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 In an ideal world, the user of financial

statements could focus only on the bottom
lines of financial reporting: net income and
stockholders equity.
 The financial reporting system is not perfect.
Economic events & accounting entries do not
correspond precisely; they diverge across the
dimensions of timing, recognition &
measurement.
◦ Economic events and accounting recognition of
those events frequently take place at different
times.
◦ Long - lived assets are written down, most of the
time, in the Fiscal Period of management’s choice.

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◦ Generally Accepted Accounting Principles (GAAP) permit
economic events that do receive accounting recognition
to be recognized in different ways by different financial
statement prepares.
◦ Financial reports often contain supplementary data
that, although not included in the statements
themselves, help the financial statement users to
interpret the statements or to adjust measures of
corporate performance to make them more
comparable.
◦ Information from outside the financial reporting
process can be used to make financial data more
useful.
◦ Many Economic events do not receive accounting
recognition at all.

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 Principal emphasis is on the Financial
statements of companies whose securities
are publicly traded.

 The common Characteristics of external

users is their general lack of authority to
prescribe the information they want from
an enterprise. They depend on general –
purpose external financial reports
provided by management.

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 External users of financial information
encompasses a wide range of interests but
can be classified into three general groups:
1. Credit and equity investors
2. Government (executive and legislative
branches), regulatory bodies & tax authorities.
3. The general public and special interest
groups, labor unions and consumer groups.

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1. Balance sheet ( statement of financial
position)
2. Income statement ( statement of earnings)
3. Statement of comprehensive income
4. Statement of cash flows
5. Statement of stockholders’ equity

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 Financial statement provide information about the assets
(resources), liabilities (obligations), income & cash flows, and
stockholders’ equity of the firm. The effects of transactions and
other events are recorded in the appropriate financial
statements.

 The income statement reports revenues, expenses,

and gains & losses.

 The balance sheet shows assets, liabilities, &

stockholders equity; the statement of stockholders’
equity reports capital transaction with owners.

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 Statement of comprehensive income reports
changes in certain balance sheet accounts
that bypass the income statement.

 The statement of cash flows includes

operating investing, and financial inflows
and outflows. Many transactions are
reflected in more than one statement so
that the entire set is required to evaluate
the firm.

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 Relevance: Defined as “the capacity of
information to make a difference in a
decision ..”

 Timeliness: Information loses value rapidly

in the financial world. Market prices are
predicted on estimates of the future; data
on the past are helpful in making
projections.

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 Reliability: Encompasses verifiability,
representational faithfulness and neutrality.
The first two elements (verifiability &
representational faithfulness) are concerned
with whether financial data have been
measured accurately and whether they are
what they purport to be.

 Neutrality: Is Concerned with whether

financial statement data are biased.

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 Consistency & Comparability: Consistency
refers to use of the same accounting
principles over time. A broader term,
comparability, refers to comparison among
companies.

 Materiality: We define information to be

material when it would make a difference in
the valuation of the firm.

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 Growing international trade, multinational
industrial and financial enterprises, and
increasingly global capital markets have
significantly expanded investment
opportunities. Creditors and equity investors
need to analyze both domestic and foreign
companies. Yet differences in accounting and
reporting standards make it difficult to
compare domestic companies with those in
other countries. Furthermore, as accounting
standards are established separately in each
country, it is difficult to generalize about those
differences.
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The IASB was established in 1973 to
harmonize (conform) the accounting
standards of different nations.

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The Balance Sheet
The balance sheet reports major classes
and amounts of assets (resources owned or
controlled by the firm), liabilities (external
claims on those assets), and stockholders’
equity (owners’ capital contributions and
other internally generated sources of
capital) and their interrelationships at
specific points of time.

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
 Assets: Are defined in SFAC 6 as –
Probable future economic benefits
obtained or enrolled by a particular entity
as a result of past transaction or events. (Para
- 25)

 Liabilities: Are defined, similarly, as –

Probable future sacrifices of economic
benefits arising from present obligations of
a particular entity to transfer assets provide
services to other entities in the future as a
result of past transactions or events. (Para –
35)

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 Owners’ equity: As required by the
fundamental accounting equation,
stockholders’ equity is therefore –
The residual interest in the net assets of an
entity that remains after deducting its
liabilities. (Para – 49)

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The income statement (statement of
earnings) reports the result of its operating
activities. It explains some but not all of the
changes in the assets, liabilities, and the
equity of the firm between two consecutive
balance sheet dates.

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 Revenues: Are defined in SFAC 6 as –
Inflows…of an entity… from delivering or
producing goods, rendering services, or
other activities that constitute the entities’
ongoing major or central operations. (Para -
78)

 Expenses: Are defined as –

Outflows…from delivering or producing
goods, rendering services, or carrying out
other activities that constitute the entities’
ongoing major or central operations. (Para -
80)

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 The statement of cash flows reports cash
receipts and payments in the period of their
occurrence, classified as to operating,
investing and financing activities.

It also provides supplementary disclosures

about noncash investing and financing
activities. Defining investing cash flows as
those resulting from:
 Acquisition or sale of property, plant an
equipment
 Acquisition or sale of a subsidiary or
segment
 Purchase or sale of investments in other
firms 19
 Similarly, financing cash flows are those
resulting from:
 Issuance or retirement of debt and equity
securities
 Dividends paid to stockholders

Cash from operations – This key performance

measure includes the cash effects of all
transactions that do not meet the definition
of investing or financing.

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 This statement reports the amounts and
sources of changes in equity from capital
transactions with owners and may include
the following components:
 Preferred shares
 common Shares (at par of stated value)
 Additional paid-in capital
 Retained earnings
 Treasury Shares (repurchase equity)
 Employee Stock Ownership Plan (ESOP)
adjustments

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 Footnotes provide information about the
accounting method, assumptions, and
estimates used by management to develop the
data reported in the financial statements.

They are designed to allow users to improve

assessments of the amounts, timing, and
uncertainty of the estimates reported in the
financial statements.

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Footnotes provide additional disclosure related to
such areas as
 Fixed assets
 Inventories
 Income taxes
 Pension and other postemployment benefit plans
 Debt (interest rates, maturity schedules, and
contractual terms)
 Lawsuits and other loss contingencies
 Marketable securities and other investments
 Hedging and other risk management activities
 Business segments
 Significant customers, sales to related parties and
export sales.

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 In some cases, additional information about
the assets and liabilities of a firm is provided
within the financial statement footnotes, or
as supplementary data outside the financial
statements. Example include:
 Oil and gas companies provide additional
data on their exploration activities, quantities
and types of reserves and the present value
of cash flows expected from those reserves.
 Disclosure of sales revenue, operating
income, and other data for major business
segments and by geographic areas. Firms
also provide information about export sales.

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 Management Discussion and Analysis
Companies with publicly traded securities
have been required since 1968 to provide
a discussion of earnings in the MD & A
sections.
The MD & A is required to discuss:
 Results of operations, including
discussion of trends in sales and
categories of expense
 Capital resources and liquidity, including
discussion of cash flow trends
 Outlook based on known trends.
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 Companies that issue securities to the
public are required to publish a
registration statement including a
prospectus.

 Proxy statements, issued in connection

with shareholder meetings, contain
information about board members and
management, executive compensation,
stock options, and major stockholders.
 Many companies prepare periodic “fact
books” containing additional financial and
operational data. Corporate press releases
also provide new information on a timely 26
 In addition, many companies hold periodic
meetings or conference telephone calls to
keep the financial community appraised of
recent developments regarding the company.

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