Financial accounting 9th jamie pratt chapter 02

Chapter 2
The Financial Statements



2


Flow of Capital



3


Business Management Activities

 Business activities are reflected in financial statements; business activities
include:

 Operating activities – production and sale of 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
month, 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



5


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.
Asset and Liability accounts are typically grouped into more detailed classifications leading
to the Classified Balance Sheet.



6


Assets
•
•

Items on the balance sheet that are expected to produce value
Current assets – benefit realized within 1 year

•
•
•

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

•
•
•
•
•

Cash
Short-term investments
Accounts receivable
Inventory
Prepaid expenses



7


Liabilities
Obligations resulting from transactions which may result in the use of assets

 Current liabilities – expected to be relieved within 1 year









Accounts payable
Wages payable
Interest payable
Short-term notes payable
Current maturities of long-term debt
Deferred revenues
Other payables

 Long-term liabilities



8


Shareholders’ (Owners’) Equity
Interest of the holders of shares in a company after liabilities have been relieved.

 Contributed capital – assets contributed by owners



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 over time.



9


Organizational Form Affects Equity
Figure 2-3



10


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



11


The Statement of Shareholders’ Equity (SSE)



Explains changed in the shareholders’ equity accounts over a period of time.



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



12


The Statement of Shareholders’ Equity (SSE)



The second column represents retained earnings with the equation:
REBegin + NI - Div = REEnd



13

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.



14


Relationships Among the Financial Statements



An essential relationship exists between the

different financial statements.



A review of Figure 2-7 demonstrates this

relationship for Harbour Island Company


Relationships Among the Financial Statements

Beginning

Ending

Balance Sheet

Balance Sheet

Assets

Statement of

(Cash)

Cash Flows

Assets
(Cash)

Income
Statement
=

=

Liabilities

Liabilities

+

+

Equity

Statement of
Stockholders’ Equity

Equity


International Perspective – Balance Sheet

•

Many non-U.S. firms that publish IFRS-based balance sheets add shareholders’ equity to noncurrent 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.


Exercise 2-3
Balance Sheet (B) or Income Statement (I)
B

a. Equipment
b. Fees Earned

I

c. Retained Earnings

B

d. Wage Expense
e. Patent

I
B

f. Cost of Goods Sold
g. Common Stock
h. Dividend Payable
i. Accumulated Depreciation

I
B
B
B


18


Exercise 2-3
Balance Sheet (B) or Income Statement (I)
B

j. Prepaid Expense

k. Gain on Sale of Short-term Investment
l. Rent Revenue

I

I

m. Supplies Inventory

B

n. Accounts Receivable
o. Land

B

B

p. Insurance Expense
q. Interest Payable
r. Deferred (Unearned) Revenue

I
B
B


19


Exercise
Given (in billions):
2012
2011 2010

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



20

Exercise, 2012
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



21


Exercise, 2011
First, find RE(E):
RE(E) 2011 = RE(B) 2012 = 1.4

Now find Expenses:
RE(B) + Rev. – Exp. - Div

= RE(E)

1.3 + 4.1 – Exp - .3 = 1.4

Exp. = 3.7



22


Exercise, 2010
First, find RE(E):
RE(E) 2010 = RE(B) 2011 = 1.3

Now find Div:
RE(B) + Rev – Exp. - Div

= RE(E)

1.2 + 3.9 – 3.5 – Div. = 1.3

Div. = .3



23


© 2014 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted
in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright
owner is unlawful. Request for further information should be addressed to the Permissions Department, John
Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or
resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these
programs or from the use of the information contained herein.

24