Module 3

Understanding
Financial Statements
M. MANAYAO, CPA, MBA
Learning Objectives
➢ Understand how business activities are reported
through the financial statements.
➢ Appreciate the general objectives of financial
statements.
➢ Enumerate and identify the needs of various users
that demand financial accounting information.
➢ Enumerate the sources of information about a
business enterprise.
Introduction
To be able to analyze a company effectively or
infer its value, it is important that one must
understand the company’s business activities. This
can be accomplished through the financial
statements. Financial statements report on
company’s performance and financial condition
and reveal executive management’s privileged
information and insights.
Introduction
Accounting information should be used in the business
context in which the information is created. All
companies without exception, plan business activities,
finance those activities, invest in those activities and
then, engage in operating activities. Business firms
conduct all these activities while confronting business
forces, including market constraints and competitive
pressures.
General Objectives
The important objectives of financial statements are:
1. Providing information for economic decisions.
2. Providing information about financial position.
3. Providing information about performance of an
enterprise.
4. Providing information about changes in financial
position.
Demand for Financial Accounting Information
The broad classes of users that demand financial accounting
information include the following:
1. Managers and employees
2. Investors and analysts
3. Creditors and suppliers
4. Shareholders and directors
5. Regulatory and tax agencies
6. Customers and potential strategic partners
7. Other decision makers
Sources of Information about Business Enterprise
1. The audited annual report that includes the four financial
statements (Statement of Financial Position, Statement of
Comprehensive Income, Statement of Stockholders’ Equity,
Statement of Cash Flows) with explanatory notes and the
management’s discussion and analysis of financial results.
2. The unaudited quarterly or interim reports that include
summary version of the four financial statements and
limited additional disclosure.
Constraints on Relevant and Reliable Information
1. Timeliness
2. Balance between benefit and cost
3. Balance between qualitative characteristics
4. True fair view or fair presentation
Financial Statements
Statement of Financial Position
A Statement of Financial Position reports a company’s
financial position at a point in time, the company’s resources
(assets) namely, what the company owns and also the sources
of asset financing. There are two ways a company can finance
its assets:
1. Owner financing. It can raise money from shareholders.
2. Nonowner financing. It can also raise money from banks or
other creditors and suppliers.
Statement of Financial Position
Working capital
Current assets are often called working capital because these
assets “turn over”, that is, they are used and then replaced
throughout the year.

Net working capital is the difference between current assets

minus current liabilities while net operating working capital is
the difference between current assets and noninterest-bearing
current liabilities.
Statement of Comprehensive Income
The Statement of Comprehensive Income reports on a
company’s performance over a period of time and lists
amounts for revenues (also called sales), expenses and
other comprehensive income. Revenues less expenses
yield the bottom-line net income amount.
Statement of Comprehensive Income
Statement of Stockholders’ Equity
The Statement of Stockholders’ Equity reports on
changes in key types of equity over a period of time. For
each type of equity, the statement reports the beginning
balance, a summary of the activity in the account during
the year and the ending balance.
Statement of Stockholders’ Equity
Blue Company
Statement of Stockholders' Equity
For the Year Ended December 31, 20x4
(pesos in millions)

Contributed Retained
Other Equity Total
Capital Earnings
December 31, 20x3 ₱53,060 ₱117,824 ₱50,478 ₱221,362
Stock issuance (repurchase) 860 860
Net income (loss) 26,426 26,426
Dividends (0) (0)
Other 56 (1,902) (1,846)
December 31, 20x4 ₱53,920 ₱144,306 ₱48,576 ₱246,802
Statement of Cash Flows
The Statement of Cash Flows reports the change (either
an increase or decrease) in a company’s cash balance
over a period of time. The statement reports on cash
inflows and outflows from operating, investing and
financing activities over a period of time.
Statement of Cash Flows
Blue Company
Statement of Cash Flows
For the Year Ended December 31, 20x4
(pesos in millions)

Operating cash flows ₱12,550

Investing cash flows (13,428)
Financing cash flows 1,464
Net increase in cash 586
Cash, December 31, 20x3 43,743
Cash, December 31, 20x4 ₱44,329
Application of
concepts
Problem A
Problem B
The assets of J&R Associates consist entirely of current
assets and net plant and equipment. The firm has total
assets of ₱2.5 million and net plant and equipment of ₱2
million. It has notes payable of ₱150,000, long-term
debt of ₱750,000, and total common equity of ₱1.5
million. The firm does have accounts payable and
accruals on its statement of financial position. The firm
only finances with debt and common equity, so it has no
preferred stock on its statement of financial position.
 Problem B
Assets Liabilities and Equity
Current assets 500,000 Accounts payable and accrual 100,000
Plant and equipment 2,000,000 Notes payable 150,000
Long-term payable 750,000
Common equity 1,500,000
Total Assets 2,500,000 Total Liabilities and Equity 2,500,000

Working capital = 500,000 – 250,000 = 250,000

Operating working capital = 500,000 – 100,000 = 400,000

Problem C
In its most recent financial statements, Newhouse Inc.
reported ₱50 million of net income and ₱810 million of
retained earnings. The previous retained earnings were ₱780
million.

Retained earnings - beginning 780,000,000

Add: Net income 50,000,000
Less: Dividend 20,000,000
Retained earnings – ending 810,000,000
➢QUESTIONS????
➢REACTIONS!!!!!
END