BUS103: Introduction to Financial Accounting

The primary purpose of financial reporting is to provide information to investors and creditors. Investors use financial information in purchasing and selling of stocks, while creditors (such as banks) use financial information in reviewing the credit-worthiness of companies wishing to obtain loans. In making these types of decisions, investors and creditors rely on financial analysts to give them accurate assessments of the value and strength of the company. The role of the financial analysts is to take the financial information reported by a company and translate that into a rating of company performance. It should therefore be no surprise that a successful financial analyst is one that has a deep understanding of financial accounting. Who better to analyze the financial statements than the person who prepared them? Who would have a better understanding of the data and information contained in financial statements than the accountant? Financial statements are becoming ever more complex and difficult to interpret by users. Thus, accountants are becoming increasingly important in assisting others to understand and interpret financial information.

Helping users understand financial information involves such tasks as developing graphs, common-size statements, and performing horizontal and vertical analysis. Analysis could also involve performing data comparisons with relevant financial and nonfinancial data. The Altman Z Model is an example of a tool used by analysts to predict bankruptcy. The model includes such items as retained earnings/total assets and sales/total assets as variables in the calculation. Based upon this test, Cooper Tire & Rubber Company earned a score of 6.07 in a recent year. A score below 2.675 was considered an indication of possible bankruptcy. Therefore, analysts evaluated Cooper as a very healthy company not likely to go bankrupt.

Financial analysts make numerous judgments about the financial condition of companies, as in the example above. These services are essential to the decisions of investors and creditors. Thus, financial analysts with a strong accounting background are well compensated for their efforts.

As owners of a corporation, stockholders provide much of the capital for its activities. On the balance sheet, we show the stockholders' capital investment in the corporation as paid-in capital under stockholders' equity. Also included in stockholders' equity is the capital accumulated through the retention of corporate earnings (retained earnings). Paid-in capital is a relatively permanent portion of stockholders' equity; the retained earnings balance is a relatively temporary portion of corporate capital and is the source of stockholders' dividends.

The preceding chapter discussed the paid-in capital obtained by issuing shares of stock for cash, property, or services. This chapter describes additional sources of paid-in capital and items affecting retained earnings.