This document provides an overview of key concepts related to financial statements and the auditor's opinion. It discusses the accounting cycle including recording transactions, adjusting entries, and preparing financial statements. It then explains the main financial statements - the income statement, balance sheet, statement of owners' equity, and statement of cash flows. The document also covers consolidated financial statements, important aspects of financial reporting, and the different types of auditor's opinions that may be issued.

1. Chapter 2
Introduction to
Financial Statements and
Auditor’s opinion

2. 2
The Accounting Cycle
1. Recording transactions
2. Recording adjusting entries
3. Preparing the financial statement

3. 3
Recording Transactions
• Internal or external event that causes a change
in a company’s assets, liabilities, or owners' equity
• Recorded in a journal (journal entry)
• Posted to general ledger accounts
• Double-entry system
 Debit: left side of an account
 Credit: right side of an account
 Debits = Credits
Account Title
Debit Credit

4. 4
Effects of Debits and Credits on Accounts
• Assets & Expenses
– Normally have debit balances
– Debits increase account balance
– Credits decrease account balance
• Liabilities, Revenue, & Owners’ Equity
– Normally have credit balances
– Credits increase account balance
– Debits decrease account balance

5. 5
Accounting System Components
Real Accounts
(Permanent)
Nominal Accounts
(Temporary)
Account class Assets
Liabilities
Equity
Revenues, Expenses
(Gains, Losses,
Dividends)
Balances Carry forward C/F to
the next fiscal period
Closed to retained
earnings at year-end
Coming period Start with the
balances B/F of the
previous period
Start with $0 balance
in the next period

6. 6
Recording Adjusting Entries
Its purpose is to assign to each accounting period the
appropriate amount of revenue and expenses.
• Required by the accrual basis of accounting
• Prepared at the end of the accounting (fiscal)
period
• Records (recognizes) for the current period
– Expenses incurred
– Revenues earned
• Recorded in the general journal
• Posted to the general ledger

7. Financial statements preparation
7

8. 8
Income Statement
• Covers a period of time
• Summarizes revenues
and expenses
• Reports net income
– Excess of revenues
over expense
• Net income increases
retained earnings (B/S)
• Net Loss will decrease
retained earnings (B/S)
Income Statement
Revenue $ 120,000
Expenses (100,000)
Net Income $ 20,000

9. 9
Income Statement
Revenue $ 120,000
Expenses (100,000)
Net Income $ 20,000
Statement of Owners' Equity
Capt. Stk. Ret. Earn.
Beginning Balance $60,000 $ 5,000
Net income 20,000
Dividends (10,000)
Ending Balance $60,000 $ 15,000
Statement of Owners’ Equity
• Covers a specific
period of time
• Reconciles
beginning and
ending balances of
the owners' equity
accounts
– Capital Stock
– Retained Earnings
– Etc.
• Links the income
statement and the
balance sheet

10. 10
Balance Sheet
Shows the financial condition
of an entity as of a particular
date
– Assets: the resources of
the business
– Liabilities: the debts of
the business
– Equity: the owners’
interest in the business
The Accounting Equation:
Assets = Liabilities +
Owners’ Equity
Balance Sheet
Assets $110,000
Liabilities 45,000
Owners' Equity
Capital Stock 60,000
Retained Earnings 5,000
$110,000
Income Statement
Revenue $ 120,000
Expenses (100,000)
Net Income $ 20,000
Statement of Owners' Equity
Ret. Earn.
Beginning Balance $ 5,000
Net income 20,000
Dividends (10,000)
Ending Balance $ 15,000

11. 11
Balance Sheet (Con’t)
The amount of retained
earning will affect both sides
of the balance sheet
– Assets increases
– Retained earning also
increases
Balance Sheet
Assets $120,000
Liabilities 45,000
Owners' Equity
Capital Stock 60,000
Retained Earnings 15,000
$120,000
Income Statement
Revenue $ 120,000
Expenses (100,000)
Net Income $ 20,000
Statement of Owners' Equity
Capt. Stk. Ret. Earn.
Beginning Balance $60,000 $ 5,000
Net income 20,000
Dividends (10,000)
Ending Balance $60,000 $ 15,000

12. 12
Statement of Cash Flows
• Covers the same period as the income
statement
• It contains three main sections:
– Cash flows from operating activities
• Cash collections & payments of a business from Revenue &
Expenses
– Cash flows from investing activities
• Cash in/out flows from buying and selling assets
– Cash flows from financing activities
• Owner investment and creditors lending money to the
company and repayment of both and payment of dividends

13. 13
Consolidated (aggregated )
Financial Statements
It is the overall group's financial statements. They
represent the total of the parent company and all
subsidiaries.
• Parent consolidates with subsidiary
– Report results of operations separately
– Sum subsidiary and parent results of operations
• Consolidation occurs when parent has effective
control over the subsidiary
– Holds a majority of risks, rewards, and decision-making
ability

14. 14
Consolidated (aggregated )
Financial Statements
ABC company
Income statement
For the period ended Dec 31, 2022
Parent entity Subsidiary Subsidiary Subsidiary Consolidated
Line item Kabul Mazar Herat Nangarhar Total
Sales 5,585 3,000 895 1,006 10,486
Cost of sales (4,678) - (700) (959) (6,337)
Gross Profit 907 3,000 195 47 4,149
Administrative expenses (359) (986) (193) (359) (1,897)
Other income 85 12 16 7 120
EBITDA 633 2,026 18 (305) 2,372
Depreciation and amortization (106) (6) (57) (24) (193)
EBIT 527 2,020 (39) (329) 2,179
Finance costs (35) (8) (12) (4) (59)
Profit/(loss)before income tax 492 2,012 (51) (333) 2,120
Income tax (expense) (172) (92) (9) 82 (191)
Profit/(loss)for the period 320 1,920 (60) (251) 1,929

15. 15
Important aspects of the
Financial Reporting
• An integral part of the financial statements
requires presentation
– Summary of significant accounting policies
– Contingent liabilities
• A potential loss that may occur at some point in the future.
Ex. warranty; there is uncertainty about the exact number
of units that will be returned by customers for repair or
replacement.

16. 16
Important aspects of the
Financial Reporting
• Subsequent Event
It occurs after a company’s year-end period but before the release
of the financial statements.

17. 17
Important aspects of the
Financial Reporting
– Subsequent events relating to conditions that
existed at the balance sheet date
• Disclose any adjustment of the financial statements
Ex. The ABC company’s client unexpectedly goes
bankrupt. After analysis, the company will only get 10%
of it’s A/R from the client. The event will require an
adjustment to the financial statements.
– Subsequent events relating to conditions that did
not exist at the balance sheet date
• Disclosure but no adjustment of the financial
statements
A labor strike that could potentially threaten the
company into bankruptcy should be disclosed in the
financial statements.

18. 18
Auditor’s opinion

19. 19
Auditor’s Opinion
Audit: An examination of a company's activities or products to
determine if a company is doing what it says it is doing.
• Audit is conducted by CPAs (Certified Public Accountant)
Auditors’ true and fair view
• It expresses the condition that financial statements are
truly prepared and fairly presented in accordance with
the accounting standards.
• It also means that a financial statement is free from
material misstatements & faithfully represents the
financial performance and position of an entity.

20. 20
Auditor’s Opinion
• The audit report is the formal statement of audit
opinion
• The audit opinions may be:
– Unqualified opinion
– Qualified opinion
– Adverse opinion
– Disclaimer of opinion

21. 21
Unqualified Opinion
• The financial statements present fairly
– The financial position
– Results of operations
– Cash flows
• The statements are in conformity with GAAP
• For the user: the highest degree of reliability

22. 22
Qualified Opinion
• Except for the matter to which the exception
relates
• The financial statements present fairly
– The financial position
– Results of operations
– Cash flows
• For the user: It determine the significance of
the exception for a specified issue.

23. 23
Adverse Opinion
• The financial statements do not present
fairly
– The financial position
– Results of operations
– Cash flows
• For the user: reliability of financial statements
need to be seriously questioned

24. 24
Disclaimer of Opinion
• The auditor does not express an opinion
• Auditor
– Has not preformed an audit sufficient in scope to
form an opinion or
– Is not independent
– The auditor may not have been allowed to complete
the planned procedure
– The client restricted the scope of the examination
• For the user: auditor’s statement conveys no
indication of financial statement reliability

25. 25
Auditor’s Report
• Paragraph #1:
– Financial statements have been audited
– Financial statements are responsibility of
management
– Auditors have responsibility to express or disclaim
an opinion

26. 26
Auditor’s Report (cont’d)
• Paragraph #2
– Audit conducted in accordance with the standards
of the (U.S.) Public Company Accounting
Oversight Board
– Auditor is required to plan and perform the audit
• Obtain reasonable assurance
• Financial statements are free from material
misstatement
– Audit provides a reasonable basis for opinion
• Examining evidence
• Assessing accounting principles and estimates

27. 27
Auditor’s Report (cont’d)
• Paragraph #3
– Opinion: in conformity with generally accepted
accounting principles (GAAP)
• Also: for public companies, reference to the
audit of internal control effectiveness
– In accordance with the (U.S.) Public Company
Accounting Oversight Board
– Based on criteria established by internal controls

28. 28
Auditor’s Report on Internal Control
• Required by Sarbanes-Oxley_2002 ("Public
Company Accounting Reform and Investor Protection Act")
• May be combined with audit opinion report
• Paragraphs
1. Scope
2. Responsibility and procedures
3. Opinion
4. Reference to financial statement audit

29. 29
Management’s Responsibility
• Management is responsible for
– The preparation of the financial statements
– The integrity of the financial statements
• Management’s Statement of Responsibility
– May be included in the annual report

30. Thank you
30