a. Publicly owned companies (those with shares) are obliged to provide annual and quarterly information b. They publish annual reports i. Includes comparative F/S for several years and other information about the companys financial position, business operations, and future prospects. ii. Before it is issued it must be audited by CPA firms iii. SEC and other government bodies need copies of the annual report c. Often takes several months after the financial year ended to finish the preparation of an annual report: note busy season! d. F/S can be directly prepared from the amounts shown in adjusted trial balance e. Prepare income statement first because you need to know profit first. Then prepare statement of changes in equity next because it will help you determine the amount of equity to be reported in the SFP II. Income statement a. Other names: profit or loss, comprehensive income, etc. b. Used to summarize the operating results of a business by matching the revenue earned during a given period of time with the expenses incurred in generating that revenue c. The measurement of profit is not absolute because of the assumptions and estimates in the accounting process i. i.e. dep expense is an estimate ii. only considers those events that have been evidenced by actual business transactions (i.e. customer base, goodwill, advertising results) III. Statement of changes in equity a. Includes share capital, R/E, and other equity balances b. Summarizes the increases and decreases in all equity balances including share capital and retained earnings i. Share capital 1. Increases: new shares issued 2. Decreases: treasury shares 3. S/C beg. + new shares issued repurchase of shares = S/C end ii. Retained earnings 1. Increases: earning profit 2. Decreases: loss, declaring dividends 3. R/E beg. + profit dividends = R/E end c. Show table in exhibit 5-2 p. 198: good way to organize thoughts!! d. Dividends i. Small corps pay div the same day they are declared ii. Large corp: date of declaration > date of record > date of payment 1. Entry of div payable is on date of declaration iii. Again, not reported in the income statement as an expense!! iv. Distribution of profit! Not a distribution of revenue IV. Statement of financial position a. Lists the amounts of the companys assets, liabilities, and equity at the end of the accounting period. b. Balances are taken directly from the adjusted trial balance c. Can be presented T- account style or in report form (parang straight line) d. Separate subtotals i. i.e. current assets: assets that are cash or must be capable of being converted into cash within a relatively short period of time 1. usually 1 yr or less but will depend on the companys operating cycle (i.e. vineyard) 2. must be used up quickly (insurance policies and office supplies) ii. i.e. current liability: existing debt/obligation that a company expects to satisfy relatively soon using its current assets 1. usually 1 yr or less but will depend on the companys operating cycle (i.e. vineyard) V. Relationship among the financial statements a. I/S (profit) > Statement of changes in equity (profit goes to R/E) > SFP (R/E balance to SHE) b. Drafting the notes that accompany financial statements i. To the users, adequate disclosure is perhaps the most important accounting principle ii. F/S should be accompanied by any information necessary for the statements to be interpreted properly iii. Content of notes often cannot be drawn directly from the accounting records. Rather they require an in-depth understanding of the company and its operations, of its accounting principles, and of how accounting information is interpreted by users of F/S iv. Two items that are always disclosed 1. Accounting methods (policies) a. i.e. deprecation method, inventory valuation 2. Maturity dates of liabilities v. What type of information must be disclosed? 1. No comprehensive list. Ikaw bahala 2. Based on a combination of official rules, tradition, and accountants professional judgement 3. GR: Include any information an informed user would consider necessary for the statements to be interpreted properly (p. 201 examples) 4. Disclose even though info has damaging effect on company a. i.e. lawsuit against you b. good faith effort by management to keep user of financial statements informed: transparency!! No shady dealings 5. whose job is it to disclose info and prepare F/S? company!! Not audit firm VI. Closing temporary accounts: illustrate the T- accounts!! a. Temporary (or nominal) accounts: accounts that accumulate the transactions of only one accounting period. At the end of the period, the effects of these accounts are transferred to R/E account b. i.e. revenue, expense, dividends accounts c. Two purposes i. Updates the balance of the retained earnings account for changes occurring during the accounting period ii. It returns the balances of the temporary accounts to zero (always!) to prepare them for the next period d. Permanent (or real) accounts: accounts which balances continue to exist beyond the current accounting period: do not close!! i. SFP accounts: assets, liabs, equity e. Closing process: transferring balance of temporary accounts to R/E i. Done by closing entries f. Rev and exp: closed by transferring balances to income summary (normal balance is credit) i. Inc summ balance is the profit or loss for the period 1. Dr > cr = loss 2. Dr < cr = profit g. Common practice to close accounts once each year h. Steps of the closing process i. Closing all revenue accounts to the income summary ii. Closing all expense accounts to the income summary iii. Closing income summary to R/E iv. Closing dividends account to R/E VII. Closing entries for revenue accounts: use page 203 to explain a. Transfer credit balance to inc summary i. Dr. rev cr. Inc summary (equal values) ii. Debit makes rev balance zero and the credit transfers balance to income summary b. Use compound entries: includes debits or credits to more than one account VIII. Closing entries for expense accounts: use page 204 to explain a. Transfer debit balance to inc summary i. Dr. inc summary cr. Expense (equal values) IX. Closing income summary account a. Remember: income summary account is temporal also so it needs to have a zero balance at the end of the year b. Entries would depend if I/S has debit or credit balance: illustrate both!! X. Closing the dividends account a. Not closed to the income summary b. Closed to R/E directly! i. Dr. R/E cr. Dividends XI. Read summary on p. 206 XII. After-closing trial balance a. Consists solely of SFP accounts b. Prepared from the ledger: extra assurance that the accounts are in balance and up to date XIII. Do p. 207: Was 2013 a good year? a. Evaluating profitability i. Real question: how it is likely to do in the future b. Evaluating liquidity: refers to a companys ability to meet its cash obligations as they become due XIV. Preparing financial statements covering different periods of time (p. 210) a. I/S: subtract from the current balance in the revenue or expense account the balance in the account as of the beginning of the desired period b. SFP: no extra computations necessary because SPF balances are always based on the account balances at the end of the reporting period XV. Financial analysis and decision making a. Measures of profitability i. Profit percentage: profit / total revenue 1. How much profit you earn per peso? How much do you have to spend to earn 1 peso? (opposite lang) ii. Return on equity: profit / average (beginning + ending) shareholders equity 1. The amount that owners get back on their investment b. Measures of liquidity i. Working capital = CA CL 1. Measure of short term debt paying ability expressed in peso 2. CA = cash inflows in the near future 3. CL = cash outflows in the near future 4. Discuss limitations in p. 209 5. If + generally good ii. Current ratio = CA/CL 1. Working capital expressed as a ratio 2. If >=1 generally good XVI. Worksheet a. Tool used by accountants to work out how the financial statements will look b. For interim financial statements c. Use p. 214