Financial accounting in an economic context 8e chapter 02

Chapter 2
The Financial Statements

2


Business Activities


Business activities are reflected in financial
statements; business activities include:
– Operating activities – selling goods and

services.
– Investing activities – acquisition and sale
of productive assets.
– Financing activities – issue and
retirement/repayment of liabilities and
equity.


The Balance Sheet
The balance sheet reports the financial
position at a point in time (end of the
quarter or year).
The Balance Sheet is also called:
 Statement of Financial Position
The components of the Balance Sheet are:
 Assets
 Liabilities

 Shareholders’ (Owners’) Equity
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The Balance Sheet
The balance sheet is represented by the
fundamental accounting equation:
Assets = Liabilities + Shareholders’ Equity
A =
L
+
SE
 The effects of all business transactions may
be represented in this formula.


5


Assets
Definition?
 Current assets
–
–
–
–
–






Cash
Short-term investments
Accounts receivable
Inventory
Prepaid expenses

Long-term investments
Property, plant, and equipment
Intangible assets
6


Liabilities
Definition?
 Current liabilities
– Accounts payable
– Wages payable
– Interest payable
– Short-term notes payable
– Current maturities of long-term debt
– Deferred revenues
– Other payables



Long-term liabilities
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Owners’ (Shareholders’) Equity
Definition?
 Contributed capital
– Shareholders’ equity (par or stated value)
– Paid-in capital in excess of par value



Earned capital
- Earned Capital has 2 components: Retained Earnings and

Other accumulated comprehensive income. We will cover
other accumulated comprehensive income in Chapter 13.
– Retained earnings represent the excess earnings retained in the
company after dividends have been paid to shareholders. This
represents the equity generated by the company for the
shareholders.

8


The Statement
of Shareholders’ Equity (SSE)
The following formula represents the basic
SSE:
Beginning shareholders’ equity
Plus: Issuance of stock
Plus: Net income
Less: Dividends

Ending shareholders’ equity
SEBegin + Issue + NI - D = SEEnd

9


The Statement
of Retained Earnings
The statement of retained earnings is a subset of
the SSE, and calculates the changes in the
retained earnings component.
Beginning retained earnings
Plus: Net income
Less: Dividends
Ending retained earnings
REBegin + NI - Div = REEnd

10


International Perspective – Balance
Sheet






Many non-U.S. firms that publish IFRS-based balance
sheets add shareholder’s equity to non-current

liabilities, referring to the total as capital employed.
Consequently, the balance sheet format looks like:
Non-current assets + Current assets - Current
liabilities = Non-current liabilities + Shareholders’
equity
Under U.S. GAAP balance sheet accounts are listed
in order of liquidity. Many non-U.S. firms that publish
IFRS-based balance sheets list their assets in the
opposite order, starting with non-current assets,
followed by current assets.
Many non-U.S. companies, especially in Europe, use
the term “turnover” instead of revenue.


The Income Statement


Operating revenues
– Sales
– Fees earned
– Other revenues



Operating expenses
–
–
–
–
–

–
–

Cost of goods sold
Wage expense
Rent expense
Selling expense
Depreciation expense
Amortization expense
Other expenses








Operating revenues
and expenses: usual
and frequent
Other revenues and
expenses: unusual
or infrequent
Disposal of a
business segment
Extraordinary items:
unusual and
infrequent
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The Statement of Cash Flows


Cash flows from operating activities:
– Cash flows associated with the acquisition and sale of a company’s

products and services
– Collections from sales, rent, interest, etc.
– Cash paid to suppliers and employees, and for rent, selling
activities, interest, and taxes etc.



Cash flow from investing activities:
– Cash flows associated with the purchase and sale of a company’s

investments.
– Proceeds from sale of investment securities, land, buildings,
equipment, etc.
– Purchase of investment securities, land, buildings, equipment, etc.



Cash flow from financing activities:
– Cash flows associated with a company’s two sources of outside

capital: liabilities and contributed capital.
– Proceeds from issuance of notes, debt, sale of equity, etc.

– Payments on notes, debt, dividends, etc.

13


Classifying Financing, Investing, and
Operating Transactions
Financing and Investing
Transactions

Operating
Transactions
Income
Statement

Balance Sheet
1

2

3

4

5

1. Exchanges with shareholders
2. Exchanges of liabilities and shareholders’ equity
3. Issues and payments of debt
4. Purchases, sales, and exchanges of assets

5. Revenues and expenses

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Classifying Operating Transactions
Transitory
Group C
Gains and losses
due to change in
accounting
principles

Extraordinary
items

Persistent
Group B
Group A
Revenues and Normal and recurring
expenses from
operating revenues
activities not
and expenses
germane to a
company’s primary
activity

Disposals of
segments

Other revenues
and expenses
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16


Relationships Among the
Financial Statements
Beginning
Balance Sheet
Assets
(Cash)

=

Ending
Balance Sheet
Statement of
Cash Flows
Income
Statement

=
Liabilities

Liabilities

+
Equity

Assets
(Cash)

+
Statement of
Stockholders’ Equity

Equity


Exercise 2-3
Balance Sheet (B) or Income Statement (I)
a. Equipment B
I
b. Fees Earned
c. Retained Earnings B
d. Wage Expense I
B
e. Patent
f. Cost of Goods Sold I
g.Common Stock B
B
h.Dividend Payable
i. Accumulated Depreciation B
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Exercise 2-3
Balance Sheet (B) or Income Statement (I)
j. Prepaid Expense
B
k. Gain on Sale of Short-term Investment I
l. Rent Revenue
I
m. Supplies Inventory B
n.Accounts Receivable
B
o.Land
B
p.Insurance Expense
I
q.Interest Payable
B
r. Deferred (Unearned) Revenue
B
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Exercise

Given (in billions):
2010
2009 2008
Beginning RE
?
1.3
1.2

Revenues
4.4
4.1
3.9
Expenses
3.9
?
3.5
Div. declared
.3
.3
?
Ending RE
1.6
?
?

Now, using the following formulas and
relationships, solve for the other missing
items:
(1) Rev - Exp = NI
(2) RE(B) + NI - Div = RE(E)
(3) RE(E) becomes RE(B) in the next year
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Exercise, 2010
Solve for RE(B) using:
RE(B) + NI - Div = RE(E)
NI = 4.4 – 3.9 = .5

RE(B) + .5 - .3 = 1.6
RE(B) = 1.4

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Exercise, 2009
First, find RE(E):
RE(E) 2009 = RE(B) 2010 = 1.4
Now find Expenses:
RE(B) + Rev. – Exp. - Div
1.3 + 4.1 – Exp - .3 = 1.4
Exp. = 3.7

= RE(E)

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Exercise, 2008
First, find RE(E):
RE(E) 2008 = RE(B) 2009 = 1.3
Now find Div:
RE(B) + Rev – Exp. - Div
1.2 + 3.9 – 3.5 – Div. = 1.3
Div. = .3

= RE(E)

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