These paragraphs are a brief explanation of the definition, purpose, and types of financial statements. There are five components to a complete set of financial statements. They are the balance sheet, income statement or profit and loss statement, the statement of cash flows, the footnotes, and the report letter or opinion.
The BALANCE SHEET is a snapshot of the entity's assets, liabilities and equity at a given point in time. This time period usually starts at the beginning of the entity's existence and ends as of the same date as the income statement. The assets of an entity are the amount of cash, inventory, equipment, etc. used to generate the entity's bottom line profit or loss. The liabilities identify what the entity owes to various creditors either in the form of unpaid bills such as payroll taxes or trade accounts payable or in the form of bank loans or other types of financing. This debt is identified as either current or short term. Short-term debt is the amount that will be repaid within the next year from the period ending date. The long-term debt is the amount that will be repaid in future years or over a time greater than one year. The third component is what the owners of the entity have as either common stock, contributed capital, or profits for both this year and all years since the entity began. The balance sheet is used to calculate many ratios which are a measure of the entity's financial health such as the number of days it takes to collect the outstanding accounts receivable.
The INCOME STATEMENT reports the entity's income and expenses for a given time period between two dates. The report letter will tell you the time period of this report. The statement's bottom line is usually the net profit after taxes for the period reported. This statement can be used for comparison to industry guidelines or "benchmarks" for the various income and expense components. The entity's owner or manager can identify what the major expenses are by variable and fixed expense category. A variable expense would be labor costs per unit of sales or income. A fixed expense would be the monthly rent. These expenses can be tracked over time for trends and be used to calculate a break-even point for each month's required income or sales.
The STATEMENT OF CASH FLOWS identifies how cash came into the entity and how this cash was used. It is the only report that ties the income statement and balance sheet together as information from both is used in this report. This report has a specific time period between two dates.
The FOOTNOTES are customarily prepared for reviews, audits, and year-end compilations. The purpose of the footnotes is to provide detailed information about the entity's loans, leasing commitments, accounting policies, and other required information as defined by the American Institute of Certified Public Accountants (AICPA). The AICPA is the organization which defines the rules and procedures used in issuing standard accounting reports.
The REPORT LETTER OR OPINION is usually the first page of any financial report package. The key words are the type of report being issued and if the opinion states there are no material modifications required for the report to be in conformance with generally accepted accounting principles (GAAP). The three types of financial statements are compilation, review, and audit. All opinions tell the reader the information is the representation of the entity's management. Thus the purpose of the report is not to detect fraud, but rather to follow the guidelines issued by the AICPA for the opinion or confidence level required.
A COMPILATION takes your information and presents the numbers in the form of financial statements. In the interest of minimizing preparation costs, the footnotes and statements of cash flow are usually omitted. This report can be thought of as taking the bank statement and reporting the results in a standard format with minimal or no discussion with the entity's management or owners.
The REVIEW takes your information and presents the numbers in the form of financial statements with the required footnotes. There are some inquiries of management and limited analytical procedures applied. This report can be thought of as taking the time to identify the various financial reporting components without any effort to verify the numbers or examine the various paper documents. This report contains the same information as an audited report but is less costly to prepare than an audit as many audit procedures are not performed.
The AUDIT report is in the same format as a review. This report can be thought of as taking the time to test the integrity of the entity's internal control systems. Appropriate paper and applicable computer records must support these controls. The procedure includes confirmation of data from outside sources such as financial institutions, customers, vendors, and other sources that might be involved with the entity.
Financial statements are prepared on the “cash” or “accrual” basis. A cash basis financial statement reports only the money received and spent. Accrual basis financial statements report all sales billed and not received and all expenses incurred but not paid. There can be differences between financial and income tax reports as different rules exist for each.
These paragraphs are only a brief overview. You are welcome to call S.J. Meyer & Associates, CPAs, Inc. at (937) 832-5209 to determine the type and purpose of your financial statements.
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