Accounting – Chapter 1 – Financial Statements and Business Decisions
Ownermanager – when the founder also functions as the manager of the business
Investors – individuals who buy small percentages of large corporations; make their purchases
hoping to gain in two ways:
1. Dividends – Receive a portion of what the company earns in the form of cash payments
2. Hope to eventually sell their share for more than they paid for it
When money is exchanged with lenders and owners it is called financing activities.
When a company buys or sells property it is called investing activities.
The Accounting System
Developing accounting information for internal decision makers is called managerial or
management accounting (detailed plans and continuous performance reports.)
Developing accounting information for external decision makers is called financial accounting
(periodic financial statements and related disclosures.)
Accounting: A system that collects and processes (analyzes, measures and records) financial
information about an organization and reports that information to decision makers.
The 4 Basic Financial Statements – Overview
The four basic financial statements include:
1. Statement of financial position
2. Statement of comprehensive income
3. Statement of changes in equity
4. Statement of cash flows
The Statement of Financial Position
Statement of financial position (balance sheet): reports the financial position (amount of
assets, liabilities and shareholders’ equity) of an accounting entity at a particular point in time.
Structure: the heading of the statement of financial position identifies four significant items 1. Name of the entity – the organization (company,) not the owner
2. Title of the statement – statement of financial position (balance sheet)
3. Specific date of the statement – At month, day, year
4. Unit of measure – (in millions of i.e. Swiss francs)
Assets = Liabilities +
Shareholders’ Economic Sources of financing for the economic resources
resources Liabilities: from creditors
Shareholders’ Equity: from shareholders
The basic accounting equation shows what we mean by a company’s financial position: the
economic resources that the company owns and the sources of financing for those resources.
The statement of financial position is like a snapshot clearly sating the entity’s financial position
at a specific point in time.
Trade receivables – when a company sells its products on credit and receives promises to pay,
which are collected in cash later.
Trade payables – when a company purchases goods and services from suppliers on credit,
without a formal written contract (or note)
Shortterm borrowings – amounts borrowed from banks and other creditors, to be repaid in the
Income taxes payable – represent an amount due to the government’s tax authorities as a result
of the company’s profitable operations.
Accrued liabilities – amounts owed to suppliers of various types of services, such as rent and
Longterm borrowings – result from cash borrowings based on formal written debt contracts
with lending institutions such as banks.
Provisions – estimated amounts payable in the future, but the exact amount and timing of the
payment depends on actual future events.
Shareholders’ equity – indicates the amount of financing provided by owners of shares in the
business as well as earnings over time. Shareholders’ equity arises from 3 sources:
1. Share capital – the investment of cash and other assets in the business by the owners in
exchange for shares
2. Retained earnings – the amount of earnings reinvested in the business (and thus not
distributed to shareholders in the form of dividends)
3. Other components – essentially reflect the changes in the values of assets and liabilities
A note on format: Assets can be listed in order of most liquid to least or vice versa.
Liabilities can be listed in increasing or decreasing order of maturity.
Most financial statements include the monetary unit sign (i.e. $) beside the first amount in a
group of items. It is common to place a single underline below the last item in a group before a
total or subtotal and a double underline below group totals.
The Statement of Comprehensive Income
Statement of comprehensive income: reports the change in shareholders’ equity, during a
period, from business activities, excluding exchanges with shareholders.
It includes all changes in equity during a period except those resulting from investments by
owners and distributions to owners.
It has two parts. The first part reports the accountant’s primary measure of a company’s
performance: revenues generated less expenses incurred during the account period. This is
The second part reports other comprehensive income, which comprises income and expense
items that are not recognized in the income statement in accordance with International Financial
Companies can present all items of income and expenses either in one statement of
comprehensive income or in two related statements 0 an income statement reporting the revenues
and expenses that have already affected profit, and a statement of comprehensive income
reporting income and expense items that will affect profit in the future.
Income statement – reports the revenues less the expenses of the accounting period.
It reports information for a specified period of time.
IS equation is Revenues – Expenses = Profit
Revenues are normally reported on the income statement when the goods or services are sold to
customers whether or not they have been paid for.
Cost of sales – cost of goods sold, what it cost to produce the items sold.
Distribution expenses – variety of expenses such as the salaries of sales staff and expenses
related to the distribution of products.
Marketing and administrative expenses – include items such as the salaries of marketing and
management personnel, promotion of company’s products through print and electronic media,
rental of office space, insurance, utilities, etc.
For account purposed, the expense reported in one accounting period may actually be paid for in
cash in another accounting period. Nevertheless, the company recognizes all expenses (cash and
credit) incurred during a specific accounting period regardless of the timing of the cash payment.
If a company owes money to sales people for commission in December 2009 but does not pay
until January 2010, the sales commission would be recognized as expenses for the accounting
period ending on December 21, 2009 because that is when the salespeople earned the
Profit normally does not equal the net cash generated by operations. The Statement of Changes in Equity
The statement of changes in equity – reports all changes to shareholders’ equity during the
It covers a specific period of time.
Retained earnings – reflect the profits that have been earned since the creation of the company
but not distributed yet to shareholders as dividends.
Profit earned during the year increases the balance of retained earnings. The declaration of
dividends to the shareholders decreases retained earnings.
The retained earnings equation that describes these relationships is:
Beginning retained earnings + Profit – Dividends = Ending retained earnings
The Statement of Cash Flows
Statement of cash flows – reports cash inflows (receipts) and outflows (payments) that are
related to operating, investing and financing activities during the accounting period.
Cash inflows and outflows are divided into three primary categories:
1. Cash flows from operating
2. Cash flows from investing
3. Cash flows from financing
It covers a specified period of time.
Revenues do not always equal cash collected from customers because some sales may be on
credit. Also, expenses reported on the IS may not be equal to cash paid out during the period
because expenses may be incurred in one period and paid for in another.
As a result, profit does not usually equal the amount of cash recei