Review of Financial Statements Paper - Essay Example

Corporate Mergers and Financial ments When two or more companies combine their interests to form a single entity, the result is a merger or a business combination. A merger may occur when one company acquires stocks in another company by paying cash or transferring other assets to its shareholders, or when it exchanges its own stock for the stock of other company. For the purpose of such mergers or business combinations financial statements are required to studied and analyzed. Mergers may be accounted for under ‘pooling of interest method’ (wherein assets and liabilities of subsidiaries are recorded at their book values) or under a ‘purchase method’ (wherein assets and liabilities taken over are recorded at fair value).

Under both systems financial statements of both entities play an important role. Financial statements of any company include inter-alia Balance Sheet, Income Statements, and the Cash flow statements. Balance SheetBalance Sheet is a statement of affairs of the company on a particular date that provides in details the sources of funds for the company and how those sources have applied for by the company. This in fact is an overall financial summary of the company as on a date. The depiction of sources of funds provides an idea as to how the company has mobilized funds in order to meet its objectives.

Basically, funds can be organized through two sources, namely investments by the company’s shareholders and/ or through borrowings by the company. Investments by shareholders is the capital of the owners invested into the company, and held by the shareholders in the shape of shares of a specific value into the total capital of the company, which may be equity or preferential. The distinction of equity and preferential capital has to do with allotment of certain priority rights relating to payment of dividend and repayment of capital invested into such shares at the time of liquidation of the company.

Further, a balance sheet describes borrowings as secured and unsecured. Repayment of secured borrowings is insured on the security of certain specific assets; whereas unsecured borrowings’ rights of repayment emerge only after the satisfaction of secured loans, and out of left over assets of the company.Balance sheet further describes how funds of the companies have been applied on a particular date on different assets and miscellaneous expenditures that include expenditures deferred over a period of some fiscal periods.

Assets may be fixed or current. Fixed assets are expenditures made by the company that provide benefits to the company over useful life of the assets. That is why only a portion of fixed assets expenditure, called depreciation, is appropriated to current period in order to facilitate income calculations for the current period as per GAAP. Current assets are appropriation of funds that prove useful to the company for a shorter period than fixed assets, and normally that period is up to next fiscal period.

Current assets are reduced by current liabilities in order to reflect net current assets. Current liabilities are short-term sources of funds or obligations of the company that are required to be met mostly over the next financial period. Application of funds also includes ‘miscellaneous expenditures’ that have not yet been written off to revenue, like preliminary expenses of formation of company, deferred expenditures and also the debit balances of ‘profit and loss account’. Income StatementIncome statement measures current period earnings.

Basically operating profits for the financial year are determined using ‘matching revenue and expenditure’ accounting principle. Expenditures of revenue nature are exclusively considered for finding operating profits for the year. There are two approaches that are commonly used in preparing income statement. Companies that have a primary source of revenues with costs that can be easily identified as related to those revenues will prepare a multiple- step income statement. When company is diverse, it is difficult to draw meaningful conclusion about a single aspect of business, and as a result such a company would prepare a single step income statement.

Besides determining operating profits, the income statement reflect certain special transactions or circumstances that are reported separately in income statement like income from discontinued operations, extraordinary items, and cumulative effect of a change in accounting principles.Cash Flow StatementAs per GAAP, cash flow statement is a necessary part of financial statements of a company. This statement provides information about inflows and outflows of cash and cash equivalents. Cash equivalents are financial instruments that are easily converted into cash and have an original maturity that is three months or less.

‘Cash equivalents refers to accounts that are as safe as cash, may earn small amounts of interest, and can be converted into cash relatively quickly. The most common examples are saving deposits, certificates of deposits, money market accounts, and money market mutual funds’ (AARP Bulletin)1 Further cash flow statements reports inflows and outflows of cash in three categories, namely, operating activities, investing activities, and financing activities of the company during the financial period.

Accounts affected through mergersDuring merger or business combination accounting two accounts that are mostly considered and affected are a) Shareholders’ equity, and b) Minority InterestShareholders’ Equity:During merger accounting, the parent company will increase shareholders’ equity for an amount equal to the shareholders’ equity of the subsidiary as of the date of combination (or merger) multiplied by the percentage acquired. In most cases the parent will acquire 100% of the stock of subsidiary in which case the amount will simply be equal to the subsidiary’s shareholders’ equity.

When parent acquires less than 100% of the subsidiary’s stocks, minority interest occurs.Minority Interest:When parent company has acquired less than 100% of the stock of the subsidiary, the portion that was not acquired is referred to as the minority interest. The minority interest represents the minority shareholders’ ownership interest in the subsidiary. Some companies consider the minority interest to be similar to a liability and will report this after long-term liabilities and before stockholders’ equity.

Other companies will consider the minority shareholders to be a class of equity and will report the minority interest in the stockholders’ equity section of the balance sheet. Mostly affected financial statementWhatever the accounting system (pooling of interest or purchase method) adopted for merger accounting, the financial statement that will be mostly affected during merger is the Balance Sheet of the parent company or the separate entity that is newly formed upon merger of entities, wherein the transactions of the merger reflects References1 AARP Bulletin, Cash by any other name, http://www.aarp.org/money/financial_planning/sessionsix/cash_equivalents.html