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.