ACCT 210 Lecture, Fall 2002

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-1 BASIC FINANCIAL STATEMENTS Chapter 2 © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-2 Learning Objective Learning Objective LO1 To explain the nature and general purpose of financial statements. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-3 Income Statement Balance Sheet Statement of Cash Flows Introduction to Financial Statements Introduction to Financial Statements Three primary financial statements. We will use a corporation to describe these statements. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-4 Introduction to Financial Statements Introduction to Financial Statements Describes where the enterprise stands at a specific date. Income Statement Balance Sheet Statement of Cash Flows © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-5 Introduction to Financial Statements Introduction to Financial Statements Depicts the revenue and expenses for a designated period of time. Income Statement Balance Sheet Statement of Cash Flows © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-6 Introduction to Financial Statements Introduction to Financial Statements Revenues result in positive cash flow. Expenses result in negative cash flow. Either in the past, present, or future. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-7 Introduction to Financial Statements Introduction to Financial Statements Net income (or net loss) is simply the difference between revenues and expenses. Income Statement Balance Sheet Statement of Cash Flows © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-8 Introduction to Financial Statements Introduction to Financial Statements Depicts the ways cash has changed during a designated period of time. Income Statement Balance Sheet Statement of Cash Flows © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-9 Vagabond Travel Agency Balance Sheet December 31, 2007 Assets Liabilities & Owners' Equity Cash 22,500 $ Liabilities: Notes receivable 10,000 Notes payable 41,000 $ Accounts receivable 60,500 Accounts payable 36,000 Supplies 2,000 Salaries payable 3,000 Land 100,000 Total liabilities 80,000 $ Building 90,000 Owners' Equity: Office equipment 15,000 Capital stock 150,000 Retained earnings 70,000 Total $ 300,000 Total 300,000 $ A Starting Point: Statement of Financial Position A Starting Point: Statement of Financial Position © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-10 Learning Objective Learning Objective LO2 To explain certain accounting principles that are important for an understanding of financial statements and how professional judgment by accountants may affect the application of those principles. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-11 The Concept of the Business Entity The Concept of the Business Entity Vagabond Travel Agency A business entity is separate from the personal affairs of its owner. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-12 Vagabond Travel Agency Balance Sheet December 31, 2007 Assets Liabilities & Owners' Equity Cash 22,500 $ Liabilities: Notes receivable 10,000 Notes payable 41,000 $ Accounts receivable 60,500 Accounts payable 36,000 Supplies 2,000 Salaries payable 3,000 Land 100,000 Total liabilities 80,000 $ Building 90,000 Owners' Equity: Office equipment 15,000 Capital stock 150,000 Retained earnings 70,000 Total $ 300,000 Total 300,000 $ Assets Assets Assets are economic resources that are owned by the business and are expected to benefit future operations. Assets are economic resources that are owned by the business and are expected to benefit future operations. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-13 Assets Assets Cost Principle Cost Principle Cost Principle Cost Principle Going-Concern Going-Concern Assumption Assumption Going-Concern Going-Concern Assumption Assumption Objectivity Objectivity Principle Principle Objectivity Objectivity Principle Principle Stable-Dollar Stable-Dollar Assumption Assumption Stable-Dollar Stable-Dollar Assumption Assumption These accounting principles support cost as the basis for asset valuation. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-14 Vagabond Travel Agency Balance Sheet December 31, 2007 Assets Liabilities & Owners' Equity Cash 22,500 $ Liabilities: Notes receivable 10,000 Notes payable 41,000 $ Accounts receivable 60,500 Accounts payable 36,000 Supplies 2,000 Salaries payable 3,000 Land 100,000 Total liabilities 80,000 $ Building 90,000 Owners' Equity: Office equipment 15,000 Capital stock 150,000 Retained earnings 70,000 Total $ 300,000 Total 300,000 $ Liabilities Liabilities Liabilities are debts that represent negative future cash flows for the enterprise. Liabilities are debts that represent negative future cash flows for the enterprise. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-15 Vagabond Travel Agency Balance Sheet December 31, 2007 Assets Liabilities & Owners' Equity Cash 22,500 $ Liabilities: Notes receivable 10,000 Notes payable 41,000 $ Accounts receivable 60,500 Accounts payable 36,000 Supplies 2,000 Salaries payable 3,000 Land 100,000 Total liabilities 80,000 $ Building 90,000 Owners' Equity: Office equipment 15,000 Capital stock 150,000 Retained earnings 70,000 Total $ 300,000 Total 300,000 $ Owners’ Equity Owners’ Equity Owners’ equity represents the owners’ claims on the assets of the business. Owners’ equity represents the owners’ claims on the assets of the business. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-16 Owners’ Equity Owners’ Equity Changes in Owners’ Equity •Owners’ Investments •Business Earnings •Payments to Owners •Business Losses © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-17 Learning Objective Learning Objective LO3 To demonstrate how certain business transactions affect the elements of the accounting equation: Assets = Liabilities + Owners’ Equity. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-18 Vagabond Travel Agency Balance Sheet December 31, 2007 Assets Liabilities & Owners' Equity Cash 22,500 $ Liabilities: Notes receivable 10,000 Notes payable 41,000 $ Accounts receivable 60,500 Accounts payable 36,000 Supplies 2,000 Salaries payable 3,000 Land 100,000 Total liabilities 80,000 $ Building 90,000 Owners' Equity Office equipment 15,000 Capital stock 150,000 Retained earnings 70,000 Total $ 300,000 Total 300,000 $ The Accounting Equation The Accounting Equation Assets = Liabilities + Owners’ Equity $300,000 = $80,000 + $220,000 Assets = Liabilities + Owners’ Equity $300,000 = $80,000 + $220,000 © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-19 Let’s analyze some transactions for JJ’s Lawn Care Service. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-20 JJ's Lawn Care Service Balance Sheet May 1, 2007 Assets Cash 8,000 $ Capital Stock 8,000 $ Total 8,000 $ Total 8,000 $ Owners' Equity On May 1, Jill Jones and her family invested $8,000 in JJ’s Lawn Care Service and received 800 shares of stock. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-21 JJ's Lawn Care Service Balance Sheet May 2, 2007 Assets Cash 5,500 $ Capital Stock 8,000 $ Tools & Equipment 2,500 Total 8,000 $ Total 8,000 $ Owners' Equity On May 2, JJ’s purchased a riding lawn mower for $2,500 cash. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-22 On May 8, JJ’s purchased a $15,000 truck. JJ’s paid $2,000 down in cash and issued a note payable for the remaining $13,000. JJ's Lawn Care Service Balance Sheet May 8, 2007 Assets Cash 3,500 $ Liabilities: Tools & Equipment 2,500 Notes Payable 13,000 $ Truck 15,000 Owners' Equity: Capital Stock 8,000 Total 21,000 $ Total 21,000 $ Liabilities and Owners' Equity © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-23 JJ's Lawn Care Service Balance Sheet May 11, 2007 Assets Cash 3,500 $ Liabilities: Tools & Equipment 2,800 Notes Payable 13,000 $ Truck 15,000 Accounts Payable 300 Total Liabilities 13,300 $ Owners' Equity: Capital Stock 8,000 Total 21,300 $ Total 21,300 $ Liabilities and Owners' Equity On May 11, JJ’s purchased some repair parts for $300 on account. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-24 JJ's Lawn Care Service Balance Sheet May 18, 2007 Assets Cash 3,500 $ Liabilities: Accounts Receivable 150 Notes Payable 13,000 $ Tools & Equipment 2,650 Accounts Payable 300 Truck 15,000 Total Liabilities 13,300 $ Owners' Equity: Capital Stock 8,000 Total 21,300 $ Total 21,300 $ Liabilities and Owners' Equity Jill realized she had purchased more repair parts than needed. On May 18, JJ’s was able to sell half of the repair parts to ABC Lawns for $150, a price equal to JJ’s cost. JJ’s will receive the cash within 30 days. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-25 JJ's Lawn Care Service Balance Sheet May 25, 2007 Assets Cash 3,575 $ Liabilities: Accounts Receivable 75 Notes Payable 13,000 $ Tools & Equipment 2,650 Accounts Payable 300 Truck 15,000 Total Liabilities 13,300 $ Owners' Equity: Capital Stock 8,000 Total 21,300 $ Total 21,300 $ Liabilities and Owners' Equity On May 25, ABC Lawns pays JJ’s $75 as a partial settlement of its accounts receivable. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-26 JJ's Lawn Care Service Balance Sheet May 28, 2007 Assets Cash 3,425 $ Liabilities: Accounts Receivable 75 Notes Payable 13,000 $ Tools & Equipment 2,650 Accounts Payable 150 Truck 15,000 Total Liabilities 13,150 Owners' Equity: Capital Stock 8,000 Total 21,150 $ Total 21,150 $ Liabilities and Owners' Equity On May 28, JJ’s pays $150 of its accounts payable. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-27 JJ's Lawn Care Service Balance Sheet May 29, 2007 Assets Cash 4,175 $ Liabilities: Accounts Receivable 75 Notes Payable 13,000 $ Tools & Equipment 2,650 Accounts Payable 150 Truck 15,000 Total Liabilities 13,150 Owners' Equity: Capital Stock 8,000 Retained Earnings 750 Total 21,900 $ Total 21,900 $ Liabilities and Owners' Equity On May 29, JJ’s recorded lawn care services provided during May of $750. All clients were paid in cash. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-28 Learning Objective Learning Objective LO4 To explain how the statement of financial position, often referred to as the balance sheet, is an expansion of the basic accounting equation. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-29 JJ's Lawn Care Service Balance Sheet May 31, 2007 Assets Cash 4,125 $ Liabilities: Accounts Receivable 75 Notes Payable 13,000 $ Tools & Equipment 2,650 Accounts Payable 150 Truck 15,000 Total Liabilities 13,150 Owners' Equity: Capital Stock 8,000 Retained Earnings 700 Total 21,850 $ Total 21,850 $ Liabilities and Owners' Equity Now, let’s review how JJ’s transactions affected the accounting equation. On May 31, JJ’s purchased gasoline for the lawn mower and the truck for $50 cash. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-30 Assets = Liabilities + Cash + Accts. Rec. + Tools & Equip. + Truck = Notes Payable + Accts. Pay. + Capital Stock + Retained Earnings May 1 $ 8,000 8,000 $ Balances $ 8,000 8,000 $ May 2 (2,500) 2,500 $ Balances $ 5,500 $ 2,500 8,000 $ May 8 (2,000) $ 15,000 13,000 $ Balances $ 3,500 $ 2,500 $ 15,000 $ 13,000 8,000 $ May 11 300 300 $ Balances $ 3,500 $ 2,800 $ 15,000 $ 13,000 $ 300 8,000 $ May 18 $ 150 (150) Balances $ 3,500 $ 150 $ 2,650 $ 15,000 $ 13,000 $ 300 8,000 $ May 25 75 (75) Balances $ 3,575 $ 75 $ 2,650 $ 15,000 $ 13,000 $ 300 8,000 $ May 28 (150) (150) Balances $ 3,425 $ 75 $ 2,650 $ 15,000 $ 13,000 $ 150 8,000 $ May 29 750 750 Balances $ 4,175 $ 75 $ 2,650 $ 15,000 $ 13,000 $ 150 $ 8,000 750 $ May 31 (50) (50) Balances $ 4,125 $ 75 $ 2,650 $ 15,000 $ 13,000 $ 150 $ 8,000 700 $ Owners' Equity © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-31 Assets = Liabilities + Cash + Accts. Rec. + Tools & Equip. + Truck = Notes Payable + Accts. Pay. + Capital Stock + Retained Earnings May 1 $ 8,000 8,000 $ Balances $ 8,000 8,000 $ May 2 (2,500) 2,500 $ Balances $ 5,500 $ 2,500 8,000 $ May 8 (2,000) $ 15,000 13,000 $ Balances $ 3,500 $ 2,500 $ 15,000 $ 13,000 8,000 $ May 11 300 300 $ Balances $ 3,500 $ 2,800 $ 15,000 $ 13,000 $ 300 8,000 $ May 18 $ 150 (150) Balances $ 3,500 $ 150 $ 2,650 $ 15,000 $ 13,000 $ 300 8,000 $ May 25 75 (75) Balances $ 3,575 $ 75 $ 2,650 $ 15,000 $ 13,000 $ 300 8,000 $ May 28 (150) (150) Balances $ 3,425 $ 75 $ 2,650 $ 15,000 $ 13,000 $ 150 8,000 $ May 29 750 750 Balances $ 4,175 $ 75 $ 2,650 $ 15,000 $ 13,000 $ 150 $ 8,000 750 $ May 31 (50) (50) Balances $ 4,125 $ 75 $ 2,650 $ 15,000 $ 13,000 $ 150 $ 8,000 700 $ Owners' Equity These transactions impact the Statement of Cash Flows. These transactions impact the Statement of Cash Flows. These transactions impact the Income Statement. These transactions impact the Income Statement. Let’s prepare the Income Statement and Statement of Cash Flows for JJ’s Lawn Care Service for the month ending May 31, 2007. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-32 Learning Objective Learning Objective LO5 To explain how the income statement reports an enterprise’s financial performance for a period of time in terms of the relationship of revenues and expenses. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-33 JJ's Lawn Care Service Income Statement For the Month Ended May 31, 2007 Sales Revenue 750 $ Operating Expense: Gasoline Expense 50 Net Income 700 $ Investments by and payments to the owners are not included on the Income Statement. Investments by and payments to the owners are not included on the Income Statement. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-34 Learning Objective Learning Objective LO6 To explain how the statement of cash flows presents the change in cash for a period of time in terms of the company’s operating, investing, and financing activities. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-35 JJ's Lawn Care Service Statement of Cash Flows For the Month Ended May 31, 2007 Cash flows from operating activities: Cash received from revenue transactions 750 $ Cash paid for expenses (50) Net cash provided by operating activities 700 $ Cash flows from investing activities: Purchase of lawn mower (2,500) $ Purchase of truck (2,000) Collection for sale of repair parts 75 Payment for repair parts (150) Net cash used by investing activities (4,575) Cash flows from financing activities: Investment by owners 8,000 Increase in cash for month 4,125 $ Cash balance, May 1, 2007 - Cash balance, May 31, 2007 4,125 $ © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-36 JJ's Lawn Care Service Statement of Cash Flows For the Month Ended May 31, 2007 Cash flows from operating activities: Cash received from revenue transactions 750 $ Cash paid for expenses (50) Net cash provided by operating activities 700 $ Cash flows from investing activities: Purchase of lawn mower (2,500) $ Purchase of truck (2,000) Collection for sale of repair parts 75 Payment for repair parts (150) Net cash used by investing activities (4,575) Cash flows from financing activities: Investment by owners 8,000 Increase in cash for month 4,125 $ Cash balance, May 1, 2007 - Cash balance, May 31, 2007 4,125 $ Operating activities include the cash effects of revenue and expense transactions. Operating activities include the cash effects of revenue and expense transactions. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-37 JJ's Lawn Care Service Statement of Cash Flows For the Month Ended May 31, 2007 Cash flows from operating activities: Cash received from revenue transactions 750 $ Cash paid for expenses (50) Net cash provided by operating activities 700 $ Cash flows from investing activities: Purchase of lawn mower (2,500) $ Purchase of truck (2,000) Collection for sale of repair parts 75 Payment for repair parts (150) Net cash used by investing activities (4,575) Cash flows from financing activities: Investment by owners 8,000 Increase in cash for month 4,125 $ Cash balance, May 1, 2007 - Cash balance, May 31, 2007 4,125 $ Investing activities include the cash effects of purchasing and selling assets. Investing activities include the cash effects of purchasing and selling assets. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-38 JJ's Lawn Care Service Statement of Cash Flows For the Month Ended May 31, 2007 Cash flows from operating activities: Cash received from revenue transactions 750 $ Cash paid for expenses (50) Net cash provided by operating activities 700 $ Cash flows from investing activities: Purchase of lawn mower (2,500) $ Purchase of truck (2,000) Collection for sale of repair parts 75 Payment for repair parts (150) Net cash used by investing activities (4,575) Cash flows from financing activities: Investment by owners 8,000 Increase in cash for month 4,125 $ Cash balance, May 1, 2007 - Cash balance, May 31, 2007 4,125 $ Financing activities include the cash effects of transactions with the owners and creditors. Financing activities include the cash effects of transactions with the owners and creditors. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-39 Assets = Liabilities + Cash + Accts. Rec. + Tools & Equip. + Truck = Notes Payable + Accts. Pay. + Capital Stock + Retained Earnings May 1 $ 8,000 8,000 $ Balances $ 8,000 8,000 $ May 2 (2,500) 2,500 $ Balances $ 5,500 $ 2,500 8,000 $ May 8 (2,000) $ 15,000 13,000 $ Balances $ 3,500 $ 2,500 $ 15,000 $ 13,000 8,000 $ May 11 300 300 $ Balances $ 3,500 $ 2,800 $ 15,000 $ 13,000 $ 300 8,000 $ May 18 $ 150 (150) Balances $ 3,500 $ 150 $ 2,650 $ 15,000 $ 13,000 $ 300 8,000 $ May 25 75 (75) Balances $ 3,575 $ 75 $ 2,650 $ 15,000 $ 13,000 $ 300 8,000 $ May 28 (150) (150) Balances $ 3,425 $ 75 $ 2,650 $ 15,000 $ 13,000 $ 150 8,000 $ May 29 750 750 Balances $ 4,175 $ 75 $ 2,650 $ 15,000 $ 13,000 $ 150 $ 8,000 750 $ May 31 (50) (50) Balances $ 4,125 $ 75 $ 2,650 $ 15,000 $ 13,000 $ 150 $ 8,000 700 $ Owners' Equity Now, let’s prepare the Balance Sheet for JJ’s Lawn Care Service for May 31, 2007. These balances will appear on the Balance Sheet. These balances will appear on the Balance Sheet. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-40 Cash $ 4,125 Notes payable 13,000 $ Accounts receivable 75 Accounts payable 150 Tools & equipment 2,650 Truck 15,000 Capital stock 8,000 Retained earnings 700 Total assets 21,850 $ Total liabilities & equity 21,850 $ Assets Liabilities Owners' Equity JJ's Lawn Care Service Balance Sheet May 31, 2007 Assets = Liabilities + Owners’ Equity $21,850 = $13,150 + $8,700 Assets = Liabilities + Owners’ Equity $21,850 = $13,150 + $8,700 © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-41 Learning Objective Learning Objective LO7 To explain the important relationships among the statement of financial position, income statement, and statement of cash flows, and how these statements relate to each other. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-42 Relationships Among Financial Statements Relationships Among Financial Statements Date at beginning of period Date at end of period Balance Sheet Balance Sheet Time Income Statement Statement of Cash Flows © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-43 Financial Statement Articulation Financial Statement Articulation JJ's Lawn Care Service Statement of Cash Flows For the Month Ended May 31, 2007 Cash flows from operating activities: Cash received from revenue transactions 750 $ Cash paid for expenses (50) Net cash provided by operating activities 700 $ Cash flows from investing activities: Purchase of lawn mower (2,500) $ Purchase of truck (2,000) Collection for sale of repair parts 75 Payment for repair parts (150) Net cash used by investing activities (4,575) Cash flows from financing activities: Investment by owners 8,000 Increase in cash for month 4,125 $ Cash balance, May 1, 2007 - Cash balance, May 31, 2007 4,125 $ Cash $ 4,125 Notes payable 13,000 $ Accounts receivable 75 Accounts payable 150 Tools & equipment 2,650 Truck 15,000 Capital stock 8,000 Retained earnings 700 Total assets 21,850 $ Total liabilities & equity 21,850 $ Assets Liabilities Owners' Equity JJ's Lawn Care Service Balance Sheet May 31, 2007 JJ's Lawn Care Service Income Statement Sales Revenue 750 $ Operating Expense: Gasoline Expense 50 Net Income 700 $ For the Month Ended May 31, 2007 © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-44 Statement of Cash Flows Balance Sheet Income Statement Other Information: •Industry •Competitors •National economy Financial Reporting and Financial Statements Financial Reporting and Financial Statements Financial statements are just one source of financial accounting information. Financial statements are just one source of financial accounting information. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-45 Learning Objective Learning Objective LO8 To explain common forms of business ownership—sole proprietorship, partnership, and corporation—and demonstrate how they differ in terms of their presentation in the statement of financial position. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-46 Forms of Business Organization Forms of Business Organization Sole Proprietorships Sole Proprietorships Partnerships Partnerships Corporations Corporations © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-47 Reporting Ownership Equity in the Statement of Financial Position Reporting Ownership Equity in the Statement of Financial Position Owner's equity: Jill Jones, capital 8,000 $ Sole Proprietorships Sole Proprietorships Partners' equity Jill Jones, capital 4,000 $ Bill Jones, capital 4,000 Total partners' equity 8,000 $ Partnerships Partnerships Owners' equity Capital stock 7,000 $ Retained earnings 1,000 Total stockholders' equity 8,000 $ Corporations Corporations © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-48 The Use of Financial Statements by External Parties The Use of Financial Statements by External Parties Creditors Investors Two concerns: Liquidity Profitability Two concerns: Liquidity Profitability © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-49 The Need for Adequate Disclosure The Need for Adequate Disclosure Notes to the financial statements often provide facts necessary for the proper interpretation of the statements. Notes to the financial statements often provide facts necessary for the proper interpretation of the statements. Income Statement Balance Sheet Statement of Cash Flows © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-50 Learning Objective Learning Objective LO9 To discuss the importance of financial statements to a company and its investors and creditors and why management may take steps to improve the appearance of the company in its financial statements. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-51 Management’s Interest in Financial Statements Management’s Interest in Financial Statements Creditors are more likely to extend credit if financial statements show a strong statement of financial position—that is, relatively little debt and large amounts of liquid assets. Window dressing occurs when management takes measures to make the company appear as strong as possible in it financial statements. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-52 End of Chapter 2 End of Chapter 2