Accounting Principles and Statements

Study Notes

Income Statement

Composed of five major sections: Sales Revenue, Cost of Goods Sold (COGS), Operating Expenses, Depreciation, Interest, and Taxes.
Begins with Sales Revenue and ends with Net Income.
Gross Profit is calculated as Sales Revenue minus COGS.

Impact of Inventory Changes on Income Statement

Inventory changes do not affect the Income Statement until goods are sold, linking expense recognition to actual sales.

Statement of Cash Flows

Reflects cash generation and usage, categorized into three activities: Operating, Investing, and Financing.
Operating Activities include Net Income adjustments for non-cash items and changes in working capital accounts.
Investing Activities cover capital expenditures and investments.
Financing Activities consist of cash movements related to debts, dividends, and equity sales.

Balance Sheet

Displays a company's financial position at a specific time, showcasing Assets, Liabilities, and Shareholder Equity.
Assets are divided into Current (cash, accounts receivable, inventory) and Long-term (property, plant, and equipment).
Equation: Assets = Liabilities + Shareholder Equity.

Linking the Three Financial Statements

Net income from the Income Statement contributes to Shareholder Equity on the Balance Sheet and the Cash Flow Statement.
Changes in Balance Sheet accounts influence cash flow due to working capital adjustments.
Transactions in investing and financing activities modify items on the Balance Sheet.

Impact of Depreciation on Financial Statements

A $10 pretax depreciation reduces EBIT by $10, resulting in a $6 decline in Net Income (assuming a 40% tax rate).
Cash Flow Statement shows Net Income decrease of $6 and adds back depreciation, resulting in a $4 increase in cash flow from operations.
On the Balance Sheet, Net Property, Plant & Equipment (PP&E) decreases by $10, while cash increases by $4, and retained earnings decrease by $6.

Depreciation's Role in Cash Flow

Depreciation lowers taxable income, reducing the tax burden and thereby indirectly influencing cash reserves.

Presentation of Depreciation on Income Statement

Can appear as a separate line item or included within COGS or Operating Expenses.

Cash Purchase of Equipment

Year 1: $100 capital expenditure has no immediate impact on net income, cash flow from operations, or the Income Statement.
Year 2: Straight-line depreciation leads to a $20 decrease in net income, an $8 increase in cash flow, and adjusted balances on the Balance Sheet.

Debt Purchase of Equipment

Year 1: No immediate changes to Income Statement; $100 increase in capex reflected in cash flow from investing activities, with no net impact on cash.
Year 2: Includes $20 depreciation and $10 interest expense, totaling an $18 decrease in net income, leading to a $2 increase in cash flow.

Treatment of Cash Collected Not Recorded as Revenue

This cash is recorded as Deferred Revenue on the Balance Sheet under Liabilities until it is earned as revenue on the Income Statement.

Cash-based vs. Accrual-based Accounting

Contrast between recognizing revenue and expenses when cash is exchanged (cash-based) versus when they are incurred or earned (accrual-based).

Description

Test your knowledge of key accounting principles including the income statement, cash flow statement, and balance sheet. This quiz covers the major components and concepts, as well as how inventory changes impact financial reporting.