2Preparing Financial Statements Publicly owned companies – those with shares listed on a stock exchange – have obligations to release annual and quarterly information to their stockholders and to the public.The annual report includes comparative financial statements and other information relating to the company’s financial position, business operations, and future prospects.The financial statements contained in the annual report must be audited by a firm of certified public accountants (CPAs).Publicly owned companies – those with shares listed on a stock exchange – have obligations to release annual and quarterly information to their stockholders and to the public. These companies don’t simply prepare financial statements – they publish annual reports.An annual report includes comparative financial statements for several years and a wealth of other information about the company’s financial position, business operations, and future prospects. Before the annual report is issued, the financial statements must be audited by a firm of certified public accounts (CPAs). Publicly owned companies must file their audited financial statements and detailed supporting schedules with the Securities and Exchange Commission.
3The Statement of Retained Earnings Summarizes the increases and decreases in Retained Earnings during the period.Business EarningsDividendsBusiness LossesRemember that net income increases retained earnings. Dividends and net losses decrease retained earnings for the period.
4Drafting the Notes that Accompany Financial Statements Examples of Items DisclosedLawsuits pendingScheduled plant closingsGovernmental investigationsSignificant events occurringafter the balance sheet dateSpecific customers thataccount for a large portion ofrevenueUnusual transactions andrelated party transactionsNotes to theFinancial StatementsIn addition to the basic financial statements, accountants must prepare notes to the financial statements. The purpose of the notes is to explain certain items or transactions to the reader. There is no comprehensive list of all information that should be disclosed in financial statements. The adequacy of disclosure is based on a combination of official rules, tradition, and accountants’ professional judgment. Two items always disclosed in the notes to financial statements are the accounting methods in use and the due dates of major liabilities. So, for example, JJ’s Lawn Care would disclose that straight-line depreciation was used to determine depreciation expense. The notes also explain any unusual or infrequent items that may be of interest to the reader. Almost all major corporations have a note disclosure about pending litigation.
5Closing the Temporary Accounts The closing process gets the temporary accounts ready for the next accounting period.Close Revenue accounts to Income Summary.Close Expense accounts to Income Summary.Close Income Summary account to Retained Earnings.Close Dividends to Retained Earnings.Once the financial statements have been prepared, the books are closed and it’s time to get ready for the next accounting period. Net income is earned over a period of time. At the start of a new period we want all revenue and expense accounts to have a zero balance so we can start recording income in this period. The closing of a company’s books is a four step process. Step one is to close all revenue accounts to a temporary account called Income Summary. Step two is to close all expense accounts to the Income Summary account. At this point, net income is isolated in the Income Summary. Step three is to then close Income Summary to Retained Earnings. Net income transfers from Income Summary to Retained Earnings and zeros out Income Summary. The Income Summary account never appears in the financial statements. The forth and final step is to close Dividends to Retained earnings. Net income is added to Retained Earnings and Dividends is subtracted from Retained Earnings. This updates Retained Earnings.
6Evaluating the Business Evaluating ProfitabilityEvaluating LiquidityMeasures of profitability help users of financial information assess current profitability of a company and future potential for increased profits. Profitability measures help answer questions like “Did the business earn a profit or loss in the current period?” and “What is the business’s future potential for a profit?”Two common measures of profitability include the company’s net income percent, and its return on equity. When a ratio is calculated that has an income measure in the numerator and balance sheet measures in the denominator, an average must be used for the denominator. For the return on equity, add together the beginning balance in stockholders’ equity and the ending balance, then divide by two. Measures of liquidity help users assess the ability of the company to pay its debts when they fall due. Liquidity measures help answer a question like “Does the business have assets available to pay debts as they become due?” Almost all companies calculate working capital and current ratio. Working capital is current assets less current liabilities. The current ratio is current assets divided by current liabilities.Net Income PercentageNet Income Total Revenue=Return on EquityNet Income Avg. Stockholders’ EquityCurrent RatioCurrent Assets Current Liabilities=Working CapitalCurrent Assets – Current Liabilities
7Preparing Financial Statements Covering Different Periods of Time Many companies prepare financial statements at various points throughout the year.AnnuallyQuarterlyInterim Financial StatementsAlmost all companies prepare annual and interim financial statements. An annual financial statement covers one year of operations. The year does not have to be a calendar year. Interim financial statements are usually prepared monthly and quarterly. Most large corporations publish quarterly reports for their shareholders.MonthlyDec. 31Jan. 1
8Ethics, Fraud, and Corporate Governance A company should disclose any facts that an intelligent person would consider necessary for the statements to be interpreted properly.Public companies are required to file annual reports with the Securities and Exchange Commission (SEC). The SEC requires that companies include a section labeled “Management Discussion and Analysis” (MD&A) because the financial statements and related notes may be inadequate for assessing the quantity and sustainability of a company’s earnings.A company should disclose any facts that an intelligent person would consider necessary for the statements to be interpreted properly.Public companies are required to file annual reports with the Securities and Exchange Commission (SEC). The SEC requires that companies include a section labeled “Management Discussion and Analysis” (MD&A) because the financial statements and related notes may be inadequate for assessing the quantity and sustainability of a company’s earnings.
9Supplemental Topic: The Worksheet A worksheet illustrates in one place the relationships among the unadjusted trial balance, proposed adjusting entries, and financial statements. A worksheet is prepared at the end of the period, but before the adjusting entries are formally recorded in the accounting records.On this slide we illustrated an abbreviated version of a worksheet. The dotted lines indicate that some accounts are not listed for illustrative purposes. To complete a worksheet follow these 5 steps.Enter the ledger account balances in the Trial Balance columns.Enter the adjustments in the Adjustments columns.Prepare an adjusted trial balance.Extend the adjusted trial balance amounts into the appropriate financial statement columns.Total the financial statement columns and determine and record net income or net loss.