Financial Accounting:

Tools for Business Decision Making

Kimmel, Weygandt, Kieso, Trenholm

1
 Chapter 1
Introduction to Financial Statements

After studying Chapter 1, you should be

able to:
1. Describe the primary forms of business organization.
2. Identify the users and uses of accounting.
3. Explain the three principal types of business activity.
4. Describe the content and purpose of each of the
financial statements.

2
 Chapter 1
Introduction to Financial Statements

After studying Chapter 1, you should be

able to:
5. Explain the meaning of assets, liabilities, and
shareholders’ equity and state the basic accounting
equation.
6. Describe the components that supplement the
financial statements in an annual report.
7. Explain the basic assumptions and principles
underlying financial statements. 3
 Illustration 1-1
Forms of Business
Organization

4
Users of Financial Information
 Internal Users
 Managers plan, organize and run a
business

5
 Users of Financial Information

 External Users
 Investors
Primary users
 Creditors
 Others
 Taxing authorities
 Regulatory agencies
 Customers
 Labour unions
 Economic planners

6
 Accounting Equation

Assets = Liabilities + Shareholders’ Equity

 Basic Terms
 Assets - resources owned by a
business
 Liabilities - obligations of the
business
 Shareholders’ equity
 Share capital - representing the primary
ownership interest in a corporation
 Retained earnings – accumulated
earnings of corporation that have not
been distributed to shareholders
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 3 Types of Business Activity

 Financing
 Investing
 Operating

9
 Financing Activities

 Borrowing
money (debt)
 Selling shares
(equity)

It takes money to
make money!
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 Investing Activities

 Obtaining the resources or assets

needed to operate the business for
the long-run
 Examples
 Purchase or sale of investments
 Purchase or sale of capital assets

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 Operating Activities

 Operating
activities are the
main activities
for which the
organization is
in business Loblaw

12
 Revenues

 Revenues arise
from sale of a
product or
service
 Revenues result
in an inflow of
assets

13
 Expenses
 Expenses are the costs of assets
consumed or services used to
generate revenues
 Examples
 Cost of sales
 Store operating expenses
 General and administrative expenses
 Interest expense

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 Net Earnings

 Net earnings are the excess of

revenue over expenses

Revenue $10,000
Less: Expenses 3,000
Net earnings $ 7,000

(Net loss is the excess of expenses over revenues)

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 Remember …
 Remaining liquid and
solvent is as
important as making
a profit because...
 A company can
survive without
earnings, but it can’t
survive very long
without cash
 Elements of an

 Management Discussion and Analysis

 Auditor's Report
 Financial Statements
 Statement of Earnings
 Statement of Retained Earnings
 Balance Sheet
 Statement of Cash Flows
 Notes to Financial Statements
 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

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 Auditor’s Report

 Auditor gives an unqualified opinion

if the financial statements present
the financial position, results of
operations, and cash flows in
accordance with generally accepted
accounting principles (GAAP)

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 Financial Accounting
Statements
 Statement of Earnings
 Reports the results of operations for a specific
period of time
 Statement of Retained Earnings
 Reports the changes in retained earnings for a
specific period of time
 Balance Sheet
 Reports the assets, liabilities, and shareholders’
equity as at a specific point in time
 Statement of Cash Flows
 Reports the cash receipts and payments for a
specific period of time
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From Page 15
Notes to Financial Statements
 Provide additional information not
included in body of statements
 Do not have to be numeric
 Examples
 Description of accounting policies or
explanation of uncertainties and
contingencies
 Statistics and supporting details

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 Assumptions and Principles

 Assumptions  Generally accepted

 Monetary unit accounting
 Economic entity principles
 Time period  Cost
 Going concern  Full disclosure

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 Illustration 1-10

Monetary Unit Assumption

 Illustration 1-10

Economic Entity Assumption

 Illustration 1-10

Time Period Assumption

 Illustration 1-10

Going Concern Assumption

 Illustration 1-11

Cost Principle
 Illustration 1-11

Full Disclosure Principle

 Decision Checkpoints

 Are the company’s operations profitable?

 What is the company’s policy toward
dividends and growth?
 Does the company rely primarily on debt
or shareholders’ equity to finance its
assets?
 Does the company generate sufficient
cash from operations to fund its investing
activities?

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 COPYRIGHT
Copyright © 2001 John Wiley & Sons Canada, Ltd. All
rights reserved. Reproduction or translation of this
work beyond that permitted by CANCOPY (Canadian
Reprography Collective) is unlawful. Request for
further information should be addressed to the
Permissions Department, John Wiley & Sons Canada,
Ltd. The purchaser may make back-up copies for his /
her own use only and not for distribution or resale. The
author and the publisher assume no responsibility for
errors, omissions, or damages, caused by the use of
these programs or from the use of the information
contained herein.

31
Do It - Page 15
 CSU CORPORATION
Statement of Earnings
For the Year Ended December 31, 2001

1st - Statement of Earnings

Head up the statement

name of company
name of statement
period of time covered
 CSU CORPORATION
Statement of Earnings
For the Year Ended December 31, 2001

Revenues
Service revenue $22,200

List the revenues

 CSU CORPORATION
Statement of Earnings
For the Year Ended December 31, 2001

Revenues
Service revenue $22,200
Expenses
Rent expense $9,000
Insurance expense 1,000
Supplies expense 200
Total expenses 10,200
Earnings before income tax 12,000
Income tax expense 5,200

List and total the expenses. Note

that income tax is shown separately
from other expenses
 CSU CORPORATION
Statement of Earnings
For the Year Ended December 31, 2001

Revenues
Service revenue $22,200
Expenses
Rent expense $9,000
Insurance expense 1,000
Supplies expense 200
Total expenses 10,200
Earnings before income tax 12,000
Income tax expense 5,200
Net earnings $ 6,800
Subtract expenses from revenues to
obtain net earnings (loss)
36
 CSU CORPORATION
Statement of Retained Earnings
For the Year Ended December 31, 2001

2nd – Statement of Retained Earnings

Head up the statement

name of company
name of statement
period of time covered (same period as
statement of earnings)
 CSU CORPORATION
Statement of Retained Earnings
For the Year Ended December 31, 2001

Retained earnings, January 1 $ 0

Start with beginning

retained earnings (same as
ending retained earnings
of prior period)
 CSU CORPORATION
Statement of Retained Earnings
For the Year Ended December 31, 2001

Retained earnings, January 1 $ 0

Add: Net earnings 6,800
6,800

Add net earnings (subtract

loss) from the current year
(see Statement of Earnings)
Subtotal
 CSU CORPORATION
Statement of Retained Earnings
For the Year Ended December 31, 2001

Retained earnings, January 1 $ 0

Add: Net earnings 6,800
6,800
Less: Dividends 0
Retained earnings, December 31 $ 6,800

Subtract current year’s

dividends (if any) and total
 CSU CORPORATION
Balance Sheet
December 31, 2001

3rd – Balance Sheet

Head up the statement

name of company
name of statement
date (as at a specific point in time)
 CSU CORPORATION
Balance Sheet
December 31, 2001

Assets
Cash $ 2,000
Accounts receivable 4,000
Supplies 1,800
Equipment 16,000
Total assets $23,800

List the assets and total

 CSU CORPORATION
Balance Sheet
December 31, 2001

Assets
Cash $ 2,000
Accounts receivable 4,000
Supplies 1,800
Equipment 16,000
Total assets $23,800
Liabilities and Shareholders’ Equity
Liabilities
Accounts payable $ 2,000
Notes payable 5,000
Total liabilities 7,000

List the liabilities and subtotal

 CSU CORPORATION
Balance Sheet
December 31, 2001

List shareholders’ equity.

Subtotal
Add to liabilities, total
 CSU CORPORATION
Balance Sheet
December 31, 2001

Assets
Cash $ 2,000
Accounts receivable 4,000
Supplies 1,800
Equipment 16,000
Total assets $23,800
Liabilities and Shareholders’ Equity
Liabilities
Accounts payable $ 2,000
Notes payable 5,000
Total liabilities 7,000
Shareholders’ equity
Common shares $10,000
Retained earnings 6,800
Total shareholders’ equity 16,800
Total liabilities and shareholders’ equity $23,800
 Stop and Check

Total assets must equal total

liabilities and shareholders’ equity
In what order are financial
statements prepared?
Presented?

WHY?
 CSU CORPORATION
Statement of Earnings
For the Year Ended December 31, 2001

Revenues
Service revenue $22,200
Expenses
Rent expense $9,000
Insurance expense 1,000
Supplies expense 200
Total expenses 10,200
Earnings before income tax 12,000
Income tax expense 5,200
Net earnings $ 6,800

Net earnings is needed for the

Statement of Retained Earnings
 CSU CORPORATION
Statement of Retained Earnings
For the Year Ended December 31, 2001

Retained earnings, January 1 $ 0

Add: Net earnings 6,800
6,800
Less: Dividends 0
Retained earnings, December 31 $ 6,800

Ending retained earnings is needed

for the Balance Sheet
 CSU CORPORATION
Balance Sheet
December 31, 2001

Assets
Cash $ 2,000
Accounts receivable 4,000
Supplies 1,800
Equipment 16,000
Total assets $23,800
Liabilities and Shareholders’ Equity
Liabilities
Accounts payable $ 2,000
Notes payable 5,000
Total liabilities 7,000
Shareholders’ equity
Common shares $10,000
Retained earnings 6,800
Total shareholders’ equity 16,800
Total liabilities and shareholders’ equity $23,800
51