Unlock document.
This document is partially blurred.
Unlock all pages and 1 million more documents.
Get Access
Section 2: Accounting Applications
Accounting Applications
Describe the income statement
Describe the statement of owner’s equity
Describe the balance sheet
Describe the statement of cash ows
Lecture Outline
0. There are four basic nancial statements that are interrelated.
0. Income statement (also known as the statement of earnings or the prot and loss
statement)
00. Shows revenues earned and expenses incurred for a period of time
00. Indicates prot or loss for an accounting period
0. Statement of owner’s equity (also known as the capital statement)
00. Shows changes in the owner’s capital account over a period of time
0. Balance sheet (also known as the statement of nancial position)
00. Usually prepared as of the last day of the accounting period to show the
organization’s nancial position (or status) as of that specic date
00. Reects the accounting equation in its structure
0. Statement of cash ows
00. Presents signicant nancing, investing, and operating activities
(cash-generating and cash-using activities) during a given period
I0. GAAP are the conventions, rules, and procedures that dene acceptable accounting
practice at a particular time.
A0. CPAs perform independent audits of businesses’ nancial statements.
B0. An audit results in a professional opinion as to whether the nancial statements
are in accordance with GAAP.
III0. Organizations that issue accounting standards
A. The FASB is responsible for developing GAAP.
B0. The IASB sets international accounting standards.
IV. Other organizations that inuence GAAP
A0. The PCAOB is a governmental body created by the Sarbanes-Oxley Act to regulate
the accounting profession.
B0. The AICPA inuences GAAP through advisory committees.
C0. The SEC sets its own standards for companies whose securities are listed on the
stock exchanges.
D0. The GASB was established to issue accounting standards for state and local
governments.
E0. IRS guidelines are established to collect taxes but play an inuential role in the
establishment of accounting practices.
V0. It is important for CPAs to conform to their code of professional ethics, because the
public relies on them for the following:
0. Integrity
0. Objectivity
0. Independence
0. Due care
E0. Management accountants have a code of professional ethics that addresses
competence, condentiality, integrity, and objectivity.
© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated,
or posted to a publicly accessible website, in whole or in part.
Chapter 1: Accounting Principles and the Financial Statements Instructor’s Manual, p. 2
Summary
Accountants communicate their information through nancial statements. The four basic
statements are the income statement, the statement of owner’s equity, the balance sheet,
and the statement of cash ows.
The income statement, whose components are revenues and expenses, is perhaps the
most important nancial statement. Its purpose is to measure a business’s protability
during a given period of time. The net income or net loss is used to update retained earnings
on the statement of retained earnings. Net income (loss) also appears on the statement of
cash ows.
The statement of owner’s equity is a calculation of the changes in owner’s capital during
the accounting period. Owner’s capital at the beginning of the period is the rst item on the
statement, followed by an addition for net income and a deduction for owner’s withdrawals.
The ending gure is transferred to the owner’s equity section of the balance sheet.
The balance sheet shows the nancial position of a business on a specic date. The
resources used in the business are called assets, debts of the business are called
liabilities, and the owner’s nancial interest in the business is called owner’s equity.
Changes that occur in these accounts are reected in the statement of cash ows.
The statement of cash ows provides users with information about the business’s
liquidity by disclosing all important nancing, investing, and operating activities that
a<ected its cash balance during the accounting period. Cash ows are the inows and
outows of cash into and out of a business. Financing activities may include issuing or
repaying debt. Investing activities may include selling a building or investing in stock.
Operating activities include receipts from customers and payments to suppliers and others
in the ordinary course of the business’s main operations.
Every nancial statement has a three-line heading. The rst line gives the name of the
company, the second line gives the name of the statement, and the third line gives the
relevant dates (the date of the balance sheet or the period of time covered by the other
three statements).
Generally accepted accounting principles (GAAP) are the conventions, rules, and
procedures that dene acceptable accounting practice at a particular time. They arise from
wide agreement on the theory and practice of accounting at a given time. These principles
change continually as business conditions change and practices improve.
The nancial statements of publicly held corporations are prepared by management but
audited by a licensed professional, called a certi$ed public accountant (CPA), so that the
statements can be made more believable to the users. Before the audit (examination) can
take place, however, the CPA must be independent of (without nancial or other ties to) the
client. On completion of the audit, the CPA reports whether the audited statements are
“presented fairly in all material respects” and are “in conformity with generally accepted
accounting principles.” Because estimates and interpretations are made in the application of
GAAP, auditors must employ their professional judgment in rendering an opinion.
The Financial Accounting Standards Board (FASB), an independent body, is the
authoritative body in the development of GAAP. The FASB issues Statements of Financial
Accounting Standards.
Spurred by the growth of nancial markets worldwide, the International Accounting
Standards Board (IASB) develops international accounting standards.
The Public Company Accounting Oversight Board (PCAOB) is a governmental body
created by the Sarbanes-Oxley Act to regulate the accounting profession.
© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated,
or posted to a publicly accessible website, in whole or in part.
Chapter 1: Accounting Principles and the Financial Statements Instructor’s Manual, p. 3
The American Institute of Certi$ed Public Accountants (AICPA), the professional
association of CPAs, inuences accounting practice through the activities of its senior
technical committees.
The Securities and Exchange Commission (SEC) is an agency of the federal government
that has the legal power to set and enforce accounting practices for companies whose
securities are traded by the general public.
The Governmental Accounting Standards Board (GASB) was established in 1984 and is
responsible for issuing accounting standards for state and local governments.
The Internal Revenue Service (IRS) has its own set of rules that govern the assessment
and collection of taxes. These rules, while sometimes contrary to GAAP, are an important
inuence on accounting practice.
© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated,
or posted to a publicly accessible website, in whole or in part.
Chapter 1: Accounting Principles and the Financial Statements Instructor’s Manual, p. 4
Professional ethics is the application of a code of conduct to the practice of a profession.
The accounting profession has developed a code that is intended to guide the accountant in
carrying out his or her responsibilities to the public. In conformity with the AICPA’s code for
CPAs, the accountant must act with integrity, objectivity, independence, and due care.
00. Integrity means the accountant is honest, regardless of consequences.
00. Objectivity means the accountant is impartial and intellectually honest in performing
his or her job.
00. Independence means the accountant avoids all relationships that could impair, or
even appear to impair, his or her objectivity, such as owning stock in a company being
audited.
00. Due care means carrying out professional responsibilities with competence and
diligence.
The Institute of Management Accountants (IMA) has a code of professional ethics,
which stipulates that managerial accountants are to be competent in their jobs, to keep
information condential, to maintain integrity and avoid conicts of interest, and to
communicate information objectively and without bias.
Relevant Examples and Exhibits
Exhibit 5 Financial Statement Relationships
Exhibit 6 Income Statement for Roland Consultancy
Exhibit 7 Statement of Owner’s Equity for Roland Consultancy
Exhibit 8 Balance Sheet for Roland Consultancy
Exhibit 9 Statement of Cash Flows for Roland Consultancy
Exhibit 10 Income Statement, Statement of Owner’s Equity, Balance Sheet and
Statement of Cash Flows for Roland Consultancy
Exhibit 11 Large International Certied Public Accounting Firms
Teaching Strategy
Explain the purpose of each nancial statement and discuss how each is used by various
user groups’ in evaluating a company’s protability and liquidity. Then refer to Exhibit 10 in
the text as you discuss how these statements interrelate. For example, students need to
know why the income statement must be prepared rst. Point out the common elements
that appear on more than one statement. Stress that it is the ending owner’s equity that
appears on the balance sheet. Distinguish between a specic date and a period of time.
Since the assets and liabilities of a business are changing from moment to moment, it is
necessary to choose a cuto< date on which to measure them.
Distinguish between net income on the income statement and net cash ows from operating
activities on the statement of cash ows.
Explain that GAAP are constantly evolving and are not like laws of science. Explain that
GAAP are designed to “accurately measure the performance of businesses” and that the
accountant, contrary to a common misconception, should not attempt to make a company
look better on paper than it really is. Emphasize that GAAP are guidelines that require
interpretation; they are not a rigid set of rules.
© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated,
or posted to a publicly accessible website, in whole or in part.
Chapter 1: Accounting Principles and the Financial Statements Instructor’s Manual, p. 5
Be sure to explain that an audit report does not state whether the audited company is a
good investment; it states only whether its nancial statements are “presented fairly” in
accordance with GAAP. Also discuss the importance of independence. Explain that an audit
provides only reasonable, not absolute, assurance because it relies on test results from a
sample of transactions.
An interesting discussion involves distinguishing between GAAP and tax law (Internal
Revenue Code). Point out that the objective of tax law is to raise revenue for the
government, not to accomplish the logical measurement of business income.
Explain the importance of ethics within the accounting profession and the possible
consequences of being in violation of the professional code. The key terms integrity,
objectivity, independence, and due care can help illustrate the concept. Describe some
situations that typically create ethical dilemmas for accountants.
Section 3: Business Applications
Business Applications
Protability
Liquidity
Ethics
Lecture Outline
0. Three major groups use accounting information.
0. Management (internal users)
0. Outsiders with a direct nancial interest
00. Present or potential investors
00. Present or potential creditors
0. People, organizations, and agencies with an indirect nancial interest
00. Tax authorities
00. Regulatory agencies
a. Securities and Exchange Commission (SEC)
00. Other groups (labor unions, nancial advisers, economic planners, etc.)
0. Government and not-for-prot organizations also use nancial information.
II0. A business is an economic unit that aims to sell goods and services to customers at
prices that will provide an adequate return to its owners.
0. Goals
00. Protability—earning a suGcient return to maintain owner interest
00. Liquidity—having enough cash to pay debts as they come due
0. Activities
00. Operating—selling goods and services to customers, employing managers
and workers, buying and producing goods and services; and paying taxes
00. Investing—spending the capital a company receives in productive ways that
help it achieve its objectives
00. Financing—obtaining funds to begin operations and to continue operating
0. Performance measures
00. Performance measures relate to achieving goals and assessing the
management of business activities.
© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated,
or posted to a publicly accessible website, in whole or in part.
Chapter 1: Accounting Principles and the Financial Statements Instructor’s Manual, p. 6
2. Financial analysis is the evaluation and interpretation of the nancial
statements and related performance measures.
30. Performance measures must be crafted to motivate managers to make
decisions that are in the best interest of the business.
I0. Ethical nancial reporting
0. Ethics is a code of conduct that addresses whether actions are right or wrong.
00. Ethics in the preparation of nancial reports is important, because users of
these reports must depend on the good faith of the people involved in their
preparation.
00. The intentional preparation of misleading nancial statements is called
fraudulent nancial reporting.
00. Fraudulent nancial reporting can result from the distortion of records,
falsied transactions, or the misapplication of various accounting principles.
00. The motivation for fraudulent nancial reporting could be to inate the
perceived value of a business, meet stockholders’ and nancial analysts’
expectations, obtain nancing, or receive personal gain.
Summary
Basically, three groups use accounting information: management, outsiders with a direct
nancial interest, and outsiders with an indirect nancial interest.
00. If a business is to survive, management must achieve protability and liquidity. The
company also has other goals, such as improving its products and expanding
operations. Management directs the company toward these goals by making the right
decisions.
00. Present or potential investors and present or potential creditors are considered outside
users with a direct nancial interest in a business. Investors use nancial statements
to assess the strength or weakness of the company, whereas creditors examine the
nancial statements to determine the company’s ability to repay loans at the
appropriate time.
00. Society as a whole, through its government oGcials and public groups, may be viewed
as a nancial statement user with an indirect nancial interest in a business.
Specically, society includes (a) tax authorities, (b) regulatory agencies, and (c) other
groups (such as labor unions and nancial analysts). The Securities and Exchange
Commission (SEC), a regulatory agency, has extensive reporting requirements for
public companies.
Managers in government and not-for-prot organizations such as hospitals, universities,
professional organizations, and charities also make extensive use of nancial information. In
addition to nancing, investing, and operating activities, these organizations have reporting
responsibilities to authoritative bodies that hold them accountable for their nancial
performance.
A business is an economic unit that aims to sell goods and services to customers at prices
that will provide an adequate return to its owners. The two major goals of all businesses are
protability and liquidity. Pro$tability is the ability to earn enough income to attract and
hold investment capital. Liquidity is the ability to have suGcient cash to pay debts as they
fall due. Businesses pursue their goals by engaging in (1) operating activities, which
include selling goods and services to customers, employing managers and workers, and
buying and producing goods and services; (2) investing activities, which involve spending
the capital a company receives in ways to help it achieve its objectives; and (3) $nancing
activities, which include obtaining funds to begin and sustain operations.
© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated,
or posted to a publicly accessible website, in whole or in part.
Chapter 1: Accounting Principles and the Financial Statements Instructor’s Manual, p. 7
Financial Analysis uses nancial statements to determine how well a business is
managed. An important function of accounting is to provide performance measures,
which indicate whether managers are achieving their business goals and whether the
business activities are well managed. Financial ratios can provide information on both how
nancial statement items relate to each other and allow for comparisons from one period to
the next.
Ethics is the code of conduct that helps individuals in their everyday life distinguish right
from wrong. Ethics is especially important in preparing nancial reports, because users of
these reports must depend on the good faith of the people involved in their preparation. The
intentional preparation of misleading nancial statements is called fraudulent $nancial
reporting. It can result from the distortion of records, falsied transactions, or the
misapplication of various accounting principles.
In 2002, Congress passed the Sarbanes-Oxley Act to regulate nancial reporting in public
corporations. This legislation requires the chief executives and chief nancial oGcers of all
publicly traded U.S. companies to attest to the accuracy and completeness of the quarterly
statements and annual reports that their companies le with the SEC.
Relevant Examples and Exhibits
Exhibit 12 The Users of Accounting Information
Exhibit 13 Business Goals and Activities
Teaching Strategy
An interesting way to present learning objective 5 is to ask students to name the many users
of nancial information while you keep a list on the board (or overhead transparency, etc.).
Students should know that the list in Exhibit 12 of the text, although ambitious, is not
exhaustive. At the same time, you may want to ask them why each user would seek a
company’s nancial information and whether each user is more interested in assessing
protability or liquidity.
Making the distinction between direct and indirect users, and between internal and external
users, is helpful. Ask students how they have used accounting information.
Case 1 provides a good foundation for discussing business goals and activities. This sets the
stage for a discussion of accounting and how it helps businesses achieve goals and perform
activities. Figure 2 in the text illustrates business goals and activities. Distinguish between
protability and liquidity and explain why a business must maintain both if it is to survive.
The key components of the AICPA’s denition of accounting are “useful,” “nancial
information,” and “decisions.”
Be sure to mention management’s responsibility for ethical nancial reporting, including the
denition of fraudulent nancial reporting and the signicance of the Sarbanes-Oxley Act.
Short Exercise 1 can be used in class to test students’ knowledge of terminology. Case 5
emphasizes the importance of cash ows and the goal of liquidity.
© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated,
or posted to a publicly accessible website, in whole or in part.
Chapter 1: Accounting Principles and the Financial Statements Instructor’s Manual, p. 8
Student Engagement Tactics
1. Divide the class into small groups. One quick way to form groups is to divide the
number of students in class by three or four (the most e<ective group size for this
activity). Ask students to count o< from 1 to the maximum number of groups. Remind
them not to forget their number. Have students get together by number after you
give complete instructions. It will encourage a speedy transition, as this activity has a
time limit.
2. Assign one of the learning tools. (If one of the problems was done for homework, use
another one in this activity; it will reinforce learning.)
3. The rst group to correctly complete the task wins. As the groups complete the task,
mark their completion time. (You may want to gather and keep their responses until
the time limit has expired. See Step 4.) The time limit is 25 minutes. If, for some
reason, no group has the correct response in 25 minutes, give them additional time
as deemed appropriate.
4. The winning group could present the correct responses to the entire class using a
solution transparency and answer student questions. You may prefer to debrief this
activity if time is limited. If you have retained group responses, quickly check them to
determine where additional review may be needed.
5. Reward each of the winning group members with one or two extra quiz points,
fun-size candy bars, novelty erasers, or other small prizes.
© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated,
or posted to a publicly accessible website, in whole or in part.
