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This document provides an excerpt from a chapter in a textbook on financial statements and business decisions. It includes sample financial statements for a company called Maxidrive Corp., including its balance sheet and income statement. The balance sheet shows Maxidrive's assets, liabilities, and equity as of December 31, 2006. The income statement reports Maxidrive's revenues and expenses for the year ended December 31, 2006, showing it had net income of $3.3 million for the period. Captions and line items in the financial statements are explained to help the reader understand what is being reported.

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Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Financial Statements and Business Decisions Chapter 1
1-3 Understanding the Business Owner-Managers Founders of the business who also function as managers are called Owner- Mangers. Creditors Creditors lend money for a specific period of time and gain by charging interest on the money they lend. Investors Investors buy ownership in the company in the form of stock.
1-4 Understanding the Business Investors purchase stock (or ownership) in businesses hoping to gain in two ways: Sell ownership interest in the future for more than they paid. Receive a portion of the company’s earnings in cash (dividends).
1-5 The Business Operations Manufacturers either make the parts needed to produce its products or buy the parts from suppliers. Manufacturer Final Product Customer
1-6 Learning Objectives Recognize the information conveyed in each of the four basic financial statements and the way that it is used by different decision makers (investors, creditors, and managers).
1-7 The Accounting System Collects and processes financial information Reports information to decision makers Managers (internal decision makers) Investors and Creditors (external decision makers)
1-8 The Accounting System Accounting System Financial Accounting System Periodic financial statements and related disclosures Managerial Accounting System Detailed plans and continuous performance reports External Decision Makers Investors, creditors, suppliers, customers, etc. Internal Decision Makers Managers throughout the organization
1-9 The Four Basic Financial Statements Income Statement Balance Sheet Statement of Cash Flows Statement of Retained Earnings Financial statements summarize the financial activities of the business.
1-10 The Four Basic Financial Statements Companies can prepare financial statements at the end of the year, quarter or month. Financial statements prepared at the end of the year are called annual reports.
1-11 Let’s look at MAXIDRIVE CORP.’s financial statements.
1-12 MAXIDRIVE CORP. Balance Sheet At December 31, 2006 (in thousands of dollars) Assets Cash 4,895 $ Accounts receivable 5,714 Inventories 8,517 Plant and equipment 7,154 Land 981 Total assets 27,261 $ Liabilities and Stockholders' Equity Liabilities Accounts payable 7,156 $ Notes payable 9,000 Total liabilities 16,156 $ Stockholders' Equity Contributed capital 2,000 $ Retained earnings 9,105 Total stockholders' equity 11,105 Total liabilities and stockholders' equity 27,261 $ 1. Name of entity 2. Title of statement 3. Specific date 4. Unit of measure The Balance Sheet reports the financial position of an entity at a particular point in time.
1-13 The Balance Sheet Basic Accounting Equation Assets = Liabilities + Stockholders’ Equity Economic Resources Sources of Financing for Economic Resources
1-14 MAXIDRIVE CORP. Balance Sheet At December 31, 2006 (in thousands of dollars) Assets Cash 4,895 $ Accounts receivable 5,714 Inventories 8,517 Plant and equipment 7,154 Land 981 Total assets 27,261 $ Liabilities and Stockholders' Equity Liabilities Accounts payable 7,156 $ Notes payable 9,000 Total liabilities 16,156 $ Stockholders' Equity Contributed capital 2,000 $ Retained earnings 9,105 Total stockholders' equity 11,105 Total liabilities and stockholders' equity 27,261 $ Assets are listed by their ease of conversion into cash. Cash Amount of cash in the company’s bank accounts. Accounts receivable Amounts owed by customers from prior sales. Inventories Parts and completed but unsold products. Plant and equipment Factories and production machinery. Land Land on which factories are built. Assets are economic resources owned by the business as a result of past transactions.
1-15 MAXIDRIVE CORP. Balance Sheet At December 31, 2006 (in thousands of dollars) Assets Cash 4,895 $ Accounts receivable 5,714 Inventories 8,517 Plant and equipment 7,154 Land 981 Total assets 27,261 $ Liabilities and Stockholders' Equity Liabilities Accounts payable 7,156 $ Notes payable 9,000 Total liabilities 16,156 $ Stockholders' Equity Contributed capital 2,000 $ Retained earnings 9,105 Total stockholders' equity 11,105 Total liabilities and stockholders' equity 27,261 $ Liabilities are debts or obligations of the business that result from past transactions. Accounts payable Amounts owed to suppliers for prior purchases. Notes payable Amounts owed on written debt contracts.
1-16 MAXIDRIVE CORP. Balance Sheet At December 31, 2006 (in thousands of dollars) Assets Cash 4,895 $ Accounts receivable 5,714 Inventories 8,517 Plant and equipment 7,154 Land 981 Total assets 27,261 $ Liabilities and Stockholders' Equity Liabilities Accounts payable 7,156 $ Notes payable 9,000 Total liabilities 16,156 $ Stockholders' Equity Contributed capital 2,000 $ Retained earnings 9,105 Total stockholders' equity 11,105 Total liabilities and stockholders' equity 27,261 $ Contributed capital Amounts invested in the business by stockholders. Retained earnings Past earnings not distributed to stockholders. Equity is the amount of financing provided by owners of the business and earnings.
1-17 MAXIDRIVE CORP. Balance Sheet At December 31, 2006 (in thousands of dollars) Assets Cash 4,895 $ Accounts receivable 5,714 Inventories 8,517 Plant and equipment 7,154 Land 981 Total assets 27,261 $ Liabilities and Stockholders' Equity Liabilities Accounts payable 7,156 $ Notes payable 9,000 Total liabilities 16,156 $ Stockholders' Equity Contributed capital 2,000 $ Retained earnings 9,105 Total stockholders' equity 11,105 Total liabilities and stockholders' equity 27,261 $ Use $ on the first item in a group and on the group total. Assets = Liabilities + Stockholders’ Equity
1-18 MAXIDRIVE CORP. Income Statement For the Year Ended December 31, 2006 (in thousands of dollars) Revenues Sales revenue 37,436 $ Expenses Cost of goods sold 26,980 $ Selling, general and administrative 3,624 Research and development 1,982 Interest expense 450 Total expenses 33,036 Pretax income 4,400 $ Income tax expense 1,100 Net income 3,300 $ 1. Name of entity 2. Title of statement 3. Specific period of time (Unlike the balance sheet, this statement covers a specified period of time.) 4. Unit of measure
1-19 MAXIDRIVE CORP. Income Statement For the Year Ended December 31, 2006 (in thousands of dollars) Revenues Sales revenue 37,436 $ Expenses Cost of goods sold 26,980 $ Selling, general and administrative 3,624 Research and development 1,982 Interest expense 450 Total expenses 33,036 Pretax income 4,400 $ Income tax expense 1,100 Net income 3,300 $ The Income Statement reports the revenues minus expenses of the accounting period.
1-20 MAXIDRIVE CORP. Income Statement For the Year Ended December 31, 2006 (in thousands of dollars) Revenues Sales revenue 37,436 $ Expenses Cost of goods sold 26,980 $ Selling, general and administrative 3,624 Research and development 1,982 Interest expense 450 Total expenses 33,036 Pretax income 4,400 $ Income tax expense 1,100 Net income 3,300 $ Revenues are earnings from the sale of goods or services to customers. Revenue is recognized in the period in which goods and services are sold, not necessarily the period in which cash is received.
1-21 Revenues June 2006 Cash from sale collected on June 10th. X May 2006 $1,000 sale made on May 25th. X When will the revenue from this transaction be recognized? Earnings from the sale of goods or services.
1-22 Revenues Earnings from the sale of goods or services. When will the revenue from this transaction be recognized? May 2006 $1,000 sale made on May 25th. X
1-23 MAXIDRIVE CORP. Income Statement For the Year Ended December 31, 2003 (in thousands of dollars) Revenues Sales revenue 37,436 $ Expenses Cost of goods sold 26,980 $ Selling, general and administrative 3,624 Research and development 1,982 Interest expense 450 Total expenses 33,036 Pretax income 4,400 $ Income tax expense 1,100 Net income 3,300 $ Expenses are the dollar amount of resources used up by the entity to earn revenues during a period. An expense is recognized in the period in which goods and services are used, not necessarily the period in which cash is paid.
1-24 MAXIDRIVE CORP. Income Statement For the Year Ended December 31, 2006 (in thousands of dollars) Revenues Sales revenue 37,436 $ Expenses Cost of goods sold 26,980 $ Selling, general and administrative 3,624 Research and development 1,982 Interest expense 450 Total expenses 33,036 Pretax income 4,400 $ Income tax expense 1,100 Net income 3,300 $ Cost of goods sold The cost to produce products sold this period. Selling, general and administrative Operating expenses not directly related to production. Research and development Expenses incurred to develop new products. Interest expense The cost of using borrowed funds. Income tax expense Income taxes on current period’s pretax income.
1-25 Expenses May 2006 June 2006 May 11 paid $75 cash for newspaper ad. X Ad appears on June 8th. X The dollar amount of resources used up by the entity to earn revenues during a period. When will the expense for this transaction be recognized?
1-26 Expenses Advertising expense recorded in June. The dollar amount of resources used up by the entity to earn revenues during a period. When will the expense for this transaction be recognized? June 2006 X
1-27 MAXIDRIVE CORP. Income Statement For the Year Ended December 31, 2006 (in thousands of dollars) Revenues Sales revenue 37,436 $ Expenses Cost of goods sold 26,980 $ Selling, general and administrative 3,624 Research and development 1,982 Interest expense 450 Total expenses 33,036 Pretax income 4,400 $ Income tax expense 1,100 Net income 3,300 $ If expenses exceed revenues, we report net loss.
1-28 MAXIDRIVE CORP. Statement of Retained Earnings For the Year Ended December 31, 2006 (in thousands of dollars) Retained earnings, January 1, 2006 6,805 $ Net income for 2006 3,300 Dividends for 2006 (1,000) Retained earnings, December 31, 2006 9,105 $ 1. Name of entity 2. Title of statement 3. Specific period of time (Like the income statement, this statement covers a specified period of time.) 4. Unit of measure
1-29 The Statement of Retained Earnings reports the way that net income and the distribution of dividends affect the financial position of the company during a period. MAXIDRIVE CORP. Statement of Retained Earnings For the Year Ended December 31, 2006 (in thousands of dollars) Retained earnings, January 1, 2006 6,805 $ Net income for 2006 3,300 Dividends for 2006 (1,000) Retained earnings, December 31, 2006 9,105 $
1-30 Statement of Cash Flows Because revenues reported do not always equal cash collected. . . . . . and expenses reported do not always equal cash paid . . . net income is usually not equal to the change in cash for the period.
1-31 MAXIDRIVE CORP. Statement of Cash Flows For the Year Ended December 31, 2006 (in thousands of dollars) Cash flows from operating activities: Cash collected from customers 33,563 $ Cash paid to suppliers and employees (30,854) Cash paid for interest (450) Cash paid for taxes (1,190) Net cash flow from operating activities 1,069 $ Cash flow from investing activities: Cash paid to purchase equipment (1,625) $ Net cash flow from investing activities (1,625) Cash flow from financing activities: Cash received from bank loan 1,400 $ Cash paid for dividends (1,000) Net cash flow from financing activities 400 Net decrease in cash during the year (156) $ Cash at beginning of the year 5,051 Cash at end of the year 4,895 $ 1. Name of entity 2. Title of statement 3. Specific period of time (Like the income statement, this statement covers a specified period of time.) 4. Unit of measure
1-32 MAXIDRIVE CORP. Statement of Cash Flows For the Year Ended December 31, 2006 (in thousands of dollars) Cash flows from operating activities: Cash collected from customers 33,563 $ Cash paid to suppliers and employees (30,854) Cash paid for interest (450) Cash paid for taxes (1,190) Net cash flow from operating activities 1,069 $ Cash flow from investing activities: Cash paid to purchase equipment (1,625) $ Net cash flow from investing activities (1,625) Cash flow from financing activities: Cash received from bank loan 1,400 $ Cash paid for dividends (1,000) Net cash flow from financing activities 400 Net decrease in cash during the year (156) $ Cash at beginning of the year 5,051 Cash at end of the year 4,895 $ The Statement of Cash Flows reports the inflows and outflows of cash during the period in the categories of operating, investing, and financing.
1-33 MAXIDRIVE CORP. Statement of Cash Flows For the Year Ended December 31, 2006 (in thousands of dollars) Cash flows from operating activities: Cash collected from customers 33,563 $ Cash paid to suppliers and employees (30,854) Cash paid for interest (450) Cash paid for taxes (1,190) Net cash flow from operating activities 1,069 $ Cash flow from investing activities: Cash paid to purchase equipment (1,625) $ Net cash flow from investing activities (1,625) Cash flow from financing activities: Cash received from bank loan 1,400 $ Cash paid for dividends (1,000) Net cash flow from financing activities 400 Net decrease in cash during the year (156) $ Cash at beginning of the year 5,051 Cash at end of the year 4,895 $ Cash flows directly related to earning income are shown in the operating section.
1-34 MAXIDRIVE CORP. Statement of Cash Flows For the Year Ended December 31, 2006 (in thousands of dollars) Cash flows from operating activities: Cash collected from customers 33,563 $ Cash paid to suppliers and employees (30,854) Cash paid for interest (450) Cash paid for taxes (1,190) Net cash flow from operating activities 1,069 $ Cash flow from investing activities: Cash paid to purchase equipment (1,625) $ Net cash flow from investing activities (1,625) Cash flow from financing activities: Cash received from bank loan 1,400 $ Cash paid for dividends (1,000) Net cash flow from financing activities 400 Net decrease in cash during the year (156) $ Cash at beginning of the year 5,051 Cash at end of the year 4,895 $ Cash flows related to the acquisition or sale of productive assets are shown in the investing section.
1-35 MAXIDRIVE CORP. Statement of Cash Flows For the Year Ended December 31, 2006 (in thousands of dollars) Cash flows from operating activities: Cash collected from customers 33,563 $ Cash paid to suppliers and employees (30,854) Cash paid for interest (450) Cash paid for taxes (1,190) Net cash flow from operating activities 1,069 $ Cash flow from investing activities: Cash paid to purchase equipment (1,625) $ Net cash flow from investing activities (1,625) Cash flow from financing activities: Cash received from bank loan 1,400 $ Cash paid for dividends (1,000) Net cash flow from financing activities 400 Net decrease in cash during the year (156) $ Cash at beginning of the year 5,051 Cash at end of the year 4,895 $ Cash flows from or to investors or creditors are shown in the financing section.
1-36 MAXIDRIVE CORP. Statement of Cash Flows For the Year Ended December 31, 2006 (in thousands of dollars) Cash flows from operating activities: Cash collected from customers 33,563 $ Cash paid to suppliers and employees (30,854) Cash paid for interest (450) Cash paid for taxes (1,190) Net cash flow from operating activities 1,069 $ Cash flow from investing activities: Cash paid to purchase equipment (1,625) $ Net cash flow from investing activities (1,625) Cash flow from financing activities: Cash received from bank loan 1,400 $ Cash paid for dividends (1,000) Net cash flow from financing activities 400 Net decrease in cash during the year (156) $ Cash at beginning of the year 5,051 Cash at end of the year 4,895 $ The statement ends with a reconciliation of Cash.
1-37 Relationship Among the Financial Statements MAXIDRIVE CORP. Income Statement For the Year Ended December 31, 2006 (in thousands of dollars) Revenues Sales revenue 37,436 $ Expenses Cost of goods sold 26,980 $ Selling, general and administrative 3,624 Research and development 1,982 Interest expense 450 Total expenses 33,036 Pretax income 4,400 $ Income tax expense 1,100 Net income 3,300 $ MAXIDRIVE CORP. Statement of Retained Earnings For the Year Ended December 31, 2006 (in thousands of dollars) Retained earnings, January 1, 2006 6,805 $ Net income for 2006 3,300 Dividends for 2006 (1,000) Retained earnings, December 31, 2006 9,105 $ Net income from the income statement increases ending retained earnings on the statement of retained earnings.
1-38 MAXIDRIVE CORP. Balance Sheet At December 31, 2006 (in thousands of dollars) Assets Cash 4,895 $ Accounts receivable 5,714 Inventories 8,517 Plant and equipment 7,154 Land 981 Total assets 27,261 $ Liabilities and Stockholders' Equity Liabilities Accounts payable 7,156 $ Notes payable 9,000 Total liabilities 16,156 $ Stockholders' Equity Contributed capital 2,000 $ Retained earnings 9,105 Total stockholders' equity 11,105 Total liabilities and stockholders' equity 27,261 $ MAXIDRIVE CORP. Statement of Retained Earnings For the Year Ended December 31, 2006 (in thousands of dollars) Retained earnings, January 1, 2006 6,805 $ Net income for 2006 3,300 Dividends for 2006 (1,000) Retained earnings, December 31, 2006 9,105 $ Relationship Among the Financial Statements Ending retained earnings from the statement of retained earnings is one of the components of stockholders’ equity on the balance sheet.
1-39 MAXIDRIVE CORP. Balance Sheet At December 31, 2006 (in thousands of dollars) Assets Cash 4,895 $ Accounts receivable 5,714 Inventories 8,517 Plant and equipment 7,154 Land 981 Total assets 27,261 $ Liabilities and Stockholders' Equity Liabilities Accounts payable 7,156 $ Notes payable 9,000 Total liabilities 16,156 $ Stockholders' Equity Contributed capital 2,000 $ Retained earnings 9,105 Total stockholders' equity 11,105 Total liabilities and stockholders' equity 27,261 $ Relationship Among the Financial Statements The change in cash on the statement of cash flows added to the beginning of the year balance in cash equals the ending balance in cash on the balance sheet. MAXIDRIVE CORP. Statement of Cash Flows For the Year Ended December 31, 2006 (in thousands of dollars) Cash flows from operating activities: Cash collected from customers 33,563 $ Cash paid to suppliers and employees (30,854) Cash paid for interest (450) Cash paid for taxes (1,190) Net cash flow from operating activities 1,069 $ Cash flow from investing activities: Cash paid to purchase equipment (1,625) $ Net cash flow from investing activities (1,625) Cash flow from financing activities: Cash received from bank loan 1,400 $ Cash paid for dividends (1,000) Net cash flow from financing activities 400 Net decrease in cash during the year (156) $ Cash at beginning of the year 5,051 Cash at end of the year 4,895 $
1-40 Notes Notes provide supplemental information about the financial condition of a company. Three basic types of notes: Description of accounting rules applied. Presentation of additional detail about an item on the financial statements. Provide additional information about an item not on the financial statements.
1-41 Management Uses of Financial Statements Marketing managers and credit managers use customers’ financial statements to decide whether to extend credit. Purchasing managers use suppliers’ financial statements to decide whether suppliers have the resources to meet our demand for products. Employees’ union and human resource managers use the company’s financial statements as a basis for contract negotiations over pay rates.
1-42 Price/Earnings Ratio Price/Earnings Ratio = Market Price (of the Company) Net Income This ratio is one method for estimating the value of a company.
1-43 Learning Objectives Identify the role of generally accepted accounting principles (GAAP) in determining the content of financial statements.
1-44 Decision makers need to understand accounting measurement rules. Responsibilities for the Accounting Communication Process Effective communication means that the recipient understands what the sender intends to convey.
1-45 How are Generally Accepted Accounting Principles Determined? Our accounting system has a long and distinguished history. An Italian monk named Luca Pacioli, published the first elements of double- entry bookkeeping in 1494. Prior to 1933, the management of most companies were free to choose the accounting principles used to keep track of its transactions.
1-46 The Securities and Exchange Commission (SEC) has been given broad powers to determine measurement rules for financial statements. Securities Act of 1933 Securities and Exchange Act of 1934 Generally Accepted Accounting Principles (GAAP)
1-47 Generally Accepted Accounting Principles (GAAP) Currently, the Financial Accounting Standards Board (FASB) is recognized as the body to formulate GAAP. The SEC has worked closely with the accounting profession to work out the detailed rules that have become known as GAAP.
1-48 Generally Accepted Accounting Principles (GAAP) Companies incur the cost of preparing the financial statements and bear the following economic consequences . . .  Effects on the selling price of stock.  Effects on the amount of bonuses received by managers and other employees.  Loss of competitive information to other companies.
1-49 International Perspective Since 2002, there has been substantial movement to develop international financial reporting standards by the International Accounting Standards Board (IASB).
1-50 Learning Objectives Distinguish the roles of managers and auditors in the accounting communication process.
1-51 To ensure the accuracy of the company’s financial information, management:  Maintains a system of controls.  Hires outside independent auditors.  Forms a board of directors to review these two safeguards. Management Responsibility and the Demand for Auditing
1-52 Independent Auditors  Auditors express an opinion as to the fairness of the financial statement presentation.  Independent auditors have responsibilities that extend to the general public. Overall, I believe these financial statements are fair.
1-53 Independent Auditors An audit involves . . .  Examining the financial reports to ensure compliance with GAAP.  Examining the underlying transactions incorporated into the financial statements.  Expressing an opinion as to the fairness of presentation of financial information.
1-54 Learning Objectives Appreciate the importance of ethics, reputation, and legal liability in accounting.
1-55 Ethics, Reputation, and Legal Liability The American Institute of Certified Public Accountants requires that all members adhere to a professional code of ethics.
1-56 A CPA’s reputation for honesty and competence is his/her most important asset. Like physicians, CPAs have liability for malpractice. Ethics, Reputation, and Legal Liability
1-57 End of Chapter 1

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chapter_01.ppt

  • 1.
    Copyright © 2007by The McGraw-Hill Companies, Inc. All rights reserved.
  • 2.
    Copyright © 2007by The McGraw-Hill Companies, Inc. All rights reserved. Financial Statements and Business Decisions Chapter 1
  • 3.
    1-3 Understanding the Business Owner-Managers Foundersof the business who also function as managers are called Owner- Mangers. Creditors Creditors lend money for a specific period of time and gain by charging interest on the money they lend. Investors Investors buy ownership in the company in the form of stock.
  • 4.
    1-4 Understanding the Business Investorspurchase stock (or ownership) in businesses hoping to gain in two ways: Sell ownership interest in the future for more than they paid. Receive a portion of the company’s earnings in cash (dividends).
  • 5.
    1-5 The Business Operations Manufacturerseither make the parts needed to produce its products or buy the parts from suppliers. Manufacturer Final Product Customer
  • 6.
    1-6 Learning Objectives Recognize theinformation conveyed in each of the four basic financial statements and the way that it is used by different decision makers (investors, creditors, and managers).
  • 7.
    1-7 The Accounting System Collectsand processes financial information Reports information to decision makers Managers (internal decision makers) Investors and Creditors (external decision makers)
  • 8.
    1-8 The Accounting System AccountingSystem Financial Accounting System Periodic financial statements and related disclosures Managerial Accounting System Detailed plans and continuous performance reports External Decision Makers Investors, creditors, suppliers, customers, etc. Internal Decision Makers Managers throughout the organization
  • 9.
    1-9 The Four BasicFinancial Statements Income Statement Balance Sheet Statement of Cash Flows Statement of Retained Earnings Financial statements summarize the financial activities of the business.
  • 10.
    1-10 The Four BasicFinancial Statements Companies can prepare financial statements at the end of the year, quarter or month. Financial statements prepared at the end of the year are called annual reports.
  • 11.
  • 12.
    1-12 MAXIDRIVE CORP. Balance Sheet AtDecember 31, 2006 (in thousands of dollars) Assets Cash 4,895 $ Accounts receivable 5,714 Inventories 8,517 Plant and equipment 7,154 Land 981 Total assets 27,261 $ Liabilities and Stockholders' Equity Liabilities Accounts payable 7,156 $ Notes payable 9,000 Total liabilities 16,156 $ Stockholders' Equity Contributed capital 2,000 $ Retained earnings 9,105 Total stockholders' equity 11,105 Total liabilities and stockholders' equity 27,261 $ 1. Name of entity 2. Title of statement 3. Specific date 4. Unit of measure The Balance Sheet reports the financial position of an entity at a particular point in time.
  • 13.
    1-13 The Balance Sheet BasicAccounting Equation Assets = Liabilities + Stockholders’ Equity Economic Resources Sources of Financing for Economic Resources
  • 14.
    1-14 MAXIDRIVE CORP. Balance Sheet AtDecember 31, 2006 (in thousands of dollars) Assets Cash 4,895 $ Accounts receivable 5,714 Inventories 8,517 Plant and equipment 7,154 Land 981 Total assets 27,261 $ Liabilities and Stockholders' Equity Liabilities Accounts payable 7,156 $ Notes payable 9,000 Total liabilities 16,156 $ Stockholders' Equity Contributed capital 2,000 $ Retained earnings 9,105 Total stockholders' equity 11,105 Total liabilities and stockholders' equity 27,261 $ Assets are listed by their ease of conversion into cash. Cash Amount of cash in the company’s bank accounts. Accounts receivable Amounts owed by customers from prior sales. Inventories Parts and completed but unsold products. Plant and equipment Factories and production machinery. Land Land on which factories are built. Assets are economic resources owned by the business as a result of past transactions.
  • 15.
    1-15 MAXIDRIVE CORP. Balance Sheet AtDecember 31, 2006 (in thousands of dollars) Assets Cash 4,895 $ Accounts receivable 5,714 Inventories 8,517 Plant and equipment 7,154 Land 981 Total assets 27,261 $ Liabilities and Stockholders' Equity Liabilities Accounts payable 7,156 $ Notes payable 9,000 Total liabilities 16,156 $ Stockholders' Equity Contributed capital 2,000 $ Retained earnings 9,105 Total stockholders' equity 11,105 Total liabilities and stockholders' equity 27,261 $ Liabilities are debts or obligations of the business that result from past transactions. Accounts payable Amounts owed to suppliers for prior purchases. Notes payable Amounts owed on written debt contracts.
  • 16.
    1-16 MAXIDRIVE CORP. Balance Sheet AtDecember 31, 2006 (in thousands of dollars) Assets Cash 4,895 $ Accounts receivable 5,714 Inventories 8,517 Plant and equipment 7,154 Land 981 Total assets 27,261 $ Liabilities and Stockholders' Equity Liabilities Accounts payable 7,156 $ Notes payable 9,000 Total liabilities 16,156 $ Stockholders' Equity Contributed capital 2,000 $ Retained earnings 9,105 Total stockholders' equity 11,105 Total liabilities and stockholders' equity 27,261 $ Contributed capital Amounts invested in the business by stockholders. Retained earnings Past earnings not distributed to stockholders. Equity is the amount of financing provided by owners of the business and earnings.
  • 17.
    1-17 MAXIDRIVE CORP. Balance Sheet AtDecember 31, 2006 (in thousands of dollars) Assets Cash 4,895 $ Accounts receivable 5,714 Inventories 8,517 Plant and equipment 7,154 Land 981 Total assets 27,261 $ Liabilities and Stockholders' Equity Liabilities Accounts payable 7,156 $ Notes payable 9,000 Total liabilities 16,156 $ Stockholders' Equity Contributed capital 2,000 $ Retained earnings 9,105 Total stockholders' equity 11,105 Total liabilities and stockholders' equity 27,261 $ Use $ on the first item in a group and on the group total. Assets = Liabilities + Stockholders’ Equity
  • 18.
    1-18 MAXIDRIVE CORP. Income Statement Forthe Year Ended December 31, 2006 (in thousands of dollars) Revenues Sales revenue 37,436 $ Expenses Cost of goods sold 26,980 $ Selling, general and administrative 3,624 Research and development 1,982 Interest expense 450 Total expenses 33,036 Pretax income 4,400 $ Income tax expense 1,100 Net income 3,300 $ 1. Name of entity 2. Title of statement 3. Specific period of time (Unlike the balance sheet, this statement covers a specified period of time.) 4. Unit of measure
  • 19.
    1-19 MAXIDRIVE CORP. Income Statement Forthe Year Ended December 31, 2006 (in thousands of dollars) Revenues Sales revenue 37,436 $ Expenses Cost of goods sold 26,980 $ Selling, general and administrative 3,624 Research and development 1,982 Interest expense 450 Total expenses 33,036 Pretax income 4,400 $ Income tax expense 1,100 Net income 3,300 $ The Income Statement reports the revenues minus expenses of the accounting period.
  • 20.
    1-20 MAXIDRIVE CORP. Income Statement Forthe Year Ended December 31, 2006 (in thousands of dollars) Revenues Sales revenue 37,436 $ Expenses Cost of goods sold 26,980 $ Selling, general and administrative 3,624 Research and development 1,982 Interest expense 450 Total expenses 33,036 Pretax income 4,400 $ Income tax expense 1,100 Net income 3,300 $ Revenues are earnings from the sale of goods or services to customers. Revenue is recognized in the period in which goods and services are sold, not necessarily the period in which cash is received.
  • 21.
    1-21 Revenues June 2006 Cash fromsale collected on June 10th. X May 2006 $1,000 sale made on May 25th. X When will the revenue from this transaction be recognized? Earnings from the sale of goods or services.
  • 22.
    1-22 Revenues Earnings from thesale of goods or services. When will the revenue from this transaction be recognized? May 2006 $1,000 sale made on May 25th. X
  • 23.
    1-23 MAXIDRIVE CORP. Income Statement Forthe Year Ended December 31, 2003 (in thousands of dollars) Revenues Sales revenue 37,436 $ Expenses Cost of goods sold 26,980 $ Selling, general and administrative 3,624 Research and development 1,982 Interest expense 450 Total expenses 33,036 Pretax income 4,400 $ Income tax expense 1,100 Net income 3,300 $ Expenses are the dollar amount of resources used up by the entity to earn revenues during a period. An expense is recognized in the period in which goods and services are used, not necessarily the period in which cash is paid.
  • 24.
    1-24 MAXIDRIVE CORP. Income Statement Forthe Year Ended December 31, 2006 (in thousands of dollars) Revenues Sales revenue 37,436 $ Expenses Cost of goods sold 26,980 $ Selling, general and administrative 3,624 Research and development 1,982 Interest expense 450 Total expenses 33,036 Pretax income 4,400 $ Income tax expense 1,100 Net income 3,300 $ Cost of goods sold The cost to produce products sold this period. Selling, general and administrative Operating expenses not directly related to production. Research and development Expenses incurred to develop new products. Interest expense The cost of using borrowed funds. Income tax expense Income taxes on current period’s pretax income.
  • 25.
    1-25 Expenses May 2006 June2006 May 11 paid $75 cash for newspaper ad. X Ad appears on June 8th. X The dollar amount of resources used up by the entity to earn revenues during a period. When will the expense for this transaction be recognized?
  • 26.
    1-26 Expenses Advertising expense recorded inJune. The dollar amount of resources used up by the entity to earn revenues during a period. When will the expense for this transaction be recognized? June 2006 X
  • 27.
    1-27 MAXIDRIVE CORP. Income Statement Forthe Year Ended December 31, 2006 (in thousands of dollars) Revenues Sales revenue 37,436 $ Expenses Cost of goods sold 26,980 $ Selling, general and administrative 3,624 Research and development 1,982 Interest expense 450 Total expenses 33,036 Pretax income 4,400 $ Income tax expense 1,100 Net income 3,300 $ If expenses exceed revenues, we report net loss.
  • 28.
    1-28 MAXIDRIVE CORP. Statement ofRetained Earnings For the Year Ended December 31, 2006 (in thousands of dollars) Retained earnings, January 1, 2006 6,805 $ Net income for 2006 3,300 Dividends for 2006 (1,000) Retained earnings, December 31, 2006 9,105 $ 1. Name of entity 2. Title of statement 3. Specific period of time (Like the income statement, this statement covers a specified period of time.) 4. Unit of measure
  • 29.
    1-29 The Statement ofRetained Earnings reports the way that net income and the distribution of dividends affect the financial position of the company during a period. MAXIDRIVE CORP. Statement of Retained Earnings For the Year Ended December 31, 2006 (in thousands of dollars) Retained earnings, January 1, 2006 6,805 $ Net income for 2006 3,300 Dividends for 2006 (1,000) Retained earnings, December 31, 2006 9,105 $
  • 30.
    1-30 Statement of CashFlows Because revenues reported do not always equal cash collected. . . . . . and expenses reported do not always equal cash paid . . . net income is usually not equal to the change in cash for the period.
  • 31.
    1-31 MAXIDRIVE CORP. Statement ofCash Flows For the Year Ended December 31, 2006 (in thousands of dollars) Cash flows from operating activities: Cash collected from customers 33,563 $ Cash paid to suppliers and employees (30,854) Cash paid for interest (450) Cash paid for taxes (1,190) Net cash flow from operating activities 1,069 $ Cash flow from investing activities: Cash paid to purchase equipment (1,625) $ Net cash flow from investing activities (1,625) Cash flow from financing activities: Cash received from bank loan 1,400 $ Cash paid for dividends (1,000) Net cash flow from financing activities 400 Net decrease in cash during the year (156) $ Cash at beginning of the year 5,051 Cash at end of the year 4,895 $ 1. Name of entity 2. Title of statement 3. Specific period of time (Like the income statement, this statement covers a specified period of time.) 4. Unit of measure
  • 32.
    1-32 MAXIDRIVE CORP. Statement ofCash Flows For the Year Ended December 31, 2006 (in thousands of dollars) Cash flows from operating activities: Cash collected from customers 33,563 $ Cash paid to suppliers and employees (30,854) Cash paid for interest (450) Cash paid for taxes (1,190) Net cash flow from operating activities 1,069 $ Cash flow from investing activities: Cash paid to purchase equipment (1,625) $ Net cash flow from investing activities (1,625) Cash flow from financing activities: Cash received from bank loan 1,400 $ Cash paid for dividends (1,000) Net cash flow from financing activities 400 Net decrease in cash during the year (156) $ Cash at beginning of the year 5,051 Cash at end of the year 4,895 $ The Statement of Cash Flows reports the inflows and outflows of cash during the period in the categories of operating, investing, and financing.
  • 33.
    1-33 MAXIDRIVE CORP. Statement ofCash Flows For the Year Ended December 31, 2006 (in thousands of dollars) Cash flows from operating activities: Cash collected from customers 33,563 $ Cash paid to suppliers and employees (30,854) Cash paid for interest (450) Cash paid for taxes (1,190) Net cash flow from operating activities 1,069 $ Cash flow from investing activities: Cash paid to purchase equipment (1,625) $ Net cash flow from investing activities (1,625) Cash flow from financing activities: Cash received from bank loan 1,400 $ Cash paid for dividends (1,000) Net cash flow from financing activities 400 Net decrease in cash during the year (156) $ Cash at beginning of the year 5,051 Cash at end of the year 4,895 $ Cash flows directly related to earning income are shown in the operating section.
  • 34.
    1-34 MAXIDRIVE CORP. Statement ofCash Flows For the Year Ended December 31, 2006 (in thousands of dollars) Cash flows from operating activities: Cash collected from customers 33,563 $ Cash paid to suppliers and employees (30,854) Cash paid for interest (450) Cash paid for taxes (1,190) Net cash flow from operating activities 1,069 $ Cash flow from investing activities: Cash paid to purchase equipment (1,625) $ Net cash flow from investing activities (1,625) Cash flow from financing activities: Cash received from bank loan 1,400 $ Cash paid for dividends (1,000) Net cash flow from financing activities 400 Net decrease in cash during the year (156) $ Cash at beginning of the year 5,051 Cash at end of the year 4,895 $ Cash flows related to the acquisition or sale of productive assets are shown in the investing section.
  • 35.
    1-35 MAXIDRIVE CORP. Statement ofCash Flows For the Year Ended December 31, 2006 (in thousands of dollars) Cash flows from operating activities: Cash collected from customers 33,563 $ Cash paid to suppliers and employees (30,854) Cash paid for interest (450) Cash paid for taxes (1,190) Net cash flow from operating activities 1,069 $ Cash flow from investing activities: Cash paid to purchase equipment (1,625) $ Net cash flow from investing activities (1,625) Cash flow from financing activities: Cash received from bank loan 1,400 $ Cash paid for dividends (1,000) Net cash flow from financing activities 400 Net decrease in cash during the year (156) $ Cash at beginning of the year 5,051 Cash at end of the year 4,895 $ Cash flows from or to investors or creditors are shown in the financing section.
  • 36.
    1-36 MAXIDRIVE CORP. Statement ofCash Flows For the Year Ended December 31, 2006 (in thousands of dollars) Cash flows from operating activities: Cash collected from customers 33,563 $ Cash paid to suppliers and employees (30,854) Cash paid for interest (450) Cash paid for taxes (1,190) Net cash flow from operating activities 1,069 $ Cash flow from investing activities: Cash paid to purchase equipment (1,625) $ Net cash flow from investing activities (1,625) Cash flow from financing activities: Cash received from bank loan 1,400 $ Cash paid for dividends (1,000) Net cash flow from financing activities 400 Net decrease in cash during the year (156) $ Cash at beginning of the year 5,051 Cash at end of the year 4,895 $ The statement ends with a reconciliation of Cash.
  • 37.
    1-37 Relationship Among theFinancial Statements MAXIDRIVE CORP. Income Statement For the Year Ended December 31, 2006 (in thousands of dollars) Revenues Sales revenue 37,436 $ Expenses Cost of goods sold 26,980 $ Selling, general and administrative 3,624 Research and development 1,982 Interest expense 450 Total expenses 33,036 Pretax income 4,400 $ Income tax expense 1,100 Net income 3,300 $ MAXIDRIVE CORP. Statement of Retained Earnings For the Year Ended December 31, 2006 (in thousands of dollars) Retained earnings, January 1, 2006 6,805 $ Net income for 2006 3,300 Dividends for 2006 (1,000) Retained earnings, December 31, 2006 9,105 $ Net income from the income statement increases ending retained earnings on the statement of retained earnings.
  • 38.
    1-38 MAXIDRIVE CORP. Balance Sheet AtDecember 31, 2006 (in thousands of dollars) Assets Cash 4,895 $ Accounts receivable 5,714 Inventories 8,517 Plant and equipment 7,154 Land 981 Total assets 27,261 $ Liabilities and Stockholders' Equity Liabilities Accounts payable 7,156 $ Notes payable 9,000 Total liabilities 16,156 $ Stockholders' Equity Contributed capital 2,000 $ Retained earnings 9,105 Total stockholders' equity 11,105 Total liabilities and stockholders' equity 27,261 $ MAXIDRIVE CORP. Statement of Retained Earnings For the Year Ended December 31, 2006 (in thousands of dollars) Retained earnings, January 1, 2006 6,805 $ Net income for 2006 3,300 Dividends for 2006 (1,000) Retained earnings, December 31, 2006 9,105 $ Relationship Among the Financial Statements Ending retained earnings from the statement of retained earnings is one of the components of stockholders’ equity on the balance sheet.
  • 39.
    1-39 MAXIDRIVE CORP. Balance Sheet AtDecember 31, 2006 (in thousands of dollars) Assets Cash 4,895 $ Accounts receivable 5,714 Inventories 8,517 Plant and equipment 7,154 Land 981 Total assets 27,261 $ Liabilities and Stockholders' Equity Liabilities Accounts payable 7,156 $ Notes payable 9,000 Total liabilities 16,156 $ Stockholders' Equity Contributed capital 2,000 $ Retained earnings 9,105 Total stockholders' equity 11,105 Total liabilities and stockholders' equity 27,261 $ Relationship Among the Financial Statements The change in cash on the statement of cash flows added to the beginning of the year balance in cash equals the ending balance in cash on the balance sheet. MAXIDRIVE CORP. Statement of Cash Flows For the Year Ended December 31, 2006 (in thousands of dollars) Cash flows from operating activities: Cash collected from customers 33,563 $ Cash paid to suppliers and employees (30,854) Cash paid for interest (450) Cash paid for taxes (1,190) Net cash flow from operating activities 1,069 $ Cash flow from investing activities: Cash paid to purchase equipment (1,625) $ Net cash flow from investing activities (1,625) Cash flow from financing activities: Cash received from bank loan 1,400 $ Cash paid for dividends (1,000) Net cash flow from financing activities 400 Net decrease in cash during the year (156) $ Cash at beginning of the year 5,051 Cash at end of the year 4,895 $
  • 40.
    1-40 Notes Notes provide supplemental informationabout the financial condition of a company. Three basic types of notes: Description of accounting rules applied. Presentation of additional detail about an item on the financial statements. Provide additional information about an item not on the financial statements.
  • 41.
    1-41 Management Uses ofFinancial Statements Marketing managers and credit managers use customers’ financial statements to decide whether to extend credit. Purchasing managers use suppliers’ financial statements to decide whether suppliers have the resources to meet our demand for products. Employees’ union and human resource managers use the company’s financial statements as a basis for contract negotiations over pay rates.
  • 42.
    1-42 Price/Earnings Ratio Price/Earnings Ratio= Market Price (of the Company) Net Income This ratio is one method for estimating the value of a company.
  • 43.
    1-43 Learning Objectives Identify therole of generally accepted accounting principles (GAAP) in determining the content of financial statements.
  • 44.
    1-44 Decision makers needto understand accounting measurement rules. Responsibilities for the Accounting Communication Process Effective communication means that the recipient understands what the sender intends to convey.
  • 45.
    1-45 How are GenerallyAccepted Accounting Principles Determined? Our accounting system has a long and distinguished history. An Italian monk named Luca Pacioli, published the first elements of double- entry bookkeeping in 1494. Prior to 1933, the management of most companies were free to choose the accounting principles used to keep track of its transactions.
  • 46.
    1-46 The Securities andExchange Commission (SEC) has been given broad powers to determine measurement rules for financial statements. Securities Act of 1933 Securities and Exchange Act of 1934 Generally Accepted Accounting Principles (GAAP)
  • 47.
    1-47 Generally Accepted AccountingPrinciples (GAAP) Currently, the Financial Accounting Standards Board (FASB) is recognized as the body to formulate GAAP. The SEC has worked closely with the accounting profession to work out the detailed rules that have become known as GAAP.
  • 48.
    1-48 Generally Accepted AccountingPrinciples (GAAP) Companies incur the cost of preparing the financial statements and bear the following economic consequences . . .  Effects on the selling price of stock.  Effects on the amount of bonuses received by managers and other employees.  Loss of competitive information to other companies.
  • 49.
    1-49 International Perspective Since 2002,there has been substantial movement to develop international financial reporting standards by the International Accounting Standards Board (IASB).
  • 50.
    1-50 Learning Objectives Distinguish theroles of managers and auditors in the accounting communication process.
  • 51.
    1-51 To ensure theaccuracy of the company’s financial information, management:  Maintains a system of controls.  Hires outside independent auditors.  Forms a board of directors to review these two safeguards. Management Responsibility and the Demand for Auditing
  • 52.
    1-52 Independent Auditors  Auditorsexpress an opinion as to the fairness of the financial statement presentation.  Independent auditors have responsibilities that extend to the general public. Overall, I believe these financial statements are fair.
  • 53.
    1-53 Independent Auditors An auditinvolves . . .  Examining the financial reports to ensure compliance with GAAP.  Examining the underlying transactions incorporated into the financial statements.  Expressing an opinion as to the fairness of presentation of financial information.
  • 54.
    1-54 Learning Objectives Appreciate theimportance of ethics, reputation, and legal liability in accounting.
  • 55.
    1-55 Ethics, Reputation, andLegal Liability The American Institute of Certified Public Accountants requires that all members adhere to a professional code of ethics.
  • 56.
    1-56 A CPA’s reputationfor honesty and competence is his/her most important asset. Like physicians, CPAs have liability for malpractice. Ethics, Reputation, and Legal Liability
  • 57.