Transcript Introduction to Financial Statement

Introduction to Financial
Statement
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
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

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
Assets are Reported
in Order of Liquidity
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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
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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.
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.
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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
Net Working Capital
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
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:
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.
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Income Statement
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.

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
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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).
Accrual Accounting
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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
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
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
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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)
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Transitory Items
Income from Continuing Operations
may still contain transitory items:
◦ Gains (losses) on asset sales
◦ Restructuring expenses
 Asset write-downs
 Accruals
Statement of Stockholders’ Equity
Statement of Equity is a
reconciliation of the beginning and
ending balances of stockholders’
equity accounts.
 Main equity categories are:
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◦ Contributed capital
◦ Retained earnings (including Other
Comprehensive Income or OCI)
◦ Treasury stock
Statement of Cash Flows
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Statement of cash flows (SCF) reports
cash inflows and outflows
Cash flows are reported based on the
three business activities of a company:
1. Operating activities: transactions related to
the operations of the business.
2. Investing activities: acquisitions and
divestitures of long-term assets
3. Financing activities: issuances and payments
toward equity, borrowings, and long-term
liabilities.