Chapter 6 Process Costing

Ch 01: Accounting and the Financial Statements 1

CHAPTER1

Accounting and the Financial Statements

This chapter covers basic aspects of accounting and financial statements. It exposes students to different forms of business organizations, types of business activities and also to the fundamental accounting equation that provides useful insights in later chapters. The chapter describes relationships among the financial statements. The material in this chapter is generally easy to comprehend for the students.

LEARNING OBJECTIVES

LO1. Explain the nature of accounting.

Accounting is the process of identifying, measuring, recording, and communicating financialinformation.
This information is used both inside and outside of the business to make better decisions.
Accounting is also called the language of business.
Financial accounting focuses on the needs of external decision-makers.

LO2. Identify the forms of business organizations and the types of business activities.

The three forms of business organizations are the sole proprietorship (owned by oneperson), the partnership (jointly owned by two or more individuals), and the corporation(separate legal entity organized under the laws of a particular state).
Regardless of the form of business, all businesses are involved in three activities. Financingactivities include obtaining funds necessary to begin and operate a business.Investing activities involve buying the assets that enable a business to operate. Operatingactivities are the activities of a business that generate a profit.

LO3. Describe the relationships shown by the fundamental accounting equation.

The fundamental accounting equation captures all of the economic activities recordedby an accounting system.
The left side of the accounting equation shows the assets, or economic resources of acompany.
The right side of the accounting equation shows the claims on the company’s assets(liabilities or stockholders’ equity).

LO4. Prepare a classified balance sheet and understand the information it communicates.

A balance sheet reports the resources (assets) owned by a company and the claimsagainst those resources (liabilities and stockholders’ equity) at a specific point in time.
These elements are related by the fundamental accounting equation:Assets = Liabilities + Stockholders’ Equity.
In order to help users identify the fundamental economic similarities and differencesbetween the various items on the balance sheet, assets and liabilities are classified as eithercurrent or noncurrent (long-term). Stockholders’ equity is classified as eithercontributed capital or retained earnings.

LO5. Prepare an income statement and understand the information it communicates.

The income statement reports how well a company has performed its operations overa period of time and provides information about the future profitability and growth ofa company.
The income statement includes the revenues and expenses of a company, which canbe reported in either a single-step or multiple-step format.

LO6. Prepare the retained earnings statement and understand the information it communicates.

The retained earnings statement reports how much of a company’s income wasretained in the business and how much was distributed to owners for a period oftime.
The retained earnings statement provides users with insights into a company’s dividendpayouts.

LO7. Understand the information communicated by the statement of cash flows.

The statement of cash flows reports the sources of a company’s cash inflow and theuses of a company’s cash over time.
The statement of cash flows can be used to assess the creditworthiness of a company.

LO8. Describe the relationships among the financial statements.

There is a natural relationship among the four basic financial statements so that financial statements are prepared in a particular order.
Starting with the balance sheet at the beginning of the accounting period, financialstatements are generally prepared in the following order: income statement, the retained earnings statement, and the balance sheet at the end of the accounting period.
The statement of cash flows explains the change in cash on the balance sheets at thebeginning and end of the accounting period.

LO9. Describe other information contained in the annual report and the importance of ethics in accounting.

The notes to the financial statements clarify and expand upon the information presentedin the financial statements, and are considered an integral part of a company’sfinancial statements.
Management’s discussion and analysis provides a discussion and explanation of variousitems reported in the financial statements.
The auditor’s report gives the auditor’s opinion as to whether the financial statementsfairly present the financial condition and results of operations of the company.
Maintenance of standards of ethical behavior is essential to the conduct of any businessactivity. Violation of these standards often brings significant short- and long-termnegative consequences for individuals and companies.
The maintenance of a high ethical standard is necessary for users to have faith in theaccuracy of the financial statements, which is a key factor in the effective and efficientfunctioning of the economy.

Cornerstones

Cornerstone 1-1Using the Fundamental Accounting Equation

Cornerstone 1-2Preparing a Classified Balance Sheet

Cornerstone 1-3Preparing an Income Statement

Cornerstone 1-4Preparing a Retained Earnings Statement

CHAPTER OUTLINE

Discussion Question: After students read the opening scenario of Apple Corporation, ask themif financial statements are the most important factor that one should consider before investing in a corporation’s stock and why.

What is Accounting?

Regardless of company’s objectives, all entities use accounting to plan future operations, make decisions and evaluate performance.

Accountingis the process of identifying, measuring, recording, and communicating financial information about a company’s activities so decision makers can make informed decisions.

Exhibit 1-1: The Demand for Accounting Information and Typical Questions

The objectives of financial accounting are to provide decision-makers with information that assists them in assessing the amounts, timing, and uncertainties of a company’s future cash flows.

Four basic financial statements are:

Balance Sheet
Income Statement
Statement of Retained Earnings
Statement of Cash Flows

Businesses: Form and activities

A. Forms of Business Organization

Exhibit 1-2: Forms of Business Organization

B. Business Activities

All businesses engage in a multitude of activities that can be categorized as financing, investing, or operating activities.

Financing Activities: Obtaining funds which are necessary to begin and operate a business. Funds come either from issue of stock or borrowing money.

Investing Activities:Once a corporation has obtained funds through its financing activities, it buys assets that enables corporation to operate. Corporation may also obtain intangible assets that lack physical substance, such as copyrights and patents.

Operating Activities: Once a corporation has acquired the assets that it needs, it can begin to operate.

Communication of Accounting Information

The Four Basic Financial Statements

Balance Sheet
Income Statement
Statement of Retained Earnings
Statement of Cash Flows

Questions Answered by Financial Statements

How much better off is the company at the end of the year than it was at the beginning of the year?
What are the economic resources of the company and the claims against those resources?
From what sources did a company’s cash come and for what did the company use cash during the year?

Fundamental Accounting Equation

Cornerstone 1-1: Using the Fundamental Accounting Equation

The Cornerstones can be implemented in your classes in several different ways:

Demonstrate Cornerstone 1-1 in the Cornerstones text as an example in class.
Use Exercise 1-14, 1-15 as a demo, in-class exercise. Students can work the exercise individually or in teams.

4. The Classified Balance Sheet

The purpose of the balance sheet is to report the financial position of a company (its assets, liabilities, and stockholders’ equity) at a specific point in time.

The relationship between the elements of the balance sheet is given by the fundamental accounting equation

(Assets = Liabilities + Stockholders’ Equity).

The balance sheet is organized, or classified, to help users identify the fundamental economic similarities and differences between the various items within the balance sheet.

Current assets: Consist of cash and other assets that are reasonably expected to be converted into cash within one year or one operating cycle, whichever is longer.

Noncurrent Assets: Assets that are not classified as current are classified as long-term or noncurrent assets.

Current liabilities: Consist of obligations that will be satisfied within one year or the operating cycle, whichever is longer.

Long-term liabilities: Are the obligations of the company that will require payment beyond one year or the operating cycle, whichever is longer.

Exhibit 1-6: Common Balance Sheet Classifications

Cornerstone 1-2: Preparing a Classified Balance Sheet

The Cornerstones can be implemented in your classes in several different ways:

Demonstrate Cornerstone 1-2 in the Cornerstonestext as an example in class.
Use Exercise 1-19 as a demo, in-class exercise. Students can work the exercise individually or in teams.
Discuss Concept Q&A. Many classifications on the balance sheet are essential. Is it really important to place accounts within a category or is it enough to simply understand if the account is an asset, liability, or stockholders’ equity?

Inventories / $ 2,300 / Accounts Receivables / $ 4,200 / Accounts Payable / $ 3,750
Land / 12,100 / Cash / 2,500 / Common Stock / 14,450
Salaries Payable / 1,200 / Equipment / 21,000 / Patents / 2,500
Retained Earnings / 11,300 / Accumulated Depreciation / 5,800 / Notes Payable / 8,100

Prepare Hightower Inc.’s balance sheet on December 31, 2009.

5. The Income Statement

Reports the results of a company’s operations – the sale of goods and services and the associated cost of operating the company for given period.Long-term survival of a company depends on its ability to produce net income by earning revenues in excess of expenses.

Income enables a company to pay for the capital it uses (dividends to stockholders and interest to creditors) and attract new capital necessary for continued existence and growth.

The Income Statementconsists of two major items:

Revenue
Expenses

Income Statement Formats:

Single-step income statement:

It has only two categories; total revenues and total expenses.

Total expenses are subtracted from total revenues in a single step to arrive at net income. The advantage of a single-step income statement is its simplicity.

Multiple-step income statement: Provides classifications of revenues and expenses that financial statement users find useful. It contains three important subtotals:

Exhibit 1-10: Typical Nonoperating Items

The income statement provides information about the future profitability and growth of a company.

Cornerstone 1-3: Preparingan Income Statement

The Cornerstones can be implemented in your classes in several different ways:

Demonstrate Cornerstone 1-3 in the Cornerstonestext as an example in class.
Use Exercise 1-19 as a demo, in-class exercise. Students can work the exercise individually or in teams.

6.Statement of Retained Earnings

Owners of a company contribute capital in two ways:

Directly - Purchases of common stock from the company.
Indirectly - Company retaining some or all of the net income earned each year rather than paying it out in dividends.

It is used to monitor a company’s dividend payouts to its shareholders.

Cornerstone 1-4: Preparinga Statement of Retained Earnings

The Cornerstones can be implemented in your classes in several different ways:

Demonstrate Cornerstone 1-4, in the Cornerstonestext as an example in class.
Use Exercise 1-20 as a demo, in-class exercise. Students can work the exercise individually or in teams.

7.Statement of Cash Flows

Cash Flows are classified into three categories:

Cash flows from operating activities - Includes cash sales and collections of accounts receivable as well as cash payments for goods, services, salaries, and interest.
Cash flows from investing activities - Any cash flow related to the acquisition or sale of investments and long-term assets such as property, plant, and equipment.
Cash flows from financing activities - Includes the issuance and repayment of debt, common stock transactions, and the payment of dividends.

8.Relationships Among the Statements

Net income from the income statement increases retained earnings on the statement of retained earnings. Ending retained earnings from the statement of retained earnings is reported in the stockholders’ equity section of the balance sheet at the end of the accounting period.

9.OTHER ITEMS in the Annual Report and Professional Ethics

Annual report includes the financial statements of a company and other important information such as the notes to the financial statements, management’s discussion and analysis of the condition of the company, and the auditor’s report.

Notes to the Financial Statements: Clarify and expand upon the information presented in the financial statements.

Management’s Discussion and Analysis: Management uses this opportunity to highlight favorable and unfavorable trends and significant risks facing the company.

Report of Independent Accountants: Objective is to gather evidence that will enable the auditor to form an opinion as to whether the financial statements fairly present the financial position and result of operations of the company.Auditor’s opinion of the financial statements is presented in the form of an audit report.

Professional Ethics:Confidence that standards of ethical behavior will be maintained even when individuals have incentives to violate those standards is essential to the conduct of any business activity. Violation of ethical standards may bring clear and direct penalties but more often bring subtle and long-lasting negative consequences for individuals and companies. Ethical principles require accountants to serve the public interest with integrity.

Discuss Concept Q&AIs there a single equation or financial statement that captures the business activities (operating, investing, and financing) that all companies engage in?

APPLICATIONS

Applications for the chapter include the following:

A.In-class Group Practice Tests. See the end-of-chapter multiple-choice questions provided in the text for an in-class, group test or for use with a personal response system. With a group test, each student takes the quiz or test individually. Then ask students to break into teams of four or five to grade the test and discuss answers.

B.End-of-Chapter Exercises, Problems, and Cases. See the preface to the Instructor’s Manual for additional information regarding the AASCB, AICPA, and ACBSP-APC tagging guidelines.

AACSB / AICPA / ACBSP
Multiple-Choice Exercises
1-1 / Analytic / FN-Measurement;
FN-Reporting / APC-03-Business Forms
1-2 / Analytic / FN-Measurement;
FN-Reporting / APC-09-Financial Statements
1-3 / Analytic / FN-Measurement;
FN-Reporting / APC-09-Financial Statements
1-4 / Analytic / FN-Measurement;
FN-Reporting / APC-09-Financial Statements
1-5 / Analytic / FN-Measurement;
FN-Reporting / APC-09-Financial Statements
1-6 / Analytic / FN-Measurement;
FN-Reporting / APC-09-Financial Statements
1-7 / Analytic / FN-Measurement;
FN-Reporting / APC-09-Financial Statements
1-8 / Analytic / FN-Measurement;
FN-Reporting / APC-09-Financial Statements
1-9 / Analytic / FN-Measurement;
FN-Reporting / APC-09-Financial Statements
1-10 / Analytic / FN-Measurement;
FN-Reporting / APC-09-Financial Statements
1-11 / Analytic / FN-Measurement;
FN-Reporting / APC-09-Financial Statements
1-12 / Analytic / FN-Measurement;
FN-Reporting / APC-09-Financial Statements
1-13 / Analytic / FN-Measurement;
FN-Reporting / APC-09-Financial Statements
Cornerstone Exercises
CE 1-14 / Analytic / FN-Measurement;
FN-Reporting / APC-02-GAAP;
APC-09-Financial Statements
CE 1-15 / Analytic / FN-Measurement;
FN-Reporting / APC-02-GAAP;
APC-09-Financial Statements
CE 1-16 / Analytic / FN-Measurement;
FN-Reporting / APC-09-Financial Statements
CE 1-17 / Analytic / FN-Measurement;
FN-Reporting / APC-09-Financial Statements
CE 1-18 / Analytic / FN-Measurement;
FN-Reporting / APC-09-Financial Statements
CE 1-19 / Analytic / FN-Measurement;
FN-Reporting / APC-09-Financial Statements
CE 1-20 / Analytic / FN-Measurement;
FN-Reporting / APC-09-Financial Statements
AACSB / AICPA / ACBSP
Exercises
E 1-21 / Analytic / FN-Measurement;
FN-Reporting / APC-01-Purpose
E 1-22 / Analytic / FN-Measurement;
FN-Reporting / APC-03-Business Forms
E 1-23 / Analytic / FN-Measurement;
FN-Reporting / APC-09-Financial Statements
E 1-24 / Analytic / FN-Measurement;
FN-Reporting / APC-09-Financial Statements
E 1-25 / Analytic / FN-Measurement;
FN-Reporting / APC-09-Financial Statements
E 1-26 / Analytic / FN-Measurement;
FN-Reporting / APC-02-GAAP;
APC-09-Financial Statements
E 1-27 / Analytic / FN-Measurement;
FN-Reporting / APC-09-Financial Statements;
APC-23- Financial Statement Analysis
E 1-28 / Analytic;
Reflective Thinking / FN-Measurement;
FN-Reporting / APC-09-Financial Statements;
APC-23- Financial Statement Analysis
E 1-29 / Analytic;
Reflective Thinking / FN-Measurement;
FN-Reporting / APC-09-Financial Statements;
APC-23- Financial Statement Analysis
E 1-30 / Analytic / FN-Measurement;
FN-Reporting / APC-09-Financial Statements
E 1-31 / Analytic / FN-Measurement;
FN-Reporting / APC-09-Financial Statements
E 1-32 / Analytic;
Reflective Thinking / FN-Measurement;
FN-Reporting / APC-09-Financial Statements;
APC-23- Financial Statement Analysis
E 1-33 / Analytic;
Reflective Thinking / FN-Measurement;
FN-Reporting / APC-09-Financial Statements;
APC-23- Financial Statement Analysis
E 1-34 / Analytic;
Reflective Thinking / FN-Measurement;
FN-Reporting / APC-09-Financial Statements;
APC-23- Financial Statement Analysis
E 1-35 / Analytic;
Reflective Thinking / FN-Measurement;
FN-Reporting / APC-09-Financial Statements;
APC-23- Financial Statement Analysis
E 1-36 / Analytic / FN-Measurement;
FN-Reporting / APC-09-Financial Statements
E 1-37 / Analytic / FN-Measurement;
FN-Reporting / APC-09-Financial Statements
E 1-38 / Analytic;
Reflective Thinking / FN-Measurement;
FN-Reporting / APC-09-Financial Statements
E 1-39 / Analytic;
Reflective Thinking / FN-Measurement;
FN-Reporting / APC-09-Financial Statements
E 1-40 / Analytic / FN-Measurement;
FN-Reporting / APC-09-Financial Statements
E 1-41 / Analytic / FN-Measurement;
FN-Reporting / APC-09-Financial Statements
E 1-42 / Analytic / FN-Measurement;
FN-Reporting / APC-09-Financial Statements
E 1-43 / Analytic / FN-Measurement;
FN-Reporting;
FN-Research / APC-09-Financial Statements
E 1-44 / Analytic / FN-Measurement;
FN-Reporting / APC-01-Purpose
AACSB / AICPA / ACBSP
Problem Set A
P 1-45A / Analytic / FN-Measurement;
FN-Reporting / APC-02-GAAP;
APC-09-Financial Statements
P 1-46A / Analytic / FN-Measurement;
FN-Reporting / APC-09-Financial Statements
P 1-47A / Analytic / FN-Measurement;
FN-Reporting / APC-09-Financial Statements
P 1-48A / Analytic / FN-Measurement;
FN-Reporting / APC-09-Financial Statements
P 1-49A / Analytic / FN-Measurement;
FN-Reporting / APC-09-Financial Statements
P 1-50A / Analytic / FN-Measurement;
FN-Reporting / APC-09-Financial Statements
P 1-51A / Analytic / FN-Measurement;
FN-Reporting / APC-09-Financial Statements
P 1-52A / Analytic / FN-Measurement;
FN-Reporting / APC-09-Financial Statements
P 1-53A / Analytic / FN-Measurement;
FN-Reporting / APC-09-Financial Statements
P 1-54A / Analytic / FN-Measurement;
FN-Reporting / APC-09-Financial Statements
Problem Set B
P 1-45B / Analytic / FN-Measurement;
FN-Reporting / APC-02-GAAP;
APC-09-Financial Statements
P 1-46B / Analytic / FN-Measurement;
FN-Reporting / APC-09-Financial Statements
P 1-47B / Analytic / FN-Measurement;
FN-Reporting / APC-09-Financial Statements
P 1-48B / Analytic / FN-Measurement;
FN-Reporting / APC-09-Financial Statements
P 1-49B / Analytic / FN-Measurement;
FN-Reporting / APC-09-Financial Statements
P 1-50B / Analytic / FN-Measurement;
FN-Reporting / APC-09-Financial Statements
P 1-51B / Analytic / FN-Measurement;
FN-Reporting / APC-09-Financial Statements
P 1-52B / Analytic / FN-Measurement;
FN-Reporting / APC-09-Financial Statements
P 1-53B / Analytic / FN-Measurement;
FN-Reporting / APC-09-Financial Statements
P 1-54B / Analytic / FN-Measurement;
FN-Reporting / APC-09-Financial Statements
AACSB / AICPA / ACBSP
Cases
C 1-55 / Analytic;
Reflective Thinking / FN-Measurement;
FN-Reporting / APC-09-Financial Statements
C 1-56 / Analytic;
Reflective Thinking / FN-Research / APC-01-Purpose
C 1-57 / Reflective Thinking / FN-Research / APC-01-Purpose
C 1-58 / Analytic;
Reflective Thinking / FN-Measurement;
FN-Reporting / APC-09-Financial Statements;
APC-23- Financial Statement Analysis
C 1-59 / Analytic;
Reflective Thinking / FN-Measurement;
FN-Reporting / APC-09-Financial Statements;
APC-23- Financial Statement Analysis
C 1-60 / Ethics;
Reflective Thinking / FN-Measurement;
FN-Reporting / APC-01-Purpose;
APC-09-Financial Statements
C 1-61 / Ethics;
Reflective Thinking / FN-Measurement;
FN-Reporting / APC-01-Purpose;
APC-09-Financial Statements;
APC-23-Financial Statement Analysis
C 1-62 / Analytic;
Reflective Thinking / FN-Measurement;
FN-Reporting;
FN-Research / APC-09-Financial Statements;
APC-23- Financial Statement Analysis
C 1-63 / Analytic;
Reflective Thinking / FN-Measurement;
FN-Reporting;
FN-Research / APC-09-Financial Statements;
APC-23- Financial Statement Analysis
C 1-64 / Analytic;
Reflective Thinking / FN-Measurement;
FN-Reporting;
FN-Research / APC-09-Financial Statements