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Chapter 1

The document discusses the purpose and users of financial statements. It describes business organizations as proprietorships, partnerships, and corporations. It outlines the key business activities of financing, investing, and operating. The four main financial statements are the income statement, statement of changes in equity, statement of financial position, and statement of cash flows. The statements are interrelated and provide important information to both internal and external users of financial reports.

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71 views28 pages

Chapter 1

The document discusses the purpose and users of financial statements. It describes business organizations as proprietorships, partnerships, and corporations. It outlines the key business activities of financing, investing, and operating. The four main financial statements are the income statement, statement of changes in equity, statement of financial position, and statement of cash flows. The statements are interrelated and provide important information to both internal and external users of financial reports.

Uploaded by

soujanya
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Chapter 1

The Purpose and Use of Financial Statements


Users of Financial Statements
Accounting is the information system that identifies and records the economic events of an
organization, and then communicates them to a wide variety of interested users.

Internal External
 Finance  Investors
 Marketing  Creditors
 Human Resources
 Production
Business Organizations

 Proprietorships

 Partnerships

 Corporations
Proprietorships
Businesses owned owned by one person.

 Relatively easy to start up with relatively small personal


initial investment
 Owner takes on all the risk
 Business income is report on the proprietor’s personal
income tax return
 Examples: Hair salons or esthetic services, small-scale
farming operations, some retail stores
Partnerships

 Similar to proprietorships in the amount of initial investment & risk


 Shared between the partners
 Written partnership agreement
 Business income also report on the owner’s personal income tax returns
 Examples: Personal service businesesses such as lawyers or accounting
offices, bookkeeping or consulting services, physician practices, etc.
Corporations
Businesses organized as a separate legal entity.

 Owned by shareholders
 Indefinite life
 Owners are not responsible for corporate debts (limited
liability)
 Taxed as a corporation, not on individual tax returns
 Public corporations vs private corporations
Business Organizations (cont’d)

 Businessescan incorporate as the needs and


owners change

 Thiscourse will focus on accounting for


corporations
Business Activities

 Financing
 Borrowing, dividends

 Investing
 Building or equipment purchases

 Operating
 Cash inflows, outflows of operations
Financing Activities

 Equity financing inflows: issuing common shares


 Equity financing outflows: payment of dividends, repurchasing
shares

 Debt financing (lenders or creditors)


 Liabilities on the statement of financial position
Financing Activities (cont’d)

 Bank indebtedness

 Notes payable

 Long-term debt
 Mortgages, bonds, etc.
Investing Activities

 Purchase or sale of long-lived assets that the company needs in order to


operate
 An example is the purchase or sale of property, plant and equipment
(PPE)
 Intangible assets and goodwill are also long-lived assets
 Investing activities primarily take the form of the purchase of these
assets
 Purchase or sale of investments (shares or bonds other companies)
Operating Activities

 Inflows:Sales and other revenues, collection of


receivables

 Outflows: Regular operating expenses, payment of


payables, purchases of inventory and supplies
Operating Activities
Inflows

 Revenue/income: Increases in economic resources that result from


the sale of a product or service in the normal course of business.
 Other types of revenue include interest income or rental revenue

 Collection of amounts owed from customers (accounts receivable)


 Other types of receivables includes interest or rent receivable
Operating Activities
Outflows
 Expenses: Decreases in economic resources, normally the cost of assets
that are consumed or services that are used in the process of generating
revenues
 Examples: Purchases of supplies, operating & administrative expenses,
interest expense, income tax expense

 Inventory
 Cost of goods sold
 Depreciation and amortization
Operating Activities
Outflows (cont’d)

 Payables
Accounts payable
Other payables: interest payable, salaries,
payable, property tax payable, income tax
payable, etc.
Operating bottom line

Revenue
_ Expenses = Net income (loss)
GAAP
Broad policies, practices, rules, and procedures that have substantive
authoritative support and agreement about how to record and report
economic events.

 International Financial Reporting Standards (IFRS)


 Publicly traded companies must use

 Accounting Standards for Private Enterprises (ASPE)


 Private companies can use
Financial Statements

 Income statement
 Statement of changes in equity
 Statement of financial position
 Statement of cash flows

* Notes to financial statements


 Investors: Pattern of growth
in revenues predicts
Income Statement potential for higher return
on investment
Reports revenue and expenses,
showing how a companies  Lenders: Prediction of cash
operations performed during a availability to make loan
period of time. principal and interest
payments.
Statement of Changes in Equity
Shows the changes in each  Share capital: Additions and
component of shareholders’ deductions in shares value.
equity (e.g., common shares
and retained earnings), as well
 Retained earnings: Net income
as total equity, during a period (loss) less any dividends
of time. declared.
Statement of Financial Position
Presents a picture of what a company owns (its assets), what it owes
(its liabilities), and the resulting difference of these two (its
shareholders’ equity) at a specific point in time.

Assets = Liabilities + Shareholders’


Equity
Statement of Financial Position (cont’d)
 Analyze a company’s  Assess inventory or cash  Assessment of ratios
liquidity needs to support sales such as debt to equity
and short-term bills financing
Statement of Cash Flows
Shows where a company obtained cash during a period of time and how
that cash was used.
 Financing: Borrowing or
 Operating: Transactions  Investing: Purchase or
repaying debt, issuing or
that create revenues and sale of long-lived
repurchasing shares, issuing
expenses resources
dividends
Relationships between the statements

Income Statement of Statement of Statement of


Statement Changes in Equity Financial Position Cash Flows

Net profit or loss Common shares Cash balance


Retained earnings
Total shareholders’ equity
Summary

 Users of financial statements (internal, external)


 Forms of business organizations
 Business activities (financing, investing, operating)
 Operating bottom line
 GAAP (IFRS, ASPE)
 Financial statements
 How the financial statements are interrelated

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