Business Finance

CHAPTER 2
Review of Financial
Statement Preparation,
Analysis, and
Interpretation
Basic Financial
Statements
 Learning Objective
• To know the information found in the different
financial statements
 Basic Financial Statements:
The Statement of Financial Position
What are the important concepts we need to know
about the STATEMENT OF FINANCIAL POSITION?

 The Statement of Financial Position provides information

regarding the liquidity position and capital structure of a
company as of a given date.
 It must be noted that the pieces of information found in
this report are only true as of a given date.
 Liquidity refers to the ability of a company to pay
maturing obligations.
 Capital structure provides information regarding the
amount of assets financed by debt or liabilities and
equity.
A Statement of Financial Position is a formal statement showing the
three elements comprising financial position, namely assets, liabilities
and equity.

• Assets is defined as resources controlled by th entity as a result of

past events and from which future economic benefits are expected to
flow to the entity.

• Liabilitity is defined as present obligation of an entity arising from

past events, the settlement of which is expected to result in an outflow
from the entity of resources embodying economic benefits.

• Equity is the residual interest in the assets of the entity after

deducting all its liabilities. Simply stated, equity means “net assets”
or total assets minus liabilities.
Forms of Statement of Financial Position
In Practice, there are two customary forms in presenting the statement of
financial position, namely:

1. REPORT FORM – This form sets forth the three major sections in a
downward sequence of assets, liabilities and equity.

2. ACCOUNT FORM – As the title suggests, the presentation follows that of an

account, meaning, the assets are shown on the left side and the liabilities and
equity on the right side of the statement of financial position
PROBLEM 1-1
Samplar Company provided the following account balances on December 31, 2016:

Accounts Receivable 580,000 Other noncurrent assets 100,000

Notes Receivable 120,000 Share, Capital 12,500,000
Inventories 900,000 Accounts Payable 900,000
Cash 500,000 Notes Payable 950,000

Long-term investment 5,100,000 Required: Prepare a Report Form

Intangible assets 2,000,000 Statement of Financial Position
Prepaid Insurance 50,000
Land 1,500,000
Building 4,500,000
Machinery 1,000,000
Furnitures and Fixtures 400,000
Accumulated Depreciation 2,400,000
 Basic Financial Statements:
The Statement of Profit or Loss
What are the important concepts we need to know
about the STATEMENT OF PROFIT OR LOSS?

 The Statement of Profit or Loss provides information

regarding the revenues or sales, expenses, and net
income of a company over a given accounting period, a
period which may be for a month, a quarter, or a year.
 In analyzing earnings performance, a comparison with
the previous periods and with other companies,
especially those coming from the same industry, is a
must. Such comparison will not be made possible without
knowing the accounting periods covered in the statement
of profit or loss.
 Basic Financial Statements:
The Statement of Profit or Loss
What are the important concepts we need to know
about the STATEMENT OF PROFIT OR LOSS?

 In analyzing Statement of Profit or Loss, it is important to

identify how much of the income comes from core
business (the main business of the company) and how
much comes from the non-core business.
Sources of income
a. Sales of merchandise to customers
The income from sales shall include all sales to
customers during the period.

Sales returns, allowances and discounts shall be

deducted from gross sales to arrive at net sales.

b. Rendering of services
Income from rendering of services, among others,
includes professional fees, media advertising
commissions, insurance agency commission, admission
fees for artistic performance and tuition fees.
Components of expense
a. Cost of goods sold or cost of sales
b. Distribution costs or selling expenses
c. Administrative expenses
d. Other expenses
e. Income tax expense
Cost of goods sold or cost of sales

Beginning inventory 500,000

Add: Net Purchases 2,000,000
Goods available for Sales 2,500,000
Ending inventory ( 300,000)
Cost of goods sold 2,200,000

Net Purchases
Gross purchases 1,900,000
Freigh it 150,000
Total 2,050,000
Purchase returns, allowances, discount ( 50,000)
Net purchases 2,000,000
Distribution costs constitute costs which are directly
related to selling, advertising and delivery of goods to
customers.

Distribution costs ordinarily include:

a. Salesmen’s salaries
b. Salesmen’s commissions
c. Traveling and marketing expenses
d. Advertising and publicity
e. Freigh out
f. Depreciation of delivery equipment and store
equipment
Administrative expenses ordinarily include all operating
expenses not related to selling and cost of goods sold.

Examples include:
a. Doubful accounts
b. Office salaries
c. Expenses of general executives
d. Expenses of general accounting and credit
department
e. Office supplies used
f. Professional fees
g. Depreciation of office building and office equipment
Other expenses are those expenses which are not
directly related to the selling and administrative function.

Examples include:
a. Loss on sale of trading investments
b. Loss on disposal of property, plant and equipment
c. Loss on sale of non current investment
d. Casualty loss – flood, earthquake, fire
Notes to Financial Statement

Notes to financial statements ared used to report

information that does not fit into the body of the financial
statements in order to enhance the understandability of
the financial statements.
 EXAMPLAR COMPANY
Statement of Profit or Loss
Year ended December 31, 2016

Note
Net sales (1) 9,000,000
Cost of goods sold (2) (5,400,000)
Gross income 3,600,000
Other income (3) 900,000
Investment income (4) 500,000
Total income 5,000,000

Expenses:
Distribution costs (5) 1,350,000
Administrative expenses (6) 1,000,000
Other expenses (7) 320,000
Finance Cost (8) 200,000 2,870,000
Income before tax 2,130,000
Income tax expense 580,000
Net Income 1,550,000
Note 1 – Net Sales
Gross sales 9,300,000
Sales return and allowances ( 100,000)
Sales discount ( 200,000)
Net Sales 9,000,000

Note 2 – Cost of goods sold

Inventory, Jan 1 1,500,000
Purchases 6,000,000
Freight in 300,000
Total 6,300,000
Purchase return and allowance( 150,000)
Purchase discount ( 250,000) 5,900,000
Goods available for sale 7,400,000
Inventory, Dec 31 (2,000,000)
Cost of sales 5,400,000
Note 3 – Other income
Interest revenue 180,000
Dividend revenue 120,000
Rent Revenue 600,000
Total 900,000

Note 4 – Investment income

Share in net income of associate (25%) 500,000

Note 5 – Distribution costs

Sales salaries 600,000
Sales commission 200,000
Advertising 100,000
Store supplies expense 50,000
Delivery expense 250,000
Depreciation – store equipment 150,000
Total distribution costs 1,350,000
Note 6 – Adminsitrative expenses
Office salaries 650,000
Bonuses 130,000
Office supplies expense 70,000
Taxes and licenses 20,000
Doubtful accounts 40,000
Depreciation expense-office equipment 90,000
Total administrative expense 1,000,000

Note 7 – Other expenses

Loss on sale of investment 30,000
Loss on sale of property 120,000
Casualty loss from earthquake 170,000
Total 320,000

Note 8 – Finance cost

Interest expense on bank loan 50,000
Interest expense on bond payable 150,000
Total finance cost 200,000
PROBLEM 2
Karla Company provided the following information for 2016:

Purchases 5,250,000
Purchases returns and allowances 150,000
Rent income 250,000
Selling expenses:
Freight out 175,000
Salesman commission 650,000
Depreciation-store equipment 125,000
Merchandise inventory, jan1 1,000,000
Merchandise inventory, Dec 31 1,500,000
Sales 7,850,000
Sales returns and allowances 140,000
Sales discount 10,000 Required:
Adminsitrative expenses: Prepare a
Officers salaries 500,000 Statement of
Depreciation- office equipment 300,000 Profit or Loss
Freight in 500,000
Income tax 250,000
with supporting
Loss on sale of equipment 50,000 Notes
Purchase discount 100,000
Dividend revenue 150,000
Loss on sale of investment 50,000
 Basic Financial Statements:
The Statement of Cash Flows
What are the important concepts we need to know
about the STATEMENT OF CASH FLOWS?

 The Statement of Cash Flows provides an explanation

regarding the change in cash balance from one
accounting period to another.
 The Cash Flows are classified into three main categories:
1. Operating;
2. Investing; and
3. Financing.
 Basic Financial Statements:
The Statement of Cash Flows
What are the important concepts we need to know
about the STATEMENT OF CASH FLOWS?

 The Cash Flows are classified into three main categories:

1. Operating. In the cash flows from operating activities, the
income reported from the statement of profit or loss which
is based on accrual principle is converted to cash.
2. Investing. The cash flows from investing activities provide
information regarding the future direction of the company; it
shows how much investment the company is making over
a given accounting period.
3. Financing. The cash flows from financing activities provide
information whether there is a proper matching of investing
and financing activities.
 Auditor Company
Statement of Cash Flows
for the Year Ended, December 31, 2016
Cash flows from operating activites
Payment to Supplier (15,000)
Cash collection from customers 60,000
Cash payment for maintenance expense (5,000)
Cash receipts from rent to clients 12,000
Cash payment for salaries of employees 18,000
Net Cash provided by operating activities 34,000

Cash flows from investing activites

Cash payment to acquire building (500,000)
Cash received for selling properties 420,000
Net cash provided by investing activities (80,000)

Cash flows from financing activites

Payment to long term creditors (25,000)
Additional cash investment from owners 90000
Cash payment for amount borrowed (6,000)
Cash receipts from bank loan 100,000
Withdrawal of owners (10,000)
Net cash provided by investing activities 149,000
Increase in Cash 103,000
Add: Cash Balance, January 1 1,500,000
Cash Balance, December 31 1,603,000
 Basic Financial Statements:
The Statement of Changes in Stockholders’ Equity
What are the important concepts we need to know
about the STATEMENT OF CHANGES IN
STOCKHOLDERS’ EQUITY?

 The Statement of Changes in Stockholders’ Equity

provides information that explains the changes in the
stockholders’ equity account from one accounting period
to another.
 The changes may be due to the following:
1. Profit or loss for the accounting period;
2. Cash dividend declaration;
3. Issuance of new shares of stocks; and
4. Other transactions that affect the stockholders’
equity such as other comprehensive income,
treasury stocks, and revaluation of assets.
 Notes to Financial Statements
What are the additional pieces of
information that the NOTES TO
FINANCIAL STATEMENTS provide?

1. Brief Description of the Company

Information may include the nature of business of the
company and the owners behind the company.
 Notes to Financial Statements
What are the additional pieces of
information that the NOTES TO
FINANCIAL STATEMENTS provide?

2. Summary of Significant Accounting Policies

This is very important because the existing generally
accepted accounting principles provide alternative
accounting policies to companies. It is therefore
important to find out what specific accounting policies are
used by the company.
 Notes to Financial Statements
What are the additional pieces of
information that the NOTES TO
FINANCIAL STATEMENTS provide?

3. Breakdown of Amounts Found in the Financial

Statements
The company’s property, plant, and equipment (PPE)
account may have too many components. Putting all the
details on the face of the balance sheet may make the
balance sheet too long. An alternative presentation is to
provide a single amount on the face of the balance sheet
for PPE but the breakdown of PPE can be presented in
the notes to financial statements.
 Self-Test Question
How can you identify and describe the financial
information that can be found in the following financial
statements:
a. Statement of Financial Position;
b. Statement of Profit or Loss;
c. Statement of Cash Flows; and
d. Statement of Changes in Stockholders’ Equity?