Introduction to Financial Statements

Learning Objectives

• Introduction to Financial Statements
• Importance of Accounting
• Ethics and GAAP
• Accounting Equation

Introduction to Financial Statements

• Investors and creditors are interested in future cash flows.
• Creditors focus on the company's ability to meet payment obligations (e.g., interest).
• Investors are interested in the market value of their stock/shares and potential dividends.

Financial Statements

• A financial statement declares information about an enterprise in monetary terms (e.g., dollars).
• Accountants describe a company's financial activities which are believed to fairly represent the enterprise.

Three Primary Financial Statements

• Statement of Financial Position (Balance Sheet):
  • Shows the company's financial position at a specific date.
  • Represents a snapshot of the company's assets, liabilities, and equity.
• Income Statement:
  • Summarizes revenues and expenses over a specific period.
  • Shows the company's profitability during that period.
  • Revenues lead to positive cash inflows; expenses result in negative ones.
• Statement of Cash Flows:
  • Tracks the sources and uses of cash over a period.
  • Helps understand changes in cash balance over time.

A Starting Point: Statement of Financial Position (December 31, 2021)

• Data displayed: Assets, Liabilities, and Equity (owners' equity) for Vagabond Travel Agency
  • Assets: Cash ($22,500), Notes Receivable, Accounts Receivable, Supplies, Office Equipment, Building, Land
  • Liabilities: Notes Payable, Accounts Payable, Salaries Payable
  • Equity: Owner's Equity - Capital Stock, Retained earnings

Importance of Accounting

• Accounting is an information and measurement system.
• It identifies, records, and communicates business activities.
• Accounting identifies business transactions, records them, and communicates the results to make informed business decisions.

Users of Accounting Information

• External users:
  • Shareholders
  • Lenders
  • External auditors
  • Nonmanagerial employees
  • Regulators
• Internal users:
  • Purchasing managers
  • Human resource managers
  • Production managers
  • Research and development managers
  • Marketing managers

Opportunities in Accounting

• Financial Accounting: Preparation, Analysis, External Auditing, Regulatory Consulting, Planning, Criminal Investigation
• Managerial Accounting: General accounting, cost accounting, budgeting, internal auditing, consulting, controller, treasurer, strategy
• Taxation: Preparation, planning, regulatory consulting, investigations, enforcement
• Accounting-related: Lenders, Consultants, Analysts, Traders, FBI investigators, Market researchers, Systems designers, Merger services, Business valuation, Forensic accounting, Directors, Underwriters, Planners, Appraisers, Entrepreneurs, Litigation support

Artificial Intelligence and Data Analytics

• AI uses software for repetitive tasks like data entry.
• Data analytics analyzes data to find trends & meaningful relationships.
• Accountants are needed to help with AI system development.
• Data visualization displays data graphically for informed decisions.

Ethics - A Key Concept

• Accounting aims for useful, trustworthy information.
• Ethics in accounting are necessary for distinguishing good and bad behavior.
• A three step process for ethical decision making:
  1. Identify ethical concerns.
  2. Analyze options.
  3. Make an ethical decision.

Fraud Triangle

• Fraud involves factors like opportunity, pressure, and rationalization.
• Opportunity: Envisioning ways to commit fraud with little risk of getting caught.
• Pressure: Motivations like unpaid bills for committing fraud
• Rationalization: Failing to see the crime nature of fraud

Generally Accepted Accounting Principles (GAAP)

• GAAP governs financial accounting.
• GAAP wants information to be relevant and faithfully represent business results.
• Relevant information affects user decisions.
• Faithful representation accurately reflects business outcomes

Financial Accounting Standards Board (FASB)

• The FASB sets GAAP.
• The SEC oversees GAAP for companies selling stock to the public.

International Financial Reporting Standards (IFRS)

• IFRS issues by IASB are similar to GAAP, but sometimes different.
• Increasing demand for comparability of accounting reports in global economy.

Conceptual Framework

• Aims to provide useful information for investors, creditors, and other stakeholders.
• Qualitative characteristics: Information must be both relevant and faithfully represented
• Elements: Defines items in financial statements.
• Recognition and measurement criteria: Shows how items are recognized in statements and how to measure them.

Accounting Principles, Assumptions, and Constraints

• Principles (e.g., revenue recognition, expense recognition, cost principle, full disclosure): Detailed guidelines for financial statements.
• Assumptions (e.g., Going concern, Monetary Unit, Time Period, Business Entity): Basic concepts underlying accounting.
• Constraints (e.g., cost-benefit, materiality, conservatism): Conditions that limit the scope and detail of financial reporting.

Accounting Principles

• Measurement Principle (Cost Principle): Accounting info is based on actual cost.
• Revenue Recognition Principle: Recognize revenue when goods or services are offered and at an expected amount to be received.
• Expense Recognition Principle (Matching Principle): Records expenses incurred to generate revenue.
• Full Disclosure Principle: Reports all details that could affect users' decisions in the notes to financial statements.

Accounting Assumptions

• Going Concern Assumption: Presumes business will continue operating.
• Monetary Unit Assumption: Expresses transactions in monetary units.
• Time Period Assumption: Divides the business life into time periods (e.g., months, years).
• Business Entity Assumption: Accounts for business separately from its owners.

Proprietorship, Partnership, and Corporation

• Attributes of different business structures:
  • Number of owners
  • Business taxation
  • Owner liability
  • Legal entity.

Accounting Constraints

• Cost-benefit constraint: Discloses information when benefits exceed costs.
• Materiality constraint: Discloses information that influences decisions.

The Accounting Equation

• Assets = Liabilities + Equity
• Expanded Equation: Assets = Liabilities + Owner's Capital - Owner's Withdrawals + Revenues - Expenses

This quiz explores the fundamentals of financial statements, their importance in accounting, and the ethical standards that govern their preparation. It covers the key financial statements, including the balance sheet and income statement, and highlights the relevance of these documents for investors and creditors. Test your understanding of the accounting equation and GAAP.