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| Income Statement | (or... statement of income, statement of earnings, statement of operations) reports the accountant's primary measure of performance of a business, revenue less expenses during the accounting period= The term profit is used widely for this measure of performance, but we prefer the terms NET INCOME or NET EARNINGS |
| Net Income | Measures a company's success in selling its product for more than the cost to generate those sales |
| Income Statement: What time period does it refer to | Unlike the balance sheet (which reports as of a certain date), it reports for a specific period of time= The time period covered by the financial statements is called an ACCOUNTING PERIOD |
| Accounting Period | Refers to the time period covered by the financial statements |
| Net Income= ? | Revenues - Expenses = Net Income |
| Companies earn REVENUES from... | The sale of goods or services to customers (i.e. the sale of its products)= Revenues are normally reported for goods or services that have been sold to a customer whether or not they have yet been paid for= The business recognizes TOTAL sales (cash or credit [i.e. customer promises to pay for the good in the future]) as REVENUE for the period |
| Expenses | Represent the dollar amount of resources the entity used to earn revenues during the period= Expenses reported in one accounting period may actually be paid for in another accounting period (some expenses need to be paid for immediately while others not) |
| Income Tax Expense | Is listed under Expenses section on an income statement= All corporations must pay for this on pretax income |
| Net Income | (aka Net Earnings) Often called "The Bottom Line," is the excess of total revenues over total expenses= If total expenses exceed total revenue, a net loss is reported= Because revenues are not necessarily the same as collections from customers and expenses are not necessarily the same as payments to suppliers, NET INCOME normally DOES NOT EQUAL the net cash generated by operations (this latter amount is reported on the Cash Flow Statement) |
| Statement of Retained Earnings | Reports the way that net income and the distribution of dividends affected the financial position of the company during the accounting period |
| Statement of Retained Earnings: What time period does it refer to | Like the Income Statement, this statement covers a specific period of time (the ACCOUNTING PERIOD) |
| What does net income earned during the year do? | Increases the balance of retained earnings, showing the relationship of the income statement to the balance sheet |
| What does the declaration of dividends to the stockholders do? | Decreases retained earnings |
| Retained Earnings Equation | Beginning Retained Earnings + Net Income - Dividends = Ending Retained Earnings |
| Statement of Retained Earnings: Elements | The statement begins with the company's "beginning-of-the-year retained earnings"= The current year's NET INCOME (reported on the INCOME STATEMENT) is added and the current year's DIVIDENDS are subtracted from this amount |
| What does the retained earnings statement indicate? | Indicates the relationship of the income statement to the balance sheet |
| Statement of Cash Flows | (aka Cash Flow Statement) Divides the company's cash inflows (=RECEIPTS) and outflows (=PAYMENTS) into 3 primary categories of cash flows in a typical business: cash flows from operating, investing, and financing activities |
| Statement of Cash FLows: What time period does it refer to | Like the income statement, it covers a specified period of time (the ACCOUNTING PERIOD) |
| Reported Revenues | Do not always equal cash collected from customers because some sales may be on credit |
| Expenses reported on the Income Statement | May not be equal to the cash paid out during the period because expenses may be incurred in one period and paid for in another |
| Statement of Cash Flows= Why is it prepared by accountants? | Because income statement does not provide information concerning cash flows, its prepared to report inflows and outflows of cash (all summed up in the CASH FLOW STATEMENT EQUATION) |
| Cash Flow Statement Equation= What does it describe | Describes the causes of the change in cash reported on the balance sheet from the end of last period to the end of the current period |
| Cash Flow Statement Equation | [ +/- {Cash Flows from Operating Activities (CFO)} +/- {Cash FLows from Investing Activities (CFI)} +/- {Cash Flows from Financing Activities (CFI)} ] = Change in Cash |
| Cash flows from operating activities | Are cash flows that are directly related to earning income |
| Cash flows from investing activities | Include cash flows related to the acquisition or sale of the company's productive assets |
| Cash flows from financing activities | Are directly related to the financing of the enterprise itself= They involve the receipt or payment of money to investors and creditors (except for suppliers) |
| How are the 4 basic financial statements related to one another? | Net income from the income statement results in an increase in ending retained earnings on the statement of retained earnings= Ending retained earnings from the statement of retained earnings is one of the 2 components of stockholders' equity on the balance sheet= The change in cash on the cash flow statement added to the beginning-of-the-year balance in cash equals the end-of-year balance in cash on the balance sheet |
| Income Statement= What does it explain? | Through the Statement of Retained Earnings, explains how the operations of the company improved or harmed the financial position of the company during the year |
| Cash Flow Statement= What does it explain? | Explains how the operating, investing, and financing activities of the company affected the cash balance on the balance sheet during the year |
| Notes | At the bottom of the 4 basic financial statements appears the warning: "The notes are an integral part of these financial statement."= It warns users that failure to read the NOTES (=footnoes) to the financial statements will result in an incomplete picture of the company's financial health= Notes provide supplemental information about the financial condition of a company without which the financial statements cannot be fully understood |
| Notes= Types of notes | There are 3 basic types of notes= TYPE 1 provides descriptions of the accounting rules applied in the company's statements= TYPE 2 presents additional detail about a line on the financial statements= TYPE 3 provides additional financial disclosures about items not listed on the statements themselves |
| Formatting Conventions | Assets are listed on the balance sheet by ease of conversion to cash= Liabilities are listed by their maturity (due date)= Most financial statements include the monetary unit sign (e.g. in US, the $) besides the first dollar amount in a group of items= Is common to place a single underline below the last item in a group before a total or subtotal= A $ sign is also placed beside group totals (e.g. total assets) and a double underline below (i.e. total amount is double underlined) |
| Generally Accepted Accounting Principals | (GAAP) Are the measurement rules used to develop the information in financial statements |
| Securities and Exchange Commission | (SEC) Following the dramatic stock market decline of 1929, the Securities Act of 1933 and the Securities Exchange Act of 1934 created the SEC= Is the US government agency that determines the financial statements that public companies must provide to stockholders and the measurement rules that they must use in producing those statements (was created to create uniformity) |
| Financial Accounting Standards Board | (FASB) Is the private sector body given the primary responsibility to work out the detailed rules that become generally accepted accounting principles (SEC relies/turns to the FASB for these principles)= The Board has 5 full0time voting members and a permanent staff who consider the appropriate financial reporting responses to ever-changing business practices |
| Financial Accounting Standards | Is the official rules/procedures set forth by the FASB= Contains over 5,000 pages of rules/principles |
| Who is most directly affected by the information presented in financial statements? | Companies and their managers and owners= Companies incur the cost of preparing the statements and bear the major economic consequences of their publication, which include (among others): effects on the selling price of a company's stock; effects on the amount of bonuses received by management and employees; loss of competitive information to other companies |
| Effect(s) of changes in GAAP | Can affect the price buyers are willing to pay for companies= ARE ACTIVELY DEBATED!!!!! |
| Who are directly concerned with any changes in how net income is computed under GAAP? | Employees who receive part of their pay based on reaching stated targets for net income |
| What are managers and owners also concerned with in regards to GAAP? | That publishing certain info. in financial statements will give away trade secrets to other companies that compete with them |
| Who has primary responsibility for the information in the financial statements? | Primary responsibility lies with management, represented by the highest officer of the company and the highest financial officer |
| What 3 steps are taken to assure investors that the company's financial records are accurate? | (1) they maintain a system of controls over both the records and the assets of the company= (2) They hire outside independent auditors to verify the fairness of the financial statements= (3) They form a COMMITTEE OF THE BOARD OF DIRECTORS to oversee the integrity of these other 2 safeguards= (These responsibilities are often reiterated in a formal REPORT OF MANAGEMENT or MANAGEMENT CERTIFICATION in the annual report) |
| What are required for companies with publicly traded stock? | The 3 safeguards and a management certification |
| Audit Report | Describes the independent auditor's opinion of the fairness of the financial statements and the evidence gathered to support that opinion= Only CERTIFIED PUBLIC ACCOUNTANTS (or CPA) may issue an audit report |
| Independent CPAs | (aka Independent Accountants) Is the certified public accountant that writes the AUDIT REPORT= Are called Independent CPAs because they have certain responsibilities that extend to the general public as well as to the specific business that pays for this service |
| Audit | Is an examination of the financial reports (prepared by the management of the entity) to ensure that they represent what the claim and conform with GAAP |
| Public Company Accounting Oversight Board | (PCAOB) Is the private sector body given the primary responsibility to issue detailed auditing standards= These standards are used in performing an audit |
| The American Institute of Certified Public Accountants | (AICPA) Requires all of its members to adhere to a professional code of ethics and professional audition standards= Also, auditors of public companies must register with and comply with standards set by the PCAOB |
