Financial Statements and Their Preparation

Four Financial Statements
  • Companies prepare four financial statements from summarized accounting data:
    • Income Statement
    • Retained Earnings Statement
    • Balance Sheet
    • Statement of Cash Flows
Income Statement
  • Purpose: Reports revenues and expenses for a specific period of time.
  • Components of Income Statement:
    • Revenues: e.g. Service revenue
    • Expenses: e.g. Salaries, supplies, rent, interest, insurance, depreciation
  • Net Income/Loss:
    • Net income occurs when revenues exceed expenses (e.g., Sierra Corp reported $2,860 net income).
    • Net loss occurs when expenses exceed revenues.
  • Note: Amounts from issuing stock are not considered revenues.
  • Statement Heading: Includes company name, type of statement, and time period covered.
Retained Earnings Statement
  • Purpose: Shows amounts and causes of changes in retained earnings during a period.
  • The time period aligns with the income statement.
  • Allows users to evaluate dividend payment practices.
  • Example: For Sierra Corporation, the retained earnings statement showed changes based on net income and dividends paid.
Balance Sheet
  • Purpose: Reports assets and claims to assets at a specific point in time.
    • Equation: Assets = Liabilities + Stockholders’ Equity
  • Structure:
    • Lists assets first, then liabilities and stockholders' equity.
  • Example: Sierra Corporation's balance sheet identifies cash, accounts receivable, and liabilities, concluding with total equity.
  • Statement Heading: Includes company name, statement type, and date of financial position.
Statement of Cash Flows
  • Purpose: Provides financial information about cash receipts and payments of a business over a specific period of time.
    • Answers:
    • Where did cash come from?
    • How was cash used?
    • What was the change in the cash balance?
  • Categories:
    • Operating Activities, Investing Activities, Financing Activities.
  • Example: For Sierra Corporation, cash balances showed a net increase due to various activities.
Interrelationships of Financial Statements
  • Linkage:
    • Net income from the income statement affects retained earnings, which is reflected in the retained earnings statement.
    • Ending retained earnings then impact stockholders' equity on the balance sheet.
  • Overall financial positions are interconnected, showcasing company performance holistically.
ESG Reporting: Beyond Financial Statements
  • ESG = Environmental, Social, Governance performance reporting.
  • Responsibility to avoid exploiting or endangering any individual or group and to adhere to fair trade practices.
Elements of an Annual Report
  1. Financial Statements: Must be included.
  2. Management Discussion and Analysis (MD&A):
    • Discusses near-term obligations, operations, expansion potential, and significant trends or uncertainties.
  3. Notes to the Financial Statements:
    • Clarify and provide further detail essential for understanding the company's operating performance.
  4. Auditor’s Report:
    • Opinion on fairness and compliance with accounting principles, performed by CPAs.
Review Questions
  1. Net Income: Achieved when revenues exceed expenses.
  2. Balance Sheet: Prepares information as of a specific point in time.
Example Calculations
  • Net Income Example:
    • For CSU Corporation, service revenue of $17,000 minus total expenses of $10,200 results in net income of $6,800.
  • Annual Report Components: Identify associations with MD&A, notes, and auditor’s report for various financial items.
Important Definitions
  • Retained Earnings: Accumulated net income that is reinvested in the business.
  • Liabilities: Any debts and obligations of a company.
  • Stockholders' Equity: The net worth of the company attributed to shareholders.