3a: Financial Statements (2 of 7)

Prepare an income statement using the following accounts.

Accounts receivable	1,800	Retained earnings	?
Supplies expense	200	Accounts payable	2,000
Equipment	16,000	Cash	1,400
Rent expense	9,000	Insurance expense	1,000
Dividends	600	Notes payable	5,000
Service revenue	17,000	Common stock	10,000
Supplies	4,000	Blank	Blank

Do It! 3a: Financial Statements (3 of 7)

Do It! 3a: Financial Statements (4 of 7)

Prepare a retained earnings statement using the following accounts.

Accounts receivable	1,800	Retained earnings	?
Supplies expense	200	Accounts payable	2,000
Equipment	16,000	Cash	1,400
Rent expense	9,000	Insurance expense	1,000
Dividends	600	Notes payable	5,000
Service revenue	17,000	Common stock	10,000
Supplies	4,000	Blank	Blank

Do It! 3a: Financial Statements (5 of 7)

Do It! 3a: Financial Statements (6 of 7)

C S U Corporation began operations on January 1, 2017. The following information is available for C S U on December 31, 2017:

Accounts receivable	1,800	Retained earnings	?
Supplies expense	200	Accounts payable	2,000
Equipment	16,000	Cash	1,400
Rent expense	9,000	Insurance expense	1,000
Dividends	600	Notes payable	5,000
Service revenue	17,000	Common stock	10,000
Supplies	4,000	Blank	Blank

Prepare an a balance sheet.

Do It! 3a: Financial Statements (7 of 7)

Other Elements of an Annual Report

U.S. companies that are publicly traded must provide shareholders with an annual report.

The annual report always includes:

Financial statements.

Management discussion and analysis.

Notes to the financial statements.

Auditor's report.

Elements of an Annual Report (1 of 5)

Management Discussion and Analysis

Management discussion and analysis (M D & A) presents management’s view on the company’s ability to pay near-term obligations, its ability to fund operations and expansion, and its results of operations.

Management must highlight favorable or unfavorable trends and identify significant events and uncertainties that affect these three factors.

Elements of an Annual Report (2 of 5)

Management Discussion and Analysis

Elements of an Annual Report (3 of 5)

Notes to the Financial Statements

Clarify the financial statements.

Provide additional detail.

Notes are essential to understanding a company’s operating performance and financial position.

Elements of an Annual Report (4 of 5)

Auditor’s Report

Auditor’s opinion as to the fairness of the presentation of the financial position and results of operations and their conformance with generally accepted accounting principles.

Only certified public accountants (C P A) may perform audits.

Elements of an Annual Report (5 of 5)

Auditor’s Report

Do It! 3b: Components of Annual Report

State whether each of the following items is most closely associated with the management discussion and analysis (MD&A), the notes to the financial statements, or the auditor’s report.

Solution

Descriptions of significant accounting policies.

Notes.

Unqualified opinion.

Auditor’s report

Explanations of uncertainties and contingencies.

Notes

Description of ability to fund operations and expansion.

MD&A

Description of results of operations.

MD&A

Certified public accountant (CPA)

Auditor’s report

A Look at I F R S- L O-4: Describe the Impact of International Accounting Standards on U.S. Financial Reporting

Key Points

Similarities

The basic techniques for recording business transactions are the same for U.S. and international companies.

Both international and U.S. accounting standards emphasize transparency in financial reporting. Both sets of standards are primarily driven by meeting the needs of investors and creditors.

A Look at I F R S (1 of 9)

Key Points

Similarities

The three most common forms of business organizations, proprietorships, partnerships, and corporations, are also found in countries that use international accounting standards.

Differences

International standards are referred to as International Financial Reporting Standards (I F R S), developed by the International Accounting Standards Board. Accounting standards in the United States are referred to as generally accepted accounting principles (G A A P) and are developed by the Financial Accounting Standards Board.

A Look at I F R S (2 of 9)

Key Points

Differences

I F R S tends to be simpler in its accounting and disclosure requirements; some people say it is more “principles-based.” G A A P is more detailed; some people say it is more “rules-based.”

The internal control standards applicable to Sarbanes-Oxley (SOX) apply only to large public companies listed on U.S. exchanges. There is continuing debate as to whether non-U.S. companies should have to comply with this extra layer of regulation.

A Look at I F R S (3 of 9)

Looking to the Future

Both the I A S B and the F A S B are hard at work developing standards that will lead to the elimination of major differences in the way certain transactions are accounted for and reported.

A Look at I F R S (4 of 9)

I F R S Practice

Which of the following is not a reason why a single set of high-quality international accounting standards would be beneficial?

a. Mergers and acquisition activity.

b. Financial markets.

c. Multinational corporations.

d. G A A P is widely considered to be a superior reporting system.

A Look at I F R S (5 of 9)

I F R S Practice

Which of the following is not a reason why a single set of high-quality international accounting standards would be beneficial?

a. Mergers and acquisition activity.

b. Financial markets.

c. Multinational corporations.

d. G A A P is widely considered to be a superior reporting system.

A Look at I F R S (6 of 9)

I F R S Practice

The Sarbanes-Oxley Act determines:

a. international tax regulations.

b. internal control standards as enforced by the I A S B.

c. internal control standards of U.S. publicly traded companies.

d. U.S. tax regulations.

A Look at I F R S (7 of 9)

I F R S Practice

The Sarbanes-Oxley Act determines:

a. international tax regulations.

b. internal control standards as enforced by the I A S B.

c. internal control standards of U.S. publicly traded companies.

d. U.S. tax regulations.

A Look at I F R S (8 of 9)

I F R S Practice

I F R S is considered to be more:

a. principles-based and less rules-based than G A A P.

b. rules-based and less principles-based than G A A P.

c. detailed than G A A P.

d. None of the above.

A Look at I F R S (9 of 9)

I F R S Practice

I F R S is considered to be more:

a. principles-based and less rules-based than G A A P.

b. rules-based and less principles-based than G A A P.

c. detailed than G A A P.

d. None of the above.

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BUS 591 Week 1 Discussion 1&2

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