Financial statements are issued by firm’s to provide financial information about the business
Its objective is to determine the value of the net investment made by the firm’s owners (the shareholders ) in their firm at a specific date
Its objective is to measure the net profit (or loss) generated by the firm’s activities during a period of time
Net profit (or loss) is a measure of the change in the value of the owners’ investment during that period
Accounting standards (GAAP in the United States)
Accountants have some leeway
To make meaningful comparisons, one needs to adjust items if identical standards are not used
EXHIBIT 2.1a: OS Distributors’ Balance Sheets. Figures in millions of dollars The balance sheets and income statements for the fictitious firm Office Supplies Distributors (OS Distributors) are presented in Exhibits 2.1 and 2.2 . These same financial statements are then used throughout the book. 1 Consists of cash in hand and checking accounts held to facilitate operating activities. 2 Prepaid expenses is rent paid in advance (when recognized in the income statement, rent is included in selling, general, administrative expenses). 3 In 2004, there was no disposal of existing fixed assets or acquisition of new fixed assets. However, during 2005, a warehouse was enlarged at a cost of $12 million and existing fixed assets, bought for $9 million in the past, were sold at their net book value of $2 million.
EXHIBIT 2.1b: OS Distributors’ Balance Sheets. Figures in millions of dollars 4 Accrued expenses consist of wages and taxes payable. 5 Long-term debt is repaid at the rate of $8 million per year. No new long-term debt was incurred during 2004, but during 2005 a mortgage loan was obtained from the bank to finance the extension of a warehouse (see Note 3). 6 During the three years, no new shares were issued and none was repurchased.
EXHIBIT 2.2: OS Distributors’ Income Statements. Figures in millions of dollars 1 There is no financial income, so net interest expenses are equal to interest expenses.
A measure of the net change in owners’ equity resulting from the transactions recorded in the income statement during the accounting period
Calculated by deducting income tax expense from EBT
The firm’s bottom line
Reconciling Balance Sheets and Income Statements
When a cash dividend is declared, the net increase in owners’ equity (called retained earnings) is the difference between earnings after tax and the dividend
By the same logic, when the firm repurchases its shares, the owners’ equity is also decreased
Conversely, when the firm sells its shares, the owners’ equity increases
Net change in owners’ equity = Earnings after tax – Dividends + Amount raised by new share issuance – Amount paid for share repurchase
EXHIBIT 2.4: OS Distributors: The Link Between the Balance Sheets and the Income Statement. Figures in millions of dollars and data from Exhibit 2.1 and Exhibit 2.2 Exhibit 2.4 demonstrates the link between the firm’s balance sheet and its income statement.
The owners’ equity account represents the accumulated contribution of the changes in owners’ equity since the firm’s inception
Par value (arbitrary fixed value)
Paid-in capital in excess of par
Accumulated retained earnings
EXHIBIT 2.5: OS Distributors Owners’ Equity on December 31, 2005. Figures in millions of dollars Exhibit 2.5 clarifies the origin of OS Distributors’ owners’ equity (common stock at par value, paid-in capital in excess of par, accumulated retained earnings, treasury stock).