Four Basic Financial Statements Income Statement Statement of Retained Earnings Balance Sheet Statement of Cash Flows McGraw-Hill/Irwin Slide 1
The Four Basic Financial Statements 1. On a company s INCOME STATEMENT, all the revenues earned from sales to customers are listed along with the expenses incurred to produce those revenues. 2. On a company s STATEMENT OF RETAINED EARNINGS accumulated net earnings less the dividends paid to owners represent reinvestments in the core business. 3. On a company s BALANCE SHEET, all resources owned and amounts owed are listed in order of liquidity. The difference between the resources owned and the amounts owed, represents the stockholders equity in the business. 4. On a company s STATEMENT OF CASH FLOWS, all sources and uses of cash are listed. Cash is generated by the company s operations. Cash is spent on investments in buildings, manufacturing equipment, and other assets. Financing activities involve amounts borrowed from long-term creditors and sale of stock to owners.
The Income Statement Typical Account Titles Revenues Sales Revenue Fee Revenue Interest Revenue Rent Revenue Expenses Cost of Goods Sold Wages Expense Rent Expense Interest Expense Depreciation Expense Advertising Expense Insurance Expense Repair Expense Income Tax Expense
Income Statement MAXIDRIVE CORP. Income Statement For the Year Ended December 31, 2009 (in thousands of dollars) Three Line Title Revenues Sales revenue $ 37,436 Total revenues 37,436 Expenses Cost of goods sold expense 26,980 Selling, general, and administrative expense 5,606 Interest expense 450 Total expenses 33,036 Operating income 4,400 Income tax expense 1,100 Net income $ 3,300
McGraw-Hill/Irwin Slide 5
Statement of Retained Earnings Beginning Retained Earnings Plus: Net Income Less: Dividends Ending Retained Earnings
Statement of Retained Earnings Retained earnings equals: The statement of retained earnings reports that portion of net income the company has retained, or kept for use in the business. Cumulative net income for all of the previous years of corporate existence Less: cumulative dividends paid for all previous years of corporate existence. Revenues -Expenses -Net Income Effects on retained earnings Net income increases retained earnings Dividends paid to stockholders decrease retained earnings McGraw-Hill/Irwin Slide 7
Statement of Retained Earnings MAXIDRIVE CORP. Statement of Retained Earnings For the Year Ended December 31, 2009 Three Line Title (in thousands of dollars) Retained earnings, January 1, 2009 $6,805 Net income for 2009 3,300 Dividends for 2009 (1,000) Retained earnings, December 31, 2009 $9,105
The Accounting Equation A = L + SE (Assets) (Liabilities) (Stockholders Equity) Economic Resources Sources of Financing for Economic Resources Liabilities: From Creditors Stockholders Equity: From Stockholders
The Accounting Equation A = L + SE (Assets) (Liabilities) (Stockholders Equity) Economic Resources Sources of Financing for Economic Resources Liabilities: From Creditors Stockholders Equity: From Stockholders McGraw-Hill/Irwin Slide 10
The Balance Sheet Assets are the economic resources of a business that are expected to be of benefit in the future Every asset has a claim against it (i.e. funding source) Claims to assets come from Liabilities Economic obligations - debts payable to outsiders, called creditors Owners equity Assets held by the owners of the business McGraw-Hill/Irwin Slide 11
Assets = Liabilities + Stockholder s Equity McGraw-Hill/Irwin Slide 12
The Balance Sheet Typical Account Titles Assets Cash Short-Term Investment Accounts Receivable Notes Receivable Inventory (to be sold) Supplies Prepaid Expenses Long-Term Investments Equipment Buildings Land Intangibles Liabilities Accounts Payable Accrued Expenses Notes Payable Taxes Payable Unearned Revenue Bonds Payable Stockholders Equity Contributed Capital Retained Earnings
Balance Sheet MAXIDRIVE CORP. Balance Sheet At December 31, 2009 (in thousands of dollars) Three Line Title 2009 ASSETS Cash $ 4,895 Accounts receivable 5,714 Inventories 8,517 Plant and equipment 7,154 Land 981 Total assets $ 27,261 LIABILITIES Accounts payable $ 7,156 Notes payable 9,000 Total liabilities 16,156 STOCKHOLDERS' EQUITY Contributed capital 2,000 Retained earnings 9,105 Total stockholders' equity 11,105 Total liabilities and stockholders' equity $ 27,261
Statement of Cash Flows MAXIDRIVE CORP. Statement of Cash Flows For the Year Ended December 31, 2009 (in thousands of dollars) Three Line Title Operating activities Cash collected from customers $ 33,563 Cash paid to suppliers and employees (30,854) Cash paid for interest (450) Cash paid for taxes (1,190) Net cash flow from operating activities 1,069 Investing Activities Cash used to purchase equipment (1,625) Net cash flow from investing activities (1,625) Financing Activities Cash received from bank loan 1,400 Cash dividends paid (1,000) Net cash provided by financing activities 400 Net increase in cash (156) Cash at beginning of month 5,051 Cash at end of month $ 4,895
STATEMENT OF CASH FLOWS Best barometer Operating activities Companies operate by buying goods and services, which are sold to customers (day-to-day activities) Plan for the future Investing Activities Companies invest in long-term assets that are used to run the business (PPE, investments, loans to others) How funded by others Financing Activities Companies finance themselves by issuing stock and borrowing money McGraw-Hill/Irwin Slide 16 1-16
Operating, Investing, and Financing? 1-17 McGraw-Hill/Irwin Slide 17
Relationships Among the Statements 1. Net income from the income statement results in an increase in ending retained earnings on the statement of retained earnings. Income Statement Revenues $ 15,500 Statement of Retained Earnings Expenses (8,500) Beginning retained earnings $ 59,000 Net income $ 7,000 Net income 7,000 Dividends (2,500) Ending retained earnings $ 63,500
Relationships Among the Statements 2. Ending retained earnings from the statement of retained earnings is one of the two components of stockholders equity on the balance sheet. Statement of Retained Earnings Balance Sheet Beginning retained earnings $ 59,000 Cash $ 14,000 Net income 7,000 Other assets 171,500 Dividends (2,500) Total assets $ 185,500 Ending retained earnings $ 63,500 Liabilities $ 42,000 Stockholders' Equity Common stock 80,000 Retained earnings 63,500 Total liabilities and equity $ 185,500
Relationships Among the Statements 3. The change in cash on the statement of cash flows is added to the beginning-of-year balance in cash to arrive at end-of-year cash on the balance sheet. Statement of Cash Flows Balance Sheet Cash flows from operating activities $ 21,000 Cash $ 14,000 Cash flows from investing activities (16,000) Other assets 171,500 Cash flows from financing activities 3,500 Total assets $ 185,500 Increase in cash $ 8,500 Liabilities $ 42,000 Beginning cash balance 5,500 Stockholders' Equity Ending cash balance $ 14,000 Common stock 80,000 Retained earnings 63,500 Total liabilities and equity $ 185,500
Notes All financial statements should be accompanied by notes which provide the reader with supplemental information about the financial condition and results of operations of the company.
Management Uses of Financial Statements Marketing managers and credit managers use customers financial statements to decide whether to extend credit. Purchasing managers use suppliers financial statements to decide whether suppliers have the resources to meet the demand for products. Employees union and human resource managers use the company s financial statements as a basis for contract negotiations pay rates.
Responsibilities for the Accounting Communication Process Effective communication means that the recipient understands what the sender intends to convey. Decision makers need to understand accounting measurement rules.
Responsibilities for the Accounting Communications Process McGraw-Hill/Irwin Slide 24
Generally Accepted Accounting Principles Securities Act of 1933 Securities and Exchange Act of 1934 The Securities and Exchange Commission (SEC) has been given broad powers to determine measurement rules for financial statements.
Generally Accepted Accounting Principles The SEC has worked closely with the accounting profession to work out the detailed rules that have become known as GAAP. Currently, the Financial Accounting Standards Board (FASB) is recognized as the body to formulate GAAP.
McGraw-Hill/Irwin Slide 27
Generally Accepted Accounting Principles Companies incur the cost of preparing the financial statements and bear the following economic consequences... Effects on the selling price of stock. Effects on the amount of bonuses received by managers and other employees. Loss of competitive information to other companies.
International Perspective Since 2002, there has been substantial movement to develop international financial reporting standards by the International Accounting Standards Board (IASB).
IFRS: No Longer If, but When The SEC will release a time line later this year for allowing U.S. companies to use international financial reporting standards. Sarah Johnson CFO.com US February 8, 2008 Securities and Exchange Commission chairman Christopher Cox, in a speech last week, quashed any doubts that the regulator will one day allow U.S. companies to use international financial reporting standards rather than GAAP. The SEC is working on a road map for transitioning U.S. companies to the global rules, he told members of the European-American Business Council. "The expanded use of a single, high-quality accounting standard will eventually empower investors to make better-informed investment decisions by giving them information that is more easily comparable," he said. His speech came just a few months after the SEC began accepting IFRS-prepared financial statements from some of its foreign registrants without requiring them to reconcile those filings to U.S. generally accepted accounting principles. McGraw-Hill/Irwin Slide 30
August 28, 2008; Page A1 WSJ SEC Moves to Pull Plug On U.S. Accounting Standards By KARA SCANNELL and JOANNA SLATER WASHINGTON -- The Securities and Exchange Commission signaled the demise of U.S. accounting standards, kicking off a process Wednesday that could ultimately require all publicly listed American companies to follow an international model instead. Introduced in two steps, the shift could eventually cut costs for companies and smooth cross-border investing. At the same time, investors worry it will create confusion, especially during the transition. Other critics worry that the international system offers too much wiggle room for companies, compared with the more precise rules enshrined in U.S. standards. The SEC's proposal would allow some large multinational companies to report earnings according to international accounting beginning in 2010. The SEC estimates at least 110 U.S. companies would qualify based on their market capitalization, among other factors. The agency also laid out a road map by which all U.S. companies would switch to International Financial Reporting Standards, or IFRS, beginning in 2014, at the expense of U.S. Generally Accepted Accounting Principles, the guiding light of accountants for decades. 2015 or later. McGraw-Hill/Irwin Slide 31
IFRS versus GAAP Conceptual differences Some treatments not allowed Differences in definitions Presentation differences Financial statement appearance Upside-down presentation Substantially more information More flexibility in format Understanding the implications Be flexible for your future classes
Management Responsibility and the Demand for Auditing To ensure the accuracy of the company s financial information, management: Maintains a system of controls. Hires outside independent auditors. Forms a board of directors to review these two safeguards.
Independent Auditors Auditors express an opinion as to the fairness of the financial statement presentation. Independent auditors have responsibilities that extend to the general public. Overall, I believe these financial statements are fair.
Independent Auditors An audit involves... Examining the financial reports to ensure compliance with GAAP. Examining the underlying transactions incorporated into the financial statements. Expressing an opinion as to the fairness of presentation of financial information.
Report of Independent Registered Public Accounting Firm 1-36 The Board of Directors and Stockholders Norfolk Southern Corporation: We have audited the accompanying consolidated balance sheets of Norfolk Southern Corporation and subsidiaries as of December 31, 2012 and 2011, and the related consolidated statements of income, comprehensive income, Changes in stockholders equity, and cash flows for each of the three years in the three-year period ended December 31, 2012. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedule as listed in Item 15(A)2. These consolidated financial statements and financial statement schedule are the responsibility of management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Norfolk Southern Corporation and subsidiaries as of December 31, 2012 and 2011, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2012, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Norfolk Southern Corporation s internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control ± Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated February 15, 2013 expressed an unqualified opinion on the effective ness of the company s internal control over financial reporting. /s/kpmg LLP KPMG LLP Norfolk, Virginia February 15, 2013 McGraw-Hill/Irwin Slide 36
Ethics, Reputation, and Legal Liability The American Institute of Certified Public Accountants requires that all members adhere to a professional code of ethics.
Ethics, Reputation, and Legal Liability A CPA s reputation for honesty and competence is his/her most important asset. Like physicians, CPAs have liability for malpractice.
My concerns on the previous slides Primacy of trust A broad wording: public trust There are no perfect solutions A few personal thoughts Can we teach ethics? Can we balance ethics and morality? Are ethics good for business? What challenges will we face?
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