1. Financial Statements Income Statement Balance Sheet
Contain primarily historical Information
Income Statement
Revenue (-) Expenses = Net Income
Balance Sheet
Assets, liabilities & owners’ equity
Statement of retained earnings
Cumulative sum of undistributed profits
Statement of cash flows
Operating, Investing and Financing activities
Footnotes
Significant accounting policies, estimates, etc.

2. Income Statement Learning about earnings, the bottom line,
Is very important most of the time.
A phony number
Just may encumber
Those folks trying to make more than a dime.
--A. Ormiston
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3. Income Statement
Income statement measures the “performance” of a company over a period of time
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4. The Income Statement Also called the Statement of Earnings Presents:
Revenues
Expenses
Net Income
Earnings Per Share
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5. The Income Statement Revenues
--a measure of economic benefits generated by the sale of products or providing of services over a period of time
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6. The Income Statement Expenses
--a measure of economic sacrifices incurred to “earn” the revenues of a given period
Examples of expenses
--cost of inventory sold, salaries to employees, rent and lighting, advertising,
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7. The Income Statement Net income = revenues (-) expenses
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8. The Income Statement Continued
Comes in two basic formats
Multiple-step
Single-step
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9. The Income Statement Continued
Multiple-step
Provides several intermediate profit measures prior to the amount of net earnings for the period:
Gross profit
Operating profit
Earnings before income tax
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10. The Income Statement Continued
Single-step
Groups all items of revenue together, then deducts all categories of expense to arrive at a figure for net income
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11. The Income Statement Continued
Regardless of format, certain special items, if they occur during an accounting period, must be disclosed separately on an income statement
These include. . .
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12. The Income Statement Continued
Discontinued operations
Extraordinary transactions
Cumulative effect of changes in accounting principles
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13. Net Sales
Sales are generally reported net of sales returns and sales allowances
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14. Net Sales Continued A sales return is a cancellation of a sale
A sales allowance is a deduction from the original sales invoice price
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15. Cost of Goods Sold (COGS)
Cost to seller of products sold to customers
Important for profit determination
Is largest expense item for may firms
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16. Gross Profit First step of profit measurement
Difference between net sales and COGS
Key analytical tool in assessing a firm’s operating performance
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17. Operating Expense
Have considerable impact on the firm’s current and future profitability
Important to track carefully--trends, absolute amounts, relationship to sales, relationship to industry competitors
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18. Operating Expense Continued
Examples:
Selling and administrative
Advertising
Depreciation and amortization
Repairs and maintenance
Operating lease payments
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19. Depreciation and Amortization
Used to allocate the cost of tangible fixed assets such as:
Buildings
Machinery
Equipment
Furniture
Motor Vehicles
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20. Depreciation and Amortization Con’t.
Amortization is the process applied to:
Capital leases
Leasehold improvements
Cost of expiration of intangible assets
Patents
Copyrights
Trademarks
Licenses
Franchises
Goodwill
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21. Depreciation and Amortization Con’t.
The amount of expense recognized in any accounting period will depend on the level of investment in the relevant asset; estimates with regard to the asset’s service life and residual value; and for depreciation, the method used
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22. Operating Profit Also called EBIT—Earnings Before Interest and Taxes
Measures overall performance of company’s operations: sales revenue less expenses associated with generating sales
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23. Other Income (Expense)
Includes
Revenues/expenses other than from operations
Dividend and interest income
Interest expense
Investment gains/losses
Equity earnings/losses
Sales of fixed assets gains/losses
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24. Equity Earnings
Two methods may be used to account for investments in other companies
Equity
Cost
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25. Equity Method
Allows the investor proportionate recognition of the investee’s net income, irrespective of the payment or nonpayment of cash dividends
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26. Cost Method
The investor recognizes investment income only to the extent of any cash dividends received
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27. Cost vs. Equity
Analysts, however, should be aware of whether a company uses the cost or the equity method
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28. Cost vs. Equity Continued
Equity earnings distorts earnings in the sense that income is recognized even though no cash may ever be received
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29. Earnings Before Income Taxes
Profit recognized before deduction of income tax expense
Remember, income taxes paid may differ from income tax expense (deferred taxes)
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30. Special Items
Are often one-time items that will not recur in the future
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31. Special Items Continued
If companies are affected by the following three items, they must be disclosed separately on the income statement, net of income tax effects:
Discontinued operations
Extraordinary items
Cumulative effect of accounting changes
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32. Discontinued Operations
Occur when a firms sells a major portion of its business
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33. Extraordinary Gains and Losses
Are items that meet two criteria:
Unusual in nature
Not expected to recur in the foreseeable future, considering the firm’s operating environment
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34. Cumulative Effect of Accounting Changes
Is disclosed when a firm changes an accounting policy
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35. Net Earnings Also called the “bottom line”
Represents the firm’s profit after consideration of ALL revenue and expenses
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36. Earnings Per Common Share
Is the net earnings available to common stockholders for the period divided by the average number of common stock shares outstanding
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37. The Balance Sheet “Old accountants never die;
they just lose their balance”
--Anonymous
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38. What is a Balance Sheet? Financial Condition
Also called the statement of condition or statement of financial position
Shows the financial condition or financial positions of a company on a particular date
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39. Financial Condition Continued
Assets =
Liabilities + Stockholders’ equity
Assets = What the firm owns
Liabilities = What the firm owes to outsiders
Stockholder’s equity = Internal owners
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40. Some General Parameters
Financial statements are often CONSOLIDATED
Balance sheet is DATED (end of accounting period): calendar year or fiscal year or interim period
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41. More General Parameters
Some COMPARATIVE DATA is presented (e.g. balances for end of previous year shown on balance sheet)
Balance sheet is prepared on a specific date
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42. Assets (the “left” side)
Generally presented in order of liquidity
Common Balance Sheet Accounts—Assets
Current Assets
Cash and Marketable Securities
Account Receivables
Inventories
Prepaid Expenses
Property, Plant, and Equipment
Other Assets
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43. Some Definitions
Current Assets--Cash or assets expected to be converted to cash within one year or operating cycle, whichever is longer
Operating Cycle--Time required to purchase or manufacture inventory, sell the product, and collect the cash
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44. Another Definition
Working Capital (Net working capital)—designates the amount by which current assets exceed current liabilities
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45. Cash and Marketable Securities
Cash in any form—cash awaiting deposit or in a back account
Generally includes currency, coin, balances in checking and other demand or “near demand” accounts
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46. Cash and Marketable Securities continued
Are cash substitutes
Not needed immediately in the business
Temporarily invested to earn a return
May include T-bills, certificates, notes, bonds, CD’s and commercial paper
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47. Accounts Receivable Arise from credit-sale transactions
Reported on the balance sheet at
NET REALIZABLE VALUE
Net Realizable Value =
Accounts Receivable
-Allowance for Doubtful Accounts
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48. Inventories
Are items held for sale or used in the manufacture of products that will be sold
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49. Inventories Continued
Retail Company
One type of inventory: Finished goods
Manufacturing Company
Three types of inventories:
Raw materials
Work-in-process
Finished goods
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50. Prepaid Expenses
Represent expenses paid in advance included in current assets if they expire within one year or operating cycle
Usually not a material item
Present few or no reporting or valuation issues
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51. Property, Plant, and Equipment (PP&E)
Encompasses a company’s fixed assets
Also called tangible, long-lived, and capital assets
Fixed assets other than land, are “depreciated” over the period of time they benefit the firm
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52. Property, Plant, and Equipment (PP&E) Continued
On any balance sheet date, PP&E is shown at book value
Book value = difference between original cost and any accumulated depreciation to date
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53. Property, Plant, and Equipment (PP&E) Continued
Depreciation methods:
Straight line spreads the expense evenly by periods
Accelerated Yields higher depreciation expense in the early years of an asset’s useful life, and lower depreciation expense in the later years
Units of production bases depreciation expense for a given period on actual use   
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54. Other Assets
Can include multitude of other noncurrent items, for example:
Property held for sale
Start-up costs in connections
with a new business
Cash surrender value of life insurance policies
Long-term advance payments
Long-term investments
Intangible assets
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55. Other Assets—Intangible
Goodwill
Most important for analytical purposes
Arises when one company acquired another company for a price in excess of the fair market value of the net identifiable assets acquired
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56. Goodwill Continued
Beginning in 2002, companies will evaluate goodwill and determine whether it has lost value
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57. Current Portion of Long-Term Debt
Liabilities
Represent claims against assets
Current Liabilities include:
Accounts Payable
Notes Payable
Current Portion of Long-Term Debt
Accrued Liabilities
Unearned Revenue
Deferred Taxes
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58. Liabilities Continued
Accounts Payable
Short-term obligations that arise from credit extended by suppliers for the purchase of goods and services
Account is eliminated when the bill is satisfied
Significant changes from period to period often result from changes in sales volume
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59. Liabilities Continued
Notes Payable
Short-term obligations in the form of promissory notes to suppliers or financial institutions
Reflect the amount extended under a line of credit
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60. Liabilities Continued
Current Maturities of Long-Term Debt
When a firm has bonds, mortgages, or other forms of long-term debt outstanding, the portion of the principal that will be repaid during the upcoming year is classified as a current liability
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61. Liabilities Continued
Accrued Liabilities
Result from accrual basis of accounting
Represent expenses that have been INCURRED and thus ACCRUED, but have NOT BEEN PAID in cash
In this case, cash flow follows expense recognition
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62. Long-Term Debt Obligations with maturities beyond one year
Capital Lease Obligations
Postretirement Benefits Other Than Pensions
Commitments and Contingencies
Hybrid Securities
Obligations with maturities beyond one year
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63. Long-Term Debt Continued
Capital Lease Obligations
Are, in substance, a “purchase” rather than a “lease”
Affect both balance sheet and income statement
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64. Stockholders’ Equity
Ownership equity is the residual interest in assets that remains after deducting liabilities
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65. Stockholders’ Equity Continued
Common Stock
Shareholders:
Do not ordinarily receive a fixed return
Have voting privileges in proportion to ownership interest
Dividends are declared at the discretion of a company’s board of directors
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66. Stockholders’ Equity Continued
Additional Paid-In Capital
Reflects the amount by which the original sales price of the stock shares exceeded par value
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67. Stockholders’ Equity Continued
Retained Earnings
Is the sum of every dollar a company has earned since its inception, less any payments made to shareholders in the form of cash or stock dividends
Beginning retained earnings ± Net income (loss) – Dividends = Ending retained earnings
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68. Stockholders’ Equity Continued
Other Equity Accounts
Other accounts that can appear in the equity section are:
Preferred stock
Treasury stock
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69. Emily’s Bakery (1)Emily contributes $10,000 in cash
Assets = Liabilities + Owners’ Equity
Cash Contributed Capital
+$10, $10,000
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70. Transactions and the Accounting Equation
Emily’s Bakery
Cash + A/R + Equip. =L/P + C. Cap.+ R/E
+10, ,000
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71. Emily’s Bakery (2) The company borrows $3,000 from a bank
Assets = Liabilities + Owners’ Equity
Cash Loans Payable
+$3, $3,000
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72. Transactions and the Accounting Equation
Emily’s Bakery
Cash + A/R + Equip. =L/P + C. Cap.+R/E
+10, ,000
+ 3, ,000
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73. Emily’s Bakery (3) Company purchases equipment for $5,000 cash
Assets = L + OE
Cash Equipment
-$5,000 +$5,000
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74. Transactions and the Accounting Equation
Emily’s Bakery
Cash + A/R + Equip. =L/P + C. Cap.+R/E
+10, ,000
+ 3, ,000
- 5, ,000
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75. Emily’s Bakery
(4) Company performs service for $12,000. The customer pays $8,000 in cash and promises to pay the balance at a later date.
Assets = L + Owners’ Equity
Cash Receivables Retained Earnings
+$8, , $12,000
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76. Transactions and the Accounting Equation
Emily’s Bakery
Cash + A/R + Equip. =L/P + C. Cap.+R/E
+10, ,000
+ 3, ,000
- 5, ,000
+ 8, , ,000
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77. Emily’s Bakery
(5) Company pays $9,000 for expenses (wages, interest, and maintenance)
Assets = Liabilities + Owners’ Equity
Cash Retained Earnings
-$9, $9,000
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78. Transactions and the Accounting Equation
Emily’s Bakery
Cash + A/R + Equip. =L/P + C. Cap.+R/E
+10, ,000
+ 3, ,000
- 5, ,000
+ 8, , ,000
- 9, ,000
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79. Emily’s Bakery (6) Company pays dividend of $1,000
Assets = Liabilities + Owners’ Equity
Cash Retained Earnings
-$1, $1,000
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80. Transactions and the Accounting Equation
Emily’s Bakery
Cash + A/R + Equip. =L/P + C. Cap.+R/E
+10, ,000
+ 3, ,000
- 5, ,000
+ 8, , ,000
- 9, ,000
- 1, ,000
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81. Balance Sheet as at December 31, 2006
Assets Amount Liability and Amount
Owner’s Equity
Cash 6, Loans Payable ,000
Receivables 4,000 Contributed Capital 10,000
Equipment 5,000 Retained Earnings 2,000
Total Total Liabilities and
Assets $15, Owners ’Equity $15,000
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82. Transactions and the Accounting Equation
Emily’s Bakery
Cash + A/R + Equip. =L/P + C. Cap.+R/E
+10, ,000
+ 3, ,000
- 5, ,000
+ 8, , ,000
- 9, ,000
- 1, ,000
6, , , , ,000+ 2,000
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83. Income Statement For the year ended December 31, 2006
Revenues: Fees earned for service $12,000
Expenses: Wages, interest, maintenance $ 9,000
Net income $ 3,000
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84. Summary Balance sheet Listing of
-Resources owned by a firm (assets or investments)
-Financing of the assets through obligations to external parties (liabilities)
-Financing of the investments through residual claimants (shareholders’ equity)
Preparing a balance sheet (and other financial statements) using transaction history
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