Chapter 2
Financial Statements:
An Overview
Albrecht, Stice, Stice, Swain
COPYRIGHT © 2008 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are
trademarks used herein under license.
1
Primary Financial Statements
• The Balance Sheet
(Statement of Financial Position)
• Income Statement
(Statement of Earnings)
• Statement of Cash Flows
2
Components of a Balance Sheet
• Assets
– Cash, inventory, accounts receivable,
buildings
• Liabilities
– Accounts payable, taxes payable, mortgage
payable
• Owners’ Equity
– Paid-in capital, retained earnings
3
Accounting Equation
Assets = Liabilities + Owners’ Equity
Sources of Financing
Resources
Resources
to use to
generate
revenues
=
Creditors’
claims
against
resources
+
Owners’
claims
against
resources
4
Sample Balance Sheet
Assets
Liabilities
Cash
$ 40 Accounts payable
Accounts receivable 100 Notes payable
Land
200
Total assets
Must
Equal
$340
Owners’ Equity
Paid-in Capital
Retained earnings
Total liabilities
and owners’ equity
$ 50
150
$200
$100
40
$140
$340
5
Classified and Comparative
Balance Sheets
• Classified balance sheet
– Distinguishes between current and long-term
assets and liabilities.
– Listed in decreasing order of liquidity.
• Comparative balance sheet
– Presents two years of balance sheet
information.
– Helps users identify significant changes.
6
Limitations of the Balance
Sheet
• Book value vs. market value.
– Which is better?
• Only records assets/liabilities that can be
quantified.
– Reputation
• Wal-Mart’s name
• Great CEO
7
The Income Statement
Revenues
Increase in a company’s
resources from the sale
of goods or services.
Expenses
Costs incurred in the
normal course of
business to generate
revenues.
Net Income or (Net Loss)
Revenues - Expenses
8
Other Items on the Income
Statement
• Earnings per share
Net Income (Net Loss)
# of Shares of Stock Outstanding
– The amount of earnings related to each share
of stock.
• Gains (losses)
– Money made or lost on activities outside the
normal operation of a business.
9
Statement of Retained
Earnings
• Shows the change in retained earnings
over the period of time.
Beginning retained earnings
+ Net income
– Dividends
Ending retained earnings
• The total amount invested by the owners
through the retention of profits
10
Statement of Cash Flows
• Reports categorized cash inflows and outflows
Operating Activities
Day-to-day activities
Investing Activities
Buying and selling
long-term assets
Financing Activities
Cash obtained or repaid
to owners or creditors
11
Financial Statement Articulation
Balance Sheet 12/31/08
Cash
Other
Total
$ 80,000
4,550,000
$4,630,000
Liabilities $2,970,000
Cap. stock 900,000
R/E
760,000
Total
$4,630,000
Cash--Op. Act. $ 973,000
Cash--Inv. Act. (1,188,000)
Cash--Fin. Act.
245,000
Net increase $ 30,000
Beg. cash
80,000
End. cash
$ 110,000
Income Statement
Revenues $12,443,000
Expenses
11,578,400
Net income $ 864,600
Stmt of Retained
Earnings
R/E 12/31/08 $ 760,000
Net income
864,600
Dividends
(400,000)
R/E 12/31/09 $1,224,600
Cash Flow
Statement
Balance
Sheet 12/31/09
Cash
Other
Total
$ 110,000
4,975,000
$5,085,000
Liabilities $2,860,400
Cap. stock 1,000,000
R/E
1,224,600
Total
$5,085,000
12
Notes to Financial Statements
1. Summary of significant accounting policies.
2. Additional information about the summary
totals found in the financial statements.
3. Disclosure of important information that is not
recognized in the financial statements.
4. Supplementary information required by the
Financial Accounting Standards Board (FASB)
or the Securities and Exchange Commission
(SEC).
13
External Audits
Audit Report
– Issued by an independent CPA firm.
– Verifies financial statements have
been prepared according to GAAP.
14
External Auditor vs. Management
Owners and managers want the
most favorable results possible.
• Bank credit
• Bonuses
• Public stock price
CPA firms have economic
incentives to perform credible
audits.
• Reputation
• Lawsuits
15
What Are the Fundamental
Concepts and Assumptions?
• Going Concern Assumption
• Monetary Measurement Concept
• Arm’s-Length Transactions
• Cost Principle
• Separate Entity Concept
16