the financial statements chapter 3. chapter 3 objectives describe the composition and objectives of...

THE FINANCIAL THE FINANCIAL STATEMENTSSTATEMENTS

Chapter 3Chapter 3

CHAPTER 3 OBJECTIVESCHAPTER 3 OBJECTIVES

Describe the composition and Describe the composition and objectives of each of the four financial objectives of each of the four financial statements.statements.

Show how the economic entity, Show how the economic entity, periodicity, monetary unit, stable periodicity, monetary unit, stable dollar, and going concern assumptions, dollar, and going concern assumptions, and the revenue recognition, matching, and the revenue recognition, matching, and historical cost principles, influence and historical cost principles, influence financial statement disclosures.financial statement disclosures.

CHAPTER 3 OBJECTIVES CHAPTER 3 OBJECTIVES (CONT.)(CONT.)

Distinguish between cash flow Distinguish between cash flow reporting and the accrual basis of reporting and the accrual basis of accounting. accounting.

Articulate the importance of cash Articulate the importance of cash flows from operating activities. flows from operating activities.

Explain and give examples of Explain and give examples of financial statement articulation.financial statement articulation.

FINANCIAL STATEMENT FINANCIAL STATEMENT CONCEPTS CONCEPTS

Objectives—all analysts, regardless Objectives—all analysts, regardless of specific objectives, desire of specific objectives, desire knowledge about knowledge about Cash flowsCash flows ResourcesResources Claims against those resourcesClaims against those resources Wealth and changes in it Wealth and changes in it

FINANCIAL STATEMENT FINANCIAL STATEMENT CONCEPTS (CONT.)CONCEPTS (CONT.)

Corporate objective—maximize Corporate objective—maximize shareholder wealth, which equals shareholder wealth, which equals share price maximizationshare price maximization


Assumptions—characteristics embedded in Assumptions—characteristics embedded in the financial reporting systemthe financial reporting system Economic entity—business is distinct from Economic entity—business is distinct from

ownersowners Periodicity—companies disclose financial Periodicity—companies disclose financial

statements at regular time intervalsstatements at regular time intervals Monetary unit—economic activity measured and Monetary unit—economic activity measured and

reported in dollarsreported in dollars Stable dollar—financial statements are not Stable dollar—financial statements are not

inflation adjustedinflation adjusted Nominal dollar capital maintenance—sum of Nominal dollar capital maintenance—sum of

monetary unit and stable dollar assumptionsmonetary unit and stable dollar assumptions


Principles—core concepts of GAAPPrinciples—core concepts of GAAP Historical cost—asset and liability Historical cost—asset and liability

attribute most commonly used to attribute most commonly used to measure and report accounts; measure and report accounts; historical exchange pricehistorical exchange price

Revenue realization principle—report Revenue realization principle—report revenues when realized (or realizable) revenues when realized (or realizable) and earnedand earned

Usually occurs at point of sale or serviceUsually occurs at point of sale or service Independent of cash receiptIndependent of cash receipt


Principles—core concepts of GAAP Principles—core concepts of GAAP (cont.) (cont.) Matching principle—costs incurred in Matching principle—costs incurred in

generating revenues generating revenues subtracted in revenue realization periodsubtracted in revenue realization period independent of cash outflowsindependent of cash outflows

Accrual accounting—sum of revenue Accrual accounting—sum of revenue realization and matching principlesrealization and matching principles


Cash accounting—equates cash Cash accounting—equates cash received for goods and services to received for goods and services to revenues and cash paid to earn revenues and cash paid to earn them as expenses; not GAAP them as expenses; not GAAP


Financial statement Financial statement interrelationshipsinterrelationships Articulation—logical relationships Articulation—logical relationships

among financial statements’ accounts among financial statements’ accounts as the four financial statements work as the four financial statements work as an integrated reporting system to as an integrated reporting system to convey financial informationconvey financial information

FINANCIAL STATEMENT FINANCIAL STATEMENT ORIENTATIONORIENTATION

eSTUFF.com—hypothetical Internet eSTUFF.com—hypothetical Internet retailer; introduces students to retailer; introduces students to financial statements; used to financial statements; used to illustrate concepts throughout the illustrate concepts throughout the texttext

eSTUFF’s financial statements—eSTUFF’s financial statements—Exhibit 3-1 (pp. 67-69 of the text)Exhibit 3-1 (pp. 67-69 of the text)


Additional financial statement Additional financial statement disclosures—strengthen articulationdisclosures—strengthen articulation Notes to the financial statements—Notes to the financial statements—

amplify and clarify financial statements; amplify and clarify financial statements; also called notes or footnotesalso called notes or footnotes

Supplementary information—additional Supplementary information—additional disclosures that add insight to financial disclosures that add insight to financial statementsstatements

INCOME STATEMENTINCOME STATEMENT (CONT.)(CONT.)

Measures change in wealth during Measures change in wealth during a reporting period a reporting period

Equation: revenues – expense = Equation: revenues – expense = net income (loss)net income (loss)

INCOME STATEMENT INCOME STATEMENT (CONT.)(CONT.)

Revenues—asset increases from Revenues—asset increases from providing services or delivering goodsproviding services or delivering goods

Gains—asset increases from peripheral Gains—asset increases from peripheral transactionstransactions

Expenses—asset decreases; costs of Expenses—asset decreases; costs of doing business; matched against doing business; matched against revenuesrevenues

Losses—asset decreases from Losses—asset decreases from peripheral transactionsperipheral transactions


Cost of goods sold—difference between the Cost of goods sold—difference between the historical cost and selling price of inventory historical cost and selling price of inventory that is soldthat is sold

Selling, general, and administrative Selling, general, and administrative expenses (S,G&A expenses; operating expenses (S,G&A expenses; operating expenses)—costs incurred in running a expenses)—costs incurred in running a business; matched against revenuesbusiness; matched against revenues

Income—difference between revenues Income—difference between revenues (gains) and expenses (losses)(gains) and expenses (losses)

Earnings per share (EPS)—profit (loss) per Earnings per share (EPS)—profit (loss) per share of common stockshare of common stock


All-inclusive income—results from All-inclusive income—results from reporting all revenues (gains) and reporting all revenues (gains) and expenses (losses) in a reporting periodexpenses (losses) in a reporting period

Multiple step format—separates central Multiple step format—separates central business activities’ revenues and expenses business activities’ revenues and expenses from peripheral gains and lossesfrom peripheral gains and losses

Single step format—combines core and Single step format—combines core and peripheral revenues and subtracts core peripheral revenues and subtracts core and peripheral expenses from themand peripheral expenses from them

eXTREMESTUFF.com, Inc.Income StatementsYear End December 31(in thousands, except EPS)

2003 2002 2001 2000Sales revenues 1,310$ 1,240$ 1,200$ 1,000$ Cost of goods sold 800 719 660 600 Gross profit 510 521 540 400 Selling expenses 355 312 352 250 Administrative expenses 150 150 133 85 Income from continuing operations 5 59 55 65 Financial expenses 20 20 20 10 Pretax income (15) 39 35 55 Income tax expense / benefit (6) 16 14 22 Net income (9) 23 21 33 Earnings per share (0.18) 0.46 0.42 0.79

STATEMENT OF STATEMENT OF SHAREHOLDERS’ EQUITYSHAREHOLDERS’ EQUITY

Measures change in owners’ Measures change in owners’ wealth during the reporting periodwealth during the reporting period

Equation: Beginning shareholders’ Equation: Beginning shareholders’ equity + net income – dividends = equity + net income – dividends = ending shareholders’ equityending shareholders’ equity

SHAREHOLDERS’ EQUITY SHAREHOLDERS’ EQUITY (CONT.)(CONT.)

Contributed capital—resources invested Contributed capital—resources invested in the business by its ownersin the business by its owners

Common stock—most prevalent stock Common stock—most prevalent stock type issued; risk capitaltype issued; risk capital

Preferred stock—dividend preference Preferred stock—dividend preference over common stock; less risky over common stock; less risky investment than common stockinvestment than common stock

Par value—minimum selling price of Par value—minimum selling price of stockstock

SHAREHOLDERS’ EQUITY SHAREHOLDERS’ EQUITY (CONT.)(CONT.)

Additional paid in capital—Additional paid in capital—difference between stock’s selling difference between stock’s selling price and its par valueprice and its par value

Retained earnings—income kept Retained earnings—income kept within the businesswithin the business

Dividends—cash paid to Dividends—cash paid to shareholders as a return on shareholders as a return on investment investment

BALANCE SHEET BALANCE SHEET

Measures wealth at one point in Measures wealth at one point in time (usually the end of the time (usually the end of the reporting period)reporting period)

Equation: assets = liabilities + Equation: assets = liabilities + shareholders’ equityshareholders’ equity

Remains in balance after every Remains in balance after every transactiontransaction

BALANCE SHEETBALANCE SHEET (CONT.) (CONT.)

Liquidity—cash or items Liquidity—cash or items convertible into cash that can be convertible into cash that can be used to pay obligations in the near used to pay obligations in the near termterm

Assets—future economic benefits, Assets—future economic benefits, controlled by an entity, resulting controlled by an entity, resulting from a past transactionfrom a past transaction


Current asset—liquid resource; Current asset—liquid resource; usually converted into cash within usually converted into cash within one yearone year

Long-term asset—illiquid resource; Long-term asset—illiquid resource; used to generate revenues and used to generate revenues and cash flows; includes long-term cash flows; includes long-term investments, property, plant, investments, property, plant, equipment, and intangible assetsequipment, and intangible assets


Liabilities—future economic Liabilities—future economic obligations, owed by an entity, obligations, owed by an entity, resulting from a past transactionresulting from a past transaction

Current liabilities—pending Current liabilities—pending obligations; usually payable within obligations; usually payable within one yearone year

Long-term liabilities—non-current Long-term liabilities—non-current obligationsobligations

eXTREMESTUFF.comBalance Sheets31-Dec(in thousands of dollars) 2003 2002 2001 2000ASSETSCurrent Assets:Cash 34$ 187$ 45$ 30$ Short-term investments 60 - - - Accounts receivable, net 160 175 140 120 Inventory 335 270 250 200 Prepaid expenses 8 12 5 10 Total current assets 597 644 440 360

Property, Plant and Equipment:Equipment, net 204 260 380 400

Intangible Assets:Trademark 5 10 15 20 Total Assets 806$ 914$ 835$ 780$

LIABILITIES 2003 2002 2001 2000Current Liabilities:Accounts payable 110$ 80$ 50$ 160$ Accrued liabilities 40 43 21 50 Taxes payable - 6 - 5 Total current liabilities 150 129 71 215

Long-term Liabilities:Notes payable 100 220 220 120 Total Liabilities 250 349 291 335

SHAREHOLDERS' EQUITYContributed capital, $1 par 50 50 50 42 Additional paid-in-capital 450 450 450 378 Total contributed capital 500 500 500 420 Retained earnings 56 65 44 25 Total Shareholders' Equity 556 565 544 445 Total Liabilities and Shareholders'. Equity806$ 914$ 835$ 780$

STATEMENT OF CASH STATEMENT OF CASH FLOWSFLOWS

Measures change in cash during a Measures change in cash during a reporting periodreporting period

Equation: cash flows from Equation: cash flows from operating activities + cash flows operating activities + cash flows from investing activities + cash from investing activities + cash flows from financing activities = flows from financing activities = net change in cashnet change in cash

STATEMENT OF CASH STATEMENT OF CASH FLOWSFLOWS(CONT.)(CONT.)

Cash flows from operating activities—cash Cash flows from operating activities—cash provided by or used for central business provided by or used for central business activities; most important section of the activities; most important section of the statementstatement Direct cash flows—method of disclosure for Direct cash flows—method of disclosure for

reporting operating cash flows; reports received reporting operating cash flows; reports received from sales and services and paid to suppliers, from sales and services and paid to suppliers, employees, and other short-term creditorsemployees, and other short-term creditors

Indirect cash flows—alternative operating cash Indirect cash flows—alternative operating cash flow reporting method; reconciles net income to flow reporting method; reconciles net income to operating cash flow to report operating cash operating cash flow to report operating cash flowsflows

STATEMENT OF CASH STATEMENT OF CASH FLOWSFLOWS(CONT.)(CONT.)

Cash flows from investing activitiesCash flows from investing activities—cash provided or used by the —cash provided or used by the disposal and acquisition of long-disposal and acquisition of long-term assetsterm assets

Cash flows from financing activitiesCash flows from financing activities—cash provided or used by issuing —cash provided or used by issuing and retiring stocks and bonds and and retiring stocks and bonds and paying dividendspaying dividends

eXTREMESTUFF.com, Inc.Statement of Cash FlowsYear End December 31

2003 2002 2001 2000Cash, beginning of the year 187$ 45$ 30$ -$ Cash flows from operating activities:Net Income (9)$ 23$ 21$ 33$ Depreciation expense, equipment 136 120 120 100 Amortization expense, trademark 5 5 5 5 Changes in current accountsAccounts Receivable 15 (35) (20) (120) Inventory (65) (20) (50) (200) Prepaid Expenses 4 (7) 5 (10) Accounts Payable 30 30 (110) 160 Accrued Liabilities (3) 22 (29) 50 Taxes payable (6) 6 (5) 5 Net cash provided (used) by operating activities 107 144 (63) 23

Cash flows from investing activities: 2003 2002 2001 2000Purchase of equipment (80) - (100) (500) Acquisition of trademark - - - (25) Purchase of short-term investments (60) - - - Net cash provided (used) by investing activ. (140) - (100) (525)

Cash flows from financing activities:Issue (retire) notes payable (120) - 100 120 Issue common stock - - 80 420 Pay cash dividend - (2) (2) (8) Net cash provided (used) by financing activ. (120) (2) 178 532 Net change in cash (153)$ 142$ 15$ 30$ Cash, end of the year 34$ 187$ 45$ 30$

the financial statements chapter 3. chapter 3 objectives describe the composition and objectives of...

Documents

financial statements

cash flow reporting

importance of cash flows

price maximization slide

resources wealth

specific objectives

historical cost principles

concern assumptions