Chapter 1 - The financial Statements
financial statements - business documents that companies use to report the results of their activities to various user groups. Like
managers, investors, creditors and regulatory agencies. The information from the financial statements are then used to make economic
decisions. Financial statements report the results of the business cycle
an accountant: prepares financial statements for the organization that employs you, audits financial statements as a public accountant,
and analyzes financial statements (as a financial analyst)
as a manager: have to certify the accuracy of financial statements, using financial statements to determine whether or not to acquire
shares of stock in a company, using the information from the financial system to make decisions.
Investors use accounting information to make economic decisions as to whether they should buyor sell shares. Creditors need
accounting information to make the economic decision as to whether or not to grant credit to or make a loan.
Accounting is the language of a business. It is an information system that measures business activities, processes data into reports,
and communicates results to decision makers. Accounting produces the financial statements. Financial statements measure
performance and tell us where a business stands in financial terms. Bookkeeping is amechanical part of accounting.
Who uses accounting information?
• investors and creditors: like shareholders and bankers are the primary users of accounting information since they provide
money to finance. The investor wants to be able to assess whether the company has been profitable in the past and thus is
likely to earn future profits so that the share price will increase and the company will be able to pay dividends. The banker
wants to determine whether the company will be able to pay the interest on the loan and will be able to repay the loan when it
• gov't and regulatory agencies: a provincial agency requires public companies to report to the investing public and publish
• taxing authorities: taxes are based on accounting data. They use the accounting information to determine if companies are
paying the correct amount of taxes.
• individuals: people need to make budgets for the monthly income and expenditures of their businesses.
• not for profit: for charities and all, accounting data is the basis for reporting the organization's stewardship of funds received.
Two kinds of accounting:
• financial accounting: provides information for devision makers outside of the organization, such as investors, creditors, gov't
agencies and the public.
• management accounting: generates inside information for the managers of the organization. Like budgeting, forecasts, and
projections that are used in making strategic decisions of the organization. internal information must be accurate and relevant
for the decision needs of managers.
Proprietorship Partnership Corporation
Owners One owner Two or more Shareholders (many owners)
Life of entity Owner's choice or death Same Indefinite
Personal liability for business Personally liable For a general partner yes, not Shareholders aren't liable
debts for a limited
Accounting status Entity separate from owner Same Same
FOR THE GRAPH...IF YOU WANT MORE EXPLANATION, FIND ON PAGE 5 AND 6
The accounting equation: ASSETS = LIABILITIES + OWNER'S EQUITY • Assets: economic resources of a business that are expected to produce a benefit in the future. LIKE cash, accounts
receivables, inventories and property, plant and equipment. Claims on assets come from two sources.
• Liabilities: these are debts payable to outsiders called creditors (those who has loaned money to you). Creditors have a claim -
a legal right - to a part of your assets to repay a debt.
o some ASSETS are cash and cash equivalents. Accounts receivables represents amounts due from customers who
have purchased from you. Inventory includes raw materials that go into finished products. PPE, are long-lived assets
that company uses to do business - manufacturing equipment, buildings, computers. Land, buildings and equipment
are also called tangible capital assets, fixed assets, or plant assets.
o for liabilities is accounts payable (ANYTHING PAYABLE)
• Owner's Equity: (also called net assets or shareholder's equity for a corporation or capital) represents the "insider claims" of a
business. Equity means ownership, so shareholders' equity is the owners' interest in the assets of a corporation.
o owner's equity is divided into two subparts: contributed capital, retained earnings. Because of this, the equation can
be written as ASSETS = LIABILITIES + CONTRIBUTED CAPITAL + RETAINED EARNINGS.
o Contributed capital is the amount the shareholders have invested in the corporation. The basic component of
contributed capital is common shares, which the corporation issues to shareholders as evidence of ownership.
o Retained earnings are the amount earned by income-producing activities and kept for use in the business.
o There are three types of transactions that affect retained earnings:
revenues: generated from sales of products
expenses: are decreases in retained earnings that result from operations. It is the cost of doing business
and are the opposite of revenues. Expenses include office supplies, salaries, and utility payments. It also
includes the depreciation of PPE like computers and buildings.
dividends: decreases retained earnings, because they're distributions to shareholders of assets (usually
cash) generated by net income. Dividends are not expenses. They never affect net income. Instead of being
subtracted from revenues to compute net income, dividends are recorded as direct reductions of retained
o When revenues exceed expenses the result is a net income/net earnings/ net profit. When expenses exceed
revenues, there is a net loss.
o BTW: the owner's equity of proprietorships and partnerships are different from corporations. Proprietorships and
partnerships don't identify contributed capital and retained earnings separately. Instead they use a single heading -
• TO CALCULATE FOR RETAINED EARNINGS ON PAGE 10: Beginning balance of retained earnings + net income -
The financial Statements
How information is reported on financial statements
Question Financial statement Answer
1. How well did the company perform Income statement (also called the REVENUES - EXPENSES = net
during the year? statement of operations) income/loss
2. Why did the company's retained Statement of retained earnings BEGININNING RETAINED EARNINGS
earnings change during the year? +NET INCOME ( - net loss) - DIVIDENDS.
3. What is the company's financial positioBalance sheet (also called the statement oA = L+OE at the end of the year? financial position)
4. How much cash did the company Statement of cash flows OPERATING CASH FLOWS +/- investing
generate and spend during the year? cash flows +/- financing cash flows =
increase/decrease in cash.
The order of the flow from one financial statement to another: ORDER IS IMPORTANT OTAY.
INCOME STATEMENT (statement of operations or statement of earnings) STATEMENT OF RETAINED EARNINGS
STATEMENT OF FINANCIAL POSITION (balance sheet) STATEMENT OF CASH FLOWS.
The income statement measures operating performance: PAGE 11
• Reports the company's revenues, expenses, and net income/loss of a period.
• Most year ends are on Oct 31st. Companies usually adopt an accounting year that ends on the low point of their operations.
• NET INCOME = TOTAL REVENUES/GAINS - TOTAL EXPENSES/LOSSES
• **the word net means the result after a subtraction. NET INCOME IS SUPER DUPER IMPORTANT IN FINANCIAL
• REVENUE: some companies don't use the term revenue. For example, net sales revenue is often abbreviated as net sales.
Net sales means sales revenue after subtracting all the goods customers have returned to the company.
• EXPENSES: Cost of sales (also called cost of goods sold) represents the cost of expenses