Introduction to Financial Accounting Chapter 1

Course Information

• Course title: Introduction to Financial Accounting
• Course code: ACCT1101
• Week 1: Financial Statements and Business Decisions (Chapter 1)
• Date: August 18, 2024

Table of Contents

• Course Outline
• Understanding the Business
• Four Basic Financial Statements
• Responsibilities for Accounting
• Wrapping up

Course Assessment

• Lecture participation (5%) - Lecture is not recorded
• Tutorial participation (5%) - 15-minute grace period and option to skip one
• Assignments (5%) - Handwritten and submitted as a single PDF
• Mid-term test (25%) - Closed-book; Chapters 1-4 & 6
• Group project (10%) - 5-6 members; form group by October 4; Due December 4
• Final exam (50%) - Closed-book; Chapters 7-9, 11-12
• Late submission is not allowed
• Double hurdle requirement

Textbook

• Financial Accounting 11th Edition by Robert Libby, Patricia Libby, and Frank Hodge

Understanding the Business

• Focus company: Le-Nature's Inc., manufactures beverages like bottled water.

Types of Business Entities

• Sole Proprietorship: unincorporated business owned by one individual
• Partnership: unincorporated business owned by two or more individuals
• Corporation: business incorporated under state laws; ownership represented by shares of stock, operates independently from owners

Advantages of Corporations

• Stockholders have limited liability
• Continuity of life
• Ease in transferring ownership (stock)
• Opportunity to raise large sums of money by selling stock to many people

Disadvantages of Corporations

• Subject to double taxation (income taxed when earned and again when distributed as dividends)

Le-Nature's Business Activities

• Financing Activities: Raising funds from stockholders (e.g., private equity, retail investors) and creditors (e.g., banks, bondholders)
• Investing Activities: Purchasing plant, property, and equipment for production
• Operating Activities: Day-to-day processes such as buying raw materials, manufacturing products, delivering to customers, collecting payments, and paying suppliers

Source of Financial Resources

• Stockholders and creditors use financial statements to evaluate future performance
• Stockholders: own portion of the company's equity; earn dividends; expect higher stock prices
• Creditors: lend money to the company; earn interest; receive principal

The Accounting System and Decision Makers

• Accounting tracks economic activities and facilitates decision-making.
• External decision-makers (focus of this subject): stockholders and creditors evaluate companies based on financial statements and disclosures.
• Internal decision-makers (focus of another course): company managers use information to manage operating, investing, and financing activities.

Four Basic Financial Statements: Overview

• Balance Sheet: reports the company's economic resources and the source of financing
• Income Statement: reports the ability to sell goods, and associated costs
• Statement of Stockholders' Equity: reports changes in stockholders' equity
• Statement of Cash Flows: reports inflows and outflows of cash
• Notes: integral part of financial statements

Financial Statement Time Period

• Financial statements can be prepared at various points, like end of year, quarter, or month.
• An accounting period is the time frame covered by financial statements.

Balance Sheet

• A snapshot of a company's financial position at a specific point in time (end of the accounting period)
• Assets: Economic resources owned by the company
• Liabilities and Equity: Sources of financing for the assets

Basic Accounting Equation

• Assets = Liabilities + Stockholders' Equity
• Reflects the company's financial position, showing what it owns and how it's financed

Interpreting the Balance Sheet

• Creditors and shareholders analyze assets to determine operational capability; assets can be sold for cash in case of closure.
• Concern over sufficient cash to pay off liabilities (debts).
• Stockholders' equity provides a cushion for creditors in the event of liquidation.

Income Statement

• Measures a business's performance during a specific accounting period.
• Revenues: cash and promises received from selling goods/services.
• Expenses: resources used to generate revenues.

Income Statement Equation

• Revenues - Expenses = Net Income
• If expenses exceed revenues, a net loss is reported.

Interpreting the Income Statement

• Investors and creditors monitor net income to evaluate the company's ability to sell goods/services at profitable prices.
• Investors buy stock when they believe future earnings will lead to dividends/increased stock value, and lenders use future earnings to assess loan repayment ability.

Statement of Stockholders' Equity

• Reports changes in stockholders' equity accounts during the accounting period.
• Common Stock: Amounts invested in the business by stockholders
• Retained Earnings: Past earnings not distributed to stockholders, retained by the company

Statement of Cash Flows

• Reports the inflows and outflows of cash during an accounting period
• Cash Flows from Operating Activities: Cash collected from customers and paid to suppliers/employees
• Cash Flows from Investing Activities: Cash from acquiring or selling assets
• Cash Flows from Financing Activities: Money received or disbursed to investors and creditors

The Cash Flows Equation

• Cash flows from Operating Activities +/- Cash flows from Investing Activities +/-Cash flows from Financing Activities = Change in Cash + Beginning Cash Balance = Ending Cash Balance

Interpreting the Statement of Cash Flows

• The Operating Activities section highlights the company's cash-generating ability to meet current needs
• Analyzing cash flow helps assess debt repayment capacity, expansion opportunities, and dividend distribution.

Relationship Among Le-Nature's Statements

• Shows the connections between income statement, statement of shareholders’ equity, and balance sheet; “Ending Cash Balance” in the statement of cash flows is equal to “Cash” in the balance sheet.

Financial Statement Formats

• Monetary unit ($) is shown beside the first dollar amount in a group of items.
• Assets are listed based on ease of conversion into cash.
• Liabilities are listed based on maturity date.
• Items in a group have an underline.

Notes (or Footnotes)

• Notes provide supplemental information to enhance the understanding of financial statements.

Generally Accepted Accounting Principles (GAAP)

• Rules that specify the content and measurement rules of financial statements.
• Decision-makers need to know the conveyed information, and verified numbers of the statements.

Standard Setters

• International Financial Reporting Standards (IFRS) are issued by the International Accounting Standards Board (IASB)
• 144 jurisdictions use IFRS
• European Union, Australia, New Zealand, Hong Kong, Malaysia, Republic of Korea, Canada, and Mexico use IFRS
• Public companies in the USA follow US GAAP.
• Foreign companies whose stock is traded in the US may use IFRS.

Conceptual Framework

• Provides the principles and concepts for creating high-quality IFRS standards.

Objective of Financial Reporting

• To provide financial information useful to decision-makers (investors, creditors, etc.) about the reporting entity.

Qualitative Characteristics of Useful Financial Information

• Fundamental characteristics: relevance, materiality, faithful representation
• Enhancing characteristics: comparability, verifiability, timeliness, understandability

Why Accounting Standards are Important

• Companies incur costs for preparing statements and are impacted financially by the contents
• Changes to accounting standards necessitate extensive debates, and involve political maneuvering to achieve compromises.

Ensuring the Accuracy of Financial Statements

• Le-Nature's financial statements depicted impressive growth, prompting borrowed funds.
• Court records reveal that the company's reported numbers were significantly inaccurate, due to fraud by the CEO and others.

Consequences of Unethical Behavior

• The fraud case highlighted the severity of financial misrepresentation..
• The CEO received a lengthy prison sentence, auditors compensated creditors, and a lending institution paid damages.

Responsibility and the Need for Controls

• To build trust, companies must maintain strong internal controls, hire independent auditors, and have oversight committees to maintain accuracy.

What is Accounting?

• Accounting is more than just numerical rules, encompassing concepts, and human judgment.

Explore the foundational concepts of financial statements and their role in business decision-making in this introductory quiz. This quiz covers Chapter 1 from the course 'Introduction to Financial Accounting,' providing insights into the four basic financial statements and accountabilities within a business context.