Financial Statements and the
Annual Report
Chapter 2
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2-1
ECON 3A UCSB ANDERSON
Objectives of Financial Reporting
(a) PROVIDE USEFUL INFORMATION
Financial reporting should provide information that is
useful to present and potential investors and creditors
and other users in making rational investment, credit, and
similar decisions.
The information should be comprehensible to those who
have a reasonable understanding of business and
economic activities and are willing to study the
information with reasonable diligence.1
1Statement
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2-2
of Financial Accounting Concepts (SFAC) No. 1
LO 1
Describe the objectives of financial reporting.
ECON 3A UCSB ANDERSON
Objectives of Financial Reporting
(b) REFLECT INFORMATION ON CASH FLOWS
Financial reporting should provide information to help
present and potential investors and creditors and other
users in assessing the amounts, timing, and uncertainty of
prospective cash receipts from dividends or interest and
the proceeds from the sale, redemption, or maturity of
securities or loans.
Since investors' and creditors' cash flows are related to
enterprise cash flows, financial reporting should provide
information to help investors, creditors, and others assess
the amounts, timing, and uncertainty of prospective net
cash inflows to the related enterprise.1
1Statement
Slide
2-3
of Financial Accounting Concepts (SFAC) No. 1
LO 1
Describe the objectives of financial reporting.
ECON 3A UCSB ANDERSON
Objectives of Financial Reporting
(c) REFLECT THE FINANCIAL POSITION OF THE ENTITY
Financial reporting should provide information about the
economic resources of an enterprise, the claims to those
resources (obligations of the enterprise to transfer
resources to other entities and owners' equity), and the
effects of transactions, events, and circumstances that
change its resources and claims to those resources.1
1Statement
Slide
2-4
of Financial Accounting Concepts (SFAC) No. 1
LO 1
Describe the objectives of financial reporting.
ECON 3A UCSB ANDERSON
ASSUMPTIONS
PRINCIPLES
CONSTRAINTS
Economic entity
Historical cost
Cost-benefit
Going concern
Revenue recognition
Materiality
Monetary unit
Matching
Industry practice
Periodicity
Full disclosure
Conservatism
QUALITATIVE
CHARACTERISTICS
Relevance
Reliability
Comparability
Conceptual
Framework for
Financial
Reporting
Slide
2-5
LO 2
Consistency
ELEMENTS
Assets, Liabilities, and
Equity
Investments by owners
Distribution to owners
Comprehensive income
Revenues and
Expenses
Gains and Losses
OBJECTIVES
1. Useful in investment and credit
decisions
2. Useful in assessing future
cash flows
3. About enterprise resources,
claims to resources, and
changes in them
Describe the qualitative characteristics of accounting information.
ECON 3A UCSB ANDERSON
ASSUMPTIONS
PRINCIPLES
CONSTRAINTS
Economic entity
Historical cost
Cost-benefit
Going concern
Revenue recognition
Materiality
Monetary unit
Matching
Industry practice
Periodicity
Full disclosure
Conservatism
Relevance and Reliability
QUALITATIVE
CHARACTERISTICS
Relevance
Reliability
Comparability
Conceptual
Framework for
Financial
Reporting
Slide
2-6
LO 2
Consistency
Capable of making a difference
in a decision.
• Verifiability
• Representational faithfulness
• Neutrality
OBJECTIVES
1. Useful in investment and credit
decisions
2. Useful in assessing future
cash flows
3. About enterprise resources,
claims to resources, and
changes in them
Describe the qualitative characteristics of accounting information.
ECON 3A UCSB ANDERSON
FUNDAMENTALS OF GAAP






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2-7
Consistency/ Comparability: All companies for all
periods account for things the same
Monetary Unit: Only items which can be expressed
in money are reflected
Economic Entity: The entity can be separated.
Time Period/ Periodicity: At least annually
Historical Cost: Items are reported at their cost and
depreciated if appropriate… but changes in value
are excluded.
Going Concern: Entity will continue in existence for
the foreseeable future. This is why historical cost is
acceptable… if there is no going concern, then
liquidation basis may be appropriate.
ECON 3A UCSB ANDERSON
Qualitative Characteristics
True or False?
Relevance and reliability are the two primary
qualities that make accounting information useful
for decision making.
True
Slide
2-8
LO 2
Describe the qualitative characteristics of accounting information.
ECON 3A UCSB ANDERSON
ASSUMPTIONS
PRINCIPLES
CONSTRAINTS
Economic entity
Historical cost
Cost-benefit
Going concern
Revenue recognition
Materiality
Monetary unit
Matching
Industry practice
Periodicity
Full disclosure
Conservatism
Comparability and Consistency
QUALITATIVE
CHARACTERISTICS
Relevance
Reliability
Comparability
Conceptual
Framework for
Financial
Reporting
Slide
2-9
LO 2
Consistency
ELEMENTS
Assets, Liabilities, and
Equity
Investments by owners
Distribution to owners
Comprehensive income
Revenues and
Expenses
Gains and Losses
OBJECTIVES
1. Useful in investment and credit
decisions
2. Useful in assessing future
cash flows
3. About enterprise resources,
claims to resources, and
changes in them
Describe the qualitative characteristics of accounting information.
ECON 3A UCSB ANDERSON
Qualitative Characteristics
True or False?
Adherence to the concept of consistency
requires that the same accounting principles be
applied to similar transactions by all companies
and for all periods?
TRUE
Slide
2-10
LO 2
Describe the qualitative characteristics of accounting information.
ECON 3A UCSB ANDERSON
ASSUMPTIONS
PRINCIPLES
CONSTRAINTS
Economic entity
Historical cost
Cost-benefit
Going concern
Revenue recognition
Materiality
Monetary unit
Matching
Industry practice
Periodicity
Full disclosure
Conservatism
QUALITATIVE
CHARACTERISTICS
Relevance
Reliability
Comparability
Conceptual
Framework for
Financial
Reporting
Slide
2-11
LO 2
Consistency
ELEMENTS
Assets, Liabilities, and
Equity
Investments by owners
Distribution to owners
Comprehensive income
Revenues and
Expenses
Gains and Losses
OBJECTIVES
1. Useful in investment and credit
decisions
2. Useful in assessing future
cash flows
3. About enterprise resources,
claims to resources, and
changes in them
Describe the qualitative characteristics of accounting information.
ECON 3A UCSB ANDERSON
CPA Question, Nov. 94, FAR
What is the underlying concept that supports the
immediate recognition of a contingent loss?
a. Substance over form.
b. Consistency.
c. Matching.
d. Conservatism.
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2-12
LO 2
Describe the qualitative characteristics of accounting information.
ECON 3A UCSB ANDERSON
WHAT IS AN OPERATING CYCLE?
The operating cycle is how long it takes a company to initiate,
perform, and deliver their primary product or service.
Take a wholesaler for instance. First they buy inventory, then
they sell it on account, and ultimately they collect the cash owed
from their customer. The period of time it takes to accomplish
this is the “Operating Cycle”.
Accounts Payable
Inventory
Cash
Accounts receivable
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2-13
ECON 3A UCSB ANDERSON
Balance Sheet
Assets
Assets are probable future economic benefits
obtained or controlled by a particular entity as a
result of past transactions or events.
Slide
2-14
LO 3
Explain the concept and purpose of a classified balance sheet.
ECON 3A UCSB ANDERSON
ASSETS, EXAMPLES AND MORE
CASH
PROCESS CULMINATES
ACCOUNTS RECEIVABLE, ON BALANCE SHEET BY:
SALES
OFF THE BALANCE SHEET WHEN:
COLLECTED, OR WRITTEN OFF
INVENTORY, ON BALANCE SHEET BY:
PURCHASES
OFF THE BALANCE SHEET WHEN:
SOLD- COGS
FIXED ASSETS, ON BALANC SHEET BY:
PURCHASES
OFF THE BALANCE SHEET AS IT IS:
DEPRECIATED- DEPRECIATION EXPENSE
PREPAID EXPENSES, ON BALANCE SHEET BY:
PAYMENT
OFF THE BALANCE SHEET AS IT IS:
CONSUMED- “BENEFIT IS REALIZED”- I.E INSURANCE EXPENSE
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2-15
ECON 3A UCSB ANDERSON
Balance Sheet
Current Assets
Defined:
An asset that is expected to be realized in cash or
sold or consumed during the operating cycle or within
one year if the cycle is shorter than one year.
OR more commonly stated:
An asset that is expected to be realized in cash or
sold or consumed within one year or the operating
cycle, whichever is longer.
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2-16
LO 3
Explain the concept and purpose of a classified balance sheet.
ECON 3A UCSB ANDERSON
Balance Sheet
Liabilities
Liabilities are probable future economic sacrifices
obtained or controlled by a particular entity as a
result of past transactions or events.
Slide
2-17
LO 3
Explain the concept and purpose of a classified balance sheet.
ECON 3A UCSB ANDERSON
Balance Sheet
Current Liabilities
Defined:
An obligation that will be satisfied within the next
operating cycle or within one year, if the cycle is
shorter than one year.
OR more commonly stated:
An obligation that will be satisfied within one year or
the operating cycle, whichever is longer.
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2-18
LO 3
Explain the concept and purpose of a classified balance sheet.
ECON 3A UCSB ANDERSON
A Classified Balance Sheet
Company Name
Balance Sheet
As of DATE
Current assets
Cash
etc.
Total current assets
xxx
xxx
xxx
Fixed assets
Other long term assets
Total assets
Current liabilities
Accounts payable
etc.
Total current liabilities
xxx
xxx
xxx
xxx
Balances?
Long-term debt, excluding current portion
Equity
Common stock
APIC
Retained earnings
Total Liabilities & Equity
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2-19
ECON 3A UCSB ANDERSON
A Multiple Step Income Statement
Company Name
Income Statement
FOR THE PERIOD ….
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2-20
Revenue
Cost of Revenue
Gross Profit
xxx
xxx
xxx
Selling general & administrativ (SG&A) expense
Depreciation expense
Other operating expenses
xxx
xxx
xxx
Income before income tax provision
Tax provision
Income from continuing operations
xxx
xxx
xxx
Discontinued operations, net of tax
Income before extraordinary items
Extraordinary items, net of tax
NET INCOME OR LOSS
xxx
xxx
xxx
XXX
ECON 3A UCSB ANDERSON
Analysis using a Classified Balance Sheet
Liquidity = the ability of a company to pay its debts as
they come due.
A comparison of current assets and current liabilities is a
starting point in evaluating the ability of a company to
meet its obligations.
Working Capital = Current Assets – Current Liabilities
Company’s strive for a balance in managing its working
capital – not too much or too little.
$118,000
Current
assets
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2-21
LO 4
–
59,900
Current
liabilities
=
$58,100
Working
capital
Use a classified balance sheet to analyze a company’s financial position.
ECON 3A UCSB ANDERSON
Analysis using a Classified Balance Sheet
The current ratio indicates the amount of current assets
available at the balance sheet date relative to
obligations coming due during that period.
Current Ratio =
Current Assets
Current Liabilities
1.97 to 1 =
$118,000
$59,900
Composition of current asset and current liabilities
important.
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2-22
LO 4
Use a classified balance sheet to analyze a company’s financial position.
ECON 3A UCSB ANDERSON
Statement of Retained Earnings Exercise
Landon Corporation was organized on January 2, 2002, with the
investment of $100,000 by each of its two stockholders. Net
income for its first year of business was $85,200. Net income
increased during 2003 to $125,320 and to $145,480 during 2004.
Landon paid $20,000 in dividends to each of the two stockholders
in each of the three years.
2002
2003
2004
0
$ 45,200
$130,520
85,200
125,320
145,480
Less: Dividends
(40,000)
(40,000)
(40,000)
End. Retained earnings
$45,200
$130,520
$236,000
Beg. Retained earnings
Net income (loss)
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2-23
LO 7
$
Prepare and identify the components of the statement of retained earnings.
ECON 3A UCSB ANDERSON
Elements of the Annual Report
BASIC- ALL AUDITED FINANCIAL STATEMENTS MUST
INCLUDE:



Financial statements
Notes to financial statements
Report of independent accountants
PUBLIC COMPANIES ALSO MUST INCLUDE:

Management’s assertions (SOX 403)

Report of independent accountants on internal
controls (SOX 404)

Management discussion & analysis

Summary of financial data

Letter to stockholders
http://www.starbucks.com/
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ECON 3A UCSB ANDERSON
DATSALLFORTHISCHAPTER
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ECON 3A UCSB ANDERSON