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Chapter 3

Overview of Financial Statements

Book Version 3
By Boundless
Boundless Accounting
Accounting
by Boundless
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Section 1
The Income Statement
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Defining the Income Statement

Income statement is a company's financial statement that indicates how the revenue is transformed into the net income.

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Elements of the Income Statement

The income statement, or profit and loss statement (P&L), reports a company's revenue, expenses, and net income over a period of time.

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Noncash Items

Noncash items, such as depreciation and amortization, will affect differences between the income statement and cash flow statement.

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Uses of the Income Statement

The primary purpose of the income statement is to assess efficiency as revenues transform into profits/losses.

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Limitations of the Income Statement

Income statements have several limitations stemming from estimation difficulties, reporting error, and fraud.

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Effects of GAAP on the Income Statement

GAAP's assumptions, principles, and constraints can affect income statements through temporary (timing) and permanent differences.

Section 2
The Balance Sheet
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Defining the Balance Sheet

A balance sheet reports a company's financial position on a particular date.

Components of the Balance Sheet

The balance sheet relationship is expressed as; Assets = Liabilities + Equity.

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Uses of the Balance Sheet

The balance sheet of a business provides a snapshot of its financial status at a particular point in time.

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Preparation of the Balance Sheet

Balance sheets are prepared with either one or two columns, with assets first, followed by liabilities and net worth.

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Temporal Classification

Cash, receivables, and liabilities on the Balance Sheet are re-measured into U.S. dollars using the current exchange rate.

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Assets

Assets on a balance sheet are classified into current assets and non-current assets. Assets are on the left side of a balance sheet.

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Liabilities and Equity

The balance sheet contains details on company liabilities and owner's equity.

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Liquidity

Liquidity, a business's ability to pay obligations, can be assessed using various ratios: current ratio, quick ratio, etc.

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Working Capital

Working capital is a financial metric which represents operating liquidity available to a business, organization and other entity.

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Debt to Equity

The debt-to-equity ratio (D/E) indicates the relative proportion of shareholder's equity and debt used to finance a company's assets.

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Market Value vs. Book Value

Book value is the price paid for a particular asset, while market value is the price at which you could presently sell the same asset.

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Limitations of the Balance Sheet

The three limitations to balance sheets are assets being recorded at historical cost, use of estimates, and the omission of valuable non-monetary assets.

Section 3
The Statement of Cash Flows
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Defining the Statement of Cash Flows

A statement of cash flows is a financial statement showing how changes in balance sheet accounts and income affect cash & cash equivalents.

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Components of the Statement of Cash Flows

The cash flow statement has 3 parts: operating, investing, and financing activities. There can also be a disclosure of non-cash activities.

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Cash Flow from Financing

Cash flows from financing activities arise from the borrowing, repaying, or raising of money.

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Cash Flow from Investing

Cash flow from investing results from activities related to the purchase or sale of assets or investments made by the company.

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Cash Flow from Operations

The operating cash flows refers to all cash flows that have to do with the actual operations of the business, such as selling products.

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Interpreting Overall Cash Flow

Having positive and large cash flow is a good sign for any business, though does not by itself mean the business will be successful.

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Limitations of the Statement of Cash Flows

The statement of cash flows is a useful tool in identifying organizational liquidity, but has limitations when it comes to non-cash reporting.

Section 4
Special Considerations for Merchandising Companies
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Overview of Merchandising Operations

Merchandising is any practice which contributes to the sale of products to a retail consumer.

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Recording Purchases

In merchandising accounting, purchases are the amount of goods a company buys in the course of a year, including the kind, quality, quantity, and cost.

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Recording Sales

Net sales are gross sales minus sales returns, sales allowances, and sales discounts.

You are in this book
Boundless Accounting by Boundless
Previous Chapter
Chapter 2
Accounting Information and the Accounting Cycle
  • The Basics of Accounting
  • The Accounting Cycle
Current Chapter
Chapter 3
Overview of Financial Statements
  • The Income Statement
  • The Balance Sheet
  • The Statement of Cash Flows
  • Special Considerations for Merchandising Companies
Next Chapter
Chapter 4
Controlling and Reporting of Cash and Receivables
  • Overview of Cash
  • Managing Cash
  • Overview of Receivables
  • Notes Receivable
  • Basics of Receivables Management
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