Both Exeter Investors (Maxidrive's new owner) and American Bank (Maxidrive's largest creditor) used Maxidrive's financial statements to learn more about the company before making their purchase and lending decisions. In doing so, Exeter and American Bank assumed that the statements accurately represented Maxidrive's financial condition. As they soon learned, and now have claimed in their lawsuits, the statements were in error.
1.On its balance sheet, Maxidrive overstated the economic resources it owned and understated its debts to others.
2.On its income statement, Maxidrive overstated its ability to sell goods for more than the cost to produce and sell them.
3.On its statement of retained earnings, Maxidrive overstated the amount of income it reinvested in the company for future growth.
4.On its statement of cash flows, Maxidrive overstated its ability to generate from sales of disk drives the cash necessary to meet its current debts.
These four financial statements are the basic statements normally prepared by profit-making organizations for use by investors, creditors, and other external decision makers.
The four basic statements summarize the financial activities of the business. They can be prepared at any point in time (such as the end of the year, quarter, or month) and can apply to any time span (such as one year, one quarter, or one month). Like most companies, Maxidrive prepares financial statements for investors and creditors at the end of each quarter (known as quarterly reports) and at the end of the year (known as annual reports).
The Balance Sheet
The purpose of the balance sheet is to report the financial position (amount of assets, liabilities, and stockholders' equity) of an accounting entity at a particular point in time. We can learn a great deal about what the balance sheet reports just by reading the statement from the top. The balance sheet of Maxidrive Corp., presented by its former owners to Exeter Investors, is shown in Exhibit 1.2.
Notice that the heading specifically identifies four significant items related to the statement:
1.Name of the entity, Maxidrive Corp.
2.Title of the statement, Balance Sheet.
3.Specific date of the statement, At December 31, 2009.
4.Unit of measure (in thousands).