After studying this chapter, students should be able to:

2-1 Chapter 2

Financial Statements and the Annual Report

After studying this chapter, students should be able to:

 Describe the objectives of financial reporting (LO1). Describe the qualitative characteristics of accounting information (LO2). Explain the concept and purpose of a classified balance sheet and prepare the statement (LO3). Use a classified balance sheet to analyze a company’s financial position (LO4). Explain the difference between a single-step and a multiple-step income statement and prepare each type of income statement (LO5). Use a multiple-step income statement to analyze a company’s operations (LO6). Identify the components of the statement of retained earnings and prepare the statement (LO7). Identify the components of the statement of cash flows and prepare the statement (LO8). Read and use the financial statements and other elements in the annual report of a publicly held company (LO9).Using Financial Accounting Information The Alternative to Debits and Credits 9th Edition Porter Solutions Manual Visit TestBankDeal.com to get complete for all chapters

INSTRUCTOR’S MANUAL

2-2 Chapter Outline LO 1 Objectives of Financial Reporting

Financial reporting has one overriding objective: to provide useful information to those who must make financial decisions. To external users, the financial statements and the notes and other information found in the annual report are the key sources of information needed to make their business decisions. Balance sheet shows what obligations are due in near future and what assets are available to satisfy them. Income statement shows revenue and expenses for a period of time. Statement of cash flows shows where cash came from and where it was used. Notes provide essential details about accounting policies and other key factors that affect the company’s financial condition and performance.

 In preparing the financial statements, accountants must consider:

 The objectives of financial reporting. The characteristics that make accounting information useful. The most useful way to display the information in the statements. The overall objective of financial reporting is to provide financial information to permit external users of the information to make informed decisions on whether to provide resources to the company. Users include management of a company (internal users) and others not involved in the daily operations of the business (external users). External users make their decisions based on general-purpose financial statements prepared by management. The purpose of financial reporting is to help the users reach their decision in an informed manner. Investors and creditors need information about prospective cash receipts. How much cash will

be received from:

 Dividends. Sale of stock. Interest on the loan. The loan, when and if it is repaid. The company needs information on its own prospective cash flows. The company needs information about its resources and claims to those resources.

CHAPTER 2 FINANCIAL STATEMENTS AND THE ANNUAL REPORT

2-3

LO 2 What Makes Accounting Information Useful? Qualitative Characteristics

Qualitative (i.e., non-numerical) characteristics that make accounting information useful:

Understandability

 Understandability: the quality of accounting information that makes it comprehensible to those willing to spend the necessary time to understand it. Two fundamental characteristics make accounting information useful – the information must be relevant and it must be a faithful representation.

Relevance

 Relevance: the capacity of information to make a difference in a decision.

 Predictive value – help predict if decision should be made. Confirming value – confirm that the right decision was made.

Faithful Representation

 Faithful representation: the quality of information that makes it complete, neutral, and free from error. Neutral: information is not slanted to make a company’s position look any better or worse than the actual circumstances would dictate.

Comparability and Consistency

 Comparability: for accounting information, the quality that allows a user to analyze two or more companies and look for similarities and differences. Not necessarily uniformity – alternative methods are acceptable under GAAP. Companies can choose from several depreciation methods. Depreciation is the process of allocating the cost of a long-term tangible asset over its useful life. Disclosure allows reader to make adjustments for these differences. Consistency: allows the financial statements to be compared within a single company from one accounting period to the next. If a company makes an accounting change, accounting standards require various disclosures to help the reader evaluate the impact of the change.

Materiality

 Materiality: the magnitude of an accounting information omission or misstatement that will affect the judgment of someone relying on the information. The threshold varies from one company to the next.

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2-4 Conservatism

 Conservatism: the practice of using the least optimistic estimate when two estimates of amounts are about equally likely. Applies when there is uncertainty about how to account for a particular item or transaction.

An International Perspective on Qualitative Characteristics

 The International Accounting Standards Board (IASB) has the same objectives and qualitative characteristics of financial reporting as the FASB.

LO 3 The Classified Balance Sheet A classified balance sheet separates both assets and liabilities into current and noncurrent.

Understanding the Operating Cycle

 The operating cycle is the period of time between the purchase of inventory and the collection of any receivable from the sale of the inventory. Begins when cash is invested in inventory and ends when cash is collected by the enterprise from its customers.

Current Assets

Current assets are assets that are expected to be realized in cash or sold or consumed during the operating cycle of a business or within one year, if the cycle is shorter than one year. Most businesses have an operating cycle shorter than one year. Cash, accounts receivable, and inventory are current assets because they are cash or will be realized in (converted to) cash within one year. Short-term investments or marketable securities are investments of excess cash made for the short term. Prepaid assets represent a prepayment of expenses such as rent, office supplies and insurance.They are current because they are usually consumed within one year.

Noncurrent Assets

Noncurrent assets (also called long-term assets) are any assets not meeting the definition of a current asset.

Noncurrent assets include:

 Investments:

 Securities not expected to be sold within the next year. Land held for future use or buildings not currently used in operations. Funds reserved for a special purpose.