Chapter 2 Mc GrawHillIrwin BASIC FINANCIAL STATEMENTS The

Chapter 2 Mc. Graw-Hill/Irwin BASIC FINANCIAL STATEMENTS © The Mc. Graw-Hill Companies, Inc. , 2002

Previous Lecture • Accounting information is for decision maker which enable them to make economic activities. • Types of business • Types of organizations & theirs plus & minus • Business Stakeholders Internal : Owners, managers, employees External: Customers, creditors, government Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2002

• Types of Accounting Information Financial, Managerial, Tax • Types of Business Activities Financing, Investing, Operating • Types of Financial Statement of earnings Statement of retained earnings Balance sheet Cash flow statement Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2002

Conceptual Framework of Accounting • Guides choices about – what to present in financial statements – decisions about alternative ways of reporting economic events – the selection of appropriate ways of communicating such information Chapter 2 Mc. Graw-Hill/Irwin 4 © The Mc. Graw-Hill Companies, Inc. , 2002

Conceptual Framework of Accounting • Four main sections – Objective of financial reporting – Qualitative characteristics of accounting information – Elements of financial statements – Recognition and measurement criteria Chapter 2 Mc. Graw-Hill/Irwin 5 © The Mc. Graw-Hill Companies, Inc. , 2002

Objective of Financial Reporting • To provide information that is useful to individuals who are making investment and credit decisions Chapter 2 Mc. Graw-Hill/Irwin 6 © The Mc. Graw-Hill Companies, Inc. , 2002

Qualitative Characteristics • To be useful for decision-making, information should have these qualitative characteristics – Relevance – Faithful representation – Comparability – Understandability Chapter 2 Mc. Graw-Hill/Irwin 7 © The Mc. Graw-Hill Companies, Inc. , 2002

Qualitative Characteristics of Accounting Information • Relevance – Information is relevant if it makes a difference in a decision. It is said to have predictive value, feedback value, and timeliness • Faithful representation – Information should reflect economic reality. It must be verifiable, neutral, and complete Chapter 2 Mc. Graw-Hill/Irwin 8 © The Mc. Graw-Hill Companies, Inc. , 2002

Qualitative Characteristics of Accounting Information • Comparability – Accounting information can be compared when companies with similar circumstances use the same accounting standards consistently from year to year • Understandability – Average user is assumed to understand the accounting information Chapter 2 Mc. Graw-Hill/Irwin 9 © The Mc. Graw-Hill Companies, Inc. , 2002

Elements of Financial Statements • • • Assets Liabilities Equity Revenues Expenses Chapter 2 Mc. Graw-Hill/Irwin 10 © The Mc. Graw-Hill Companies, Inc. , 2002

Recognition and Measurement Criteria • Accountants need detailed criteria to help them decide when and where an item is included in the financial statements. • Includes – Assumptions – Principles – Constraints Chapter 2 Mc. Graw-Hill/Irwin 11 © The Mc. Graw-Hill Companies, Inc. , 2002

Assumptions • • Monetary unit Economic entity Time period Going concern Chapter 2 Mc. Graw-Hill/Irwin 12 © The Mc. Graw-Hill Companies, Inc. , 2002

Monetary Unit Assumption • Only those things that can be expressed in terms of money should be included in the accounting records • Important presumption is that the monetary unit remains stable over time and the effects of inflation are nominal Chapter 2 Mc. Graw-Hill/Irwin 13 © The Mc. Graw-Hill Companies, Inc. , 2002

Economic Entity • Every economic entity can be separately identified and accounted for • Personal items relating to shareholders are not accounted for by the business Chapter 2 Mc. Graw-Hill/Irwin 14 © The Mc. Graw-Hill Companies, Inc. , 2002

Time Period Assumption • The economic life of a business can be divided into artificial time periods Mc. Graw-Hill/Irwin Chapter 2 15 © The Mc. Graw-Hill Companies, Inc. , 2002

Going Concern Assumption • The business will continue operating in the foreseeable future • Justifies the use of the cost principle Chapter 2 Mc. Graw-Hill/Irwin 16 © The Mc. Graw-Hill Companies, Inc. , 2002

Introduction to Financial Statements Companies prepare interim financial statements and annual financial statements 2000 X Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2002

Introduction to Financial Statements Balance Sheet Income Statement of Cash Flows Mc. Graw-Hill/Irwin Three primary financial statements. We will use a corporation to describe these statements. © The Mc. Graw-Hill Companies, Inc. , 2002

Introduction to Financial Statements Balance Sheet Income Statement of Cash Flows Mc. Graw-Hill/Irwin Describes where the enterprise stands at a specific date. © The Mc. Graw-Hill Companies, Inc. , 2002

Introduction to Financial Statements Balance Sheet Income Statement of Cash Flows Mc. Graw-Hill/Irwin Depicts the revenue and expenses for a designated period of time. © The Mc. Graw-Hill Companies, Inc. , 2002

Introduction to Financial Statements Revenues result in positive cash flow. Expenses result in negative cash flow. Either in the past, present, or future. Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2002

Introduction to Financial Statements Balance Sheet Income Statement of Cash Flows Mc. Graw-Hill/Irwin Net income (or net loss) is simply the difference between revenues and expenses. © The Mc. Graw-Hill Companies, Inc. , 2002

Introduction to Financial Statements Balance Sheet Income Statement of Cash Flows Mc. Graw-Hill/Irwin Depicts the ways cash has changed during a designated period of time. © The Mc. Graw-Hill Companies, Inc. , 2002

The Concept of the Business Entity Vagabond Travel Agency Mc. Graw-Hill/Irwin A business entity is separate from the personal affairs of its owner. © The Mc. Graw-Hill Companies, Inc. , 2002

A Starting Point: Statement of Financial Position Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2002

Assets are economic resources that are owned by the business and are expected to provide positive future cash flows. Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2002

Assets Cost Principle These accounting Stable-Dollar principles support Going-Concern Assumption cost as the basis for Assumption asset valuation. Objectivity Principle Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2002

Liabilities are debts that represent negative future cash flows for the enterprise. Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2002

Owners’ Equity Owners’ equity represents the owner’s claim to the assets of the business. Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2002

Owners’ Equity Changes in Owners’ Equity • Owners’ Investments • Payments to Owners • Business Earnings • Business Losses Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2002

End of Todays session Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2002