Chapter 15
Financial Statements and Ratios
Student Performance Objectives:
Section I The Balance Sheet
15-1 Preparing a Balance Sheet
Section II The Income Statement
15-4 Preparing an Income Statement
Section III Financial Ratios and Trend Analysis
15-7 Calculating Financial Ratios
Chapter Notes, Teaching Tips and Lecture Launchers
• Lecture Launcher: Students are often intimidated by the concept of financial ratios, and
would rather skip the topic altogether. Impress upon them that the study and use of financial
• Spotlight: Remind students that financial statements such as the income statement and
balance sheet are like monetary “report cards” of how a company is doing. They are a
summary of a company’s financial data compiled from business activity over a period of time
or, in the case of balance sheets, are a “snapshot” at a specific time.
• Spotlight: As each new topic is covered, it is a good idea to have students work in groups of
two’s or three’s to solve classroom exercises in this chapter, particularly those involving
• Make students aware that this chapter has a feature entitled “The Annual Report,” which are
recent financial statements from major corporations for them to analyze including:
• Macy’s (Section I exercises)
• Spotlight: Homework Assignment: To help reinforce the concepts in this chapter, have
students prepare a “personal” balance sheet and/or income statement. Also have them
• Spotlight: For students interested in accounting as a career, further information can be
obtained from:
• American Institute of Certified Public Accountants
• Classroom Activity: Have an accountant or financial manager in as a guest speaker to
discuss the importance of financial statements and ratios and how they are used in business.
Section I The Balance Sheet
• Classroom Activity: Point out to students how the balance sheet is based on the Accounting
Equation, and that both sides must “balance.”
• To help reinforce the concept, have student use their knowledge of equations, Chapter
5, to solve the accounting equation for the other variables.
typical balance sheet.
• Collaborative Learning Activity: Have students break into groups to complete Section I
Review Exercises 12 – 33 Next, ask the groups to compare their answers with those of
another group, and resolve any differences.
• Spotlight: Collaborative Learning Activity: Have students work in pairs to prepare the
balance sheet for Try-It Exercise 1.
• Call attention to the fact that the owners of a corporation are the stockholders; therefore the
owner’s equity is called stockholder’s equity on the balance sheet of a corporation.
• To further explain the distinction between common and preferred stock, note that
• The basic concept of depreciation should be introduced during the discussion of the balance
sheet. Explain that property, plant, and equipment (except land), such as cars, trucks and
business equipment, “wear out” over time and therefore lose value.
• Point out that the “values” of these assets on the balance sheet are at “book value.”
• Emphasize to students that comparative financial statements are used to predict and analyze
relationships and trends from year to year.
• In vertical analysis, be sure students remember that each individual item on the balance sheet
is the portion, and total assets is the base.
• Spotlight: Have students recall that this procedure is an application of percent
change, covered in Chapter 6. Remind them, the original amount is always the base,
and the difference between the two periods is the portion.
Section II The Income Statement
• Use Example 15-5, Income Statement – Hypothetical Enterprises, Inc., to illustrate the layout
of a typical income statement.
• When discussing income statements,
• Review the definitions of gross, before deductions, and net, after deductions. Remind
• Spotlight: Be sure students understand that an income statement covers a given “period” of
time, whereas a balance sheet covers a “moment” in time.
• Remind students that income statements are also called operating statements, profit and loss
statements, or P&L statements.
• Spotlight: Emphasize to students that the important business term “bottom line” comes from
the structure of an income statement:
Revenue Earnings from sales during an operating period
• Demonstrate to students how the “bottom line” of an income statement can be improved by
increasing revenue, cutting expenses, or a combination of both.
• Collaborative Learning Activity: In groups, have students list ways in which
companies in the following categories can reduce their expenses or increase their
revenues:
• In vertical analysis of an income statement, remind students that each individual item is the
portion, and net sales is always the base.
Section III Financial Ratios and Trend Analysis
• Spotlight: Point out to students that understanding of financial ratios is facilitated by keeping
the four major categories and their purpose in mind:
• Liquidity ratios – Tell how well a company can pay off its short-term debts and meet
unexpected needs for cash.
• Alert students that although they are referred to as financial “ratios,” not all of them are
expressed in that manner:
• When discussing financial ratios, be sure students know what these ratios represent and how
they are used in the business world.
• For example, the acid test is an important ratio because it indicates whether a
company can pay its current debts without having to sell its inventory. This is
• Collaborative Learning Activity: In groups, have students discuss which financial ratios
would be most important to:
• A banker deciding whether to loan money to a company.
• Call students’ attention to the trend analysis graph. Point out that these are frequently used in
presentations of financial data since they are easier to read and interpret than a chart.
• Collaborative Learning Activity: Have students write, call, or visit the Web sites of various
companies to request a copy of the most recent annual report. The library would be an
alternate source for the financial statements found in those reports.
In groups, have them:
• Choose one company to analyze from the annual reports on hand.
Questions Students Always Ask
“ Is it stockholders or shareholders?”
“What are goodwill and other intangible assets?”
• This part of the balance sheet can get a little murky. Intangible assets are intellectual
“Where can I find industry averages for comparison?”
• To find industry averages for comparison purposes, a place to start is the Web site
“Do I really need to know how to calculate financial ratios?”