Financial Statement Analysis Fourth Lecture

8/2/2019 Financial Statement Analysis Fourth Lecture

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FINANCIAL REPORTINGMECHANICS

The financial statements of a company are

end products of a process for recordingtransactions

of the company related to operations,financing, and investment. The structures offinancial statements themselves reflect thesystem of recording and organizingtransactions. To be an informed user of

financial statements, the analyst must beknowledgeable about the principles of thissystem.

Classification of Business Activities for

Financial Reporting: 11


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OPERATING ACTIVITIES AND INVESTINGACTIVITIESOperating activities are those activities

that are part of the day - to - day businessfunctioning of an entity. Examples includethe sale of meals by a restaurant, the sale ofservices by a consulting firm, the

manufacture and sale of ovens by an oven-manufacturing company, and takingdeposits and making loans by a bank.

Investing activities are those activitiesassociated with acquisition and disposal oflong-term assets. Examples include thepurchase of equipment or sale of surplus

equipment (such as an oven) by arestaurant and the urchase or sale of an22


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FINANCING ACTIVITIES

Financing activities are those

activities related to obtaining orrepaying capital. The two

primary sources for such funds are

owners (shareholders) or creditors.Examples include

issuing common shares, taking out a

bank loan, and issuing bonds.

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Typical Business Activities andFinancial Statement Elements Affected

Assets (A), Liabilities (L), Owners Equity (E), Revenue (R), and

Expenses (X)Operating activities Sales of goods and services to

customers: (R) Costs of providingthe goods and services: (X)Income tax expense: (X)Holding short-term assets or

incurring short-term liabilitiesdirectly related to operatingactivities: (A), (L)

Investing activities Purchase or sale of assets, such asproperty, plant, andequipment: (A)

Purchase or sale of other entitiesequity and debt securities: (A)

Financing activities Issuance or repurchase of thecompanys own preferred orcommon stock: (E)

Issuance or repayment of debt: (L)Payment of distributions (i.e.,44


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ACCOUNTS AND FINANCIALSTATEMENTS

Business activities resulting in transactionsare

reflected in the broad groupings of financialstatement elements: assets, liabilities,

owners equity, revenue, and expenses.

Assets are the economic resources of acompany.

Liabilities are the creditors claims on theresources of a company.

Owners equity is the residual claim onthose resources.

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ACCOUNTS AND FINANCIAL STATEMENTScontinued

Accounts provide individual records ofincreases and decreases in a specificasset, liability,

component of owners equity, revenue,or expense. The financial statementsare constructed using these elements.

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Financial Statement Elements andAccountsAccounts are individual records of

increases and decreases in a specific asset,liability, component of owners equity,revenue, or expense. Within the financialstatement elements, accounts are sub-

classifications.

With regard to financial statements,

amounts recorded in every individualaccount are summarized and groupedappropriately within a financial statementelement.

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Common Accounts

Assets Cash and cash equivalentsAccounts receivable, trade

receivablesPrepaid expensesInventoryProperty, plant, and equipmentInvestment propertyIntangible assets (patents,

trademarks, licenses, copyright,goodwill)Financial assets, trading securities,investment securitiesInvestments accounted for by theequity method

Current and deferred tax assets(for banks, Loans [receivable])

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Common Accounts continued

Liabilities Accounts payable, tradepayablesProvisions or accruedliabilitiesFinancial liabilitiesCurrent and deferred taxliabilities

ReservesMinority interestUnearned revenueDebt payableBonds (payable)(for banks, Deposits)

Owners equity Capital, such as commonstock par valueAdditional paid-in capitalRetained earnings

Other comprehensive99


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Revenue Revenue, salesGainsInvestment income(e.g., interest anddividends)

Expense Cost of goods sold

Selling, general, andadministrativeexpenses (SG&A; e.g.,rent, utilities,

salaries, advertising)Depreciation andamortizationInterest expenseTax expense

Losses 1010

C A t


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Common Accountscontinued

The estimated uncollectible amount is

recorded

in an account called allowance for baddebts/provision for bad debt.

Accumulated depreciation (an offset toproperty, plant, and equipment reflectingthe amount of the cost of property, plant,and equipment that has been allocated

to current and previous accounting periods).

A sales returns and allowances (anoffset to revenue reflecting any cash

refunds, credits on account, and discounts1111

C A t


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Common AccountscontinuedNoncurrent assets

Intangible assets including goodwill

Property, plant, and equipment

Investment propertyInvestments in joint ventures andassociates

Current assets

Inventories

Trade and other receivables 1212


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Current assets are those that areexpected to be consumed or convertedinto cash in the near future, typicallyone year or less. Inventories are the

unsold units of product on hand(sometimes referred to as inventorystock).

Trade receivables (also referred to ascommercial receivables, or simplyaccounts receivable) are amounts

customers owe the company for1313

C A t


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Common AccountscontinuedGoodwill is an intangible asset that

represents the excess of the purchaseprice of an acquired company over thevalue of the net assets acquired.

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ACCOUNTING EQUATIONS

The five financial statement elements

noted previously serve as the inputsfor equations

that underlie the financial statements.

The balance sheet presents acompanys financial position at aparticular point in time. It provides a

listing of a company s assets and theclaims on those assets (liabilities andequity claims). The equation that

underlies the balance sheet is also1515


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ACCOUNTING EQUATIONScontinued

Assets - Liabilities = Owners equity

Owners equity = Contributed capital+ Retained earnings,

Revenue - Expenses = Net income(loss),

Net income (loss) is the difference

between two of the elements: revenueand

expenses.

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Financial Statement Analysis Fourth Lecture

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