1-1 Chapter 1 Financial Statements: An Overview Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall

1-2 Map or Maze A map helps its user reach a desired destination through clarity of representation. A maze attempts to confuse its user by purposefully introducing conflicting elements and complexities that prevent reaching the desired goal. Financial statements have the potential for being both map and maze. Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall 1-2

1-3 Financial Statements as a Map Form the basis for understanding the financial position of a firm Allow users to assess historical and prospective financial performance Present clear representations of a firm’s financial health Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall 1-3

1-4 Financial Statements as a Maze Overwhelming amount of information Unreliable auditing Constantly changing and complex policies and reporting requirements Considerable discretion given to management Key information hidden or omitted Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall 1-4

1-5 Map or Maze The main objectives of this book are to: ensure that financial statements serve as a map, not a maze, demonstrate how to read and evaluate financial statements, provide the tools and techniques needed to complete a comprehensive financial statement analysis, and encourage intelligent decision making. Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall 1-5

1-6 Map or Maze Usefulness of Information Financial position Success of operations Policies and strategies of management Insight into future performance Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall 1-6

1-7 Map or Maze Volume of Information Financial statements Notes to the financial statements Auditor’s report Five-year summary of key financial data High and low stock prices Management’s discussion and analysis of operations Other material Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall 1-7

1-8 Map or Maze Volume of Information Generally accepted accounting principles (GAAP) Securities and Exchange Commission (SEC) Financial Accounting Standards Board (FASB) International Accounting Standards Board (IASB) Issues Statements of Financial Accounting Standards (SFASs) Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall 1-8

1-9 Map or Maze Volume of Information Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall 1-9

1-10 Map or Maze Where to Find a Company’s Financial Statements Form 10-K  Filed annually with the SEC  Same order for all filing companies  Electronic Data Gathering, Analysis, and Retrieval (EDGAR) Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall 1-10

1-11 Map or Maze Where to Find a Company’s Financial Statements Annual report  Financial statements  Public relations material  Sent to shareholders and prospective investors Corporate website Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall 1-11

1-12 Map or Maze The Financial Statements Balance sheet (or statement of financial position) Income statement (or earnings statement) Statement of stockholders’ equity Statement of cash flows Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall 1-12

1-13 Map or Maze Notes to the Financial Statements Integral part of the statements Summary of the firm’s accounting policies Details about particular accounts Other supplementary information Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall 1-13

1-14 Map or Maze Auditor’s Report Attests to the fairness of the presentation of financial statements Sarbanes-Oxley (SOX) Act of 2002 Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall 1-14

1-15 Map or Maze Auditor’s Report Types of reports  Unqualified reports  Qualified reports  Adverse opinion  Disclaimer of opinion  Unqualified opinion with explanatory language Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall 1-15

1-16 Map or Maze Financial Reporting Reforms SOX Title I – Public Company Accounting Oversight Board (PCAOB) SOX Title II – prohibits nonaudit services during an external audit SOX Titles III and IV – corporate responsibility SOX Title IX – harsh penalties for violations Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall 1-16

1-17 Map or Maze Management Discussion and Analysis (MD&A) Sometimes labeled financial review Coverage of favorable or unfavorable trends, events, and/or uncertainties in areas of liquidity Capital resources Results of operations Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall 1-17

1-18 Map or Maze Management Discussion and Analysis (MD&A) Companies do a good job of describing historical events. Very few firms provide accurate and meaningful forecasts Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall 1-18

1-19 Map or Maze Five-year Summary of Selected Financial Data and Market Data Net sales or operating revenues Income or loss from continuing operations per common share Total assets Long-term obligations and redeemable preferred stock Cash dividends per common share Two years of high and low common stock price by quarter Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall 1-19

1-20 Map or Maze Pandora (a.k.a. “PR Fluff”) Colored photographs Charts Shareholders’ letter from the CEO Other items to make the report attractive Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall 1-20

1-21 Map or Maze Proxy Statement Used to solicit shareholder votes Important in assessing  who manages the firm  how management is paid  conflict of interest issues Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall 1-21

1-22 Map or Maze Missing and Hard-to-Find Information Employee relations with management Morale and efficiency of employees Reputation of the firm Firm’s prestige in the community Effectiveness of management Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall 1-22

1-23 Map or Maze Missing and Hard-to-Find Information Provisions for management succession Potential exposure to regulation changes Publicity in the media Companies operating in several lines of unrelated business Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall 1-23

1-24 Complexities Accounting Choices Management discretion in application of regulations Differing accounting methods Financial data appropriated to particular time periods Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall 1-24

1-25 Complexities Anticipated Changes due to FASB/IASB joint projects Anticipated changes in several areas  Lease accounting  Classification of financial instruments  Inventory accounting  Revenue recognition  Reformatting of financial statements Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall 1-25

1-26 Quality of Financial Reporting Many opportunities for management to affect quality Timing of revenue and expense recognition Discretionary items Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall 1-26

1-27 The Journey Through the Maze Continues Chapter 2 – The Balance Sheet Chapter 3 – Income Statement and Statement of Stockholders’ Equity Chapter 4 – Statement of Cash Flows Chapter 5 – The Analysis of Financial Statements Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall 1-27

1-28 Copyright Notice All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher. Printed in the United States of America. Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall 1-28