Financial

Financial Statements
Statements and
and
the
the Annual
Annual Report
Report

Chapter 2

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2-1
ECON 3A UCSB ANDERSON
 Objectives
Objectives of
of Financial
Financial Reporting
Reporting

(a)
(a) PROVIDE
PROVIDE USEFUL
USEFUL INFORMATION
INFORMATION
Financial
Financial reporting
reporting should
should provide
provide information
information that
that is
is
useful
useful to
to present
present and
and potential
potential investors
investors and
and
creditors
creditors and
and other
other users
users in
in making
making rational
rational
investment,
investment, credit,
credit, and
and similar
similar decisions.
decisions.
The
The information
information should
should be
be comprehensible
comprehensible to to those
those
who
who have
have aa reasonable
reasonable understanding
understanding of of business
business
and
and economic
economic activities
activities and
and are
are willing
willing to
to study
study the
the
information
information with
with reasonable
reasonable diligence.
diligence.
11

Statement
1
1
Statementof
ofFinancial
FinancialAccounting
AccountingConcepts
Concepts(SFAC)
(SFAC)No.
No.11

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2-2
LO 1 Describe the objectives of financial reporting.
ECON 3A UCSB ANDERSON
 Objectives
Objectives of
of Financial
Financial Reporting
Reporting
(b)
(b) REFLECT
REFLECT INFORMATION
INFORMATION ON
ON CASH
CASH FLOWS
FLOWS
Financial
Financial reporting
reporting should
should provide
provide information
information to to help
help
present
present and
and potential
potential investors
investors and
and creditors
creditors and
and
other
other users
users inin assessing
assessing the
the amounts,
amounts, timing,
timing, and
and
uncertainty
uncertainty ofof prospective
prospective cash
cash receipts
receipts from
from
dividends
dividends oror interest
interest and
and the
the proceeds
proceeds from
from the
the sale,
sale,
redemption,
redemption, or or maturity
maturity of
of securities
securities or
or loans.
loans.
Since
Since investors'
investors' and
and creditors'
creditors' cash
cash flows
flows are
are related
related
to
to enterprise
enterprise cash
cash flows,
flows, financial
financial reporting
reporting should
should
provide
provide information
information toto help
help investors,
investors, creditors,
creditors, and
and
others
others assess
assess the
the amounts,
amounts, timing,
timing, and
and uncertainty
uncertainty of
of
prospective
prospective net
net cash
cash inflows
inflows to
to the
the related
related enterprise.
enterprise.1
1

Statement
1
1
Statementof
ofFinancial
FinancialAccounting
AccountingConcepts
Concepts(SFAC)
(SFAC)No.
No.11

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2-3
LO 1 Describe the objectives of financial reporting.
ECON 3A UCSB ANDERSON
 Objectives
Objectives of
of Financial
Financial Reporting
Reporting

(c)
(c) REFLECT
REFLECT THE
THE FINANCIAL
FINANCIAL POSITION
POSITION OF
OF THE
THE ENTITY
ENTITY
Financial
Financial reporting
reporting should
should provide
provide information
information about
about
the
the economic
economic resources
resources ofof anan enterprise,
enterprise, the
the claims
claims
to
to those
those resources
resources (obligations
(obligations of of the
the enterprise
enterprise to
to
transfer
transfer resources
resources to to other
other entities
entities and and owners'
owners'
equity),
equity), and
and the
the effects
effects of
of transactions,
transactions, events,
events, and
and
circumstances
circumstances thatthat change
change its its resources
resources andand claims
claims to
to
those
those resources.
resources.1
1

Statement
1
1
Statementof
ofFinancial
FinancialAccounting
AccountingConcepts
Concepts(SFAC)
(SFAC)No.
No.11

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2-4
LO 1 Describe the objectives of financial reporting.
ECON 3A UCSB ANDERSON
 ASSUMPTIONS PRINCIPLES CONSTRAINTS
Economic entity Historical cost Cost-benefit
Going concern Revenue recognition Materiality

Relevance
Relevance and
and Reliability
Monetary unit
Reliability Matching Industry practice
Periodicity Full disclosure Conservatism

QUALITATIVE
CHARACTERISTICS Capable
Capableofofmaking
makingaadifference
difference
ininaadecision.
decision.
Relevance
Reliability • • Verifiability
Verifiability
Comparability • • Representational
Representationalfaithfulness
faithfulness
Consistency • • Neutrality
Neutrality
Conceptual
Framework for OBJECTIVES
Financial 1. Useful in investment and credit
decisions
Reporting 2. Useful in assessing future
cash flows
3. About enterprise resources,
claims to resources, and
changes in them
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2-5
LO 2 Describe the qualitative characteristics of accounting information.
ECON 3A UCSB ANDERSON
 Fair
Fair Values:
Values:
Many items are now required to be reported/ disclosed at fair value, such as:
 Financial instruments (these are common, such as debt and accounts
receivable)
 Impairments
 Many others, we just havent learned enough about accounting to discuss them
all yet!

Historical cost is very objective, BUT fair value is very subjective thus somewhat
contradicting the “consistency/ comparability” objective of financial reporting.
Accordingly:
 New GAAP standard was written to provide guidance on how to determine fair
value. The guidance is intended to result in more standardized fair value
measurements:
 “Market Participant” approach, using the most advantageous and active market, and
3 levels of input:
 Level 1: Active market for the item

STOP
 Level 2: Active market for similar items

STOP
 Level 3: “Unobservable” Inputs.

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2-6
ECON 3A UCSB ANDERSON
 ASSUMPTIONS PRINCIPLES CONSTRAINTS
Economic entity Historical cost Cost-benefit
Going concern Revenue recognition Materiality
Monetary unit Matching Industry practice
Periodicity Full disclosure Conservatism

QUALITATIVE ELEMENTS
CHARACTERISTICS Assets, Liabilities, and
Equity
Relevance Investments by owners
Reliability Distribution to owners
Comprehensive income
Comparability Revenues and
Expenses
Consistency
Conceptual Gains and Losses

Framework for OBJECTIVES

Financial 1. Useful in investment and credit
decisions
Reporting 2. Useful in assessing future
cash flows
3. About enterprise resources,
claims to resources, and
changes in them
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2-7
LO 2 Describe the qualitative characteristics of accounting information.
ECON 3A UCSB ANDERSON
 WHAT
WHAT IS
IS AN
AN OPERATING
OPERATING CYCLE?
CYCLE?
The operating cycle is how long it takes a company to initiate,
perform, and deliver their primary product or service.

Take a wholesaler for instance. First they buy inventory, then

they sell it on account, and ultimately they collect the cash owed
from their customer. The period of time it takes to accomplish
this is the “Operating Cycle”.

Accounts Payable

Cash Inventory

Accounts receivable

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2-8
ECON 3A UCSB ANDERSON
 Balance
Balance Sheet
Sheet

Current
Current Assets
Assets
Defined:
Defined:
An
An asset
asset that
that is
is expected
expected to to be
be realized
realized in
in cash
cash or
or
sold
sold or
or consumed
consumed duringduring the
the operating
operating cycle
cycle or
or
within
within one
one year
year ifif the
the cycle
cycle is
is shorter
shorter than
than one
one year.
year.

OR
OR more
more commonly
commonly stated:
stated:
An
An asset
asset that
that is
is expected
expected toto be
be realized
realized in
in cash
cash or
or
sold
sold or
or consumed
consumed within
within one
one year
year or
or the
the operating
operating
cycle,
cycle, whichever
whichever is is longer.
longer.

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2-9
LO 3 Explain the concept and purpose of a classified balance sheet.
ECON 3A UCSB ANDERSON
 Balance
Balance Sheet
Sheet

Liabilities
Liabilities
Liabilities
Liabilities are
are probable
probable future
future economic
economic sacrifices
sacrifices
obtained
obtained oror controlled
controlled by
by aa particular
particular entity
entity as
as aa
result
result of
of past
past transactions
transactions or
or events.
events.

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2-10
LO 3 Explain the concept and purpose of a classified balance sheet.
ECON 3A UCSB ANDERSON
 Balance
Balance Sheet
Sheet

Current
Current Liabilities
Liabilities
Defined:
Defined:
An
An obligation
obligation that
that will
will be
be satisfied
satisfied within
within the the next
next
operating
operating cycle
cycle or
or within
within one
one year,
year, ifif the
the cycle
cycle is
is
shorter
shorter than
than one
one year.
year.

OR
OR more
more commonly
commonly stated:
stated:
An
An obligation
obligation that
that will
will be
be satisfied
satisfied within
within one
one year
year
or
or the
the operating
operating cycle,
cycle, whichever
whichever isis longer.
longer.

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2-11
LO 3 Explain the concept and purpose of a classified balance sheet.
ECON 3A UCSB ANDERSON
 A
A Classified
Classified Balance
Balance Sheet
Sheet
Company Name
Balance Sheet
As of DATE
Current assets
Cash xxx
etc. xxx
Total current assets xxx
Fixed assets
Other long term assets
Total assets xxx
Current liabilities
Accounts payable xxx
etc. xxx Balances?
Total current liabilities xxx
Long-term debt, excluding current portion
Equity
Common stock
APIC
Retained earnings
Total Liabilities & Equity
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2-12
ECON 3A UCSB ANDERSON
 Analysis
Analysis using
using aa Classified
Classified Balance
Balance
Sheet
Sheet
Liquidity = the ability of a company to pay its debts as
they come due.
A comparison of current assets and current liabilities is a
starting point in evaluating the ability of a company to
meet its obligations.

Working Capital = Current Assets – Current Liabilities

Company’s strive for a balance in managing its working
capital – not too much or too little.

$118,000 – 59,900 = $58,100

Current Current Working
assets liabilities capital
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2-13
LO 4 Use a classified balance sheet to analyze a company’s financial position.
ECON 3A UCSB ANDERSON
 Analysis
Analysis using
using aa Classified
Classified Balance
Balance
Sheet
Sheet
The
The current
current ratio
ratio indicates
indicates the
the amount
amount ofof current
current
assets
assets available
available at at the
the balance
balance sheet
sheet date
date relative
relative
to
to obligations
obligations coming
coming due due during
during that
that period.
period.
Current Assets
Current Ratio =
Current Liabilities

$118,000
1.97 to 1
= $59,900

Composition of current asset and current liabilities

important.
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2-14
LO 4 Use a classified balance sheet to analyze a company’s financial position.
ECON 3A UCSB ANDERSON
 Statement
Statement of of Retained
Retained Earnings
Earnings
Exercise
Exercise
Landon Corporation was organized on January 2, 2002, with the
Landon Corporation was organized on January 2, 2002, with the
investment of $100,000 by each of its two stockholders. Net
income for its first year of business was $85,200. Net income
increased during 2003 to $125,320 and to $145,480 during
2004. Landon paid $20,000 in dividends to each of the two
stockholders in each of the three years.

2002 2003 2004

Beg. Retained $ 0 $ $130,52
earnings 45,200 0
Net income 85,200 125,320 145,480
(loss)
Less: Dividends (40,000) (40,000) (40,000)
End. Retained $45,200 $130,52 $236,00
earnings 0 0

Slide
LO 7 Prepare and identify the components of the statement of retained earnings.
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ECON 3A UCSB ANDERSON
 Elements
Elements of
of the
the Annual
Annual Report
Report
BASIC- ALL AUDITED FINANCIAL STATEMENTS MUST
INCLUDE:

 Financial statements
 Notes to financial statements
 Report of independent accountants

PUBLIC COMPANIES ALSO MUST INCLUDE:

 Management’s assertions (SOX 403)
 Report of independent accountants on internal
controls (SOX 404)
 Management discussion & analysis
 Summary of financial data
 Letter to stockholders

http://www.starbucks.com/
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ECON 3A UCSB ANDERSON
 DATSALLFORTHISCHAPTER

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ECON 3A UCSB ANDERSON