Chapter 1: Introduction to Financial Statements

Study Guide

Learning Objectives:
1. Identify the forms of business organization and the uses of accounting information.
2. Explain the three principal types of business activity.
3. Describe the four financial statements and how they are prepared.

Learning Objective 1: Identify the forms of business organization and the uses
of accounting information.

Main Forms of Business Organization

Type Description/Features
[Link] Proprietorship Simple to establish
Greater controlled
Tax advantages
[Link] Simple to establish
Shared control
Broader skills and resources
Tax advantages
[Link] Easier to transfer ownership
Easier to raise capital
No personal liability

The purpose of financial information is to provide inputs for decision making.

Accounting is the information system that identifies, records, and communicates

the economic events of an organization to interested users.

Users of accounting information

Users Examples How use financial information:

[Link] Supervisors, Answer questions relevant to their
managers, company jobs
officials
[Link] Investors, creditors, Make investing decisions, evaluate
regulators risks of lending, ensure compliance
to regulations

ACCT 2001: Ch. 01 Page 1 of 6

 Ethics in Financial Reporting
Sarbanes-Oxley Act (SOX)
Reason passed:

Key Provisions:
1. Top management must certify financial statements
2. Increased penalties for fraud
3. Increased duties of outside auditors

Effective financial reporting depends on sound ethical behavior

Learning Objective 2: Explain the three principal types of business activity.

Three types of business activities and examples of each:

Business activity Definition Examples

[Link] Acquiring funds needed to be 2 primary sources of
used by a business outside funds are:
- Borrow money from
creditors
- Issue (sell) shares
of stock to investors

[Link] Purchasing the resources Resources owned and

(assets) needed to operate used by a business
(computers, equipment,
delivery trucks)

[Link] Conducting day to day Shoe store selling

operations shoes, dentist cleaning
teeth, lawn care
company mowing lawns

ACCT 2001 10e Study Guide Page 2 of 6

Match the terms with their definition:
_C_ Assets A. The cost of assets consumed or services used in the
process of generating revenues
_E_ Liabilities B. The Owners’ claim to assets
_B_ Stockholders’ Equity C. Resources owned by a business
_F_ Revenues D. Payment of cash from a corporation to its
stockholders.
_A_ Expenses E. Amounts owed to creditors in the form of debts and
other obligations.
_D_ Dividends F. An increase in assets or decrease in liabilities
resulting from the sale of goods or the performance of
services in the normal course of business

Learning Objective 3: Describe the four financial statements and how they
are prepared.

Name and define the 4 financial statements:

Name Definition Components Time span or

date
[Link] Shows how successful Revenues – Time span
Statement your business performed. Expenses = Net (month, quarter or
Reports revenues, Income year)
expenses, and net
income (or net loss)

[Link] Indicates how much of Beginning R/E + Time span (same

Earnings previous income was Net Income – as income
Statement distributed to owners and Dividends = Ending statement)
how much was retained R/E
in the business for future
growth.

[Link] Gives a picture at a point Accounting Date – point in

Sheet in time of what your Equation time
business owns and what
it owes. Assets = Liabilities Last day of time
+ Stockholder’s span
Equity

[Link] of Reports about cash 3 sections Time span (same

Cash Flows receipts and cash as income
payments - Financing statement)
- Investing
- Operating

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ACCT 2001 10e Study Guide Page 4 of 6
 Review the Definitions and give examples of the following financial statement
items:
Definition Examples
Asset Resources owned by a business Cash, accounts
receivable, inventory,
supplies, property,
plant and equipment

Liabilities Amounts owed to creditors in Accounts payable,

the form of debts and other notes payable, bonds
obligations payable

Stockholders’ Equity The owners’ claim to assets 1. Common Stock

2. Retained Earnings

Common Stock The total amount paid in by

stockholders for the shares they
purchase

Dividends Payments of cash from a

corporation to its stockholders

Retained Earnings The amount of net income

retained in the corporation
Revenues The increase in assets or Sales Revenue,
decrease in liabilities resulting Service Revenue,
from the sale of goods or the Interest Revenue
providing of services

Expenses The cost of assets consumed or Rent Expense, Utilities

services used in the process of Expense, Interest
generating revenues Expense, Cost of
Goods Sold
Net Income The amount by which revenues
exceed expenses

Net Loss The amount by which expenses

exceed revenues

ACCT 2001 10e Study Guide Page 5 of 6

 State the basic accounting equation:

Assets = Liabilities = Liabilities + Stockholder’s Equity

Components of the Annual Report

Component Definition
1. Financial Statements (see previous notes)

2. Management Managements view on the company’s ability to pay

Discussion and Analysis obligations, fund operations and expansion and its
results of operations.

3. Notes to the Financial Notes to clarify financial statements and provide

Statements additional information

4. Auditor’s Report Report prepared by independent outside auditors as

to the fairness of the presentation of the financial
statements.

Financial statements should be prepared in the following order:

1. Income Statement

2. Retained Earnings Statement

3. Balance Sheet

ACCT 2001 10e Study Guide Page 6 of 6