Page 342 - Encyclopedia of Business and Finance

eobf_F 7/5/06 3:02 PM Page 319

Financial Statements

Firms frequently issue a separate statement of stock- The statement of cash flows replaced the statement of
holders’ equity to present certain changes in equity rather changes in financial position in 1987 as a required finan-
than showing them on the face of the balance sheet. The cial statement for all business enterprises. The statement
statement of stockholders’ equity itemizes the changes in of cash flows presents cash receipts and payments classi-
equity over the period covered, including investments by fied by whether they stem from operating, investing, or
owners and other capital contributions, earnings for the financing activities and provides definitions of each cate-
period, and distributions to owners of earnings (divi- gory. Information about key investing and financing
dends) or other capital. Sometimes companies present a activities not resulting in cash receipts or payments in the
statement of changes in retained earnings rather than a period must be provided separately. The cash from oper-
statement of stockholders’ equity. The statement of ating activities reported on the statement of cash flows
changes in retained earnings, also known as the statement must be reconciled to net income for the period. Because
of earned surplus, details only the changes in earned cap- GAAP requires accrual accounting methods in preparing
ital: the net income and the dividends for the period. financial statements, there may be a significant difference
Then the changes in contributed capital (stock issued, between net income and cash generated by operations.
stock options, etc.) must be detailed on the balance sheet The cash-flow statement is used by creditors and investors
or in the notes to the financial statements. to determine whether cash will be available to meet debt
and dividend payments.
The income statement, also known as the statement
of profit and loss, the earnings statement, or the opera- Financial statements include notes, which are consid-
tions statement, presents the details of the earnings ered an integral part of the statements. The notes contain
achieved for the period. The income statement separately required disclosures of additional data, assumptions and
itemizes revenues and expenses, which result from the methodologies employed, and other information deemed
company’s ongoing major or central operations, and the useful to users.
gains and losses arising from incidental or peripheral The financial statements of publicly owned compa-
transactions. Certain irregular items, such as discontinued nies also include an auditor’s report, indicating that the
operations, extraordinary items, and effects of accounting statements have been audited by independent auditors.
changes, are presented separately, net of tax effect, at the The auditor’s opinion is related to fair presentation in
end of the statement. When revenues and gains exceed conformity with GAAP.
expenses and losses, net income is realized. Net income for The external financial statements required for not-
the period increases equity. The results of the firm’s oper- for-profit organizations are similar to those for business
ating activities for the period as presented in the income enterprises, except that there is no ownership component
statement provide information that can be used to predict (equity) and no income. Not-for-profit organizations
the amount, timing, and uncertainty of future cash flows. present a statement of financial position, a statement of
This statement is useful to investors, creditors, and other activities, and a statement of cash flows. The financial
users in determining the profitability of operations. The statements must classify the organization’s net assets and
income statement must also show earnings per share its revenues, expenses, gains, and losses based on the exis-
(EPS), where the net income is divided by the weighted tence or absence of donor-imposed restrictions. Each of
average number of shares of common stock outstanding. three classes of net assets—permanently restricted, tem-
Since EPS scales income by the magnitude of the invest- porarily restricted, and unrestricted—must be displayed
ment, it allows investors to compare diverse companies of in the statement of financial position, and the amounts of
different sizes; hence, investors commonly use it as a sum- change in each of those classes of net assets must be dis-
mary measurement of firm performance. played in the statement of activities. Governmental bod-
ies, which are guided by the Governmental Accounting
In 1998, the FASB required that companies present a
separate statement that classifies all items of other com- Standards Board (GASB), present general-purpose exter-
prehensive income by their nature. Other comprehensive nal financial statements that are similar to those of other
not-for-profit organizations, but they classify their finan-
income includes all equity changes not recorded in the
income statement or in the statement of changes in cial statements according to fund entities.
retained earnings and that do not result from contribu- SEE ALSO Accounting; Financial Statement Analysis
tions by owners. In addition to providing a separate state-
ment, companies must display the total of other
BIBLIOGRAPHY
comprehensive income separately from retained earnings
Engstrom, J., and Copley, Paul A. (2004). Essentials of Account-
and additional paid-in capital in the equity section of the ing for Governmental and Not-for-Profit Organizations (7th
balance sheet. ed.). Boston: McGraw-Hill/Irwin.

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