Chapter 1

Financial Statements and

Business Decisions
 1-2

Understanding the Business

Founders of the business who also function as

managers are called Owner-Mangers.

Owner-Managers

Creditors lend money for a specific period of

time and gain by charging interest on the
money they lend.

Creditors

Investors buy ownership in the company in

the form of stock.
Investors
 1-3

Understanding the Business

Investors purchase stock (or ownership) in

businesses hoping to gain in two ways:

Sell
Receive a
ownership
portion of the
interest in the
company’s
future for more
earnings in cash
than they
(dividends).
paid.
 1-4

The Accounting System

Managers
(internal
decision
Reports makers)
information
to decision
Collects and processes makers
financial information Investors
and
Creditors
(external
decision
makers)
 1-5

The Accounting System

Accounting System

Financial Accounting System Managerial Accounting System

Periodic financial statements and Detailed plans and continuous
related disclosures performance reports

External Decision Makers Internal Decision Makers

Investors, creditors, Managers throughout the
suppliers, customers, etc. organization
 1-6

Learning Objectives

Recognize the information conveyed in each of

the four basic financial statements and the way
that it is used by different decision makers
(investors, creditors, and managers).
 1-7

The Four Basic Financial Statements

Statement of Cash Flows Statement of Stockholders’ Equity

Balance Sheet Income Statement

Financial statements summarize the financial activities of

the business.
 1-8

The Four Basic Financial Statements

Companies can prepare financial statements at

the end of the year, quarter or month.

2021

Financial statements prepared at the end

of the year are called annual reports.
 1-9

Let’s look at
MAXIDRIVE
CORP.’s
financial
statements.
1. Name of entity MAXIDRIVE CORP. 1-10

2. Title of statement Balance Sheet

At December 31, 2021
3. Specific date
(in thousands of dollars)
4. Unit of measure Assets
Cash $ 4,895
Accounts receivable 5,714
Inventories 8,517
The Balance Plant and equipment 7,154
Land 981
Sheet reports Total assets $ 27,261
the financial Liabilities and Stockholders' Equity
Liabilities
position of an Accounts payable $ 7,156
entity at a Notes payable 9,000
Total liabilities $ 16,156
particular point Stockholders' Equity
in time. Common stock $ 2,000
Retained earnings 9,105
Total stockholders' equity 11,105
Total liabilities and stockholders' equity $ 27,261
 1-11
MAXIDRIVE CORP.
Balance Sheet
At December 31, 2021
(in thousands of dollars)
Assets
Cash $ 4,895
Accounts receivable 5,714
Inventories 8,517
Plant and equipment 7,154
Land 981
Total assets $ 27,261
Liabilities Amount of cash in the company’s bank
Cash and Stockholders' Equity
accounts.
Liabilities
Accounts
Accounts Amounts owed by customers
payable $ 7,156 from prior
receivable
Notes payable sales. 9,000
Total liabilities
Parts and completed but unsold $ 16,156
Inventories Stockholders'
[Link]
Contributed capital $ 2,000
Plant and
Retained earnings Factories and production machinery.
9,105
equipment
Total stockholders' equity 11,105
TotalLand
liabilities Land on which factories
and stockholders' equity are built.$ 27,261
 1-12
MAXIDRIVE CORP.
Balance Sheet
At December 31, 2021
(in thousands of dollars)
Assets
Cash $ 4,895
Accounts receivable 5,714
Inventories 8,517
Plant and equipment 7,154
Land 981
Total assets $ 27,261
Liabilities and Stockholders' Equity
Liabilities
Accounts payable $ 7,156
Notes payable 9,000
Total liabilities $ 16,156
Accounts Amounts owed toStockholders'
suppliers for Equity
prior
payable Contributed capital
purchases. $ 2,000
Notes Retained earnings 9,105
Amounts owed
Totalon written debt
stockholders' contracts.
equity 11,105
payable
Total liabilities and stockholders' equity $ 27,261
 1-13

MAXIDRIVE CORP.
Balance Sheet
At December 31, 2021
(in thousands of dollars)
Assets
Cash $ 4,895
Accounts receivable 5,714
Inventories 8,517
Plant and equipment 7,154
Land 981
Total assets $ 27,261
Liabilities
Amounts invested and Stockholders'
in the business by Equity
Common stock stockholders. Liabilities
Accounts payable $ 7,156
Retained earnings
Notes
Past earnings not payable
distributed to stockholders. 9,000
留存收益
Total liabilities $ 16,156
Stockholders' Equity
Common stock $ 2,000
Retained earnings 9,105
Total stockholders' equity 11,105
Total liabilities and stockholders' equity $ 27,261
 1-14

The Balance Sheet

Basic Accounting Equation

Balance Sheet Equation
Assets = Liabilities + Stockholders’ Equity

Economic
Resources Sources of Financing for
Economic Resources
 MAXIDRIVE CORP. 1-15

Balance Sheet
At December 31, 2021
(in thousands of dollars)
Assets
Cash $ 4,895
Accounts receivable 5,714
Inventories 8,517
Plant and equipment 7,154
Land 981
Total assets $ 27,261
Liabilities and Stockholders' Equity
Liabilities
Accounts payable $ 7,156
Notes payable 9,000
Assets = Liabilities + Stockholders’ Equity
Total liabilities $ 16,156
Stockholders' Equity
Common stock $ 2,000
Retained earnings 9,105
Total stockholders' equity 11,105
Total liabilities and stockholders' equity $ 27,261
 1-16
MAXIDRIVE CORP.
Income Statement
For the Year Ended December 31, 2021
(in thousands of dollars)

Revenues
1. Name
Sales of entity
revenue $ 37,436
2. Title of statement
Expenses
3. Specific
Cost of goodsperiod
sold of time (Unlike the balance
$ 26,980
sheet, this statement covers a specified
Selling, general and administrative 3,624
period of time.)
Research and development 1,982
4. Unit of measure
Interest expense 450
Total expenses 33,036
Pretax income $ 4,400
Income tax expense 1,100
Net income $ 3,300
 1-17
MAXIDRIVE CORP.
The Income Statement
Income Statementreports the
For the Year
revenues Ended expenses
minus December 31, of2011
the
(in thousands of
accounting dollars)
period.
Revenues
Sales revenue $ 37,436
Expenses
Cost of goods sold $ 26,980
Selling, general and administrative 3,624
Research and development 1,982
Interest expense 450
Total expenses 33,036
Pretax income $ 4,400
Income tax expense 1,100
Net income $ 3,300
 1-18
MAXIDRIVE CORP.
Income Statement
For the Year Ended December 31, 2021
(in thousands of dollars)

Revenues
Sales revenue $ 37,436
Expenses are earnings from the sale of goods
Revenues
Cost of goodsor sold $ 26,980
services to customers.
Selling, general and administrative 3,624
Revenue
Research andisdevelopment
recognized in the period in which
1,982
goods
Interest and services are sold, not necessarily
expense 450
Totalthe period in which cash is received. 33,036
expenses
Pretax income $ 4,400
Income tax expense 1,100
Net income $ 3,300
 1-19

Revenues

Earnings from the sale of goods or services.

(1) When will the revenue from this

transaction be recognized?

$1,000 sale made Cash from sale

on May 25th. collected on June 10th.
X X
May 2021 June 2021
 1-20

Revenues

Earnings from the sale of goods or services.

(2) When will the revenue from this

transaction be recognized?

Receive cash $6,000 Goods are delivered

on May 15th. on July 1st.
X X
May 2021 July 2021
 1-21
MAXIDRIVE CORP.
Expenses are theIncomedollar amount of resources used
Statement
up by the
Forentity to earn
the Year Ended revenues
Decemberduring a period.
31, 2011
(in thousands of dollars)
An expense is recognized in the period in which
goods and services are used, not necessarily
Revenues
the period in which cash is paid.
Sales revenue $ 37,436
Expenses
Cost of goods sold $ 26,980
Selling, general and administrative 3,624
Research and development 1,982
Interest expense 450
Total expenses 33,036
Pretax income $ 4,400
Income tax expense 1,100
Net income $ 3,300
 1-22

MAXIDRIVE CORP.
Income Statement
For the Year Ended December 31, 2021
(in thousands of dollars)

Cost of
Revenues The cost to produce products sold this
goods
Sales sold period.
revenue $ 37,436
Expenses
Selling,
Operating expenses not directly related
Cost of goods
general and sold $ 26,980
to production.
administrative
Selling, general and administrative 3,624
Research
Researchand anddevelopment 1,982 new
Expenses incurred to develop
Interest
developmentexpenseproducts. 450
Total expenses 33,036
Interest
Pretax income The cost of using borrowed funds.
$ 4,400
expense
Incometax
Income tax expense 1,100
Income taxes on current period’s pretax
Netexpense
income income. $ 3,300
 1-23

Expenses

An expense is recognized in the period

in which goods and services are used

May 11 paid $75 cash Ad appears

for newspaper ad. on June 8th.
X X
May 2021 June 2021
 1-24

Expenses

An expense is recognized in the period

in which goods and services are used

Received $120 utility bills Pay utility

on May. 30th on June 2nd.
X X
May 2021 June 2021
 1-25
MAXIDRIVE CORP.
Income Statement
For the Year Ended December 31, 2021
(in thousands of dollars)

Revenues
Sales revenue $ 37,436
Expenses
Cost of goods sold $ 26,980
Selling, general and administrative 3,624
Research and development 1,982
Interest expense 450
Total expenses 33,036
Pretax income $ 4,400
Income tax expense 1,100
Net income $ 3,300
 1-26

MAXIDRIVE CORP.
Statement of Stockholders' Equity
For the Year Ended December 31,2021
(in thousands of dollars)
Common Retained
stock earnings
Balance December 31,2020 $ 2,000.00 $ 6,805.00
1. Name
Net incomeofforentity
2021 3,300.00
2. Title offorstatement
Dividend 2021 -1,000.00
3. Specific period of time (Like the income
Balance December 31,2021 $ 2,000.00 $ 9,105.00
statement, this statement covers a specified
period of time.)
4. Unit of measure
 1-27

Statement of Stockholders’ Equity

Elements of the Statement

of Stockholders’ Equity

Common Retained Earnings

Beginning Retained Earnings

+Net Income
-Dividends
Ending Retained Earnings
 1-28

Statement of Stockholders' Equity

Income of the enterprise.

Re
n ds by ta i
id e en ne
i v te r d
D pr i
se

Stockholders Retained Earnings

 1-29

MAXIDRIVE CORP.
Statement of Stockholders' Equity
For the Year Ended December 31,2021
(in thousands of dollars)
Common Retained
stock earnings
Balance December 31,2020 $ 2,000.00 $ 6,805.00
Net income for 2021 3,300.00
Dividend for 2021 -1,000.00
Balance December 31,2021 $ 2,000.00 $ 9,105.00
 1-30

Statement of Cash Flows

Because . . . and expenses

revenues reported reported do not
do not always equal always equal
cash collected. . . cash paid . . .

net income is
usually not equal
to the change
in cash for
the period.
 1-31
MAXIDRIVE CORP.
Statement of Cash Flows
For the Year Ended December 31, 2021
(in thousands of dollars)

Cash flows from operating activities:

Cash collected from customers $ 33,563
[Link]
Name ofsuppliers
paid to entity and employees (30,854)
[Link]
Title offorstatement
paid interest (450)
Cash paid for taxes (1,190)
[Link]
Specific period of time (Like
cash flow from operating activities
the income $ 1,069
Cashstatement, thisactivities:
flow from investing statement covers a specified
period
Cash paid toof time.)equipment
purchase $ (1,625)
[Link] cash flow from investing activities
Unit of measure (1,625)
Cash flow from financing activities:
Cash received from bank loan $ 1,400
Cash paid for dividends (1,000)
Net cash flow from financing activities 400
Net decrease in cash during the year $ (156)
Cash at beginning of the year 5,051
Cash at end of the year $ 4,895
 1-32
MAXIDRIVE CORP.
Statement of Cash Flows
For the Year Ended December 31, 2011
(in thousands of dollars)

Cash flows from operating activities:

Cash collected from customers $ 33,563
Cash paid to suppliers and employees (30,854)
Cash paid for interest (450)
Cash paid for taxes (1,190)
Net cash flow from operating activities $ 1,069
Cash flow from investing activities:
Cash paid to purchase equipment $ (1,625)
Net cash flow from investing activities (1,625)
Cash flow from financing activities:
Cash received from bank loan $ 1,400
Cash paid for dividends (1,000)
Net cash flow from financing activities 400
Net decrease in cash during the year $ (156)
Cash at beginning of the year 5,051
Cash at end of the year $ 4,895
 1-33
MAXIDRIVE CORP.
Statement of Cash Flows
For the Year Ended December 31, 2021
(in thousands of dollars)

Cash flows from operating activities:

Cash collected from customers $ 33,563
Cash paid to suppliers and employees (30,854)
Cash paid for interest (450)
Cash paid for taxes (1,190)
Net cash flow from operating activities $ 1,069
Cash flow from investing activities:
Cash paid to purchase equipment $ (1,625)
Net cash flow from investing activities (1,625)
Cash flow from financing activities:
Cash received from bank loan $ 1,400
Cash paid for dividends (1,000)
Net cash flow from financing activities 400
Net decrease in cash during the year $ (156)
Cash at beginning of the year 5,051
Cash at end of the year $ 4,895
 1-34
MAXIDRIVE CORP.
Statement of Cash Flows
For the Year Ended December 31, 2021
(in thousands of dollars)

Cash flows from operating activities:

Cash collected from customers $ 33,563
Cash paid to suppliers and employees (30,854)
Cash paid for interest (450)
Cash paid for taxes (1,190)
Net cash flow from operating activities $ 1,069
Cash flow from investing activities:
Cash paid to purchase equipment $ (1,625)
Net cash flow from investing activities (1,625)
Cash flow from financing activities:
Cash received from bank loan $ 1,400
Cash paid for dividends (1,000)
Net cash flow from financing activities 400
Net decrease in cash during the year $ (156)
Cash at beginning of the year 5,051
Cash at end of the year $ 4,895
 1-35
MAXIDRIVE CORP.
Statement of Cash Flows
For the Year Ended December 31, 2021
(in thousands of dollars)

Cash flows from operating activities:

Cash collected from customers $ 33,563
Cash paid to suppliers and employees (30,854)
Cash paid for interest (450)
Cash paid for taxes (1,190)
Net cash flow from operating activities $ 1,069
Cash flow from investing activities:
Cash paid to purchase equipment $ (1,625)
Net cash flow from investing activities (1,625)
Cash flow from financing activities:
Cash received from bank loan $ 1,400
Cash paid for dividends (1,000)
Net cash flow from financing activities 400
Net decrease in cash during the year $ (156)
Cash at beginning of the year 5,051
Cash at end of the year $ 4,895
 1-36
MAXIDRIVE CORP.
Statement of Cash Flows
For the Year Ended December 31, 2021
(in thousands of dollars)

Cash flows from operating activities:

Cash collected from customers $ 33,563
Cash paid to suppliers and employees (30,854)
Cash paid for interest (450)
Cash paid for taxes (1,190)
Net cash flow from operating activities $ 1,069
Cash flow from investing activities:
Cash paid to purchase equipment $ (1,625)
Net cash flow from investing activities (1,625)
Cash flow from financing activities:
Cash received from bank loan $ 1,400
Cash paid for dividends (1,000)
Net cash flow from financing activities 400
Net decrease in cash during the year $ (156)
Cash at beginning of the year 5,051
Cash at end of the year $ 4,895
 1-37

Relationship Among the Financial Statements

MAXIDRIVE CORP.
Income Statement
For the Year Ended December 31, 2021
(in thousands of dollars)

Revenues
Sales revenue $ 37,436
Expenses
Cost of goods sold $ 26,980
Selling, general and administrative 3,624
Research and development 1,982
Interest expense 450
Total expenses 33,036
Pretax income $ 4,400
Income tax expense 1,100
Net income $ 3,300
 1-38

Relationship Among the Financial Statements

MAXIDRIVE CORP.
Balance Sheet
At December 31, 2021
(in thousands of dollars)
Assets
Cash $ 4,895
Accounts receivable 5,714
Inventories 8,517
Plant and equipment 7,154
Land 981
Total assets $ 27,261
Liabilities and Stockholders' Equity
Liabilities
Accounts payable $ 7,156
Notes payable 9,000
Total liabilities $ 16,156
Stockholders' Equity
Contributed capital $ 2,000
Retained earnings 9,105
Total stockholders' equity 11,105
Total liabilities and stockholders' equity $ 27,261
 1-39

Relationship Among the Financial Statements

MAXIDRIVE CORP.
Balance Sheet
MAXIDRIVE CORP.
At December 31, 2021
Statement of Cash Flows
(in thousands of dollars)
For the Year Ended December 31, 2021
Assets
(in thousands of dollars)
Cash $ 4,895
Accounts receivable 5,714
Cash flows from operating activities:
Inventories 8,517 Cash collected from customers $ 33,563
Plant and equipment 7,154 Cash paid to suppliers and employees (30,854)
Land 981 Cash paid for interest (450)
Total assets $ 27,261 Cash paid for taxes (1,190)
Net cash flow from operating activities $ 1,069
Liabilities and Stockholders' Equity
Cash flow from investing activities:
Liabilities Cash paid to purchase equipment $ (1,625)
Accounts payable $ 7,156 Net cash flow from investing activities (1,625)
Notes payable 9,000 Cash flow from financing activities:
Total liabilities $ 16,156 Cash received from bank loan $ 1,400
Cash paid for dividends (1,000)
Stockholders' Equity
Net cash flow from financing activities 400
Contributed capital $ 2,000
Net decrease in cash during the year $ (156)
Retained earnings 9,105
Cash at beginning of the year 5,051
Total stockholders' equity 11,105
Cash at end of the year $ 4,895
Total liabilities and stockholders' equity $ 27,261

The change in cash on the statement of cash flows added to the

beginning of the year balance in cash equals the ending balance
in cash on the balance sheet.
 1-40

Financial Statement Summary

 1-41

Notes

They are very important parts in the

financial reports
 describe accounting rules used by the
company.
 provide the reader with additional detail
about information in the financial
statements.
 provide additional information to the
reader about information that is not
included in the financial statements.
 1-42

Price/Earnings Ratio

Market Price (of the Company)

Price/Earnings Ratio =
Net Income

This ratio is one method

for estimating the value
of a company.
 1-43

Learning Objectives

Identify the role of generally accepted

accounting principles (GAAP) in determining
the content of financial statements.
 1-44

Responsibilities for the Accounting Communication

Process

Effective communication means that the

recipient understands what the sender
intends to convey.

Decision makers need to understand

accounting measurement rules.
 1-45

How are Generally Accepted Accounting

Principles Determined?
Our accounting system has a long and
distinguished history. An Italian monk named Luca
Pacioli, published the first elements of double-
entry bookkeeping in 1494.
Prior to 1933, the management of most
companies were free to choose the accounting
principles used to keep track of its transactions.
 1-46

Generally Accepted Accounting Principles

(GAAP)
Securities Act of 1933
Securities and Exchange Act of 1934

The Securities and Exchange Commission (SEC)

has been given broad powers to determine
measurement rules for
financial statements.
 1-47

Generally Accepted Accounting Principles

(GAAP)

The SEC has worked closely with the

accounting profession to
work out the detailed rules that have
become known as GAAP.

Currently, the Financial Accounting

Standards Board (FASB) is recognized
as the body to formulate GAAP.
 1-48

The Equivalents in China

 SEC:
CSRC (China Securities Regulatory Commission,
中国证券监督管理委员会，证监会)

 FASB:
Accounting Department of the Ministry of Finance
(财政部会计司)
 1-49

International Perspective
The International Accounting Standards Board and
Global Convergence of Accounting Standards

Since 2002, there has been substantial movement toward the adoption of
International Financial Reporting Standards (IFRS) issued by the
International Accounting Standards Board (IASB).

Examples of jurisdictions requiring the use of IFRS either currently or by 2012:

• European Union • Israel and Turkey
• Australia and New Zealand • Brazil and Chile
• Canada and Mexico • Hong Kong, India, Malaysia, & South Korea

In the United States, the Securities and Exchange Commission now allows
foreign companies whose stock is traded in the U.S. to use IFRS and is
considering requiring the use of IFRS for U.S. domestic companies by 2015.
 1-50

Understanding Foreign Financial Statements

 1-51

Learning Objectives

Appreciate the importance of ethics,

reputation, and legal liability in accounting.
 1-52

Ethics, Reputation, and Legal Liability

Three Step Process for Making Ethical Decisions
1. Identify the benefits of a decision (often to the manager or
employee involved) and who will be harmed (other
employees, owners, creditors, the environment).
2. Identify alternative courses of action.
3. Choose the one you would like your family and friends to
see reported on your local news.

To ensure the accuracy of the company’s financial information,

management:
1. Maintains a system of controls.
2. Hires external independent auditors.
3. Forms a committee of the board of directors to review
these other two safeguards.
 1-53

What if the numbers are wrong?

After it was determined that the financial statements for Le-Nature’s

were misleading, the consequences for the defendants were severe.
 1-54

Kangmei Pharmaceutical
Kangmei Pharmaceutical, founded in 1997, is a large
pharmaceutical enterprise specializing in traditional Chinese medicine
decoction pieces, chemical active pharmaceutical ingredients, and
pharmaceutical manufacturing. It integrates drug production, R&D, as
well as the marketing of pharmaceuticals and medical devices. The
company was listed on the Shanghai Stock Exchange in 2001
(600518).
In January 2014, Kangmei obtained a direct selling license issued
by the Ministry of Commerce, and its revenue and net profit grew
steadily. In 2015, as China became the world’s second-largest
pharmaceutical market, Kangmei, benefiting from the domestic
pharmaceutical industry boom, became the first listed pharmaceutical
company in China’s capital market to surpass RMB 100 billion in
market capitalization.
 1-55

Kangmei Pharmaceutical
The responsible parties were held
False Records liable for RMB 2.459 billion in damages
and received a 12-year prison sentence.

According to the China Securities Regulatory Commission

(CSRC), Kangmei Pharmaceutical’s semi-annual reports for
2016, 2017, and 2018 contained false records. The company
inflated its monetary funds by not recording certain
transactions, making false entries, falsifying or altering large-
denomination certificates of deposit and bank statements, and
fabricating sales receipts to support fictitious revenue. As a
result, Kangmei overstated its monetary funds by RMB 22.549
billion in 2016, RMB 29.933 billion in 2017, and RMB 36.188
billion in 2018.
 1-56

End of Chapter 1
 1-57

1. Reading: Chapter 1
2. Overview four financial statements
3. Get familiar with the main categories in each
financial statement.
4. Role & history of GAAP
5. The importance of ethics