FB 5810

FINANCIAL REPORTING
ANALYSIS FOR BUSINESS
DECISION

THE ROLE OF FINANCIAL REPORTING AND

INTRODUCTION TO FINANCIAL
STATEMENTS
LEARNING
LEARNING OBJECTIVES
OBJECTIVES
After this lecture, you should be able to:

1. Understand the role of financial reporting in capital market

2. Identify the users and uses of accounting information.
3. Describe the content and purpose of each of the financial
statements.
 HOW
HOW CAPITAL
CAPITAL MARKETS
MARKETS FUNCTION
FUNCTION

Savings

Financial
intermediaries Information
intermediaries

Business
ideas
ROLE
ROLE OF
OF FINANCIAL
FINANCIAL INTERMEDIARIES
INTERMEDIARIES
• Financial intermediaries: venture capital firms,
banks, pension funds, insurance companies
• Role: Aggregate funds from individual investors
and analyze different investment alternatives to
make investment decisions
ROLE
ROLE OF
OF INFORMATION
INFORMATION INTERMEDIARIES
INTERMEDIARIES

• Auditors, financial analysts, credit-rating

agencies, financial press
• Provide or assure information to investors on the
quality of various business investment
opportunities
 THE ROLE OF FINANCIAL
REPORTING IN CAPITAL
MARKETS
• Financial reporting provides much-needed information to
capital market participants given:
• Information asymmetry between savers and entrepreneurs.
• Conflicts of interests between savers and entrepreneurs.
• Expertise asymmetry between savers and entrepreneurs.

• Information and financial intermediaries help resolve these

issues.
• Their relative importance varies across markets.
 THE ROLE OF FINANCIAL
REPORTING IN CAPITAL
MARKETS
• Financial reporting provides much-needed
information to capital market participants given:
• Financial intermediaries depend upon the information in
financial statements to evaluate investment opportunities.
• Information intermediaries assure the quality of financial
statement representations.
• Relevant and reliable financial information is essential for
the functioning of capital markets.
Business Investors
&
Information Gap - Unobservable
Other
Stakeholders

Business performance?
Profitability?
Is it risky?

To reduce information gap

1. Financial Statements (Accounting Standard)

8

2. Audited Financial Statements

PURPOSES
PURPOSES OF
OF FINANCIAL
FINANCIAL REPORTING
REPORTING

• To provide information, through financial

statements, for the making of economic
decisions.
• To provide information for predicting, comparing
and evaluating the effectiveness of management
use of resources.
• To provide information to predict and evaluate
the going concern of an entity.
• To provide information on earnings, cash flows,
profitability and financial position of the entity.
Users
Users and
and Uses
Uses of
of Financial
Financial Information
Information

Internal
Users
Users
Users and
and Uses
Uses of
of Financial
Financial Information
Information

External
Users
Use of Financial Accounting
Information in Investing and Lending
Decisions

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COMMUNICATING
COMMUNICATING WITH
WITH USERS
USERS

Company’ Financial
Statements Users
s activities
BUSINESS
BUSINESS ACTIVITIES
ACTIVITIES

All businesses are involved in three types of activity —

 financing,
 investing,
 and operating.

The accounting information system keeps track of

the results of each of these business activities.
BUSINESS
BUSINESS ACTIVITIES
ACTIVITIES
Financing Activities
Two primary sources of outside funds are:
1. Borrowing money (debt financing)
 Amounts owed are called liabilities.
 Party to whom amounts are owed are creditors.
 Notes payable and bonds payable are different types
of liabilities.
2. Issuing (selling) shares of stock for cash.
 Payments to stockholders are called dividends.
BUSINESS
BUSINESS ACTIVITIES
ACTIVITIES
Investing Activities
Purchase of resources a company needs to operate.
 Computers, delivery trucks, furniture, buildings, etc.
(property, plant, and equipment).

 Resources owned by a business

are called assets.
 Investments are another
example of an investing activity.
BUSINESS
BUSINESS ACTIVITIES
ACTIVITIES
Operating Activities
Once a business has the assets it needs, it can begin its
operations.
 Revenues - Amounts earned from the sale of products
(sales revenue, service revenue, and interest revenue).
 Inventory - Goods available for
sale to customers.
 Accounts receivable - Right to
receive money from a customer
as the result of a sale.
BUSINESS
BUSINESS ACTIVITIES
ACTIVITIES
Operating Activities
 Expenses - cost of assets consumed or services used.
(cost of goods sold, selling, marketing, administrative,
interest, and income taxes expense).
 Liabilities arising from expenses include accounts payable,
interest payable, wages payable, sales taxes payable, and
income taxes payable.
 Net income – when revenues exceed expenses.
 Net loss – when expenses exceed revenues.
Basic
Basic Accounting
Accounting Equation
Equation

BASIC ACCOUNTING EQUATION

• Explains resources and their claims

• Measure Profitability
Revenues – Expenses = Net income (loss)

• Dividends: distributions to owners

Business
Business Activities
Activities and
and their
their Measurement
Measurement
COMMUNICATING
COMMUNICATING WITH
WITH USERS
USERS
Companies
Companiesprepare
preparefour
fourfinancial
financialstatements
statementsfrom
fromthe
the
summarized
summarizedaccounting
accountingdata:
data:

S
Statement of Statement of
Statement of Statement
Changes in Financial
Comprehensive
Income
Equity Position of Cash
Flows
(Income Statement) (Retained Earnings (Balance Sheet)
Statement)

International Note The primary types of financial statements required by International

Financial Reporting Standards (IFRS) and U.S. generally accepted accounting
principles (GAAP) are the same. Hong Kong Financial Reporting Standards (HKFRS)
adopt IFRS and thus are the same.
INCOME
INCOME STATEMENT
STATEMENT
Sierra Company Ltd.  Reports revenues and
For the month ended December 2021
expenses for a specific
Revenues
period of time.
Service revenue
 Net income – revenues
$7,200 exceed expenses.
Expenses
Rent expense  Net loss – expenses
exceed revenues.
500
 Past net income
Supplies expense
provides information for
1,000 predicting future net
Salaries expense income.

3,100Hint The financial statement heading identifies the company, the type of
Helpful
Utilities
statement, expense
and the time period covered. Sometimes, another line indicates the unit of
measure, e.g., “in thousands” or “in millions.”
Statement
Statement of
of Changes
Changes in
in Equity
Equity

Sierra Company Ltd.

Statement of Stockholders’ Equity
For the month ended December 31, 2021

Total
Common Retained Stockholders’
Stock Earnings Equity
Beginning balance (Dec. 1) $ -0- $ -0- $ -0-
Issuance of common stock 25,000 25,000
Add: Net income for the period 1,200 1,200
Less: Dividends (200) (200)
Ending balance (Dec. 31) $25,000 $1,000 $26,000
*Beginning balances are zero only because this is the first month of operations for Eagle. Normally, beginning balances for
Common Stock and Retained Earnings equal ending balances from the previous period.

1-23
Balance Sheet

Presents the financial position of the

company on a particular date

Financial position:
Resources = Claims to Resources

Liabilities &
Assets = Stockholders’ Equity

1-24
 Balance
Balance
Balance Sheet
Sheet
Sheet for Eagle Soccer Academy
Sierra Company Ltd.
Balance Sheet
December 31, 2021
Assets Liabilities
Cash $ 6,900 Accounts payable $ 2,300
Accounts receivable 2,700 Salaries payable 300
Supplies 1,300 Utilities payable 900
Equipment, net 23,600 Interest payable 100
Other assets 5,500 Notes payable 10,000
Other liabilities 400
Total 14,000
liabilities
Stockholders’ Equity
Common stock 25,000
Retained earnings 1,000
Total stockholders’ equity 26,000
Total liabilities and
Total assets $40,000 stockholders’ equity $40,000
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LIMITATIONS
LIMITATIONS OF
OF BALANCE
BALANCE SHEET
SHEET
 Single point in time
 Out of date
 Does it show all assets?
- intangibles
- human resources
 All liabilities?
- law suits
- guarantees
 Classify each item as an asset, liability, common stock,
revenue, or expense.
Solution
1. Cost of renting property.
2. Truck purchased.
3. Notes payable.
4. Issuance of ownership shares.
5. Amount earned from providing service.
6. Amounts owed to suppliers.
Statement of Cash Flows
Measures activities involving cash receipts and
cash payments over an interval of time

Can be classified into three categories

Operating Investing Financing

cash flows cash flows cash flows

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Statement
Statement of
of Cash
Cash Flows
Flows
Sierra Company Ltd.
Statement of Cash Flows
For the month ended December 31, 2021
Cash Flows from Operating Activities
Cash inflows:
From customers $ 4,900
Cash outflows:
For salaries (2,800)
For rent (6,000)
Net cash flows from operating $ (3,900)
activities Cash Flows from Investing Activities
Purchase equipment (24,000)
Net cash flows from investing activities (24,000)
Cash Flows from Financing Activities
Issue common stock 25,000
Borrow from bank 10,000
Pay dividends (200)
Net cash flows from financing 34,800
activities 6,900
Net increase in cash -0-
Cash at the beginning of the period $ 6,900
Cash©2019
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Statement
Statement of
of Cash
Cash Flows
Flows

Help to answer:
Where did cash come from during the period?

How was cash used during the period?

What was the change in the cash balance during the

period?
 Links among Financial
Statements
Sierra Company Ltd.
Income Statement Sierra Company Ltd.
Revenues $7,200 Statement of Stockholders’ Equity
Expenses 6,000
Net Income $1,200
Total
[1] Common Retained Stockholders’
Stock Earnings Equity
Beginning balance (Dec. 1) $ -0- $ -0- $ -0-
Issuances 25,000 25,000
Add: Net income 1,200 1,200
Less: Dividends (200) (200)
[2]
Ending balance (Dec. 31) $25,000 $1,000 $26,000

Sierra Company Ltd. Sierra Company Ltd.

Balance Sheet Statement of Cash Flows
Cash $ 6,900 [3] Liabilities $14,000 Cash flows from operating activities $ (3,900)
Other assets 33,100 Stockholders’ equity 26,000 Cash flows from investing activities (24,000)
Total liabilities and Cash flows from financing activities 34,800
Total assets $40,000 stockholders’ equity $40,000 Net increase in cash 6,900
Cash at the beginning of the year -0-
Cash at the end of the year $ 6,900

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 NON-FINANCIAL REPORTING

• Because financial statements focus on economic resources and

obligations, they may ignore some important other resources and
obligations:
• Trust relationships with stakeholders.
• Skilled workforces.
• Investments in environmental pollution reduction.
• Good governance.

• The importance of non-financial disclosures has therefore increased.

 NON-FINANCIAL REPORTING

• Examples of non-financial disclosures, also known as

environmental, social, and governance (ESG) or sustainability
disclosures, include:
• Sustainability strategy discussions.
• Information about labor conditions in the supply chain.
• Information on water and chemicals use or carbon dioxide emissions.

• One of non-financial reporting’s greatest challenges is its strong

industry dependence.
 NON-FINANCIAL REPORTING
• Important frameworks and standards that have been
developed to improve the quality and comparability of
non-financial reporting are:
• The Global Reporting Initiative (GRI)
• The European Union Non-Financial Reporting Directive, and its
successor, the Corporate Sustainability Reporting Directive.
• The International Sustainability Standards Board (ISSB) issued
its first two IFRS® Sustainability Disclosure Standards, IFRS
S1 General Requirements for Disclosure of Sustainability-related
Financial Information and IFRS S2 Climate-related Disclosures.
• The Hong Kong Stock Exchange ESG Reporting Guide (Appendix
C2)
KEY CONCEPTS

• Financial statements are an important source of

information to the capital markets and business
analysts.
• Financial reporting helps resolve information problems,
supported by its core features and institutional environment.

• Analyzing financial statements addresses variety of

questions of interest to external stakeholders and
company insiders.
CLASS DISCUSSIONS

• Based on the 2023 Annual Report of Hong Kong

Electric Investment to find out what are the key
information you can obtain from the annual report.
• Based on the 2023 Sustainability Report of Hong
Kong Electric to find out what are the key features
of the sustainability report.
• Discuss what are the differences between financial
reporting and non-financial reporting.