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 Chapter 2 Financial Statements: An Overview Albrecht, Stice, Stice, Swain

2 Primary Financial Statements The Balance Sheet (Statement of Financial Position) Income Statement (Statement of Earnings) Statement of Cash Flows

3 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

4 Accounting Equation Assets = Liabilities + Owners’ Equity Sources of Financing Creditors’ claims against resources =+ Owners’ claims against resources Resources to use to generate revenues

5 Assets Cash $ 40 Accounts receivable 100 Land 200 Total assets$340 Liabilities Accounts payable $ 50 Notes payable 150 $200 Owners’ Equity Paid-in Capital $100 Retained earnings 40 $140 Total liabilities and owners’ equity $340 Sample Balance Sheet Must Equal

6 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.

7 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

8 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

9 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.

10 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

11 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

12 Financial Statement Articulation Revenues $12,443,000 Expenses 11,578,400 Net income $ 864,600 Income 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 Cash Flow Statement R/E 12/31/08 $ 760,000 Net income 864,600 Dividends (400,000) R/E 12/31/09 $1,224,600 Stmt of Retained Earnings Cash $ 110,000 Other 4,975,000 Total $5,085,000 Liabilities $2,860,400 Cap. stock 1,000,000 R/E 1,224,600 Total $5,085,000 Balance Sheet 12/31/09 Balance Sheet 12/31/08 Cash $ 80,000 Other 4,550,000 Total $4,630,000 Liabilities $2,970,000 Cap. stock 900,000 R/E 760,000 Total $4,630,000

13 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).

14 External Audits Audit Report –Issued by an independent CPA firm. –Verifies financial statements have been prepared according to GAAP.

15 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

16 Going Concern Assumption Monetary Measurement Concept Arm’s-Length Transactions Cost Principle Separate Entity Concept What Are the Fundamental Concepts and Assumptions?