IMA(r), the association of accountants and financial professionals in business, is one of the largest and most respected associations focused exclusively on advancing the management accounting profession. Globally, IMA supports the profession through research, the CMA(r) (Certified Management Accountant) program, continuing education, networking and advocacy of the highest ethical business practices. IMA has a global network of more than 80,000 members in 140 countries and 300 professional and student chapters. Headquartered in Montvale, N.J., USA, IMA provides localized services through its four global regions: The Americas, Asia/Pacific, Europe, and Middle East/Africa. For more information about IMA, please visit www.imanet.org.
THE FOUR FINANCIAL STATEMENTS DISCUSSED in this topic are required by the Securities and Exchange Commission (SEC) for all publicly traded companies and are useful for presenting a financial picture of any company. The four required financial statements include the income statement, the statement of changes in equity, the balance sheet, and the statement of cash flows.
The four financial statements are integrally related. The balance sheet is connected to the income statement (net income) through the change in retained earnings shown in the statement of changes in shareholders' equity. The balance sheet change in cash and other changes in financial position are presented in the statement of cash flow. Changes in capital received in the balance sheet are shown in the statement of changesin shareholders' equity. A simple way to think of the balance sheet and income statement is as stocks and flows. The "net flow" during a time period reflects the change the balance sheet's "stocks."
The way in which various financial transactions affect the elements of each of the financial statements and the proper classification of the various financial transactions is covered in Topic 2: Recognition, Measurement, Valuation, and Disclosure.
The financial statements displayed for this topic are for a fictitious organization, Robin Manufacturing Company. They are for a given year. The linkages between the various statements are illustrated with notes and by the amounts themselves. The footnotes to the financial statements, which present required disclosures, are also covered.
Most entities provide their prior years' financial statement information located next to the current year's information for comparison. For example, income and cash flow statements usually show the results of three consecutive years.This allows analysts to compare past financial performance to present performance which can provide an indication for the company's future performance.
This topic ends with a discussion of the needs of external users, such as investors and regulatory agencies, and how financial statements satisfy some of those needs.
READ the Learning Outcome Statements (LOS) for this topic as found in Appendix A and then study the concepts and calculations presented here to be sure you understand the content you could be tested on in the CMA exam.
The income statement, commonly called a profit and loss (P&L) statement, measures the earnings of an entity's operations over a given period of time, such as a quarter or a year. The income statement is used to measure profitability, creditworthiness, and investment value of an entity. When its information is combined with information from the other statements, they collectively help assess the amounts, timing, and uncertainty of future cash flows.
Income and Other Comprehensive Income
The financial statement elements reported on the income statement are revenues, expenses, gains, and losses. Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Topic 220, Comprehensive Income (formerly SFAS No. 130), requires firms to report certain unrealized gains and losses outside of net income as components of other comprehensive income. Comprehensive income is the sum of net income plus (or minus) the items of other comprehensive income.
Firms have the option of p the calculation of comprehensive income either as part of an income statement (appended at the end) or as a separate statement of comprehensive income. Comprehensive income can no longer be presented as a part of the statement of shareholders' equity.
Format of Financial Information
The two most common formats are single-step income statements and multiple-step income statements.
Single-Step Income Statement
A single-step income statement subtracts total expenses and losses from total revenues and gains in a single step. No attempt is made to categorize expenses and revenues or to arrive at interim subtotals. However, despite the inherent simplicity of the single-step income statement, the multiple-step income statement is more popular because it provides more information to explain a firm's financial performance.
Figure 1A-1 shows a single-step income statement for Robin Manufacturing Company, Year 1.
Figure 1A-1 Single-Step Income Statement
Multiple-Step Income Statement
The multiple-step income statement separates information into operating and non-operating categories. The sections in the statement that do not relate to operating cash flows are called other revenues and gains and other expenses and losses. These categories can include gains and losses from the sale of equipment, interest revenue and expense, or dividends received.
The multiple-step income statement has subcategories, such as cost of goods sold (COGS); operating (selling and administrative) expenses; and other revenues, expenses, gains, and losses. These subcategories allow users to compare a company's results over time or to evaluate its financial performance relative to its competitors. Such comparisons become more useful as more years of income statements are compared.
The multiple-step income statement often reports subtotals for gross profit and income from operations, which are useful for financial statement analysis purposes. For example, gross profit can be used to compare how competitive pressures have affected profit margins.
Figure 1A-2 shows a multiple-step income statement.
Figure 1A-2 Multiple-Step Income Statement
Additional Income Statement Presentation Items
Occasionally, companies will experience an unplanned event that requires separate reporting displayed below the income from continuing operations line.
- Discontinued operations. When an entity disposes of a business component that has clearly distinguishable operations and cash flows from the continuing business then the item is recorded in a separate section of the income statement located after continuing operations. Discontinued operations are shown net of tax.
Figure 1A-3 shows how net income is determined when these items are included.
Figure 1A-3 Multistep Income Statement with Additional Income Statement Items
Statements of Change in Equity
When a balance sheet is issued, the FASB requires disclosure of the changes in each separate shareholder's equity account. This requirement satisfies the FASB's suggestion that complete financial statements should include investments by and distributions to owners during the period. The required statements of change in equity is intended to help external users assess how changes in the company's financial structure may affect its financial flexibility.
Major Components and Classifications
Shareholders' equity commonly includes these four components: capital stock (par value of preferred and common shares), additional paid-in capital, retained earnings, and accumulated other comprehensive income. The first two categories combine to form contributed capital, also called paid-in capital.
- Capital stock is the par value (or face value) for the shares,
- Additional paid-in capital is the amount paid for the shares in excess of par.
- Retained earnings can be subdivided into general earnings retained for company use and appropriated earnings set aside for some purpose.
Format of Financial Information
The statement of changes in equity usually lists information in the following order:
- Beginning balance for the period
- Ending balance for the period
Figure 1A-4 shows a sample statement of changes in equity. This example shows the statement listed in a columnar format for a company with only common stock outstanding.
Figure 1A-4 Statement of Changes in Equity
The balance sheet (sometimes called a statement of financial position) is an essential tool in assessing the amounts, timing, and uncertainty of prospective cash flows. It is referred to as the balance sheet because of the balance expressed by the accounting equation:
Alternatively, the accounting equation can tell us that equity equals assets less liabilities, which is also known as net assets. The balance sheet provides a snapshot of the company's assets and the claims on those assets at a specific point in time.
While the balance sheet does not claim to show the value of the entity, it should allow external users to make their own estimates of the entity's value when used in conjunction with the other financial statements and other relevant information. An example of "other relevant information" could be forecasts of future period's cash flows.
The balance sheet helps users evaluate the capital structure of the entity and assess the entity's liquidity, solvency, financial flexibility, and operating capability.
The balance sheet is also essential in understanding the income statement because revenues and expenses reflect changes in assets...