Part I. 

Financial Statements Structure and Vocabulary

(Table of Contents on back) 

Ch. 1 Twelve Basic Principles

Ch. 2 The Balance Sheet

Ch. 3 The Income Statement

Ch. 4  Statement of Cash Flows

(Not included: Statement of Retained Earnings aka st. of owner's equity aka st. of net assets)

Ch. 5 Connections

a) Balance Sheet Connections

b) Sales Cycle

c) Expense Cycle

d) Investment Cycle

e) Asset Purchase & Depreciation Cycle 

Transactions are reported for common business dealings such as...

Selling stock,issuing divd.       Paying Deposits       

Borrowing money               Receiving Raw Materials

Receiving orders               Scrapping damaged prod.

Shipping Goods                  Paying suppliers

Invoicing Customers         Booking manfc.variances Receiving Payments          Depreciating FixedAssets

Paying Sales Commisions   Valuing Inventory

Writing off bad debts        Hiring staff, paying s

Prepaying Expenses           Computing profit

Ordering Equipment           Paying Income Taxes 

A few things to remember...

Sales and Revenue (same thing, refer to top line)

Profits, earnings, income (same thing, bottom line,

what is left over after all costs and expenses)

Costs,Expenses (different from expenditures)

Sales (same as shipments)

                                     continued...

Costs (money spent making product)

 Expenses (money spent developing, selling, accounting for it, and managing process)

*Costs and Expenses become expenditures when money is actually sent to vendors to pay for them

Orders: NO impact until actually shipped

when shipped, orders then become sales!

Shipments and sales (syn.) 

Solvency

v.

Profitability 

Solvency

Having enough money in bank to pay for bills

Profitability

Able to generate sales >

costs and expenses 

Ch. 1

Twelve Basic Principles

Table of contents (on back)

1)  the accounting entity       10) substance over fo

2) going concern                11) Accrual basis for

3) measurement                        presentation

4) units of measure

5) historical cost

6) materiality

7) estimates and judgements

8) consistency

9) conservatism

 1.

Accounting Entity 

Business unit for which the financial statements are prepared for.

(there is a "business entity" separate from its owners...a "person" aka corporation for which books can be written) 

Assumption: life of business entity is infinitely long

(Reason is to simplify presentation of firm and aid in preparation of financial statements)

1) Must be quantifiable

2) consists of resources and obligations with agreed upon value 

*Valuable assets left out:  loyal customers

brand equity, etc (research others!)

             Units of measurure

USD (units of value from foreign subsidies reported converted into dollars for consolidated reporting)

Cost recorded at original or historical cost

(with NO adjustment for inflation)

thus, a building worth $50 billion today could be carried on the books at $5 million - accumulated depreciation costs! huge understatement in value

why: easier to do (you do not have to appriase and reappraise constantly as a result)

 6.

Materiality 

 refers to the relative importance of financial information

 (a judgement call by accountant)

here, accountants don't sweat small stuff...only that which materially effects the financial condition of the company) 

downward measurement bias is recommended

i.e. losses are recorded when there there is a high probability of occurring

conversely, recording of gain is postponed until it actually occurs 

10. 

profits recorded on periodic basis for convenience

11.

accountants report economic "substance" rather than legal form

i.e. equipment lease that is really a purchase should be booked as purchase on financ. st. 

Rules Based 

(U.S. accounting standards have become “rules-based,” filled with specific details in an attempt to address as potential contingencies..however, system is misleading,inappropriate at times)

    v. 

Principles Based Accounting ...

Princ. Based Accounting

-recent push to switch due to different industry types, talks of it in SOX...

GAAP is principals-based, but only at first)..

principals based means a conceptual basis for accountants to follow instead of a list of detailed rules.  list key objectives of good reporting with examples.

Specifically, during the 1980s, companies used leasing arrangements as a means of off–balance-sheet financing. In some instances, companies would buy a piece of equipment, sell it, and then lease it back to avoid recording an asset and a liability for the equipment. SFAS 13 requires that firms distinguish between operating and capital leases using four specific criteria: 1, 2, 3, 4?

Advantages to leasing...

Operational:

-leasing ready to use can be attractive

-leasing good when asset only needed seasonally

-leasing for short periods protects against obsolescnc

Financial: -pymts. can be tailored to leasee's C.Flow (up to 100% financing instead of 80% limit by banks)

-properly structure leases may be off-balance sheet, avoiding bondholders restrictions on taking on debt

-leasing provides tax advt. from acc.depr.& int. exp..

Disadvantages to lessee:

-leased ready-to-use may be lower quality

-premium for obsol. protection

Disadvantages to financial statement users:

-off-balance sheet financing hides the true leverage of firm (see bookmarks on cpu for nyu sloan analysi

An accounting method that measures the performance and position of a company by 1:(revenue recognition)recognizing economic events regardless of when cash transactions occur. The general idea is that economic events are recognized by 2:(the matching principle) matching revenues to expenses at the time in which the transaction occurs rather than when payment is made (or received). This method allows the current cash inflows/outflows to be combined with future expected cash inflows/outflows to give a more accurate picture of a current fin. position (companies w/ inventory must use accrual)

  why the switch from cash acc.? Selling on credit and projects that provide revenue streams over a long period of time affect the company's financial condition at the transaction point. i.e. tv is purchased on credit has impact on financial position.  thus, revenue recognized when tv shipped(booked in sellers A.R.)" 3:(allocation) many costs not specifically associated with a product must be allocated over fiscal periods in reasonable fashion.  i.e. each insurance policy ea. period

Rules

and

Rulemakers

Ch. 2

The Balance Sheet

 (snapshot of today)

                    basic def. on back....

basic equation:

what you have - what you owe = your worth

 Assets - liabilities = shareholder's equity (aka owner's equity aka worth aka net worth aka value of company belonging to its owners)

if you add an asset, you must increase right side by adding a liability or increasing shareholders equity)

Balance Sheet Format

 (matchup for C.A. and C.L)

Assets

(what are they, groups)

Balance sheet

-snapshot-

what assets a company controls, and what claims against exist assets

 *Classified according to liquidity—how close is it to being converted to cash

Assets
a probable future economic benefit obtained or controlled by a particular entity as a result of a past transaction or event. 

3 characteristics:

1) capacity to contribute directly/indirectly to future cash flows.

2)The entity can control access to the benefit; and,

3) The transaction or event giving rise to the entity's right to, or control of, the benefit has already occurred