1. FINANCIAL STATEMENT ANALYSIS
CONCEPTUAL FRAMEWORK

2. What are the Financial Statements?
Economic Events
Recognize
Classify
Report (Financial Statements)
Accounting Cycle Accounting is a system which identifies, collects, recognizes, classifies and reports the economic and financial events that an entity meets.

3. What are the Financial Statements?
Economic Events
Recognize
Classify
Report (Financial Statements)
According to accounting cycle, the procedures of accounting process starts with identifying and collecting economic events. After, the identified economic events are recorded in books (journal entries and ledgers). The recognized economic events are classified and accumulated in order to report the events in financial statements. This procedures ends with reporting activity.

4. The Meaning Financial Statements
Journal
Withdrawals
Revenue
Expense
Ledger
Post-Closing
Trial Balance
Income
Statement
Balance
Assets
Liabilities
Net Profit
- Expenses
Net Income/
or Loss
Assets = Liabilities
+ Net Worth
Closing entries are recorded in the Journal at the end of the accounting period.
Entries are then posted to Ledger Accounts.
Ledger accounts are then listed in the Post-Closing Trial Balance.
Then the Financial Statements are prepared.

5. Accounting Activities
Identifying Business Activities
Recording Business Activities
Communicating Business Activities
Not all transactions entered into by a business entity are capable of being recorded. Our first task as accountants is to identify those transactions that may be recorded in the accounting system. In recording business transactions, we must follow the rules of double-entry bookkeeping. We will spend a significant amount of time early in the course discussing in detail the rules of the accounting process. Next, we should follow standard formatting when reporting information to users outside the organization. External users include stockholders of the company, lenders, various governmental agencies, and others.

6. What do the Financial Statements Present?
Financial statements present the financial position and financial performance of an entity. The objective of financial statement is to provide useful financial information about the reporting business activities.

7. What are Business Activities
FINANCIAL STATEMENT ANALYSIS
What are Business Activities

8. Business Activities An entity has planning, financing, investing and
operating activities.
An entity performs these activities for producing/purchasing and selling goods and services and to yield a satisfactory return on investment.

9. Business Activities Planning Activities
A company has specific goals and strategies to gain profit from its activities.
A company plans expected opportunities (expected return, expected cash flow etc.) and obstacles (market risk, interest rate risk, inflation risk, political risks etc.).
The results of planning activity are directly reflected to financial statements.

10. Business Activities Planning Activities
For example; if an entity plans to invest than management must give a decision about capital structure.
If the proper decision is not made it reflects to entity’s expected return.

11. Business Activities
For example; if an entity plans to invest than management must give a decision about capital structure. If the proper decision is not made it reflects to entity’s expected return.
Income Statement
Sales
Cost of Goods Sold
Gross Profit/Loss
Operating Expenses
Operating Profit/Loss
Finance Income
Finance Expense
Profit/Loss of Current Period
Tax Expense
Net Profit/Loss of Current Period
Assets
Balance Sheet
Liabilities
Debt
Equity

12. Business Activities Financing Activities
A company needs financing in purchasing raw material plant and equipment and technology. In financing assets company use most common forms of financing; debt and equity. In debt financing, company promises to return the money with interest (principle and interest) at maturity date. For this reason, interest payments are defined as the cost of debt.
Income Statement
Sales
Cost of Goods Sold
Gross Profit/Loss
Operating Expenses
Operating Profit/Loss
Finance Income
Finance Expense
Profit/Loss of Current Period
Tax Expense
Net Profit/Loss of Current Period
Assets
Balance Sheet
Liabilities
Debt
Equity
Cost of Debt

13. Business Activities Financing Activities
Equity investors are the major supplier of company’s fund. Equity financing can be cash or any assets. Unlike debt financing, equity financing usually raises capital without incurring liabilities, but the risk of return (dividends) exists for the investor.
Except for the purpose of being partner, funds from shareholders’ can not be mentioned as equity. This kind of funds from shareholders are classified as debt (Debts from shareholders).
Assets
Balance Sheet
Liabilities
Debt
Loans
Debts from shareholders
Equity

14. Business Activities Investing Activities
Investing activities are the business activities that involve the acquiring and selling of long-term assets, the acquiring and selling of equity or debt securities other than trading. With financing activities company provides funds and with investment activities company invests the funds to the assets necessary for business activities. Investments include land, building, equipment (Property, Plant and Equipment (Maddi Duran Varlıklar)), patents, licenses, information systems and components (Intangible Assets (Maddi Olmayan Duran Varlıklar)).
Assets
Balance Sheet
Liabilities
Debt
Land
Property, Plant and Equipment
Loans
Debts from shareholders
Patents, liences etc.
Equity

15. Business Activities Operating Activities
Operating activities refers to the carrying out of the business plan. These activities contains five basic components:
Research,
Purchase,
Produce,
Marketing and
Labor.
Operating activities are the primary source of income. Analysis of income numbers measures the performance of company in managing business activities (financing, investing and operating activities). The information about operating activities are reported both in balance sheet and income statement.

16. Reporting Business Activities
The financial information about business activities are reported in financial statements and other disclosures.
The information about financing and investing activities are reported in balance sheet.
The results of financing, investing and operating activities are reported in income statement.
The information about cash flow is reported in Cash Flow Statement.

17. What are the Financial Statements?
The objective of financial statement is to provide useful financial information about the reporting entity’s activities.
The general purposed financial statements are;
Statement of Financial Position (Balance Sheet),
Statement of Comprehensive Income (Income Statement),
Statement of Cash Flows
Statement of Changes in Equity and
Notes (disclosures)

18. Why Do The Users Deal With Financial Reports?
FINANCIAL STATEMENT ANALYSIS
Why Do The Users Deal With Financial Reports?

19. Why Do The Users Deal With Financial Reports?
The external users of financial information are;
existing and potential investors,
lenders and other creditors,
customers and suppliers
state
labor unions and
auditing firms
The internal user of financial information is
Managerial board
Potential Investors
Lenders
Audit Firms
Labor Unions
State
Management and Existing investors

20. Why Do The Users Deal With Financial Reports?
External Users
Financial accounting provides external users with financial statements.
Internal Users
Managerial accounting provides information needs for internal decision makers.
The users of financial statements deal with these reports, in order to make decisions about
buying, selling or holding equity and debt instruments
providing or settling loans and others forms of credit.

21. Why Do The Users Deal With Financial Reports?
For example, existing and potential investors expect to get returns as dividends, interests (for debt instruments), payments or market price increases (for holding equity instruments).
Internal Users

22. Why Do The Users Deal With Financial Reports?
Similarly, lenders focus on financial information for making decisions in providing or settling loans and other forms of credit.
They also expect a kind of return like principal and interest payments or other returns that they expect.
External Users
Lenders, Audit Firms, Labor Unions, State, Potential Investors.

23. Why Do The Users Deal With Financial Reports?
Object of the Analysis
Focus on
Lenders (Creditors)
Credibility
Solvency, Liquidity, Working Capital, Future Cash Flows
Investors
Expected returns on investment
Profitability, earning per share, dividends per share
Board of management
Efficiency , profitability, financial growing, internal control.
Profitability, Liquidity, Solvency, Future Cash Flows
State
Taxation policies and tax income
Profitability, earnings per share
Labor Unions
Profitability and Credibility
Solvency, profitability, working capital, future cash flows.

24. Why Do The Users Deal With Financial Reports?
Consequently, existing and potential investors, lenders and other creditors need information about future net cash inflows to an entity. Because the users of financial reports are focus on returns from the money that they invest. To give stated decisions, external users need financial information presented in financial statements. For this lesson we are going to look at financial statements with the eye of external users and analyze the financial statements on this perspective.

25. FINANCIAL STATEMENT ANALYSIS
QUALITIVE CHARACTERISTICS OF FINANCIAL INFORMATION AND ASSUMPTIONS IN PREPARING FINANCIAL STATEMENTS

26. Qualitative Characteristics of Financial Information
Fundamental Qualitative Characteristics
Relevance (İlgili Olma)
Materiality (Önemlilik)
Faithful representation (Gerçeğe Uygun Sunum)
Comparability (Karşılaştırılabilirlik)
Verifiability (Doğrulanabilirlik)
Timeliness (Zamanında Sunum)
Understandability (Anlaşılabilirlik)

27. Qualitative Characteristics of Financial Information:
Relevance
Relevant financial information is capability of making a difference in decisions made by users. If a financial information has predictive and confirmatory value it means the information is relevant.

28. Qualitative Characteristics of Financial Information: Materiality
Main principle in materiality is effecting decisions. If an information influence the decisions made by users that information is material. We can not specify the financial information’s nature or magnitude in defining materiality. If we omit or misstate the information and this situation influences the decisions it means “information is material”.

29. For faithful presentation financial statements must be
Qualitative Characteristics of Financial Information:
Faithful Presentation
With financial statements the economic events are presented in words and numbers. This is information must be faithful for making accurate decisions.
For faithful presentation financial statements must be
Complete (tam açıklama)
Neutral and (tarafsız)
Free from eror (hatasız)

30. Qualitative Characteristics of Financial Information:
Faithful Presentation
Complete financial information includes not only numerical depiction but also all necessary definition and explanation about the economic event. Neutral financial information must be objective. In presenting financial information the entity must not tend to report according to only one user’s benefit. Neutral information mean not emphasize or deemphasize or manipulate to increase profit or loss that will receive unfavorably by users. Free from error means there are no omission or error in description of economic event.

31. Comparability contains two aspect:
Qualitative Characteristics of Financial Information:
Comparability
Comparability enables users to identify similarities or differences among reported items.
Comparability contains two aspect:
Comparing similar information about reporting entity to other entities and
Comparing similar information about the same entity for different periods.
The presentation and classification of items in the financial statements shall be retained from one period to the next.

32. EXAMPLE: Statement of Financial Position of Arçelik Co. NOTES
NOTES
ASSETS
CURRENT ASSETS
Cash and Cash Equivalents 6
Financial Assets 7
1.185
2.932
Trade Receivables 10
Inventories 12
Other Current Assets 22
NON-CURRENT ASSETS
Investments Accounted for Using the Equity Method 13
Non-current Assets Held for Sale 14
5.480
6.441
Tangible Assets 15
Intangible Assets 16
Goodwill 17
7.190
Deferred Tax Assets 30
39.244
63.387
TOTAL ASSETS

33. EXAMPLE: Statement of Financial Position of Arçelik Co. NOTES
NOTES
LIABILITIES
Current Liabilities
Financial Liabilities 8
Other Financial Liabilities 9
129769
183886
Trade Payables 10
Provisions for Tax 30
18.970
23.250
Provisions 20
Other Liabilities 22
Non-Current Liabilities
63.681
58.136
81.519
Provisions for Employee Benefits 21
99.700
Deferred Tax Liabilities
Other Non-Current Liabilities
3.898
2.273
EQUITY
TOTAL LIABILITIES AND EQUITY

34. Verifying amount by direct observation
Qualitative Characteristics of Financial Information:
Verifiability (Doğrulanabilirlik)
Verifiability helps assure users that information faithfully presented. Verification can be performed in two way:
Verifying amount by direct observation
Checking inputs and calculating outputs by using formula or recalculating.
For example checking beginning inventory quantity and costs and recalculating ending inventory under same cost flow assumption (FIFO or Weighted Average).

35. Qualitative Characteristics of Financial Information:
Timeliness and Understandability
Timeliness means presenting financial information at the time that users need.
Understandability means classifying and presenting information clearly to make the financial event understandable.

36. Fundamental Qualitative Characteristics Relevance Materiality
Qualitative Characteristics of Financial Information
Fundamental Qualitative Characteristics
Relevance
Materiality
Faithful representation
Comparability
Verifiability
Timeliness
Understandability

37. Limitations Of Financial Statements
FINANCIAL STATEMENT ANALYSIS
Limitations Of Financial Statements

38. Limitations of Accounting & Financial Reporting
Accountancy assists users of financial statements to make better financial decisions. It is important however to realize the limitations of accounting and financial reporting when forming those decisions.
Following are the main limitations of accounting and financial reporting:
Accounting Estimates
Historical Cost
Fraud or Error
Accounting Policies

39. Limitations of Accounting & Financial Reporting
Accounting Estimates Accounting requires the use of estimates in the preparation of financial statements where certain amounts cannot be established. Where estimates are not based on objective and verifiable information, they can reduce the reliability of accounting information. Because of this limitation, the estimates used in financial reporting is disclosed in notes.

40. Limitations of Accounting & Financial Reporting
Historical Cost Historical cost is the most widely used basis of measurement of assets. Use of historical cost presents various problems for the users of financial statements. Historical costs do not cover the change in price levels of assets over a period of time.

41. Limitations of Accounting & Financial Reporting
Historical Cost Due to the disadvantages associated with the use of historical cost, some preparers of financial statements use the revaluation model to account for long-term assets. However, due to the limited market of various assets and the cost of regular valuations required under revaluation model, it is not widely used in practice.

42. Limitations of Accounting & Financial Reporting
Historical Cost For example, Company A purchase an equipment for 100 TL on the 1st January 2010 which had a useful life of 10 years. Depreciation is charged on straight line basis. At the end of reporting period 31st December 2010 the equipment will be reported as follows:
Assets
Liabilities
Current Assets
Non-Current Assets
Tangible Assets (Net Value) 90
- Property Plant and Equipment
100
- Accumulated Depreciation
(10)

43. Limitations of Accounting & Financial Reporting
Example: Next year the value of same plant is 130 TL and Company B purchased same plant for 130 TL which had a 10 year useful life. The financial statement of these two companies for the year 2011 will be as follows:
BALANCE SHEET COMPANY A
31st December 2011
BALANCE SHEET COMPANY B
Assets
Current Assets
Non-Current Assets
Tangible Assets (Net Value) 80
117
- Property Plant and Equipment
100
130
- Accumulated Depreciation
(20)
(13)

44. Limitations of Accounting & Financial Reporting
Accounting Policies Accounting policies are the principles, rules and procedures selected and followed by the management of accounting entity in preparing and reporting financial statements. For example, depreciation methods, goodwill, inventory pricing etc. are some of the accounting policies used in an entity.

45. Limitations of Accounting & Financial Reporting
Accounting Policies
Changes in accounting policies and estimates directly reflect to financial statements. The result of changes in accounting policies also effect the comparability of reported entity.
Comparability contains two aspect:
Comparing similar information about reporting entity to other entities and
Comparing similar information about the same entity for different periods.
Therefore the changes in accounting policies influence the comparability of entity within the periods and without the entity (comparing information with other entities).

46. Limitations of Accounting & Financial Reporting
For Example: Company A uses FIFO method, Company B uses weighted average cost method in measuring inventory. These two company operate in the same industry. Detailed information about their inventories are as follows:
Company A
Company B
Unit
Cost Per Unit
Beginning Inventory
200
50 TL
Purchased Inventory
800
60 TL
Ending Inventory
400 ?
Cost of Goods Sold
600

47. Limitations of Accounting & Financial Reporting
Company A
Company B
Uses FIFO
Unit
Cost Per Unit
Uses Weighted Average
Beginning Inventory
200
50 TL
Purchased Inventory
800
60 TL
Ending Inventory
400 ?
Cost of Goods Sold
600
Sales
100 TL
Company A Ending Period Balance Sheet
Current Assets
Cash and Cash Equivalent
Trade Receivables
Inventory
24.000
Company A Ending Period Balance Sheet
Current Assets
Cash and Cash Equivalent
Trade Receivables
Inventory
23.200

48. Limitations of Accounting & Financial Reporting
Company A Ending Period Balance Sheet
Current Assets
Cash and Cash Equivalent
Trade Receivables
Inventory
24.000
Income Statement Company A
Sales
Cost of Goods Sold (34.000)
Gross Profit/Loss
Company B Ending Period Balance Sheet
Current Assets
Cash and Cash Equivalent
Trade Receivables
Inventory
23.200
Income Statement Company B
Sales
Cost of Goods Sold (34.800)
Gross Profit/Loss