introduction to financial statements and other financial reporting topics chapter 2 © 2011 cengage...

Introduction to Financial Statements and Other

Financial Reporting Topics

Chapter 2

© 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter 2, Slide #2

Sole Proprietorship Partnership Corporation

Number of owners 1 2 or more (partners)

Numerous (shareholders)

Legally separate from owners

No No Yes

Owners liable for business debts

Yes Yes No

Profits taxable To the owner To the owners

To the corporation as

earnings; to the owners

when dividends are received

Modified form

“LLC” limits liability of owner; may

increase income tax exposure

“Subchapter S” profits are

taxed at ownership level

only

Forms of Business Entities


Chapter 2, Slide #3

• Income statement• Statement of stockholders’ equity• Balance sheet• Statement of cash flows• Support for the financial statements is

provided by notes

The Financial Statements


Chapter 2, Slide #4

• Dated for a specific period

• Summarizes revenues and expenses

• Reports net income– Excess of revenues

over expense

• Net income increases retained earnings

Income StatementFor the Year Ended Dec. 31, 2011

Revenue $ 120,000Expenses (100,000)Net Income $ 20,000

Income Statement


Chapter 2, Slide #5

Income StatementFor Year Ending December 31, 2011

Revenue $ 120,000Expenses (100,000)Net Income $ 20,000 Statement of Stockholders’ Equity

For Year Ending December 31, 2011

Capt. Stk. Ret. Earn.Beginning Balance $40,000 $ 25,000Issue stock 10,000Net income 20,000Dividends (10,000)Ending Balance $50,000 $ 35,000

• Dated for a specific period

• Reconciles beginning and ending balances of the stockholders’ equity accounts– Capital Stock– Retained Earnings– Etc.

• Links the income statement and the balance sheet

Statement of Stockholders’ Equity


Chapter 2, Slide #6

Shows the financial condition of an entity as of a particular date

– Assets: the resources of the business

– Liabilities: the debts of the business

– Equity: the owners’ interest in the business

The Accounting Equation:Assets = Liabilities +

Stockholders’ Equity

Assets = Liabilities +Capital Stock +Retained Earnings

Balance SheetAssets $110,000Liabilities 25,000Stockholders’ Equity

Capital Stock 50,000Retained Earnings 35,000

Tot Liab. & Equity $110,000

Income StatementRevenue $ 120,000Expenses (100,000)Net Income $ 20,000Statement of Stockholders’ Equity

Capt. Stk. Ret. Earn.Beginning Balance $40,000 $ 25,000Issue stock 10,000Net income 20,000Dividends (10,000)Ending Balance $50,000 $ 35,000

Statement of Stockholders’ Equity


Chapter 2, Slide #7

• Covers the same period as the income statement

• Three sections– Cash flows from operating activities– Cash flows from investing activities– Cash flows from financing activities

Statement of Cash Flows


Chapter 2, Slide #8

• An integral part of the financial statements• Required presentation

– Summary of significant accounting policies– Contingent liabilities– Subsequent events relating to conditions that

existed at the balance sheet date• Disclose and adjustment of the financial statements

– Subsequent events relating to conditions that did not exist at the balance sheet date

• Disclosure but no adjustment of the financial statements

Notes


Chapter 2, Slide #9

1. Recording transactions

2. Recording adjusting entries

3. Preparing the financial statement

The Accounting Cycle


Chapter 2, Slide #10

• Internal or external event that causes a change in a company’s assets, liabilities, or stockholders’ equity

• Recorded in a journal (journal entry)• Posted to general ledger accounts• Double-entry system

Debit: left side of an accountCredit: right side of an accountDebits = Credits

Account Title

Debit Credit

Recording Transactions



Permanent Temporary

Account types

AssetsLiabilitiesEquity

Revenues, Gains Expenses, Losses Dividends

Balances Carry forward to the next fiscal period

Closed to retained earnings at year-end

Represent the accounting equation

Accounting System Components



• Required by the accrual basis of accounting• Prepared at the end of the fiscal period• Records (recognizes) for the current period

– Expenses incurred– Revenues earned

• Recorded in the general journal• Posted to the general ledger

Accounting System Components



• The output of the accounting system• Based on the adjusted general ledger

account balances• Directly from the general ledger

– Income statement– Balance sheet

• From analysis of general ledger accounts– Statement of cash flows

Preparing the Financial Statements



• Voluntary private sector organization (Treadway)• Committee of Sponsoring Organizations (COSO)

– Internal control reports– Standard framework for evaluating internal control

• Need for internal control emphasized by– Sarbanes-Oxley Act §404– Management's Report on Internal Control– Independent auditor’s opinion on management’s

assessment of internal control

Treadway Commission



• Audit is conducted by CPAs• The audit report is the formal statement of

audit opinion– Unqualified opinion– Qualified opinion– Adverse opinion– Disclaimer of opinion

Auditor’s Opinion



• The financial statements present fairly– The financial position– Results of operations– Cash flows

• In conformity with generally accepted accounting principles

• For the user: the highest degree of reliability

Unqualified Opinion



• Except for the matter to which the exception relates

• The financial statements present fairly– The financial position– Results of operations– Cash flows


• For the user: determine the significance of the exception

Qualified Opinion



• The financial statements do not present fairly– The financial position– Results of operations– Cash flows


• For the user: reliability of financial statements need to be seriously questioned

Adverse Opinion



• The auditor does not express an opinion• Auditor

– Has not preformed an audit sufficient in scope to form an opinion or

– Is not independent

• For the user: auditor’s statement conveys no indication of financial statement reliability

Disclaimer of Opinion



• Paragraph #1:– Financial statements have been audited– Financial statements are responsibility of

management– Auditors have responsibility to express or disclaim

an opinion

Unqualified Auditor’s Report



• Paragraph #2– Audit conducted in accordance with the standards

of the (U.S.) Public Accounting Oversight Board– Auditor is required to plan and perform the audit

• Obtain reasonable assurance• Financial statements are free from material

misstatement

– Audit provides a reasonable basis for opinion• Examining evidence• Assessing accounting principles and estimates

Unqualified Auditor’s Report (cont’d)



• Paragraph #3– Opinion: in conformity with generally accepted

(U.S.) accounting principles

• Also: for public companies, reference to the audit of internal control effectiveness– In accordance with the (U.S.) Public Accounting

Oversight Board– Based on criteria established by COSO

Unqualified Auditor’s Report (cont’d)



• Required by Sarbanes-Oxley• May be combined with audit opinion report• Paragraphs

1. Scope

2. Responsibility and procedures

3. Opinion

4. Reference to financial statement audit

Auditor’s Report on Internal Control



• Review– Less in scope than an audit

– An opinion is not expressed

– Provides negative assurance• “Not aware of any material misstatements or required

modifications”

• Compilation– Presents only financial information provided by

management

– No opinion or any other assurance is given

Other Types of Engagements



• Management is responsible for– The preparation of the financial statements– The integrity of the financial statements

• Management’s Statement of Responsibility– May be included in the annual report

Management’s Responsibility



Required filings– 10-K: annual filing (audited)

• Includes financial statements plus– Information on the business entity– Market information– Management discussion and analysis– Directors, executive officers, and their compensation– Related party transactions

– 10-Q: quarterly filing (unaudited)– 8-K: “current report”

• To report the occurrence of any material events or corporate changes

The SEC’s Integrated Disclosure System



• Proxy– Notice and authorization of shareholder voting

rights on corporate actions– Content and form governed by the SEC

• Summary Annual Report– Highly condensed financial information– Must be accompanied by a proxy containing full

financial information– Not adequate for financial analysis

Additional Reporting Venues



• Capital markets generate security prices that reflect worth

• Publicly available information is reflected in share prices

• Investors will be harmed if full disclosure is not made

• Method of disclosure does not impact value– Body of the financial statements– Notes to the financial statements

• Benefit of making disclosure outweighs the cost

The Efficient Market Hypothesis



Caring

Honesty

Accountability

Promise keeping

Pursuit of excellence

Loyalty

Fairness

Integrity

Respect for others

Responsible citizenship

Essential values in interpersonal relationships

Ethics



1. Determine the facts

2. Define the ethical issues

3. Identify major principles, rules, and values

4. Specify the alternatives

5. Compare norms, principles, and values with alternatives

6. Assess the consequences

7. Make your decision

AAA Ethical Decision Framework



• Enacted under Sarbanes-Oxley Act• Applicable to chief financial officers• Disclosure requirements

– Whether a code of ethics has been adopted– If not, why not– Code is published in the annual report or on the

firm’s web site

SEC Requirement: A Code of Ethics



• Accounting standards can vary by country– Development is often in response to domestic

needs

• International accounting standards set by– IASC (1973 – 2000)– IASB (2001 to present) has no enforcement

power

• In the U.S.– SEC requires registrants to report in U.S. GAAP– FASB is participating in the harmonization project

Harmonization of International Accounting Standards



Harmonization of International Accounting Standards

• IASB issues (IFRS) International Financial Reporting Standards.

• 2002 Norwalk agreement – FASB and IASB commit to high-quality, compatible accounting standards.

• 2007 agreement between US and European Union to allow companies to drop US GAAP if financials were prepared by IFRS.



• Parent consolidates with subsidiary– Report results of operations separately– Sum subsidiary and parent results of operations

• Legal control vs. effective control• Consolidation occurs when parent has

effective control over the subsidiary– Holds a majority of risks, rewards, and decision-

making ability

Consolidated Financial Statements



• Effected through merger or acquisition

• Purchase method of accounting

• Record assets and liabilities acquired at their fair values

• Excess of purchase price over fair value of net assets acquired is reported as goodwill

Accounting for Business Combinations


introduction to financial statements and other financial reporting topics chapter 2 © 2011 cengage...

Documents

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income statement revenue

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