MODULE 2:
FINANCIAL STATEMENTS
Financial Statements include:
Balance Sheet*
Income Statement*
Statement of Cash Flow
Statement of Stockholders’ Equity
*Module 2 focus
Financial Statements
1
BALANCE SHEET OVERVIEW
Purpose: indicate the financial position, including what
the company owns and owes.
Time: relates to a single point in
time, rather than a period of time.
Two Parts:
 Assets – are owned and have probable future
benefits
 Equities – indicate how assets were acquired, two
types:
 Debtors’ equity, known as liabilities
 Stockholders’ equity
The balance sheet is also called the
“Statement of Financial Position.”
In fact, that is the preferred term
used by international standards.
Financial Statements
2
Use of the Balance Sheet
Based on formula:
Everything we have came from somewhere.
Both sides of the equation
should be the same!
Assets = Liabilities + Owners’ Equity
The balance sheet is used to evaluate:
 Liquidity – time needed to change an asset into cash or to
cancel a liability
 Solvency – ability to pay long-term debts as they mature
Financial Statements
3
BALANCE SHEET FORMAT
Balance Sheet
XXX Corporation
At Dec. 31, 20XX
Assets
Current Assets
Investments
Fixed Assets
Intangible Assets
Other Assets
Liabilities
17,000
1,000
80,000
1,500
500
Current Liabilities
Deferred Taxes
Long-Term Liabilities
Total Liabilities
8,000
2,000
30,000
40,000
Owners’ Equity
Capital Stock
Retained Earnings
Total Equity
Total Assets
Financial Statements
100,000
Total Liabilities and Equity
40,000
20,000
60,000
100,000
4
BALANCE SHEET CLASSIFICATION
Asset – Probable future economic benefit obtained or
controlled by the entity
Assets are recorded if:
You own it!
 Rights are acquired
It has value!
 Possesses future economic benefits
Five Major Categories
 Current Assets - Expected to be realized in cash, sold,
or used up within one year.
 Investments - Securities or property held longer than
one year for the purpose of enhancing income.
 Fixed Assets - Property, plant and equipment used in
business.
 Intangibles - Lack physical existence.
 Other assets – do not fit in above categories
Financial Statements
5
Balance Sheet Classification
Current Assets
Current Assets – Expected to be realized in cash, sold, or used
up within one year.
Examples:
Cash – coin, currency, and funds on deposit in the bank; most
liquid asset
Accounts Receivable – claims against customers and others for
money, goods, or services (amounts owed to us)
Prepaid Expenses – cash paid to others before receipt of goods
or performance of services
Inventories – raw materials, work in process, or finished goods
held for further manufacturing or sale
Short-Term Investments – securities held for less than a year,
usually for cash management purposes
Balance Sheet Classification
Long-Term Investments
Securities or property held longer than one year for the
purpose of enhancing income (rather than cash
management).
Financial Statements
6
Balance Sheet Classification
Fixed Assets
Fixed Assets - Property, plant and equipment used in
business (does not include property held for investment).
Examples:





Land
Buildings
Furniture
Equipment
Construction in Progress
Balance Sheet Classification
Intangible Assets
Intangibles – Non-financial assets with no physical substance
Trademarks – word, symbol, or phrase that identifies a particular
company or product
Patents – government granted right to use, manufacture, and sell a
product or process (20 years in US)
Copyrights – government granted right to utilize the creation of an
author, artist, or musician
Franchise Rights – right to sell certain products or services
Goodwill – excess cost over the fair market value of identifiable assets;
occurs only when buying another company.
Financial Statements
7
BALANCE SHEET CLASSIFICATION
Accounting for Liabilities
Liability – probable future sacrifice of an economic
benefit
Qualities of a Liability
 An asset or service must be transferred in the future
 The entity cannot avoid the transfer
 The event causing the obligation has already occurred
 Current Liabilities – Due within year and paid by
current assets. Example: amounts owed to suppliers
(called accounts payable).
 Long-Term Debt – Financial payments to be made
after one year. Example: mortgage on a building.
 Other Long-Term Liabilities – Obligations not
considered current liabilities or long term debt
Example: deferred income taxes and retirement
obligations
Financial Statements
8
BALANCE SHEET CLASSIFICATION
Shareholders’ Equity
Residual interests after obligations to creditors are met.
Equity Accounts:
 Common Stock – represents voting ownership in
corporation
 Additional Paid In Capital –
common stock that exceeds “par”
For analysis purposes,
APIC is treated the same
as Common Stock.
 Preferred Stock – optional form of ownership, usually
with dividends and without voting rights
 Retained Earnings – cumulative net income that has
not been paid in dividends
 Treasury Stock – stock repurchased by the company
(contra-equity)
Financial Statements
9
CONSOLIDATED BALANCE SHEETS
The Home Depot, Inc. and Subsidiaries
AMOUNTS IN MILLIONS, EXCEPT SHARE DATA
ASSETS
Current Assets:
Cash and Cash Equivalents
Receivables, net
Merchandise Inventories
Other Current Assets
Total Current Assets
Property and Equipment, at cost:
Land
Buildings
Furniture, Fixtures and Equipment
Leasehold Improvements
Construction in Progress
Capital Leases
Less Accumulated Depreciation and
Amortization
Net Property and Equipment
Notes Receivable
Goodwill
Other Assets
Total Assets
January 29,
2012
January 28,
2007
$1,987
1,245
10,325
963
14,520
$600
3,223
12,822
1,341
18,000
8,480
17737
10,040
1,372
758
588
38,975
8,355
15,215
7,799
1,391
1,123
475
34,358
14,527
7,753
24,448
26,605
135
1,120
295
343
6,314
1,001
$40,518
$52,263
Footnote Disclosures:
2012
US Stores
Canadian
Other Countries
HD Supply Stores (Business Customers)
Total Stores
Financial Statements
1,974
180
98
2,252
2007
1,872
155
73
893
2,993
10
CONSOLIDATED BALANCE SHEETS
The Home Depot, Inc. and Subsidiaries
AMOUNTS IN MILLIONS, EXCEPT SHARE DATA
January 29,
2012
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Short-Term Debt
Accounts Payable
Accrued Salaries and Related Expenses
Sales Taxes Payable
Deferred Revenue
Income Taxes Payable
Current Installments of Long-Term Debt
Other Accrued Expenses
Total Current Liabilities
Long-Term Debt, excluding current
installments
Other Long-Term Liabilities
Deferred Income Taxes
Total Liabilities
STOCKHOLDERS' EQUITY
Common Stock
Paid-In Capital
Retained Earnings
Accumulated Other Comprehensive Income
Treasury Stock**
Total Stockholders' Equity
Total Liabilities and Stockholders' Equity
Financial Statements
January 28,
2007
$0
4,856
1,372
391
1,147
23
30
1,557
9,376
$ —
7,356
1,307
475
1,634
217
18
1,924
12,931
10,758
11,643
2,146
340
22,620
1,243
1,416
27,233
87
6,966
17,246
293
-6694
17,898
121
7,930
33,052
310
-16,383
25,030
$40,518
$52,263
11
INCOME STATEMENT
Compare to the balance sheet:
Balance sheet: a specific point in time (on Dec 31)
Income statement: over a period of time (from Jan 1 to
Dec 31)
INCOME STATEMENT COMPONENTS
Revenue – enhancement of assets or settlement of liabilities
due to delivering goods or rendering services
Expenses – use of assets or incurrence of liabilities related to
delivering goods or providing services
Income – difference between revenue and expenses
Financial Statements
12
INCOME STATEMENT FORMATS
Single Step Format - All types of revenues and gains
listed first, followed by all expenses and losses.
Multi-Step Format - Separates operating and nonoperating activities; classifies expenses by function

Reality Check – 16.7% of Fortune 100 uses a single
step format.
Financial Statements
13
INCOME STATEMENT FORMATS
Single Step Format
All types of revenues and gains listed first, followed by all
expenses and losses.
X CORPORATION
INCOME STATEMENT
For the period ending December 31, 20XX
Revenues
Sales
Rent Revenue
Investment Gains
Total Revenue
$150,000
10,000
5,000
165,000
Expenses
Cost of Goods Sold
Selling, General, and Administrative Expense
Interest Expense
Tax Expense
Total Expenses
70,000
10,000
5,000
25,000
110,000
Net Income
$55,000
Earnings per Share
All revenues
are shown
together
All expenses
are shown
together
$1.25
Advantages of Single Step: Format is simple and does
not imply greater importance to certain types of
accounts.
Financial Statements
14
INCOME STATEMENT FORMATS
Multiple Step Format
A multi-step income statement:
 Separates operating and non-operating activities
 Classifies expenses by function
X CORPORATION
INCOME STATEMENT
For the period ending December 31, 20XX
Sales
Cost of Goods Sold
Gross Profit
Selling, General, and Administrative Expenses
Income from Operations
Rent Income
Investment Gains
Interest Expense
Income before Tax
Tax Expense
Net Income
Earnings per Share (44,000 shares outstanding)
$150,000
-70,000
80,000
-10,000
70,000
10,000
5,000
-5,000
80,000
-25,000
$55,000
Operating
revenues and
expenses
NonOperating
revenues and
expenses
$1.25
Operating – within corporate mission
Non-Operating – rent, interest, equipment sales
Note: Multistep income statements usually include Gross Profit
(Sales – Cost of Goods Sold).
Financial Statements
15
CONSOLIDATED STATEMENT OF EARNINGS
The Home Depot, Inc. and Subsidiaries
AMOUNTS IN MILLIONS, EXCEPT SHARE DATA
Amounts in millions
NET SALES
Cost of Sales
GROSS PROFIT
Operating Expenses:
Selling, General and Administrative
Depreciation and Amortization
Total Operating Expenses
January
28,
2007
January 29,
2012
$70,395
46,133
24,262
100.0%
65.5%
34.5%
$90,837
61,054
29,783
100.0%
67.2%
32.8%
16,028
1,573
17,601
22.8%
2.2%
25.0%
18,348
1,762
20,110
20.2%
1.9%
22.1%
OPERATING INCOME
Interest and Other (Income) Expense:
Interest and Investment Income
Interest Expense
Other
Interest and Other, net
6,661
9.5%
9,673
10.6%
EARNINGS BEFORE TAXES
6,068
8.6%
9,308
10.2%
Provision for Income Taxes
2,185
3.1%
3,547
3.9%
EARNINGS FROM CONTINUING
OPERATIONS
3,883
13
-606
0
-593
-0.9%
5.5%
27
-392
0
-365
5,761
Why did Home Depot’s income decline?
ANS: Sold a business (an independent unit for commercial).
Financial Statements
16
-0.4%
6.3%
Discontinued Operations
Discontinued Operations – component that
(1)
will be eliminated from ongoing operations, and (2) has
no management involvement after disposal.
Rules:
 a component must be a product group or division, but not a
brand
 Discontinued operations are always reported net of taxes
 No longer part of regular operations, separated off for both
balance sheet and income statement.
Reported in two parts:
 Part 1 - Gain or loss from operations of discontinued
operations
 Part 2 - Gain or loss from the disposal (FMV – BV)
Financial Statements
17
IRREGULAR ITEMS
In the US, two items:
 Discontinued Operations
 Extraordinary Items
receive special treatment.
Treatment: Show
 near the bottom of the income statement (prior to
net income)
 net of taxes
Note:
 DE items receive this treatment whether single or
multi-step.
 Income before DE items is referred to as “Income
from Continuing Operations”
 IFRS standards do not recognize extraordinary items.
Financial Statements
18
PROFITABILITY RATIOS
1.
Profit Margin on Sales
Indicates: The relation of profits to sales.
Profit
Margin
=
Net Income
Sales
Interpretation:
Higher - less sales are needed to generate a desired level of profit.
How is the ratio improved? Hint: The denominator is the top of the IS and the
numerator is the bottom of the IS. What is in between?
2.
Return on Assets
Indicates: How assets are utilized to achieve a profit.
Return
on Assets
=
Current Year Net Income
Average Total Assets
Options: Some add interest expense to the numerator to put leveraged and
unleveraged entities on equal basis.
Interpretation:
Higher - greater ability to produce profits.
Financial Statements
19
3.
Return on Stockholders' Equity
Indicates: The degree of profitability attributable to stockholders. Differs from
ROA to extent that the entity is leveraged (has debt).
Return
on Equity
=
Current Year Net Income
Average Stockholders’ Equity
Options: Some subtract PS dividends from numerator to evaluate only amounts
available to CS.
Interpretation:
Higher - a greater degree of profits available to stockholders.
Financial Statements
20