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Introduction to Financial
Statements

Kimmel ● Weygandt
Survey of Accounting, First Edition
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 CHAPTER OUTLINE
LEARNING OBJECTIVES

Identify the forms of business organization and

1 the uses of accounting information.

Explain the three principal types of business

2 activity.

Describe the four financial statements and how

3 they are prepared.

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Identify the forms of business organization

LEARNING
OBJECTIVE 1 and the uses of accounting information.

FORMS OF BUSINESS ORGANIZATION

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 USERS AND USES OF FINANCIAL
INFORMATION

Internal
Users

Illustration 1-1
Questions that
internal users ask

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USERS AND USES OF FINANCIAL

INFORMATION

External
Users

Illustration 1-2
Questions that external
users ask
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 USERS AND USES OF FINANCIAL
INFORMATION

Ethics In 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.

 Recent financial scandals include: Enron, WorldCom,

HealthSouth, AIG, and others.

 Congress passed Sarbanes-Oxley Act (SOX).

 Effective financial reporting depends on sound ethical

behavior.
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DO IT! 1 Business Organization Forms

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.
1. Easier to raise funds. 4. Tax advantages.
2. Simple to establish. 5. Easier to transfer ownership.
3. No personal legal liability.

SOLUTION
1. Corporation. 4. Sole proprietorship and
2. Sole proprietorship and partnership.
partnership. 5. Corporation.
3. Corporation.
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 USERS AND USES OF FINANCIAL
INFORMATION

Review Question
Which of the following did not result from the Sarbanes-
Oxley Act?

a. Top management must now certify the accuracy of

financial information.

b. Penalties for fraudulent activity increased.

c. Independence of auditors increased.

d. Tax rates on corporations increased.

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Explain the three principal types of

LEARNING
OBJECTIVE 2 business activity.

All businesses are involved in three types of activity —

 financing,
 investing, and
 operating.

The accounting information system keeps track of

the results of each of these business activities.

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 FINANCING ACTIVITIES

Two primary sources of outside funds are:

1. Borrowing money (debt)
 Amounts owed are called liabilities.

 Party to whom amounts are owed are creditors.

 Notes payable and bonds payable are different types

of liabilities.

2. Issuing (selling) shares of stock for cash (equity).

 Common stock is the term used to describe the
amount paid by stockholders for shares they purchase.

 Payments to stockholders are called dividends.

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INVESTING ACTIVITIES

Purchase of resources a company needs to operate.

 Computers, delivery trucks, furniture, buildings.

 Resources owned by a business are called assets.

 Investments are another

example of an investing
activity.

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 OPERATING ACTIVITIES

Once a business has the assets it needs, it can begin

its operations.
 Revenues - Amounts earned from the sale of products and
other sources (sales revenue, service revenue, and
interest revenue).

 Inventory - Goods available for

sale to customers.

 Accounts receivable - Right to

receive money from a customer
as the result of a sale.

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OPERATING ACTIVITIES

Once a business has the assets it needs, it can

begin its operations.
 Expenses - cost of assets consumed or services used.
(cost of goods sold, selling, marketing,
administrative, interest, and income taxes expense).

 Liabilities arising from expenses include accounts

payable, interest payable, wages payable, sales taxes
payable, and income taxes payable.

 Net income – when revenues exceed expenses.

 Net loss – when expenses exceed revenues.

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 DO IT! 2 Business Activities

Classify each item as an asset, liability, common stock, revenue, or

expense. SOLUTION
1. Cost of renting property. 1. Expense.
2. Truck purchased. 2. Asset.
3. Notes payable. 3. Liabilities.
4. Issuance of ownership shares. 4. Common stock.
5. Amount earned from providing service. 5. Revenue.
6. Amounts owed to suppliers. 6. Liabilities.

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Describe the four financial statements

LEARNING
OBJECTIVE 3 and how they are prepared.

Companies prepare four financial statements from the

summarized accounting data:

Retained Statement
Income Balance
Earnings of Cash
Statement Sheet
Statement Flows

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.

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 FINANCIAL STATEMENTS

 Reports revenues and

Income Statement
expenses for a specific
Illustration 1-4
period of time.

 Net income – revenues

exceed expenses.

 Net loss – expenses

exceed revenues.

 Past net income provides

information for
predicting future net
income.

▼Helpful Hint The financial statement heading identifies the company, the type of
statement, and the time period covered. Sometimes, another line indicates the unit of
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FINANCIAL STATEMENTS
Retained Earnings
Income Statement Statement
Illustration 1-4 Illustration 1-5

Net income is needed to

determine the ending balance in
retained earnings.
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 FINANCIAL STATEMENTS
Retained Earnings
 Statement shows amounts and
causes of changes in retained
Statement
Illustration 1-5
earnings during the period.

 Time period is the same as

that covered by the income
statement.

 Users can evaluate dividend

payment practices.

▼Helpful Hint The heading of this

statement identifies the company, the
type of statement, and the time period
covered by the statement.

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FINANCIAL STATEMENTS
Balance Sheet Retained Earnings
Illustration 1-7 Statement
Illustration 1-5

Ending balance in retained

earnings is needed in preparing
the balance sheet.

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 FINANCIAL STATEMENTS
Balance Sheet  Reports assets and claims
Illustration 1-7
to assets at a specific
point in time.

 Assets = Liabilities +
Stockholders’ Equity.

 Lists assets first, followed

by liabilities and
stockholders’ equity.

▼Helpful Hint The heading of a

balance sheet must identify the
company, the statement, and the date.

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FINANCIAL STATEMENTS
Balance Sheet Statement of Cash Flows
Illustration 1-7
Illustration 1-8

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 FINANCIAL STATEMENTS
Statement of Cash Flows Provides answers to:
Illustration 1-8
 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?

▼Helpful Hint The heading identifies the company, the type of statement, and the
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FINANCIAL STATEMENTS

Review Question
Net income will result during a time period when:

a. assets exceed liabilities.

b. assets exceed revenues.

c. expenses exceed revenues.

d. revenues exceed expenses.

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 FINANCIAL STATEMENTS

Review Question
Which of the following financial statements is prepared as
of a specific date?
a. Balance sheet.
b. Income statement.
c. Retained earnings statement.
d. Statement of cash flows.

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DO IT! 3a Financial Statements

CSU Corporation began operations on January 1, 2017. The following

information is available for CSU on December 31, 2017:
Accounts receivable 1,800 Retained earnings ?
Supplies expense 200 Accounts payable 2,000
Equipment 16,000 Cash 1,400
Rent 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.

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 Prepare an income statement using the following accounts.
Accounts receivable 1,800 Retained earnings ?
Supplies expense 200 Accounts payable 2,000
Equipment 16,000 Cash 1,400
Rent expense 9,000 Insurance expense 1,000
Dividends 600 Notes payable 5,000
Service revenue 17,000 Common stock 10,000
Supplies 4,000

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Prepare a retained earnings statement using the following accounts.

Accounts receivable 1,800 Retained earnings ?
Supplies expense 200 Accounts payable 2,000
Equipment 16,000 Cash 1,400
Rent expense 9,000 Insurance expense 1,000
Dividends 600 Notes payable 5,000
Service revenue 17,000 Common stock 10,000
Supplies 4,000

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 DO IT! 3a Financial Statements

CSU Corporation began operations on January 1, 2017. The following

information is available for CSU on December 31, 2017:
Accounts receivable 1,800 Retained earnings ?
Supplies expense 200 Accounts payable 2,000
Equipment 16,000 Cash 1,400
Rent 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 a balance sheet.

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 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:

 Financial statements.

 Management discussion and analysis.

 Notes to the financial statements.

 Auditor's report.

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ELEMENTS OF AN ANNUAL REPORT

Management Discussion and Analysis

Management discussion and analysis (MD&A) presents
management’s view on the company’s 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.

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 ELEMENTS OF AN ANNUAL REPORT

Management Discussion and Analysis

ILLUSTRATION 1-10
Columbia Sportswear’s
management discussion and analysis

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ELEMENTS OF AN ANNUAL REPORT

Notes to the Financial Statements

 Clarify the financial statements.

 Provide additional detail.

Notes are essential to understanding a company’s operating

performance and financial position.
ILLUSTRATION 1-11

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 ELEMENTS OF AN ANNUAL REPORT

Auditor’s Report
 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 principles.

 Only certified public accountants (CPA) may perform

audits.

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ELEMENTS OF AN ANNUAL REPORT

Auditor’s Report

ILLUSTRATION 1-12
Excerpt from auditor’s report on
Columbia Sportswear’s financial
statements

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 DO IT! 3b Components of Annual Report

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. SOLUTION
1. Descriptions of significant accounting policies. 1. Notes
2. Unqualified opinion. 2. Auditor’s report
3. Explanations of uncertainties and contingencies. 3. Notes
4. Description of ability to fund operations and 4. MD&A
expansion.
5. Description of results of operations. 5. MD&A
6. Certified public accountant (CPA). 6. Auditor’s report

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