Accounting Equ

8/2/2019 Accounting Equ.

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Accounting

Prof: Jim Wallace

TA: Charles Yeh


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Overview of Week 1

Administrative stuff

What is financial accounting?

Financial statements GAAP

What number do you want?


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Administrative Stuff

Who am I

Who is your T.A.

Teaching philosophy Syllabus

Homework

Calculator


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Web Access to Class Info

The site should contain:

Syllabus PowerPoint slides

Handouts

Homework solutions

http://www.cgu.edu/pages/3471.asp


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What is Financial Accounting?

A method to communicate financial informationto interested external parties.

Users include capital providers, regulators,customers, suppliers, employees, etc

Capital suppliers include debt and equity providers

Financial accounting is used for both prediction

and control


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Some Preconceptions

- Misconceptions?

Accounting yields the truth.

Accounting is rigid.

Accounting is useless.Accounting is hard!

Accountants are boring.


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Other Types of Accounting

Managerial

Non-profit

Tax


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The Financial Statements

The accounting equation

Balance Sheet

Income Statement Statement of Cash Flows

Statement of Owners Equity

Statement of retained earnings


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Balance Sheet

Mirrors the Accounting Equation

Assets = Liabilities + Equity

Uses of funds = Sources of fundsAssets are listed in order of liquidity

Current and non-current

Liabilities are listed in order of maturity

Equity consists of Contributed Capital andRetained Earnings


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Assets

To be reported on a balance sheet, anasset must:

1. Be owned or controlled by thecompany

2. Must possess expected future

benefits


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Most Assets are Reported at

Historical Cost

Historical Cost is

Objective

Verifiable

Therefore, not subject to bias

However, historical cost is not particularlyrelevant to most readers of the balance sheet

Relevance vs. Reliability is an important issue

with accountants.


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Disneys Assets


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Liabilities

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 thancurrent liabilitiesthis difference is callednet working capital


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Disneys Liabilities and Equity


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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:


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Market Value vs. Book Value

Stockholders equity = Company book value

Book value is determined using GAAP.

Book value is not the same as Market Value.

Market Value = # of Shares x Price per share

On average, US company book value is roughlytwo-thirds of market value.


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Income Statement


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Walt Disneys Income Statement


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Accrual Accounting

Accrual accounting refers to the

recognition of revenue when earned(even if not received in cash) andthe matching of expenses when

incurred (even if not paid in cash).


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Accrual Accounting

Accrual accounting rests on two guidingprinciples:

Revenue Recognition Principlerecord revenuewhen

Earned

Realized or Realizable

Matching Principlerecord expenses when

Incurred

Neither the recognition of revenue nor therecording of expense necessarily involves the

receipt or payment of cash


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Statement of Stockholders Equity

Statement of Equity is a reconciliation of the

beginning and ending balances of

stockholders equity accounts.

Main equity categories are:

Contributed capital

Retained earnings (including Other

Comprehensive Income or OCI)

Treasury stock


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Disneys Statement of Stockholders

Equity


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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 assets3. Financing activities: issuances and payments toward

equity, borrowings, and long-term liabilities.


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Walt Disney

Companys

Statement ofCash Flows


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Articulation of Financial Statements

Financial statements are linked within andacross timethey articulate.

Balance sheet and income statement are

linked via retained earnings.Absent of equity transactions such as stock

issuances and purchases and dividend

payments, the change in stockholdersequity equals the income or loss for theperiod.


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In Class Example

Baron Coburg


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Oversight of Financial Accounting

GAAP

Oversight of Financial Accounting

SEC oversees all publicly traded companies

Financial Accounting Standards Board

(FASB)

Generally Accepted Accounting Principles

(GAAP)

B i A i d


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Basic Assumptions and

Principles

Monetary Unit

Fiscal period

Going concern Objectivity (Reliability)

Consistency

Versus comparability


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Question?

Financial statements must contain objective andverifiable 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 inconsistentstatements.

E i h


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Exception to the

Basic Principles

Materiality

Only transactions with amounts large enough tomake a difference are considered material

Non-material transactions can be treated in theeasiest manner


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Information Beyond Financial

Statements

Management Discussion and Analysis

(MD&A)

Independent Auditor Report

Financial Statement Footnotes


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Audit Report

Financial statementspresent fairlyand in all material respectscompany financial condition.

Financial statements are prepared in conformity with GAAP

Financial statements are managements responsibility. Auditor

responsibility is to express an opinion on those statements Auditing involves a sampling of transactions, not investigation

of each transaction

Audit opinion provides reasonable assurancethat the statements

are free ofmaterialmisstatements Auditors review accounting policies used by management and

estimates used in preparing the statements


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Question?

The SEC requires all publicly traded companies tohave their financial statements audited. Prior tothis requirement many companies voluntarily

had their statements audited. Given the costand inconvenience, why would they do this?


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What Number Do You Want?

Accounting is a political process, not an exactscience.

There is a great deal of discretion available tomanagers.


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Earnings Management

Reasons to manage earnings

ACCOUNTING NUMBERS HAVE

ECONOMIC CONSEQUENCES BEYOND

SIMPLY RECORDING TRANSACTIONS


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Earnings Management - Why

Compensation contracts

Debt contracts

Political considerations


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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:


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Journal Entries


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Transaction Analysis


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Credit Sales Transaction


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Accrued Expense Transaction


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Deferred Revenue Transaction


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Asset Write-Down

(Impairment) Transaction


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Takeaways

Financial statements that are produced are theresult of one possible set of rules that haveresulted from a political process.

Users need to be aware of these limitations.

Users should read the notes to the financialstatements since these contain a lot of useful

guidance to interpreting the statements.


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Financial Statement Limitations

Assets are valued at historical cost less anestimated depreciation

Other possibilities include cost, net realizable value,

replacement cost, price level adjusted

Not all assets appear

Human capital, internally generated goodwill

Could be argued that approach is more conservative


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Financial Statement Limitations

Not all liabilities appear

Contingencies appear only in the footnotes

Off balance sheet financing

Other limitations include management biasesand a lack of timeliness

Fi i l A i


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Financial Accounting:

not an exact science

GAAP allows companies choices in preparingfinancial statements (inventories, property, andequipment).

Financial statements also depend on countlessestimates.


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Financial Accounting in Context

A companys financial statements only tell part

of the story.

You must continually keep in mind the world in

which the company operates.

Financial statement analysis must be conductedwithin the framework of a thorough

understanding of the broader forces whichimpact company performance.

Accounting Equ

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