Financial Statements: An Overview

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Questions and Answers

Which financial statement details a company's revenues, expenses, and profit or loss?

  • Cash Flow Statement
  • Statement of Changes in Equity
  • Balance Sheet
  • Income Statement (correct)

The balance sheet provides a snapshot of a company's financial position at a specific point in time.

True (A)

What does the cash flow statement primarily detail?

Cash inflows and outflows

The statement of changes in equity details changes in company equity from an ______ balance to an end of period balance.

<p>opening</p> Signup and view all the answers

Which of the following provides details of assumptions made and other important details related to the financial statements?

<p>Notes on the Financial Statements (C)</p> Signup and view all the answers

Other Comprehensive Income (OCI) includes items already realized and included in the net income of an income statement.

<p>False (B)</p> Signup and view all the answers

Name one item included in Other Comprehensive Income (OCI).

<p>Gains or losses from investments available for sale.</p> Signup and view all the answers

Accounting ______, also known as GAAP, are a set of guidelines and rules that govern the preparation of financial statements.

<p>Principles</p> Signup and view all the answers

What is the purpose of accounting principles?

<p>To ensure consistency and comparability in financial reporting (D)</p> Signup and view all the answers

Accounting concepts are strict rules that must be followed without exception.

<p>False (B)</p> Signup and view all the answers

What is the role of accounting conventions?

<p>guide the application of accounting principles</p> Signup and view all the answers

The accounting convention of ______ suggests accounting rules, practices and convention should be continuously observed and applied.

<p>consistency</p> Signup and view all the answers

Which accounting convention emphasizes providing comprehensive information in financial statements and footnotes?

<p>Full Disclosure (C)</p> Signup and view all the answers

The conservatism convention focuses on taking possible gains into account and ignoring possible losses

<p>False (B)</p> Signup and view all the answers

According to the accounting concept of materiality, should financial statements include all facts and information?

<p>no</p> Signup and view all the answers

The ______ concept dictates that a business is treated as a separate entity, distinct from its owners.

<p>business entity</p> Signup and view all the answers

What does the Money Measurement concept in accounting emphasize?

<p>Recording only transactions that can be expressed in monetary terms (D)</p> Signup and view all the answers

The 'going concern' concept assumes that a business will liquidate in the near future.

<p>False (B)</p> Signup and view all the answers

What does the Cost concept in accounting indicate about recording assets?

<p>assets are recorded at historical cost</p> Signup and view all the answers

The dual aspect accounting concept states that every business transaction has two ______ - a debit and a credit.

<p>aspects</p> Signup and view all the answers

The accounting period concept divides the economic life of a business into:

<p>Specific and regular time periods (D)</p> Signup and view all the answers

The matching principle dictates that companies report expenses completely separately from its related revenues.

<p>False (B)</p> Signup and view all the answers

When does revenue recognition typically occur in accrual accounting?

<p>When it's earned.</p> Signup and view all the answers

The ______ concept encompasses both revenue and expenses and emphasizes the timing of recording.

<p>accrual</p> Signup and view all the answers

Which income statement item is calculated by subtracting Cost of Goods Sold (COGS) from Revenue?

<p>Gross Profit (B)</p> Signup and view all the answers

Economic Value Added (EVA) may be negative.

<p>True (A)</p> Signup and view all the answers

State the formula to calculate Economic Value Added.

<p>Selling price - Expenses associated with selling the asset – Purchase price - Expenses associated with buying the asset</p> Signup and view all the answers

Vertical analysis involves stating line items on the income statement as a ______ of the sales.

<p>percentage</p> Signup and view all the answers

Financial statements help leaders ensure the business:

<p>Complies with mandatory accounting regulations (D)</p> Signup and view all the answers

Financial statements only help leaders monitor income and expenditure.

<p>False (B)</p> Signup and view all the answers

List one thing that leaders can do with the data presented by the financial statements.

<p>make better budgeting and forecasting decisions</p> Signup and view all the answers

Return on Equity (ROE) is equal to Net Income divided by ______.

<p>Equity</p> Signup and view all the answers

What is the formula of Return on Equity (ROE)?

<p>Net Income/Equity (C)</p> Signup and view all the answers

Financial statement analysis is of very little use in monitoring a company's performance.

<p>False (B)</p> Signup and view all the answers

What is the benefit of the DuPont analysis?

<p>to help understand what drives a company's profitability</p> Signup and view all the answers

The tax burden is shown by dividing ______ by EBT (Earnings Before Tax).

<p>Net Income</p> Signup and view all the answers

What does an Equity Multiplier of 2 indicate?

<p>Half of the company's assets are funded by shareholders' equity (C)</p> Signup and view all the answers

Financial Statements don't need to be adjusted to gain a better understanding of the company.

<p>False (B)</p> Signup and view all the answers

OCI is the abbreviation of which term?

<p>Other Comprehensive Income</p> Signup and view all the answers

In the formula to calculate the net income to the parent company in a combined company, what gets added to Net Income?

<p>Equity Investment Earnings</p> Signup and view all the answers

Match the financial statements with their descriptions

<p>Balance Sheet = Details of Assets, Equity and liabilities Cash flow Statement = Details of cash inflows and outflows Income statement = Details of Income, Expenditure and Profit or loss</p> Signup and view all the answers

Flashcards

Statement of Profit or Loss

Details income, expenditure, and profit or loss.

Statement of Financial Position

Details of assets, equity, and liabilities at a specific point in time.

Cash Flow Statement

Details of cash inflows and outflows during a period.

Statement of Changes in Equity

Details of changes in company equity from the beginning to the end of a period.

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Notes on the Financial Statements

Details of assumptions made and other important information related to the financial statements.

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Other Comprehensive Income (OCI)

Items of revenue, expense, gain and loss that are excluded from net income on an income statement.

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Operating Activities

Activities related to the main operations of the business.

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Investing Activities

Investing activities are those activities which are related to the acquisition and disposal of the long term (fixed) assets of business.

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Financing Activities

Activities related to raising and repaying funds from owners or outsiders.

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Understandability

Financial information should be clear, concise, and easily understandable to users with reasonable business knowledge.

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Relevance

Information that can influence decisions by helping users evaluate past, present, or future events.

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Reliability

Information free from material error and bias, faithfully representing what it purports to represent.

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Comparability

Information presented in a way that allows users to compare it with similar information about other entities.

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Complies with Regulations

How companies apply Mandatory Accounting Regulations.

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Tracking History

Shows tracking Historical Performance

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Spending Focus

Highlights Key areas of Spending

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Providing Data

Provides data needed to make better budgeting and forecasting decisions

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Economic Value Added

Selling price - Expenses associated with selling the asset – Purchase price - Expenses associated with buying the asset

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Accounting Concepts

Broad basic assumptions that underlie the accounting process.

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Accounting Conventions

Customs or traditions that guide the application of accounting principles.

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Consistency

Accounting rules, practices and conventions should be continuously observed and applied i.e.; they should not change from one year to another.

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Full Disclosure

All information which is of material interest to proprietors, creditors and investors should be disclosed in accounting statements.

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Conservatism

It is a policy of caution or playing safe. With this, the businessmen take into account all the possible losses which may occur and ignore the possible gains in future while recording the accounts.

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Materiality

The convention of materiality makes a point that the financial statements should include all the facts and information which is material.

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Business Entity

Treat the business as a separate economic entity, distinct from its owners

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Money Measurement

Record only transactions and events that can be expressed in monetary terms in accounting records

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Going Conversion

Assume that the business will continue its operations indefinitely

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Cost

Record assets at their historical cost, which is the amount paid or the fair value of the consideration given to acquire them

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Dual Aspect

Every business transaction has two aspects - a debit and a credit - representing both the giving and receiving in the accounting equation

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Accounting Period

Divide the economic life of a business into specific and regular time periods of preparing financial statements

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Matching

The matching principle is an accounting concept that dictates that companies report expenses at the same time as the revenues they are related to. Revenues and expenses are matched on the income statement for a period of time

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Realization

Revenue recognition is an aspect of accrual accounting that stipulates when and how businesses recognize or record their revenue

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Accrual

Encompasses both revenue and expenses, emphasizing the timing of recording economic activities

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Return on Equity (ROE)

measure of a company's profitability, calculated by dividing net income by shareholders' equity.

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DuPont Analysis

Analyzing the sources of a company's return on equity (ROE) breaking it down into distinct performance metrics.

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Revenue Recognition

Sales were booked on order placement instead of delivery, inflating revenue and profits artificially.

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Cash surge

Trade receivables surged at 107% CAGR, indicating revenue was not converting into cash.

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Statement of Revenue

Overstatement of revenue led to misleading financial statements, attracting investor trust initially but causing a market crash when fraud was exposed.

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Auditor Collusion

Auditor collusion risks due to repeated reappointments. Unexplained liabilities suggested fictitious expenses. Lack of fraud detection mechanisms allowed misstatements to continue for years.

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Study Notes

  • Financial statements monitor income and expenditure, and ensures a business complies with regulations, tracks performance, identifies spending areas, and provides data for decision-making

Statement of Profit or Loss (Income Statement)

  • Details income, and expenditure
  • Determines profit or loss

Statement of Financial Position (Balance Sheet)

  • It details Assets, Equity, and Liabilities

Cash Flow Statement

  • Details cash inflows and outflows

Statement of Changes in Equity

  • It details changes in company equity
  • Shows from opening balance to end of period balance

Notes on the Financial Statements

  • Details assumptions made and other important notes

Other Comprehensive Income (OCI)

  • Includes revenues, expenses, gains, and losses not yet realized
  • Excluded from net income on an income statement
  • Gains or losses from investments classified as available for sale are part of OCI
  • Gains or losses from foreign currency conversion also appear in OCI
  • Gains or losses from the pension plan impact OCI
  • Derivatives instruments contribute to profit or loss
  • The value change in an asset that is available for sale also changes the OCI

Qualitative Characteristics of Financial Reporting

  • Understandability relies on clear, concise presentation for users with business knowledge
  • Relevance influences decisions by evaluating past, present, and future events
  • Reliability is achieved through adherence to standards, controls, audits, and transparency
  • Comparability allows users to compare information across entities and periods
  • Gains or losses from the pension plan impact OCI
  • Derivatives instruments contribute to profit or loss
  • The value change in an asset that is available for sale also changes the OCI

Accounting Conventions:

  • Consistency entails applying the same accounting methods year after year
  • Full Disclosure requires all material information of interest to be included, ensuring transparency
  • Conservatism means accounting for all possible losses while ignoring possible future gains
  • Materiality dictates financial statements include all facts and information that is considered relevant

Accounting Concepts:

  • Business Entity treats the business as separate from its owners
  • Money Measurement records only transactions that can be expressed in monetary terms
  • Going Concern assumes the business will continue operating indefinitely
  • Cost records assets at their historical cost
  • Dual Aspect recognizes that every transaction has a debit and a credit

Periodic Reporting

  • The economic life of a business is divided into time periods
  • This is to prepare reports to and assess financial performance

Matching

  • The expenses should be recorded at the same time as the revenues they are related to

Realization

  • Revenue must be recognized when it is earned, despite when payment is received

Accrual

  • Revenue and expenses are recorded once activities occur

DuPont Analysis

  • ROE (Return on Equity) indicates how much profit a company generates with the money shareholders have invested

Profitability

  • Profit margin

Efficiency

  • Asset turnover

Leverage

  • How much debt a company uses to finance its assets

Key financial ratios expressed as a percentage

  • Profit Margin formula is (Net Income / Revenue) * 100
  • High net profit numbers may indicate the company is doing well
  • Return on Assets (ROA) formula is (Net Income / Average Total Assets) * 100
  • Could also point to a positive direction
  • Operating Margin formula is Operating Income / Revenue) * 100
  • Dividend Yield formula is (Dividends per Share / Stock Price) * 100
  • Helps to determine investor preference
  • Gross Profit Margin formula is (Gross Profit / Revenue) * 100
  • Net Profit Margin formula is (Net Income / Revenue) * 100, High, High
  • Return on Investment (ROI) formula is (Net Profit / Cost of Investment) * 100
  • Return on Capital Employed (ROCE) formula is (Net Operating Profit / Capital Employed) * 100
  • Earnings Retention Ratio formula is (Net Income - Dividends) / Net Income * 100
  • Retention ratio may point to reinvesting

Key financial ratios expressed in times:

  • Inventory Turnover formula is Cost of Goods Sold / Average Inventory, and high rates are seen positively
  • Receivables Turnover formula is Net Credit Sales / Average Accounts Receivable

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