Preparing Financial Statements and Analyzing Business Transactions

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Chapter 7

• Preparing Financial Statements and Analyzing
  Business Transactions

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Objectives

• Understand financial reporting
• Understand four Financial Statements
• Understand Notes to Financial Statements
• Analyze transactions! prepare a worksheet
• Ratios

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Financial Reporting
The Process of preparing and presenting financial
information, to include The four financial
statements Income Statement Statement of Changes
in Shareholders Equity Balance Sheet Statement
of Cash Flows
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The Financial Accounting Standards Board
Establishes the guidelines for financial
statements. These broad principles are referred
to as Generally Accepted Accounting
Principles. The goal is to increase the quality
and usefulness of the information
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It takes good information
To make good decisions
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(No Transcript)
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Is the Information Useful?
It must be capable of making a difference in the
decision making process
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Qualities of Accounting Information
Information is only good if it is Relevant Reliab
le Comparable Consistent
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Relevant Information is.
Someone else bought it this morning ?
We would be able to expand our operations
I hear that our neighbor is selling their land
No longer relevant
Important to the company Has the potential to
influence decisions Provided on a timely basis
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Reliable Information is.
Is this information accurate and free of bias?
Neutral Verifiable And independent of the
specific person who prepared it
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Comparable Information
Each company has prepared its information using
the same set of rules Allows meaningful
comparisons of two companies
Are we doing better or worse than they are? Why?
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Consistent Information
How are we doing this year versus last year?
The company uses the same set of rules from year
to year Allows meaningful comparisons of a
companys performance at two points in time
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Take a closer look at the Balance Sheet
Adding Subtotals to the Balance Sheet is called
Classifying the Balance Sheet
These subtotals allow the reader to make
decisions as to the type, amount and the timing
of item under review
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Current Assets
Current Assets are those that will be converted
to cash or used in the next 12 months
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Non-Current Assets
Non-Current Assets (also called Plant Assets) are
those that will be Not Be converted to cash or
used in the next 12 months
Non-Current Assets will not be used in the next
12 months
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Current Liabilities
Current Liabilities are those that will be paid
off or worked off in the next 12 months
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CURRENT RATIO

• Current Assets/Current Liabilities
• What does THIS mean????

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Non-Current Liabilities
Non-Current Liabilities are those that will Not
Be paid off or worked off in the next 12 months
Non-Current Liabilities will not be paid off in
the next 12 months
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Stockholders Equity
Is the Residual Claim on the Net Assets of the
Corporation, after the claims of creditors have
been satisfied.
Contributed Capital represents the investment by
the stockholders
Retained Earnings represents the cumulative
(lifetime) profitability of the corporation less
dividends
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Transaction Analysis in simplest terms
Is the process of Analyzing the impact a
transaction has on the Accounting Equation
2) Did the transaction change the amount of
Liabilities?
3) If the change in Assets does not equal the
change in Liabilities, evaluate the impact on
Equity.
1) Did the transaction change the amount of
Assets?
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If Shareholders Equity changed
Either the Income Statement or Statement of
Shareholders Equity will be affected
If the transaction is between the business and
non-owners, it is an Income Statement
transaction.
If the transaction is between the business and
its owners, it is a Statement of Shareholders
Equity transaction
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A really big example. . .
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Lets try it.
Transactions in January
1) Clint and some of his friends contribute
2,000 to start the business.
This transaction increases Assets and Contributed
Capital by 2,000.
2,000
2,000
This transaction affects the Balance Sheet and
the Statement of Changes in Shareholders Equity
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2) Clints Consulting Company borrows 4,000
from a local bank. The loan will be repaid in
six months.
This transaction increases Assets and Liabilities
by 4,000.
Transactions that dont change Equity only affect
the Balance Sheet
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3) The firm spends 1,400 cash for operating
expenses.
This transaction decreases Assets and
Shareholders Equity by 1,400.
Cash will be reduced on the Balance Sheet and
Operating Expenses will reduce Income on the
Income Statement.
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4) Clints Consulting acquires office equipment
at a cost of 5,000 for cash.
This transaction Increases the Asset Office
Equipment, and decreases another Asset - Cash by
5,000.
This transaction is restricted to the Balance
Sheet
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5) Clints earned 6,000 for service revenue,
all paid in cash by clients.
This transaction Increases the Asset Cash, and
increases the Retained Earnings portion of
Shareholders Equity by 6,000.
This transaction increases Assets on the Balance
Sheet, and Net Income on the Income Statement.
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6) Clints Consulting paid 20 interest to the
bank.
This transaction Decreases the Asset Cash, and
decreases the Retained Earnings portion of
Shareholders Equity by 20.
This transaction decreases Assets on the Balance
Sheet, and Net Income on the Income Statement.
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The totals are used to create the financial
statements.
The Revenues and Expenses will be reported on the
Income Statement
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Income Statement
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Statement of Shareholders Equity
Transferred from the Income Statement
This amount is transferred to the Balance Sheet
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Balance Sheet
From the Statement of Shareholders Equity
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Assumptions and Principles underlying financial
reporting

• Assumptions
• Separate Entity Assumption
• Monetary Unit Assumption
• Time-period Assumption
• Going-Concern Assumption

• Principles
• Historical Cost Principle
• Revenue Recognition Principle
• Matching Principle

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Separate Entity Assumption
Financial Statements of a business only contain
information about that firm Exclude transactions
of the owners
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Monetary Unit Assumption
Only items that can be expressed in monetary
units (dollars in the United States) Will be
included in the Financial Statements
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Time-Period Assumption
The life of a business can be divided into
artificial time periods for financial
reporting These time periods are presented at the
top of each financial statement
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Going-Concern Assumption
A company will remain in business for the
foreseeable future
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Historical Cost Principle
Assets are recorded on the Balance Sheet at
cost Cost includes all costs necessary to get the
asset ready for its intended purpose
5,000
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Revenue Recognition Principle
6,000 of consulting work was performed in the
month of January
Revenues are recorded on the Income
Statement When the earnings process is
complete And the amount is reasonably
assured Generally at the time the goods or
services are provided
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Matching Principle
1,420 of expenses were incurred to generate the
6,000 of revenues
Expenses are recorded on the Income Statement In
the Same Time Period As the Revenue they helped
Generate
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Accrual-Basis Accounting
6,000 Revenue Total work done in January for
Cash and Credit Customers
Revenues and Expenses are recorded on the Income
Statement At the time the economic activity
occurs Regardless of cash flow
1,420 Expense Total costs incurred in January
whether paid in Cash or with credit
4,580 Net Income growth in total asset base,
not necessarily growth in Cash.
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EARNINGS PER SHARE

• Net Income/Average Shares of Stock
• What does it mean???

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End Chapter 7
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Statement of Cash Flows