Chapter 2 - Summary LO 1 Explain the nature and general purpose of financial statements. Financial statements are declarations of information in financial terms about
an enterprise that are believed to be fair and accurate. They describe certain
attributes of the enterprise that are important for decision makers, particularly
investors (owners) and creditors. LO 2 Explain certain accounting principles that are important for an understanding
of financial statements and how professional judgment by accountants may affect
the application of those principles. Accountants prepare financial statements by applying a set of standards or
rules referred to as generally accepted accounting principles. Consistent application
of these standards permits comparisons between companies and between years of
a single company. Generally accepted accounting principles allow for significant
latitude in how certain transactions should be accounted for, meaning that professional
judgment is particularly important. LO 3 Demonstrate how certain business transactions affect the elements of the accounting
equation: Assets = Liabilities+ Owner's Equity. Business transactions result in changes in the three elements of the basic
accounting equation. A transaction that increases total assets must also increase
total liabilities and owner's equity. Similarly, a transaction that decreases
total assets must simultaneously decrease total liabilities and owner's equity.
Some transactions increase one asset and reduce another. Regardless of the nature
of the specific transaction, the accounting equation must stay in balance at
all times. LO 4 Explain that the statement of financial position, often referred to as the
balance sheet, is an expansion of the basic accounting equation. The statement of financial position, or balance sheet, presents in great detail
the elements of the basic accounting equation. Various types of assets are listed
and totaled. The enterprise's liabilities are listed, totaled, and added to
the owner's equity. The balancing feature of this financial statement is one
of its dominant characteristics because the statement is simply an expansion
of the basic accounting equation. LO 5 Explain that the income statement reports an enterprise's financial performance
for a period of time in terms of the relationship of revenues and expenses. Revenues are created as the enterprise provides goods and services for its
customers. Many expenses are required to be able to provide those goods and
services. The difference between the revenues and expenses is net income or
net loss. LO 6 Explain that the statement of cash flows presents the change in cash for a
period of time in terms of the company's operating, investing, and financing
activities. Cash is one of the most important assets, and the statement of cash flows shows
in detail how the enterprise's cash balance changed between the beginning and
ending of the accounting period. Operating activities relate to ongoing revenue
and sales transactions. Investing activities relate to the purchase and sale
of various types of assets (for example, land, buildings, and equipment). Financing
activities describe where the enterprise has received its permanent debt and
equity financing. The statement of cash flows combines information about all
of these activities into a concise statement of changes in cash that reconciles
the beginning and ending cash balances. LO 7 Explain important relationships among the statement of financial position,
income statement, and statement of cash flows, and how these statements articulate. The three primary financial statements are based on the same underlying transactions.
They are not alternatives to each other, but rather represent three different
ways of looking at the financial activities of the reporting enterprise. Because
they are based on the same transactions, they relate, or "articulate,"
very closely with each other. LO 8 Explain common forms of business ownership - sole proprietorship, partnership,
and corporation - and demonstrate how they differ in terms of their presentation
in the statement of financial position. Owner's equity is one of three major elements in the basic accounting equation.
Regardless of the form of organization, owner's equity represents the interest
of the owner(s) in the assets of the reporting enterprise. For a sole proprietorship,
owner's equity consists only of the interest of a single owner. For a partnership,
the ownership interests of all partners are added together to determine the
total owners' equity of the enterprise. For a corporation, which usually has
many owners, the total contribution to the enterprise represents its owners'
equity. In all cases, the enterprise's net income is added to owner's equity. LO 9 Discuss and illustrate the importance of nonfinancial information to supplement
the information in the primary financial statements. All important aspects of an enterprise's activities usually cannot be captured
in financial terms. Financial statements typically are accompanied by notes
that provide qualitative information that supplements and helps interpret the
financial information included in the body of the financial statements. LO 10 Discuss the importance of financial statements to a company and its investors
and creditors and why management may take steps to improve the appearance of
the company in its financial statements. Financial statements are particularly important for investors and creditors
in their attempts to evaluate future cash flows from the enterprise to them.
Management is interested in the enterprise looking as positive as possible in
its financial statements and may take certain steps to improve the overall appearance
of the enterprise. A fine line, however, exists between the steps management
can take and the steps that are unethical, or even illegal. Throughout this text we emphasize how accounting information is the basis for
business decisions. In this chapter you were introduced to business transactions
and how they lead to the preparation of three basic financial statements: statement
of financial position (balance sheet), income statement, and statement of cash
flows. These statements constitute one of the primary products of the accountant's
work, and they provide investors, creditors, and other parties with pertinent
information that is useful for decision making. As you continue your study of financial accounting in Chapter 3, you will learn
how business transactions are actually recorded, how they move through an accounting
system, and how they eventually lead to the preparation of financial statements. | 
2002 McGraw-Hill Higher Education