1. Introduction to Financial Statement

2. Form of Financial Statement
Accounting Equation
The Balance Sheet
The Income Statement
The Cash Flow Statement
The statement of Stockholders’ Equity
Statement of Retain Earnings
Foot notes and supplement information to financial statement

3. Assets = Liabilities + Equity
Balance Sheet
Mirrors the Accounting Equation
Assets = Liabilities + Equity
Uses of funds = Sources of funds
Assets are listed in order of liquidity
Liabilities are listed in order of maturity
Equity consists of Contributed Capital and
Retained Earnings

4. Assets To be reported on a balance sheet, an asset must
Be owned or controlled by the company
Generally, this means owning title to the asset
Leased assets are recorded under certain circumstances
Must possess expected future benefits
Generally this means cash inflow
Future benefits may mean the receipt of another asset or the reduction of a liability
When the receipt of future benefits is in doubt, the asset may become “impaired” and written down of off entirely

5. Assets are Reported in Order of Liquidity
Liquidity refers to the ease of converting a noncash asset to cash.
Asset portion of the balance sheet is divided into Current and Noncurrent Assets
Current assets comprise assets that can be converted to cash within a year
Noncurrent assets (long-term assets) cannot be easily converted to cash within a year.

6. Assets are Reported at Historical Cost
Historical Cost is
Objective
Verifiable
Therefore, not subject to bias
However, historical cost is not particularly “relevant” to most readers of the balance sheet
“Relevance vs. Reliability” is an important issue with accountants.

7. Liabilities Liabilities are listed in order of maturity
Current Liabilities come due in less than a year.
Noncurrent liabilities come due after a year.
Companies desire more current assets than current liabilities – this difference is called net working capital

8. Net Working Capital

9. Tactics Used to Reduce Operating Cycles
Increase trade credit to minimize the cash invested in inventories
Reduce inventory levels by improved production systems and management
Decrease accounts receivable by better collection procedures

10. Equity Equity consists of:
Contributed Capital (cash raised from the issuance of shares)
Earned Capital (retained earnings). Retained Earnings is updated each period as follows:

11. Market Value vs. Book Value
Stockholders’ equity = Company book value
Book value is determined using GAAP.
Book value is not the same as Market Value.
Market Value = # of Shares x Price per share
On average, the book value is roughly two-thirds of market value.

12. Income Statement

13. Income Statement
Revenues are increases in net assets as a result of business activities.
Expenses are the outflow or use of assets to generate revenues, including costs of products and services sold, operating costs like wages and advertising, and nonoperating costs like interest on debt.

14. Operating vs. Nonoperating
Operating expenses are the usual and customary costs that a company incurs to support its main business activities
Nonoperating expenses relate to the company’s financing and investing activities

15. Accrual Accounting
Accrual accounting refers to the recognition of revenue when earned (even if not received in cash) and the matching of expenses when incurred (even if not paid in cash).

16. Accrual Accounting Accrual accounting rests on two guiding principles:
Revenue Recognition Principle – record revenue when
Earned
Realized or Realizable
Matching Principle – record expenses when
Incurred
Neither the recognition of revenue nor the recording of expense necessarily involves the receipt or payment of cash

17. Accrual Example Assume the following:
Purchase of $100 of inventory on account
Sale of all of the inventory for $150 on account
Employees earn $20 of wages to be paid next period

18. Transitory vs. Core
Transitory items are one-time events (e.g., not likely to recur)
Core items are likely to recur (persist) and are, therefore, more relevant for company valuation

19. Transitory Items
Discontinued operations: net income or loss from business segments that are up for sale or sold in the current period
Extraordinary items: revenue and expenses that are both unusual and infrequent
Changes in accounting principles: cumulative income or loss from changes in accounting methods (may be reflected in income from continuing operations in the future)

20. Transitory Items
Income from Continuing Operations may still contain transitory items:
Gains (losses) on asset sales
Restructuring expenses
Asset write-downs
Accruals

21. Statement of Stockholders’ Equity
Statement of Equity is a reconciliation of the beginning and ending balances of stockholders’ equity accounts.
Main equity categories are:
Contributed capital
Retained earnings (including Other Comprehensive Income or OCI)
Treasury stock

22. Statement of Cash Flows
Statement of cash flows (SCF) reports cash inflows and outflows
Cash flows are reported based on the three business activities of a company:
Operating activities: transactions related to the operations of the business.
Investing activities: acquisitions and divestitures of long-term assets
Financing activities: issuances and payments toward equity, borrowings, and long-term liabilities.