Chapter 3
Accounting
Book Cover
10e
and Finance
Copyright © 2018
Copyright by The
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by The Companies,
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rights reserved
reserved
Topics Covered
3.1 The Balance Sheet
3.2 The Income Statement
3.3 The Statement of Cash Flows
3.4 Accounting Practice and Malpractice
3.5 Taxes
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The Balance Sheet (1 of 5)
▪ Definition
– Financial statement that shows the value of
the firm’s assets and liabilities at a particular
time (from an accounting perspective)
– Assets (uses of funds) are on the left, liabilities
(sources of funds) are on the right of the
balance sheet.
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The Balance Sheet (2 of 5)
The Main Balance Sheet Items
Current Assets Current Liabilities
• Cash & Securities • Payables
• Receivables • Short-term Debt
• Inventories
+
+ =
Long-term Liabilities
Fixed Assets
• Tangible Assets +
• Intangible Assets
Shareholders’ Equity
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The Balance Sheet (3 of 5)
3- 5
The Balance Sheet (4 of 5)
▪ Common-Size Balance Sheet
– All items in the balance sheet are expressed as
a percentage of total assets.
– Easier to compare items over years.
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The Balance Sheet (5 of 5)
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Book Values and Market Values (1 of 3)
▪ Book Values
– Value of assets or liabilities according to the balance sheet.
▪ Market Values
– The value of assets or liabilities were they to be resold in a
market.
▪ Generally Accepted Accounting Principles (GAAP)
– Procedures for preparing financial statements.
– Requires assets to be recorded at historical costs, net of
depreciation.
– IFRS for international markets.
▪ Equity and asset “market values” are usually higher
than their “book values”, but reverse is also possible
(e.g., a competitor develops a superior product)
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Book Values and Market Values (2 of 3)
Example
According to GAAP, your firm has equity worth $6
billion, debt worth $4 billion, assets worth $10
billion. The market values your firm’s 100 million
shares at $75 per share and the debt at $4 billion
Q: What is the market value of your assets?
A: Since (Assets = liabilities + equity), your assets
must have a market value of $11.5 billion
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Book Values and Market Values (3 of 3)
Example (continued)
Book Value Balance Sheet
Assets = $10 bil Debt = $4 bil
Equity = $6 bil
Market Value Balance Sheet
Assets = $11.5 bil Debt = $4 bil
Equity = $7.5 bil
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The Income Statement (1 of 3)
▪ Definition
– Financial statement that shows the revenues,
expenses, and net income of a firm over a
period of time (from an accounting
perspective).
– The starting item is revenues and the ending
item is net income.
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The Income Statement (2 of 3)
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The Income Statement (3 of 3)
▪ Earnings Before Interest and Taxes (EBIT)
EBIT = total revenues + other income - costs - deprecation
= 78,112 − (54,864 + 16,233) − 2,357
= $4,658 million
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Profits vs. Cash Flows
▪ Differences
– “Profits” subtract depreciation (a non-cash
expense).
– “Profits” ignore cash expenditures on new
capital (the expense is capitalized).
– “Profits” record income and expenses at the
time of sales, not when the cash exchanges
actually occur (see the example in Section 3.2).
– “Profits” do not consider changes in working
capital.
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The Statement of Cash Flows (1 of 4)
▪ Definition
– Financial statement that shows the firm’s cash
receipts and cash payments over a period of
time.
– It shows how the “cash” item in the balance
sheet changes over the year.
– These changes in cash could come from
operations, investment or financing activities.
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The Statement of Cash Flows (2 of 4)
The statement of cash flows uses three types of cash flows:
• Cash flows from operations.
✓ Current business generate cash flows. Hopefully, these cash
flows are positive.
• Cash flows from investment.
✓ Firms may invest in profitable new businesses. Most of the
time, these investments require upfront investment. Thus,
cash flow is typically negative.
• Cash flow from financing.
✓ If firms issue new equity or borrow new capital, there will
be an inflow of cash to the firm (i.e., positive cash flows). If
the firm pays out dividends, or repays debt, then cash flows
out of the firm (i.e., negative cash flows).
3- 16
The Statement of Cash Flows (3 of 4)
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The Statement of Cash Flows (4 of 4)
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Finance Databases
Where to get financial statements?
- WRDS (North American Firms)
[Link]
Class account available - see the document on SuCourse.
- Refinitiv EIKON (Global)
Available at the Sabanci IC
Free options (limited data):
[Link]
[Link]
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Accounting Malpractice
▪ Revenue recognition
– Firms record a sale when it is made, not when the
payment is received. Firms may increase sales through
discounting, employing lax return policies,..
▪ Cookie-jar reserves
– Excessive use of reserves in bad times may hide losses
from investors.
▪ Off-balance sheet assets and liabilities
– Firms may hide / transfer their liabilities from their
balance sheets.
See the top accounting scandals. Link here.
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Corporate Tax Rates (2024)
Companies pay tax on their income. The
U.S. Tax Cuts and Jobs Act, passed in
December 2017, reduced the corporate tax
rate from 35% to 21%. Thus, for every
$100 that the company earns, it pays $21
in federal tax.
Turkey (2025): 25%
Links: Corporate Tax Rates by Country
Tax havens
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Personal Tax Rates (2018)
Turkey (2025)
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Taxes (4 of 5)
▪ Taxes have a major impact on financial
decisions.
▪ Marginal Tax Rate is the tax that the
individual pays on each extra dollar of
income.
▪ Average Tax Rate is the total tax bill divided
by total income.
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Taxes (5 of 5)
Example - Taxes paid by single person making $50,000
Tax = .10 × 9,950 + .12 × 30, 575 + .22 × 9,475
= $6,748.5
6,748.5
Average tax rate = = .135 or 13.5%
50,000
His/her marginal tax rate is 22%. That is, an additional dollar
earned at the top of 50,000 is taxed at 22%.
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End of Chapter 3
Please complete
Weekly Assignment 1
on the Connect Platform
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