1. © 2011 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Introduction to Financial
Statements and Other
Financial Reporting Topics
Chapter 2

2. © 2011 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Chapte
r 2,
Slide
#2
FORMS OF BUSINESS ENTITIES
Sole
Proprietorship Partnership Corporation
Number of owners 1
2 or more
(partners)
Numerous
(shareholders)
Legally separate from
owners
No No Yes
Owners liable for
business debts
Yes Yes No
Profits taxable To the owner
To the
owners
To the
corporation as
earnings;
to the owners
when dividends
are received
Modified form
“LLC”
limits liability of owner; may
increase income tax
exposure
“Subchapter S”
profits are
taxed at
ownership level
only

3.  Income statement
 Statement of stockholders’ equity
 Balance sheet
 Statement of cash flows
 Support for the financial statements is provided by
notes
© 2011 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Chapte
r 2,
Slide
#3
THE FINANCIAL STATEMENTS

4.  Dated for a specific
period
 Summarizes
revenues and
expenses
 Reports net income
 Excess of revenues
over expense
 Net income
increases retained
earnings
© 2011 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Chapte
r 2,
Slide
#4
INCOME STATEMENT
Income Statement
For the Year Ended Dec. 31, 2011
Revenue $ 120,000
Expenses (100,000)
Net Income $ 20,000

5.  Dated for a
specific period
 Reconciles
beginning and
ending balances
of the
stockholders’
equity accounts
 Capital Stock
 Retained Earnings
 Etc.
 Links the income
statement and
the balance sheet
© 2011 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Chapte
r 2,
Slide
#5
STATEMENT OF STOCKHOLDERS’ EQUITY
Income Statement
For Year Ending December 31, 2011
Revenue $ 120,000
Expenses (100,000)
Net Income $ 20,000
Statement of Stockholders’ Equity
For Year Ending December 31, 2011
Capt. Stk. Ret. Earn.
Beginning Balance $40,000 $ 25,000
Issue stock 10,000
Net income 20,000
Dividends (10,000)
Ending Balance $50,000 $ 35,000

6. Shows the financial
condition of an entity as
of a particular date
 Assets: the resources of
the business
 Liabilities: the debts of
the business
 Equity: the owners’
interest in the business
The Accounting Equation:
© 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole or in part.
Chapte
r 2,
Slide
#6
STATEMENT OF STOCKHOLDERS’ EQUITY
Assets = Liabilities +
Stockholders’ Equity
Assets = Liabilities +
Capital Stock +
Retained Earnings
Balance Sheet
Assets $110,000
Liabilities 25,000
Stockholders’ Equity
Capital Stock 50,000
Retained Earnings 35,000
Tot Liab. & Equity $110,000
Income Statement
Revenue $ 120,000
Expenses (100,000)
Net Income $ 20,000
Statement of Stockholders’ Equity
Capt. Stk. Ret. Earn.
Beginning Balance $40,000 $ 25,000
Issue stock 10,000
Net income 20,000
Dividends (10,000)
Ending Balance $50,000 $ 35,000

7.  Covers the same period as the income statement
 Three sections
 Cash flows from operating activities
 Cash flows from investing activities
 Cash flows from financing activities
© 2011 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Chapte
r 2,
Slide
#7
STATEMENT OF CASH FLOWS

8.  An integral part of the financial statements
 Required presentation
 Summary of significant accounting policies
 Contingent liabilities
 Subsequent events relating to conditions that existed at the
balance sheet date
 Disclose and adjustment of the financial statements
 Subsequent events relating to conditions that did not exist at
the balance sheet date
 Disclosure but no adjustment of the financial statements
© 2011 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Chapte
r 2,
Slide
#8
NOTES

9. 1. Recording transactions
2. Recording adjusting entries
3. Preparing the financial statement
© 2011 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Chapte
r 2,
Slide
#9
THE ACCOUNTING CYCLE

10.  Internal or external event that causes a change in a
company’s assets, liabilities, or stockholders’ equity
 Recorded in a journal (journal entry)
 Posted to general ledger accounts
 Double-entry system
Debit: left side of an account
Credit: right side of an account
Debits = Credits
© 2011 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Chapte
r 2,
Slide
#10
RECORDING TRANSACTIONS
Account Title
Debit Credit

11. ACCOUNTING SYSTEM COMPONENTS
Permanent Temporary
Account
types
Assets
Liabilities
Equity
Revenues, Gains
Expenses, Losses
Dividends
Balances Carry forward to
the next fiscal
period
Closed to retained
earnings at year-end
Represent the
accounting
equation
Chapte
r 2,
Slide
#11
© 2011 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.

12.  Required by the accrual basis of accounting
 Prepared at the end of the fiscal period
 Records (recognizes) for the current period
 Expenses incurred
 Revenues earned
 Recorded in the general journal
 Posted to the general ledger
© 2011 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Chapte
r 2,
Slide
#12
ACCOUNTING SYSTEM COMPONENTS

13.  The output of the accounting system
 Based on the adjusted general ledger account balances
 Directly from the general ledger
 Income statement
 Balance sheet
 From analysis of general ledger accounts
 Statement of cash flows
© 2011 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Chapte
r 2,
Slide
#13
PREPARING THE FINANCIAL STATEMENTS

14.  Voluntary private sector organization (Treadway)
 Committee of Sponsoring Organizations (COSO)
 Internal control reports
 Standard framework for evaluating internal control
 Need for internal control emphasized by
 Sarbanes-Oxley Act §404
 Management's Report on Internal Control
 Independent auditor’s opinion on management’s assessment
of internal control
© 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole or in part.
Chapte
r 2,
Slide
#14
TREADWAY COMMISSION

15.  Audit is conducted by CPAs
 The audit report is the formal statement of audit opinion
 Unqualified opinion
 Qualified opinion
 Adverse opinion
 Disclaimer of opinion
© 2011 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Chapte
r 2,
Slide
#15
AUDITOR’S OPINION

16.  The financial statements present fairly
 The financial position
 Results of operations
 Cash flows
 In conformity with generally accepted accounting
principles
 For the user: the highest degree of reliability
© 2011 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Chapte
r 2,
Slide
#16
UNQUALIFIED OPINION

17.  Except for the matter to which the exception relates
 The financial statements present fairly
 The financial position
 Results of operations
 Cash flows
 In conformity with generally accepted accounting
principles
 For the user: determine the significance of the exception
© 2011 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Chapte
r 2,
Slide
#17
QUALIFIED OPINION

18.  The financial statements do not present fairly
 The financial position
 Results of operations
 Cash flows
 In conformity with generally accepted accounting
principles
 For the user: reliability of financial statements need to
be seriously questioned
© 2011 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Chapte
r 2,
Slide
#18
ADVERSE OPINION

19.  The auditor does not express an opinion
 Auditor
 Has not preformed an audit sufficient in scope to form an
opinion or
 Is not independent
 For the user: auditor’s statement conveys no indication
of financial statement reliability
© 2011 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Chapte
r 2,
Slide
#19
DISCLAIMER OF OPINION

20.  Paragraph #1:
 Financial statements have been audited
 Financial statements are responsibility of management
 Auditors have responsibility to express or disclaim an opinion
© 2011 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Chapte
r 2,
Slide
#20
UNQUALIFIED AUDITOR’S REPORT

21.  Paragraph #2
 Audit conducted in accordance with the standards of the (U.S.)
Public Accounting Oversight Board
 Auditor is required to plan and perform the audit
 Obtain reasonable assurance
 Financial statements are free from material misstatement
 Audit provides a reasonable basis for opinion
 Examining evidence
 Assessing accounting principles and estimates
© 2011 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Chapte
r 2,
Slide
#21
UNQUALIFIED AUDITOR’S REPORT
(CONT’D)

22.  Paragraph #3
 Opinion: in conformity with generally accepted (U.S.)
accounting principles
 Also: for public companies, reference to the audit of
internal control effectiveness
 In accordance with the (U.S.) Public Accounting Oversight
Board
 Based on criteria established by COSO
© 2011 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Chapte
r 2,
Slide
#22
UNQUALIFIED AUDITOR’S REPORT
(CONT’D)

23.  Required by Sarbanes-Oxley
 May be combined with audit opinion report
 Paragraphs
1. Scope
2. Responsibility and procedures
3. Opinion
4. Reference to financial statement audit
© 2011 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Chapte
r 2,
Slide
#23
AUDITOR’S REPORT ON INTERNAL
CONTROL

24.  Review
 Less in scope than an audit
 An opinion is not expressed
 Provides negative assurance
 “Not aware of any material misstatements or required
modifications”
 Compilation
 Presents only financial information provided by management
 No opinion or any other assurance is given
© 2011 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Chapte
r 2,
Slide
#24
OTHER TYPES OF ENGAGEMENTS

25.  Management is responsible for
 The preparation of the financial statements
 The integrity of the financial statements
 Management’s Statement of Responsibility
 May be included in the annual report
© 2011 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Chapte
r 2,
Slide
#25
MANAGEMENT’S RESPONSIBILITY

26. Required filings
 10-K: annual filing (audited)
 Includes financial statements plus
 Information on the business entity
 Market information
 Management discussion and analysis
 Directors, executive officers, and their compensation
 Related party transactions
 10-Q: quarterly filing (unaudited)
 8-K: “current report”
 To report the occurrence of any material events or corporate
changes
© 2011 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Chapte
r 2,
Slide
#26
THE SEC’S INTEGRATED DISCLOSURE
SYSTEM

27.  Proxy
 Notice and authorization of shareholder voting rights on
corporate actions
 Content and form governed by the SEC
 Summary Annual Report
 Highly condensed financial information
 Must be accompanied by a proxy containing full financial
information
 Not adequate for financial analysis
© 2011 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Chapte
r 2,
Slide
#27
ADDITIONAL REPORTING VENUES

28.  Capital markets generate security prices that reflect
worth
 Publicly available information is reflected in share prices
 Investors will be harmed if full disclosure is not made
 Method of disclosure does not impact value
 Body of the financial statements
 Notes to the financial statements
 Benefit of making disclosure outweighs the cost
© 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole or in part.
Chapte
r 2,
Slide
#28
THE EFFICIENT MARKET HYPOTHESIS

29. Caring
Honesty
Accountability
Promise keeping
Pursuit of excellence
Loyalty
Fairness
Integrity
Respect for others
Responsible citizenship
© 2011 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Chapte
r 2,
Slide
#29
ETHICS
Essential values in interpersonal relationships

30. 1. Determine the facts
2. Define the ethical issues
3. Identify major principles, rules, and values
4. Specify the alternatives
5. Compare norms, principles, and values with
alternatives
6. Assess the consequences
7. Make your decision
© 2011 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Chapte
r 2,
Slide
#30
AAA ETHICAL DECISION FRAMEWORK

31.  Enacted under Sarbanes-Oxley Act
 Applicable to chief financial officers
 Disclosure requirements
 Whether a code of ethics has been adopted
 If not, why not
 Code is published in the annual report or on the firm’s web site
© 2011 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Chapte
r 2,
Slide
#31
SEC REQUIREMENT: A CODE OF ETHICS

32.  Accounting standards can vary by country
 Development is often in response to domestic needs
 International accounting standards set by
 IASC (1973 – 2000)
 IASB (2001 to present) has no enforcement power
 In the U.S.
 SEC requires registrants to report in U.S. GAAP
 FASB is participating in the harmonization project
© 2011 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Chapte
r 2,
Slide
#32
HARMONIZATION OF
INTERNATIONAL ACCOUNTING STANDARDS

33.  IASB issues (IFRS) International Financial Reporting
Standards.
 2002 Norwalk agreement – FASB and IASB commit to high-
quality, compatible accounting standards.
 2007 agreement between US and European Union to allow
companies to drop US GAAP if financials were prepared by
IFRS.
© 2011 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Chapte
r 2,
Slide
#33
HARMONIZATION OF
INTERNATIONAL ACCOUNTING STANDARDS

34.  Parent consolidates with subsidiary
 Report results of operations separately
 Sum subsidiary and parent results of operations
 Legal control vs. effective control
 Consolidation occurs when parent has effective control
over the subsidiary
 Holds a majority of risks, rewards, and decision-making ability
© 2011 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Chapte
r 2,
Slide
#34
CONSOLIDATED FINANCIAL STATEMENTS

35.  Effected through merger or acquisition
 Purchase method of accounting
 Record assets and liabilities acquired at their fair values
 Excess of purchase price over fair value of net assets
acquired is reported as goodwill
© 2011 Cengage Learning. All Rights Reserved. May not be
scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Chapte
r 2,
Slide
#35
ACCOUNTING FOR BUSINESS
COMBINATIONS