Study: What are the General-Purpose Financial Statements and what are their standard equations?
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Slides 1-2 (:47s)
Links to an external site.
Welcome to Introduction to Accounting for a User’s Perspective
What are the general-purpose financial statements and what are their standard equations?
Through this topic you should learn the names of the four general-purpose financial statements Links to an external site. and footnotes that public companies are required to prepare and submit every year and learn their respective equations. Throughout this topic, you will learn about the unique information that each of the four general-purpose financial statements provides. In later topics, you will learn, among other things, how creditors Links to an external site.and investors Links to an external site.use the financial statements to assess what a business is worth and what its future prospects are for debt repayment and profitability. In later topics we will also discuss how the four financial statements articulate with each other.
Slide 3 (1m:15s)
Links to an external site. What are the names of the four general-purpose financial statements?
Because investors and creditors have determined that the general-purpose financial statements are so valuable to their decision-making process, the United States Securities Exchange Commission (SEC
Links to an external site.) requires publicly traded companies such as McDonalds
Links to an external site., Microsoft
Links to an external site. and Google
Links to an external site., to prepare, have audited and submit their general-purpose financial statements every year. Once the SEC receives the statements, it makes them publicly available on its EDGAR
Links to an external site. website, where anyone, especially existing and potential creditors and investors, can use them to make credit and investment decisions. There are four general-purpose financial statements as listed below:
1) Balance Sheet
Links to an external site. (also known as the Statement of Financial Position)
2) Statement of Shareholder Equity (also known in the US as Statement of Stockholder Equity, it
includes the Statement of Retained Earnings
Links to an external site.)
3) Income Statement
Links to an external site. (also known as the Statement of Comprehensive Income and Statement
of Operations. Internationally, it is known as the Profit & Loss account)
4) Statement of Cash Flows
Links to an external site.
Slide 4 (:36s)
Links to an external site. 1) Balance Sheet (also known as the Statement of Financial Position)
The Balance Sheet indicates what resources a company has as of a given point in time and what claims external parties have against the company for those resources.
The Balance Sheet equation Links to an external site. is:
Assets = Liabilities + Equity
It will be described in more detail in later topics.
Internationally, and sometimes in the United States, it is also called the Statement of Financial Position because it indicates the position of a business' resources as of a given point in time and how those resources were financed.
Slide 5 (:35s)
Links to an external site. 2) Statement of Shareholder Equity (also known as Statement of Stockholder Equity, it includes the Statement of Retained Earnings)
The Statement of Shareholder Equity indicates how the shareholders' ownership in the business, known as Shareholder Equity Links to an external site. or Stockholder Equity, increased or decreased from the beginning to the end of given accounting period.
The Statement of Shareholder Equity equation is:
Beginning Shareholder Equity
+ Additions to Shareholder Equity
- Subtractions from Shareholders Equity
= Ending Shareholders Equity
Slide 6 (1m:04s)
Links to an external site. The synonymous terms Statement of Shareholder Equity and Statement of Stockholder Equity are both used by companies in the United States, but, per US GAAP
Links to an external site. as defined in FASB ASC Section 215-10-05 “Statement of Shareholder Equity” is the official term for this statement.
One thing I learned while working as an auditor in Europe was that although Americans frequently use the term “stock” to describe a share of ownership in a company, the British-influenced English in our Luxembourg office, frequently used the term "stock" to describe “inventory”. When one of my supervisors asked me to perform a “stock take”, I thought I was supposed to take the company’s shares somewhere, instead, he meant that I should go and “take” a count of the company’s stock (i.e. inventory). Needless to say, I was a little confused for a moment.
In order to avoid confusing you in this course, I will use the term "stock Links to an external site." to represent ownership shares in companies, and use the term "inventory Links to an external site." to represent products held for sale to customers.
Slide 7 (:35s)
Links to an external site. The Statement of Shareholder Equity tracks not only the increases in equity caused by shareholder capital
Links to an external site.contributions, but it also tracks increases in equity caused by the company’s profits, known as Net Income
Links to an external site., which the owners choose to retain in the business to provide the company additional equity financing
Links to an external site.. I will refer to this as "internally generated capital".
Shareholder Equity can also decrease when the shareholders’ original capital is paid out to them, or when the company pays its shareholders Dividends Links to an external site.out of its profits.
Slide 8 (:57s)
Links to an external site. As noted, the total shareholder equity at any given point in time is made up of the owners’ contributed capital (i.e. Capital Contributions) and their earned capital (i.e. Retained Earnings
Links to an external site.). Some private companies like to create a Statement of Retained Earnings that helps owners track changes in their Retained Earnings account. It is considered a sub-statement of the Statement of Shareholder Equity. It is computed as follows:
Beginning Retained Earnings at the beginning of the accounting period
+ Net Income or – Net Loss during the accounting period
- Dividends during the accounting period
= Ending Retained Earnings at the end of the accounting period
The statement effectively keeps a running balance of all of a company’s Earnings (i.e. Net Income) that the owners have elected to retain in the company (i.e. held back, did not give out to owners).
Slide 9 (:48s)
Links to an external site. 3) Income Statement (also known as the Statement of Comprehensive Income and Statement of Operations. Internationally, it is known as the Profit & Loss account)
The Income Statement indicates a business' profitability for a given period of time.
The basic Income Statement equation is:
Revenues Links to an external site.- Expenses = Net Income
It will be described in more detail in later topics.
It is also called the Statement of Comprehensive Income which expands the definition of income to include items that may not yet be realized.
It is also called the Statement of Operations, because it strives to summarize the operating results of a company as it attempts to deliver goods and services to customers (thus earning Revenues) that exceed its matching costs (i.e. Expenses).
Finally, it is also known internationally as the Profit and Loss Account.
Slide 10 (1m:25s)
Links to an external site. 4) Statement of Cash Flows
The Statement of Cash Flows describes how a company’s cash inflows and outflows change the company’s cash balance from the beginning of the year to the end of the year. The types of cash flows that cause the cash balance to change are classified into the following three activities, operating activities, investing activities, and financing activities.
The math behind the Statement of Cash Flows equation is:
Beginning cash
+ Operating cash inflows (outflows)
+ Investing cash inflows (outflows)
+ Financing cash inflows (outflows)
= Ending Cash
But it is often presented in the official statement as follows:
+ Operating cash inflows (outflows)
+ Investing cash inflows (outflows)
+ Financing cash inflows (outflows)
Change in cash
+ Beginning cash
= Ending Cash
A more detailed equation is provided later, but the above should suffice for now. Just realize that the cash flow activities noted in the formula could be positive representing cash inflows, or they could be (negative) representing cash outflows.
Slide 11 (:26s)
Links to an external site. Subsequent topics will focus more on the information that each of the four general-purpose financial statements provides and on how users can use them to make credit and investment decisions. In preparation for the quiz related to this topic, you should ensure you know the names of the four-general purpose financial statements and their respective equations.