CHAPTER
2
Financial Statements:
An Overview
Primary Financial Statements
These financial statements
answer basic questions:
What is the company’s current
financial status?
What were the company’s
operating results for the
period?
How did the company obtain
and use cash during the
period?
Learning Objective 1
Understand the
basic elements,
uses, and
limitations of
the Balance
Sheet
Balance
Sheet
The Balance Sheet
Summary of the financial
Assets: cash, accounts
position of a company at
receivable, inventory,
a particular date.
land, buildings,
equipment, and
intangible items.
• What are the resources
Sometimes
of the company?
Liabilities:
accounts
referred to as a
payable, notes
Statement
payable,
and of
• What are the company’s
Financial
mortgages
payable.
existing obligations?
Position
Owners’ Equity: net
assets after all
• What are the company’s
obligations have been
net assets?
satisfied.
What Is the Accounting
Equation?
Define double-entry
accounting
Accounting Equation
Assets = Liabilities + Owners’ Equity
Resources
Resources
to use to
generate
revenues
Sources of Financing
=
Creditors’
claims
against
resources
+
Owners’
claims
against
resources
Sample Balance Sheet
Assets
Liabilities
Cash
$ 40 Accounts payable
Accounts receivable 100 Notes payable
Land
200
Total assets
Must
Equal
$340
Owners’ Equity
Capital stock
Retained earnings
Total liabilities
and owners’ equity
$ 50
150
$200
$100
40
$140
$340
What Are Classified and
Comparative Balance Sheets?
Describe Three Balance Sheet
Limitations.
Learning Objective 2
Understand the
elements and
uses of the
Income
Statement
The Income Statement
Revenues
Assets (cash or AR)
created through
business
operations
Sometimes
Expenses
referred to
Assets (cash
as a or AP)
consumed through
Statement
of
business
operations
Earnings
Net Income
or (Net Loss)
Revenues - Expenses
Shows the results of a
company’s operations
over a period of time.
• What goods were sold or
services performed that
provided revenue for the
company?
• What costs were incurred in
normal operations to
generate these revenues?
• What are the earnings or
company profit?
Sample Income Statement
The Example Company
Income Statement
For the years ended 2006 and 2005
Revenues:
Sales
Other revenue
Total revenues
Expenses:
Cost of goods sold
Operating & admin.
Income tax
Total expenses
Net Income
2006
2005
$100
30
$130
$ 85
15
$100
$ 62
16
20
$ 98
$ 32
$ 58
12
18
$ 88
$ 12
How Do You Calculate
Earnings Per Share?
Earnings per share (EPS):
Statement of Retained Earnings
Beginning retained earnings
+ Net income
– Dividends paid
= Ending retained earnings
An additional
financial statement
that identifies
changes in retained
earnings from one
accounting period to
the next.
Dividends result in:
Net income results in:
Decrease in net assets
Increase in net assets
Increase in retained earnings Decrease in retained earnings
Decrease in owners’ equity
Increase in owners’ equity
Learning Objective 3
Understand the
categories and
uses of the
Statement of
Cash Flows and
see how the
financial
statements tie
together.
Statement of Cash Flows
Statement of Cash Flows
Cash inflows
Sell goods or services.
Sell other assets or by
borrowing.
Receive cash from
investments by owners.
Cash outflows
Pay operating expenses.
Expand operations, repay
loans.
Pay owners a return on
investment.
Reports the amount of cash
collected and paid out by a
company in operating,
investing, and financing
activities.
How did the company
receive cash?
How did the company
use its cash?
Name The Primary Activities
On A Statement Of Cash
Flows?
Statement of Cash Flows
Operating
Activities
Investing
Activities
Financing
Activities
Investing
Activities
Financing
Activities
CASH
INFLOWS
CASH
OUTFLOWS
Operating
Activities
Sample Statement of Cash
Flows
The Example Company
Statement of Cash Flows
December 31, 2006
Cash Flows From Operating Activities:
Receipts
48
Payments
(43)
5
Cash Flows From Investing Activities:
Receipts
0
Payments
(4)
(4)
Cash Flows Used By Financing Activities:
Receipts
10
Payments
(6)
4
Net Cash Flow
5
Financial Statements Tying
Together Is Called?
Financial Statement Articulation
Cash Flow Statement
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
Balance Sheet 12/31/02
Cash
Other
Total
$
80,000
4,550,000
$4,630,000
Income Statement
Revenues $12,443,000
Expenses
11,578,400
Net income $ 864,600
Liabilities $2,970,000
Stmt of Retained Earnings
Cap. stock 900,000
R/E
760,000
R/E 12/31/02 $ 760,000
Total
$4,630,000
Net income
864,600
Dividends
(400,000)
R/E 12/31/03 $1,224,600
Balance
Sheet 12/31/03
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
Learning Objective 4
Recognize the need for
financial statement
notes and identify the
types of information
included in the notes.
Notes to the Financial
Statements
What are the four general types?
Learning Objective 5
Describe the
purpose of an
audit report and
the incentives the
auditor has to
perform a good
audit.
The Audit Report
CPA firms have economic incentives
to perform credible audits.
• Reputation
• Lawsuits
Owners and managers want the
most favorable results possible.
• Bank credit
• Bonuses
• Public stock price
The Audit Report
• Issued by independent CPA firms.
• CPAs attest to conformity with GAAP.
• Financial
statements are the
responsibility of
the company’s
management and
not the CPA.
Learning Objective 6
Explain the
fundamental
concepts and
assumptions that
underlie financial
accounting.
Accounting Model
The basic accounting assumptions,
concepts, principles, and procedures
that determine the manner of
recording, measuring, and reporting a
company’s transactions.
What Are The Fundamental
Concepts and Assumptions?
Describe the Separate Entity
Concept.
What Is An Arm’s-Length
Transaction?
What Is Meant By The Cost
Principle?
What Is The Monetary
Measurement Concept?
What Do We Mean By The Going
Concern Assumption?
“If You Always Do What You
Always Did, You Always Get
What You Always Got.”
W. Edward Deming
End Chapter 2