Understanding Financial

Statements A Basic Overview

Introduction to Accounting and A
Conceptual Overview
The Business Environment
Sole Proprietorships
Partnerships (general and limited)
Limited liability companies
All countries have three basic
forms of business organization:
The Business Environment
Oldest form of business organization.
Business income is accounted for on the owners
personal income tax form.
Sole Proprietorship -- A business form for
which there is one owner. This single
owner has unlimited liability for all debts
of the firm.
Summary for Sole
Proprietorship
Advantages

Simplicity
Low setup cost
Quick setup
Single tax filing on
individual form
Disadvantages

Unlimited liability
Hard to raise additional
capital
Transfer of ownership
difficulties
The Business
Environment
Business income is accounted for on each
partners personal income tax form.
Partnership -- A business form in
which two or more individuals act
as owners.
Types of Partnerships
Limited Partnership -- Limited partners have
liability limited to their capital contribution (investors
only). In some countries like USA, at least one general
partner is required and all general partners have
unlimited liability. In some other countries, like India,
all partners can have limited liabilities.
General Partnership -- All partners have unlimited
liability and are liable for all obligations of the
partnership. Maximum Number of Partners can be 20
(India)
Summary for Partnership
Advantages
Can be simple
Low setup cost, higher
than sole proprietorship
Relatively quick setup
Limited liability for limited
partners
Disadvantages
Unlimited liability for the
general partner
Difficult to raise
additional capital, but
easier than sole
proprietorship
Transfer of ownership
difficulties
The Business
Environment
An artificial entity that can own assets and
incur liabilities.
Business income is accounted for on the
income tax form of the corporation.
Corporation -- A business form
legally separate from its owners.
Summary for Corporation
Advantages
Limited liability
Easy transfer of ownership
Unlimited life
Easier to raise large
quantities of capital
Disadvantages
Double taxation
More difficult to
establish
More expensive to set
up and maintain
Accounting as an Information
System
Todays accountant focuses on the ultimate
needs of decision makers who use
accounting information, whether those
decision makers are inside or outside the
business.
Accounting as an Information
System
Accounting is not an end in itself, but is
an information system that measures,
processes, and communicates financial
information about an identifiable
economic entity.
Accounting as an Information
System
Accounting provides a vital service by
supplying the information that decision
makers need in order to make reasoned
choices among alternative uses of scarce
resources in the conduct of business and
economic activities.
Accounting as an Information
System
Accounting is a link between business
activities and decision makers.
Accounting measures business activities by
recording data about them for future use.
The data are stored until needed and then
processed to become useful information.
Accounting as an Information
System
The information is
communicated,
through reports, to
decision makers.
Accounting as an Information
System
Data about business
activities are the input
to the accounting
system and useful
information for decision
makers is the output.
1-1
Data
Information
ACCOUNTING
BUSINESS
ACTIVITIES
DECISION
MAKERS
MEASUREMENT
Accomplished
by recording of
data
PROCESSING
Accomplished
by storage and
preparation of
data
Communication
Accomplished
by reporting
Accounting as an Information System
Users of Financial Information
Internal Users - managers plan, organize and
run a business.
External Users -
Investors
Creditors
Others
Taxing authorities
Regulatory agencies
Customers
Labor unions
Economic planners
The Users of Accounting Information
1-3
THOSE WITH INDIRECT
FINANCIAL INTEREST
Tax Authorities
Regulators
Labor Unions
Customers
Economic Planners
Investors
Creditors
THOSE WITH DIRECT
FINANCIAL INTEREST
Finance
Operations and
Production
Marketing
Human Resources
Information Systems
Accounting
MANAGEMENT
DECISION MAKERS
Questions Asked by Internal
Users
Is cash sufficient to pay bills?
What is the cost of manufacturing each
unit of product?
Can we afford to give employee pay
raises this year?
What product line is most profitable?
Questions Asked by External
Users
Is the company earning satisfactory
income?
How does the company compare in
size and profitability with competitors?
Will the company be able to pay its
debts when they become due?
Business Goals, Activities, and
Performance Measures
A business is an economic unit that aims to
sell goods and services to customers at
prices that will provide an adequate return
to its owners.
Businesses, though different, have similar
goals and engage in similar activities.
Business Goals
1. Profitability - A business must take in
enough money to pay all the costs of
doing business, with enough left over as
profit for the owners to want to stay in
business.
2. Liquidity - A business must have enough
funds available to pay debts when they
are due.
Business Goals and Activities
1-2
BUSINESS GOALS BUSINESS ACTIVITIES
FINANCING OPERATING
INVESTING
PROFITABILITY
LIQUIDITY
Business Activities
1. Financing Activities.
Obtaining capital from owners and creditors.
Repaying creditors and paying a return to
owners.
2. Investing Activities.
Spending the capital it receives in ways that are
productive and will help the business achieve its
objectives.
Buying and selling resources to be used in the
business.
Business Activities
3. Operating Activities.
Selling goods and services to customers.
Employing managers and workers,
buying and producing goods and
services, and paying taxes.
3 Types of Business Activity
Financing
Investing
Operating
Financing Activities
It
Takes
MONEY
to
Make
MONEY!
Two Ways of Outside
Financing of a Corporation
Borrowing money
(Outside liabilities)
Issuing shares of
stock in exchange
for cash (Equity)
Basic Terms
Assets - resources owned by a business
Liabilities - debts and obligations of the
business - represents claims of creditors on
the assets of the business
Common stock - stock representing the
primary ownership interest in a corporation
Investing Activities
Cash
Accounts Receivable
Inventory
Buildings, Equipment, Furniture

Obtaining the
Resources or Assets
needed to operate the business
Examples of assets...



Investing Activities - Examples
Purchase or sale of computers,
delivery trucks, furniture,
buildings
Purchase or sale of investments
What Are
Revenues?
Revenues are the assets that result
from sale of a product or service.
Examples of Revenues
Taxi Company - sells services

Theatre - sells services & products

Retail Store - sells products
Expenses are the costs of assets
consumed or services used to
generate revenues. Examples...
What Are Expenses?
Cost of sales
Store operating expenses
General and administrative expenses
Interest expense

Examples of Expenses
Taxi Company - fuel, maintenance,
insurance
Theatre - salaries, supplies, film rental,
concessions to resale
Retail Store - utilities, taxes, rent,
supplies, salaries
Net Income
Net Income is the excess of revenues
over expenses.

Revenue Rs 10,000
Expenses 3,000
Net income Rs 7,000

Summary of Business Activities
Long Term Short Term Short Term Long Term
Land, Buildings, Cash Banks Long-Term
and Equipment Accounts Suppliers Creditors
Contractual Receivable Employees Owners
Rights Inventories Governments
Stocks and Stocks and
Bonds Bonds
Purchasing
Production
Marketing
Administration
Goals and
Strategies
Financing Investing
Operating
Financial Statements
Income Statement
Statement of Retained Earnings
Balance Sheet
Statement of Cash Flows
Management Discussion and Analysis
Notes to Financial Statements
Auditor's Report
Elements of an
Management Discussion
and Analysis
Covers three aspects of a company:
liquidity - ability to pay near-term
obligations
capital resources - ability to fund
operations and expansions
results of operations
Notes to Financial Statements
Provide additional information not
included in body of statements
Does not have to be numeric
Examples:
Description of accounting policies or
explanation of uncertainties and
contingencies
Statistics and voluminous details
Auditor's Report
Auditor, a professional accountant who conducts
an independent examination of the financial
accounting data presented by a company.
Auditor gives an unqualified opinion if the
financial statements present the financial
position, results of operations, and cash flows in
accordance with GAAP.
Relation between Business Activities and Balance Sheet and I ncome Statement
Noncurrent Current Current Noncurrent
Land, Buildings, Cash Notes Payable Bonds Payable
and Equipment Accounts Accounts Common Stock
Patents Receivable Payable Retained Earnings
Investments Inventories Salaries
in Securities Marketable Payable
Securities Income Taxes
Payable
Assets Sales Revenue Liabilities and
(Balance Sheet) Cost of Goods Sold Shareholders Equity
Selling Expense (Balance Sheet)
Administrative Expenses
Interest Expense
Income Tax
Expense
Net Income
(Income Statement)
Goals and
Strategies
Financing Investing
Operating