chapter 1 Financial Statements

and Business Decisions

Financial Accounting
9e
 Exhibit 1.1
• The Accounting System and Decision Makers
Accounting System

Financial Accounting Reports Managerial Accounting Reports

Periodic financial statements Detailed plans and continuous
and related disclosures performance reports
provided to

External Decision Makers Internal Decision Makers

Evaluate the company Run the company

Creditors Investors Managers

Business Activities

Financing
Activities

Operating Investing
Activities Activities
The Four Basic Financial Statements

BALANCE SHEET – reports the amount of assets, liabilities, and

stockholders’ equity of an accounting entity at a point in time.

INCOME STATEMENT – reports the revenues less the expenses of the

accounting period.

STATEMENT OF STOCKHOLDERS’ EQUITY – reports the changes in each

of the company’s stockholders’ equity accounts, including the change
in the retained earnings balance caused by net income and dividends
during the reporting period.

STATEMENT OF CASH FLOWS – reports inflows and outflows of cash

during the accounting period in the categories of operating, investing,
and financing.

The notes are an integral part of these financial statements.

Balance Sheet

Assets Elements of the

Cash Balance Sheet
Short--Term Investments
Short
Accounts Receivable
Notes Receivable
Inventory (to be sold) Liabilities
Supplies Accounts Payable
Prepaid Expenses Accrued Expenses
Long--Term Investments
Long Notes Payable
Equipment Taxes Payable
Buildings Unearned Revenue
Land Bonds Payable
Intangibles

Stockholders’ Equity
Common Stock
Retained Earnings
 Exhibit 1.2
• Balance Sheet
EXPLANATION
LE-NATURE’S INC. Name of the entity
Balance Sheet Title of the statement
At December 31, 2012 Specific date of the statement
(in millions of dollars) Unit of measure

Assets: Resources controlled by the company

Cash $ 10.6 Amount of cash in the company’s bank accounts
Accounts receivable 6.6 Amounts owed by customers from prior sales
Inventories 51.2 Ingredients and beverages ready for sale
Property, plant, and equipment 459.0 Factories, production equipment, and land
Total assets $527.4 Total amount of company’s resources
Liabilities and stockholders’ equity: Sources of financing for company’s resources
Liabilities Financing supplied by creditors
Accounts payable $ 26.0 Amounts owed to suppliers for prior purchases
Notes payable to banks 381.7 Amounts owed to banks on written debt contracts
Total liabilities 407.7
Stockholders’ equity Financing provided by stockholders
Common stock 55.7 Amounts invested in the business by stockholders
Retained earnings 64.0 Past earnings not distributed to stockholders
Total stockholders’ equity 119.7
Total liabilities and stockholders’ equity $527.4 Total sources of financing for company’s resources

The notes are an integral part of these financial statements.

The Accounting Equation

A = L + SE Stockholders’
Assets Liabilities
Equity

Economic Sources of Financing for Resources

Resources Liabilities: From Creditors
Stockholders’ Equity: From Stockholders

The balance sheet reports a company's assets, liabilities, and

stockholders' equity at a specific point in time.
Income Statement

Elements of the
Income
Revenues Statement
Cash and promises received
from delivery of goods and
services.
Examples: Expenses
Resources used to earn
Sales Revenue
period’s revenues.
Fee Revenue
Interest Revenue Examples:
Rent Revenue
Cost of Goods Sold
Wages Expense
Rent Expense
Depreciation Expense
Insurance Expense
Repair Expense
Income Tax Expense
 Exhibit 1.3
• Income Statement
EXPLANATION
LE-NATURE’S INC. Name of the entity
Income Statement Title of the statement
For the Year Ended December 31, 2012 Accounting period
(in millions of dollars) Unit of measure

Revenues
Sales revenue $275.1 Cash and promises received from sale of beverages
Expenses
Cost of goods sold 140.8 Cost to produce beverages sold
Selling, general, and administrative Other operating expenses (utilities, delivery costs, etc.)
expenses
77.1 Cost of using borrowed funds
Interest expense 17.2
Income before income taxes 40.0 Income taxes on period’s income before income taxes
Income tax expense 17.1 Revenues earned minus expenses incurred
Net income $ 22.9

The notes are an integral part of these financial statements.

Statement of Stockholders’ Equity

Elements of the Statement of

Stockholders’ Equity

Common Stock Retained Earnings

Beginning Common Stock Beginning Retained Earnings

+Stock Issuance +Net Income
Ending Common Stock −Dividends
Ending Retained Earnings
 Exhibit 1.4
• Statement of Stockholders’ Equity
EXPLANATION
LE-NATURE’S INC. Name of the entity
Statement of Stockholders’ Equity Title of the statement
For the Year Ended December 31, 2012 Accounting period
(in millions of dollars) Unit of measure

Common Retained
Stock Earnings
Balance December 31, 2011 $55.7 $43.1 Last period’s ending balances
Net income for 2012 22.9 Net income reported on the income statement
Dividends for 2012 (2.0) Dividends declared during the period
Balance December 31, 2012 $55.7 $64.0 Ending balances on the balance sheet

The notes are an integral part of these financial statements.

Statement of Cash Flows

Elements of the Statement of Cash Flows

Cash Flows from Operating Activities

Cash Flows from Investing Activities
Cash Flows from Financing Activities

Note that each of the three cash flow

/ sources can be positive (net cash
inflow) or negative (net cash outflow)
 Exhibit 1.5
• Statement of Cash Flows
EXPLANATION
LE-NATURE’S INC. Name of the entity
Statement of Cash Flows (Summary) Title of the statement
For the Year Ended December 31, 2012 Accounting period
(in millions of dollars) Unit of measure

Cash flows from operating activities $ 87.5 Cash flows directly related to earning income
Cash flows from investing activities (125.5) Cash flows from purchase/sale of plant, equipment, & investments
Cash flows from financing activities 47.0 Cash flows from investors and creditors
Net increase (decrease) in cash 9.0 Change in cash during the period
Cash balance December 31, 2011 1.6 Last period’s cash on the balance sheet
Cash balance December 31, 2012 $ 10.6 Ending cash on the balance sheet

The notes are an integral part of these financial statements.

 Exhibit 1.6
• Relationships Among Le-Nature’s Statements

Statement of Stockholders’ Equity

Income Statement Common Retained
Revenues $ 275.1 Stock Earnings
− Expenses 252.2 1 Beginning $55.7 $43.1
Net Income $ 22.9 + Net Income 22.9
− Dividends (2.0)
Ending $55.7 $64.0

Statement of Cash Flows

+/− Cash Flows from Operating
Activities $ 87.5 Balance Sheet
Cash $ 10.6 2
+/− Cash Flows from Investing
Other Assets 516.8
Activities (125.5) 3 Total Assets $527.4
+/− Cash Flows from Financing
Activities 47.0 Liabilities $407.7
Change in Cash 9.0 Common Stock 55.7
+ Cash at Beginning of Period 1.6 Retained Earnings 64.0
Cash at End of Period $ 10.6 Total Liabilities &
Stockholders’ Equity $527.4
Notes

Did you notice a sentence at the bottom of each financial statement?

All financial statements should be accompanied by notes that provide

the reader with supplemental information to help the reader better
understand the financial statements.
 Exhibit 1.7
• Summary of the Four Basic Financial
Statements
Financial Statement Purpose Structure Examples of Content
Balance Sheet Reports the financial position
(Statement of (economic resources and
Financial Position) sources of financing) of an
accounting entity at a point
in time.
Income Statement Reports the accountant’s
(Statement of Income, primary measure of
Statement of Earnings, economic performance
Statement of Operations) during the accounting period.
Statement of Reports changes in the
Stockholders’ Equity company’s common stock
and retained earnings during
the accounting period.
Statement of Cash Flows Reports inflows (receipts)
(Cash Flow Statement) and outflows (payments) of
cash during the accounting
period in the categories of
operating, investing, and
financing.
Cash, accounts receivable,
plant and equipment, long-
term debt, common stock
Sales revenue, cost of goods
sold, selling expense, interest
expense
Beginning and ending
stockholders’ equity
balances, stock issuances,
net income, dividends
Cash collected from
customers, cash paid to
suppliers, cash paid to
purchase equipment, cash
borrowed from banks
Rules that Determine Content of Financial Statements

Generally
Accepted
Accounting
Principles
(GAAP)
History of Financial Reporting

• Our accounting system has a long and distinguished history. Luca

Pacioli, an Italian monk and mathematician, published the first
elements of double-entry bookkeeping in 1494.

• Prior to 1933, the management teams of most companies were

largely free to choose their own financial reporting practices.
Generally Accepted Accounting Principles

The Securities and Exchange Commission (SEC)

has been given broad powers to determine
measurement rules for financial statements.

The SEC has worked closely with the accounting profession

to work out the detailed rules that have become known as GAAP.

Currently, the Financial Accounting Standards Board (FASB) is

recognized as the body to formulate GAAP.
Generally Accepted Accounting Principles

Companies incur the cost of preparing the financial statements and

bear the following economic consequences of their publication:

 Effects on the selling price of stock

 Effects on the amount of bonuses received by managers
and other employees
 Loss of competitive information to other companies
International Perspective

Since 2002, there has been substantial movement toward the

adoption of International Financial Reporting Standards (IFRS).

Examples of jurisdictions requiring the use of IFRS:

• European Union • Israel and Turkey

• Australia and New Zealand • Brazil and Chile
• Hong Kong, India, Malaysia, and South • Canada and Mexico
Korea
Ethical Conduct

Three-Step Process for Making Ethical Decisions

1. Identify the benefits of a decision (often to the manager or

employee involved) and who will be harmed (other employees,
owners, creditors, the environment).

2. Identify alternative courses of action.

3. Choose the one you would like your family and friends to see
reported on your local news.
Consequences of Unethical Behavior

What if the
After it was determined that the financial
numbers are
statements for Le-Nature’s Inc. were misleading,
wrong?
the consequences for the defendants were severe.
Responsibility and the Need for Controls

To ensure the accuracy of a company’s financial information,

management:
 Maintains a system of controls.
 Hires external independent auditors.
 Forms a committee of the board of directors to review these
other two safeguards.
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

Advantages of a Corporation:
Limited liability
Continuity of life
Ease of transfer of ownership
Opportunity to raise large amounts of money
Disadvantage of a Corporation:
Double taxation