Chapter 2: financial and accounting

Chapter Financial Statements: An Overview Albrecht, Stice, Stice, Swain COPYRIGHT © 2008 Thomson South-Western, a part of The Thomson Corporation Thomson, the Star logo, and South-Western are trademarks used herein under license LEARNING OBJECTIVES • Understand the basic elements, uses, and limitations of the financial statements (FS): balance sheet, income statement, and the statement of cash flows • Recognize the need for financial statement notes and identify the types of information included in the notes • Describe the purpose of an audit report and the incentives the auditor has to perform a good audit • Explain the fundamental concepts and assumptions that underlie financial accounting Three basic questions • (1) What is the company’s current financial status? • (2) What were the company’s operating results for the period? • (3) How did the company obtain and use cash during the period? Primary Financial Statements • The Balance Sheet (Statement of Financial Position) • Income Statement (Statement of Earnings) • Statement of Cash Flows Accounting Equation Assets = Liabilities + Owners’ Equity Sources of Financing Resources Resources to use to generate revenues = Creditors’ claims against resources + Owners’ claims against resources Sample Balance Sheet Assets Liabilities Cash $ 40 Accounts payable Accounts receivable 100 Notes payable Land 200 Total assets Must Equal $340 Owners’ Equity Paid-in Capital Retained earnings Total liabilities and owners’ equity $ 50 150 $200 $100 40 $140 $340 Classified and Comparative Balance Sheets • Classified balance sheet – Distinguishes between current and long-term assets and liabilities – Listed in decreasing order of liquidity • Comparative balance sheet – Presents two years of balance sheet information – Helps users identify significant changes Limitations of the Balance Sheet • Book value vs market value – Which is better? • Only records assets/liabilities that can be quantified – Reputation • Wal-Mart’s name • Great CEO 10 20 21 What are the differences among the statements? • B/S: – How big? – How risky? – Snapshot • I/S: – How profitable? – Periodic performance • Statement of cash flows – Can a profitable firm goes bankrupt? – Cash is king! 22 What are the interrelationships among the FSs (articulation)? Balance Sheet 12/31/08 Cash Other Total $ 80,000 4,550,000 $4,630,000 Liabilities $2,970,000 Cap stock 900,000 R/E 760,000 Total $4,630,000 Cash Op Act $ 973,000 Cash Inv Act (1,188,000) Cash Fin Act 245,000 Net increase $ 30,000 Beg cash 80,000 End cash $ 110,000 Income Statement Revenues $12,443,000 Expenses 11,578,400 Net income $ 864,600 Stmt of Retained Earnings R/E 12/31/08 $ 760,000 Net income 864,600 Dividends (400,000) R/E 12/31/09 $1,224,600 Cash Flow Statement Balance Sheet 12/31/09 Cash Other Total $ 110,000 4,975,000 $5,085,000 Liabilities $2,860,400 Cap stock 1,000,000 R/E 1,224,600 Total $5,085,000 23 Practice 2-47/p.66 24 • Can we put all financial information in the financial statements? 25 Notes to Financial Statements Summary of significant accounting policies – – assumptions, estimates, and judgments more than one acceptable method of accounting Additional information about the summary totals found in the financial statements – additional detail Disclosure of important information that is not recognized in the financial statements – too uncertain to be recognized (i.e guarantee) Supplementary information required by the Financial Accounting Standards Board (FASB) or the Securities and Exchange Commission (SEC) – quarterly financial information , business segment information 26 Note to Wal-Mart’s FS 27 Questions??? • Who control the preparation of the financial statements? • Who use them? • Do the managements have any incentive to bias the reported financial statement numbers? • How to make them trust-worthy? 28 External Audits Audit Report – Issued by an independent CPA firm – Verifies financial statements have been prepared according to GAAP 29 External Auditor vs Management Owners and managers want the most favorable results possible • Bank credit • Bonuses • Public stock price CPA firms have economic incentives to perform credible audits • Reputation • Lawsuits 30 What Are the Fundamental Concepts and Assumptions? • Going Concern Assumption – will continue to exist for the foreseeable future  record assets at what they are worth to a company in normal use, rather than what they would sell for in a liquidation sale • Monetary Measurement Concept – Record only the economic activities that can be measured in monetary terms – The listed values may not be the same as the actual market values 31 What Are the Fundamental Concepts and Assumptions? • Arm’s-Length Transactions – Business dealings between independent, rational parties who are looking out for their own interests – Would you trust the profit generated from the transactions between a parent company and its children? • Historical Cost Principle – More objective • Separate Entity Concept – the activities of an entity should be kept separate from those of its owners 32 Case (2-64) 33 End of chapter 34 ... R/E 12/ 31/09 $1 ,22 4,600 Cash Flow Statement Balance Sheet 12/ 31/09 Cash Other Total $ 110,000 4,975,000 $5,085,000 Liabilities $2, 860,400 Cap stock 1,000,000 R/E 1 ,22 4,600 Total $5,085,000 23 Practice... bankrupt? – Cash is king! 22 What are the interrelationships among the FSs (articulation)? Balance Sheet 12/ 31/08 Cash Other Total $ 80,000 4,550,000 $4,630,000 Liabilities $2, 970,000 Cap stock 900,000... Fin Act 24 5,000 Net increase $ 30,000 Beg cash 80,000 End cash $ 110,000 Income Statement Revenues $ 12, 443,000 Expenses 11,578,400 Net income $ 864,600 Stmt of Retained Earnings R/E 12/ 31/08