Basic Finance

MODULE MATERIALS
List of Modules

No. MODULE
MODULE TITLE
CODE

1 The Philippine Financial System BFin 313-1

2 Banking Key Concepts BFin 313-2

3 The Principles of Stock Market BFin 313-3

4 The Concept and Development of Money BFin 313-4

5 Introduction to Finance BFin 313-5

6 Introduction to Managerial Finance BFin 313-6

7 Finance and Accounting BFin 313-7

8 Understanding Financial Statements BFin 313-8

9 Financial Statement Tools for Decision Making BFin 313-9

10 The Financial Environment BFin 313-10

11 Financial Intermediation BFin 313-11

12 Interest Rate and Its Role in Finance BFin 313-12

13 Financial Assets BFin 313-13

14 Basic Capital Market BFin 313-14

 MODULE #8-BFin 313-8
Understanding Financial Statements

MODULE MATERIALS

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UNDERSTANDING
FINANCIAL
STATEMENTS

(BFIN 313-8)

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 MODULE CONTENT
COURSE TITLE: Basic Finance

MODULE TITLE Understanding Financial Statements

NOMINAL DURATION: 6 Hours

SPECIFIC LEARNING OBJECTIVES:

At the end of this module you MUST be able to:
1. Identify the users of financial statements and their needs.
2. Demonstrate an understanding of the purposes and uses of each
statement.
3. Identify the major components and classifications of each statement.
4. Know the differences of preparing income statement for a merchandising
business and manufacturing business.
5. Explain the different kinds of basic costs.
6. Understand market value and book value.
7. Prepare financial statements and retained earnings.

TOPIC: (SUB-TOPICS)
1. Definition of Financial Statements
2. Basic Financial Statements
3. Income Statement of Manufacturing and Merchandising Business
4. Product Costs versus Period Costs
5. Variable and Fixed costs
6. Pro-forma of Balance Sheet Presentation
7. Market Value versus Book value
8. Statement of Retained Earnings
ASSESSMENT METHOD/S:
Quiz-Multiple Choice
REFERENCE/S:
1. Leuterio, M.M. & Estepa, C.B.
Banking Theory & Practice (Revised Edition), 2018
Pasig City: Anvil Publishing, Inc.
2. Fajardo, Feliciano R. & Manansala, Manuel M.
Money, Credit and Banking 4th Edition, 2017
Mandaluyong City: National Book Store
3. A) Mejorada, N.D.
Introduction to Management Accounting, 2018 Edition
Makati City: Goodwill Trading Co.,Inc.
B) Edlagan and Mercado
Management Advisory Services (Concepts, Methods and
Applications) Volume 1, 2016 Edition
Makati City: Goodwill Trading Co.,Inc.
4. Melicher, Ron & Norton, Edgar
Introduction to Finance, 2018 Edition
New York: John Wiley & Sons
5. A) Brigham, Eugene F.

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 Fundamentals of Financial Management, 20th Edition 2016
Hoboken, New Jersey, USA: John Wiley and Sons
B) Dr. Hughes
Personal Finance 12th Edition, 2017
Upper Saddle River, New Jersey, USA: Pearson Prentice Hall
Information Sheet-BFin 313-8
Understanding Financial Statements

Learning Objectives:
After reading this INFORMATION SHEET, YOU MUST be able to:
1. Identify the limitations of each financial statement.
2. Identify how various financial transactions affect the elements of each of
the financial statements and determine the proper classification of the
transaction.
3. Demonstrate an understanding of the relationship among the financial
statements.
4. Demonstrate an understanding of how the financial statements are
prepared.
5. Illustrate an actual application of the preparation of financial statements.
INTRODUCTION
If you are in business, you need to understand financial statements. For
one thing, the law no longer allows high-ranking executives to plead ignorance
or fall back on delegation of authority when it comes to taking responsibility for
a firm’s financial reporting.
In a business environment tainted by episodes of fraudulent financial
reporting and other corporate misdeeds, top managers are now being held
accountable for the financial statements issued by the people who report them.
For another thing, top managers need to know if the company is hitting on all
cylinders or sputtering down the road to bankruptcy. If he did not understand
the financial statements issued by the company’s accountants, an executive
would be like an airplane pilot who does not know how to read the instrument
in the cockpit. He might be able to keep the plane in the air for a while, but he
would not recognize any signs of impending trouble until it was too late.

FINANCIAL STATEMENTS
• the product of financial accounting.
• show the results of operation, financial condition, changes in
owner’s equity and sources and uses of cash
BASIC FINANCIAL STATEMENTS
• Income Statement or Statement of Comprehensive Income
• Balance Sheet or Statement of Financial Position or Statement of
Financial Condition
• Statement of Changes in Owner’s Equity (for a sole proprietorship) or
Statement of Changes in Partners’ Equity (for partnership) or
Statement of Changes in Stockholders’ Equity (for a corporation)
• Cash Flow Statement or Statement of Cash Flows
INCOME STATEMENT

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 • now called “Statement of Comprehensive Income”, details the
revenues earned and the expenses incurred by a company
• shows the results of operation of a company
• the “bottom line” in business parlance is the net profit or the net
loss
• shows profitability of the firm
• covers a certain accounting period, a month, a quarter, a six-month
period, or a year.
INCOME STATEMENT OF A SERVICE ENTERPRISE
• very simple.
• simply lists the income from operations, like service revenue or
professional fees and deducts from such revenue the total operating
expenses
• OPERATING PROFIT – if the income is greater than the operating
expenses
• OPERATING LOSS – if the income is less than the operating
expenses
• To the operating profit or loss is added the net of the other income
(interest income, rent income, commission income, among others)
less the other expenses (interest expense, finance charges, among
others).

INCOME STATEMENT OF A MERCHANDISING FIRM/TRADING FIRM

• a little complicated
• shows the sales figure and deductions from gross sales like sales
discount and sales return and allowance to arrive at net sales
• From net sales, the cost of sales is deducted which is computed by
adding the beginning inventory to the net cost of purchases and
deducting the ending inventory.
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 • The cost of sales is deducted from the net sales to arrive at the gross
profit.
• From the gross profit, the operating expenses are deducted to obtain the
profit from operations or operating profit.
• From the operating profit is added the net of other incomes and other
expenses to arrive at the “bottom line” or profit (or loss, if expenses are
greater than revenue).

INCOME STATEMENT OF A MANUFACTURING COMPANY

• More complicated than a trading firm because of the different costs
involved (cost of goods manufactured and the cost of goods sold) in
addition to the operating expenses.
• Different costs involve direct materials, direct labor and
manufacturing overhead.
• The manufacturing firm’s cost is complicated due to the fact that its
manufacturing operations detail the cost of goods manufactured first
before the cost of goods sold is computed.
• Manufacturing cost is broken down into direct materials, direct labor and
manufacturing overhead, the three components of manufacturing cost.
Then there is the work in process inventories and the finished goods in
inventories.

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 • Schedule A
1. total manufacturing cost
Direct materials Pxxx
Direct labor xxx
Manufacturing Overhead xxx
TOTAL MANUFACTURING COSTS Pxxx

To the total manufacturing cost is added the beginning work in process

inventory and from the total thus obtained is deducted the ending work in
process to yield total cost of goods manufactured.
Thus we have:
2. total cost of goods manufactured
Total Manufacturing Cost Pxxx
Work in Process, Beginning xxx
Work in Process, End (xxx)
TOTAL COST OF GOODS MANUFACTURED Pxxx

To the cost of goods manufactured is added the beginning finished goods

inventory to arrive at the total goods available for sale and then from the
total thus obtained is deducted the ending finished goods inventory to
arrive at the cost of goods sold.
Similarly, we have:
3. total goods available for sale & 4. cost of goods sold
Total Cost of Goods Manufactured Pxxx
Finished Goods Inventory, Beginning xxx
Total Goods Available for Sale xxx
Finished Goods Inventory, End (xxx)

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Cost of Goods Sold Pxxx

• Schedule B - shows the details of the selling or marketing expenses.

Expenses related to sales are grouped under the selling or marketing
expenses

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 • Schedule C – is the schedule of the general or administrative
expenses. These expenses refer to those operating expenses related
to the office/general/administrative operations. The salary of the
president and the different vice presidents and managers are all part
of the general or administrative expenses. The rent expense for the
office space is administrative.

PRODUCT COSTS VERSUS PERIOD COSTS

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 • Product costs are the costs of direct materials, direct labor and
overhead, also called manufacturing cost (Schedule A) while
• Period costs refer to the costs incurred during a particular time
period and reported either as selling or marketing expenses
(Schedule B) and administrative or general expenses (Schedule C)
VARIABLE COSTS VERSUS FIXED COSTS
• Like product costs, they could be variable (e.g., income taxes,
commission expense, utilities expense, among others) or fixed (e.g.,
officers’ salaries, office rent depreciation for office building and office
equipment, among others)
BALANCE SHEET
• Or statement of financial condition, sometimes also called statement
of financial position
• Shows the assets, liabilities and owner’s equity of a business
• Shows financial condition or financial position of the business
• Details the company’s resources and obligations and the
composition of the owner’s equity
• Assets – Liabilities = Owner’s Equity
• it also shows the liquidity and solvency of the firm
CURRENT AND NONCURRENT ASSETS
• Total assets are divided into current and non-current assets
• Current assets are the resources that will be used for current
operations (short term) or within the operating cycle. Examples:
cash, prepaid expenses, accounts receivable, inventory
• Non-current assets refer to the resources of the firm that are
durable or will last longer than a year like land, equipment,
furniture and fixture and long-term investments.
CURRENT AND NONCURRENT LIABILITIES
• Total liabilities are divided into current liabilities and non-current
liabilities or long-term liabilities.
• Current liabilities are obligations of the firm that will mature or need
payment during the accounting period or accounting year.
Examples: accrued liabilities (accrued property taxes payable),
payroll liabilities (salaries and wages due within the year), company
liabilities (accounts payable, dividends payable)
• Non-current liabilities are obligations of the firm that will mature or
become due within more than a year. That portion of the long-term
liability that is due during the current period is classified as a current
liability and the rest or balance is classified as long-term or non-current.
Examples: long-term loans, deferred revenues, deferred income taxes,
capital leases

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 Bachelor of Science in Bulacan Date Developed:
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ACCOUNT FORM AND REPORT FORM
• A balance sheet can be reported using the account form where
assets are listed on the left side and liabilities and owner’s equity on
the right side. The report form lists the assets followed by the
liabilities and the owner’s equity.
MARKET VALUE VERSUS BOOK VALUE
• The book value of an asset is its original purchase cost, adjusted for
any subsequent changes, such as for impairment or depreciation.
Market value is the price that could be obtained by selling an asset
on a competitive, open market.
• For example, a company buys a machine for $100,000 and
subsequently records depreciation of $20,000 for that machine,
resulting in net book value of $80,000. If the company were to then
sell the machine at its current market price of $90,000, the business
would record a gain on the sale of $10,000.

STATEMENT OF CHANGES IN OWNER’S EQUITY

• Shows the investments made by the owner reduced by his
withdrawals and increased by net profit (or reduced by net loss) for a
sole proprietorship or partnership

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• For a corporation, the statement of changes in stockholders’ equity
shows the capital stock at the beginning of the period increased by
any additional issues of shares.

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STATEMENT OF RETAINED EARNINGS
• For a corporation, the accumulated profits of the company are
reflected in the retained earnings account.
• Retained earnings account details the beginning retained earnings,
the profit/loss of the corporation, dividends declared, retained
earnings appropriated and the return of appropriation of retained
earnings.
• Retained earnings appropriated are the appropriation of the company’s
accumulated earnings for such purposes as plant expansion, building
construction, land acquisition, bond retirement and other purposes as
the corporation sees fit.
• Appropriated retained earnings portion shows all appropriations of
retained earnings at the beginning of the period and to each respective
appropriation are added additional appropriations and deducted all
reversal of appropriated retained earnings back to the unappropriated
retained earnings. New appropriations for the year are also included in
the statement.

STATEMENT OF CASH FLOWS OR FUND FLOWS

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 • Is sometimes called the funds flow statement or the statement of the
sources and uses of cash or the statement of sources and uses of
funds.

• Accrual method – recognition of income and expenses are made

when income is earned, regardless when cash is received and
expenses are recognized when expenses are incurred, irrespective of
when they are paid.
• The profit or net income shown in the income statement does not show
the cash position of the company. Income in the income statement can
only be “paper profits” if receivables are not collected and converted into
cash. This is the basic reason why the cash flow is important to provide
additional information as to the cash position, which is an indication of
the liquidity of the firm.

• Net cash inflow from investing activities shows purchases and

sales of fixed assets.
• Net cash inflow from financing activities shows sales of capital
stock, payment of dividends and repayment of long-term liabilities.
• Operating activities are all operation-related earning activities of the
company – rendering service for a firm, selling goods for a trading
concern and manufacturing and selling activities for a manufacturing
company.
• Financing activities involve obtaining resources from owners (issuances
of capital stock) and paying them dividends as their share in the profit of
the company.
• Investing activities involve all activities related to non-current assets—
disposing of them or selling them and buying them.

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 Bachelor of Science in Bulacan Date Developed:
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Diagrams of Statement of Cash Flows Showing the Two Methods

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 Bachelor of Science in Bulacan Date Developed:
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