Lesson 9Lesson 9Financial StatementsFinancial StatementsTask Team ofTask Team ofFUNDAMENTAL ACCOUNTINGFUNDAMENTAL ACCOUNTINGSchool of Business, Sun School of Business, Sun Yat-senYat-sen University UniversityOutlinesOutlinesttA General View of Financial statementsA General View of Financial statementsttIncome statementIncome statementttBalance sheetBalance sheetttStatement of owners equityStatement of owners equitytt A Simple Illustration A Simple Illustration 22Opening StoryOpening StoryShow me the money!Cuba Gooding Jr. uttered an immortal Cuba Gooding Jr. uttered an immortal Cuba Gooding Jr. uttered an immortal line in the movie line in the movie line in the movie Jerry MaguireJerry MaguireJerry Maguire, “Show , “Show , “Show me the money!” Well, that is what me the money!” Well, that is what me the money!” Well, that is what financial statements do. They show you financial statements do. They show you financial statements do. They show you the money.the money.the money.ttThe questions are:The questions are: Do they show you where a companys money came Do they show you where a companys money came Do they show you where a companys money came from?from?from? Do they show you where it went, and where it is now. Do they show you where it went, and where it is now. Do they show you where it went, and where it is now. How accountants make all these ends satisfied?How accountants make all these ends satisfied?How accountants make all these ends satisfied?33General View of Financial General View of Financial statementsstatements: GAAP: GAAPttStatement of Financial Position (Balance Statement of Financial Position (Balance Sheet).Sheet).ttIncome Statement.Income Statement.ttStatement of Cash Flows.Statement of Cash Flows.44General View of Financial General View of Financial statementsstatements: : Stock vs. FlowStock vs. FlowttStock/ resources and obligations at a point Stock/ resources and obligations at a point in time:in time: Balance sheet.Balance sheet.ttFlow/activity over a period of time:Flow/activity over a period of time: Income statement.Income statement. Statement of cash flows.Statement of cash flows.55Financial Statement ObjectivesFinancial Statement ObjectivesttUseful for investment decisions. (All financial Useful for investment decisions. (All financial statements)statements)ttComprehensible. (All financial statements)Comprehensible. (All financial statements)ttAbout economic resources and claims on resources About economic resources and claims on resources (Balance Sheet).(Balance Sheet).ttAbout financial performance during a period About financial performance during a period (Income Statement).(Income Statement).ttAbout cash flows (Statement of Cash Flows).About cash flows (Statement of Cash Flows).66General View of Financial General View of Financial statementsstatements: a Comparison: a ComparisonPoint in timePoint in timePoint in timePoint in timePeriod of timePeriod of timeIncomeIncomeStatementStatementStatement ofStatement ofOwners EquityOwners EquityStatement ofStatement ofCash FlowsCash FlowsBeginningBeginningBalanceBalanceSheetSheetEndingEndingBalanceBalanceSheetSheet77General View of Financial General View of Financial statementsstatements: Brief Comments: Brief CommentsThe financial statements are a pictureof the company in financial terms.Each financial statement relates to a specificdate or covers a particular period.88Information Disclosed on Information Disclosed on Financial StatementsFinancial StatementsQuestionQuestionAnswerAnswerFinancialFinancialStatementStatement1. How well did the1. How well did the company perform company perform (or operate) during (or operate) during the period? the period? RevenuesRevenues Expenses Expenses Net income (Net loss) Net income (Net loss)IncomeIncomestatementstatement2. Why did the companys2. Why did the companys retained earnings retained earnings change during the change during the period? period? Beg. retained earningsBeg. retained earnings+ Net income (or Net loss)+ Net income (or Net loss) Ending retained earnings Ending retained earningsStatement ofStatement ofRetained earningsRetained earnings99Information Disclosed on Information Disclosed on Financial Statements (cont)Financial Statements (cont)3. What is the companys3. What is the companys financial position at the financial position at the end of the period? end of the period? Assets Assets= Liabilities= Liabilities+ Owners equity+ Owners equityBalanceBalancesheetsheetQuestionQuestionAnswerAnswerFinancialFinancialStatementStatement4. How much cash did4. How much cash did the company generate the company generate and spend during and spend during the period? the period? Operating cash flows Operating cash flows Investing cash flows Investing cash flows Financing cash flows Financing cash flowsIncrease or decrease in cashIncrease or decrease in cashStatementStatementofofcashcashflowsflows1010Income StatementIncome StatementttAlso called: Profit & Loss statement = P&L Also called: Profit & Loss statement = P&L statement = statement of earnings = statement = statement of earnings = statement of operationsstatement of operationsttTechnically subordinate to BS.Technically subordinate to BS. Shows detail of changes to RE.Shows detail of changes to RE.ttMany investors consider IS more important Many investors consider IS more important than BS.than BS.ttVariations in format.Variations in format.1111Parts of Income StatementParts of Income StatementttHeading:Heading:1.1.Name of entity.Name of entity.2.2.Name of statementName of statement3.3.Time period covered.Time period covered.ttRevenues.Revenues.ttCost of Sales.Cost of Sales.ttGross Margin.Gross Margin.ttExpenses.Expenses.ttNet IncomeNet Income1212Revenues inRevenues inIncome StatementIncome StatementttSeveral separate revenue items or net.Several separate revenue items or net.ttNet sales = gross sales - sales returns and Net sales = gross sales - sales returns and allowances - sales or cash discounts.allowances - sales or cash discounts. Trade discounts not shown.Trade discounts not shown. Excludes sales or excise taxes collected for government.Excludes sales or excise taxes collected for government. Other revenues (from activities not associated with sales Other revenues (from activities not associated with sales of entitys goods/services) may be included in net sales of entitys goods/services) may be included in net sales or shown separately. or shown separately. 1313Expenses onExpenses onIncome StatementIncome StatementttCost of Sales (or cost of goods sold). Cost of Sales (or cost of goods sold). Associated with a decrease in the asset inventory.Associated with a decrease in the asset inventory.ttGross margin = gross profit = Sales - COGS.Gross margin = gross profit = Sales - COGS. May or may not be shown.May or may not be shown.ttSeparate disclosure of:Separate disclosure of: Research & development expenses.Research & development expenses. Interest expense.Interest expense.1414Income Statement FormatIncome Statement FormatttOperating income may be shown before Operating income may be shown before Other income and expense.Other income and expense.ttNet income = Income before taxes Income Net income = Income before taxes Income tax expense.tax expense.ttIncome before taxes = Operating income Income before taxes = Operating income adjusted for other revenues and expenses.adjusted for other revenues and expenses.1515Inflows of assetsInflows of assetsin exchange forin exchange forproducts andproducts andservicesservicesprovided toprovided tocustomers.customers.Example of Income Example of Income StatementStatement1616Example of Income Statement Example of Income Statement (cont)(cont)Outflows orOutflows orthe usingthe usingup of assetsup of assetsthat resultthat resultfrom providingfrom providingproductsproductsand services toand services tocustomers.customers.1717Example of Income Statement Example of Income Statement (cont)(cont)Revenues ExpensesRevenues ExpensesNet IncomeNet IncomeRevenues ExpensesRevenues ExpensesNet LossNet Loss1818Balance SheetBalance SheetttPoint in time or status report.Point in time or status report.ttMore formally, Statement of Financial More formally, Statement of Financial Position.Position.ttContains (and shows equality of amounts Contains (and shows equality of amounts of):of): Assets.Assets. Liabilities and Owners equity.Liabilities and Owners equity.1919Beauty Photo Store: Beauty Photo Store: Balance SheetBalance Sheet2020AssetsAssetsttAssets are properties or economic resources Assets are properties or economic resources owned by a businessowned by a businessttThey are expected to provide future benefits They are expected to provide future benefits to the business.to the business.2121Liabilities Liabilities ttLiabilities are obligations of the business.Liabilities are obligations of the business.ttThey are claims against the assets of the They are claims against the assets of the business.business.2222Equity Equity ttEquity is the owners claim on the assets of Equity is the owners claim on the assets of the business.the business.ttIt is the residual interest in he assets of the It is the residual interest in he assets of the business after deducting liabilitiesbusiness after deducting liabilities2323An Illustration of Balance SheetAn Illustration of Balance SheetAssets:Assets:Current assets:Current assets:Cash and cash equivalentsCash and cash equivalents$ 68$ 68$ 80$ 80Short-term investmentsShort-term investments 5 5 11 11Accounts receivableAccounts receivable 74 74 63 63InventoriesInventories 104 104 81 81Prepaid expensesPrepaid expenses 19 19 18 18 Total current assets Total current assets$270$270$253$253InvestmentsInvestments1 16 6Property, plant, and equipment, netProperty, plant, and equipment, net 90 90 42 42Intangible and other assetsIntangible and other assets 20 20 7 7Total assetsTotal assets$381$381$308$308December 31,December 31,2001 20002001 2000Amounts in millionsAmounts in millions2424An Illustration of Balance Sheet An Illustration of Balance Sheet (cont)(cont)Liabilities:Liabilities:Current liabilities:Current liabilities:Notes payable, short-termNotes payable, short-term$ 16$ 16$ 5$ 5Accounts payableAccounts payable 21 21 19 19Advertising payableAdvertising payable 15 15 14 14Compensation (salary) payable Compensation (salary) payable 8 8 6 6Other accrued expenses payableOther accrued expenses payable 28 28 19 19Income taxes payableIncome taxes payable 18 18 20 20 Total current liabilities Total current liabilities$106$106$ 83$ 83Long-term liabilitiesLong-term liabilities 11 11 4 4Total liabilitiesTotal liabilities$117$117$ 87$ 87December 31,December 31,2001 20002001 2000Amounts in millionsAmounts in millions2525An Illustration of Balance Sheet An Illustration of Balance Sheet (cont)(cont)Stockholders equity:Stockholders equity:Common stockCommon stock$ 16$ 16$ 15$ 15Retained earningsRetained earnings 252252 208208Other equityOther equity (4) (4) (2) (2)Total stockholders equityTotal stockholders equity $264$264$221$221Total liabilities and stockholders equityTotal liabilities and stockholders equity$381$381$308$308December 31,December 31,2001 20002001 2000Amounts in millionsAmounts in millions2626An Illustration of Balance Sheet An Illustration of Balance Sheet (cont)(cont)Total assetsTotal assets$381$381= Total liabilities= Total liabilitiesCurrentCurrent$106$106Long-termLong-term 11 11Total liabilitiesTotal liabilities 117 117+ Total stockholders equity+ Total stockholders equity 264 264Total liabilities and stockholders equityTotal liabilities and stockholders equity$381$381 20012001MustMustequalequal2727Flow StatementsFlow StatementsttExplains changes between the dates of the Explains changes between the dates of the two balance sheet snapshots.two balance sheet snapshots.tt2 types of flow statements:2 types of flow statements: Income statement (and related statement of Income statement (and related statement of retained earnings).retained earnings).Reconciles change in RE.Reconciles change in RE. Statement of Cash Flows.Statement of Cash Flows.Reconciles changes in cash.Reconciles changes in cash.2828Statement of Cash FlowsStatement of Cash FlowsttAccounts provide information summarized Accounts provide information summarized in balance sheet and income statement.in balance sheet and income statement.ttThird statement required by GAAP.Third statement required by GAAP.ttDoes not affect the way transactions are Does not affect the way transactions are recorded.recorded.ttDerived from data reported in other Derived from data reported in other financial statements.financial statements.2929The Statement of Cash FlowsThe Statement of Cash Flows3030Statement of cash flowsStatement of cash flowsttProvides info about cash flows associated Provides info about cash flows associated with the periods operations and investing with the periods operations and investing and financing activities.and financing activities.ttNumbers on cash flow statement are Numbers on cash flow statement are objective: cash is cash.objective: cash is cash.ttEliminates judgments and estimates Eliminates judgments and estimates involved with accrual accounting and the involved with accrual accounting and the income statement and balance sheet.income statement and balance sheet.3131Statement of Cash Flows:Statement of Cash Flows:2 Categories of Activities2 Categories of ActivitiesttSources = activities that Sources = activities that generate cash.generate cash.ttUses = activities that Uses = activities that involve spending cashinvolve spending cash3232SourcesSourcesttOperations.Operations.ttNew borrowings.New borrowings.ttNew stock issues.New stock issues.ttSale of property, plant, and equipment.Sale of property, plant, and equipment.ttSale of other non-current assets.Sale of other non-current assets.3333UsesUsesttCash dividends.Cash dividends.ttRepayment of borrowings.Repayment of borrowings.ttRepurchase of stock.Repurchase of stock.ttPurchase of property, plant, and equipment.Purchase of property, plant, and equipment.ttPurchase of non-current assets.Purchase of non-current assets.3434Illustration:Illustration: Statement of Cash Flows Statement of Cash FlowsOperating activities:Operating activities:Net incomeNet income$44$44$56$56Adjustments to reconcile net incomeAdjustments to reconcile net income to net cash from operating activities to net cash from operating activities 5 5(16)(16)Net cash provided by operating activitiesNet cash provided by operating activities$49$49$40$40Amounts in millionsAmounts in millionsDecember 31,December 31,2001 20002001 20003535Illustration (cont):Illustration (cont): Statement of Cash Flows Statement of Cash FlowsInvesting activities:Investing activities:Business acquisitionsBusiness acquisitions$(16)$(16) (2) (2)Additions to property, plant, and equipmentAdditions to property, plant, and equipment (56) (56) (20) (20)Sale of investmentsSale of investments 6 6 Other investing activitiesOther investing activities (2 (2) ) (2) (2)Net cash used for investing activitiesNet cash used for investing activities$(68)$(68)$(24)$(24)Amounts in millionsAmounts in millionsDecember 31,December 31,2001 20002001 20003636Illustration (cont):Illustration (cont):Statement of Cash FlowsStatement of Cash FlowsFinancing activities:Financing activities:Issuance of common stockIssuance of common stock$3$3$ 1$ 1Purchase and retirement of common stock (4) (28)Purchase and retirement of common stock (4) (28)Issuance of notes payable (borrowing)Issuance of notes payable (borrowing) 9 9 Other financing activitiesOther financing activities (1) (1) Net cash provided by financing activitiesNet cash provided by financing activities$7$7$(27)$(27)Amounts in millionsAmounts in millionsDecember 31,December 31,2001 20002001 20003737Illustration (cont): Illustration (cont): Statement of Cash Flows Statement of Cash FlowsNet increase in cash and cash equivalentsNet increase in cash and cash equivalents $(12) $(12) $(11) $(11)Cash and cash equivalents,Cash and cash equivalents, beginning of year beginning of year 80 80 91 91Cash and cash equivalents, end of yearCash and cash equivalents, end of year $ 68 $ 68 $ 80 $ 80Amounts in millionsAmounts in millionsDecember 31,December 31,2001 20002001 20003838Statement of owners equityStatement of owners equityttThe statement of owners equity reports on The statement of owners equity reports on changes in equity over the reporting period.changes in equity over the reporting period.ttStart with beginning equity Start with beginning equity ttAdjust for events :Adjust for events : Increase:Increase:Investments by ownerInvestments by ownerNet incomeNet income decrease: decrease:Owner withdrawalsOwner withdrawalsNet lossNet loss3939Two Categories ofTwo Categories ofShareholders EquityShareholders EquityttPaid-in or contributed capital.Paid-in or contributed capital.ttRetained earnings.Retained earnings.4040Balance Sheet andBalance Sheet and Changes in Equity Changes in EquityOwnersOwnersEquityEquityOwnersOwnersInvestmentInvestmentRevenuesRevenuesOwnersOwnersWithdrawalWithdrawalExpensesExpenses41414242Beauty Photo Store:Beauty Photo Store:Statement of Owners EquityStatement of Owners Equity4343Summary Summary ttThere are two major types of financial There are two major types of financial statements-stock reports and flow reportsstatements-stock reports and flow reportsttFinancial statement can serve as an Financial statement can serve as an important device to disclose information to important device to disclose information to investors in order for them to make better investors in order for them to make better decisionsdecisionsttFour major financial statements are Four major financial statements are compared, explained and illustrated in this compared, explained and illustrated in this lessonlesson4444Case for Open DiscussionCase for Open DiscussionttThe financial statement sits imposingly in front of The financial statement sits imposingly in front of you, a stream of numbers rolling endlessly down you, a stream of numbers rolling endlessly down the page. the page. ttYou are a new board member, studying the You are a new board member, studying the numbers, hoping to decipher their meaning. Then numbers, hoping to decipher their meaning. Then you are hit with the accounting jargon: balance you are hit with the accounting jargon: balance sheets and income statements; cash basis and sheets and income statements; cash basis and accrual basis. You think you hear the financial accrual basis. You think you hear the financial statements quietly laugh at you, and youstatements quietly laugh at you, and youbegin to wonder if the board should hirebegin to wonder if the board should hirea psychiatrist instead of an accountant. a psychiatrist instead of an accountant. 4545Suggested QuestionsSuggested QuestionsttHow are financial statements prepared?How are financial statements prepared?ttDo they make things simpler?Do they make things simpler?ttWhat information can we infer from these What information can we infer from these statements?statements?ttHow can we make use of them?How can we make use of them?ttetcetc4646The End of Lesson 9The End of Lesson 9