1. Overview of the Financial Statements
Chapter 2
Overview of the Financial Statements

2. The Need for Financial Statements

3. Financial Disclosure Benefits
Enhances decision-making
Reduces risk
Reduces risk lowers cost
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4. Three Primary Financial Statements
Balance Sheet
Income Statement
Statement of Cash Flows
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5. The Balance Sheet

6. The Balance Sheet
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7. The Balance Sheet
Presents the financial position of a company at a particular point in time.
Three categories:
Assets
Liabilities
Owners’ Equity
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8. Assets
Probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events.
likely to occur
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9. 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
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10. 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
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11. Assets
Probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events.
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12. 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
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13. 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
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14. 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
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15. 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.
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16. 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
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17. 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
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18. 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
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19. 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
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20. 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
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21. The Accounting Equation
The balance sheet is a detailed version of the accounting equation
ASSETS = LIABILITIES + STOCKHOLDERS’ EQUITY
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22. 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.
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23. Balance Sheet Concepts and Conventions
The going concern assumption presumes that the business will continue for the foreseeable future
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24. The Income Statement

25. The Income Statement
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26. The Income Statement
Describes a company’s financial performance for a specified period of time
Reports
Revenues
Expenses
Net Income
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27. 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
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28. 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
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29. Elements of the Income Statement
Earnings per share represents how much income belongs to the owner of one share of stock
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30. 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
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31. The Statement of Cash Flows

32. The Statement of Cash Flows
Describes a company’s cash flows for a specified period of time
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33. The Statement of Cash Flows
Classifies individual cash flows according to three main activities:
Operating activities
Investing activities
Financing activities
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34. 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.
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35. 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
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36. 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
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37. Cash Flow Process Raw Cash Flow Data Accounting Adjustments Net Income
Undo Accounting Adjustments
Statement of Cash Flows
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38. Notes to the Financial Statements

39. 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
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40. The External Audit

41. 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
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42. Other Concepts and Conventions

43. 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
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44. 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
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45. 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
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46. 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
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47. Articulation
Accrual Adjustments $ $
Net Income - Dividends

48. 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
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