week 1 slides s06 2 accounting

The Financial Statements Balance Sheet  Statement of retained earnings... Balance Sheet Mirrors the Accounting Equation Assets = Liabilities + Equity Uses of funds = Sources of funds

Prof: Jim WallaceTA: Charles Yeh

Web Access to Class Info

 The site should contain:

What is Financial

Accounting?

information to interested external

parties.

regulators, customers, suppliers,

employees, etc

 Capital suppliers include debt and equity

providers

prediction and control

The Financial Statements

 Balance Sheet

 Statement of retained earnings

Balance Sheet

 Mirrors the Accounting Equation

Assets = Liabilities + Equity Uses of funds = Sources of funds

 Assets are listed in order of liquidity

 Current and non-current

 Liabilities are listed in order of maturity

 Equity consists of Contributed Capital and

Retained Earnings

Most Assets are Reported at

Historical Cost

 Historical Cost is

 Objective

 Verifiable

 Therefore, not subject to bias

 However, historical cost is not

particularly “relevant” to most readers

of the balance sheet

 “Relevance vs Reliability” is an

important issue with accountants.

Disney’s Assets

 Liabilities are listed in order of maturity

 Current Liabilities come due in less than a year.

 Noncurrent liabilities come due after a year.

 Companies desire more current assets than current liabilities – this difference

is called net working capital

Disney’s Liabilities and

Equity

Equity

Equity consists of:

 Contributed Capital (cash raised

from the issuance of shares)

 Earned Capital (retained earnings) Retained Earnings is updated each period as follows:

Market Value vs Book

Value

Stockholders’ equity = Company book value

Value.

share

roughly two-thirds of market value.

Income Statement

Walt Disney’s Income

Statement

Accrual Accounting

Accrual accounting refers to the recognition of revenue when

earned (even if not received in

cash) and the matching of

expenses when incurred (even if not paid in cash).

the recording of expense necessarily

Statement of Stockholders’

Equity

reconciliation of the beginning

and ending balances of

stockholders’ equity accounts.

Comprehensive Income or OCI)

Disney’s Statement of Stockholders’ Equity

Statement of Cash Flows

 Statement of cash flows (SCF) reports

cash inflows and outflows

 Cash flows are reported based on the

three business activities of a company:

1 Operating activities: transactions related

to the operations of the business.

2 Investing activities: acquisitions and

divestitures of long-term assets

3 Financing activities: issuances and

payments toward equity, borrowings, and long-term liabilities.

Articulation of Financial

Statements

within and across time – they

articulate.

are linked via retained earnings.

as stock issuances and purchases

and dividend payments, the change

in stockholders’ equity equals the

income or loss for the period.

In Class Example

Oversight of Financial

Accounting

 GAAP

Basic Assumptions and

Financial statements must contain

objective and verifiable numbers if they are to be useful Yet, many

estimates and subjective

assumptions are required for the

preparation of these reports Please reconcile these apparently

inconsistent statements

Exception to the Basic Principles

 Materiality

 Only transactions with amounts large enough to make a difference are

considered material

 Non-material transactions can be

treated in the easiest manner

Information Beyond Financial Statements

Analysis (MD&A)

Audit Report

GAAP

responsibility Auditor responsibility is to express an opinion on those statements

investigation of each transaction

management and estimates used in preparing the

statements

The SEC requires all publicly traded companies to have their financial statements audited Prior to this requirement many companies

voluntarily had their statements

audited Given the cost and

inconvenience, why would they do this?

What Number Do You

Earnings Management

 ACCOUNTING NUMBERS HAVE ECONOMIC CONSEQUENCES

BEYOND SIMPLY RECORDING

TRANSACTIONS

Transaction Analysis

 Transaction analysis is the process of identifying impacts of transactions and events on the balance sheet, income

statement, or both.

 We use the following template:

Journal Entries

Transaction Analysis

Credit Sales Transaction

Accrued Expense

Transaction

Deferred Revenue

Transaction

Asset Write-Down (Impairment) Transaction

are the result of one possible set of rules that have resulted from a political process.

limitations.

financial statements since these contain a lot of useful guidance to interpreting the statements

Financial Statement

Limitations

 Assets are valued at historical cost less

an estimated depreciation

 Other possibilities include cost, net

realizable value, replacement cost, price level adjusted

 Not all assets appear

 Human capital, internally generated

goodwill

conservative

Financial Statement

Limitations

 Not all liabilities appear

 Contingencies appear only in the

footnotes

 Off balance sheet financing

 Other limitations include

management biases and a lack of timeliness

Financial Accounting:

not an exact science

preparing financial statements

(inventories, property, and

equipment)

 Financial statements also depend on countless estimates