Transcript Core Concepts in Accounting II

Overview of Corporate
Financial Statements
Or . . . What are all those
numbers anyway?
Required Financial Statements

Financial Position at the end of the
period;

Earnings for the period;

Cash flows during the period; and

Investments by and distributions to
owners during the period.
The Accounting Equation
Assets
=
Resources owned by the firm with the
potential to provide future economic
benefits, as a result of past transactions
or events.
The Accounting Equation
Assets
=
Liabilities
Creditors’ fixed claims on the assets
resulting from past transactions and
representing probable future sacrifices of
economic benefits (resources).
The Accounting Equation
Assets
=
Liabilities
+
Owners’
Equity
Owners’ residual interest after all
liabilities have
been settled.
The Accounting Equation
Assets
=
Liabilities
Capital
Stock
Invested
Capital
+
Owners’
Equity
Retained
Earnings
Earned Capital
The Accounting Equation
Assets
Revenue =
=
Liabilities
Capital
Stock
The Value of goods and/or
services
provided to
customers.
+
Owners’
Equity
Retained
Earnings
Revenue
The Accounting Equation
Assets
Expense =
=
Liabilities
+
Owners’
Equity
Capital
Stock
Retained
Earnings
The Cost of goods and/or
services provided to customers.
Revenue
-
Expenses
The Accounting Equation
Assets
=
Liabilities
+
Owners’
Equity
Capital
Stock
Retained
Earnings
Net Income =
Net Value added to the firm
Revenue
=
-
Expenses
Net
Income
The Financial Statements
Financial Statements

We will illustrate the “set” of financial
statements by examining Sourdough
Alaska, Inc. 2001 and 2002 financial
statements.

Sourdough Alaska is a fictitious company
but it will provide us with an opportunity to
examine the individual statements.
The Balance Sheet
AKA: Statement of Financial
Position . . .
The Balance Sheet . . .
A Balance sheet lists a firm’s
assets,
liabilities, and
owners’ equity
at a given point in time. That is, it is a
snapshot of the financial position of a
firm at a specific point in time.
Sourdough Alaska, Inc.
Balance Sheet
2002
2001
Increase/Decrease
Amount Percent
ASSETS
Current Assets
Cash
Accounts Rec. Net
Inventory
Prepaid Expenses
Total Current Assets
$1,200 $2,600 ($1,400) (53.8%)
7,000
4,000
3,000
75.0%
8,000
9,750 ($1,750) (17.9%)
450
150
300 200.0%
$16,650 $16,500
$150
0.9%
Property and Equipment
Land
Buildings, Net
Equipment, Net
Total Prop. & Equip.
TOTAL ASSETS
6,500
6,000
3,000
15,500
$32,150
6,500
6,000
1,500
14,000
$30,500
00
0
1,500
1,500
$1,650
0.0%
0.0%
100.0%
10.7%
5.4%
LIABILITIES
2002
Current Liabilities
Accounts Payable
$6,250
Accrued Payables
1,000
Notes Payable
500
Total Curr Liabilities
$7,750
Long Term Liabilities
Bonds Payable, 6%
7,000
TOTAL LIABILITIES
14,750
STKHOLDERS EQUITY
Pref. Stock, $100 Par, 6%
1,800
Common Stock, $10 Par
6,000
Additional Paid in Cap.
3,100
Total Paid In Capital
10,900
Retained Earnings
6,500
TOTAL SE
17,400
TOTAL LIAB & EQUITY $32,150
2001
Increase/Decrease
Amount Percent
$5,000
600
450
$6,050
$1,250
400
50
$1,700
8,000
14,050
(1,000) (12.5%)
700
5.0%
1,800
6,000
3,100
10,900
5,550
16,450
$30,500
0
0
00
0
950
950
$1,650
25.0%
66.7%
11.1%
28.1%
0.0%
0.0%
0.0%
0.0%
17.1%
5.8%
5.4%
Current Assets . . .

Consist of cash and other assets the firm
expects to convert into cash within one
year or the operating cycle, whichever is
longer.

A firm’s operating cycle is the average time
from when materials are purchased to when
sales of finished goods or services yield
cash.
Current Assets . . .

Are listed in order of liquidity; that is, how
easily they can be converted into cash.

A typical order would be:

Cash and cash equivalents

Marketable securities

Receivables

Inventory
Sourdough Alaska, Inc.
Balance Sheet
2002
2001
Increase/Decrease
Amount Percent
ASSETS
Current Assets
Cash
Accounts Rec. Net
Inventory
Prepaid Expenses
Total Current Assets
$1,200 $2,600 ($1,400) (53.8%)
7,000
4,000
3,000
75.0%
8,000
9,750 ($1,750) (17.9%)
450
150
300 200.0%
$16,650 $16,500
$150
0.9%
Property and Equipment
Land
Buildings, Net
Equipment, Net
Total Prop. & Equip.
TOTAL ASSETS
6,500
6,000
3,000
15,500
$32,150
6,500
6,000
1,500
14,000
$30,500
00
0
1,500
1,500
$1,650
0.0%
0.0%
100.0%
10.7%
5.4%
Noncurrent Assets . . .

Consist of those assets that do not meet
the definition of a current asset.

Noncurrent assets include . . .

Long-term receivables;

Investments;

Property, plant and equipment; and

Purchased intangible assets
Sourdough Alaska, Inc.
Balance Sheet
2002
2001
Increase/Decrease
Amount Percent
ASSETS
Current Assets
Cash
Accounts Rec. Net
Inventory
Prepaid Expenses
Total Current Assets
$1,200 $2,600 ($1,400) (53.8%)
7,000
4,000
3,000
75.0%
8,000
9,750 ($1,750) (17.9%)
450
150
300 200.0%
$16,650 $16,500
$150
0.9%
Property and Equipment
Land
Buildings, Net
Equipment, Net
Total Prop. & Equip.
TOTAL ASSETS
6,500
6,000
3,000
15,500
$32,150
6,500
6,000
1,500
14,000
$30,500
00
0
1,500
1,500
$1,650
0.0%
0.0%
100.0%
10.7%
5.4%
Current Liabilities . . .

. . . are obligations the firm expects to
discharge over the next year, either
through using current assets or by
creating new current liabilities.

Typical current liabilities . ..
Accounts Payable
 Short-term debt
 Accrued expenses of various kinds

LIABILITIES
2002
Current Liabilities
Accounts Payable
$6,250
Accrued Payables
1,000
Notes Payable
500
Total Curr Liabilities
$7,750
Long Term Liabilities
Bonds Payable, 6%
7,000
TOTAL LIABILITIES
14,750
STKHOLDERS EQUITY
Pref. Stock, $100 Par, 6%
1,800
Common Stock, $10 Par
6,000
Additional Paid in Cap.
3,100
Total Paid In Capital
10,900
Retained Earnings
6,500
TOTAL SE
17,400
TOTAL LIAB & EQUITY $32,150
2001
Increase/Decrease
Amount Percent
$5,000
600
450
$6,050
$1,250
400
50
$1,700
8,000
14,050
(1,000) (12.5%)
700
5.0%
1,800
6,000
3,100
10,900
5,550
16,450
$30,500
0
0
00
0
950
950
$1,650
25.0%
66.7%
11.1%
28.1%
0.0%
0.0%
0.0%
0.0%
17.1%
5.8%
5.4%
Noncurrent Liabilities . . .

. . . are long-term liabilities that do not
meet the definition of current liabilities.

Noncurrent Liabilities include . . .

Long-term debt;

Capital Leases;

Deferred Tax Liabilities
LIABILITIES
2002
Current Liabilities
Accounts Payable
$6,250
Accrued Payables
1,000
Notes Payable
500
Total Curr Liabilities
$7,750
Long Term Liabilities
Bonds Payable, 6%
7,000
TOTAL LIABILITIES
14,750
STKHOLDERS EQUITY
Pref. Stock, $100 Par, 6%
1,800
Common Stock, $10 Par
6,000
Additional Paid in Cap.
3,100
Total Paid In Capital
10,900
Retained Earnings
6,500
TOTAL SE
17,400
TOTAL LIAB & EQUITY $32,150
2001
Increase/Decrease
Amount Percent
$5,000
600
450
$6,050
$1,250
400
50
$1,700
8,000
14,050
(1,000) (12.5%)
700
5.0%
1,800
6,000
3,100
10,900
5,550
16,450
$30,500
0
0
00
0
950
950
$1,650
25.0%
66.7%
11.1%
28.1%
0.0%
0.0%
0.0%
0.0%
17.1%
5.8%
5.4%
Owners’ Equity . . .

Typically has three major components:

Contributed Capital

Common and preferred stock at par value

Additional paid-in capital

Retained Earnings

Treasury Common or Preferred Stock
LIABILITIES
2002
Current Liabilities
Accounts Payable
$6,250
Accrued Payables
1,000
Notes Payable
500
Total Curr Liabilities
$7,750
Long Term Liabilities
Bonds Payable, 6%
7,000
TOTAL LIABILITIES
14,750
STKHOLDERS EQUITY
Pref. Stock, $100 Par, 6%
1,800
Common Stock, $10 Par
6,000
Additional Paid in Cap.
3,100
Total Paid In Capital
10,900
Retained Earnings
6,500
TOTAL SE
17,400
TOTAL LIAB & EQUITY $32,150
2001
Increase/Decrease
Amount Percent
$5,000
600
450
$6,050
$1,250
400
50
$1,700
8,000
14,050
(1,000) (12.5%)
700
5.0%
1,800
6,000
3,100
10,900
5,550
16,450
$30,500
0
0
00
0
950
950
$1,650
25.0%
66.7%
11.1%
28.1%
0.0%
0.0%
0.0%
0.0%
17.1%
5.8%
5.4%
The Income Statement
AKA: Statement of
Operations . . .
Income Statement . . .

Summarizes the firm’s operating
activities over a given period of time.

An income statement always begins by
reporting revenue

Key expenses are then subtracted from
revenues to yield operating income
Sourdough Alaska, Inc.
Income Statement
Sales
Cost of Goods Sold
Gross Margin
Increase/Decrease
2002
2001 Amount Percent
$55,000 $52,000 $3,000
5.8%
38,000
36,000
2,000
5.6%
$17,000 $16,000 $1,000
6.3%
Operating Expenses:
Selling Expenses
Administrative Exp.
Total Operating Expense
$7,500
6,300
$13,800
$7,000
6,000
$13,000
$500
300
$800
7.1%
5.0%
6.2%
Net Operating Income
Interest Expense
Net Income Before Taxes
Income Taxes
$3,200
436
$2,764
1,106
$3,000
435
$2,565
1,026
$200
1
$199
80
6.7%
0.2%
7.8%
7.8%
Net Income
$1,658
$1,539
$119
7.8%
Income Statement . . .

Immediately following operating income:

Nonoperating income,

Income tax expense,

Effects of discontinued operations,

Extraordinary items,
Income Statement . . .

Immediately following operating income:

Cumulative effects of changes in accounting
principles

Net Income
For Example
Let’s briefly examine the Bridgeport
Corporation Income Statement for the
year ended December 31, 2002.
Bridgeport Corporation
Income Statement
For the Year Ended December 31, 2002
Sales
$2,000,000
Cost of Goods Sold
1,200,000
Gross Profit
$800,000
Operating Expenses
Selling
Administrative
Income from operations
$280,000
170,000
450,000
$350,000
Bridgeport Corporation
Income Statement
For the Year Ended December 31, 2002
Income From Operations
Other Revenue (Expense)
$350,000
1
Loss on sale of machinery
(50,000)
Inc. From Continuing Opns. BT
$300,000
Income Tax on Continuing Operations
Income From Continuing Operations
2
120,000
$180,000
Bridgeport Corporation
Income Statement
For the Year Ended December 31, 2002
Income From Continuing Operations
$180,000
Earnings From Sunrise Division
operations, less applicable taxes
($110,000 - $44,000)
66,000
3
Loss on disposal of Sunrise facilities,
less tax savings ($250,000 - $100,000)
Income Before Extraordinary Item
(150,000)
$96,000
Bridgeport Corporation
Income Statement
For the Year Ended December 31, 2002
Income Before Extraordinary Item
$96,000
Extraordinary Item
Flood loss, less tax savings
($60,000 - $24,000)
(36,000)
4
Cumulative effect on prior years of a
change in accounting principle, less
applicable taxes ($25,000 - $10,000)
Net Income
5
15,000
$75,000
The Statement of
Cash Flows
Where the cash came from . . . and
Where the cash went . . .
Statement of Cash Flows

A statement of cash flows subdivides the
change in a firm’s cash balance over the
period into three categories . . .

operating activities

investing activities, or

financing activities
Statement of Cash Flows

Is used extensively by creditors who are
interested in . .

The extent to which the firm will be able to
meet interest payments on its current and
potential future debt; and

The firm’s liquidity, solvency, and financial
flexibility.
Statement of Cash Flows

Is used extensively by investors, who are
interested in . . .

The firm’s ability to pay future dividends
from future operating cash flows; and

The firm’s liquidity, solvency, and financial
flexibility.
W. T. Grant Co.
“Retailing With A Difference”
A Classic Example . . .
The W. T. Grant Co.

The W. T. Grant Company was the
nation’s largest retailer when it filed for
protection under Chapter XI of the
bankruptcy act on October 2, 1975.

Four months later the company was
liquidated.
What Happened?
Chain of Events . . .

1906: First store opened

1928: Public stock offering

1950: Had 500 stores

1963: W. T. Grant retired

1969: Opened 410 new stores

1973: Stock sold at 20 times earnings
Chain of Events . . .

1974: Borrowed $600 million

1974: Stock price was at $2 from a high
of $71

1974: Hired new president

1975: Opened 6 new stores

1975: Closed 107 stores and laid off
7,000 employees
Chain of Events . . .

Oct. 1975: Chairman, Senior VP and all
outside directors resigned - FILED FOR
CHPT 11 BANKRUPTCY.

Feb. 1976: Judge ordered liquidation in
60 days

Apr. 1976: Company adjudicated as a
bankrupt.
Millions of
Dollars
W. T. Grant Company
Working Capital
Provided By Operations
40
Net Income
20
0
1966
1968
1970
-20
-40
-100
Cash Flow Provided
by Operations
1972
1974
The Statement of
Cash Flows
Where Does
It Fit In?
The Income Statement

Focuses on the results of operations and
reveals a firm’s revenues and expenses
for a given accounting period.
The Balance Sheet . . .

Discloses information on the economic
resources, financial obligations, and
stock-holders’ equity of a business
enterprise at a specific point in time.
Inherent Limitations

Neither the Balance Sheet nor the
Income Statement disclose specific
events or transactions that occurred
during the period.
Examine Two Balance Sheets
Property Plant
and Equipment
2001
$50,000
Property Plant
and Equipment
2002
$75,000
Difference
$25,000
What caused the change?
1. Purchase $25,000 of Equipment?
2. Sell/Buy with net change of $25,000?
The Balance Sheet doesn’t say!
P.S.: The Income Statement doesn’t either!
The Statement of
Shareholder’s Equity
Statement of Shareholders’ Equity

. . . details the changes in shareholders’
equity accounts from one period to the
next.
Financial Statement
Articulation
Or . . . How do the
financial statements
fit together?
Financial Statement Articulation
Statement
of Cash
Flows
Statement of
Owners Equity
Balance
Sheet
Income
Statement
Notes
Financial Statement Articulation
Statement
of Cash
Flows
Income
Statement
Notes
Balance
Sheet
Statement of
Owners Equity
Financial Statement Articulation
Or, How the Financial Statements Fit Together
Statement of Cash Flows
For Period Ending
12/31/02
Balance Sheet
as of
12/31/01
Income Statement
For Period Ending
12/31/02
Balance Sheet
as of
12/31/02
Notes to the Financial
Statements
Or . . . Helping us to read between
the lines . . .
Notes to the Financial
Statements

Notes are valuable to many different
user groups because of the wealth of
information they provide about the firm’s:

Operating activities,

Investing activities, and

Financing activities
Notes to the Financial
Statements

Some is information that is not formally
recognized in the financial statements,
but is either . . .

Mandated by the FASB to be disclosed in
notes, or

Is voluntarily disclosed by the firm.
Notes to the Financial
Statements

Note #1

It is crucial that the reader carefully
scrutinize note 1 with a view to understanding management’s objectives as
revealed through its choices in accounting
methods.

Management objectives may not always
agree with investor objectives.
Notes to the Financial
Statements

The sophisticated reader can use the
notes to adjust the stated information in
the firm’s financial statements . . .

to make adjustments based on his or her
own analysis of such off-financial
statement items.