Chapter The Financial Statements 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 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 Assets Definition? Current assets – – – – – Cash Short-term investments Accounts receivable Inventory Prepaid expenses Long-term investments Property, plant, and equipment Intangible assets 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 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 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 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 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 12 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 Exchanges with shareholders Exchanges of liabilities and shareholders’ equity Issues and payments of debt Purchases, sales, and exchanges of assets Revenues and expenses 14 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 15 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 18 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 19 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 ? 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, 2010 Solve for RE(B) using: RE(B) + NI - Div = RE(E) NI = 4.4 – 3.9 = RE(B) + - = 1.6 RE(B) = 1.4 21 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 - = 1.4 Exp = 3.7 = RE(E) 22 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 = = RE(E) 23 Copyright © 2011 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 backup 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