Understading Financial Statements

• Income is recognized when earned, regardless of when received and expense is recognized when incurred regardless of when paid


  Accrual Accounting
• Financial Statements should reflect transactions at the time they actually occur, not necessarily when cash is paid

  Accrual Accounting
• Costs and expense incurred in earning a revenue should be reported in the same period

  Matching Principle
• Financial Statements represent a combination of matters of fact and matters of estimate. Judgment is used on making reasonable estimates

  The use of Judgment and Estimates
• Users of financial statements must have reasonable knowledge if the financial accounting guidance that firms follow to prepare financial reports and reasonable understanding of the judgment and estimates required to apply accounting principles

  The use of Judgment and Estimates
• Anticipation of losses and expenses but defers recognition of gains and profit until they are realized

  Conservatism | Prudence
• Conservatism Practices

  • Potential Gain
  • Potential Loss
  • Expected Gains
  • Expected Losses
• If there is uncertainty regarding future revenue and profits the accountant should avoid recognizing the gain

  Conservatism on Potential Gain
• If there is uncertainty about incurring loss, the accountant should be inclined to record the loss on the financials

  Conservatism on Potential Loss
• Left unaccounted (e.g. increase in PPE or Inventory)

  Conservatism on Expected Gain
• Accrued for (e.g. Bad Debt/Uncollectible Receivables)

  Conservatism on Expected Loss
• Not intentionally understating the value of asset and revenue but rather preventing overstating

  Conservatism Effect on Valuation
• Produces the likelihood of the two occurrence (1) overstated revenue and asset value (2) understated expenses and liabilities

  Conservatism Effect on Valuation
• Indefinite life of an entity is divided into time periods which are usually of equal length

  Time Period Principle
• Ensures companies that they are able to assess their financial performance and position separately over each period

  Time Period Principle
• Also referred to as accounting period or reporting time period

  Time Period Principle
• Starts January 1 and ends December 31 of the same year

  Calendar Year
• Starts from the first day of any month other than January

  Fiscal Year
• Two primary standard setting bodies

  (1) Financial Accounting Standards Board

  (2) International Accounting Standards Board
• Sets forth generally accepted principles in the United States (US GAAP)

  Financial Accounting Standards Board (FASB)
• Establishes international financial reporting standards (IFRS) outside the US

  International Accounting Standards Board (IASB)
• IFRS

  International Financial Reporting Standards
• IASB

  International Accounting Standards Board
• FASB

  Financial Accounting Standards Board
• GAAP

  Generally Accepted Accounting Principles
• Financial statements are the firm's report card to the stakeholders

  Objectives of the firm
• Types of Stakeholders

  (1) Shareholders

  (2) Creditors

  (3) Employees and Management

  (4) Suppliers

  (5) Local Community

  (6) Government
• Stakeholder wherein it is also referred to as an investor, who have invested funds into the business

  Shareholder
• Stakeholder who lends money to the company and may or may not have secured secured interest in the company's asset

  Creditors
• Stakeholder whose continued employment is tied to the company

  Employee and Management
• Stakeholder wherein substantial portion of their revenue may come from the company

  Suppliers
• Stakeholder wherein actions of the company may impact the community if it causes environmental damage

  Local Community
• Stakeholder wherein it relies on the company for tax revenue

  Government
• Stakeholders' Financial Interest

  (1) Profitability

  (2) Solvency

  (3) Stability
• Measurement of efficiency, a metric that is used to determine scope of a company's profit in relation to the size of the business and ultimately its success or failure

  Profitability
• Ability to meet long-term debt and financial obligations

  Solvency
• Ability to meet its obligation and continue its business for the foreseeable future where in company should be financially stable

  Stability
• One of the accounting principles that states that a business entity will continue running its operations in the foreseeable future and will not be liquidated or forced to discontinue operations for any reason.

  Going Concern
• Principal Financial Statements

  (1) Balance Sheet

  (2) Income Statement

  (3) Statement of Cash Flows

  (4) Statement of Shareholders' Equity

  (5) Notes to the Financial Statement
• A report of the resources of the company and claims on these resources

  Balance Sheet