Chapter 2

INTRODUCTION TO
FINANCIAL
STATEMENTS AND
OTHER FINANCIAL
REPORTING TOPICS
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Income Statement #2

 Covers a period of time Income Statement

Revenue $ 120,000
 Summarizes revenues and Expenses (100,000)
expenses Net Income $ 20,000
 Reports net income
 Excess of revenues over
expense
 Net income increases
retained earnings (B/S)
 Net Loss will decrease
retained earnings (B/S)
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Statement of Owners’ #3

Equity
 Covers a specific Income Statement
period of time Revenue $ 120,000
Expenses (100,000)
 Reconciles beginning Net Income $ 20,000
and ending balances of
the owners' equity Statement of Owners' Equity
accounts Capt. Stk. Ret. Earn.
Beginning Balance $20,000 $ 5,000
 Capital Stock Net income 20,000
 Retained Earnings Dividends (10,000)
Ending Balance $20,000 $ 15,000
 Etc.
 Links the income
statement and the
balance sheet
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Balance Sheet #4
Income Statement
Shows the financial condition of Revenue $ 120,000
an entity as of a particular date Expenses (100,000)
Net Income $ 20,000
 Assets: the resources of the
business Statement of Owners' Equity
Capt. Stk. Ret. Earn.
 Liabilities: the debts of the
Beginning Balance $20,000 $ 5,000
business
Net income 20,000
 Equity: the owners’ interest Dividends (10,000)
in the business Ending Balance $20,000 $ 15,000
The Accounting Equation: Balance Sheet
Assets = Liabilities + Assets $110,000
Owners’ Equity Liabilities 25,000
Owners' Equity
Capital Stock 50,000
Retained Earnings 35,000
$110,000
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Statement of Cash Flows #5

 Covers the same period as the income statement

 Three sections
 Cash flows from operating activities
 Cash flows from investing activities
 Buying and selling assets
 Cash flows from financing activities
 Financing cash from banks and dividends
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Notes #6

 An integral part of the financial statements

 Required presentation
 Summary of significant accounting policies
 Contingent liabilities
 Subsequent events relating to conditions that existed at the balance sheet
date
 Disclose and adjustment of the financial statements
 Subsequent events relating to conditions that did not exist at the balance
sheet date
 Disclosure but no adjustment of the financial statements
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The Accounting Cycle #7

1. Recording transactions
2. Recording adjusting entries
3. Preparing the financial statement
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Recording Transactions #8

 Internal or external event that causes a change in a company’s assets,

liabilities, or owners' equity
 Recorded in a journal (journal entry)
 Posted to general ledger accounts
 Double-entry system
 Debit: left side of an account
 Credit: right side of an account
 Debits = Credits
Account Title
Debit Credit
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Effects of Debits and Credits on #9
Accounts

 Assets & Expenses

 Normally have debit balances
 Debits increase account balance
 Credits decrease account balance
 Liabilities, Revenue, & Owners’ Equity
 Normally have credit balances
 Credits increase account balance
 Debits decrease account balance
Accounting System Components

Permanent Temporary
Account Assets Revenues, Gains
types Liabilities Expenses, Losses
Equity Dividends
Balances Carry forward to Closed to retained
the next fiscal earnings at year-end
period
Start with $0 balance
in the next period

Chapter 2, Slide #10

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Recording Adjusting 11

Entries
Required by the accrual basis of accounting
 Prepared at the end of the fiscal period
 Records (recognizes) for the current period
 Expenses incurred
 Revenues earned
 Recorded in the general journal
 Posted to the general ledger
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Auditor’s Opinion 12

 Audit is conducted by CPAs

 The audit report is the formal statement of audit opinion
 Unqualified opinion
 Qualified opinion
 Adverse opinion
 Disclaimer of opinion
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Unqualified Opinion 13

 The financial statements present fairly

 The financial position
 Results of operations
 Cash flows
 In conformity with generally accepted accounting principles
 For the user: the highest degree of reliability
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Qualified Opinion 14

 Except for the matter to which the exception relates

 The financial statements present fairly
 The financial position
 Results of operations
 Cash flows
 For the user: determine the significance of the exception
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Adverse Opinion 15

 The financial statements do not present fairly

 The financial position
 Results of operations
 Cash flows
 For the user: reliability of financial statements need to be seriously
questioned
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Disclaimer of Opinion 16

 The auditor does not express an opinion

 Auditor
 Has not preformed an audit sufficient in scope to form an opinion or
 Is not independent
 For the user: auditor’s statement conveys no indication of financial
statement reliability
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Auditor’s Report 17

 Paragraph #1:
 Financial statements have been audited
 Financial statements are responsibility of management
 Auditors have responsibility to express or disclaim an opinion
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Auditor’s Report (cont’d) 18

 Paragraph #2
 Audit conducted in accordance with the standards of the (U.S.) Public
Accounting Oversight Board
 Auditor is required to plan and perform the audit
 Obtain reasonable assurance
 Financial statements are free from material misstatement
 Audit provides a reasonable basis for opinion
 Examining evidence
 Assessing accounting principles and estimates
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Auditor’s Report (cont’d) 19

 Paragraph #3
 Opinion: in conformity with generally accepted (U.S.) accounting
principles
 Also: for public companies, reference to the audit of internal control
effectiveness
 In accordance with the the (U.S.) Public Accounting Oversight Board
 Based on criteria established by COSO
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Auditor’s Report on 20

Internal

Control
Required by Sarbanes-Oxley
 May be combined with audit opinion report
 Paragraphs
1. Scope
2. Responsibility and procedures
3. Opinion
4. Reference to financial statement audit
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Management’s 21

Responsibility
Management is responsible for
 The preparation of the financial statements
 The integrity of the financial statements
 Management’s Statement of Responsibility
 May be included in the annual report
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The SEC’s Integrated 22

Disclosure
Required filings System
 10-K: annual filing (audited)
 Includes financial statements plus
 Information on the business entity
 Market information
 Management discussion and analysis
 Directors, executive officers, and their compensation
 Related party transactions
 10-Q: quarterly filing (unaudited)
 8-K: “current report”
 To report the occurrence of any material events or corporate changes
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Additional Reporting 23

Venues
 Proxy
 Notice and authorization of shareholder voting rights on corporate actions
 Content and form governed by the SEC
 Summary Annual Report
 Highly condensed financial information
 Must be accompanied by a proxy containing full financial information
 Not adequate for financial analysis
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The Efficient Market 24

Hypothesis
Capital markets generate security prices that reflect worth
 Publicly available information is reflected in share prices
 Investors will be harmed if full disclosure is not made
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Consolidated Financial 25

Statements
Parent consolidates with subsidiary
 Report results of operations separately
 Sum subsidiary and parent results of operations
 Legal control vs. effective control
 Consolidation occurs when parent has effective control over the
subsidiary
 Holds a majority of risks, rewards, and decision-making ability
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Accounting for Business 26

Combinations
Effected through merger or acquisition
 Purchase method of accounting
 Record assets and liabilities acquired at their fair values
 Excess of purchase price over fair value of net assets acquired is
reported as goodwill