Lecture

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Financial Accounting and Financial Statements

Overview Financial Accounting

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Whats Accounting?
Accounting is business language
An information system that collects and summarizes a firms firm s economic activities Then reports those processed information to users

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The accounting process

Economic activities

Accounting links decision makers k with ith economic activities and with the results of their decisions. decisions
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Accounting information

Actions (d i i (decisions) )

Wh Accounting Why A ti i is needed? d d?

Different users need different information
Stockholders: profitability Debtholders: ability to repay interest, liquidity Plant managers: cost allocation Top management: profitability, financial position Board of directors: overall performance p Government: taxable income

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T Types of f Accounting A ti Information I f ti

Financial Accounting
Financial information produced that primarily used by external users, such h as ( (potential) t ti l) i investors, t d debtholders, bth ld and d regulators l t

Managerial Accounting
Financial information produced that used by internal users within a firm, such as plant managers and top management

T Accounting Tax A ti
Financial information produced that used to fulfill obligations for tax or regulatory agencies
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Financial Accounting
Since Accounting g is an information system y
Who sets the rules to run this system?
Financial Accounting Standard Board (FASB) Rules are called Generally Accepted Accounting Principles (GAAP)

Who should comply with GAAP?

Company/Corporations

Inputs to the system: economic transactions Outputs to the system: financial statements To ensure the system to be consistent with GAAP
Auditors A dit and di internal t l control t l mechanism h i i in place l
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Financial Statements

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Financial Statements
Financial Fi i l St Statements t t include: i l d
Balance Sheet (Statement of Financial Position) Income Statement Statement of Cash Flows Statement of Owners Equity Statement of Retained Earnings

Frequency: annual or quarterly

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Balance Sheet
It reports the financial positions (assets, liabilities and owners equity) of a firm at a particular point of time) Elements of the balance sheet include assets assets, liabilities, and owners equity. Assets = Liabilities + Owners Equity
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Balance Sheet
Assets: the economic resources owned or controlled by the firm (cash, accounts receivable, inventory, buildings, patent)
Current Assets: cash and other assets that can be converted to cash within a year, e.g. cash, accounts receivable and inventory. Noncurrent assets: assets to be used or turned into cash beyond a year (notes receivable, buildings, land and patent)
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Balance Sheet
Liabilities Liabilities: probable debts or obligations that will ill be paid for with assets or services (accounts payable tax payable payable, payable, unearned revenue revenue) )
Current liabilities: obligations expected to be satisfied by cash or services rendered within a year (accounts payable, tax payable) Long Long-term term liabilities: liabilities debts or obligations to be paid beyond a year (bank loan, bond payable)

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Balance Sheet
Owners equity: the owners claims on the assets (net assets) of the firm:
Common stock: face value of issued common stocks Additional p paid-in capital: p the difference between face value and the market value of common stocks when issued Retained earnings: the amount of accumulated net income (earnings) that have not been distributed to owners owners.
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Income Statement
It reports t the th amount t of f net t income i (revenue ( minus expenses) earned by a firm during a period of time Elements of the income statement include revenue, expenses and net income Revenue Expenses = Net Income (loss)

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Income Statement
Revenue: Increase in the firms resources from the sale of goods or services (e.g. sales revenue). revenue) Expenses: Costs incurred in the normal course of running the firm to generate revenues (e.g. cost of goods sold, salary) Net income (earnings): the excess of total revenues over total expenses p
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Statement of Cash Flows

It reports the amount of cash collected and paid out by a firm during a period of time Elements include cash flows from operating, financing and investing activities Cash (Beg. Balance) + Changes in Cash Flows from operating operating, financing and investing activities = Cash (End. Balance)
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Statement of Retained Earnings

It reports the way net income and the distribution of dividends affect retained earnings of a firm during a period of time Elements include retained earnings (beginning and ending balances), net income, and dividends R/E (Beg) + N/I Dividends = R/E (End)
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Notes to the Financial Statements

Details of each line item (summary numbers) in th fi the financial i l statements t t t Example: Property, Plant and Equipment (PPE)
Straight-line method and estimated useful lives of PPE (2 (2-7 7 years for equipment and 30 30-40 40 years for buildings)

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Underlying Assumptions and Accounting Principles Balance Sheet:

Cost principle: requires assets to be recorded at their historical costs or exchange prices at the transaction date Going concern assumption: businesses are assumed to continue to operate in the foreseeable future Objective principle
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Underlying Assumptions and Accounting Principles Income Statement:

Revenue recognition principle: revenues should s ou d be recognized ecog ed when e 1) ) goods o or services have been delivered or substantially completed and 2) cash has either been collected or collection is reasonably assured Matching principle: all costs and expenses incurred in generating revenues must be recognized in the same reporting period as the related revenue
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Articulation of the Financial Statements

1. Net income affects the ending balance of retained earnings 2. Ending balance of retained earnings is part of elements of owners equity on the balance sheet 3 Ending balance of cash from the statement of 3. cash flows appear under current assets on the balance sheet
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NUS Corporation Statement of Cash Flows For the Year Ended December 31, 2008 C h Fl Cash Flows f from O Opearing i A Activities ti iti Cash Flows from Financing Activities Cash Flows from Investing Activities Changes in Cash Flows Cash (Beg. Balance) Cash (End. (End Balance) $ XXX XXX XXX $XXX $XXX $XXX

NUS Corporation Balance Sheet At December 31, 2008 Assets Current Assets Cash $XXX XXX Liabilities Current Liabilities Accounts Payable Tax Payable $XXX XXX

Accounts Receivable Inventory Prepaid Insurance Expenses Total Current Assets Noncurrent Assets Property, Plant and Equipment Goodwill Total Noncurrent Assets T Total l Assets A

XXX Long-term Liabilities XXX Bond Payable XXX $XXX

$XXX Total Liabilities Owners' Equity XXX XXX Common Stock Retained Earnings

XXX XXX $XXX $XXX

$XXX Total Owners' Equity $XXX Total T l Liabilities i bili i & Owners' O ' Equity E i

NUS Corporation Income Statement For the Year Ended December 31, 2008 Revenue: Sales Revenue Total Revenue Expenses: Wage Expenses Utility Expenses Rent Expenses Total Expenses Net Income $XXX $XXX XXX XXX XXX $XXX $XXX

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NUS Corporation Statement of Retained Earnings F the For th Year Y ended d d December D b 31, 31 2008 Retained Earnings (Beg) Net Income Dividends Retained Earnings (End) $XXX XXX XXX $XXX

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Summary
Whats accounting acco nting and why h we e need it? Constituents of Balance Sheet, Income Statement, Statement of Cash Flows and Statement of Retained Earnings Assumptions and principles that are used to prepare financial statements statements. Articulation of financial statements
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