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
In an ideal world, the user of financial statements could
focus only on the bottom lines of financial reporting: net
income and stockholders equity.
 The financial reporting system is not perfect. Economic
events & accounting entries do not correspond precisely;
they diverge across the dimensions of timing, recognition &
measurement.
 Generally Accepted Accounting Principles (GAAP) permit
economic events that do receive accounting recognition to
be recognized in different ways by different financial
statement prepares.

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◦ Financial reports often contain supplementary data that,
although not included in the statements themselves,
help the financial statement users to interpret the
statements or to adjust measures of corporate
performance to make them more comparable.

◦ Information from outside the financial reporting

process can be used to make financial data more useful.

◦ Many Economic events do not receive accounting

recognition at all.

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 Principal emphasis is on the Financial statements
of companies whose securities are publicly traded.

 The common Characteristics of external users is

their general lack of authority to prescribe the
information they want from an enterprise. They
depend on general – purpose external financial
reports provided by management.

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 External users of financial information
encompasses a wide range of interests but can
be classified into three general groups:
1. Credit and equity investors
2. Government (executive and legislative branches),
regulatory bodies & tax authorities.
3. The general public and special interest groups,
labor unions and consumer groups.

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1. Balance sheet ( statement of financial position)

2. Income statement ( statement of earnings)

3. Statement of comprehensive income
4. Statement of cash flows

5. Statement of stockholders’ equity

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 Growing international trade, multinational industrial and
financial enterprises, and increasingly global capital markets
have significantly expanded investment opportunities.
Creditors and equity investors need to analyze both domestic
and foreign companies.

Yet differences in accounting and reporting standards make

it difficult to compare domestic companies with those in
other countries. Furthermore, as accounting standards are
established separately in each country, it is difficult to
generalize about those differences.

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 The IASB was established in 1973 to harmonize
(conform) the accounting standards of different
nations.

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The Balance Sheet
The balance sheet reports major classes and amounts
of assets (resources owned or controlled by the firm),
liabilities (external claims on those assets), and
stockholders’ equity (owners’ capital contributions
and other internally generated sources of capital) and
their interrelationships at specific points of time.

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 Assets: Are defined in SFAC 6 as –
Probable future economic benefits obtained or enrolled
by a particular entity as a result of past transaction or
events. (Para - 25)

 Liabilities: Are defined, similarly, as –

Probable future sacrifices of economic benefits arising
from present obligations of a particular entity to
transfer assets provide services to other entities in the
future as a result of past transactions or events. (Para – 35)

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 Owners’ equity: As required by the fundamental
accounting equation, stockholders’ equity is
therefore – The residual interest in the net assets of an
entity that remains after deducting its liabilities. (Para
– 49)

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 The income statement (statement of earnings) reports
the result of its operating activities. It explains some
but not all of the changes in the assets, liabilities, and
the equity of the firm between two consecutive
balance sheet dates.

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 Revenues: Are defined in SFAC 6 as –
Inflows…of an entity… from delivering or producing
goods, rendering services, or other activities that
constitute the entities’ ongoing major or central
operations. (Para -78)
 Expenses: Are defined as –
Outflows…from delivering or producing goods,
rendering services, or carrying out other activities that
constitute the entities’ ongoing major or central
operations. (Para -80)

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The statement of cash flows reports cash receipts and
payments in the period of their occurrence, classified as
to operating, investing and financing activities.

It also provides supplementary disclosures about

noncash investing and financing activities.

Defining investing cash flows as those resulting from:

 Acquisition or sale of property, plant an equipment
 Acquisition or sale of a subsidiary or segment
 Purchase or sale of investments in other firms

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 Similarly, financing cash flows are those resulting
from:
 Issuance or retirement of debt and equity securities
 Dividends paid to stockholders

Cash from operations – This key performance

measure includes the cash effects of all transactions
that do not meet the definition of investing or
financing.

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 This statement reports the amounts and sources of
changes in equity from capital transactions with
owners and may include the following components:
 Preferred shares
 common Shares (at par of stated value)
 Additional paid-in capital
 Retained earnings
 Treasury Shares (repurchase equity)
 Employee Stock Ownership Plan (ESOP)
adjustments

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 Footnotes provide information about the accounting
method, assumptions, and estimates used by
management to develop the data reported in the
financial statements.

They are designed to allow users to improve

assessments of the amounts, timing, and uncertainty of
the estimates reported in the financial statements.

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Footnotes provide additional disclosure related to such areas as
 Fixed assets

 Inventories

 Income taxes
 Pension and other postemployment benefit plans
 Debt (interest rates, maturity schedules, and contractual terms)

 Lawsuits and other loss contingencies

 Marketable securities and other investments
 Hedging and other risk management activities
 Business segments
 Significant customers, sales to related parties and export sales.

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 Relevance: Defined as “the capacity of information
to make a difference in a decision ..”
 Timeliness: Information loses value rapidly in the
financial world. Market prices are predicted on
estimates of the future; data on the past are helpful
in making projections.

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 Reliability: Encompasses verifiability,
representational faithfulness and neutrality.
The first two elements (verifiability &
representational faithfulness) are concerned
with whether financial data have been
measured accurately and whether they are
what they purport to be.

 Neutrality: Is Concerned with whether

financial statement data are biased.

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 Consistency & Comparability: Consistency
refers to use of the same accounting
principles over time. A broader term,
comparability, refers to comparison among
companies.

 Materiality: We define information to be

material when it would make a difference in
the valuation of the firm.

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 Management Discussion and Analysis
Companies with publicly traded securities have been
required since 1968 to provide a discussion of earnings
in the MD & A sections.

The MD & A is required to discuss:

 Results of operations, including discussion of trends in
sales and categories of expense
 Capital resources and liquidity, including discussion
of cash flow trends
 Outlook based on known trends.

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 Companies that issue securities to the public are required to
publish a registration statement including a prospectus.

 Proxy statements, issued in connection with shareholder

meetings, contain information about board members and
management, executive compensation, stock options, and
major stockholders.
 Many companies prepare periodic “fact books” containing
additional financial and operational data. Corporate press
releases also provide new information on a timely basis.

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 In addition, many companies hold periodic
meetings or conference telephone calls to keep the
financial community appraised of recent
developments regarding the company.

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