Hello,

It's me again.I need help with my Accounting class his time. If you accept I would like to work with you for 9 weeks but I must get no lower than a B grade so I can get out of academic probation.

Thanks!

c01IntroductiontoFinancialStatements.qxd 7/27/10 9:08 AM Page 2 1 chapter INTRODUCTION TO FINANCIAL STATEMENTS the navigator Scan Study Objectives Read Feature Story Scan Preview After studying this chapter, you should be able to: Read Text and Answer Do it! p. 5 p. 11 p. 18 p. 20 1 Describe the primary forms of business organization. Work Using the Decision Toolkit Review Summary of Study Objectives Work Comprehensive Do it! p. 23 Answer Self-Test Questions Complete Assignments Go to WileyPLUS for practice and tutorials 2 Read A Look at IFRS p. 42 study objectives 2 Identify the users and uses of accounting information. 3 Explain the three principal types of business activity. 4 Describe the content and purpose of each of the financial statements. 5 Explain the meaning of assets, liabilities, and stockholders' equity, and state the basic accounting equation. 6 Describe the components that supplement the financial statements in an annual report. The Navigator is a learning system designed to prompt you to use the learning aids in the chapter and to set priorities as you study. c01IntroductiontoFinancialStatements.qxd 7/27/10 8:57 AM Page 3 feature story Many students who take this course do not plan to be accountants. If you are in that group, you might be thinking, \"If I'm not going to be an accountant, why do I need to know accounting?\" In response, consider this quote from Harold Geneen, the former chairman of IT&T: \"To be good at your business, you have to know the numberscold.\" Success in any business comes back to the numbers. You will rely on them to make decisions, and managers will use them to evaluate your performance. That is true whether your job involves marketing, production, management, or information systems. In business, accounting and financial statements are the means for communicating the numbers. If you don't know how to read financial statements, you can't really know your business. Many companies spend significant resources teaching their employees basic accounting so that they can read financial statements and understand how their actions affect the company's financial results. One such company is Springfield ReManufacturing Corporation (SRC). When Jack Stack and 11 other managers purchased SRC for 10 cents a share, it was a failing division of International Harvester. Jack's 119 employees were counting on him for their livelihood. He decided that for the company to survive, every employee needed to think like a businessperson and to act like an owner. To accomplish this, all employees at SRC took basic accounting courses and participated in weekly reviews of the company's financial statements. SRC survived, and eventually thrived. To this day, every employee (now numbering more than 1,000) undergoes this same training. Many other companies have adopted this approach, which is called \"open-book management.\" Even in companies that do not practice open-book management, employers generally assume that managers in all areas of the company are \"financially literate.\" Taking this course will go a long way to making you financially literate. In this book you will learn how to read and prepare financial statements, and how to use basic tools to evaluate financial results. In this first chapter we will introduce you to the financial statements of a real company whose products you are probably familiar withTootsie Roll. Tootsie Roll's presentation of its financial results is complete, yet also relatively easy to understand. Tootsie Roll started off humbly in 1896 in a small New York City candy shop owned by an Austrian immigrant, Leo Hirshfield. The candy's name came from his five-year-old daughter's nickname\"Tootsie.\" Today the Chicago-based company produces more than 49 million Tootsie Rolls and 16 million Tootsie Pops each day. In fact, Tootsie Pops are at the center of one of science's most challenging questions: How many licks does it take to get to the Tootsie Roll center of a Tootsie Pop? The answer varies: Licking machines created at Purdue University and the University of Michigan report an average of 364 and 411 licks, respectively. In studies using human lickers, the answer ranges from 144 to 252. We recommend that you take a few minutes today away from your studies to determine your own results. KN O W I N G TH E NUMBERS Source: Tootsie Roll information adapted from www.tootsie.com. INSIDE CHAPTER 1 . . . The Scoop on Accounting (p. 6) Spinning the Career Wheel (p. 7) The Numbers Behind Not-for-Profit Organizations (p. 8) Rocking the Bottom Line (p. 15) 3 c01IntroductiontoFinancialStatements.qxd 7/26/10 1:09 PM Page 4 preview of chapter 1 How do you start a business? How do you determine whether your business is making or losing money? How should you finance expansionshould you borrow, should you issue stock, should you use your own funds? How do you convince lenders to lend you money or investors to buy your stock? Success in business requires making countless decisions, and decisions require financial information. The purpose of this chapter is to show you what role accounting plays in providing financial information. The content and organization of the chapter are as follows. Introduction to Financial Statements Forms of Business Organization Sole proprietorship Partnership Corporation Users and Uses of Financial Information Internal users External users Ethics in financial reporting Communicating with Users Business Activities Financing Investing Operating Income statement Retained earnings statement Balance sheet Statement of cash flows Interrelationships of statements Other elements of an annual report Forms of Business Organization study objective 1 Describe the primary forms of business organization. Sole Proprietorship -Simple to establish -Owner controlled -Tax advantages Partnership -Simple to establish -Shared control -Broader skills and resources -Tax advantages Corporation -Easier to transfer ownership -Easier to raise funds -No personal liability 4 Suppose you graduate with a business degree and decide you want to start your own business. But what kind of business? You know that you enjoy working with people, especially teaching them new skills. And, ever since you were young, you have spent most of your free time outdoors, kayaking, backpacking, skiing, rock climbing, and mountain biking. You therefore realize that you might be most successful in opening an outdoor guide service where you grew up, in the Sierra Nevada mountains. Your next decision is to determine what organizational form your business will have. You have three choicessole proprietorship, partnership, or corporation. You might choose the sole proprietorship form for your outdoor guide service. A business owned by one person is a sole proprietorship. It is simple to set up and gives you control over the business. Small owner-operated businesses such as barber shops, law offices, and auto repair shops are often sole proprietorships, as are farms and small retail stores. Another possibility is for you to join forces with other individuals to form a partnership. A business owned by two or more persons associated as partners is a partnership. Partnerships often are formed because one individual does not have enough economic resources to initiate or expand the business. Sometimes, partners bring unique skills or resources to the partnership. You and your partners should formalize your duties and contributions in a written partnership agreement. Retail and service-type businesses, including professional practices (lawyers, doctors, architects, and certified public accountants), often organize as partnerships. As a third alternative, you might organize as a corporation. A business organized as a separate legal entity owned by stockholders is a corporation. Investors in a corporation receive shares of stock to indicate their ownership claim. Buying stock in a corporation is often more attractive than investing in a partnership because shares of stock are easy to sell (transfer ownership). Selling a proprietorship or partnership interest is much more involved. Also, individuals c01IntroductiontoFinancialStatements.qxd 7/26/10 1:09 PM Page 5 5 Users and Uses of Financial Information can become stockholders by investing relatively small amounts of money. Therefore, it is easier for corporations to raise funds. Successful corporations often have thousands of stockholders, and their stock is traded on organized stock exchanges like the New York Stock Exchange. Many businesses start as sole proprietorships or partnerships and eventually incorporate. For example, in 1896 Leo Hirshfield started Tootsie Roll as a sole proprietorship, and by 1919 the company had incorporated. Other factors to consider in deciding which organizational form to choose are taxes and legal liability. If you choose a sole proprietorship or partnership, you generally receive more favorable tax treatment than a corporation. However, proprietors and partners are personally liable for all debts of the business; corporate stockholders are not. In other words, corporate stockholders generally pay higher taxes but have no personal liability. We will discuss these issues in more depth in a later chapter. The combined number of proprietorships and partnerships in the United States is more than five times the number of corporations. However, the revenue produced by corporations is eight times greater. Most of the largest enterprises in the United Statesfor example, Coca-Cola, ExxonMobil, General Motors, Citigroup, and Microsoftare corporations. Because the majority of U.S. business is transacted by corporations, the emphasis in this book is on the corporate form of organization. Alternative Terminology Stockholders are sometimes called shareholders. Alternative Terminology notes present synonymous terms that you may come across in practice. before you go on... Do it! In choosing the organizational form for your outdoor guide service, you should consider the pros and cons of each. Identify each of the following organizational characteristics with the organizational form or forms with which it is associated. BUSINESS ORGANIZATION FORMS 1. 2. 3. 4. 5. Do it! exercises prompt you to stop and review the key points you have just studied. Easier to raise funds Simple to establish No personal legal liability Tax advantages Easier to transfer ownership Solution 1. 2. 3. 4. 5. Easier to raise funds: Corporation. Simple to establish: Sole proprietorship and partnership. No personal legal liability: Corporation. Tax advantages: Sole proprietorship and partnership. Easier to transfer ownership: Corporation. Action Plan Know which organizational form best matches the business type, size, and preferences of the owner(s). Action Plans give you tips about how to approach the problem. Related exercise material: BE1-1 and Do it! 1-1. Users and Uses of Financial Information The purpose of financial information is to provide inputs for decision making. Accounting is the information system that identifies, records, and communicates the economic events of an organization to interested users. Users of accounting information can be divided broadly into two groups: internal users and external users. INTERNAL USERS Internal users of accounting information are managers who plan, organize, and run a business. These include marketing managers, production supervisors, finance directors, and company officers. In running a business, managers must answer many important questions, as shown in Illustration 1-1 (page 6). study objective 2 Identify the users and uses of accounting information. c01IntroductiontoFinancialStatements.qxd 6 7/26/10 1:09 PM Page 6 chapter 1 Introduction to Financial Statements Questions Asked by Internal Users ST ST RIK E ON RIK E r fai es Un ctic a Pr playlist itunes L. H.C.B. Brien's In Sgt. Pepper's Comes My Ship Cowboy? When Do Wia Gonna What is A Life Want All I MENU Snack chi ack ch ck chi k chips h Beverage Beverages eve ag everag everage ge Stockholder Finance Is cash sufficient to pay dividends to Microsoft stockholders? Illustration 1-1 Questions that internal users ask Illustrations like this one convey information in pictorial form to help you visualize and apply the ideas as you study. Marketing What price for an Apple iPod will maximize the company's net income? Human Resources Can we afford to give General Motors employees pay raises this year? Management Which PepsiCo product line is the most profitable? Should any product lines be eliminated? To answer these and other questions, you need detailed information on a timely basis. For internal users, accounting provides internal reports, such as financial comparisons of operating alternatives, projections of income from new sales campaigns, and forecasts of cash needs for the next year. In addition, companies present summarized financial information in the form of financial statements. Accounting Across the Organization The Scoop on Accounting Accounting can serve as a useful recruiting tool even for the human resources department. Rhino Foods, located in Burlington, Vermont, is a manufacturer of specialty ice cream. Its corporate website includes the following: \"Wouldn't it be great to work where you were part of a team? Where your input and hard work made a difference? Where you weren't kept in the dark about what management was thinking? . . . Wellit's not a dream! It's the way we do business . . . Rhino Foods believes in family, honesty and open communicationwe really care about and appreciate our employeesand it shows. Operating results are posted and monthly group meetings inform all employees about what's happening in the Company. Employees also share in the Company's profits, in addition to having an excellent comprehensive benefits package.\" Source: www.rhinofoods.com/workforus/workforus.html. Accounting Across the Organization stories show applications of accounting information in various business functions. Illustration 1-2 Questions that external users ask ? What are the benefits to the company and to the employees of making the financial statements available to all employees? (See page 41.) EXTERNAL USERS There are several types of external users of accounting information. Investors (owners) use accounting information to make decisions to buy, hold, or sell stock. Creditors such as suppliers and bankers use accounting information to evaluate the risks of selling on credit or lending money. Some questions that investors and creditors may ask about a company are shown in Illustration 1-2. Questions Asked by External Users Yeah! What do we do if they catch us? BILL COLLECTOR Investors Is General Electric earning satisfactory income? Investors How does Disney compare in size and profitability with Time Warner? Creditors Will United Airlines be able to pay its debts as they come due? c01IntroductiontoFinancialStatements.qxd 7/26/10 1:09 PM Page 7 Users and Uses of Financial Information The information needs and questions of other external users vary considerably. Taxing authorities, such as the Internal Revenue Service, want to know whether the company complies with the tax laws. Customers are interested in whether a company like General Motors will continue to honor product warranties and otherwise support its product lines. Labor unions, such as the Major League Baseball Players Association, want to know whether the owners have the ability to pay increased wages and benefits. Regulatory agencies, such as the Securities and Exchange Commission or the Federal Trade Commission, want to know whether the company is operating within prescribed rules. For example, Enron, Dynegy, Duke Energy, and other big energy-trading companies reported record profits at the same time as California was paying extremely high prices for energy and suffering from blackouts. This disparity caused regulators to investigate the energy traders to make sure that the profits were earned by legitimate and fair practices. Accounting Across the Organization Spinning the Career Wheel One question that business students frequently ask is, \"How will the study of accounting help me?\" It should help you a great deal, because a working knowledge of accounting is desirable for virtually every field of business. Some examples of how accounting is used in business careers include: General management: Imagine running Ford Motors, Massachusetts General Hospital, California State University-Fullerton, a McDonald's franchise, a Trek bike shop. All general managers need to understand accounting data in order to make wise business decisions. Marketing: A marketing specialist at a company like Procter & Gamble develops strategies to help the sales force be successful. But making a sale is meaningless unless it is a profitable sale. Marketing people must be sensitive to costs and benefits, which accounting helps them quantify and understand. Finance: Do you want to be a banker for Citicorp, an investment analyst for Goldman Sachs, a stock broker for Merrill Lynch? These fields rely heavily on accounting. In all of them you will regularly examine and analyze financial statements. In fact, it is difficult to get a good job in a finance function without two or three courses in accounting. Real estate: Are you interested in being a real estate broker for Prudential Real Estate? Because a third partythe bankis almost always involved in financing a real estate transaction, brokers must understand the numbers involved: Can the buyer afford to make the payments to the bank? Does the cash flow from an industrial property justify the purchase price? What are the tax benefits of the purchase? ? How might accounting help you? (See page 41.) ETHICS IN FINANCIAL REPORTING People won't gamble in a casino if they think it is \"rigged.\" Similarly, people won't \"play\" the stock market if they think stock prices are rigged. In recent years the financial press has been full of articles about financial scandals at Enron, WorldCom, HealthSouth, and AIG. As more scandals came to light, a mistrust of financial reporting in general seemed to be developing. One article in the Wall Street Journal noted that \"repeated disclosures about questionable accounting practices have bruised investors' faith in the reliability of earnings reports, which in turn has sent stock prices tumbling.\"1 Imagine trying to carry on a business or invest money if you could not depend on the financial statements to be honestly prepared. 1 \"U.S. Share Prices Slump,\" Wall Street Journal (February 21, 2002). 7 c01IntroductiontoFinancialStatements.qxd 8 7/26/10 1:09 PM Page 8 chapter 1 Introduction to Financial Statements Ethics Note Circus-founder P.T. Barnum is alleged to have said, \"Trust everyone, but cut the deck.\" What Sarbanes-Oxley does is to provide measures that (like cutting the deck of playing cards) help ensure that fraud will not occur. Information would have no credibility. There is no doubt that a sound, wellfunctioning economy depends on accurate and dependable financial reporting. United States regulators and lawmakers were very concerned that the economy would suffer if investors lost confidence in corporate accounting because of unethical financial reporting. In 2002, Congress passed the Sarbanes-Oxley Act (SOX) to reduce unethical corporate behavior and decrease the likelihood of future corporate scandals. As a result of SOX, top management must now certify the accuracy of financial information. In addition, penalties for fraudulent financial activity are much more severe. Also, SOX increased the independence of the outside auditors who review the accuracy of corporate financial statements, and increased the oversight role of boards of directors. Effective financial reporting depends on sound ethical behavior. To sensitize you to ethical situations and to give you practice at solving ethical dilemmas, we address ethics in a number of ways in this book: (1) A number of the Feature Stories and other parts of the text discuss the central importance of ethical behavior to financial reporting. (2) Insight boxes with an ethics perspective highlight ethics situations and issues in actual business settings. (3) At the end of the chapter, an Ethics Case simulates a business situation and asks you to put yourself in the position of a decision maker in that case. When analyzing these various ethics cases and your own ethical experiences, you should apply the three steps outlined in Illustration 1-3. Illustration 1-3 Steps in analyzing ethics cases Solving an Ethical Dilemma #1 ALT #2 ALT 1. Recognize an ethical situation and the ethical issues involved. Use your personal ethics to identify ethical situations and issues. Some businesses and professional organizations provide written codes of ethics for guidance in some business situations. 2. Identify and analyze the principal elements in the situation. Identify the stakeholders persons or groups who may be harmed or benefited. Ask the question: What are the responsibilities and obligations of the parties involved? 3. Identify the alternatives, and weigh the impact of each alternative on various stakeholders. Select the most ethical alternative, considering all the consequences. Sometimes there will be one right answer. Other situations involve more than one right solution; these situations require you to evaluate each alternative and select the best one. Ethics Insight The Numbers Behind Not-for-Profit Organizations Insights provide examples of business situations from various perspectivesethics, investor, and international. Accounting plays an important role for a wide range of business organizations worldwide. Just as the integrity of the numbers matters for business, it matters at least as much for not-for-profit organizations. Proper control and reporting help ensure that money is used the way donors intended. Donors are less inclined to give to an organization if they think the organization is subject to waste or theft. The accounting challenges of some large international not-for-profits rival those of the world's largest businesses. For example, after the Haitian earthquake, the Haitian-born musician Wyclef Jean was criticized for the poor accounting controls in a relief fund that he founded. Since then, he has hired a new accountant and improved the transparency regarding funds raised and spent. ? What benefits does a sound accounting system provide to a not-for-profit organization? (See page 41.) c01IntroductiontoFinancialStatements.qxd 7/26/10 1:09 PM Page 9 9 Business Activities Business Activities All businesses are involved in three types of activityfinancing, investing, and operating. For example, Leo Hirshfield, the founder of Tootsie Roll, obtained cash through financing to start and grow his business. Some of this financing came from personal savings, and some likely came from outside sources like banks. Hirshfield then invested the cash in equipment to run the business, such as mixing equipment and delivery vehicles. Once this equipment was in place, he could begin the operating activities of making and selling candy. The accounting information system keeps track of the results of each of the various business activitiesfinancing, investing, and operating. Let's look in more detail at each type of business activity. FINANCING ACTIVITIES It takes money to make money. The two primary sources of outside funds for corporations are borrowing money and issuing (selling) shares of stock in exchange for cash. Tootsie Roll Industries may borrow money in a variety of ways. For example, it can take out a loan at a bank or borrow directly from investors by issuing debt securities called bonds. Persons or entities to whom Tootsie Roll owes money are its creditors. Amounts owed to creditorsin the form of debt and other obligationsare called liabilities. Specific names are given to different types of liabilities, depending on their source. Tootsie Roll may have a note payable to a bank for the money borrowed to purchase delivery trucks. Debt securities sold to investors that must be repaid at a particular date some years in the future are bonds payable. A corporation may also obtain funds by selling shares of stock to investors. Common stock is the term used to describe the total amount paid in by stockholders for the shares they purchase. The claims of creditors differ from those of stockholders. If you loan money to a company, you are one of its creditors. In lending money, you specify a payment schedule (e.g., payment at the end of three months). As a creditor, you have a legal right to be paid at the agreed time. In the event of nonpayment, you may legally force the company to sell property to pay its debts. In the case of financial difficulty, creditor claims must be paid before stockholders' claims. Stockholders, on the other hand, have no claim to corporate cash until the claims of creditors are satisfied. If you buy a company's stock instead of loaning it money, you have no legal right to expect any payments until all of its creditors are paid. However, many corporations make payments to stockholders on a regular basis as long as there is sufficient cash to cover required payments to creditors. These payments to stockholders are called dividends. INVESTING ACTIVITIES Once the company has raised cash through financing activities, it will then use that cash in investing activities. Investing activities involve the purchase of the resources a company needs in order to operate. A growing company purchases many resources, such as computers, delivery trucks, furniture, and buildings. Resources owned by a business are called assets. Different types of assets are given different names. Tootsie Roll's mixing equipment is a type of asset referred to as property, plant, and equipment. Cash is one of the more important assets owned by Tootsie Roll or any other business. If a company has excess cash that it does not need for a while, it might study objective 3 Explain the three principal types of business activity. STO C K BOND Financing Essential terms are printed in blue. They are defined again in the glossary at the end of the chapter. CANDY TIME CANDY TIME CANDY TIME Investing Alternative Terminology Property, plant, and equipment is sometimes called fixed assets. c01IntroductiontoFinancialStatements.qxd 10 7/26/10 1:09 PM Page 10 chapter 1 Introduction to Financial Statements choose to invest in securities (stocks or bonds) of other corporations. Investments are another example of an investing activity. Operating OPERATING ACTIVITIES Once a business has the assets it needs to get started, it can begin its operations. Tootsie Roll is in the business of selling all things that taste, look, or smell like candy. It sells Tootsie Rolls, Tootsie Pops, Blow Pops, Caramel Apple Pops, Mason Dots, Mason Crows, Sugar Daddy, and Sugar Babies. We call amounts earned on the sale of these products revenues. Revenue is the increase in assets resulting from the sale of a product or service in the normal course of business. For example, Tootsie Roll records revenue when it sells a candy product. Revenues arise from different sources and are identified by various names depending on the nature of the business. For instance, Tootsie Roll's primary source of revenue is the sale of candy products. However, it also generates interest revenue on debt securities held as investments. Sources of revenue common to many businesses are sales revenue, service revenue, and interest revenue. The company purchases its longer-lived assets through investing activities as described earlier. Other assets with shorter lives, however, result from operating activities. For example, supplies are assets used in day-to-day operations. Goods available for future sales to customers are assets called inventory. Also, if Tootsie Roll sells goods to a customer and does not receive cash immediately, then the company has a right to expect payment from that customer in the near future. This right to receive money in the future is called an account receivable. Before Tootsie Roll can sell a single Tootsie Roll, Tootsie Pop, or Blow Pop, it must purchase sugar, corn syrup, and other ingredients, mix these ingredients, process the mix, and wrap and ship the finished product. It also incurs costs like salaries, rents, and utilities. All of these costs, referred to as expenses, are necessary to produce and sell the product. In accounting language, expenses are the cost of assets consumed or services used in the process of generating revenues. Expenses take many forms and are identified by various names depending on the type of asset consumed or service used. For example, Tootsie Roll keeps track of these types of expenses: cost of goods sold (such as the cost of ingredients); selling expenses (such as the cost of salespersons' salaries); marketing expenses (such as the cost of advertising); administrative expenses (such as the salaries of administrative staff, and telephone and heat costs incurred at the corporate office); interest expense (amounts of interest paid on various debts); and income taxes (corporate taxes paid to government). Tootsie Roll may also have liabilities arising from these expenses. For example, it may purchase goods on credit from suppliers; the obligations to pay for these goods are called accounts payable. Additionally, Tootsie Roll may have interest payable on the outstanding amounts owed to the bank. It may also have wages payable to its employees and sales taxes payable, property taxes payable, and income taxes payable to the government. Tootsie Roll compares the revenues of a period with the expenses of that period to determine whether it earned a profit. When revenues exceed expenses, net income results. When expenses exceed revenues, a net loss results. c01IntroductiontoFinancialStatements.qxd 7/26/10 1:09 PM Page 11 Communicating with Users 11 before you go on... Do it! Classify each item as an asset, liability, common stock, revenue, or BUSINESS ACTIVITIES expense. 1. Cost of renting property 2. Truck purchased 3. Notes payable 4. Issuance of ownership shares 5. Amount earned from providing service 6. Amounts owed to suppliers Solution 1. Cost of renting property: Expense. 2. Truck purchased: Asset. 3. Notes payable: Liabilities. Action Plan Classify each item based on its economic characteristics. Proper classification of items is critical if accounting is to provide useful information. 4. Issuance of ownership shares: Common stock. 5. Amount earned from providing service: Revenue. 6. Amounts owed to suppliers: Liabilities. Related exercise material: BE1-3, Do it! 1-2, and E1-3. Communicating with Users Assets, liabilities, expenses, and revenues are of interest to users of accounting information. This information is arranged in the format of four different financial statements, which form the backbone of financial accounting: To present a picture at a point in time of what your business owns (its assets) and what it owes (its liabilities), you prepare a balance sheet. To show how successfully your business performed during a period of time, you report its revenues and expenses in an income statement. To indicate how much of previous income was distributed to you and the other owners of your business in the form of dividends, and how much was retained in the business to allow for future growth, you present a retained earnings statement. To show where your business obtained cash during a period of time and how that cash was used, you present a statement of cash flows. To introduce you to these statements, we have prepared the financial statements for your outdoor guide service, Sierra Corporation, after your first month of operations. To summarize, you officially started your business in Truckee, California, on October 1, 2012. Sierra provides guide services in the Lake Tahoe area of the Sierra Nevada mountains. Its promotional materials describe outdoor day trips, such as rafting, snowshoeing, and hiking, as well as multi-day backcountry experiences. To minimize your initial investment, at this point the company has limited outdoor equipment for customer use. Instead, your customers either bring their own equipment or you arrange for them to rent equipment through local outfitters. The financial statements for Sierra's first month of business are provided in the following pages. INCOME STATEMENT The income statement reports the success or failure of the company's operations for a period of time. To indicate that its income statement reports the study objective 4 Describe the content and purpose of each of the financial statements. International Note The primary types of financial statements required by International Financial Reporting Standards (IFRS) and U.S. generally accepted accounting principles (GAAP) are the same. Neither IFRS nor GAAP is very specific regarding format requirements for the primary financial statements. However, in practice, some format differences do exist in presentations commonly employed by IFRS companies compared to GAAP companies. c01IntroductiontoFinancialStatements.qxd 12 7/26/10 1:09 PM Page 12 chapter 1 Introduction to Financial Statements results of operations for a period of time, Sierra dates the income statement \"For the Month Ended October 31, 2012.\" The income statement lists the company's revenues followed by its expenses. Finally, Sierra determines the net income (or net loss) by deducting expenses from revenues. Sierra Corporation's income statement is shown in Illustration 1-4. Congratulations, you are already showing a profit! Illustration 1-4 Sierra Corporation's income statement SIERRA CORPORATION Income Statement For the Month Ended October 31, 2012 Revenues Service revenue Expenses Salaries expense Supplies expense Rent expense Insurance expense Interest expense Depreciation expense Helpful Hint The heading identifies the company, the type of statement, and the time period covered. Sometimes, another line indicates the unit of measure, e.g., \"in thousands\" or \"in millions.\" Ethics Note When companies find errors in previously released income statements, they restate those numbers. Perhaps because of the increased scrutiny shortly after Sarbanes-Oxley was implemented, companies filed a record 1,195 restatements. Decision Toolkits summarize the financial decision-making process. $10,600 $5,200 1,500 900 50 50 40 Total expenses Net income 7,740 $ 2,860 Why are financial statement users interested in net income? Investors are interested in a company's past net income because it provides useful information for predicting future net income. Investors buy and sell stock based on their beliefs about a company's future performance. If investors believe that Sierra will be successful in the future and that this will result in a higher stock price, they will buy its stock. Creditors also use the income statement to predict future earnings. When a bank loans money to a company, it believes that it will be repaid in the future. If it didn't think it would be repaid, it wouldn't loan the money. Therefore, prior to making the loan the bank loan officer uses the income statement as a source of information to predict whether the company will be profitable enough to repay its loan. Thus, reporting a strong profit will make it easier for Sierra to raise additional cash either by issuing shares of stock or borrowing. Amounts received from issuing stock are not revenues, and amounts paid out as dividends are not expenses. As a result, they are not reported on the income statement. For example, Sierra Corporation does not treat as revenue the $10,000 of cash received from issuing new stock, nor does it regard as a business expense the $500 of dividends paid. DECISION TOOLKIT DECISION CHECKPOINTS Are the company's operations profitable? INFO NEEDED FOR DECISION Income statement TOOL TO USE FOR DECISION HOW TO EVALUATE RESULTS The income statement reports on the success or failure of the company's operations by reporting its revenues and expenses. If the company's revenue exceeds its expenses, it will report net income; otherwise it will report a net loss. RETAINED EARNINGS STATEMENT If Sierra is profitable, at the end of each period it must decide what portion of profits to pay to shareholders in dividends. In theory, it could pay all of its c01IntroductiontoFinancialStatements.qxd 7/26/10 1:09 PM Page 13 13 Communicating with Users current-period profits, but few companies do this. Why? Because they want to retain part of the profits to allow for further expansion. High-growth companies, such as Google and Cisco Systems, often pay no dividends. Retained earnings is the net income retained in the corporation. The retained earnings statement shows the amounts and causes of changes in retained earnings during the period. The time period is the same as that covered by the income statement. The beginning retained earnings amount appears on the first line of the statement. Then the company adds net income and deducts dividends to determine the retained earnings at the end of the period. If a company has a net loss, it deducts (rather than adds) that amount in the retained earnings statement. Illustration 1-5 presents Sierra Corporation's retained earnings statement. SIERRA CORPORATION Retained Earnings Statement For the Month Ended October 31, 2012 Retained earnings, October 1 Add: Net income Less: Dividends Retained earnings, October 31 $ 0 2,860 2,860 500 $2,360 Illustration 1-5 Sierra Corporation's retained earnings statement Helpful Hint The heading of this statement identifies the company, the type of statement, and the time period covered by the statement. By monitoring the retained earnings statement, financial statement users can evaluate dividend payment practices. Some investors seek companies, such as Dow Chemical, that have a history of paying high dividends. Other investors seek companies, such as Amazon.com, that reinvest earnings to increase the company's growth instead of paying dividends. Lenders monitor their corporate customers' dividend payments because any money paid in dividends reduces a company's ability to repay its debts. DECISION TOOLKIT DECISION CHECKPOINTS What is the company's policy toward dividends and growth? INFO NEEDED FOR DECISION Retained earnings statement TOOL TO USE FOR DECISION How much of this year's income did the company pay out in dividends to shareholders? BALANCE SHEET The balance sheet reports assets and claims to assets at a specific point in time. Claims to assets are subdivided into two categories: claims of creditors and claims of owners. As noted earlier, claims of creditors are called liabilities. Claims of owners are called stockholders' equity. Illustration 1-6 shows the relationship among the categories on the balance sheet in equation form. This equation is referred to as the basic accounting equation. Assets Liabilities Stockholders' Equity HOW TO EVALUATE RESULTS A company striving for rapid growth will pay a low (or no) dividend. study objective 5 Explain the meaning of assets, liabilities, and stockholders' equity, and state the basic accounting equation. Illustration 1-6 Basic accounting equation c01IntroductiontoFinancialStatements.qxd 14 7/26/10 1:09 PM Page 14 chapter 1 Introduction to Financial Statements Alternative Terminology Liabilities are also referred to as debt. This relationship is where the name \"balance sheet\" comes from. Assets must balance with the claims to assets. As you can see from looking at Sierra's balance sheet in Illustration 1-7, the balance sheet presents the company's financial position as of a specific date in this case, October 31, 2012. It lists assets first, followed by liabilities and stockholders' equity. Stockholders' equity is comprised of two parts: (1) common stock and (2) retained earnings. As noted earlier, common stock results when the company sells new shares of stock; retained earnings is the net income retained in the corporation. Sierra has common stock of $10,000 and retained earnings of $2,360, for total stockholders' equity of $12,360. Illustration 1-7 Sierra Corporation's balance sheet SIERRA CORPORATION Balance Sheet October 31, 2012 Assets Cash Accounts receivable Supplies Prepaid insurance Equipment, net $15,200 200 1,000 550 4,960 Total assets $21,910 Liabilities and Stockholders' Equity Helpful Hint The heading of a balance sheet must identify the company, the statement, and the date. Liabilities Notes payable Accounts payable Salaries payable Unearned service revenue Interest payable $ 5,000 2,500 1,200 800 50 Total liabilities Stockholders' equity Common stock Retained earnings $ 9,550 10,000 2,360 Total stockholders' equity Total liabilities and stockholders' equity 12,360 $21,910 Creditors analyze a company's balance sheet to determine the likelihood that they will be repaid. They carefully evaluate the nature of the company's assets and liabilities. In operating the Sierra Corporation guide service, the balance sheet will be used to determine whether cash on hand is sufficient for immediate cash needs. The balance sheet will also be used to evaluate the relationship between debt and stockholders' equity to determine whether the company has a satisfactory proportion of debt and common stock financing. DECISION TOOLKIT DECISION CHECKPOINTS Does the company rely primarily on debt or stockholders' equity to finance its assets? INFO NEEDED FOR DECISION Balance sheet TOOL TO USE FOR DECISION HOW TO EVALUATE RESULTS The balance sheet reports the company's resources and claims to those resources. There are two types of claims: liabilities and stockholders' equity. Compare the amount of debt versus the amount of stockholders' equity to determine whether the company relies more on creditors or owners for its financing. c01IntroductiontoFinancialStatements.qxd 7/26/10 1:09 PM Page 15 Communicating with Users 15 Ethics Insight Rocking the Bottom Line What topic has performers such as Tom Waits, Clint Black, Sheryl Crow, and Madonna so concerned that they are pushing for new laws regarding its use? Accounting. Recording-company accounting to be more precise. Musicians receive royalty payments based on the accounting done by their recording companies. Many performers say that the recording companieseither intentionally or unintentionallyhave very poor accounting systems, which, the performers say, has resulted in many inaccurate royalty payments. They would like to see laws created that would hit the recording companies with stiff fines for accounting errors. ? What is one way that some of these disputes might be resolved? (See page 41.) STATEMENT OF CASH FLOWS The primary purpose of a statement of cash flows is to provide financial information about the cash receipts and cash payments of a business for a specific period of time. To help investors, creditors, and others in their analysis of a company's cash position, the statement of cash flows reports the cash effects of a company's operating, investing, and financing activities. In addition, the statement shows the net increase or decrease in cash during the period, and the amount of cash at the end of the period. Users are interested in the statement of cash flows because they want to know what is happening to a company's most important resource. In operating Sierra, the statement of cash flows will provide answers to these simple but important questions: Where did cash come from during the period? How was cash used during the period? What was the change in the cash balance during the period? The statement of cash flows for Sierra, in Illustration 1-8, shows that cash increased $15,200 during the month. This increase resulted because operating Illustration 1-8 Sierra Corporation's statement of cash flows SIERRA CORPORATION Statement of Cash Flows For the Month Ended October 31, 2012 Cash flows from operating activities Cash receipts from operating activities Cash payments for operating activities $11,200 (5,500) Net cash provided by operating activities Cash flows from investing activities Purchased office equipment $ 5,700 (5,000) Net cash used by investing activities Cash flows from financing activities Issuance of common stock Issued note payable Payment of dividend Net cash provided by financing activities Net increase in cash Cash at beginning of period Cash at end of period (5,000) 10,000 5,000 (500) 14,500 15,200 0 $15,200 Helpful Hint The heading of this statement identifies the company, the type of statement, and the time period covered by the statement. Negative numbers are shown in parentheses. c01IntroductiontoFinancialStatements.qxd 16 7/26/10 1:09 PM Page 16 chapter 1 Introduction to Financial Statements activities (services to clients) increased cash $5,700, and financing activities increased cash $14,500. Investing activities used $5,000 of cash for the purchase of equipment. DECISION TOOLKIT DECISION CHECKPOINTS Does the company generate sufficient cash from operations to fund its investing activities? Tootsie Roll Annual Report Walkthrough INFO NEEDED FOR DECISION Statement of cash flows TOOL TO USE FOR DECISION HOW TO EVALUATE RESULTS The statement of cash flows shows the amount of cash provided or used by operating activities, investing activities, and financing activities. Compare the amount of cash provided by operating activities with the amount of cash used by investing activities. Any deficiency in cash from operating activities must be made up with cash from financing activities. INTERRELATIONSHIPS OF STATEMENTS Illustration 1-9 shows simplified financial statements of Tootsie Roll Industries, Inc. (We have simplified the financial statements to assist your learning.) Tootsie Roll's actual financial statements are presented in Appendix A, at the end of the textbook. Note that the numbers in Tootsie Roll's statements are presented in thousandsthat is, the last three 000s are omitted. Thus, Tootsie Roll's net income in 2009 is $53,475,000, not $53,475. Because the results on some financial statements become inputs to other statements, the statements are interrelated. These interrelationships can be seen in Tootsie Roll's financial statements, as follows. 1. The retained earnings statement depends on the results of the income statement. Tootsie Roll reported net income of $53,475,000 for the period. It adds the net income amount to the beginning amount of retained earnings in order to determine ending retained earnings. 2. The balance sheet and retained earnings statement are also interrelated. Tootsie Roll reports the ending amount of $145,928,000 on the retained earnings statement as the retained earnings amount on the balance sheet. 3. Finally, the statement of cash flows relates to information on the balance sheet. The statement of cash flows shows how the Cash account changed during the period. It shows the amount of cash at the beginning of the period, the sources and uses of cash during the period, and the $90,990,000 of cash at the end of the period. The ending amount of cash shown on the statement of cash flows must agree with the amount of cash on the balance sheet. Study these interrelationships carefully. To prepare financial statements, you must understand the sequence in which these amounts are determined and how each statement impacts the next. c01IntroductiontoFinancialStatements.qxd 7/26/10 1:09 PM Page 17 Communicating with Users Illustration 1-9 Tootsie Roll Industries, Inc.'s financial statements TOOTSIE ROLL INDUSTRIES, INC. Income Statement For the Year Ended December 31, 2009 (in thousands) $499,331 $319,497 115,655 10,704 445,856 $ 53,475 Revenues Expenses Cost of goods sold Selling, marketing, and administrative expense and other Income tax expense Total expenses Net income TOOTSIE ROLL INDUSTRIES, INC. Retained Earnings Statement For the Year Ended December 31, 2009 (in thousands) Helpful Hint Note that final sums are double-underlined, and negative amounts (in the statement of cash flows) are presented in parentheses. 1 Retained earnings, December 31, 2009 $145,928 Less: Dividends and other (net) $142,872 53,475 196,347 50,419 Retained earnings, January 1, 2009 Add: Net income Helpful Hint The arrows in this illustration show interrelationships of the four financial statements. TOOTSIE ROLL INDUSTRIES, INC. Balance Sheet December 31, 2009 (in thousands) $ 90,990 8,663 45,909 56,387 8,562 220,721 407,015 Total assets Assets Cash Investments Accounts receivable Inventories Prepaid expenses Property, plant and equipment, net Other assets 2 $838,247 Liabilities and Stockholders' Equity $ 9,140 4,458 42,468 44,582 7,500 77,614 Stockholders' equity Common stock Retained earnings 506,557 145,928 Total liabilities and stockholders' equity $185,762 652,485 Liabilities Accounts payable Dividends payable Accrued liabilities Deferred income taxes payable Bonds payable Employee benefits payable and other $838,247 3 TOOTSIE ROLL INDUSTRIES, INC. Statement of Cash Flows For the Year Ended December 31, 2009 (in thousands) Net cash provided by operating activities Cash flows from investing activities Capital expenditures and acquisitions Net purchases/sales of investment securities and other Net cash used by investing activities Cash flows from financing activities Repurchase of common stock Dividends paid in cash Net cash used by financing activities Net increase (decrease) in cash Cash at beginning of year Cash at end of year $491,344 (416,063) $ 75,281 (20,831) 6,180 (14,651) (20,723) (17,825) (38,548) 22,082 68,908 $ 90,990 Cash flows from operating activities Cash receipts from operating activities Cash payments for operating activities 17 c01IntroductiontoFinancialStatements.qxd 18 7/26/10 1:09 PM Page 18 chapter 1 Introduction to Financial Statements before you go on... FINANCIAL STATEMENTS Action Plan Report the revenues and expenses for a period of time in an income statement. Show the amounts and causes (net income and dividends) of changes in retained earnings during the period in the retained earnings statement. Present the assets and claims to those assets at a specific point in time in the balance sheet. Do it! CSU Corporation began operations on January 1, 2012. The following information is available for CSU Corporation on December 31, 2012: Accounts receivable 1,800 Retained earnings ? Supplies expense 200 Accounts payable 2,000 Equipment 16,000 Cash 1,400 Building rental expense 9,000 Insurance expense 1,000 Dividends 600 Notes payable 5,000 Service revenue 17,000 Common stock 10,000 Supplies 4,000 Prepare an income statement, a retained earnings statement, and a balance sheet. Solution CSU CORPORATION Income Statement For the Year Ended December 31, 2012 Revenues Service revenue Expenses Rent expense Insurance expense Supplies expense Total expenses Net income $17,000 $9,000 1,000 200 10,200 $ 6,800 CSU CORPORATION Retained Earnings Statement For the Year Ended December 31, 2012 Retained earnings, January 1 Add: Net income $ 0 6,800 6,800 600 $6,200 Less: Dividends Retained earnings, December 31 CSU CORPORATION Balance Sheet December 31, 2012 Assets Cash Accounts receivable Supplies Equipment Total assets $ 1,400 1,800 4,000 16,000 $23,200 Liabilities and Stockholders' Equity Liabilities Notes payable Accounts payable Total liabilities Stockholders' equity Common stock Retained earnings Total stockholders' equity Total liabilities and stockholders' equity $ 5,000 2,000 $ 7,000 10,000 6,200 16,200 $23,200 Related exercise material: BE1-5, BE1-6, BE1-7, BE1-8, BE1-9, BE1-10, Do it! 1-3, E1-4, E1-5, E1-6, E1-7, E1-8, E1-9, E1-10, E1-11, and E1-14. c01IntroductiontoFinancialStatements.qxd 7/26/10 1:09 PM Page 19 Communicating with Users OTHER ELEMENTS OF AN ANNUAL REPORT U.S. companies that are publicly traded must provide shareholders with an annual report. The annual report always includes the financial statements introduced in this chapter. The annual report also includes other important information such as a management discussion and analysis section, notes to the financial statements, and an independent auditor's report. No analysis of a company's financial situation and prospects is complete without a review of these items. study objective 19 6 Describe the components that supplement the financial statements in an annual report. Management Discussion and Analysis The management discussion and analysis (MD&A) section covers various financial aspects of a company, including its ability to pay near-term obligations, its ability to fund operations and expansion, and its results of operations. Management must highlight favorable or unfavorable trends and identify significant events and uncertainties that affect these three factors. This discussion obviously involves a number of subjective estimates and opinions. A brief excerpt from the MD&A section of Tootsie Roll's annual report is presented in Illustration 1-10. TOOTSIE ROLL INDUSTRIES, INC. Management's Discussion and Analysis of Financial Condition and Results of Operations Illustration 1-10 Tootsie Roll's management discussion and analysis The Company has a relatively straightforward financial structure and has historically maintained a conservative financial position. Except for an immaterial amount of operating leases, the Company has no special financing arrangements or \"off-balance sheet\" special purpose entities. Cash flows from operations plus maturities of shortterm investments are expected to be adequate to meet the Company's overall financing needs, including capital expenditures, in 2010. Notes to the Financial Statements Explanatory notes and supporting schedules accompany every set of financial statements and are an integral part of the statements. The notes to the financial statements clarify the financial statements, and provide additional detail. Information in the notes does not have to be quantifiable (numeric). Examples of notes are descriptions of the significant accounting policies and methods used in preparing the statements, explanations of uncertainties and contingencies, and various statistics and details too voluminous to be included in the statements. The notes are essential to understanding a company's operating performance and financial position. Illustration 1-11 is an excerpt from the notes to Tootsie Roll's financial statements. It describes the methods that Tootsie Roll uses to account for revenues. TOOTSIE ROLL INDUSTRIES, INC. Notes to Financial Statements Revenue recognition Revenue, net of applicable provisions for discounts, returns, allowances, and certain advertising and promotional costs, is recognized when products are delivered to customers based on a customer purchase order, and collectibility is reasonably assured. Auditor's Report An auditor's report is prepared by an independent outside auditor. It states the auditor's opinion as to the fairness of the presentation of the financial position and results of operations and their conformance with generally accepted accounting standards. Illustration 1-11 Notes to Tootsie Roll's financial statements c01IntroductiontoFinancialStatements.qxd 20 7/26/10 1:09 PM Page 20 chapter 1 Introduction to Financial Statements An auditor is an accounting professional who conducts an independent examination of a company's financial statements. Only accountants who meet certain criteria and thereby attain the designation Certified Public Accountant (CPA) may perform audits. If the auditor is satisfied that the financial statements provide a fair representation of the company's financial position and results of operations in accordance with generally accepted accounting principles, then the auditor expresses an unqualified opinion. If the auditor expresses anything other than an unqualified opinion, then readers should only use the financial statements with caution. That is, without an unqualified opinion, we cannot have complete confidence that the financial statements give an accurate picture of the company's financial health. For example, in April 2009 Blockbuster, Inc.'s auditor stated that its financial situation raised \"substantial doubt about the Company's ability to continue as a going concern.\" Illustration 1-12 is an excerpt from the auditor's report from Tootsie Roll's 2009 annual report. Tootsie Roll received an unqualified opinion from its auditor, PricewaterhouseCoopers. Illustration 1-12 Excerpt from auditor's report on Tootsie Roll's financial statements TOOTSIE ROLL INDUSTRIES, INC. Excerpt from Auditor's Report To the Board of Directors and Shareholders of Tootsie Roll Industries, Inc. In our opinion, the accompanying consolidated statements of financial position and the related consolidated statements of earnings, comprehensive earnings and retained earnings, and of cash flows present fairly, in all material respects, the financial position of Tootsie Roll Industries, Inc. and its subsidiaries at December 31, 2009 and December 31, 2008, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2009 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). before you go on... COMPONENTS OF ANNUAL REPORTS Action Plan Realize that financial statements provide information about a company's performance and financial position. Be familiar with the other elements of the annual report in order to gain a fuller understanding of a company. Do it! State whether each of the following items is most closely associated with the management discussion and analysis (MD&A), the notes to the financial statements, or the auditor's report. 1. 2. 3. 4. 5. 6. Descriptions of significant accounting policies Unqualified opinion Explanations of uncertainties and contingencies Description of ability to fund operations and expansion Description of results of operations Certified Public Accountant (CPA) Solution 1. 2. 3. 4. 5. 6. Descriptions of significant accounting policies: Notes. Unqualified opinion: Auditor's report. Explanations of uncertainties and contingencies: Notes. Description of ability to fund operations and expansion: MD&A. Description of results of operations: MD&A. Certified Public Accountant (CPA): Auditor's report. Related exercise material: BE1-11, Do it! 1-4, and E1-17. c01IntroductiontoFinancialStatements.qxd 9/2/10 2:01 PM Page 21 Summary of Study Objectives 21 USING THE DECISION TOOLKIT The Hershey Company, located in Hershey, Pennsylvania, is the leading North American manufacturer of chocolatefor example, Hershey's Kisses, Reese's Peanut Butter Cups, Kit Kat, and Take 5 bars. Imagine that you are considering the purchase of shares of Hershey's common stock. Using the Decision Toolkit exercises ask you to use information from financial statements to make financial decisions. Instructions Answer these questions related to your decision whether to invest. (a) What financial statements should you request from the company? (b) What should these financial statements tell you? (c) Should you request audited financial statements? Explain. (d) Appendix B at the end of this book contains financial statements for Hershey. What comparisons can you make between Tootsie Roll and Hershey in terms of their respective results from operations and financial position? Solution (a) Before you invest, you should investigate the income statement, retained earnings statement, statement of cash flows, and balance sheet. (b) You would probably be most interested in the income statement because it tells about past performance and thus gives an indication of future performance. The retained earnings statement provides a record of the company's dividend history. The statement of cash flows reveals where the company is getting and spending its cash. This is especially important for a company that wants to grow. Finally, the balance sheet reveals the relationship between assets and liabilities. (c) You would want audited financial statements. These statements indicate that a CPA (certified public accountant) has examined and expressed an opinion that the statements present fairly the financial position and results of operations of the company. Investors and creditors should not make decisions without studying audited financial statements. (d) Many interesting comparisons can be made between the two companies. Tootsie Roll is smaller, with total assets of $838,247,000 versus $3,675,031,000 for Hershey, and it has lower revenue$499,331,000 versus $5,298,660,000 for Hershey. In addition, Tootsie Roll's cash provided by operating activities of $75,281,000 is less than Hershey's $1,065,749,000. While useful, these basic measures are not enough to determine whether one company is a better investment than the other. In later chapters, you will learn of tools that will allow you to compare the relative profitability and financial health of these and other companies. Summary of Study Objectives 1 Describe the primary forms of business organization. A sole proprietorship is a business owned by one person. A partnership is a business owned by two or more people associated as partners. A corporation is a separate legal entity for which evidence of ownership is provided by shares of stock. 2 Identify the users and uses of accounting information. Internal users are managers who need accounting information to plan, organize, and run business operations. The primary external users are investors and creditors. Investors (stockholders) use accounting information to help them decide whether to buy, hold, or sell shares of a company's stock. Creditors (suppliers and bankers) use accounting information to assess the risk of granting credit or loaning money to a business. Other groups who have an indirect interest in a business are taxing authorities, customers, labor unions, and regulatory agencies. 3 Explain the three principal types of business activity. Financing activities involve collecting the necessary funds to support the business. Investing activities involve acquiring the resources necessary to run the business. Operating activities involve putting the resources of the business into action to generate a profit. c01IntroductiontoFinancialStatements.qxd 22 4 5 7/26/10 1:09 PM Page 22 chapter 1 Introduction to Financial Statements Describe the content and purpose of each of the financial statements. An income statement presents the revenues and expenses of a company for a specific period of time. A retained earnings statement summarizes the changes in retained earnings that have occurred for a specific period of time. A balance sheet reports the assets, liabilities, and stockholders' equity of a business at a specific date. A statement of cash flows summarizes information concerning the cash inflows (receipts) and outflows (payments) for a specific period of time. Explain the meaning of assets, liabilities, and stockholders' equity, and state the basic accounting equation. Assets are resources owned by a business. Liabilities are the debts and obligations of the business. Liabilities represent claims of creditors on the assets of the business. Stockholders' equity represents the claims of DECISION TOOLKIT DECISION CHECKPOINTS owners on the assets of the business. Stockholders' equity is subdivided into two parts: common stock and retained earnings. The basic accounting equation is: Assets Liabilities Stockholders' Equity. 6 Describe the components that supplement the financial statements in an annual report. The management discussion and analysis provides management's interpretation of the company's results and financial position as well as a discussion of plans for the future. Notes to the financial statements provide additional explanation or detail to make the financial statements more informative. The auditor's report expresses an opinion as to whether the financial statements present fairly the company's results of operations and financial position. A SUMMARY INFO NEEDED FOR DECISION TOOL TO USE FOR DECISION HOW TO EVALUATE RESULTS Are the company's operations profitable? Income statement The income statement reports on the success or failure of the company's operations by reporting its revenues and expenses. If the company's revenue exceeds its expenses, it will report net income; otherwise it will report a net loss. What is the company's policy toward dividends and growth? Retained earnings statement How much of this year's income did the company pay out in dividends to shareholders? A company striving for rapid growth will pay a low (or no) dividend. Does the company rely primarily on debt or stockholders' equity to

Answer rating: 100% (QA)

There wa... View the full answer