College Course Content/Curriculum

Written for an Accounting college course with two learning objectives provided. The goal is to create connections for students by providing casual language and relatable scenarios:

Learning Objectives:

• Describe the structure of financial statements

• Examine the quality of a company’s financial statements

Lola Smith owns Savory Sweets, a small baked-goods shop, in a small Montana town. Lola operates her shop in commercial space she rents on downtown Main Street. The shop's income results from the sale of baked products. Lola purchases flour, eggs, butter, and other ingredients from local suppliers, and she personally makes all the products sold. About 75% of Savory's revenue comes from in-store sales, and the other 25% results from deliveries to local restaurants who sell Lola’s desserts.

The shop’s rented space consists of a kitchen in the back and a retail area in the front. Lola installed electric ovens, commercial mixers, a walk-in refrigerator, a freezer, and various other kitchen equipment. The retail area has one refrigerator that Lola uses to store cold beverages for customers, along with some tables, chairs, and benches for seating.

Lola's business spends most of its gross income on supplies (including flour and other ingredients, paper bags, cardboard boxes, and napkins), rent, payroll, and utilities. The bakery's gross income is about $800 per day. On an average day, Lola’s expenses are around $400 for supplies, rent, utilities, payroll, and other business necessities, meaning the shop earns a pretax profit of approximately $400 per day.

Why would this information matter to you? If you were an accountant preparing Lola’s financial statements, you’d need to know all the above. Come along to find out more about financial statements.

Financial Statements

What are financial statements, anyway? Let’s start with the basics. Financial statements are “written records that convey the business activities and the financial performance of a company” (Murphy, 2019). At their core, financial statements “communicate a company’s key financial information to stakeholders by covering every aspect of financial affairs with the goal of improving efficiency as well as financial fluency” (Durcevic, 2019). The three components of a financial statement include the following:

1. The balance sheet provides “an overview of assets, liabilities, and stockholders' equity as a snapshot in time” (Murphy, 2019). Think of it as a Polaroid that captures a moment in time. The balance sheet shows when this snapshot was taken, which is usually at the end of the fiscal year. This report also provides what a company is worth from a book value perspective.

o For a sheet to balance, assets must equal liabilities plus equity (“The three major,” 2019).

2. The income statement mostly focuses on “revenues and expenses of an organization during a particular period. Once expenses are subtracted from revenues, the statement produces a company's profit figure called net income” (Murphy, 2019). The income statement usually provides information over two or three years for comparison, and in doing so, offers a great deal of transparency.

o Direct expenses, indirect expenses, and capital expenses are the three categories on an income statement (“The three major,” 2019).

3. The cash flow statement (CFS) measures “how well a company generates cash to pay its debt obligations and funds its operating expenses and investments” (Murphy, 2019). CSFs allow investors to understand where a company’s money is coming from and how the money is spent, which provides insight into a company’s financial footing (Murphy, 2019). A CFS also provides a summation of total cash available.

o Operating, investing, and financing are the three parts of a CFS (“The three major,” 2019).

These three statements provide insight on a company’s financial performance and potential issues that may needed addressed (“The three major,” 2019). Lola at Savory Sweets would need each of these documents to manage her business properly. Overall, though, these reports will help any business do the following:

• Track revenue, expenses, and profitability

• Make predictions based on data that can be trusted

• Plan a budget more effectively and accurately

• Improve the performance of business processes

• Create fully customizable reports (Durcevic, 2019)

As with anything, though, financial statements can be open to interpretation to a certain degree, so conclusions may vary about a company’s economic performance. However, financial reporting practices provide a comprehensive overview to business leaders, which helps them comprehend and measure critical components of their financial status (Durcevic, 2019). Now that we have covered the features included in financial statements, let’s take a look at how to achieve quality in statements for reliability and accuracy.

Quality of Financial Statements

We can all agree that quality matters…whether it’s vitamins, education, or management. Likewise, quality in financial statements is vital and includes the following:

• Follows rules of accounting. Standards are enforced (Generally Accepted Accounting Principles or GAAP) to provide a set of common concepts that evaluate a company’s business practices.

• Understandable and reliable. People with varying backgrounds and different levels of understanding should be able to read financial statements. With this in mind, the language should be as clear and simple as possible, and the financial statements should also be free from error so that they can be trusted for decision-making.

• Relevant and material. Without relevant and material facts, it’s difficult to determine a company’s potential. Relevancy means that future trends should be predicted by looking at the data, and material refers to information that might directly affect a decision. Both are crucial to sound financial reporting.

• Comparable and consistent. Measuring and reporting methods should be similar and should reflect consistent data (Heibutzki, 2017). Information should be presented in such a way that it can be compared to previous years. If there are deviations, they should come from the method, not the performance.

• Timeliness. Financials should be promptly available at the end of a financial period. (“Top 10,” 2019). When delayed, statements become useless.

Now that we’ve defined financial statements and looked at characteristics of a proper financial statement, let’s turn to the value of these documents and who uses them.

Value of Financial Statements

Financial statements that meet the criteria listed above provide incredible value. When done correctly, they give tremendous insight to internal users, such as management, and external users, including investors, stakeholders, and regulatory bodies. Let’s take a look at each one:

• Management. Those in management find value in financial statements because they provide an assessment of a company’s profitability, liquidity, and operational efficiency. Financial statements can help determine a company’s performance, develop strategy and benchmarking, decide about investment opportunities, and manage credit risk (Fowler, 2017).

• Investors. Current and potential investors want to know a company’s ability to grow—plus anything that might prevent growth. As stockholders and part-owners, investors want to keep an eye on how much the company is making, how much they owe, how much cash flow is available, and how much equity the company holds (Hartman, n.d.).

• Shareholders. As part owners of a corporation, shareholders use financial statements to gauge the general condition of a company. This guides their financial decisions and changes in strategy. Though companies often provide financial statements quarterly, shareholders sometimes receive additional updates between quarters to get an idea of how much profit they can expect and what looming threats may be present (Lacoma, n.d.).

• Regulatory bodies. A myriad of government agencies exist that regulate financial markets and companies. The law requires proper financial reporting for tax purposes, and the government will utilize your reports to ensure you are paying your fair share of taxes. These requirements have led to an entire industry of auditing firms that exist to review the financial reports of companies (Durcevic, 2019). These agencies have a specific range of duties and responsibilities. In particular, we will discuss four that each have a different purpose to protect accounting standards:

1. Securities and Exchange Commission. This agency regulates the financial statements of companies to protect investors. Their goal is that investors will have access to all relevant information to make an investment decision, accomplished by requiring all public companies to release reliable and prompt financial information.

2. American Institute of Certified Public Accountants (AICPA). This agency is in charge of representing the field of accountants. They develop the CPA exam, set standards for audits of private companies, and provide continuing education for members. The AICPA also ensures that members follow strict ethical and technical standards and investigate any infractions. Overall, they monitor the professional conduct of practicing accountants.

3. Financial Accounting Standards Board (FASB). This board is in charge of “the accounting standards of nongovernmental organizations. The FASB establishes guidelines for companies to follow to ensure proper financial reporting,” ensuring companies provide more accurate and uniform financial statements and making it easier for investors to review and compare to other companies (Rodeck, 2017).

4. Governmental Accounting Standards Board (GASB). This board takes charge of accounting standards for governmental organizations. They set the guidelines for state and local governments’ financial reports, ensuring that their reports are easy to understand and compare. They also develop and improve the accounting standards for the government sector (Rodeck, 2017).

As you can see, the financial statements are highly regulated to ensure the proper representation of a company’s standing. At Savory Sweets, Lola needs accurate financial statements because she is considering expansion to a second location. This information will guide her in the decision-making pr0cess. As we move forward in this course, you’ll continue to learn more about financial statements and following GAAP.

References

Durcevic, S. (2019, March 20). The importance of financial reporting and analysis: Your essential guide. Data Pine. Retrieved on March 23, 2020. https://www.datapine.com/blog/financial-reporting-and-analysis/

Fowler, S. (2017, September 26). Why do managers analyze financial statements? Biz Fluent. Retrieved on March 23, 2020. https://bizfluent.com/info-8507676-do-managers-analyze-financial-statements.html

Hartman, D. (n.d.). What investors look for in financial statements. Sapling. Retrieved on March 23, 2020. https://www.sapling.com/8174236/investors-look-financial-statements

Heibutzki, R. (2017, September 26). Characteristics of a good financial statement. Biz Fluent. Retrieved on March 23, 2020. https://bizfluent.com/list-5942306-characteristics-good-financial-statement.html

Lacoma, T. (n.d.). Uses of financial statements for shareholders. Sapling. Retrieved on March 23, 2020. https://www.sapling.com/8079876/uses-financial-statements-shareholders

Murphy, C. (2019, May 30). Financial statements. Investopedia. Retrieved on March 23, 2020. https://www.investopedia.com/terms/f/financial-statements.asp

Rodeck, D. (2017, September 26). Purpose of accounting regulatory bodies. Biz Fluent. Retrieved on March 23, 2020. https://bizfluent.com/info-8605713-purpose-accounting-standards.html

Top 10 best qualities of an ideal financial statement (2019, November 6). Google Sir. Retrieved on March 23, 2020. https://www.googlesir.com/best-qualities-of-an-ideal-financial-statement/

The three major financial statements: How they’re interconnected (2019, April 10). Investopedia. Retrieved on March 23, 2020. https://www.investopedia.com/ask/answers/031815/how-are-three-major-financial-statements-related-each-other.asp