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Financial Statements

Lecture No. 2
Chapter 2
Contemporary Engineering Economics
Third Canadian Edition
Copyright 2012

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Lecture 2 Objectives

What is the role of accounting in economic


decisions?

What are the types of financial statements


prepared for investors and regulators?

How does a company use its financial


statements to manage its business?

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Accounting: The Language of Business

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Information in Financial Statements

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Major Factors Affecting Stock Prices

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The Balance Sheet

A balance sheet statement


(or statement of financial position)
reports three categories of items:

assets,

liabilities, and

shareholders (or owners) equity.


The accounting equation shows:
Assets = Liabilities + Owners Equity
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Four Quadrants of the Balance Sheet


ASSETS

LIABILITIES

Current Liabilities

Current Assets

Long-Term Liabilities

Long-Term Assets

Equity
1.
2.

Owner Contributions
Retained Earnings

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Consolidated Balance Sheet: RIM


Current
Assets

Long-Term
Assets
Current
Liabilities
Long-Term Liabilities
Equity

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Components of a Balance Sheet (1)

Assets are items to which the organization has legal title,


that have some value, and can create future benefits.

Current Assets can be converted into cash or its equivalent


within one year and include:
Cash (and cash equivalents)
Short-term notes (or investments)
Accounts receivable represent money that is owed to the
firm by its customers but has not yet been paid.
Inventory constitutes the dollar amount of materials, supplies,
work-in-process, and finished goods available for sale.
Prepaid expenses, e.g., bills

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Components of a Balance Sheet (2)

Long-Term Assets have liquidity of over one year.

Fixed assets (or capital assets) are relatively permanent,


would usually take longer than a year to convert into cash,
and include:
Land
Buildings
Factory machinery
Office equipment, furniture and fixtures
Vehicles

Other assets include:

Long-term investments made in other companies, and


Intangible assets, such as licences, patents, and
copyrights, and goodwill
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Components of a Balance Sheet (3)

Liabilities is the money the company owes.

Current Liabilities are those debts that must be paid in


the near future (normally, within one year).
Short-term credit line
Accounts payable are money owed to suppliers.
Accrued expenses or liabilities are the opposite of prepaid
expenses. Firms will typically incur periodic expenses, such
as wages, rent, interest, and taxes.
Income taxes payable may be listed as a separate item.
Current portion of the long-term debt is the principal due
within the year

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Components of a Balance Sheet (4)

Long-Term Liabilities are due and payable more than


one year in the future.

Long-term portion of the long-term debt is the amount of


principal due after the next year

Additional long-term liabilities, such as bonds, mortgages,


grants, and long-term notes

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Components of a Balance Sheet (5)

Shareholders Equity is the liability of the


company to its owners and generally consists of:
Common stock (aggregate par value of stock issued),
Preferred stock (stock and debt, may not be used)
Treasury stock (when company buys back stock)
Paid-in capital (from stock sale above par value), and
Retained earnings.

Retained earnings:

Represent the cumulative net income of the firm since its


beginning, less the total dividends that have been paid to
stockholders.
Indicate the amount of assets that have been financed by
plowing profits back into the business.
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The Income Statement: Basic Equation


Revenue

Expenses
Net Income (Loss)

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Consolidated Statement of Operations: RIM

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Components of an Income Statement (1)

Revenue is the money received from goods sold and services


rendered during a given accounting period.

Net revenue represents the revenue less any sales returns and
allowances. When these adjustments are minor, as in RIMs case,
revenue is used in the place of net revenue.

Cost of sales (also called cost of goods sold or cost of revenue)


represents the expenses and costs of doing business as deductions
from the revenues. The largest expense for a typical manufacturing
firm is its production costs, including such items as labour, materials,
depreciation, and overhead, known as cost of goods sold.

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Components of an Income Statement (2)

Operating expenses (also called overhead, fixed costs,


or sales, general and administrative costs) include cost
items that are not directly related to manufacturing the
products or delivering the services. They may include:
research and development expenses,
rental expenses,
administrative expenses,
marketing expenses,
property taxes,
interest charges on debts, and
depreciation or amortization of capital & intangible assets.
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Components of an Income Statement (3)

Income from operations (or operating income) is


calculated by subtracting operating expenses from the
gross margin.
Investment income is income generated from investment
activities that are not directly related to the
manufacturing and/or service activities of the company.
Income before income taxes (or taxable income) is the
sum of income from operations and investment income.
Net income (or net profit) by subtracting income taxes
from the taxable income. Net income is also known as
accounting income.
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The Cash Flow Statement

Three types of activities:

1. Operating Activities: include operating cash flows related to


the production and sales of goods or services and all noncash expenses (such as depreciation) are added back to net
income. Any adjustments in working capital also included.
2. Investing Activities: cash flow transactions related to
investment activities, which included purchasing new fixed
assets, selling old equipment, and buying and selling financial
assets.
3. Financing Activities: cash transactions related to financing
any capital used in business. Activities include the amount of
borrowing, selling stock, and paying of existing debt.
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Consolidated Statement of Cash Flows: RIM

Operating
Activities

Financing
Activities

Investing
Activities

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Summary

The three basic financial statements contained in


the annual report are the balance sheet, the
income statement, and the statement of cash flows.

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