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1. Accounting1. Accounting
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2. Basic Question & 2. Basic Question & Financial StatementsFinancial Statements
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FINANCIAL STATEMENTS Financial statements are the principal means of
reporting financial information to people outside a business organization through a set of accounting reports.
Financial statements are reports that summarize the results of a company’s accounting transactions for a fiscal period.
A Fiscal Period is any time period for which a company wants to report its financial activities.
Financial statements prepared for a period of time shorter than one year (e.g. 1 month or 3 months) are referred to as Interim Financial Statements.
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FOUR BASIC FINANCIAL STATEMENTS
1. Balance Sheet – provides a snapshot of a firm’s financial position at one point in time.
2. Income Statement – summarizes a firm’s revenues and expenses over a given period of time.
3. Statement of Retained Earnings – shows how much of the firm’s earnings were retained, rather than paid out as dividends.
4. Statement of Cash Flows – reports the impact of a firm’s activities on cash flows over a given period of time.
3. Balance Sheet3. Balance Sheet
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Quadrants of Balance Sheet Quadrants of Balance Sheet Assets
=
Liabilities
Current Assets Current Liabilities
Long Term Assets Long Term Liabilities
Equity
1.Owner Contributions2.Retained Earnings
ACCOUNTING EQUATION
Assets = Liabilities + Owner’s Equity
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AssetsAssets
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LiabilitiesLiabilities
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Stockholder’s equity Stockholder’s equity
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Stockholder’s equity is the liability of a company to its owners
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BALANCE SHEET: ASSETS
CashA/RInventories
Total CAGross FALess: Dep.
Net FATotal Assets
20027,282
632,1601,287,3601,926,8021,202,950 263,160 939,7902,866,592
200157,600
351,200 715,2001,124,000
491,000 146,200 344,8001,468,800
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BALANCE SHEET: LIABILITIES AND EQUITY
Accts payableNotes payableAccruals
Total CLLong-term debtCommon stockRetained earnings
Total EquityTotal L & E
2002524,160
636,808 489,6001,650,568
723,432460,000
32,592 492,5922,866,592
2001145,600200,000
136,000481,600323,432460,000
203,768 663,7681,468,800
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THE BALANCE SHEET: LIABILITIES VS. STOCKHOLDERS’
EQUITY
The common stockholders’ equity, or net worth, is a residual.
For example, at the end of 2002,
Common Stockholders’ Equity = Assets – Liabilities – Preferred Stock = 2,866,592 – 2,374,000
- 0 = 492,592
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THE BALANCE SHEET: LIABILITIES VS. STOCKHOLDERS’
EQUITY
Suppose assets decline in value (for example, some of the accounts receivable are written off as debts), liabilities and preferred stock remain constant, so the value of the common stockholders’ equity must decline.
Therefore, the risk of asset value fluctuations is borne by the common stockholders.
However, if assets’ value rises (perhaps because of inflation), these benefits will be accrued exclusively to the common stockholders.
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THE BALANCE SHEET: PREFERRED VS. COMMON
STOCK Therefore, when the term “equity” is used
in finance, it means “common equity” unless the word “total” is included.
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THE BALANCE SHEET: IMPORTANCE OF BREAKDOWN OF THE
COMMON EQUITY ACCOUNTS
The breakdown of common equity accounts is important for two reasons:
1) A potential stockholder would want to know whether the company actually earned the funds reported in its equity accounts or whether the funds came mainly from selling stock.
2) A potential creditor, on the other hand, would be more interested in the total equity the owners have in the firm and would be less concerned with the source of the equity.
