2: Financial Statement and Cash Flow Analysisasset, it can choose to depreciate this asset rapidly for the purpose of obtaining large, immediate tax
write-offs. When the company constructs financial statements for release to the public, however, it may
choose a different depreciation method – perhaps one that results in higher reported earnings in the
early years of the asset’s life. The deferred taxes entry is a long-term liability that reflects the difference
between the taxes that companies actually pay and the tax liabilities they report on their public financial
statements. Long-term debt represents debt that matures more than one year in the future.
The shareholders’ equity section provides information about the claims against the company held by
investors who own preferred and ordinary shares. The preferred shares entry shows the proceeds from
the sale of preferred shares ($30 million for GPC), which is a form of ownership that has preference over
ordinary shares when the company distributes income and assets. Next, two entries show the amount
paid in by the original purchasers of ordinary shares, the most basic form of corporate ownership. The
ordinary shares entry equals the number of outstanding ordinary shares multiplied by the par value per
share, which is an arbitrary nominal value with little or no economic significance. Paid-in capital in excess
of par equals the number of shares outstanding multiplied by the original selling price of the shares,
net of the par value. The combined value of ordinary shares and paid-in capital in excess of par equals
the proceeds the company received when it originally sold shares to investors. Retained earnings are the
cumulative total of the earnings that the company has reinvested since its inception. Be sure you know
that retained earnings are not a reservoir of unspent cash. When the retained earnings vault is empty, it
is because the company has already reinvested the earnings in new assets.
Finally, the treasury stock entry records the value of ordinary shares that the company currently holds
in reserve. Usually, treasury stock appears on the balance sheet because the company has reacquired
previously issued shares through a share repurchase program.
GPC’s balance sheet (Table 2.1) shows that the company’s total assets increased by $1,279 million,
from $8,310 million in 2015 to $9,589 million in 2016. As expected, the total liabilities and shareholders’
equity exactly match these totals in 2015 and 2016.2-1b INCOME STATEMENT
Table 2.2 presents Global Petroleum Corporation’s income statement (also called the profit-and-loss
statement, or P & L) for the year ended 30 June 2016. As with the balance sheet, GPC’s income
statement includes data from 2015 for comparison. When reporting to shareholders, companies
typically also include a so-called common-size income statement that expresses all income statement
entries as a percentage of sales.) In the vocabulary of accounting, income (also called profit, earnings
or margin) equals revenue minus expenses. A company’s income statement, however, has several
measures of ‘income’ appearing at different points. The first income measure is gross profit, the amount
by which sales revenue exceeds the cost of goods sold (the direct cost of producing or purchasing the
goods sold).
Next, a company deducts from gross profits various operating expenses, including selling expense,
general and administrative expense and depreciation expense.^3 The resulting operating profit ($1,531
million for GPC) represents the profits earned from the sale of products, although this amount does not
include financial and tax costs. Other income, earned on transactions not directly related to producing
and/or selling the company’s products, is added to operating income to yield earnings before interest and3 Companies frequently include depreciation expense in manufacturing costs – the cost of goods sold – when calculating gross profits. In this
text, we show depreciation as an expense in order to isolate its effect on cash flows.LO2.1
deferred taxes
An account that reflects the
difference between the taxes
that companies actually pay
and the tax liabilities they
report on their public financial
statements
long-term debt
Debt that matures more than
one year in the future
preferred shares
A form of ownership that
has preference over ordinary
shares when the company
distributes income and assets
ordinary shares
The most basic form of
corporate ownership
par value (ordinary
shares)
An arbitrary value assigned to
ordinary shares on a company’s
balance sheet
paid-in capital in excess
of par
The number of ordinary shares
outstanding multiplied by the
original selling price of the
shares, net of the par value
retained earnings
The cumulative total of the
earnings that a company has
reinvested since its inception
treasury stock (shares)
Ordinary shares that were
issued and later reacquired by
the company through share
repurchase programs and are
therefore being held in reserve
by the company
common-size income
statement
An income statement in which
all entries are expressed as a
percentage of sales