Chapter 1 Overview of Corporate

Financial Reporting
A Importance of Accounting
B Financial Statements
 Four Basic Financial Statements
 Relationships Among the Statements
C Accounting Equation
 Assets, Liabilities, and Equity
D Generally Accepted Accounting Principles
E Ethics—A Key Concept

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 A. Importance of Accounting
is a
Accounting Identifies
system that

Records

information
Relevant Communicates
that is

Reliable
to help users make
Comparable and better decisions.
Consistent
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 Accounting as the “language of business”
 It is a necessary feature in all organizations
to communicate data to help people make
better decisions!
 Accounting information system serves many
kinds of users

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 Users of Accounting Information

External Users Internal Users

•Lenders •Consumer Groups •Managers •Sales Staff

•Shareholders •External Auditors •Officers/Directors •Budget Officers
•Governments •Customers •Internal Auditors •Controllers

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 Users of Accounting Information

External Users Internal Users

Financial accounting provides Managerial accounting provides

external users with financial information needs for internal
statements. decision makers.

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 B. Basic Financial Statements
1. BALANCE SHEET
2. INCOME STATEMENT
3. STATEMENT OF RETAINED EARNINGS
(Statement of Shareholders’ Equity)
4. STATEMENT OF CASH FLOWS

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 Balance Sheet
MAXIDRIVE CORP.
Balance Sheet
At December 31, 2009
(in thousands of dollars)
2009
ASSETS
Cash $ 4,895
Accounts receivable 5,714
Inventories 8,517
Plant and equipment 7,154
Land 981
Total assets $ 27,261
LIABILITIES
Accounts payable $ 7,156
Notes payable 9,000
Total liabilities 16,156
STOCKHOLDERS' EQUITY
Contributed capital 2,000
Retained earnings 9,105
Total stockholders' equity 11,105
Total liabilities and stockholders' equity $ 27,261

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 Income Statement
MAXIDRIVE CORP.
Income Statement
For the Year Ended December 31, 2009
(in thousands of dollars)
Revenues
Sales revenue $ 37,436
Total revenues 37,436
Expenses
Cost of goods sold expense 26,980
Selling, general, and administrative expense 5,606
Interest expense 450
Total expenses 33,036
Operating income 4,400
Income tax expense 1,100
Net income $ 3,300

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 Statement of Retained Earnings
MAXIDRIVE CORP.
Statement of Retained Earnings
For the Year Ended December 31, 2009
(in thousands of dollars)
Retained earnings, January 1, 2009 $6,805 
Net income for 2009 3,300 
Dividends for 2009 (1,000)

Retained earnings, December 31, 2009 $9,105 

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 Statement of Cash Flows
MAXIDRIVE CORP.
Statement of Cash Flows
For the Year Ended December 31, 2009
(in thousands of dollars)
Operating activities
Cash collected from customers $ 33,563
Cash paid to suppliers and employees (30,854)
Cash paid for interest (450)
Cash paid for taxes (1,190)
Net cash flow from operating activities 1,069
Investing Activities
Cash used to purchase equipment (1,625)
Net cash flow from investing activities (1,625)
Financing Activities
Cash received from bank loan 1,400
Cash dividends paid (1,000)
Net cash provided by financing activities 400
Net increase in cash (156)
Cash at beginning of month 5,051
Cash at end of month $ 4,895

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 Relationships Among the Statements
1. Net income from the income statement results in
an increase in ending retained earnings on the
statement of retained earnings.

Income Statement
Revenues  $ 15,500  Statement of Retained Earnings
Expenses (8,500) Beginning retained earnings $ 59,000 
Net income $   7,000  Net income  7,000 
Dividends (2,500)
Ending retained earnings $ 63,500 

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 Relationships Among the Statements
2. Ending retained earnings from the statement of
retained earnings is one of the two components of
stockholders’ equity on the balance sheet.
Statement of Retained Earnings Balance Sheet
Beginning retained earnings $ 59,000  Cash $   14,000 
Net income  7,000  Other assets 171,500 
Dividends (2,500) Total assets $ 185,500 
Ending retained earnings $ 63,500  Liabilities $   42,000 
Stockholders' Equity
Common stock 80,000 
Retained earnings 63,500 
Total liabilities and equity $ 185,500 

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 Relationships Among the Statements
3. The change in cash on the statement of cash flows
is added to the beginning-of-year balance in cash
to arrive at end-of-year cash on the balance sheet.
Statement of Cash Flows Balance Sheet
Cash flows from operating activities $ 21,000  Cash $   14,000 
Cash flows from investing activities (16,000) Other assets 171,500 
Cash flows from financing activities 3,500  Total assets $ 185,500 
Increase in cash $   8,500  Liabilities $   42,000 
Beginning cash balance 5,500  Stockholders' Equity
Ending cash balance $ 14,000  Common stock 80,000 
Retained earnings 63,500 
Total liabilities and equity $ 185,500 

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 C. Accounting Equation

Assets = Liabilities + Equity

Liabilities
Assets & Equity

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 Accounting Equation
 Assets (LHS) are economic resources.
 An asset has the ability or potential to provide future benefits
(cash flow) to a firm
 Liabilities (RHS) are creditor’s claims on the assets of
a firm.
 Creditors has provided funds to the firm
 The firm must pay a specified amount on a specified date
 Creditor’s claim has higher priority
 Equity (RHS) is the owner’s claim on the assets of a
firm.
 After all creditor claims are satisfied, the owners, or
stockholders, have a claim on those assets.
 Note: shareholder’s equity, stockholder’s equity and owner’s
equity are used interchangeably

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 Accounting Equation
 Forms of funds = Sources of funds
 A firm acquires assets by funds. Liabilities and
equity are the sources of funds to acquire those
assets.
 Basis for understanding the double-entry system
of accounting
 If a business has assets of $500,000 and
liabilities of $200,000; then its equity has to be
$300,000

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 Assets
Cash
Accounts Notes
Receivable Receivable
Resources
owned or
Prepaid controlled
Expenses by a Land
company

Store Buildings
Supplies
Equipment

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 Asset Accounts
 Accounts Receivable – held by a seller and refer to
promises of payment from customers to sellers

 Notes Receivable – a written promise of another

entity to pay a definite sum of money on a specified
future date to the holder of the note

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 Asset Accounts
 Prepaid Accounts (prepaid expenses) – assets that
represent prepayments of future expenses (not current
expense).

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 Asset Accounts
 Supplies – assets until they are used  costs are
reported as expenses when they are used up
 Office Supplies – stationery, paper

 Store Supplies – packaging materials, paper bags

 Equipment – when equipment is used and worn

down, its cost is gradually reported as an expense
(depreciation)
 Buildings – costs of stores, offices, warehouses, etc,
which are depreciated.
 Land – cost of land owned by a business

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 Liabilities
Accounts Notes
Payable Payable

Creditors’
claims on
assets
Taxes Wages
Payable Payable

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 Liability Accounts
 Accounts Payable -- oral or implied promises to
pay later, arises from purchases of merchandise
(or purchase of supplies, equipments, and
services)
 Note Payable -- a formal promise, usually
denoted by the signing of a promissory note, to
pay a future amount

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 Liability Accounts
 Unearned Revenue – represents advance payment a
firm received before delivering products and services.
 Liability will be settled in the future when a company
delivers its products or services

 Accrued Liabilities – amounts owed that are not yet

paid

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 Equity

Equity

Contributed Retained
CAPITAL Earnings

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 Equity Accounts
 Contributed Capital (Owner Capital) – cash (and
sometimes other assets) invested by shareholders (or
an owner) in a company
 Retained Earnings – the cumulative earnings of a
company that are not distributed to the owners and are
re-invested in the business. In a given period,
earnings consists of:
 Revenues: gross increase in equity from a

company’s earnings activities.

 Expenses: the cost of assets or services used to

earn revenue. Expenses decrease owner’s equity.

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 D. Generally Accepted Accounting Principles
Financial accounting practice is governed by
concepts and rules known as generally accepted
accounting principles (GAAP).

Relevant Affects the decision of

Information its users.

Reliable Information Is trusted by

users.

Comparable and Is helpful in contrasting

consistent organizations over time.
Information

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 Setting Accounting Principles

Financial Accounting Standards

Board is the private group that sets
both broad and specific principles.

The Securities and Exchange Commission is the

government group that establishes reporting
requirements for companies that issue stock to
the public.

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 International Perspective
International Financial Reporting Standards

Since 2002, there has been substantial movement toward the

adoption of International Financial Reporting Standards (IFRS)
issued by the International Accounting Standards Board (IASB).
Examples of jurisdictions requiring the use of IFRS either currently or
by 2012 include:
• European Union
• Australia and New Zealand
• Hong Kong, India, Malaysia, and South Korea
• Israel and Turkey
• Brazil and Chile
• Canada and Mexico
In the United States, the Securities and Exchange Commission now
allows foreign companies whose stock is traded in the U.S. to use IFRS
and is considering requiring the use of IFRS for U.S. domestic
companies by 2014.
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 E. Ethics—A Key Concept

Ethics
Beliefs that
distinguish Accepted
right from standards of
wrong good and bad
behavior

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 Ethics - A Key Concept

 Identify ethical  Analyze Make ethical

concerns options decision

Use personal Consider all good Choose best

ethics to and bad option after
recognize ethical consequences. weighing all
concern. consequences.

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 Supplement A: Types of Business
Entities
Sole Proprietorship: owned by a single individual.
Partnership: owned by two or more individuals.
Corporation: ownership represented by shares of stock.

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