Foundations of Business
Introduction to Financial Reporting
The Income Statement
6 Roles of Financial Management
1. Recording transactions
2. Budgeting
3. Allocating capital to the best projects for the
company
 Board decides:
 Reinvest earnings
 Pay dividends
4. Projecting
5. Raising capital
1. Issue stock
2. Borrow (loans/bonds)
6. Preparing financial reports
Financial Reporting



Financial accounting for external users (e.g.
the IRS & SEC) through financial statements
Generally Accepted Accounting Principles
(GAAP, US-GAAP)
4 primary statements




Income statement
Balance Sheet
Statement of Cash Flows
Statement of Changes in Stockholders’ Equity
What are Earnings?
Sales – Expenses = Net Income (earnings, profit,
the bottom line)
INCOME STATEMENT EQUATION

Sales (Revenue)
= $ value of what customers have
bought
e.g. # ice cream cones X $ price
e.g. 3 cones X $2.50 = $7.50 total
sales
 Recorded when transacted

Expenses
= Costs used up in generating sales
 Recorded when incurred
Net Income
(Net Loss)
= What’s left over from sales after
accounting for all expenses in the
period

EXPENSES
Matching principle: costs incurred (used
up) must be matched with the sales that
these costs helped generate in the same
period
2 types of expenses
 Fixed: do not fluctuate when sales
change
 Variable: fluctuate with sales
Champ Creemee Company
Income Statement


Sales (Revenue)
Expenses:
(for the Year ending 12/31/10)
$3,000
Cost of Goods sold (Cost of
Revenue)


Operating Profit (EBIT)
Interest

Pre-Tax Profit
Taxes (35%)

(1,000)
Gross Profit
Waste/Spoilage
Wages
Salaries
Payroll Remittances
Rent/Permits
Advertising
Maintenance and Repair
Operating Expenses
Net Income
Covers a period
of time.
2,000
50
500
50
50
100
100
50
(900)
1,100
(500)
600
(210)
$ 390
Champ Creemee Company
Cost of Goods Sold
2 gallons of ice cream
cones
napkins
We sell 1 ice cream cone.
What have we used up?
1 cone 3 scoops
Direct product costs (COGS)
1 napkin
= VARIABLE costs
Unqualified (= “clean”) Opinion by the Independent Auditors
Independent auditors:
Report of Independent Registered Public Accounting Firm (link from
finance.yahoo.com to Form 10-K, SEC document, pp. 181)
“Nothing is wrong with the
financial statements.”
To the Board of Directors and Shareholders of Merck & Co., Inc.:
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, of equity and
of cash flows present fairly, in all material respects, the financial position of Merck & Co., Inc. and its subsidiaries at
December 31, 2009 and December 31, 2008, and the results of their operations and their cash flows for each of the three years
in the period ended December 31, 2009 in conformity with accounting principles generally accepted in the United
States of America. Also in our opinion, Merck maintained, in all material respects, effective internal control over financial
reporting as of December 31, 2009, based on criteria established in Internal Control — Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO). Merck’s management is responsible for these
financial statements, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness
of internal control over financial reporting, included in Management’s Report under Item 9A. Our responsibility is to express
opinions on these financial statements and on Merck’s internal control over financial reporting based on our integrated audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).
Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial
statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all
material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts
and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting
included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness
exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our
audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our
audits provide a reasonable basis for our opinions.
PricewaterhouseCoopers LLP
Florham Park New Jersey
February 26, 2010
Independent Auditors
Homework Assignment to prepare for the
Finance Application Assignment
You may work with a partner to prepare the research and financial analysis, but you must write the memo
individually.
1.
2.
3.
4.
Select two publicly traded U.S. companies in similar businesses, i.e. in the same industry. Consult
the major industries on Valueline (http://www3.valueline.com/secure/vlispdf/stk1700/industry.aspx)
(NOTE: Do not choose financial institutions, e.g. banks, or automobile manufacturers and make sure
the companies are profitable, produce a product, and are listed in Value Line.) You may identify
2 companies from this list and get information by clicking on its name.
An alternate source for a list of major industries is Yahoo's Industry Index at
http://biz.yahoo.com/ic/ind_index.html.
Find your two comparable companies on Valueline. Click the radio button for Company and type in
the name of your company. Confirm that the companies are listed on a U.S. stock exchange (NYSE-New York Stock Exchange, NASDAQ, American) and note the "Ticker Symbol"--you will need this
later.
Download or copy the pages from Value Line for both companies..
For each company, get the Balance Sheet and Income Statement for the latest year. These can be
found under Financials on the company's site in Yahoo!Finance (http://finance.yahoo.com/) or in the
company's Annual Report (also called 10-K) on either the company's Web site or under the SEC
filings on the Yahoo!Finance site, MSN-Money
(http://moneycentral.msn.com/investor/research/profile.asp), or another source. Make sure you get
the annual (not quarterly) financial statement.
Do NOT use this as the
“Current Stock Price” as it
is not current. Get the
current stock price from
Yahoo!Finance.
Value Line
Investment
Survey
sheet for Merck
www.valueline.com
SMC subscription to
Value Line
Business
description,
recent company
events
Date
of
Report