1. Explain the nature and general purpose of financial statements.
2. Explain certain accounting principles “that are important for an understanding of financial statements and that professional judgment by accountants may affect the application of those principle
3. Demonstrate how certain business transactions affect the elements of the accounting equation: Assets = Liabilities + Owner’s Equity.
4. Explain that the statement of financial position, (Jftan referred to a,s the b’ilanca sheet, is an expansion of the basic aee,ounting equation,
5. Explain that the income statement reports an enterprise’s financial performance for a period of time in terms ot the relationship of revenues ‘ and expenses.
6. Explain that the statement of cash flows· presents the change in cash for a period of time in terms of the company’s operating, investing and financing activities.
7. Explain imPortant relationships among the statement of financial position. income statement. and statement of cash flows. and how these statements relate to each other,
HOW TO PLAY THE VIDEO-GAME MAKERS ABLE PORTFOLIO WINNERS?
Video game as exuberant these days as the kids who play their shoot-’em-ups. Sony’s threeyelr- old PlayStatlon, Iiong with Nlntendo 64, Just capped off the hoUest video-game season ever~ Market 1 ‘ . IliderrPII•,St.uon racked up more than $2.4 billion In North American sales In 1997, and analysts think the run of Dood nl•• II nowhere near Its end
WHb all thlltype. you’d thInk now would be a great time to Invest In the game biz. But tread carefulty. Thil II a hit-driven industry IUbject to the fickle cravings of male teens and twentysomethings. Look no
furtherthan Sep £rifiijJrt.es, which has watched sales-1Jf-lts .saturn system disintegrate amid inept software development Ind poor management. And some analysts wonder If high-speed cable TV or OSL phone modems wlllipur oiline IIft’Ilng and lure video-garners onto PCs with improved 3·0 graphics.
H.ow do high-tech companies like Sony, Seg~ Enterprises, Electronic Arts, and Activision measure their performance? They look at amounts and trends in profit, the strength of their balance sheets, and other financial repnrts, as well as nonfinancial factors ~ch ~s the ‘ltrength of their development teams and management. Financial statements-particularly the balance sheet, the income statement, and the statement of cash flowsare important parts of the system of financial reporting by which information flows from management to external parties and by which the enterprise is evaluated.
INTRODUCTION TO FINANCIAL STATEMENTS
we learned that investors and creditors are particularly interested in cash flows that they might receive. Creditors, for example-are interested in the ability of the enterprise; to which they have made loans ‘or sold merchandise on credit, to meet its payment obligations, which may include payment of interest. -Sirnilarly, investors are interested in the market value of their stock holdings, as well as dividends th.1lthe enterprise will pay while they own the stock .
One of the primary ways investorsand creditors assess the probability that an enterprise will be able to make these cash payments is to study, analyze, and understand the enterprise’s financial statements. In the general sense of the word, a statement is simply u declaration of something believed to be true, For example, the statement “This pen is blue” is a declaration concerning the color of the pen, which the speaker believes is true, A financial statement, therefore, is simply a declaration of what is believed to be true communicated in terms of a monetary unit, such as the dollar. When accountants prepare financial statements, they ate describing in financial terms certain attributes of the enterprise’
that they believe fairly represent its financial activities.
Time is an important factor in preparing and understanding an enterprise’s financial statements. Statements might cover a period as shoh as a week or as long as a year. AIInual financial statements of companies include financial statements for a year. Financial, statements prepared for periods of time shorter than one year (for example, for three months, or a month) are referred to ~s interim financial statements. Throughout this text, we use varying lengths of time in the preparation of financial statements, including both annual
and interim periods. As you approach financial statements-either as a user or as a preparer-it is-important to establish the time period those statements arc intended to cover
• Statement of financial position (commonly referred to as the balance sheet)
•Statement of cash flows
As businesses operate, they engage in transactions that create revenues and incur expenses that are necessary to earn those revenues. An income statement is an activity statement that depicts the .revenues and expenses for a designated .pertod of time. Revenues are transactions in which the enterprise is’ involved that already have resulted in positive cash flows or that are expected to do so in the near future, meaning that cash will flow into the enterprise as a result of the transaction. For example, a company might sell a product for $ I00. This revenue transaction results in an immediate positive cash now into the enterpriseif the transaction is carried out in cash or an expected future cash now If it is a credit transaction. expenses are the opposite. They result in an immediate
cash flow out of the enterprise (if a cash transaction) or an expected future.flow of cash out of the enterprise (if a credit transaction). For example, if a company incurs a certain , expense of $75 and pays itat that time, an immediate cash outflow takes place. If payment is delayed until some future date, the transaction ‘represents an expected future cash outflow. Revenues result in positive. cash flows-either past, present, or future-while expenses result in negative cash flows-either past, present, Positive and negative indicate the directional impact on cash. The term net income (or net loss) is simply the difference between revenues and expenses for 41 designated period of time.
The statement of cash flows is particularly important in understanding an enterprise for purposes of investment and credit decisions. As its name implies, the statement of cash flows depicts the ways cash has changed during a designated period-s-the cash received from revenues and other transactions as well as the cash paid for certain expenses and other acquisitions during the period. While the interest of investors and creditors is in cash flows to themselves. rather than to the enterprise, information about cash activity of the enterprise is considered to be ail important signal to investors and creditors.