ch01 fundamental of financial accounting by edmonds (4th edition)

Fundamental Fundamental Financial Accounting Financial Accounting

ConceptsConceptsFourth EditionFourth Edition

bybyEdmonds, McNair, Milam, OldsEdmonds, McNair, Milam, Olds

PowerPoint® presentation byJ. Lawrence Bergin

Winona State University

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003

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Welcome to the study ofWelcome to the study of

Financial AccountingFinancial Accounting


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Chapter 1Chapter 1

Elements

of

Financial Statements


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What is accounting? The language of business

Measures financial aspects of a business

Communicates this information to decision makers


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Why should everyone in business study accounting??

Many business decisions are based on accounting information.

Since accounting information is prepared according to “rules,” an understanding of these rules is necessary for the appropriate use of the information.

“Rules” = Generally Accepted Accounting Principles (GAAP)


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The Accounting Equation Assets = Claims

Assets = Liabilities + Equity

Asset: something of valueEx: Cash, Land, Buildings, Equipment, Inventories, Supplies, Prepaid Insurance, Accounts Receivables from customers.

Liability: something owed (creditors’ share of the assets)

Ex: Accounts Payable, Notes Payable, Mortgage Payable, Interest Payable, Salaries Payable.

Equity: what remains (owners’ share of the assets)

Ex: Common Stock, Retained Earnings


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Equity: The Owners’ Share There are two sources of equity

equity acquired from the owners by issuing stock.

equity “earned” by operations

Expanded accounting equation:

Common Retained

Assets = Liabilities + Stock + Earnings

Stockholders’ Equity


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Answer: By earning “Net Income*” (*also called “Net Earnings” or “Net Profit”.)

Revenue - Expenses = Net Income (Loss)

Revenue:

How is equity “earned by operations”?

Amounts received or to be received from having sold a product or provided a service. [Ex: The amount the customer pays at the cash register.]


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Answer: By earning “Net Income*” (*also called “Net Earnings” or “Net Profit”.

Revenue - Expenses = Net Income (Loss)

Revenue:

Expenses:

How is equity “earned by operations”?

Amounts received or to be received from having sold a product or provided a service. [Ex: The amount the customer pays at the cash register.]Assets or services “used up” in the process of earning the revenue this period. [Ex: What it cost the store for the item it sold to the customer, rent, wages, utilities, advertising, taxes]


1- 10 Equity: The Owners’ Share-cont’d.

Dividends:

Retained Earnings:

Company assets given to or withdrawn by owners for their personal use. [Other terms used: Withdrawals, Drawings, and Distributions.]


1- 11 Equity: The Owners’ Share-cont’d.

Dividends:

Retained Earnings:

Company assets given to or withdrawn by owners for their personal use. [Other terms used: Withdrawals, Drawings, and Distributions.]

The Net Income [Earnings] kept [Retained] in the business since its beginning.

It is the total of all net income (minus all losses) and minus all dividends since the start of the company.


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Four Basic Financial Statements Balance SheetBalance Sheet

Assets = Liabilities + Equity

Income Statement Income Statement (also called Statement of (also called Statement of Operations, Earnings Statement, Profit/Loss (or P&L) Operations, Earnings Statement, Profit/Loss (or P&L) StatementStatement Revenues - Expenses = Net income (or Net Earnings)

Statement of Changes in Statement of Changes in Stockholders’ EquityStockholders’ Equity Beginning of period total equity + Stock issued +

Net income - Dividends = End of period total equity Statement of Cash FlowsStatement of Cash Flows

Cash inflow - Cash outflow = Net cash flow


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Transaction Analysis What is a transaction?

a business event involving a transfer of something of value between entities

What is transaction analysis? determining the effect of a business event on the

financial statements

Where do you start? First, determine the transaction’s effects on the

accounting equation. Second, determine the effects on other financial

statements.


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Four Types of Transactionsthat keep the equation in

balance Asset SourceAsset Source Transactions Transactions--an asset increases and a corresponding claims account increases

Asset UseAsset Use Transactions Transactions--an asset decreases and a corresponding claims account decreases

Asset ExchangeAsset Exchange Transactions Transactions--one asset increases and another asset decreases

Claims ExchangeClaims Exchange Transactions Transactions--one claims account increases and another decreases

(Claims Exchange Transactions will be introduced in Chapter 2.)

Assets = ClaimsAssets = Claims


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The horizontal model is a teaching/learning tool used to show the impact a transaction has on the three basic financial statements (Balance Sheet, Income Statement and Statement of Cash Flows).

Notice how the Balance Sheet section is similar to the Accounting Equation.

Introducing the

Horizontal Financial Statements Model


1- 16 Horizontal Model Transaction Analysis

Record the six transactions that follow in the Horizontal Model below.

Horizontal Model Transaction Analysis


Assets = Liabilities + Stk. Equity Amount &

Cash + Land = A/Pay+N/Pay+C.Stk.+ R.E. Rev. - Exp. = N. I. OA,IA,FA

Balance Sheet Income Statement Cashflow


1- 17 Horizontal Model Transaction Analysis


Horizontal Model Transaction Analysis



Cash + Land = A/Pay+N/Pay+C.Stk.+ R.E. Rev. - Exp. = N. I. OA,IA,FA


Abbreviations: Accounts Payable

Notes Payable

Common Stock


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Kleen Sweep, Kleen Sweep, Inc.Inc.

Following are six transactions of Kleen

Sweep, Inc., a company that

provides janitorial services for local

businesses.


1- 19 Kleen Sweep, Kleen Sweep, Inc.Inc.

1. Kleen Sweep was formed on Jan. 1, 2004 by issuing Common Stock in exchange for $2,000 cash.

2. The company provided services to customers for $500 cash.

3. The company incurred $300 of expenses which were paid in cash.

4. The company purchased Land by paying $1,500 cash.

5. The company borrowed $1,000 cash from the bank by issuing a Note Payable on Dec. 31st.

6. The company pays a $50 cash dividend to the company’s owners (the stockholders).


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Horizontal Model Transaction Analysis Horizontal Model Transaction Analysis


Cash + Land = A/Pay+N/Pay +C.Stk.+ R.E. Rev. - Exp. = N. I. OA,IA,FA


Transaction #1:Transaction #1: Kleen Sweep was formed on Jan. 1, 2004 by issuing Common Stock in exchange for $2,000 cash.

1 2000 2000 2000 ????

What category of Cash flow “activity” is this?


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Classifications of Cash Flows Operating activities:

Inflows: Collection of Revenues Outflows: Payment of Expenses, including interest

Investing activities:Inflows: Disposals of our Land, Building, Equipment Collections of loans made to others Outflows: Purchases of Land, Building, Equipment Lending money to others (our “debtors”)

Financing activities:Inflows: Borrowing money from others (our “creditors”) Cash received from issuing Common Stock Outflows: Cash Dividends paid to stockholders Repayment of loans to creditors, but not interest

So, transaction #1 is what kind of Cash flow “activity”?So, transaction #1 is what kind of Cash flow “activity”?


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Classifications of Cash Flows Operating activities:

Inflows: Collection of Revenues Outflows: Payment of Expenses, including interest

Investing activities:Inflows: Disposals of our Land, Building, Equipment Collections of loans made to others Outflows: Purchases of Land, Building, Equipment Lending money to others (our “debtors”)

Financing activities:Inflows: Borrowing money from others (our “creditors”) Cash received from issuing Common StockCash received from issuing Common Stock Outflows: Cash Dividends paid to stockholders Repayment of loans to creditors, but not interest

So, transaction #1 is what kind of Cash flow “activity”?So, transaction #1 is what kind of Cash flow “activity”?


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Transaction #1:Transaction #1: Kleen Sweep was formed on Jan. 1, 2004 by issuing Common Stock in exchange for $2,000 cash.

1 2000 2000 2000 FAFA

Financing Activity


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1 2000 2000 2000 FA


2 500 500 500 500 500 OA

Transaction #2:Transaction #2: The Company provided services to customers for $500 cash.


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1 2000 2000 2000 FA


2 500 500 500 500 500 OA

3 (300) (300) 300 (300) (300)OA

Transaction #3:Transaction #3: The Company incurred $300 of expenses which were paid in cash.


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1 2000 2000 2000 FA


2 500 500 500 500 500 OA

3 (300) (300) 300 (300) (300)OA4 (1500) 1500 (1500) IA

Transaction #4:Transaction #4: The Company purchased Land by paying $1,500 cash.


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1 2000 2000 2000 FA


2 500 500 500 500 500 OA

3 (300) (300) 300 (300) (300)OA4 (1500) 1500 (1500) IA 5 1000 1000 1000 FA

Transaction #5:Transaction #5: The Company borrowed $1,000 cash from the bank by issuing a Note Payable on Dec. 31st.


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Assets = Liabilities + Stk. Equity Amount & Cash + Land = A/Pay+N/Pay +C.Stk.+ R.E. Rev. - Exp. = N. I. OA,IA,FA

1 2000 2000 2000 FA


2 500 500 500 500 500 OA

3 (300) (300) 300 (300) (300)OA4 (1500) 1500 (1500) IA 5 1000 1000 1000 FA

6 (50) (50) (50)

FA

Transaction #6:Transaction #6: The Company pays a $50 cash dividend to the company’s owners (the stockholders).


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Assets = Liabilities + Stk. Equity Amount & Cash + Land = A/Pay+N/Pay +C.Stk.+ R.E. Rev. - Exp. = N. I. OA,IA,FA

1 2000 2000 2000 FA


2 500 500 500 500 500 OA

3 (300) (300) 300 (300) (300)OA4 (1500) 1500 (1500) IA 5 1000 1000 1000 FA

6 (50) (50) (50)

FAB 1650 1500 0 1000 2000 150 500 300 200 1650 Bal

Calculate the end-of-year balances of each General LedgerGeneral Ledger account.

Notice where these balances will appear on the financial statements we will prepare shortly.


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Which of the 2004 ending balances are carried forward to become the beginning

balances of 2005?1. Carry forward all Balance Sheet account balances.2. Do NOT carry forward any Income Statement account balances; i.e. Revenues and Expenses. Closing Entries are used to transfer the Revenue and

Expense balances to the Retained Earnings account.3. On the Cashflow Statement, the 2004 ending cash balance is carried forward to become the 2005beginning cash balance.

(but, the OA, IA, FA categories start 2005 at $0.)


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1 2000 2000 2000 FA


2 500 500 500 500 500 OA

3 (300) (300) 300 (300) (300)OA4 (1500) 1500 (1500) IA 5 1000 1000 1000 FA

6 (50) (50) (50)FA

B4 1650 1500 0 1000 2000 150 500 300 200 1650 Bal

Show the balances that will be carried over to start the next year, 2005. (B5 = Balance at beginning of 2005)

Bal. Sheet balances are carried forward. Inc.Statem’t balances are not. B5 1650 1500 0 1000 2000 150 0 0 0 1650 Bal.

Now let’s prepare the financial statements.


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Kleen Sweep, Inc.Income Statement

For the Year Ended December 31, 2004

Revenue

- Expenses

Net income

Date line must specify:

(1) the length of time covered by the statement, and

(2) the period’s ending date.


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Kleen Sweep, Inc.Income Statement


Revenue

- Expenses

Net income

$ 500

300

$ 200


1- 35 Kleen Sweep, Inc.Statement of Changes in Stockholders’

Equity For the Year Ended December 31, 2004

Beginning Common Stock $ Plus: Common Stock Issued Ending Common Stock $

Beginning Retained Earnings $ Plus: Net income Less: Dividends Ending Retained Earnings $Total Stockholders’ Equity $




Beginning Common Stock $ 0Plus: Common Stock Issued 2,000 Ending Common Stock $

2,000Beginning Retained Earnings $Plus: Net incomeLess: Dividends Ending Retained Earnings $

Total Stockholders’ Equity $




Beginning Common Stock $ 0Plus: Common Stock Issued 2,000 Ending Common Stock $ 2,000

Beginning Retained Earnings $ 0

Plus: Net income 200

Less: Dividends

Ending Retained Earnings $

Total Stockholders’ Equity $




Beginning Common Stock $ 0Plus: Common Stock Issued 2,000 Ending Common Stock $ 2,000

Beginning Retained Earnings $ 0 Plus: Net income 200 Less: Dividends (50) Ending Retained Earnings $ 150Total Stockholders’ Equity $ 2,150


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Kleen Sweep, Inc.Balance Sheet

As of December 31, 2004

AssetsCash $Land

Total Assets $

Liabilities Note payable $Stockholders’ Equity

Common Stock $Retained Earnings Total Stockholders’ Equity

Total Liabilities and Stockholders’ Equity $

Balance Sheet date line specifies one POINT in time, NOT a period of time.


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AssetsCash $ 1,650Land

Total Assets $

Liabilities Note payable $ Stockholders’ Equity

Common Stock $ Retained Earnings Total Stockholders’ Equity



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AssetsCash $ 1,650Land 1,500

Total Assets $ 3,150

Liabilities Note payable $ Stockholders’ Equity




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Liabilities Note payable $ 1,000Stockholders’ Equity




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Common Stock $ 2,000Retained Earnings Total Stockholders’ Equity



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Common Stock $ 2,000Retained Earnings 150 Total Stockholders’ Equity

2,150Total Liabilities and Stockholders’ Equity $


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Common Stock $ 2,000Retained Earnings 150 Total Stockholders’ Equity

2,150Total Liabilities and Stockholders’ Equity $ 3,150


1- 46 Kleen Sweep, Inc.Statement of Cash Flows

For the Year Ended December 31, 2004Cash flows from operating activities

$

Net cash flow from operating activities $Cash flows from investing activities

$Net cash flow from investing activities $

Cash flows from financing activities $Net cash flow from financing activities $

Net increase (decrease) in cash $Plus: Cash Balance, Jan. 1, 2004

Cash Balance, Dec. 31, 2004 $




Cash flows from operating activitiesCash receipts from revenues $ 500Cash payments for expenses (300)

Net cash flow from operating activities $ 200

Cash flows from investing activities

Cash flows from financing activities




Cash flows from operating activitiesCash receipts from revenues $ 500Cash payments for expenses (300)


Cash flows from investing activitiesCash payment for Land $(1,500)

Net cash flow from investing activities $(1,500)

Cash flows from financing activities




Cash receipts from revenues $ 500Cash payments for expenses (300)



Net cash flow from investing activities $(1,500)Cash flows from financing activities

Cash receipts from stock issue $ 2,000 Cash receipts from bank loan 1,000 Cash payments for dividends (50)

Net cash flow from financing activities $ 2,950

Net increase in cash $







Net cash flow from investing activities $(1,500)Cash flows from financing activities


Net cash flow from financing activities $ 2,950

Net increase in cash $ 1,650





Net cash flow from operating activities $ 200Cash flows from investing activities

Cash payment for Land $(1,500)Net cash flow from investing activities $(1,500)Cash flows from financing activities


Net cash flow from financing activities $ 2,950Net increase in cash $ 1,650Plus: Cash balance, Jan. 1, 2004 0 Cash balance, Dec. 31, 2004 $ 1,650


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Financial Statements that show the combined results of a “Parent” company and all the “subsidiary” companies in which the parent has a “controlling interest” (usually more than 50% ownership).

Many of the “real world” financial statements you look at in this course will be consolidated statements.

What are

ConsolidatedConsolidatedFinancial Statements?


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Summary of General Ledger Accounts for 2004 Transactions

Assets = Liabilities + Stockholders’ Eq.

Trans. Notes Common Ret.Event Cash + Land = Payable + Stock + Earn.

1 2,000 2,000

2 500 500 + Revenue

3 (300) (300) + Expenses

4 (1,500) 1,500

5 1,000 1,000

6 (50) (50) + Dividends

Bal. 1,650 + 1,500 = 1,000 + 2,000 + 150

Titles of Nominal accts.affected that resulted in the change in Ret. Earn.


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Price-Earnings Ratio

This ratio is used by analysts to evaluate the future prospects of a company.

The higher the PE ratio, the more optimistic investors are about a company’s future.

* Earnings per share = Net income divided by the weighted average number of common shares of outstanding stock. [Why is the “weighted average” number of shares used?]

Selling price of one share of stock

Earnings per share*


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Percentage ChangeThe percentage change in any two numbers can be calculated by dividing the DIFFERENCE between the two numbers by the base year amount.

Given the following data:

2004 Net Income = $ 80,000

2005 Net Income = $100,000

What was the percentage growth in Net Income from 2004 to 2005?

100,000 – 80,000 = 20,000 80,000 = 80,000 25.0%25.0% =


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Wow!

You have learned a lot in only one

chapter!!

Now, you should go over each of these “slides” on your own. Make sure you UNDERSTAND how and why everything is done.


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Chapter 1

The End

ch01 fundamental of financial accounting by edmonds (4th edition)

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