Chapter 2 Financial Statements and the Annual Report Financial Accounting: The Impact on Decision Makers 6/e by Gary A. Porter and Curtis L. Norton Copyright © 2009 South-Western, a part of Cengage Learning.

Primary Objective of Financial Reporting Provide information for decision making Extend credit $$?? Loan $$?? Borrow $$?? Sell stocks or bonds?? Invest?? Start new business?? LO1 2 2

Secondary Objectives of Financial Reporting Reflect the company’s resources and claims to its Reflect prospective cash receipts to investors and creditors Reflect prospective cash flows to the company Assets = Liabilities + OE 2 2

Qualitative Characteristics Understandability – Relevance – Reliability – To those willing to take The time to understand it Has capacity to Make a difference Represents what it purports LO2 3 3 3

Qualitative Characteristics From one period to the next Comparability between companies Consistency From one period to the next 3 4 4

Qualitative Characteristics Materiality Will it make a difference To the decision maker? Conservatism All else equal, choose Least optimistic estimate 3 5 5

Basic Structure of a Classified Balance Sheet Current assets + Noncurrent (long-term) assets Total assets Current liabilities + Noncurrent (long-term) liabilities + Stockholders’ equity Total liabilities and stockholders’ equity LO3 5 7 7

Dixon Sporting Goods Balance Sheet A = L + SE Dixon Sporting Goods Balance Sheet Realized, sold, or consumed in one year or operating cycle A Assets Current assets Cash $ 5,000 Marketable securities 11,000 Accounts receivable 23,000 Merchandise inventory 73,500 Prepaid insurance 4,800 Supplies 700 Total current assets $118,000 Investments Land held for future expansion 150,000 Property, plant, and equipment Land $100,000 Buildings $150,000 Less: Accumulated depreciation (60,000) 90,000 Store furniture and fixtures $ 42,000 Less: Accumulated depreciation (12,600) 29,400 Total property, plant and equipment 219,400 Intangible assets Franchise agreement 55,000 Total assets $542,400

Dixon Sporting Goods Balance Sheet A = L + SE Satisfied within one year or operating cycle Liabilities and Stockholders’ Equity = L Current liabilities Accounts payable $ 15,700 Salaries and wages payable 9,500 Income taxes payable 7,200 Interest payable 2,500 Bank loan payable 25,000 Total current liabilities $ 59,900 Long-term debt Notes payable $ 120,000 Total liabilities $179,900 Contributed capital Capital stock, $10 par, 5,000 shares issued and outstanding $ 50,000 Paid-in capital in excess of par value 25,000 Total contributed capital $ 75,000 Retained earnings 287,500 Total stockholders' equity $ 362,500 + SE Total liabilities and stockholders’ equity $542,400

Of particular interest Analysis of Liquidity Of particular interest to bankers and other creditors Ability of company to pay debts as they become due Working Capital Current Ratio LO4 7 8 8

Dixon Sporting Good’s Liquidity What's the trend?? Current assets $2,000 Current liabilities 1,600 Working = Current Assets Capital (Current Liabilities) $58,100 Current = Current Assets Ratio Current Liabilities 1.97:1 8 9 9

Single-Step Income Statement Revenues $$ Less: expenses ($$) Net income $$ LO5 16 16

Multiple-Step Income Statement Three important subtotals Operating revenues Operating expenses: – General and administrative expenses – Selling expenses = Income from operations +/– Other revenues and expenses = Income before taxes – Income tax expense = Net income 6 13 13

Dixon Sporting Goods Multiple Step - Income Statement For the Year Ended December 31, 2008 Sales $357,500 Cost of Goods Sold 218,300 Gross Profit $139,200 Operating expenses: Selling expenses Depreciation on store furniture and fixtures $ 4,000 Advertising 13,750 Salaries and wages 22,000 Total selling expenses $ 39,950 General and administrative expenses Depreciation of buildings and amortization of trademark $ 6,000 Salaries and wages 15,000 Insurance 3,600 Supplies 1,050 Total general and administrative expenses 25,650 Total operating expenses 65,600 Income from operations $ 73,600 Other revenues and expenses: Interest revenue $ 1,500 Interest expense 16,900 Excess of other revenues over other expenses 15,400 Income before taxes $ 58,200 Income tax expense 17,200 Net income $ 41,000

Analysis of Profitability particular interest to current and potential investors Profit Margin % LO6 14 14

Dixon Sporting Goods– Profit Margin Profit Margin % = Net Income Operating Revenues Profit Margin % = $41,000 = 11% $357,500 (The amount of every sales dollar that results in income)

Statement of Retained Earnings Shows changes in the components of owners’ equity Net income (net loss) and Dividends Provides an important link between the income statement and the balance sheet Statement of Retained Earnings Beginning retained earnings Add: Net income Deduct: Dividends = Ending retained earnings LO7 19 19

Statement of Cash Flows Basic Format of the Statement of Cash Flows Cash flows from operating activities: $$ Cash flows from investing activities: Cash flows from financing activities: Net increase in cash $$ Cash at beginning of year $$ Cash at end of year $$ Reconciles change in cash for the period LO8 20 20

Statement of Cash Flows Basic Format for the Statement of Cash Flows Cash flows from operating activities: $$ Cash flows from investing activities: Cash flows from financing activities: Net increase in cash $$ Cash at beginning of year $$ Cash at end of year $$ Involves the purchase and sale of products or services Involves the acquisition and sale of long-term or noncurrent assets Involves the issuance and repayment of long-term liabilities and stock 20 20

Financial Statements for a Real Company: General Mills LO9

General Mills’s Liquidity (in millions) 2006 2007 Current assets $ 38,091 $ 46,572 Current liabilities 110,043 61,912 Working capital $ ( 2,962) $(1,129) Current ratio = 0.52:1 0.73:1 Current = Current Assets Ratio Current Liabilities (How many $ of current assets for every $ of current liabilities) 15 15

General Mills’s Profitability (in million’s) 2006 2005 2004 Net sales $ 11,640 $11,244 $11,070 Net income $ 1,090 $ 1,240 $ 1,055 Profit margin % = 9.4% 11.9% 9.5% Profit Margin % = Net Income Sales (How many cents on every $ of sales are left over after covering all expenses) 16 16

Other Elements of an Annual Report Letter to stockholders Description of company’s products and markets Financial statements Notes to financial statements Report of independent accountants Management discussion and analysis Summary of significant accounting policies 21 21

End of Chapter 2