Chapter 2

©© Kimberly Lyons Kimberly Lyons 11

Chapter 2Chapter 2Financial StatementsFinancial Statements

© Kimberly Lyons© Kimberly Lyons 22September 2008September 2008

Primary Financial StatementsPrimary Financial Statements

Balance Sheet: statement of financial Balance Sheet: statement of financial positionposition

Income Statement: the statement of Income Statement: the statement of earnings earnings

Statement of Cash FlowsStatement of Cash FlowsStatement of Retained EarningsStatement of Retained Earnings


Balance SheetBalance Sheet

The statement of financial position The statement of financial position reports on the company’s resources reports on the company’s resources (assets) and claims to resources (assets) and claims to resources (liabilities and equity) at the end of (liabilities and equity) at the end of the accounting periodthe accounting period

Assets = Liabilities + Owner’s EquityAssets = Liabilities + Owner’s Equity


Assets: resources owned or Assets: resources owned or controlled by a business that controlled by a business that bring current or future benefitbring current or future benefit

In order of In order of decreasing liquiditydecreasing liquidity

Cash & equivalentsCash & equivalents Accounts receivableAccounts receivable ““Other” receivablesOther” receivables SuppliesSupplies

PrepaidsPrepaids InventoryInventory InvestmentsInvestments Property, plant, Property, plant,

EquipEquip Natural resourcesNatural resources IntangiblesIntangibles


Liabilities: current and future Liabilities: current and future obligations to lenders and obligations to lenders and

creditorscreditorsAccounts payableAccounts payableAccrued liabilitiesAccrued liabilitiesUnearned revenuesUnearned revenuesNotes payable (IOU’s)Notes payable (IOU’s)Lease LiabilitiesLease LiabilitiesMortgages payableMortgages payableBonds payableBonds payable


Owner’s EquityOwner’s Equity

Owner’s claims to resources (net assets Owner’s claims to resources (net assets or residual) includes two components:or residual) includes two components:

Contributed Capital: investment by owners Contributed Capital: investment by owners in exchange for ownership interestin exchange for ownership interest

Retained Earnings: accumulated earnings Retained Earnings: accumulated earnings that have not been paid back to that have not been paid back to shareholders in the form of dividendsshareholders in the form of dividends


Classified Balance SheetClassified Balance Sheet

Assets and liabilities categorized as Assets and liabilities categorized as current or long-termcurrent or long-term

Current: converted to cash, sold, used or Current: converted to cash, sold, used or expired within one year or the operating expired within one year or the operating cycle, whichever is longercycle, whichever is longer

Includes: cash and equivalents, accounts Includes: cash and equivalents, accounts receivable, ST notes receivable, supplies, receivable, ST notes receivable, supplies, prepaids, inventories, etc.prepaids, inventories, etc.


Classified Balance SheetClassified Balance SheetContinuedContinued

Long term assetsLong term assetsProperty, plant, and equipmentProperty, plant, and equipmentLong-term investmentsLong-term investmentsNatural resourcesNatural resourcesIntangiblesIntangibles


Income StatementIncome Statement

Reports on the results of operations Reports on the results of operations for the entire accounting periodfor the entire accounting period

Measures profitabilityMeasures profitability

++ RevenuesRevenues- - ExpensesExpenses

+/- Gains/Losses+/- Gains/Losses= = Net incomeNet income


RevenuesRevenues

IncreasesIncreases in resources that result in resources that result from sales of goods and services as from sales of goods and services as well as other business operationswell as other business operationsSales revenueSales revenueCommissionsCommissionsFee incomeFee incomeRental incomeRental incomeInterest and dividend incomeInterest and dividend income


ExpensesExpenses

Resources Resources usedused to generate revenues to generate revenues

Cost of goods soldCost of goods soldWages expenseWages expenseUtilities expenseUtilities expenseRent expenseRent expenseInterest expenseInterest expenseIncome tax expenseIncome tax expense


Gains and LossesGains and Losses

Gains and losses result from peripheral Gains and losses result from peripheral transactions: sales of long-term assets at transactions: sales of long-term assets at greater (less than) their net book valuegreater (less than) their net book value

These transactions are outside of a These transactions are outside of a company’s normal, day-to-day operationscompany’s normal, day-to-day operations

Recovering more than book value = gainsRecovering more than book value = gainsFailure to recover book value = lossesFailure to recover book value = losses


Earnings Per ShareEarnings Per Share

Net Income Net Income

Common Shares OutstandingCommon Shares Outstanding

Provides each shareholder Provides each shareholder information on their respective information on their respective increase (decrease) in claims to increase (decrease) in claims to equity as a result of operations for equity as a result of operations for the yearthe year


Multi-step Income StatementMulti-step Income Statement

Sales revenueSales revenue- Cost of goods soldCost of goods sold

==Gross marginGross margin- Operating expensesOperating expenses

= Operating income= Operating income

+/- “Other” (non-operating) +/- “Other” (non-operating)

revenues, expenses, gains, & lossesrevenues, expenses, gains, & losses

= Income before tax= Income before tax- Income tax expenseIncome tax expense

= Net income= Net income

Earnings Per ShareEarnings Per Share


Statement of Retained Statement of Retained EarningsEarnings

Reports on changes to retained Reports on changes to retained earnings for the entire periodearnings for the entire period

Retained Earnings Retained Earnings 1/1/20081/1/2008

+ + Net Income 2008Net Income 2008

-- Dividends 2008Dividends 2008

= = Retained Earnings Retained Earnings 12/31/200812/31/2008


DividendsDividends

Return of capital to the shareholders Return of capital to the shareholders Paid out of retained earningsPaid out of retained earningsPaid as a return in exchange for riskPaid as a return in exchange for riskNot to be confused with expensesNot to be confused with expensesNot deductible on the income Not deductible on the income

statementstatement


Statement of Cash FlowsStatement of Cash Flows

Reports on changes in cash for the Reports on changes in cash for the entire periodentire period

Sources and uses of cash are Sources and uses of cash are categorized by functional categorycategorized by functional categoryOperating activities – day-to-day Operating activities – day-to-day

operations of the business (cash earnings)operations of the business (cash earnings)Investing activities – purchases and sales Investing activities – purchases and sales

of long-term assetsof long-term assetsFinancing activities – Borrowing and Financing activities – Borrowing and

repayments to lenders and ownersrepayments to lenders and owners


ArticulationArticulation

How a change in one financial How a change in one financial statement explains the change in statement explains the change in othersothers

IncomeIncome Retained Retained Balance Balance

StatementStatement Earnings Earnings Sheet SheetAssets=

Liabilities +

Owner’s Equity

Ret. Earn. 1/1+ Net Income- DividendsRet. Earn. 12/31

Revenues- Expenses= Net Income


Notes to the Financial Notes to the Financial StatementsStatements

Summary of significant accounting Summary of significant accounting policiespolicies

Assumptions, estimates, and judgmentsAssumptions, estimates, and judgments Information about summary totalsInformation about summary totals

Details of specific account balancesDetails of specific account balancesDisclosure of contingencies and Disclosure of contingencies and

uncertaintiesuncertaintiesPending lawsuitsPending lawsuits

Supplementary informationSupplementary informationSegment and quarterly disclosuresSegment and quarterly disclosures


Concepts & AssumptionsConcepts & Assumptions

Separate entitySeparate entityAssumption of arm’s lengthAssumption of arm’s lengthCost principleCost principleMonetary measurement conceptMonetary measurement conceptGoing concern assumptionGoing concern assumption


Audit ReportAudit Report

Issued by the Certified Public Issued by the Certified Public Accountant (CPA)Accountant (CPA)

Independence is keyIndependence is keyFinancial statements present “fairly, Financial statements present “fairly,

in all material respects, the financial in all material respects, the financial position, results of operations, and position, results of operations, and cash flows, for the years ended . . . in cash flows, for the years ended . . . in accordance with U.S. generally accordance with U.S. generally accepted accounting principles”accepted accounting principles”


Exam ReviewExam Review

What are the components of each of What are the components of each of the following financial statements?the following financial statements?Income statementIncome statementBalance sheetBalance sheetStatement of retained earningsStatement of retained earningsStatement of cash flowsStatement of cash flows

Define “articulation” in terms of the Define “articulation” in terms of the above financial statementsabove financial statements


Exam ReviewExam ReviewContinuedContinued

Define each of the following:Define each of the following:AssetsAssets RevenuesRevenues

LiabilitiesLiabilities ExpensesExpenses

Owner’s equityOwner’s equity DividendsDividendsWhat are the two components of What are the two components of

owner’s equity?owner’s equity?Explain the difference between net Explain the difference between net

income (earnings) and retained income (earnings) and retained earnings.earnings.



What information does a balance What information does a balance sheet provide?sheet provide?

What information does an income What information does an income statement provide?statement provide?

Specifically, how do the two differ?Specifically, how do the two differ?Why do we need a statement of cash Why do we need a statement of cash

flows when we have balance sheets flows when we have balance sheets and income statements?and income statements?



What information does a classified What information does a classified balance sheet provide that an balance sheet provide that an unclassified balance sheet does not?unclassified balance sheet does not?

What makes comparative financial What makes comparative financial statements more useful than those statements more useful than those not presented in comparative not presented in comparative format?format?

Chapter 2

Documents

net income earnings

income statement reports

operating income

net income dividends

dividend income

earnings reports

business cash earnings

expense income tax expense