Accounting: The Language of Business - Vol. 2 (Intermediate: Part 74)

Never measure literature by accounting statistics. A quarter of working authors earn less than $1,000.

Rita Mae Brown

Statements of Financial Position and Cash Flows and the Annual Report (Part L)

by

Charles Lamson

Financial Statement Articulation

Financial statement articulation, the relationship among financial statements and financial statement elements, is a critical concept in understanding financial statements. The elements of the four basic financial statements are intrinsically interrelated:

• Firms compute net income and other comprehensive income (OCI) on the statements of net income and comprehensive income. Revenues and gains increase net income and expenses and losses decrease net income.

• Both net income and OCI are then included in the stockholders' equity section of the balance sheet and affect the statement of stockholders' equity. Net income is used to arrive at ending retained earnings, and current year OCI is used to arrive at the ending balance in accumulated OCI.

• Firms use the statements of net income (or the statement of comprehensive income) and the balance sheet to prepare the statement of cash flows. For example, operating cash flows are computed as net income, adjusted for the changes in operating working capital accounts on the balance sheet and noncash revenues and expenses on the statement of net income.

 Exhibit 6.11 provides an overview of financial statement articulation.

EXHIBIT 6.11 Financial Statement Articulation

Click to Enlarge.

Exhibit 6.12 illustrates financial articulation using the 2016 Johnson & Johnson financial statements. 

1. Johnson & Johnson reported net income of $16,540 million on the statement of comprehensive income (and the statement of net income). This number then flows into the statement of stockholders' equity, resulting in an increase in retained earnings.

2.  OCI for the year on the statement of comprehensive income is a loss of $1,736 million, resulting in a decrease in accumulated OCI on the statement of stockholders equity.

3.  Johnson & Johnson reported the ending retained earnings balance, $110,551 million, and the ending accumulated OCI balance $(14,901) million, from the statement of stockholders' equity on the balance sheet. 

4. Under the indirect method, the cash flow statement begins with net income from the statement of comprehensive income, $16,540 million, and adjusts for changes in various balance sheet accounts such as accounts receivable and inventory. 

5. On the cash flow statement, the increase in cash and cash equivalents of $5,240 million reconciles to the change in cash and cash equivalents from the balance sheet, where beginning cash and cash equivalents are $13,732 million and ending cash and cash equivalents are $18,972 million. 

EXHIBIT 6.12 Johnson & Johnson Financial Statement Articulation (in millions), Financial Statements, for Year Ending January 1, 2017 

EXAMPLE 6.3 Financial Statement Articulation

 PROBLEM: Complete the following financial statement articulation exercises.

1. If net income is $52,000 and comprehensive income is $70,000, what is other comprehensive income?

2. If ending retained earnings are $122,000, beginning retained earnings are $98,000, and dividends declared are $20,000, what is net income?

3. If the beginning balance of cash was $653,000 and the ending balance of cash is $522,000, what is the net change in cash?

SOLUTION:

*GORDON, RAEDY, SANNELLA, 2019, INTERMEDIATE ACCOUNTING, 2ND ED., PP. 252-255*

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