EN.662.611 Chap.1 Financial Statements and the Language of Business
Financial Statements and the Language of Business
Why the course calls accounting a language
The first Week 1 lecture starts from the market. Prices are set by expectations, expectations are formed largely from past performance, and companies deliver feedback on past performance through financial statements prepared under generally accepted accounting principles.
Those statements serve interested parties outside the company, its creditors and owners, as well as the managers inside it. Seen this way, accounting is the vocabulary that lets savers and borrowers exchange resources in capital markets.
Rules, filings and the people responsible
GAAP is written by the Financial Accounting Standards Board, and management chooses among the rules and estimates GAAP allows.
The SEC requires public companies to file an audited annual 10-K, a reviewed quarterly 10-Q and an 8-K when a significant event occurs.
The lecture ties three qualities to three bodies: consistency to the FASB, reliability to the auditors overseen by the PCAOB, and timeliness to the SEC's requirement that reporting periods not exceed one year.
Four statements and how they connect
The balance sheet follows the accounting equation, assets equal liabilities plus equity, with assets ordered by liquidity and liabilities by maturity.
The income statement measures performance over a period on the accrual basis. The statement of stockholders' equity centers on retained earnings: the beginning balance plus net income less dividends. The cash flow statement converts the accrual picture back to cash under operating, investing and financing activities.
Net income, retained earnings and cash are the three threads that tie the set together.
What the dividend decision reveals
A business can reinvest its income or distribute it. The lecture reads that choice against the life cycle: a growth company pays little or nothing because it needs cash to expand, while a mature company pays dividends on a regular schedule.
The same retained earnings line therefore carries both an accounting fact and a clue about strategy.
Reading a real annual report
The course's running company is McCormick, whose 2025 Annual Report is required reading.
Open any annual report at the four statements and trace the same threads: find net income, follow it to the change in retained earnings, then find ending cash and confirm it matches the balance sheet. Notice the comparative columns, which let you see a trend before any ratio is computed, and the notes, where management explains the choices GAAP allowed it to make.
What this chapter covers
- 01
Expectations, past performance and market prices
- 02
GAAP, the FASB and management's choices
- 03
The 10-K, 10-Q and 8-K
- 04
The accounting equation and balance sheet order
- 05
Accrual basis and the matching principle
- 06
Retained earnings and the business life cycle
- 07
Cash flow categories and statement linkages
Worked example · free
Place six accounts on the right statement
- 2Prepaid Rent is a current asset; Unearned Revenue is a current liability.
- 2Interest Expense and Capital Gain are non-operating income statement items, an expense and a revenue.
- 2Retained Earnings is earned capital in equity; the three-year note is a non-current liability.
Key terms
- Generally Accepted Accounting Principles
- The common rules, set by the FASB, that make financial statements comparable across companies.
- Balance Sheet
- The statement of financial position: the resources a company controls and the claims that financed them, at a single date.
- Matching Principle
- The rule that an expense is recorded in the period in which it helps earn revenue.
- Form 10-K
- The annual report a public company files with the SEC, audited by an independent CPA.
Financial Statements and the Language of Business FAQ
Why does the income statement differ from the cash flow statement?
The income statement follows the accrual basis, so revenue counts when earned and expenses when used, whatever the timing of cash. The cash flow statement reverses those timing differences to show actual cash moving in and out.
What is the difference between contributed and earned capital?
Contributed capital is what owners paid in when the company issued stock. Earned capital is retained earnings: income kept in the business since it began rather than paid out as dividends.
Who audits and who reviews public company statements?
Independent CPAs audit the annual statements and review the quarterly ones. An audit gives an opinion on the annual report, while a review is a lighter check, and the PCAOB oversees the firms that do this work.
Exam move
Draw the four statements from memory with arrows for net income, retained earnings and cash, then classify a dozen accounts by statement, type and current or non-current until you can do it without hesitation.
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