FINANCIAL ACCOUNTING AND FINANCIAL STATEMENT ANALYSIS COURSE MANUAL Copyright 2008, AZEK/ILPIP FINANCIAL ACCOUNTING AND FINANCIAL STATEMENT ANALYSIS Copyright 2008, AZEK/ILPIP All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of AZEK/ILPIP. 1.) Financial Reporting Environment 2.) Framework for the Preparation and Presentation of Financial Statements 3.) Statement of Cash Flows 4.) Generally Accepted Accounting Principles: Income Recognition 5.) Generally Accepted Accounting Principles: Assets, Liabilities and Shareholders Equity 6.) Business Combinations 7.) Foreign Currency Transactions 8.) Financial Reporting and Financial Statement Analysis 9.) Analytical Tools for Gaining Financial Statements Insights 10.) Analytical Tools for Assessing Profitability and Risk 11.) Exercises: Questions 12.) Exercises: Solutions FINANCIAL ACCOUNTING AND FINANCIAL STATEMENT ANALYSIS Chapter 1 FINANCIAL REPORTING ENVIRONMENT Copyright 2008, AZEK/ILPIP FINANCIAL ACCOUNTING AND FINANCIAL STATEMENT ANALYSIS Copyright 2008, AZEK/ILPIP All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of AZEK/ILPIP. Table of contents 1. The financial reporting environment 1 1 1. .1 1 T Th he e f fi in na an nc ci ia al l s st ta at te em me en nt ts s. . 1 1 1 1. .1 1. .1 1 T Th he e b ba al la an nc ce e s sh he ee et t. . 1 1 1 1. .1 1. .2 2 T Th he e i in nc co omme e s st ta at te em me en nt t . . 3 3 1 1. .1 1. .3 3 T Th he e c ca as sh h f fl lo ow w s st ta at te em me en nt t. . 7 7 1 1. .1 1. .4 4 T Th he e s st ta at te emme en nt t o of f c ch ha an ng ge es s i in n e eq qu ui it ty y. . 8 8 1 1. .1 1. .5 5 T Th he e n no ot te es s t to o f fi in na an nc ci ia al l s st ta at te em me en nt ts s. . 9 9 1 1. .1 1. .6 6 T Th he e r re el la at ti io on n b be et tw we ee en n b bu us si in ne es ss s a ac ct ti iv vi it ti ie es s a an nd d f fi in na an nc ci ia al l s st ta at te em me en nt ts s. . 1 10 0 1 1. .2 2 F Fi in na an nc ci ia al l r re ep po or rt ti in ng g i is ss su ue es s. . 1 12 2 1 1. .2 2. .1 1 U Us se es s o of f f fi in na an nc ci ia al l s st ta at te em me en nt ts s. . 1 12 2 1 1. .2 2. .2 2 I In nt te er rn na at ti io on na al l d di if ff fe er re en nc ce es s i in n a ac cc co ou un nt ti in ng g. . 1 13 3 1.2.2.1. The two accounting models.13 1.2.2.2. Accounting harmonisation and the IASB14 1 1. .3 3 A Ap pp pe en nd di ix x. . 1 16 6 chapter 1 / page 1 1. The financial reporting environment 1.1 The financial statements Financial accounting is considered to be the language of business. It is a medium by which the business activities of an organisation are made known to the external world. It is not possible to explain in detail every activity of a business succinctly. Hence, financial statements are used to disseminate information about the organisation. The main objective of financial statements is to provide a true and fair view of the operations of the business to their readers. Thus, all organisations make their activities known through their financial statements. Please note that this is an introductory chapter. The entire gamut of financial accounting is like a telescope. The initial chapters contain a crisp introduction to the terminology and later chapters explain these terms in detail. The reader is therefore requested to read through the terms such as balance sheet, etc. and be comfortable with them. For a better understanding of balance sheet, income statement, cash flow statement etc., the financial statements of Novartis group are provided in an appendix at the end of this chapter. You may go through this appendix and try to understand various items. Do not worry too much if you do not understand some things. They will be explained in detail in later chapters. There are three principal financial statements: the balance sheet, the income statement and the statement of cash flows. These are also known as the basic financial statements. Apart from these, there is also the statement of changes in equity, as well as explana