Section A.1.Financial Statements

Question 1

a.Identify the users of these financial statements and their needs

Answer 1

1) investors (buy, hold, or sell interest in a corporation)
2) employees (stability, sustainability, and profitability)
3) lenders (borrowers ability to pay debt)
4) trade creditors (whether they should sell on credit)
5) customers (org continuity)
6) governmental agency (regulations, tax policies)
7) public (contribution to local community)

Question 2

b.Purposes and uses of each statement

Answer 2

1) Balance sheet - to show the financial position of the organization at a point in time. (assets and claims to those assets). Evaluate the capital structure of the entity and assess the entity’s liquidity, solvency, financial flexibility, and operating capability.
2) Income statement- shows the results of operations (revenues and gains less expenses, losses, and taxes) for an organization for a period of time (use: measures profitability, creditworthiness, and investment value of the entity)
3) Statement of changes in equity - shows the changes in capital received and retain earnings for a fiscal period. (Changes in capital received: issuance and repurchase of shares; changes in retained earnings: net income and dividends)
4) Statement of cash flow - shows the change in cash and cash equivalents, which are classified as operations, investing, or financing.

Question 3

c.Identify the major components and classifications of each statement

Answer 3

1) Balance Sheet
-current assets (may be converted into cash, sold, or consumed within a year)
-long-term assets
-current liabilities (debts that are due to be paid within a year)
-long-term liabilities
-shareholders’ equity (investments from shareholders and retained earnings; shareholders’ interest in the net assets of the company)
2) Income Statement
-sales (from ordinary course of business)
-cost of goods sold (direct costs related to the product sold or services rendered)
-operating expenses (other necessary and ordinary expenses not included in COGS)
-other revenues and expenses (other inflows and outflows not related directly to operations)
-taxes (tax liability incurred in connection with reported income)
3) Statement of Cash Flows
-operating activities (cash flows related to the normal course of business; cash from customers, cash paid to employees, interest paid on debt)
-investing activities (cash flow related to long-term asset accounts;sale and purchase of property, plant, and equipment, intangibles, and investments)
-financing activities (cash flow related to long term liability or equity accounts; inflows from issuance of debt or stock, outflows from payment of debt, reacquisition of treasury stock, and payment of dividends)
4) Statement of Changes in Shareholders’ Equity
-beginning equity
+new investments
+net income
-dividends
=ending equity

Question 4

d. Identify the limitations of each financial statement

Answer 4

1) use of historical cost (all 4)
2) use of different accounting principles and methods, estimates, and judgements
3) excludes human capital and liabilities that are handled off balance sheet (balance sheet only)

Question 5

e. Identify how various financial transactions affect the elements of each of the financial statements, and determine the proper classification of the transaction

Answer 5

Covered in Topic 2: recognition, measurement, valuation, and disclosure

Question 6

f. Identify the basic disclosures related to each of the statements (footnotes, supplementary schedules, etc)

Answer 6

1) Footnotes or disclosures - are used when parenthetical explanations would not suffice to describe situations particular to the entity

Typical disclosures:
-contingencies
-contractual situations
-accounting policies
-subsequent events

Question 7

g. Demonstrate an understanding of the relationship among the financial statements

Answer 7

-the four financial statements are integrally related
-B/S is connected to I/S through the change in retained earnings shown in the statement of changes in shareholders’ equity
-B/S change in cash and other changes in financial position are presented in the statement of cash flow
-Changes in capital received in the B/S are shown in the statement of changes in shareholders’ equity

Question 8

h. Prepare a balance sheet, an income statement, a statement of changes in equity, and the statement of cash flow

Answer 8

Balance sheet
Income statement
Statement of cash flow
Statement of changes in equity