chapter 7 preparing financial statements and analyzing business transactions
TRANSCRIPT
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Chapter 7
Preparing Financial Statements and Analyzing Business Transactions
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Objectives
Understand financial reporting
Understand four Financial Statements
Understand Notes to Financial Statements
Analyze transactions! –prepare a worksheet
Ratios
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Financial Reporting
The Process of preparing and presenting financial information, to include:
The four financial statements:
Income Statement
Statement of Changes in Shareholders’ Equity
Balance Sheet
Statement of Cash Flows
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The Financial Accounting Standards Board
Establishes the guidelines for financial statements.
These broad principles are referred to as Generally Accepted Accounting Principles.
The goal is to increase the quality and usefulness of the information
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It takes good information
To make good decisions
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Is the Information Useful?
It must be capable of making a
difference in the decision making
process
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Qualities of Accounting Information
Information is only good if it is:
Relevant
Reliable
Comparable
Consistent
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Relevant Information is….
Important to the company Has the potential to
influence decisions
Provided on a timely basis
“I hear that our neighbor is selling
their land”
“We would be able to expand
our operations…”
“Someone else bought it this morning ”
“No longer relevant”
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Reliable Information is….
Neutral
Verifiable
And independent of the specific person who prepared it
“Is this information
accurate and free of bias?”
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Comparable Information
Each company has prepared its information using the same set of rules
Allows meaningful comparisons of two companies
“Are we doing better or worse than they are?
Why?
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Consistent Information
The company uses the same set of rules from year to year
Allows meaningful comparisons of a company’s performance at two points in time
“How are we doing this year
versus last year?
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Take a closer look at the Balance Sheet
Adding Subtotals to the Balance Sheet is called Classifying the Balance Sheet
These subtotals allow the reader to make decisions as to the type, amount and the timing of item under review
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Current Assets
Current Assets are those that will be converted to cash or used in the next 12 months
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Non-Current Assets
Non-Current Assets (also called Plant Assets) are those that will be Not Be converted to cash or used in the next 12 months
Non-Current Assets will not be used in the next 12 months
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Current Liabilities
Current Liabilities are those that will be paid off or worked off in the next 12 months
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CURRENT RATIO
= Current Assets/Current Liabilities
What does THIS mean????
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Non-Current Liabilities
Non-Current Liabilities are those that will Not Be paid off or worked off in the next 12 months
Non-Current Liabilities will not be paid off in the next 12 months
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Stockholders’ Equity
Is the Residual Claim on the Net Assets of the Corporation, after the claims of creditors have been satisfied.
Contributed Capital represents the investment by the stockholders
Retained Earnings represents the cumulative (lifetime) profitability of the corporation less dividends
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Transaction Analysis – in simplest terms
Is the process of Analyzing the impact a transaction has on the Accounting Equation
1) Did the transaction change the amount of Assets?
2) Did the transaction change the amount of Liabilities?
3) If the change in Assets does not equal the change in Liabilities, evaluate the impact on Equity.
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If Shareholder’s Equity changed…
Either the Income Statement or Statement of Shareholders’ Equity will be affected
If the transaction is between the business and non-owners, it is an Income Statement transaction.
If the transaction is between the business and its owners, it is a Statement of Shareholders’ Equity transaction
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A really big example. . .
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Let’s try it….
This transaction increases Assets and Contributed Capital by $2,000.
$2,000 $2,000
Transactions in January
1) Clint and some of his friends contribute $2,000 to start the business.
This transaction affects the Balance Sheet and the Statement of Changes in Shareholders’ Equity
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2) Clint’s Consulting Company borrows $4,000 from a local bank. The loan will be repaid in six months.
This transaction increases Assets and Liabilities by $4,000.
Transactions that don’t change Equity only affect the Balance Sheet
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3) The firm spends $1,400 cash for operating expenses.
This transaction decreases Assets and Shareholders’ Equity by $1,400.
Cash will be reduced on the Balance Sheet and Operating Expenses will reduce Income on the Income Statement.
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4) Clint’s Consulting acquires office equipment at a cost of $5,000 for cash.
This transaction Increases the Asset – Office Equipment, and decreases another Asset - Cash by $5,000.
This transaction is restricted to the Balance Sheet
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5) Clint’s earned $6,000 for service revenue, all paid in cash by clients.
This transaction Increases the Asset – Cash, and increases the Retained Earnings portion of Shareholders’ Equity by $6,000.
This transaction increases Assets on the Balance Sheet, and Net Income on the Income Statement.
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6) Clint’s Consulting paid $20 interest to the bank.
This transaction Decreases the Asset – Cash, and decreases the Retained Earnings portion of Shareholders’ Equity by $20.
This transaction decreases Assets on the Balance Sheet, and Net Income on the Income Statement.
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The totals are used to create the financial statements.
The Revenues and Expenses will be reported on the Income Statement
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Income Statement
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Statement of Shareholders’ Equity
Transferred from the Income Statement
This amount is transferred to the Balance Sheet
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Balance Sheet
From the Statement of Shareholders’ Equity
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Assumptions and Principles underlying financial reporting
Assumptions: Separate Entity Assumption Monetary Unit Assumption Time-period Assumption Going-Concern Assumption
Principles: Historical Cost Principle Revenue Recognition Principle Matching Principle
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Separate Entity Assumption
Financial Statements of a business only contain information about that firm
Exclude transactions of the owners
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Monetary Unit Assumption
Only items that can be expressed in monetary units (dollars in the United States)
Will be included in the Financial Statements
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Time-Period Assumption
The life of a business can be divided into artificial time periods for financial reporting
These time periods are presented at the top of each financial statement
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Going-Concern Assumption
A company will remain in business for the foreseeable future
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Historical Cost Principle
Assets are recorded on the Balance Sheet at cost
Cost includes all costs necessary to get the asset ready for its intended purpose $5,000
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Revenue Recognition Principle
Revenues are recorded on the Income Statement
When the earnings process is complete
And the amount is reasonably assured
Generally at the time the goods or services are provided
$6,000 of consulting work was performed in the month of January
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Matching Principle
Expenses are recorded on the Income Statement
In the Same Time Period
As the Revenue they helped Generate
$1,420 of expenses were incurred to generate the $6,000 of revenues
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Accrual-Basis Accounting
Revenues and Expenses are recorded on the Income Statement
At the time the economic activity occurs
Regardless of cash flow
$6,000 Revenue = Total work done in January for Cash and Credit Customers
$1,420 Expense = Total costs incurred in January whether paid in Cash or with credit
$4,580 Net Income = growth in total asset base, not necessarily growth in Cash.
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EARNINGS PER SHARE
= Net Income/Average Shares of Stock
What does it mean???
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End – Chapter 7
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Statement of Cash Flows