HB 311 Lecture 2 Current Lecture Financial Statements Numerical Representations of a firm s activities Provide picture of what is happening Net Income Does Not Represent cash a firm has in pocket Differences between cash and net income Accounts receivable and Depreciation 3 Financial Statements Income Statement Balance Sheet Statement of Cash Flows Accounting System Firm s financial books are collection of records in which transactions are recorded Includes selling product buying inventory paying wages borrowing money Each transaction recorded by an entry into books Double Entry System Each entry has two parts ex If 1 000 is borrowed to buy a machine must increase asset account as well as liability Books are closed by updating period s transactions in accounting system and creating financial statements Implications Last years statements are NOT indicators of what will happen in future Income Statement o Flows of over a period of time o Presents financial position on a specific date o Shows what firm owns and how they are financed debt and equity Balance Sheet o Stocks of money at a period of time o Conveys results to investors and creditors o Management reviews ratios to make sure all conditions are met o Limitations include intangible sources of value such as human resources Static in nature only reflects period of time some items are estimates o Equity Represents funds supplied to businesses by their owners thru direct investment stock or retained earnings o Retained Earnings Company s profits can be paid to owners dividends or retained does not represent reserve of cash Relationship between net income and retained earnings on Balance Sheet If Net Income is not distributed and no new equity investments are made o Beginning equity Net Income Ending Equity If dividends are paid o Beginning equity net income dividends ending equity These notes represent a detailed interpretation of the professor s lecture GradeBuddy is best used as a supplement to your own notes not as a substitute If new equity is raised o Beginning equity Net Income Dividends Stock Ending Equity Preferred Stock Cross between debt and common equity Total Capital Sum of long term debt and equity Total Liabilities and Equity Sum of right side of balance sheet must equal total assets Taxing Authorities and Tax Bases Three Taxing Levels Federal State and Local A Tax Base is the item that is taxed usually from o Income Tax Pay of income in particular time period Effective Tax Rate TETR Tfederal fax rate Tstate tax rate o Wealth Tax Based on value on certain types of assets such a real estate o Consumption Tax Based on amount of goods we use sales tax Progressive Tax Systems Marginal and Average Rates Characterized by higher tax rates on incrementally higher income Tax bracket is a range of income in which tax rate is constant Marginal Tax Rate rate that will be paid on next dollar of income Average Tax Rate of total income person pays in taxes Capital Gains and Losses Arises when an assets that s held for investment is sold for more or less than was paid Historically taxed at lower rates than ordinary income about 15 Personal Taxes Tax Relief Reconciliation Act of 2001 lowers personal tax rate over 5 years Separate tax forms for married single and head of household Taxable income Some items exempt from taxation such as interest or bonds Investments Municipal Bonds over corporate bonds are not taxed Corporate Taxes Similar to personal taxes Total Income is revenue exemptions not allowed deductions are the charges to run the company Earnings before Tax EBT represent a corporation s taxable amount Tax rates DO NOT rise as taxable income rises Corporate Tax System Favors debt financing over equity financing Interest payments made to debt investors are tax deductible Dividends paid to another corporation are partially tax exempt Business Losses can be carried back or forward to offset taxes