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IBC & Friends Presentation

Financial Statements and Related Stuff

FASBs Conceptual Framework

SFAC No. 1: Objectives of Financial Reporting by Business Enterprises SFAC No. 2: Qualitative Characteristics of Accounting Information SFAC No. 3: Elements of Financial Statements of Business Enterprises* SFAC No. 4: Objectives of Financial Reporting by Nonbusiness Organizations SFAC No. 5: Recognition and Measurement in Financial Statements of Business Enterprises

SFAC No. 6: Elements of Financial Statements

Objectives of Financial Reporting

Provide information useful to economic decision makers Allow decision makers to predict businesses future cash flows (and cash flows they will receive from these businesses) Provide information concerning businesses assets and liabilities and related transactions and events

Key Attributes of Accounting Information

Decision Usefulness

Understandability Relevance Reliability

A Quick Trip through the Four Financial Statements

Balance Sheet Income Statement Statement of Cash Flows Statement of Stockholders Equity /Statement of Retained Earnings

The Balance Sheet

A financial snapshot of a company at one point in time.

The accounting or balance sheet equation

Assets = Liabilities + Owners Equity Or Assets - Liabilities = Owners Equity

Questions Answered by a Balance Sheet . . . Among Others

How much cash does a firm have on hand? Does a company have sufficient cash to pay off its debts that are coming due in the next few months? Does a firm have more longterm debt than its major competitor?

Assets . . . defined
Probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events.

Things a company owns.

Types of Assets
Current Assets: Cash, Short-Term Investments, Accounts Receivable, Inventory, and Prepaid Expenses Property, Plant & Equipment Long-Term Investments Intangible Assets Other Assets

Liabilities . . . defined
Generally . . . amounts by businesses to third parties.

Current: Accounts Payable, Accrued Liabilities, Notes Payable Long-Term: Long-Term Notes Payable, Mortgages Payable, Long-Term Accrued Liabilities

Stockholders Equity
Common Stock Additional Paid-In Capital Retained Earnings

AIR & SEA TRAVEL, INC. Balance Sheet April 30, 2003 Assets Cash $33,300 Accounts receivable 2,000 Office supplies 500 Land 18,000 Liabilities Accounts payable $ 100

Total assets


Stockholders Equity Common stock 50,000 Retained earnings 3,700 Total stockholders equity 53,700 Total liabilities and stockholders equity $53,800

The Income Statement

Basic Format: Revenues - Expenses = Net Income
Revenues: Increases in assets and decreases in liabilities resulting from an entitys profitoriented activities. Expenses: Decreases in assets and increases in liabilities resulting from an entitys profitoriented activities.

Key Income Statement Items

Gross Profit Operating Expenses Operating Income Earnings per Share

Questions Answered by a Companys Income Statement . . . Among Others

Did the company earn a profit during its most recent fiscal year? What was the firms gross profit percentage? What is the firms principal source of revenue?

AIR & SEA TRAVEL, INC. Income Statement Month Ended April 30, 2003 Revenue: Service revenue Expenses: Salary expense Rent expense Utilities Total expenses Net Income $1,200 1,100 400 2,700 $5,800


Statement of Stockholders Equity. . . A Few Notes

Essentially, this financial statement is a supporting schedule to the balance sheet. Reconciles the beginning-of-the-year and end-of-theyear dollar amounts of individual stockholders equity items. Question answered: What events or transactions accounted for the changes in a companys stockholders equity over the previous year?

Note: Instead of an S.O.S. many companies prepare a Statement of Retained Earnings

Statement of Retained Earnings

The statement of retained earnings reports that portion of net income the company has retained, or kept for use in the business
Net income increases retained earnings Dividends paid to stockholders decrease retained earnings


AIR & SEA TRAVEL, INC. Statement of Retained Earnings Month Ended April 30, 2003 Retained earnings, April 1, 2001 Add: Net income for the month Less: Dividends Retained Earnings, April 30, 2001 $ 0 5,800 $5,800 (2,100) $3,700

Statement of Cash Flows

Reveals how a business generated and used cash during an accounting period. Four Sections:
Cash flows from operating activities Cash flows from investing activities Cash flows from financing activities Reconciliation of a businesss cash balances at the beginning and end of a year


Operating Activities
Companies operate by buying goods and services, which are sold to customers

Investing Activities
Companies invest in long-term assets that are used to run the business

Financing Activities
Companies finance themselves by issuing stock and borrowing money

Questions Answered by a Statement of Cash Flows . . . Among Others

How does a firms cash flows from its operating (profitoriented) activities compare to its net income? What was the major source of the companys cash inflows during its most recent year? During the past year, what was the firms major cash outflow?

AI A AVEL, I . t t t f Fl w t Ended April , fl w fr per ting ti ities: Coll ctions from c stomers P ments to s liers nd employees Net c s inflow from oper ting cti ities Cash fl ws fr investing activities: c isition of l nd $(4 , S le of l nd , Net c s outflow from investing ctivities Cash fl ws fr financing activities: , Issuance (sale) of stock $ Payment of dividends ( , Net cas inflow from financing activities Net increase in cas Cas alance, pril , Cas alance, pril ,
6, ( , ,4 ) ( ) 4 ,9 $ , $ , , )

Accounting Gimmicks
Asset Issues
Inflating inventory Understating allowance for bad debts Overstating useful lives of depreciable assets Misclassifying current assets & liabilities Capitalizing expenses

Pumping Up Revenues
Channel stuffing Bill and hold sales Grossing up revenues Front loading

Assorted Other Sordid Accounting Tricks

Issuing pro forma earnings Bribes & kickbacks Skimming cash receipts Lapping accounts receivable Lying to your auditors

A Few Red Flags

Revenues rising but operating cash flows stagnant or falling Receivables growing more rapidly than sales Inventory growing more rapidly than accounts payable Complex/convoluted transactions Related party transactions Lotsa management turnover

Recent Accounting Disasters

Enron: SPEs & SPVs WorldCom: Capitalizing expenses Leslie Fay: Inflating inventory Livent: Overstating revenues (bogus ticket sales) Lincoln Savings & Loan: Swapping desert land to produce bogus profits