Overview of the Financial Statements Chapter 2 Overview of the Financial Statements

The Need for Financial Statements

Financial Disclosure Benefits Enhances decision-making Reduces risk Reduces risk lowers cost Financial Accounting, 7e Stice/Stice, 2006 © Thomson

Three Primary Financial Statements Balance Sheet Income Statement Statement of Cash Flows Financial Accounting, 7e Stice/Stice, 2006 © Thomson

The Balance Sheet

The Balance Sheet Financial Accounting, 7e Stice/Stice, 2006 © Thomson

The Balance Sheet Presents the financial position of a company at a particular point in time. Three categories: Assets Liabilities Owners’ Equity Financial Accounting, 7e Stice/Stice, 2006 © Thomson

Assets Probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events. likely to occur Financial Accounting, 7e Stice/Stice, 2006 © Thomson

Assets Probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events. assets have implications for the future Financial Accounting, 7e Stice/Stice, 2006 © Thomson

Assets Probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events. substance rules over legal form Financial Accounting, 7e Stice/Stice, 2006 © Thomson

Assets Probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events. Financial Accounting, 7e Stice/Stice, 2006 © Thomson

Liabilities Probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events. includes legal and implied commitments Financial Accounting, 7e Stice/Stice, 2006 © Thomson

Liabilities Probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events. the obligation can involve either type of future event Financial Accounting, 7e Stice/Stice, 2006 © Thomson

Liabilities Probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events. have already happened Financial Accounting, 7e Stice/Stice, 2006 © Thomson

Liabilities Probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events. Financial Accounting, 7e Stice/Stice, 2006 © Thomson

Owners’ Equity The residual interest in the assets of an entity that remains after deducting liabilities Also known as net assets Creditors legally have first claim to assets The owners’ equity of a corporation is referred to as stockholders’ equity Financial Accounting, 7e Stice/Stice, 2006 © Thomson

Owners’ Equity Factors Impacting the Amount of Owners’ Equity DECREASE Owners’ Equity INCREASE Owners’ Equity Owners Withdraw Assets Company Suffers a Loss Owners Invest Assets Company Generates a Profit Financial Accounting, 7e Stice/Stice, 2006 © Thomson

Owners’ Equity: Two Primary Components Paid-in Capital The value of assets contributed by investors in exchange for shares of stock Retained Earnings The cumulative earnings of the company not paid to owners as dividends Financial Accounting, 7e Stice/Stice, 2006 © Thomson

Owners’ Equity: Two Additional Components Treasury Stock Repurchased shares of the company’s stock Accumulated Other Comprehensive Income Increases and decreases to equity due to changes in the market prices of investments changes in exchange rates Financial Accounting, 7e Stice/Stice, 2006 © Thomson

The Balance Sheet Format A classified balance sheet distinguishes between current and noncurrent categories for assets and liabilities Current assets are more liquid than other assets Current liabilities are repaid usually within one year Financial Accounting, 7e Stice/Stice, 2006 © Thomson

The Accounting Equation The balance sheet is a detailed version of the accounting equation ASSETS = LIABILITIES + STOCKHOLDERS’ EQUITY Financial Accounting, 7e Stice/Stice, 2006 © Thomson

Balance Sheet Concepts and Conventions The entity concept requires that the records of the business must be kept separate from the personal finances of the owner. Under the historical cost convention, assets and liabilities are recorded at their original costs and are not adjusted for changes in value. Financial Accounting, 7e Stice/Stice, 2006 © Thomson

Balance Sheet Concepts and Conventions The going concern assumption presumes that the business will continue for the foreseeable future Financial Accounting, 7e Stice/Stice, 2006 © Thomson

The Income Statement

The Income Statement Financial Accounting, 7e Stice/Stice, 2006 © Thomson

The Income Statement Describes a company’s financial performance for a specified period of time Reports Revenues Expenses Net Income Financial Accounting, 7e Stice/Stice, 2006 © Thomson

Elements of the Income Statement Revenue is the amount of assets created through the performance of business operations Retailers generate revenue by selling goods Service businesses generate revenue by providing a valuable service Financial Accounting, 7e Stice/Stice, 2006 © Thomson

Elements of the Income Statement Expenses are the amount of assets consumed from the performance of business operations Gains and losses refer to money made or lost on activities outside the normal business operations Net income (loss) is the difference between revenues and expenses Financial Accounting, 7e Stice/Stice, 2006 © Thomson

Elements of the Income Statement Earnings per share represents how much income belongs to the owner of one share of stock Financial Accounting, 7e Stice/Stice, 2006 © Thomson

Income Statement Concepts and Conventions Time Period The life of a business is divided into time periods to measure performance Revenue recognition occurs when The goods have been delivered or the service has been provided and Cash has been collected or collection is reasonably assured Financial Accounting, 7e Stice/Stice, 2006 © Thomson

The Statement of Cash Flows

The Statement of Cash Flows Describes a company’s cash flows for a specified period of time Financial Accounting, 7e Stice/Stice, 2006 © Thomson

The Statement of Cash Flows Classifies individual cash flows according to three main activities: Operating activities Investing activities Financing activities Financial Accounting, 7e Stice/Stice, 2006 © Thomson

Producing and Selling Goods and Services Day-to-Day Activities Operating Activities Producing and Selling Goods and Services Day-to-Day Activities Inflows/Receipts: Selling products Providing services Outflows/Payments: Inventory Wages Utilities Rent Interest Taxes, etc. Financial Accounting, 7e Stice/Stice, 2006 © Thomson

Buying and Selling Long-Term Assets Investing Activities Buying and Selling Long-Term Assets Inflows/Sale of: Land Buildings Equipment Stocks of other companies Outflows/Purchase of: Land Buildings Equipment Stocks of other companies Financial Accounting, 7e Stice/Stice, 2006 © Thomson

Cash to/from Creditors and Investors Financing Activities Cash to/from Creditors and Investors Inflows/Receipts: Sell stock shares Loan proceeds Outflows/Payments: Repay loans Acquire treasury stock Pay cash dividends Financial Accounting, 7e Stice/Stice, 2006 © Thomson

Cash Flow Process Raw Cash Flow Data Accounting Adjustments Net Income Undo Accounting Adjustments Statement of Cash Flows Financial Accounting, 7e Stice/Stice, 2006 © Thomson

Notes to the Financial Statements

Four Types of Notes A summary of significant accounting policies Additional information about the summary totals found in the statements Disclosure of important information not recognized in the statements Supplementary information required by the FASB or the SEC Financial Accounting, 7e Stice/Stice, 2006 © Thomson

The External Audit

The External Audit Provides an independent outside opinion from a CPA firm that The statements are prepared in accordance with GAAP The audit was conducted using generally accepted auditing standards Not a guarantee! The SEC requires all publicly traded companies to provide potential investors with audited financial statements Financial Accounting, 7e Stice/Stice, 2006 © Thomson

Other Concepts and Conventions

Other Concepts and Conventions Relevance and reliability are the two primary qualities that make information useful Relevant information must be timely, useful for evaluating past decisions, and useful for evaluating future decisions Reliable information must be reliable, unbiased, and represent the economic conditions that it purports to represent Financial Accounting, 7e Stice/Stice, 2006 © Thomson

Other Concepts and Conventions Comparability Information is more useful when it can be compared to that of other companies or to that of the same company over time Consistency Financial statements should be prepared using the same accounting methods consistently to be comparable Financial Accounting, 7e Stice/Stice, 2006 © Thomson

Other Concepts and Conventions Conservatism When in doubt, recognize all losses but do not anticipate gains Materiality An item is material if misstatement of that item could impact a decision Materiality is largely a matter of professional judgement Financial Accounting, 7e Stice/Stice, 2006 © Thomson

Other Concepts and Conventions Articulation The three primary financial statements are an integrated set of reports on a company’s financial health For example, net income (income statement) increases retained earnings (balance sheet) in order for net assets to equal stockholders’ equity Financial Accounting, 7e Stice/Stice, 2006 © Thomson

Articulation Accrual Adjustments $ $ Net Income - Dividends

In Summary ... Financial information reduces uncertainty for creditors and investors The balance sheet reports assets, liabilities, and equity The income statement reports revenues and expenses The statement of cash flows reports changes in cash Notes to financial statements provide important detail and supplemental explanations Audits do not provide guarantees Financial Accounting, 7e Stice/Stice, 2006 © Thomson