Lesson 9
Financial Statements
Task Team of
FUNDAMENTAL ACCOUNTING
School of Business, Sun Yat-sen University
Outlines
•
•
•
•
•
A General View of Financial statements
Income statement
Balance sheet
Statement of owners’ equity
A Simple Illustration
2
Opening Story
Cuba Gooding Jr. uttered an immortal line
in the movie Jerry Maguire, “Show me the
money!” Well, that is what financial
statements do. They show you the money.
• The questions are:
– Do they show you where a company’s money came from?
– Do they show you where it went, and where it is now.
– How accountants make all these ends satisfied?
3
General View of Financial statements:
GAAP
• Statement of Financial Position (Balance
Sheet).
• Income Statement.
• Statement of Cash Flows.
4
General View of Financial statements:
Stock vs. Flow
• Stock/ resources and obligations at a point in
time:
– Balance sheet.
• Flow/activity over a period of time:
– Income statement.
– Statement of cash flows.
5
Financial Statement Objectives
• Useful for investment decisions. (All financial
statements)
• Comprehensible. (All financial statements)
• About economic resources and claims on resources
(Balance Sheet).
• About financial performance during a period
(Income Statement).
• About cash flows (Statement of Cash Flows).
6
General View of Financial statements: a
Comparison
Income
Statement
Beginning
Balance
Sheet
Statement of
Owner’s Equity
Ending
Balance
Sheet
Statement of
Cash Flows
Point in time
Period of time
7
Point in time
General View of Financial statements:
Brief Comments
The financial statements are a picture
of the company in financial terms.
Each financial statement relates to a specific
date or covers a particular period.
8
Information Disclosed on Financial
Statements
Question
Answer
Financial
Statement
1. How well did the
company perform
(or operate) during
the period?
Revenues
– Expenses
Net income (Net loss)
2. Why did the company’s
retained earnings
change during the
period?
Beg. retained earnings
+ Net income (or – Net loss)
Ending retained earnings
9
Income
statement
Statement of
Retained earnings
Information Disclosed on Financial
Statements (cont)
Question
Answer
3. What is the company’s
financial position at the
end of the period?
4. How much cash did
the company generate
and spend during
the period?
Assets
= Liabilities
+ Owners’ equity
Operating cash flows
± Investing cash flows
± Financing cash flows
Increase or decrease in cash
10
Financial
Statement
Balance
sheet
Statement
of
cash
flows
Income Statement
• Also called: Profit & Loss statement = P&L
statement = statement of earnings =
statement of operations
• Technically subordinate to BS.
– Shows detail of changes to RE.
• Many investors consider IS more important
than BS.
• Variations in format.
11
Parts of Income Statement
•
Heading:
1. Name of entity.
2. Name of statement
3. Time period covered.
•
•
•
•
•
Revenues.
Cost of Sales.
Gross Margin.
Expenses.
Net Income
12
Revenues in
Income Statement
• Several separate revenue items or net.
• Net sales = gross sales - sales returns and
allowances - sales or cash discounts.
– Trade discounts not shown.
– Excludes sales or excise taxes collected for government.
– Other revenues (from activities not associated with sales
of entity’s goods/services) may be included in net sales
or shown separately.
13
Expenses on
Income Statement
• Cost of Sales (or cost of goods sold).
– Associated with a decrease in the asset inventory.
• Gross margin = gross profit = Sales - COGS.
– May or may not be shown.
• Separate disclosure of:
– Research & development expenses.
– Interest expense.
14
Income Statement Format
• Operating income may be shown before
Other income and expense.
• Net income = Income before taxes – Income
tax expense.
• Income before taxes = Operating income
adjusted for other revenues and expenses.
15
Example of Income Statement
Inflows of assets
in exchange for
products and
services
provided to
customers.
Finlay Interiors
Income S tatement
For Month Ended January 31, 2011
Revenues:
Consulting revenue
Rental revenue
Total revenues
Operating Expenses:
Rent expense
$ 1,000
S alaries expense
700
Total operating expenses
Net income
16
$ 3,800
300
$ 4,100
1,700
$ 2,400
Example of Income Statement (cont)
Finlay Interiors
Income S tatement
For Month Ended January 31, 2011
Outflows or
the using
up of assets
that result
from providing
products
and services to
customers.
Revenues:
Consulting revenue
Rental revenue
Total revenues
Operating Expenses:
Rent expense
$ 1,000
S alaries expense
700
Total operating expenses
Net income
17
$ 3,800
300
$ 4,100
1,700
$ 2,400
Example of Income Statement (cont)
Finlay Interiors
Income S tatement
For Month Ended January 31, 2011
Revenues > Expenses
Net Income
Revenues < Expenses
Net Loss
Revenues:
Consulting revenue
Rental revenue
Total revenues
Operating Expenses:
Rent expense
$ 1,000
S alaries expense
700
Total operating expenses
Net income
18
$ 3,800
300
$ 4,100
1,700
$ 2,400
Balance Sheet
• Point in time or status report.
• More formally, Statement of Financial
Position.
• Contains (and shows equality of amounts of):
– Assets.
– Liabilities and Owners’ equity.
19
Beauty Photo Store:
Balance Sheet
Beauty Photo Store
Balance Sheet
January 31,2011
Assets
Cash
Supplies
Equipment
$
Liabilities
8,400
3,600
26,000
Accounts payable
Notes payable
Total liabilities
$
$
200
6,000
6,200
Owner's Equity
Total assets
$
38,000
Wang Fang, capital
Total liabilities and
owner's equity
20
31,800
$
38,000
Assets
• Assets are properties or economic resources
owned by a business
• They are expected to provide future benefits
to the business.
21
Liabilities
• Liabilities are obligations of the business.
• They are claims against the assets of the
business.
22
Equity
• Equity is the owner’s claim on the assets of
the business.
• It is the residual interest in he assets of the
business after deducting liabilities
23
An Illustration of Balance Sheet
Amounts in millions
Assets:
Current assets:
Cash and cash equivalents
Short-term investments
Accounts receivable
Inventories
Prepaid expenses
Total current assets
Investments
Property, plant, and equipment, net
Intangible and other assets
Total assets
24
December 31,
2011
2010
$ 68
5
74
104
19
$270
1
90
20
$381
$ 80
11
63
81
18
$253
6
42
7
$308
An Illustration of Balance Sheet (cont)
Amounts in millions
Liabilities:
Current liabilities:
Notes payable, short-term
Accounts payable
Advertising payable
Compensation (salary) payable
Other accrued expenses payable
Income taxes payable
Total current liabilities
Long-term liabilities
Total liabilities
25
December 31,
2011
2010
$ 16
21
15
8
28
18
$106
11
$117
$ 5
19
14
6
19
20
$ 83
4
$ 87
An Illustration of Balance Sheet (cont)
December 31,
2011
2010
Amounts in millions
Stockholders’ equity:
Common stock
Retained earnings
Other equity
Total stockholders’ equity
$ 16
252
(4)
$264
$ 15
208
(2)
$221
Total liabilities and stockholders’ equity
$381
$308
26
An Illustration of Balance Sheet (cont)
2011
Total assets
$381
= Total liabilities
Current
$106
Long-term
11
Total liabilities
117
+ Total stockholders’ equity
264
Total liabilities and stockholders’ equity $381
27
Must
equal
Flow Statements
• Explains changes between the dates of the
two balance sheet snapshots.
• 2 types of flow statements:
– Income statement (and related statement of
retained earnings).
• Reconciles change in RE.
– Statement of Cash Flows.
• Reconciles changes in cash.
28
Statement of Cash Flows
• Accounts provide information summarized in
balance sheet and income statement.
• Third statement required by GAAP.
• Does not affect the way transactions are
recorded.
• Derived from data reported in other financial
statements.
29
The Statement of Cash Flows
The statement of cash flows reports
the company’s cash inflows and
outflows from operating, investing,
and financing activities.
30
Statement of cash flows
• Provides info about cash flows associated
with the period’s operations and investing
and financing activities.
• Numbers on cash flow statement are
objective: cash is cash.
• Eliminates judgments and estimates involved
with accrual accounting and the income
statement and balance sheet.
31
Statement of Cash Flows:
2 Categories of Activities
• Sources = activities that
generate cash.
• Uses = activities that
involve spending cash
32
Sources
•
•
•
•
•
Operations.
New borrowings.
New stock issues.
Sale of property, plant, and equipment.
Sale of other non-current assets.
33
Uses
•
•
•
•
•
Cash dividends.
Repayment of borrowings.
Repurchase of stock.
Purchase of property, plant, and equipment.
Purchase of non-current assets.
34
Illustration:
Statement of Cash Flows
Amounts in millions
Operating activities:
Net income
Adjustments to reconcile net income
to net cash from operating activities
Net cash provided by operating activities
35
December 31,
2011
2010
$44
$56
5
$49
(16)
$40
Illustration (cont):
Statement of Cash Flows
Amounts in millions
December 31,
2011
2010
Investing activities:
Business acquisitions
Additions to property, plant, and equipment
Sale of investments
Other investing activities
Net cash used for investing activities
$(16)
(56)
6
(2)
$(68)
36
(2)
(20)
–
(2)
$(24)
Illustration (cont):
Statement of Cash Flows
December 31,
2011
2010
Amounts in millions
Financing activities:
Issuance of common stock
Purchase and retirement of common stock
Issuance of notes payable (borrowing)
Other financing activities
Net cash provided by financing activities
37
$3
(4)
9
(1)
$7
$ 1
(28)
–
–
$(27)
Illustration (cont):
Statement of Cash Flows
December 31,
2011
2010
Amounts in millions
Net increase in cash and cash equivalents
Cash and cash equivalents,
beginning of year
Cash and cash equivalents, end of year
38
$(12)
$(11)
80
$ 68
91
$ 80
Statement of owner’s equity
• The statement of owner’s equity reports on changes
in equity over the reporting period.
• Start with beginning equity
• Adjust for events :
– Increase:
• Investments by owner
• Net income
– decrease:
• Owner withdrawals
• Net loss
39
Two Categories of
Shareholders’ Equity
• Paid-in or contributed capital.
• Retained earnings.
40
Balance Sheet and
Changes in Equity
Owner’s
Withdrawal
Owner’s
Investment
Owner’s
Equity
Revenues
Expenses
41
Beauty Photo Store:
Statement of Owner’s Equity
Beauty Photo Store
Statement of Owner's Equity
For month ended January 31,2011
wang Fang, capital, January 1
Add:
Investment by owner
$
Net income
Total
Less: Withdrawal by owner
Wang Fang, capital, January 31
$
-
$
32,400
32,400
600
31,800
30,000
2,400
42
Summary
• There are two major types of financial
statements-stock reports and flow reports
• Financial statement can serve as an
important device to disclose information to
investors in order for them to make better
decisions
• Four major financial statements are
compared, explained and illustrated in this
lesson
43
Case for Open Discussion
• The financial statement sits imposingly in front of
you, a stream of numbers rolling endlessly down
the page.
• You are a new board member, studying the
numbers, hoping to decipher their meaning. Then
you are hit with the accounting jargon: balance
sheets and income statements; cash basis and
accrual basis. You think you hear the financial
statements quietly laugh at you, and you
begin to wonder if the board should hire
a psychiatrist instead of an accountant.
44
Suggested Questions
• How are financial statements prepared?
• Do they make things simpler?
• What information can we infer from these
statements?
• How can we make use of them?
• etc…
45
The End of Lesson 9