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Learning Objective 1

Describe and interpret the elements of

and the information conveyed by
financial statements.

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 Four Main Financial Statements

 Balance Sheet
 Income Statement
 Statement of Stockholders’ Equity
 Statement of Cash Flows

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 Balance Sheet

 Mirrors the Accounting Equation

Assets = Liabilities + Equity
Uses of funds = Sources of funds

 Assets are listed in order of liquidity

 Liabilities are listed in order of maturity
 Equity consists of Contributed Capital and
Retained Earnings

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 Assets

To be reported on a balance sheet, an asset must

1. Be owned (or controlled) by the company
2. It must confer expected future economic benefits
that result from a past transaction or event.

Assets are listed in order of liquidity

 Current assets comprise assets that can be
converted to cash within a year
 Long-term assets cannot be easily converted to
cash within a year.
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 Examples of Current Assets
 Cash—currency, bank deposits, and investments with an
original maturity of 90 days or less (called cash equivalents)
 Short-term investments—marketable securities and other
investments that the company expects to dispose of in the
short run
 Accounts receivable, net—amounts due to the company from
customers arising from the sale of products and services on
credit (“net” refers to the subtraction of uncollectible accounts)
 Inventories—goods purchased or produced for sale to
customers
 Prepaid expenses—costs paid in advance for rent, insurance,
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 Examples of Long-Term Assets

 Property, plant and equipment (PPE), net—land, factory

buildings, warehouses, office buildings, machinery, motor
vehicles, office equipment and other items used in
operating activities (“net” refers to the subtraction of
accumulated depreciation, the portion of the assets’ cost
that has been expensed);
 Long-term investments—investments that the company
does not intend to sell in the near future;
 Intangible and other assets—assets without physical
substance, including patents, trademarks, franchise rights,
goodwill and other costs the company incurred that
provide future benefits.

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Apple’s Assets

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Cisco Systems, Inc.
Assets

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 Knowledge Based Assets are not
Reflected on the Balance Sheet

 NOTE: While resources expended for research and

development reflect and economic asset, they generally
are expensed as incurred.
 INSIGHT: Pharmaceutical firms do not report assets
reflecting the full cost that they have expended in
developing drugs. These costs, for the most part, have
been expensed in the income statement as R&D
expense.

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Disney’s Assets

Where’s Mickey?
The market value
of the Mickey Mouse
trademark does
not explicitly
show up here.

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Apple’s Liabilities and Equity

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 Examples of Current Liabilities
 Accounts payable—amounts owed to suppliers for goods and services
purchased on credit.
 Accrued liabilities—obligations for expenses that have been incurred
but not yet paid; examples are accrued wages payable (wages earned by
employees but not yet paid), accrued interest payable (interest that is
owing but has not been paid), and accrued income taxes (taxes due).
 Unearned revenues—obligations created when the company accepts
payment in advance for goods or services it will deliver in the future;
also called advances from customers, customer deposits, or deferred
revenues.
 Short-term notes payable—short-term debt payable to banks or other
creditors.
 Current maturities of long-term debt—principal portion of long-term
debt that is due to be paid within one year.

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Cisco Systems, Inc.
Current Liabilities

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Net Working Capital

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Operating Cycle

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 Examples of Noncurrent Liabilities

 Long-term debt—amounts borrowed from

creditors that are scheduled to be repaid more
than one year in the future. Long-term debt
includes bonds, mortgages, and other long-term
loans.
 Other long-term liabilities—various obligations,
such as pension liabilities and long-term tax
liabilities, that will be settled a year or more into
the future.

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 Cisco Systems, Inc.
Long-Term Liabilities

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 Equity

Equity consists of:

 Contributed Capital (cash raised from the issuance of
shares)
 Earned Capital (retained earnings). Retained Earnings
is updated each period as follows:

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 Examples of Equity Accounts
 Common stock—par value received from the original sale of
common stock to investors.
 Preferred stock—value received from the original sale of preferred
stock to investors; preferred stock has fewer ownership rights
compared to common stock.
 Additional paid-in capital—amounts received from the original sale
of stock to investors in excess of the par value of stock.
 Treasury stock—amount the company paid to reacquire its common
stock from shareholders.
 Retained earnings—accumulated net income (profit) that has not
been distributed to stockholders as dividends.
 Accumulated other comprehensive income or loss—accumulated
changes in asset and liability fair values that are not reported in the
income statement.
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Cisco Systems, Inc.
Stockholders’ Equity

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Income Statement

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Apple’s Income Statement

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 Operating vs. Nonoperating
 Operating expenses are the usual and customary costs that
a company incurs to support its main business activities
 Cost of goods sold
 Selling expenses
 Depreciation expense, and
 Research and development expense
 Nonoperating expenses relate to the company’s financing
and investing activities
 Interest expense
 Interest or dividend income, and
 Gains and losses from the sale of securities
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Cisco Systems, Inc.
Income Statement

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 When are Revenues
and Expenses Recognized?
 Revenue Recognition Principle—recognize revenues
when earned
 Expense Recognition (Matching) Principle—recognize
expenses when incurred
 These two principles are the foundation of accrual
accounting
 First, recognize revenues in the time period they are earned;
 Then, record all expenses incurred to generate those
revenues during that same time period (this is called
matching expenses to revenues).
 Net income is, then, correctly reported for that period.
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 Transitory Items
in the Income Statement

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 Statement of Stockholders’ Equity

 Statement of Equity is a reconciliation of the

beginning and ending balances of stockholders’
equity accounts.
 Main equity categories are:
 Contributed capital
 Retained earnings (including Other Comprehensive
Income or OCI)
 Treasury stock

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 Apple’s Statement
of Stockholders’ Equity

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 Statement of Cash Flows

 Statement of cash flows reports cash inflows and

outflows
 Cash flows are reported based on the three business
activities of a company:
 Cash flows from operating activities—Cash flows from the
company’s transactions and events that relate to its
operations.
 Cash flows from investing activities—Cash flows from
acquisitions and divestitures of investments and long-term
assets.
 Cash flows from financing activities—Cash flows from
issuances of and payments toward borrowings and equity.
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 Apple’s
Statement
of
Cash Flows

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 Cisco
Systems

Statement
of
Cash Flows

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 Relation of SCF to
Income Statement and Balance Sheet

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 General Coding
of Balance Sheet Changes

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Working Capital Accounts

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 Learning Objective 2

Analyze and interpret transactions

using the financial statement effects
template.

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 Articulation of Financial Statements

 Financial statements are linked within and across

time – they articulate.
 Balance sheet and income statement are linked
via retained earnings.

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Apple’s Retained Earnings
Reconciliation

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Accounting Cycle

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The End