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Chapter 1 - Elements of Financial Statements


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A Market is a group of people or organizations that come together for the purpose of exchanging things of value.

Markets have 3 distinct participants: Consumers, Conversion Agents, and Resource Owners.
Consumers are Resource Users.

Consumers are members of a market that use resources.
Conversion Agents
Conversion Agents = Businesses.

Conversion Agents, or businesses, exist for the purpose of transforming resources into products that satisfy consumer preferences.
Resource Owners
Resource Owners control the distribution of resources to the conversion agents, and in turn expect to be rewarded for doing so.
Profit = Earnings = Income
Profit, Earnings, or income - these are the added value created in the transformation process of resources.
Investors accept ownership interests in businesses and share in the distribution of income, as well as the risk of loss or failure.
Creditors lend financial resources to businesses.

Instead of recieving ownership interests in a business, creditors expect businesses to return the borrowed resources at some future date.
Liquidation is the process of dividing the assets and returning them to the resource providers in the event of a business failure.
Interest is a fixed fee paid to creditors for providing financial resources.

Instead of sharing in the profitability of a company, because of their more secure position, creditors receive interest, or a fixed fee, for providing financial resources to a business.
Physical Resources
Natural Resources.
Labor Resources
Labor resources include intellectual as well as physical labor.
Financial Accounting
Financial Accounting is accounting information that is designed to satisfy the needs of external resource providers.

Financial accounting is meant for external users.
Managerial Accounting
Managerial Accounting provides information that is useful in operating a business.

Managerial Accounting is meant for internal users, and is more detailed that financial information.
Not-For-Profit Entities
Not-For-Profit = Non-Profit = Non-Business Entities.

Not for profit entities are organizations that are not motivated by profit.
Generally Accepted Accounting Principles

GAAP are the rules of measurement for accounting used in the United States.
Reporting Entities
Reporting Entities = Individuals or Organizations.

for example - A business is a reporting entity that is separate from its owners and its creditors.
Financial Reporting
Financial Reporting is the process through which business entities communicate information to the public.
Financial Statements
Financial Statements are the principle means of communicating economic information.
The Four Basic Financial Statements
1. Income Statement.
2. Statement of Changes in Shareholder Equity.
3. Balance Sheet.
4. Statement of Cash Flows.
FASB = Financial Accounting Standards Board.
Elements are the classes and categories in which items reported in financial statements are organized.
The 10 Elements of Financial Statements
The FASB has identified 10 Elements of Financial Statements.
1. Assets.
2. Liabilities.
3. Equity.
4. Common Stock.
5. Revenue.
6. Expenses.
7. Distributions.
8. Net Income.
9. Gains.
10. Losses.
Accounts are the sub-classifications of elements in a financial statement.
Accounting Equation.
Assets = Claims

The Assets of a business belong to the resource providers who are said to have claims on the assets.

Assets = Claims
Liabilities + Equity

The Accounting Equation is an expression of the relationship between the assets and the claims on those assets.
Residual Interest
Since creditors have first claims on the assets, owners are said to have a residual interest.
Asset Sources
The Claims side of the Accounting Equation (Liabilities + Equity) can be viewed as a list of the sources of assets.

Sources of Assets:
1. Liabilities.
2. Equity.
Equity can be viewed as a source of assets. Equity is composed of two distinct sources of assets.

Equity Sources of Assets:
1. Stockholders Equity.
2. Retained Earnings.
Liabilities are considered the obligations of the enterprise.

Liabilities are sometimes considered a source of assets.
Common Stock
To acknowledge the receipt of assets from owners, businesses frequently issue certificates known as common stock.
Stockholders are the owners of a business.
Stockholder's Equity
Stockholder's Equity is the term for a stockholder's ownership interest in a company.
Balance Sheet Report
The Balance Sheet Report lists the assets of the business and corresponding claims on those assets.
Income Statement Report
The Income Statement Report measures the difference between the asset increases, called Revenues, and the asset decreases, called Expenses, associated with operating a business.
Revenues are asset increases resulting from operating activities.
Expenses are asset decreases incurred to generate revenue.
Net Income
Net Income is the remainder if revenue is greater than expenses.
Net Loss
Net Loss is the difference if expenses are greater than revenue.
Dividends that are transferred from a business to its owners.

Dividends are not expenses because the asset decrease (cash) is not incurred to generate revenue.

Dividends are not shown on the Income Statement Report.
Statement of Cash Flows Report
The Statement of Cash Flows Report explains how a company obtained and used cash during the accounting period.

The sources of cash are called Cash Inflows, and the uses are called Cash Outflows.

The Statement classifies inflows and outflows into 3 categories:

1. Financing Activities.
2. Investing Activities.
3. Operating Activities.

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