C H A P T E R 1 :

F I N A N C I A L
S T A T E M E N T S
A N D
R E P O R T S
_FINANCIAL ANALYSIS_
 The purpose of accounting is to organize the financial
details of business;

To identify the financial transactions;

Review of To organize the financial data into useful information;

Accounting
To measure the value of these information in terms of
money;

To analyze, interpret, and communicate the information

to persons or groups, both inside or outside the business.
 Scope and role of financial statements
• The objective of financial statements is to provide information about the financial position,
performance and changes in financial position of an enterprise that is useful to a wide range
of users in making economic decisions (IASB Framework).
• Financial statements are an important source of information to the capital markets and
business analysts.
• Analyzing financial statements addresses a number of issues of interest to external
stakeholders and company insiders.
The Role of Financial Reporting in Capital Markets

• Financial reporting provide much needed information to capital market

participants
• Financial intermediaries depend upon the information in financial statements to
evaluate investment opportunities.

• Information intermediaries assure the quality of financial statement

representations.

• Relevant and reliable financial information is essential for the functioning of

capital markets.
 Types of Financial statements
Balance sheet

üFinancial position at a point in time (asset, liabilities ad equity)

Income statement

üFinancial performance over a period of time

Cash flow statement
üCash receipts and payment
Financial statement notes

üProvide further details about the information summarized in the financial

statements
 Balance Sheet
• The Balance Sheet, presents the financial position of an entity at a given date. It is
comprised of the following three elements:

• Assets: Something a business owns or controls (e.g., cash, inventory, plant and
machinery,…)

• Liabilities: Something a business owes to someone (e.g., creditors, bank loans,…)

• Equity: What the business owes to its owners. This represents the amount of capital
that remains in the business after its assets are used to pay off its outstanding
liabilities. Equity therefore represents the difference between the assets and liabilities.
Accounting Equation

Liabilities Equity Assets

Bartlett Company Balance Sheets ($000)
Bartlett Company Balance Sheets ($000)
Personal Finance Example
 Income Statement
• Income Statement, also known as the Profit and Loss Statement, reports the
company's financial performance in terms of net profit or loss over a specified
period. Income Statement is composed of the following two elements:

• Income: What the business has earned over a period (e.g., sales revenue,
dividend income,…)

• Expense: The cost incurred by the business over a period (e.g., salaries and
wages, depreciation , rental charges,…)

• Net profit or loss is arrived by deducting expenses from income.

Bartlett Company Income Statements ($000)
Personal Finance Example
 Cash Flow Statement
• Cash Flow Statement, presents the movement in cash and bank balances over a
period. The movement in cash flows is classified into the following segments:

• Operating Activities: Represents the cash flow from primary activities of a business.

• Investing Activities: Represents cash flow from the purchase and sale of assets other
than inventories (e.g., purchase of a factory plant)

• Financing Activities: Represents cash flow generated or spent on raising and repaying
share capital and debt together with the payments of interest and dividends.
Bartlett Company Statement of Cash Flows ($000) for the Year Ended
December 31, 2012
Statement of Retained Earnings

•The statement of retained earnings reconciles the net income earned

during a given year, and any cash dividends paid, with the change in
retained earnings between the start and the end of that year.
Bartlett Company Statement of Retained Earnings ($000) for the Year Ended
December 31, 2012
 Account System

Classifying accounts

• Assets
• Liabilities
• Equity
• Revenue
• Expense
• Contra accounts–used to offset some part of the value
of another account, i.e., accumulated depreciation
 Accounting Equation

Liabilities Equity Assets

Contributed Retained
Liabilities Capital Earning Assets
Accounting Equation

Assets = Liabilities

+ Contributed Capital

+ Beginning Retained Earning

+ Revenue

– Expenses

– Dividends
Example 1
• Canon- a photocopy producer reported the balance sheet as of 31st
December in 2004 and 2005 as follow:

31/12/2004 31/12/2005
(Million JPY) (Million JPY)
Total asset 3,587,021 4,043,553

Liabilities 1,190,331 1,238,535

Owners’ equity 2,396,690 ?

Total resource 3,587,021 4,043,553

Example 1

Requirements:

1. Calculate owners’ equity at 31/12/2005

2. Compare the absolute change in total asset in 2004 with

that in 2005 and give comment on the importance of
liabilities and equity in financing asset growth over the two
years.
 Solution 1
1. Owners’ equity = Assets-Liabilities

2005 equity= 4,043,553-1,238,535=2,805,018 million JPY

2. Total asset increase : 4,043,553-3,587,021= 456,532 million JPY

Equity increase: 2,805,018-2,396,690=408,423 million JPY

Comment: Asset increase at higher rate than equity and the difference between increase in asset
and increase in equity are equal to the difference between liabilities over two years.

456.532-408.423=1.238.535-1.190.331=48.204 million JPY

Equity took much more important role in financing growth of asset.

The linkage among financial statements
Income statement Balance sheet Cash flow statement
Revenue Current asset Cash flow from operating
Cost of good sold Cash activities
Gross profit Long term asset Cash flow from investing
Financial expense Total asset activities
S&A expense Current liabilities Cash flow from financing
Operating profit Long term liabilities activities
Other profit Total liabilities Change in cash balance
Profit before tax Charter capital Beginning cash balance
Corporate tax Retained earning Ending cash balance
Profit after tax Total equity
Total resource

Ending Retained
earning=Beginning Ending cash
retained earning + balance (CF)= Cash
Net profit-dividends Total asset=Total balance (BS)
resource
 Financial Reporting Mechanics

• Double entry accounting: a transaction must be recorded in at least two

accounts to keep the accounting equation in balance

• For example: an increase in an asset account must be balanced by a decrease in

another asset account or by an increase in a liability or owners’ equity account.
 Example 3
Accounting for following transactions

Transaction Accounting Treatment

Purchase equipment for 10,000$ cash

Borrow 10,000 USD to purchase equipment

Buy office supplies for 100$ cash

Buy inventory for 8,000$ cash and sell it for 10,000$ cash
 Example 3
Accounting for following transactions

Transaction Accounting Treatment

Purchase equipment for Tangible asset increases by 10,000 USD. Cash (an asset) decreases by
10,000$ cash 10,000 USD
Borrow 10,000 USD to Tangible asset increases by 10,000 USD. Notes payable (a liability)
purchase equipment increases by 10,000 USD
Buy office supplies for 100$ Cash decreases by 100$. Supply expense increases by 100$. An expense
cash reduces retained earnings, so owners’ equity decreases by 100$

Buy inventory for 8,000$ cash Inventories increases by $8,000; cash decreases by $8,000
and sell it for 10,000$ cash Cash increases by 10,000, inventory reduces by $8,000à Asset increases
by 2,000
Revenue increases by 10,000$, cost of good sold increases by $8.000à
net profit increases by $2.000à retained earning increases 2.000$à
equity increases $2,000
 Example 4
Accounting for the following transaction according to double entry accounting principle

1. Receive $150,000 contributed from three owners.

2. Set up a $100,000 investment account and purchase a portfolio of equities and fixed
income securities.

3. Pay $3,000 to landlord for office/warehouse. $2,000 represents a refundable deposit and
1,000$ represents the first month’s rent.
4. Receive $1,200 cash for one year subscription to monthly newsletter.

5. Spend $600 on newspaper and trade magazine advertising for the month.

6. Borrow $12,000 from a bank for working capital. Interest is payable annually at 10%. The
principal is due in two years.

7. Ship first order to a customer consisting of five books at 25$ per book. Invoice terms are
that payment is due in 30 days. No cash changes hands. The company purchased those
books at 20$ per book.

8. Sell for cash 10 books at $25 per book. The company bought these book at 20$ per book.
 Example 4
No. Transaction Accounting treatment
1 Receive $150,000 contributed from 3 Cash (asset) increases by $150,000; Contributed
owners capital (equity) increases by $150,000
2 Set up a portfolio of equities and fixed Investments (A) increases by $100,000; Cash (A)
income securities valued at $100,000 reduces by $100,000
3 Pay $3,000 for office/warehouse. Cash(A) reduces by $3,000; Deposit (A) rises by
$2,000 is deposit, and $1,000 is first $2,000, prepaid expense (A) rises by $1,000
month’s rent
4 Receive $1,200 cash for one year Cash (A) increases by $1,200, unearned revenue
subscription to monthly newsletter (L) rises by $1,200
5 Spend $600 on newspaper and trade Cash (A) reduces $600; advertising expense (E)
magazine advertising for the month rises by $600; Net profit decreases $600;
retained earning (E) decreases by $600; equity
reduces by $600.
 Example 4

No. Transaction Accounting treatment

6 Borrow $ 12.000 from a bank for working Cash (A) increases by 12,000 USD, bank
capital. Interest is payable annually at debt (L) increase by 12,000 USD
10%. The principal is due in two years.

7 Ship first order to a customer consisting of Account receivables (A) increases by 125
five books at 25$ per book. Invoice terms USD, revenue (R) rises by 125 USD.
are that payment is due in 30 days. No cash Inventories(A) decreases 100 USD, cost of
changes hands. The company purchased good sold rises by 100 USD.
those books at 20$ per book
8 Sell for cash 10 books at $25 per book. The Cash (A) rises by 250$, revenue rises by
company bought these book at 20$ per 250$, inventories (A) reduces 200$, COGS
book. rises by 200$.
 Accrual Basis
Revenue Recognition

• Revenue is recorded when earned and expense is recorded when

incurred, irrespective of when the related cash movements occur.

• The purpose of accrual entries is to report revenue and expense in the

proper accounting period.
Accrual Basis
Cash movement prior to Cash movement in the Cash movement after
accounting recognition same period as accounting recognition
accounting recognition
Unearned revenue Accrued revenue
ØOriginating entry – record ØOriginating entry: record
cash receipt and establish a revenue and establish an asset
Revenue liability (receivables)
ØAdjusting entry- reduce the ØAdjusting entry- when cash is
liability while recording collected, eliminate the
revenue No accrual entry needed receivables
Prepaid expense (A) Accrued expense (L)
ØOriginating entry: Cash ØOriginating entry- establish a
reduces, prepaid expense (A) liability and record an expense
Expense
rises ØAdjusting entry- reduce the
ØAdjusting entry: recording liability as cash is paid
expense while reducing
prepaid expense,
Accrual Basis

ACCRUAL Balance Sheet

BASIS
Income Statement

CASH
BASIS Cash Flow Statement
 Framework for financial reporting
Accounting standards regulates amount and type of information
that companies must provide for creditors and investors

Standard-setting bodies are professional organizations of

accountants and auditors that establish financial reporting
standards.
Regulatory authorities are government agencies that have the legal
authority to enforce compliance with financial reporting standards.
Financial Accounting Standards

Vietnam USA International

Standard setting Ministry of Financial International
bodies finance Accounting Accounting
Standards Board Standards Board
(FASB) (IASB)

Standards Vietnam Generally Accepted International

accounting Accounting Financial Reporting
standards (VAS) principles (GAAP) Standards (IFRS)
Fundamentals principles for preparing financial statements
Vietnam International Explanation
( VAS N0 21) (IFRS)
Going concern Going concern Financial statements are developed on the assumption that
basis basis the firm will continue to exist unless its management intend to
(must) liquidate it
Accrual basis Accrual basis Accrual accounting is used to prepare the financial statements
other than the statement of cash flow
Consistency Consistency Apply consistent definition, standards, accounting method
from period to period.
No offsetting No offsetting No offsetting of assets against liabilities or income against
expenses
Essential and Small and inessential misstatements or omissions that do not
comprehensive affect the faithfulness and reasonability of financial
statements
Comparable Financial statements must present comparative information
Fundamentals principles for preparing financial statements

(IFRS) Explanation
Fair presentation Faithfully representing the effects of the
entity’s transactions and events according to
the standards for recognizing assets, liabilities,
revenues and expenses
Materiality Financial statements should be free of
misstatements or omissions that could
influence the decisions of users of financial
statements.
 Accrual basis vs. Cash basis
1. Sold merchandise (inventory) for $25,000 on credit this year.

2. The merchandise cost $12,500 when purchased in the prior year.

3. Purchased merchandise this year in the amount of $30,000 on credit.

4. Paid suppliers of merchandise $18,000 this year.

5. Collected $15,000 from sales.

Using the above assumptions, which basis can be considered as a better measure
of a firm’s performance?
 From Business Activities to Financial Statements

• Financial statements measure and summarize the economic

consequences of business activities.
• Accounting systems facilitate information quality.
• The role of accrual basis accounting.

• The need for generally accepted accounting principles (GAAP).

• Auditing and the quality of financial information.
From Business
Activities to
Financial
Statements
Financial Statements and Business Analysis

• Business intermediaries use financial statements to accomplish four

key objectives:

• Business strategy analysis

• Accounting analysis

• Financial analysis

• Prospective analysis
Business
Analysis
Scope of financial statement analysis
Financial Statement Analysis

Use Financial reports + Other information

Evaluate the past, current and prospective performance

and financial position

Purpose:
Making investment, credit and other economic decision
Financial Statement Analysis
üFinancial statement analysis is an important element of fundamental
analysis
üFundamental analysis aims to determine the intrinsic value of a stock by
analyzing related economic, financial, quantitative and qualitative factors.
• Macro Economic analysis
• Industry Analysis
• Company
• Stock valuation