Introducing Financial Statements PDF

Introducing Financial Statements Chapter 1 Presented By: Dr Ruqia Shaikh Copyright ©2021 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of...

Introducing Financial Statements Chapter 1 Presented By: Dr Ruqia Shaikh Copyright ©2021 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Chapter 1 Learning Objectives CONCEPTUAL C1 Explain the importance of accounting and identify its users. C2 Describe the importance of ethics and GAAP. ANALYTICAL A1 Define and interpret the accounting equation and each of its components. A2 Compute and interpret return on assets. PROCEDURAL P1 Analyze business transactions using the accounting equation. P2 Identify and prepare basic financial statements and explain how they interrelate. 1-2 © McGraw-Hill Education  Learning Objective C1 Explain the importance of accounting and identify its users. 1-3 © McGraw-Hill Education  1-4 Importance of Accounting Exhibit 1.1 Accounting is an information and measurement system that identifies, records, and communicates an organization’s business activities. © McGraw-Hill Education 1-4 Learning Objective C1: Explain the importance of accounting and identify its users.  1-5 Users of Accounting Information Accounting is called the language of business because all organizations set up an accounting information system to communicate data to help people make better decisions. Accounting serves many users who can be divided into two groups: external users and internal users. Shareholders Purchasing managers Lenders Human resource managers External auditors Production managers Boards of directors Research and development managers Regulators Marketing managers © McGraw-Hill Education 1-5 Learning Objective C1: Explain the importance of accounting and identify its users.  1-6 Artificial Intelligence and Data Analytics Artificial Intelligence (AI) uses software and can be used to complete repetitive tasks such as entering invoices and transaction data. Accountants are needed to help develop advanced AI systems and analyze reports and graphics. Data analytics is a process of analyzing data to identify meaningful relations and trends. Data visualization is a graphical presentation of data to help individuals make informed business decisions. © McGraw-Hill Education 1-6 Learning Objective C1: Explain the importance of accounting and identify its users.  Learning Objective C2 Describe the importance of ethics and GAAP. 1-7 © McGraw-Hill Education  1-8 Ethics – A Key Concept The goal of accounting is to provide useful information for decisions. For information to be useful, it must be trusted. This demands ethics in accounting. Ethics are beliefs that distinguish right from wrong. They are accepted standards of good and bad behavior. Learning Objective C2: Describe the importance of ethics and GAAP. © McGraw-Hill Education 1-8  1-9 Fraud Triangle Three factors must exist for a person to commit fraud: opportunity, pressure, and rationalization. Envision a way to commit Fails to see the criminal fraud with a low perceived nature of the fraud or risk of getting caught justifies the action Must have some pressure to commit fraud, like unpaid bills Learning Objective C2: Describe the importance of ethics and GAAP. © McGraw-Hill Education 1-9  1 - 10 Generally Accepted Accounting Principles (GAAP) Financial accounting is governed by concepts and rules known as generally accepted accounting principles (GAAP). GAAP wants information to have relevance and faithful representation. Relevant information Faithful representation affects decisions means information of users. accurately reflects business results. Learning Objective C2: Describe the importance of ethics and GAAP. © McGraw-Hill Education 1-10  1 - 11 Financial Accounting Standards Board (FASB) The FASB sets GAAP. Authority provided by the Securities and Exchange Commission (SEC). The SEC is a U.S. government agency that oversees GAAP by companies that sell stock and debt to the public. Learning Objective C2: Describe the importance of ethics and GAAP. © McGraw-Hill Education 1-11  1 - 12 International Standards In today’s global economy, there is increased demand by external users for comparability in accounting reports. International Accounting Standards Board (IASB) Issues International Financial Reporting Standards (IFRS) Standards identify preferred accounting practices Standards are similar to, but sometimes different from U.S. GAAP. FASB and IASB are working to reduce differences. Learning Objective C2: Describe the importance of ethics and GAAP. © McGraw-Hill Education 1-12  1 - 13 Conceptual Framework Exhibit Objectives – provide useful 1.6 information to investors, creditors and others. Qualitative characteristics – information has relevance and faithful representation. Elements – defines items in financial statements. Recognition and measurement – criteria for an item to be recognized as an element and how to measure it. Learning Objective C2: Describe the importance of ethics and GAAP. © McGraw-Hill Education 1-13  1 - 14 Principles, Assumptions and Constraint Exhib it 1.7 General principles are the Specific principles are detailed assumptions, concepts, and rules used in reporting guidelines for preparing business transactions and financial statements. events. Learning Objective C2: Describe the importance of ethics and GAAP. © McGraw-Hill Education 1-14  1 - 15 Accounting Principles Measurement Principle Revenue Recognition Principle (Cost Principle) 1. Recognize revenue when goods or Accounting information is based on services are provided to customers actual cost. Actual cost is and considered objective. 2. at an amount expected to be received from the customer. Expense Recognition Principle Full Disclosure Principle (Matching Principle) A company reports the details behind A company records its expenses financial statements that would impact incurred to generate the revenue users’ decisions in the notes to the reported. financial statements. Learning Objective C2: Describe the importance of ethics and GAAP. © McGraw-Hill Education 1-15  1 - 16 Accounting Assumptions Going-Concern Assumption Monetary Unit Assumption The business is presumed to Transactions and events are continue operating instead of being expressed in monetary, or closed or sold. money, units. Time Period Assumption Business Entity Assumption The life of a company A business is accounted for can be divided into time periods, separately from other business such as months and years. entities, including its owner. Learning Objective C2: Describe the importance of ethics and GAAP. © McGraw-Hill Education 1-16  1 - 17 Proprietorship, Partnership, and Corporation Here are some of the major attributes of sole proprietorships, partnerships, corporations and limited liability companies (LLC): Exhibi t 1.8 Learning Objective C2: Describe the importance of ethics and GAAP. © McGraw-Hill Education 1-17  Accounting Constraint Cost-benefit constraint Only information with benefits of disclosure greater than the cost need be disclosed. Materiality constraint Only information that would influence the decisions of a reasonable person need be disclosed. Conservatism and industry practices are sometimes included as a constraint, also. Learning Objective C2: Describe the importance of ethics and GAAP. © McGraw-Hill Education 1-18  Learning Objective A1 Define and interpret the accounting equation and each of its components. © McGraw-Hill Education 1-19  1 - 20 Business Transactions and Accounting The Accounting Equation Assets = Liabilities + Equity Expanded Accounting Equation: Net Income Learning Objective A1: Define and interpret the accounting equation and each of its components. © McGraw-Hill Education 1-20 Learning Objective P1 Analyze business transactions using the accounting equation. © McGraw-Hill Education 1-21  Transaction 1: Investment by Owner Chas Taylor invests $30,000 cash in a new company named FastForward and received Common Stock. The accounts involved are: (1) Cash (asset) (2) Common Stock (equity) Learning Objective P1: Analyze business transactions using the accounting equation. © McGraw-Hill Education 1-22  Accounting Equation 1 Chas Taylor invests $30,000 cash to start the business, FastForward. Assets = Liabilities + Equity Accounts Notes Common Cash Supplies Equipment Payable Payable Stock (1) $ 30,000 $ 30,000 $ 30,000 $ - $ - $ - $ - $ 30,000 $ 30,000 = $ 30,000 Learning Objective P1: Analyze business transactions using the accounting equation. © McGraw-Hill Education 1-23  Transaction 2: Purchase Supplies for Cash FastFoward purchased supplies paying $2,500 cash. The accounts involved are: (1) Cash (asset) (2) Supplies (asset) Learning Objective P1: Analyze business transactions using the accounting equation. © McGraw-Hill Education 1-24  Accounting Equation 2 FastFoward purchased supplies paying $2,500 cash. Assets = Liabilities + Equity Accounts Notes Common Cash Supplies Equipment Payable Payable Stock (1) $ 30,000 $ 30,000 (2) (2,500) $ 2,500 Accounting Equation must remain in balance!! $ 27,500 $ 2,500 $ - $ - $ - $ 30,000 $ 30,000 = $ 30,000 Learning Objective P1: Analyze business transactions using the accounting equation. © McGraw-Hill Education 1-25  Transaction 3: Purchase Equipment for Cash FastForward purchased equipment for $26,000 cash. The accounts involved are: (1) Cash (asset) (2) Equipment (asset) Learning Objective P1: Analyze business transactions using the accounting equation. © McGraw-Hill Education 1-26  Accounting Equation 3 Purchased equipment for $26,000 cash. Assets = Liabilities + Equity Accounts Notes Common Cash Supplies Equipment Payable Payable Stock (1) $ 30,000 $ 30,000 (2) (2,500) $ 2,500 (3) (26,000) $ 26,000 Accounting Equation still remains in balance!! $ 1,500 $ 2,500 $ 26,000 $ - $ - $ 30,000 $ 30,000 = $ 30,000 Learning Objective P1: Analyze business transactions using the accounting equation. © McGraw-Hill Education 1-27  Transaction 4: Purchase Supplies on Credit FastFoward purchased supplies of $7,100 on credit. The accounts involved are: (1) Supplies (asset) (2) Accounts Payable (liability) Learning Objective P1: Analyze business transactions using the accounting equation. © McGraw-Hill Education 1-28  Accounting Equation 4 supplies of $7,100 FastForward purchased on credit. Assets = Liabilities + Equity Accounts Notes Common Cash Supplies Equipment Payable Payable Stock (1) $ 30,000 $ 30,000 (2) (2,500) $ 2,500 (3) (26,000) $ 26,000 (4) 7,100 $ 7,100 Accounting Equation still remains in balance!! $ 1,500 $ 9,600 $ 26,000 $ 7,100 $ - $ 30,000 $ 37,100 = $ 37,100 Learning Objective P1: Analyze business transactions using the accounting equation. © McGraw-Hill Education 1-29  Transaction 5: Provide Services for Cash FastForward provided consulting services to a customer and received $4,200 cash immediately. The accounts involved are: (1) Cash (asset) (2) Revenues (equity) Learning Objective P1: Analyze business transactions using the accounting equation. © McGraw-Hill Education 1-30  Accounting Equation 5 FastForward provided consulting services to a customer and received $4,200 cash immediately. Assets = Liabilities + Equity Accounts Notes Common Cash Supplies Equipment Payable Payable Stock Revenue Bal. $ 1,500 $ 9,600 $ 26,000 $ 7,100 $ 30,000 (5) 4,200 $ 4,200 $ 5,700 $ 9,600 $ 26,000 $ 7,100 $ - $ 30,000 $ 4,200 $ 41,300 = $ 41,300 Learning Objective P1: Analyze business transactions using the accounting equation. © McGraw-Hill Education 1-31  Transactions 6 and 7: Payment of Expenses in Cash FastForward paid rent of $1,000 and salaries of $700 to employees. The accounts involved are: (1) Cash (asset) (2) Rent expense (equity) (3) Salaries expense Remember that the balance in the Expense accounts actually increase. (equity) But, total Equity decreases, because expenses reduce equity. Learning Objective P1: Analyze business transactions using the accounting equation. © McGraw-Hill Education 1-32  Accounting Equation 6 and 7 FastForward paid rent of $1,000 and salaries of $700 to employees. Assets = Liabilities + Equity Accounts Notes Common Cash Supplies Equipment Payable Payable Stock Revenue Expenses Bal. $ 5,700 $ 9,600 $ 26,000 $ 7,100 $ 30,000 $ 4,200 (6) (1,000) (1,000) (7) (700) $ (700) $ 4,000 $ 9,600 $ 26,000 $ 7,100 $ - $ 30,000 $ 4,200 $ (1,700) $ 39,600 = $ 39,600 Remember that expenses decrease equity. Learning Objective P1: Analyze business transactions using the accounting equation. © McGraw-Hill Education 1-33  Transaction 8: Provide Services and Facilities for Credit FastForward provided consulting services of $1,600 and rents facilities for $300 to a customer for credit. The accounts involved are: (1) Accounts receivable (asset) (2) Consulting revenues (equity) (3) Rental revenue (equity) Learning Objective P1: Analyze business transactions using the accounting equation. © McGraw-Hill Education 1-34  Accounting Equation 8 FastForward provided consulting services of $1,600 and rents facilities for $300 to a customer for credit. Assets = Liabilities + Equity Accounts Accounts Common Cash Receivable Supplies Equipment Payable Stock Revenue Expenses Bal. $ 4,000 $ 9,600 $ 26,000 $ 7,100 $ 30,000 $ 4,200 (1,700) (8) 1,900 $ 1,600 300 $ 4,000 $ 1,900 $ 9,600 $ 26,000 $ 7,100 $ 30,000 $ 6,100 $ (1,700) $ 41,500 = $ 41,500 Learning Objective P1: Analyze business transactions using the accounting equation. © McGraw-Hill Education 1-35  Transaction 9: Receipt of Cash from Accounts Receivable Client in transaction 8 pays $1,900 for consulting services. The accounts involved are: (1) Cash (asset) (2) Accounts receivable (asset) Learning Objective P1: Analyze business transactions using the accounting equation. © McGraw-Hill Education 1-36  Accounting Equation 9 Client in transaction 8 pays $1,900 for consulting services. Assets = Liabilities + Equity Accounts Accounts Common Cash Receivable Supplies Equipment Payable Stock Revenue Expenses Bal. $ 4,000 1,900 $ 9,600 $ 26,000 $ 7,100 $ 30,000 $ 4,200 (1,700) (9) 1,900 (1,900) $ 1,600 300 $ 5,900 0 $ 9,600 $ 26,000 $ 7,100 $ 30,000 $ 6,100 $ (1,700) $ 41,500 = $ 41,500 Learning Objective P1: Analyze business transactions using the accounting equation. © McGraw-Hill Education 1-37  Transaction 10: Payment of Accounts Payable FastForward pays $900 as partial payment for supplies purchased in transaction 4. The accounts involved are: (1) Cash (asset) (2) Accounts payable (liability) Learning Objective P1: Analyze business transactions using the accounting equation. © McGraw-Hill Education 1-38  Accounting Equation 10 FastForward pays $900 as partial payment for supplies purchased in transaction 4. Assets = Liabilities + Equity Accounts Accounts Common Cash Receivable Supplies Equipment Payable Stock Revenue Expenses Bal. $ 5,900 0 $ 9,600 $ 26,000 $ 7,100 $ 30,000 $ 4,200 (1,700) (10) (900) (900) $ 1,600 300 $ 5,000 0 $ 9,600 $ 26,000 $ 6,200 $ 30,000 $ 6,100 $ (1,700) $ 40,600 = $ 40,600 Learning Objective P1: Analyze business transactions using the accounting equation. © McGraw-Hill Education 1-39  Transaction 11: Payment of Cash Dividend to Owner Owner withdraws $200 cash for personal use. The accounts involved are: (1) Cash (asset) (2) Dividends (equity) Remember that the Dividends account actually increases (just like our Expense accounts). But, total Equity decreases because dividends cause equity to go down!! Learning Objective P1: Analyze business transactions using the accounting equation. © McGraw-Hill Education 1-40  Accounting Equation 11 Owner withdraws $200 cash for personal use. Assets = Liabilities + Equity Accounts Accounts Common Cash Receivable Supplies Equipment Payable Stock Dividends Revenue Expenses Bal. $ 5,000 0 $ 9,600 $ 26,000 $ 6,200 $ 30,000 $ 4,200 (1,700) (11) (200) (200) $ 1,600 300 $ 4,800 0 $ 9,600 $ 26,000 $ 6,200 $ 30,000 $ (200) $ 6,100 $ (1,700) $ 40,400 = $ 40,400 Learning Objective P1: Analyze business transactions using the accounting equation. © McGraw-Hill Education 1-41  Summary of Transactions Learning Objective P1: Analyze business transactions using the accounting equation. © McGraw-Hill Education 1-42  Learning Objective P2 Identify and prepare basic financial statements and explain how they interrelate. © McGraw-Hill Education 1-43  1 - 44 Financial Statements The four financial statements and their purposes are: 1. Income statement — describes a company’s revenues and expenses and computes net income or loss over a period of time. 2. Statement of retained earnings — explains changes in retained earnings from net income (or loss) and from any dividends over a period of time. 3. Balance sheet — describes a company’s financial position (types and amounts of assets, liabilities, and equity) at a point in time. 4. Statement of cash flows — identifies cash inflows (receipts) and cash outflows (payments) © McGraw-Hill Education 1-44 over Learning Objective a period P2: Identify and prepare basic of time. financial statements and explain how they interrelate.  Exhibit 1.10: Financial Statements and Their Links – Part 1 1 - 45 (cont. next slide) Learning Objective P2: Identify and prepare basic financial statements and explain how they interrelate. © McGraw-Hill Education 1-45  Exhibit 1.10: Financial Statements and Their Links – Part 2 1 - 46 Learning Objective P2: Identify and prepare basic financial statements and explain how they interrelate. © McGraw-Hill Education 1-46  Learning Objective A2 Compute and interpret return on assets. © McGraw-Hill Education 1-47  1 - 48 Return on Assets Return on assets (ROA) is stated in ratio form as net income divided by the average total assets invested. Net income Return on assets = Average total assets Learning Objective A2: Compute and interpret return on assets. © McGraw-Hill Education 1-48