Lesson: 71

Topic: Interpreting the Income Statement and Balance Sheet

Objectives:

By the end of this class, the student should clearly understand what an Income Statement and Balance Sheet says. In addition, the student will come to understand what these statements do NOT say.

Finally, students will review the following GAAPs related to formal financial statements:

• the Consistency Principle,
• the Materiality Principle, and
• the Full Disclosure Principle.

Method of Instruction and Evaluation:

Students will be evaluated within the context of a Socratic discussion. 

Expectations Addressed:

The "Internal Control, Financial Analysis, and Decision Making" strand of the BAF3M Ministry of Education Curriculum Guidelines outlines all of the following specific expectations. The expectations addressed by this lesson have been highlighted below.

• Internal Control Procedures:

  • describe the basic elements of an internal control system (e.g., separation of duties, pre-numbered documents, rotation of staff);

  • apply appropriate control measures used in accounting for assets (e.g., petty cash procedures, bank reconciliation procedures);

  • describe the role of budgeted financial statements in planning, controlling, and evaluating business results (e.g., difference between budgeted and actual income statements);

  • describe the role and work of an auditor.

• Financial Analysis:

  • explain the importance of current assets and current liabilities when interpreting a balance sheet;

  • analyse a company’s liquidity and solvency by using simple financial ratios (e.g., current ratio, debt ratio) and other financial analysis tools (e.g., comparative statements, trend analysis, common size statements);

  • analyse a company’s profitability by using simple financial ratios (e.g., gross profit percentage, return on equity) and other financial analysis tools (e.g., comparative statements, trend analysis, common size statements).

• Decision Making:

  • describe how accounting information is used by company personnel (e.g., department managers, owners) in making decisions;

  • explain the role of financial analysis in decision making from the standpoint of potential investors (e.g., mutual fund managers, institutional investors, individual investors);

  • describe how accounting information is used by individuals or organizations outside the company (e.g., governments, Ontario Securities Commission, police, forensic accountants) in making decisions.

References:

• Text, chapter #8; pages 280 - 281
• Power Point: Interpreting Financial Statements