CHAPTER 1: A FRAMEWORK FOR

FINANCIAL ACCOUNTING

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PART A: ACCOUNTING AS A
MEASUREMENT/COMMUNICATION
PROCESS

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 Financial Accounting

 Accounting information provided to external users is referred to as

financial accounting, which is the focus of this book.
 The two functions of financial accounting are
– to measure business activities of a company, and

– to communicate those measurements to external parties for decision-making purposes.

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 Framework for Financial Accounting

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 Key Point

The functions of financial accounting are to measure business

activities of a company and to communicate information about those
activities to investors and creditors and other outside users for
decision-making purposes.

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 Business Activities

 Financing activities: transactions the company has with

investors and creditors
 Investing activities: transactions involving the purchase
and sale of resources that are expected to benefit the
company for several years
 Operating activities: transactions that relate to the primary
operations of the company

1-6
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 Types of Business Organizations

 A corporation is a company that is legally separate from its

owners.
– The advantage of being legally separate is that the stockholders
have limited liability.

 A sole proprietorship is a business owned by one person.

 A partnership is a business owned by two or more persons.

– Neither sole proprietorships nor partnerships offer limited liability.

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 The Accounting Equation

• Assets = total resources of the company.

• Liabilities = amounts owed to creditors.
• Stockholders’ equity = owners’ claims to resources

The accounting equation illustrates a

fundamental model of business valuation.

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 Revenues, Expenses, and Dividends
• Revenues are the amounts recognized when the company sells
products or provides services to customers.

• Expenses are the costs of providing products and services and

other business activities during the current period.

• Net income is the difference between revenues and expenses.

Other common names for net income include earnings or profit.

• Dividends are cash payments to stockholders.

 Dividends are not expenses.

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 Key Point

The measurement role of accounting is to create a record of

the activities of a company.
To make this possible, a company must maintain an accurate
record of its assets, liabilities, stockholders’ equity, revenues,
expenses, and dividends.

1-10
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 Communicating through Financial Statements

Financial statements are periodic reports published by the

company for the purpose of providing information to external
users.
 Primary financial statements
– Income statement
– Statement of stockholders’ equity
– Balance sheet
– Statement of cash flows

1-11
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 Income Statement

 Reports the company’s revenues and expenses over an

interval of time
– If revenues > expenses, then net income
– If revenues < expenses, then net loss

Key Point: The income statement compares revenues and expenses for the
current period to assess the company’s ability to earn a profit from running its
operations.

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 EAGLE SOCCER ACADEMY
Income Statement
For the month ended December 31, 2024
Revenues
Service revenueEAGLE SOCCER ACADEMY$72,000
Expenses Income Statement
Rent expense 5,000
For the month ended December 31, 2021
Supplies expense 10,000
Salaries expense 31,000
Utilities expense 9,000
Interest expense 1,000
Other expenses 2,000
Total expenses 58,000
Net income $14,000

Income Statement for Eagle Soccer Academy

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 Statement of Stockholders’ Equity

Stockholders’ Equity = Common Stock + Retained Earnings

Summarizes the changes in stockholders’

equity over an interval of time

External Company Internal

Source Value Source

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 EAGLE SOCCER ACADEMY
Statement of Stockholders’ Equity
For the month ended December 31, 2024
Total
Common Retained Stockholders’
Stock Earnings Equity
Beginning balance (Dec. 1) $ -0- $ -0- $ -0-
Issuance of common stock 200,000 200,000
Add: Net income for the period 14,000 14,000
Less: Dividends (4,000) (4,000)
Ending balance (Dec. 31) $200,000 $ 10,000 $210,000
*Beginning balances are zero only because this is the first month of operations for Eagle. Normally, beginning
balances for Common Stock and Retained Earnings equal ending balances from the previous period.

Statement of Stockholders’ Equity for Eagle Soccer Academy

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 Common Mistake

Dividends represent the payment of cash but are not considered an

expense in running the business.
Students sometimes mistakenly include the amount of dividends as
an expense in the income statement, rather than as a distribution of
net income in the statement of stockholders’ equity.

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 Key Point

The statement of stockholders’ equity reports information related to

changes in common stock and retained earnings each period.
The change in retained earnings equals net income less dividends for
the period.

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 Balance Sheet

Presents theFinancial
financial position of the
position:
Resources
company on= a
Claims to Resources
particular date

Liabilities +
Assets = Stockholders’ Equity

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 EAGLE SOCCER ACADEMY
Balance Sheet
December 31, 2024
Assets Liabilities
Cash $137,000 Accounts payable $ 23,000
Accounts receivable 27,000 Salaries payable 3,000
Supplies 13,000 Utilities payable 9,000
Equipment, net 118,000 Interest payable 1,000
Other assets 55,000 Notes payable 100,000
Other liabilities 4,000
Total liabilities 140,000
Stockholders’ Equity
Common stock 200,000
Retained earnings 10,000
Total stockholders’ equity 210,000
Total liabilities and
Total assets $350,000 stockholders’ equity $350,000

Balance Sheet for Eagle Soccer Academy

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 Statement of Cash Flows

Measures activities involving cash receipts and

cash payments over an interval of time

Operating Investing Financing

cash flows cash flows cash flows

cash transactions cash transactions cash transactions

involving revenue for the purchase with lenders
and expense and sale of investments and stockholders
activities and long-term assets
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 EAGLE SOCCER ACADEMY
Statement of Cash Flows
For the month ended December 31, 2024
Cash Flows from Operating Activities
Cash inflows:
From customers $ 49,000
Cash outflows:
For salaries (28,000)
For rent (60,000)
Net cash flows from operating activities $(39,000)
Cash Flows from Investing Activities
Purchase equipment (120,000)
Net cash flows from investing activities (120,000)
Cash Flows from Financing Activities
Issue common stock 200,000
Borrow from bank 100,000
Pay dividends (4,000)
Net cash flows from financing activities 296,000
Net increase in cash 137,000
Cash at the beginning of the period -0-
Cash at the end of the period $137,000

Statement of Cash Flows for Eagle Soccer Academy

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 Links among Financial Statements

EAGLE SOCCER ACADEMY

Income Statement EAGLE SOCCER ACADEMY
Revenues $72,000 Statement of Stockholders’ Equity
Expenses 58,000
Net Income $14,000 Total
[1] Common Retained Stockholders’
Stock Earnings Equity
[1] Notice that the amount of net
income in the income statement Beginning balance (Dec. 1) $ -0- $ -0- $ -0-
appears in the statement of Issuances 200,000 200,000
stockholders’ equity.
Add: Net income 14,000 14,000
[2] Notice that the ending balance in
the statement of stockholders’ Less: Dividends (4,000) (4,000)
equity reappears in the balance [2]
sheet.
Ending balance (Dec. 31) $200,000 $10,000 $210,000

EAGLE SOCCER ACADEMY EAGLE SOCCER ACADEMY

Balance Sheet Statement of Cash Flows
Cash $137,000 [3] Liabilities $140,000 Cash flows from operating activities $ (39,000)
Other assets 213,000 Stockholders’ equity 210,000 Cash flows from investing activities (120,000)
Total liabilities and Cash flows from financing activities 296,000
Total assets $350,000 stockholders’ equity $350,000 Net increase in cash 137,000
Cash at the beginning of the year -0-
Cash at the end of the year $137,000
[3] Notice that the amount of cash in the balance sheet reappears
as the ending cash balance in the statement of cash flows. 1-22
 Key Point

All transactions that affect revenues or expenses reported in the

income statement ultimately affect the balance sheet through the
balance in retained earnings.

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 Other Information Reported to Outsiders

• The financial statements are a key component of a company’s annual report.

• Two other important components of the annual report are (1) management’s
discussion and analysis and (2) note disclosures to the financial statements.
• The management discussion and analysis (MD&A) section typically
includes management’s views on significant events, trends, and uncertainties
pertaining to the company’s operations and resources.
• Note disclosures offer additional information either to explain the information
presented in the financial statements or to provide information not included in
the financial statements.

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 Key Point

No single piece of company information better explains companies’ stock

price performance than does financial accounting net income.
A company’s debt level is an important indicator of management’s ability to
respond to business situations and the possibility of bankruptcy.

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PART B: FINANCIAL ACCOUNTING
INFORMATION

26
Financial Accounting Standards

Make their
decisions based Financial
Investors on Accounting
& Information
Creditors
Should be based
on formal
standards

Generally Accepted Accounting Principles

(GAAP)

1-27
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written consent of McGraw-Hill.
 Standard Setting Today

United States Global

Financial Accounting International Accounting

Standards Board (FASB) Standards Board (IASB)

Governed by the
Securities and Exchange
Commission (SEC)

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 Importance of Auditors

Trained individuals hired by a company as an

independent party to express a professional opinion
of the extent to which financial statements are
prepared in compliance with GAAP and are free of
material misstatement.
Role of auditors

Help ensure that Play a major role in

management has in fact investors’ and creditors’
appropriately applied GAAP decisions by adding
in preparing the company’s credibility to the financial
financial statements. statements.

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 DICK’S SPORTING GOODS, INC.
Report of Independent Auditors
To the Board of Directors and Stockholders of
Dick’s Sporting Goods, Inc.
Pittsburgh, Pennsylvania

We have audited the accompanying consolidated balance sheets of Dick's Sporting

Goods, Inc., and subsidiaries (the "Company") as of February 1, 2020, and February 2,
2019, and the related consolidated statements of income, comprehensive income, changes
in stockholders' equity, and cash flows for each of the three years in the period ended
February 1, 2020and the related notes (collectively referred to as the
“financial statements”).
In our opinion, such consolidated financial statements present fairly, in all material
respects, the financial position of the Company as of February 1, 2020, and February 2,
2019, and the results of their operations and their cash flows for each of the three years in
the period ended February 1, 2020, in conformity with accounting principles generally
accepted in the United States of America.

Excerpts from the Independent Auditor’s

Report of Dick’s Sporting Goods, Inc. 1-30
 Objectives of Financial Accounting

 Financial accounting should provide information that:

– Is useful to investors and creditors in making decisions.
– Helps to predict cash flow.
– Tells about economic resources, claims to resources, and changes in
resources and acclaims.

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 Key Point

The primary objective of financial accounting is to

provide useful information to investors and creditors in
making decisions.

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PART C: CAREERS IN ACCOUNTING

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 Some of the Career Options in Accounting

Public Accounting Private Accounting

(Big 4 and Non-Big 4)
Who are the clients? Corporations Your particular
Governments employer
Nonprofit organizations
Individuals
What are the Auditors Financial accountants
traditional career Tax preparers/planners Managerial accountants
opportunities? Business consultants Internal auditors
Tax preparers
Payroll managers
What other career Financial planners Information managers
opportunities are Information technology developers Management advisors
available? Financial analysts Tax planners
Forensic accountants Acquisition specialists
Information risk managers FBI agents
Investment bankers Sports agents
Environmental accountants
Financial advisors
Tax lawyers

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END OF CHAPTER 1

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