2nd session:Introduction to Accounting

Firm of the Day

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Goal of Today’s Class

• Understand the four financial statements.

• Understand which business processes and transactions are reflected in each financial statement.

• Understand how the four financial statements fit together.

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Reporting Business Activities

Obtain FinancingIssue debt and stock

Make InvestmentsPurchase land, bldgs, inventory,

etc.

Conduct OperationsSell goods and services to customers Pay employees, suppliers, creditors

Balance SheetLiabilities & Owner’s

Equity

Balance SheetAssets

Income StatementRevenues & Expenses,

Net income

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Desirable Characteristics of Accounting

FASB Concept Statement #2(See Figure 2.1 of LLS)

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Balance Sheet• Describes the financial position of the firm at a

given point in time

• Assets are – resources owned or controlled by the firm– Future economic benefits or rights that are owned or

controlled by the firm • Liabilities are

– a source of claim against the resources of the firm – Fixed and unavoidable obligations to transfer cash or

some other good or service to an outside party at some future time

Assets = Liabilities + Shareholders’ Equity

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Balance Sheet – Cont’d• Shareholders’ Equity – another source of and

claim against the resources of the firm

• Shareholders' equity represents amounts invested in the firm by it’s owners, either:

a) directly => when they purchase shares from the company (i.e., contributed capital);

b) indirectly => when they allow the firm to retain its earnings rather than requiring that it paying them out in the form of dividends.

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Remember the Mandatory Reports?

All SEC-mandated reports are available on EDGAR at:http://www.sec.gov/edgar.shtml

Firms also post reports on their investor relations sites

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What does Consolidated mean?

Why this date?

Why is this an asset?

What must this be equal to?

Why is this an asset?

Which one is the largest asset?

Fiscal Year 2009 Report

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Why are these liabilities?

What must this be equal to?

Fiscal Year 2009 Report

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Income Statement• Describes the financial results of the firm’s

operations over a period of time

• Revenues represent resources (assets) acquired or obligations (liabilities) satisfied by the firm in exchange for the goods or services sold by the firm to others

• Expenses represent assets used or liabilities incurred to generate revenue by selling goods and/or services to others

Net Income = Revenues - Expenses

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Why the reference?

Fiscal Year 2009 Report

Why are these expenses reported separately? What’s in either of them?

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Fiscal Year 2009 Report

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How much was the expense for employee stock compensation?

Fiscal Year 2009 Report

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Bottom line: • primary statements are of limited use• footnotes contain the bulk of the details

Fiscal Year 2009 Report

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How much merchandise did

Best Buy purchase during FY 2009?

Fiscal Year 2009 Report

Best estimate:

COGS: $34,017

Ending Inventory:$4,753No need to buy what came from Beginning Inventory: -$4,708

$34,017 + 4,753 – 4,708 = $34,062 16

Statement of Cash Flows

• Describes the flow of cash in and out of the firm during a period of time

Three categories on statement

1. Operating: activities carried out on a day to day basis to meet the goals of the company

2. Investing: activities carried out periodically that alter the firm’s infrastructure, enabling it to carry out the operating activities

3. Financing: activities carried out to obtain (and repay) funds used in the other activities

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Where does this number come from?

Fiscal Year 2009 Report

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How were these 1.9 billion dollars used?

Where else can we find these numbers?

Fiscal Year 2009 Report

Check the Balance Sheet:

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Statement of Shareholders’ Equity

• Describes the amounts and changes in the components of the shareholders’ investment in the firm

• Retained earnings provide a reconciliation between the income statement and the balance sheet

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Fiscal Year 2009 Report

Balance sheet - Outline

• Define – Assets– Liabilities– Shareholders’ Equity

• Valuation • Balance sheet classification

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The Balance Sheet• A “snap shot” of the investing and

financing activities of a firm at a point in time.

• Assets: economic resources that are expected to provide future economic benefits.

• Liabilities: creditors’ claims on the assets of the firm.

• Equity: owners’ claims on the assets of the firm.

Assets = Liabilities + Equity 24

The Accounting Identity

• Equates economic resources to the claims on those resources

• Equity holders are the residual claimants:

A – L = E

Assets = Liabilities + Equity

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Balance Sheet

• Reports the financial condition of the firm at a given point in time

• Assets = Liabilities + Shareholders’ Equity

• Resources = Finances• Core financial statement• Other financial statements provide

details of the changes in components of the balance sheet

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Assets

• A resource or right to future benefits• Must satisfy three conditions to be included in

the balance sheet– Capacity to increase cash inflows or reduce cash

outflows– Entity must be able to obtain the benefits and control

others’ access to the benefits– Transaction must have occurred in the past.

Probable and measurable future economic benefits controlled by an entity as a result of past transactions

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Types of Assets

• Tangible assets– Merchandise inventory– Property, plant and equipment

• Monetary and financial assets– Accounts receivable– Marketable securities

• Intangible assets– Patents– Trade name

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Liabilities

• Obligation to produce or transfer a good, or deliver a service in the future, in return for benefits received in the past

• Claims against assets of the business– Accounts payable– Income taxes payable– Bonds payable– Pensions and other post-retirement

benefits29

Shareholders’ Equity (Owners’ or Stockholders’ Equity)

• Amount invested in the company by owners either directly or indirectly

• Residual interest in the assets of the firm after deducting the liabilities

Contributed capitalRetained earnings

Beginning Retained Earnings+ Net Income- Dividends (Declared)

= Ending Retained Earnings

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Exercise I – Fill in the gaps

2009 2008 2007 2006Retained Earnings, January 1 $37,922 $25,634

Net Income 4,940 5,665

Dividends Declared and Paid 1,203 1,203 815

Retained Earnings, December 31 35,669 37,922 34,338 30,48

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$30,484

1,086

$34,338

4,787(1,050)

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Balance Sheet Equation

Assets – Liabilities =

Shareholders’ Equity

= Contributed Capital + R(etained) E(arnings)

= Contributed Capital + REbeginning of period + Net Income – Dividend

= Contributed Capital + REbeginning of period + Revenues – Expenses – Dividend

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Valuation

• Assets All assets are designed to provide future benefits

(i.e., increase cash flow), but not all future benefits are recorded as assets

– Because some future benefits involve a great deal of uncertainty, they may not be recorded as assets

– This reflects a tradeoff between the relevance and reliability of accounting information

– Because the historical cost of the asset is so reliable, it is frequently used to value the asset on the balance sheet, even though it may not be the most relevant measure of value

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Valuation – Cont’d

• Historical (original) cost – this is what we generally use.

• Three exceptions– Inventory – lower of cost or market (Asymmetric)– Long-term asset impairments (Asymmetric)– Marketable securities (Symmetric)

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Valuation – Cont’d

• Liabilities– Present value of the cash outflows that

will be made to satisfy the obligation

• Shareholders’ Equity– Indirect – depends on how assets and

liabilities are valued.Shareholders’ Equity = Assets – Liabilities

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Balance Sheet Classification

• Assets– Current Assets– Investments– Other Assets

• Liabilities– Current Liabilities– Non-current (Long-term liabilities)

• Shareholders’ Equity– Contributed capital– Retained earnings

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Next Class…

• Balance Sheet Concepts

• The Accounting Process

• Debits, Credits, and T-Accounts

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