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Introduction to Financial Statements

1) Key Things To Know 6) Hard Practice Test
2) Self Test 7)On Your Test
3) Practice as You Learn 8) Quick Study Sheet
4) Easy Practice Test 9) Common Accounts
5) Medium Practice Test  

Key Things to Know  

The Purpose of Financial Accounting is to: 
      1) Record     2) Summarize, and      3) Report transactions of the company:


Transaction:  an act that creates an exchange of something for something else
                        o  provide a service or goods to a customer in exchange for cash
                        o  purchase a delivery truck, pay cash for the truck
                        o  pay an employee for work
                        o  pay the utility company for providing electricity
                        o  receive money from the bank and agree to pay it back later  

     Most often the exchange is giving or receiving cash either now or in the future


Record:    enter each transaction into a system - record what is increasing or decreasing
                    - use descriptive names for “accounts” to put things in catagories


Summarize:  net the impact of the increases and decreases for each item - “account”
                        The total of the “accounts” will be what you have and what you owe;
                        what you have earned from providing goods and services and what it
                        costs you to provide goods and services


Report:     provide useful information to investors and creditors regarding cash
                     flows, resources (assets/have), and obligations (liabilities/owe).

                         4 Primary Financial Statements are used:
                                                o Balance Sheet
                                                o Income Statement
                                                o Statement of Stockholder’s Equity
                                                o Statement of Cash Flows

             Report to:

                        Internal Users:  managers who plan, organize and run the company

                        External Users:  Investors who invest in the company
                                                     Creditors who loan money to the company


Financial Statements:

Balance Sheet:          States what your business owns (assets) and owes (liabilities) on
                                    a specific date.   
                                    Also shows the amount owned – assets less liabilities


Income Statement:  Shows how much the business earned during a period of time.
                                   This is what you have earned from providing goods and services
                                    less what it costs you to provide goods and services


Statement of              Shows the activity of shareholder’s (owners) during a period of time
Owner’s Equity            Shows receipt of funds from shareholders and payments back to
                                      shareholders in the form of dividends.
                                   Shows the earnings of the business that go to the shareholders
                                     (Some companie’s present a “statement of retained earnings”
                                         showing earnings and dividends paid only)

Cash Flow
Statement:                 Shows the source of cash and what the cash was used for during
                                   a period of time            (Cash and Income are not the same)


What does each financial statement really tell you about the business?

            Each statement has a heading that states the company name and the date
             or time period covered


Balance Sheet:          What the company has and what they owe on a certain date
                                       along with the ownership interest


Income Statement:  How much the company earned during a specific period of time
                                                                                                            (monthly, quarterly, year)


Owner’s Equity:         What occurred that impacted the owners of the company during
                                    a specific period of time


Cash Flows:               How much cash was generated from day to day operations
                                 What the cash was used for
                                     Where additional cash came from and how much was received


Additional Information on the Statement of Retained Earnings:

            “Retained Earnings” is the amount of cumulative profits and losses kept by
               the company since the first day of operations.

            Retained earnings changes with net income (profits and losses) and dividends
             paid to shareholders (owners) 

                           Beginning Retained Earnings
                        + Net Income or - Net Loss
                        -  Dividends Paid
                        = Ending Retained Earnings


Additional Information on the Statement of Cash Flows:
            The cash flow statement has 3 separate sections:

                        Operating Activities:             directly related earnings from day to day
                                                                     business operations

                        Investing Activities:               directly related to buying and selling assets
                                                                     used long term in the business

                        Financing Activities:             directly related to borrowing and repaying debt
                                                                    and receipts and payments from/to owners


“Elements” that are reported on financial statements

Asset:     The company’s economic resources used to operate the business        
                            What the company HAS

                      1)  Probable future economic benefit
                      2) Owned or controlled by the company
                      3) Resulting from a past transaction, something that has already occurred

                        The economic benefit is using the asset to generate future cash flows
                        or the asset itself will convert to cash


Liability:  The company’s debts and obligations        What the company OWES

                      1)         Probable use of a future economic benefit (an asset)
                      2)           Owed
                      3)           Resulting from a past transaction

                        You will give up an asset to pay what you owe


Stockholder’s Equity:  Earnings kept in the company / financing provided by the owners

                      1)   Owner contributions to the company
                      2)   Less dividends paid to owners
                      3)   Plus profits and less losses, also called net income                           

            Stockholder’s Equity is also equal to total assets less total liabilities


Revenues:  Earned from providing goods or services in exchange for an asset.
                      This is the amount the customer is expected to pay for the goods
                         or services they received

                        A revenue occurs when the good/service is provided to the customer
                        regardless of whether the customer has paid or not


Expenses:   Using an asset of the company to provide goods or services

                         What it costs the company to provide the goods or services
                         to the customer.

                        A service or good is provided to the company that the company
                        will have to pay for.  The expense occurs when the company
                         receives the service or the asset is used up, not when the
                         company pays for the goods or service


      Important:    Revenues and expenses do not occur when the cash is received
                               or paid.  They occur when the good or service is exchanged.
                               Revenues:  the company gives the good or service
                               Expense:   the company receives the service or uses up the asset

                                 **   Net Income (Revenues – Expenses) will not equal cash.



The Accounting Equation:  Must always stay in balance

Assets     =     Liabilities    +     Stockholder’s Equity

Have       =    Owe       +          Own (Includes net profits)
What you have you owe for or own outright             - Expenses
                                                                                Net profit or loss


Generally Accepted Accounting Principles “GAAP”:

Guidelines established by various accounting standard setting groups in consultation
  with accounting professionals that give guidance on
            1)         What type of financial information must be provided
            2)         What format to use to provide information
            3)         How to measure assets, liabilities, revenues and expenses

“FASB”  -  Financial Accounting Standards Board

        Is the primary accounting standards setting authority in the US

“IASB” – International Accounting Standards Board

        Is the primary accounting standards setting authority for several
          countries outside of the US

“SEC” – Securities & Exchange Commission

        The government agency that oversees US financial markets and
          accounting standards for public companies


Financial statements that follow consistent guidelines are comparable
  among companies and much easier to interpret for investors and creditors


            Additional information provided after the financial statements

            3 types of footnotes:
                        1)  provides a description of the accounting rules followed
                        2)  provides more details for the items listed on the financial statements
                        3)  provides information on things not listed on the financial statements

Auditor’s Report:

  A professional accountant examines the company’s financial statements and gives a
     report that determines if the statements are fairly stated in accordance with GAAP.






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