Module 2 notes

Module 2 notes - Module 2 Introducing the Fin Statements...

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Unformatted text preview: Module 2 Introducing the Fin Statements, and Transaction analysis. Start by looking at Flow of Costs Flow And what are the four main financial statements? Balance Sheet Income Statement Statement of Stockholders Equity Statement of Cash flows Balance Sheet Balance • Mirrors the Accounting Equation Mirrors Assets = Liabilities + Equity Assets Uses of funds = Sources of funds Uses • • • Assets are listed in order of liquidity Liabilities are listed in order of maturity Equity consists of Contributed Capital Equity and and Retained Earnings Retained Assets Assets To be reported on a balance sheet, an asset must 1. Be owned (or controlled) by the company Be 2. Must possess expected future economic Must benefits benefits Assets are listed in order of liquidity • • Current assets comprise assets that can be Current converted to cash within a year converted Long-term assets cannot be easily converted Long-term to cash within a year. to Examples of Current Assets Examples • Cash—currency, bank deposits, and investments with an original maturity of 90 days or less (called cash equivalents); • Marketable securities—short-term investments that can be quickly sold to raise cash; • Accounts receivable, net—amounts due to the company from customers arising from the sale of products and services on credit (“net” refers to uncollectible accounts explained in Module 6); • Inventory—goods purchased or produced for sale to customers; • Prepaid expenses—costs paid in advance for rent, insurance, advertising or other services. Examples of Long-term Assets Examples • Property, plant and equipment (PPE), net—land, —land, factory buildings, warehouses, office buildings, machinery, motor vehicles, office equipment and other items used in operating activities (“net” refers to subtraction of accumulated depreciation, the portion of the assets’ cost that has been transferred from the balance sheet to the income statement, which is explained in Module 6); explained • Long-term investments—investments that the —investments company does not intend to sell in the near future; company • Intangible and other assets—assets without physical —assets substance, including patents, trademarks, franchise rights, goodwill and other costs the company incurred that provide future benefits. that Assets are Reported at Historical Cost Historical • Historical Cost is – Objective – Verifiable • “Relevance vs. Reliability” • Only include items that can be reliably Only measured. measured. – Considerable amount of “assets” may not be Considerable reflected on a balance sheet reflected – Strong management team, a well-designed Strong supply chain, or superior technology. supply Knowledge Based Assets are not Reflected on the Balance Sheet Reflected • NOTE: While resources expended for research While and development reflect and economic asset, they generally are expensed as incurred. • INSIGHT: Pharmaceutical firms do not have Pharmaceutical assets reflecting the full amount of money that they have spent developing drugs. These amounts, for the most part, have been expensed in the past and serve to reduce retained earnings. Internally developed trade marks are also economic assets, but may not show up on the balance sheet. [The purchase of externally developed trademarks are treated as assets.] developed Examples of Current Liabilities Examples of • Accounts payable—amounts owed to suppliers for goods and services purchased on credit. • Accrued liabilities—obligations for expenses that have been incurred but not yet paid; examples are accrued wages payable (wages earned by employees but not yet paid), accrued interest payable (interest that is owing but has not been paid), and accrued income taxes (taxes due). • Unearned revenues—obligations created when the company accepts payment in advance for goods or services it will deliver in the future; also called advances from customers, customer deposits, or deferred revenues. • Short-term notes payable—short-term debt payable to banks or other creditors. • Current maturities of long-term debt—principal portion of longterm debt that is due to be paid within one year. NET WORKING CAPITAL = CURRENT ASSETS – CURRENT LIAB Operating cycle • Cashpurchases of (on acct??) • Inventorysales (acct receivable) • Collect and pay cash Examples of Noncurrent Liabilities Examples of • Long-term debt—amounts borrowed from creditors that are scheduled to be repaid more than one year in the future; any portion of long-term debt that is due within one year is reclassified as a current liability called current maturities of long-term debt. Long-term debt includes bonds, mortgages, and other long-term loans. • Other long-term liabilities—various obligations, such as pension liabilities and long-term tax liabilities, that will be settled a year or more into the future. We discuss these items in later modules. Equity Equity Equity consists of: – Contributed Capital (cash raised from the Contributed issuance of shares) issuance – Earned Capital (retained earnings). Earned Retained Earnings is updated each period as follows: as Examples of Equity Accounts Examples Accounts • Common stock—par value received from the original sale of common stock to investors. • Preferred stock—value received from the original sale of preferred stock to investors; preferred stock has fewer ownership rights compared to common stock. • Additional paid-in capital—amounts received from the original sale of stock to investors in addition to the par value of common stock. • Treasury stock—amount the company paid to reacquire its common stock from shareholders. • Retained earnings—accumulated net income (profit) that has not been distributed to stockholders as dividends. • Accumulated other comprehensive income or loss— accumulated changes in equity that are not reported in the income statement (explained in Module 9). Income Statement Income When are Revenues and Expenses Recognized? Recognized? • Revenue Recognition Principle— recognize revenues when earned • Matching Principle—recognize expenses when incurred. Profit vs. Cash Profit • Net Income does not necessarily correspond to a net Net cash flow. A firm could have “good income” but “poor cash flow” or vice versa (i.e., there are two dimensions to consider). consider). • We have previously summarized the mechanics of the We balance sheet with the expanded accounting equation: balance Permanent: Operating vs. Nonoperating and Transitory Income items Transitory Permanent • Operating expenses are the usual and customary costs that a company incurs to support its main business activities activities • Nonoperating expenses relate to the company’s financing and investing activities financing Transitory • Discontinued operations Gains or losses (and net income or loss) from business segments that are being sold or have been sold in the current period. • Extraordinary items Gains or losses from events that are both unusual and infrequent. Accrual Accounting Accrual Accrual accounting refers to Accrual 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). cash). Statement of Stockholders’ Equity Statement • Statement of Equity is a reconciliation Statement of the beginning and ending balances of stockholders’ equity accounts. of • Main equity categories are: – Contributed capital – Retained earnings (including Other Retained Comprehensive Income or OCI) Comprehensive – Treasury stock Statement of Cash Flows Statement • Statement of cash flows (SCF) reports cash Statement inflows and outflows inflows • Cash flows are reported based on the three Cash business activities of a company: business – Cash flows from operating activities - Cash flows Cash from the company’s transactions and events that relate to its operations. relate – Cash flows from investing activities - Cash flows Cash from acquisitions and divestitures of investments and long-term assets. long-term – Cash flows from financing activities- Cash flows Cash from issuances of and payments toward borrowings and equity. and Relation of SCF to Income Statement and Balance Sheet Statement General Coding of Balance sheet Changes Balance Articulation of Financial Statements Articulation • Financial statements are linked within Financial and across time – they articulate. articulate • Balance sheet and income statement Balance are linked via retained earnings. are Recording transactions – Pay $100 Wages in Cash Pay • Cash assets are reduced by $100, and wage expense of $100 is reflected in the income statement, which reduces income and retained earnings by that amount. • All transactions incurred by the company during the accounting period are recorded similarly. Adjusting Accounts Adjusting Prepaid Rent; wage accrual Prepaid Accrual of Revenue Accrual Exercise: The Ice Cream Store, Inc. Exercise: The Ice Cream Store, Inc. incurred the following start-up costs: costs: 1. The Ice Cream Store, Inc. was formed on October 1, The 20XX, with the investment of $90,000 in cash by the owners. 2. Obtained a bank loan and received the proceeds of 2. Obtained $35,000 on October 2. The cash will be used for operations. 3. Purchased equipment for $25,000 cash on October 2. 3. Purchased 4. Acquired a building at a cost of $80,000. It was 4. Acquired financed by making a $20,000 down-payment and obtaining a mortgage for the balance. The transaction occurred on October 2. 5. On October 2, the President of the United States 5. On publicly declared that she will eat (and plug) our ice our cream while entertaining guests in the White House. Balance Sheet Transaction 1. The Ice Cream Store, Inc. was formed on October 1, 20XX, with the investment of $90,000 by the owners. Income Statement + Contrib. capital +90 Cash Asset +90 + Noncash Assets = Liabi -lities + Retained Earnings Revenues – Expenses 2. Obtained a bank loan and received the proceeds of $35,000 on October 2. The cash will be used for operations. +35 +35 N/P 3. Purchased equipment for $25,000 cash on October 2. 4. Acquired a building at a cost of $80,000. It was financed by making a $20,000 downpayment and obtaining a mortgage for the balance. The transaction occurred on October 2. -25 +25 Equip +80 Bldg. +60 M/P -20 5. The President of the United States agreed to eat (and plug) our ice cream while entertaining guests in the White House on Oct. 2. ASSETS Cash $80,000 25,000 80,000 $185,000 Equipment Building Total Assets LIABILITY AND STOCKHOLDERS' EQUITY Liabilities: Note Payable Mortgage Payable Total Liabilities Stockholders Equity: Capital Stock Total Liabilities and Stockholders Equity $185,000 90,000 $35,000 60,000 95,000 Ice Cream Shop Balance Sheet: Ice Cream Shop – additional transactions additional 1. On October 4, purchased merchandise inventory (i.e., ice cream) at On a cost of $15,000 by paying $5,000 cash and receiving short-term credit for the remainder from the supplier. 2. Immediately returned some of the ice cream because some of the 2. Immediately flavors delivered were not ordered. The cost of the inventory returned was $3,000. returned 3. Sales of ice cream for the month of October, 20XX, totaled $8,000. Sales All sales were for cash. The ice cream cost $3,500. 4. For all of October, total employee wages and salaries earned/paid 4. For were $3,000. were 5. As of the end of October, one month's depreciation on the As equipment and building was recognized -- $383 for the building and $167 for the equipment. $167 6. $450 interest expense on the note and mortgage was due and paid $450 on October 31. Assume that the principal amounts ($35,000 + $60,000) of the note and mortgage remain unchanged. $60,000) Prepare a transaction analysis of 6. -11. using the balance Prepare sheet/income statement template presented above: Balance Sheet Transaction Cash Asset + Noncash Assets = Liabilities + Contrib. capital + Retained Earnings Income Statement Revenues – Expenses 6. 7. 8. 9. 10. -5 +15 Inv. -3 Inv. +10 A/P -3 A/P +4.5 -3 -.550 +8 Sales -3.5 COGS -3 Wage exp. -.550 Dep. exp. +8 -3 -3.5 Inv. . - .383 Bldg., net -.167 Equip., net 11. -.450 -.450 -.450 Int. Exp. Prepare the following financial statements (ignore income taxes): (i) an updated Balance Sheet as of October 31, 20XX; and (ii) an Income Statement for the month of October 20XX. Cash ($80,000 -5,000 +8,000 -3,000 -450) Merchandise Inventory ($0 + 15,000 -3,000 -3,500) Equipment ($25,000 ) Less: Accumulated Depreciation Building ($80,000) Less: Accumulated Depreciation Total Assets $79,550 8,500 25,000 (383) 80,000 (167) $192,500 Accounts Payable ($0 + 10,000 – 3,000) Note Payable ($35,000 principal is unchanged) Mortgage Payable (60,000 principal is unchanged) Stockholders' Equity: Capital Stock Retained Earnings Total Liabilities and Stockholders' Equity $7,000 35,000 60,000 102,000 90,000 500 90,500 $192,500 REVENUES: Sales of Ice Cream Cost of Sales GROSS PROFIT: Payroll Expense Depreciation Expense INCOME FROM OPERATIONS Interest Expense NET INCOME Note: Assume no income taxes. $8,000 3,500 4,500 3,000 550 950 450 $500 Additional Sources of Information Information • Form 10-K – Item 1, Business; Item 1A. Risk Factors; – Item 2, Properties; – Item 3, Legal Proceedings; – Item 4, Submission of Matters to a Vote of Security Holders; – Item 5, Market for Registrant’s Common Equity and Related Stockholder Matters; – Item 6, Selected Financial Data; – Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations; – Item 7A, Quantitative and Qualitative Disclosures About Market Risk; – Item 8, Financial Statements and Supplementary Data; – Item 9, Changes in and Disagreements With Accountants on Accounting and Financial Disclosure; – Item 9A, Controls and Procedures. • Form 8-K Additional Sources of Information Information – Entry into or termination of a material definitive agreement (including petition for bankruptcy) – Exit from a line of business or impairment of assets – Change in the company’s certified public accounting firm – Change in control of the company – Departure of the company’s executive officers – Changes in the company’s articles of Credit and Data Services Credit • Analyst reports – on line or in person – Yahoo and google et – If you have an on-line or in person trading firm like Ameritrade or Charles Schwa b Credit Analysis – Standard & Poor’s ( – Moody’s Investors Service ( – Fitch Ratings ( Data Services – Thomson Corporation ( • First Call - summary of analysts’ earnings forecasts • Compustat database - individual data items for all publicly traded companies or for any specified subset of companies. • • ...
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This note was uploaded on 03/02/2010 for the course ACCT 6015 taught by Professor Satin during the Fall '09 term at CSU East Bay.

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