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Module02 - Module 2 Financial Statements and Transaction...

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Unformatted text preview: Module 2: Financial Statements and Transaction Analysis Four Main Financial Statements Balance Sheet Income Statement Statement of Stockholders' Equity Statement of Cash Flows Balance Sheet Assets = Liabilities + Equity Uses of funds = Sources of funds Mirrors the Accounting Equation Assets To be reported on a balance sheet, an asset must 1. Be owned or controlled by the company 2. Must possess expected future benefits Assets are listed in order of liquidity Current assets comprise assets that can be converted to cash within a year Longterm assets cannot be easily converted to cash within a year. Examples of Current Assets Cash Marketable securities Accounts receivable Inventory Prepaid expenses Examples of Longterm Assets Property, plant and equipment (PPE) Longterm investments Intangible and other assets Apple's Assets General Mills, Inc. Assets Assets are Reported at Historical Cost Historical Cost is "Relevance vs. Reliability" Fair Value is used where prices are readily determinable Objective Verifiable Flow of Costs NOTE: While resources expended for research and development reflect and economic asset, they generally are expensed as incurred. INSIGHT: Knowledge Based Assets are not Reflected on the Balance Sheet Pharmaceutical firms do not have 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.] Disney's Assets Where's Mickey? The market value of the Mickey Mouse trademark does not explicitly show up here. Liabilities Liabilities are listed in order of maturity Current Liabilities come due in less than a year. Noncurrent liabilities come due after a year. Examples of Current Liabilities Accounts payable Accrued liabilities Unearned revenues Shortterm notes payable Current maturities of longterm debt Examples of Noncurrent Liabilities Longterm debt Other longterm liabilities pension liabilities longterm tax liabilities Apple's Liabilities and Equity General Mills, Inc. Current Liabilities General Mills, Inc. Longterm Liabilities Net Working Capital Operating Cycle 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: Examples of Equity Accounts Common stock Preferred stock Additional paidin capital Treasury stock Retained earnings Accumulated other comprehensive income or loss General Mills, Inc. Stockholders' Equity Income Statement Apple's Income Statement General Mills, Inc. Income Statement When are Revenues and Expenses Recognized? Revenue Recognition Principle--recognize revenues when earned Matching Principle--recognize expenses when incurred. Profit vs. Cash Net Income does not necessarily correspond to a net cash flow. A firm could have "good income" but "poor cash flow" or vice versa (i.e., there are two dimensions to consider). We have previously summarized the mechanics of the balance sheet with the expanded accounting equation: Operating vs. Nonoperating Operating expenses are the usual and customary costs that a company incurs to support its main business activities Nonoperating expenses relate to the company's financing and investing activities Transitory Items in the Income Statement Transitory items Discontinued operations Gains or losses (and Discontinued operations 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 Extraordinary items events that are both unusual and infrequent. Accrual Accounting Accrual accounting refers to 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). 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 Apple's Statement of Stockholders' Equity 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: Cash flows from operating activities Cash flows from investing activities Cash flows from financing activities Apple's Statement of Cash Flows General Coding of Balance sheet Changes Articulation of Financial Statements Financial statements are linked within and across time they articulate. Balance sheet and income statement are linked via retained earnings. Apple's Retained Earnings Reconciliation Recording transactions 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 Accrual of Wages Exercise: The Ice Cream Store, Inc. The Ice Cream Store, Inc. incurred the following startup costs: 1. The Ice Cream Store, Inc. was formed on October 1, 20XX, with the investment of $90,000 in cash by the owners. 2. Obtained a bank loan and received the proceeds of $35,000 on October 2. The cash will be used for operations. 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. 5. On October 2, the President of the United States publicly declared that she will eat (and plug) our ice cream while entertaining guests in the White House. Prepare a transaction analysis of 1. 5. using the financial statement effects template: 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 1. 2. 3. 4. 5. 6. On October 4, purchased merchandise inventory (i.e., ice cream) at a cost of $15,000 by paying $5,000 cash and receiving shortterm credit for the remainder from the supplier. Immediately returned some of the ice cream because some of the flavors delivered were not ordered. The cost of the inventory returned was $3,000. Sales of ice cream for the month of October, 20XX, totaled $8,000. All sales were for cash. The ice cream cost $3,500. For all of October, total employee wages and salaries earned/paid were $3,000. As of the end of October, one month's depreciation on the equipment and building was recognized $383 for the building and $167 for the equipment. $450 interest expense on the note and mortgage was due and paid on October 31. Assume that the principal amounts ($35,000 + $60,000) of the note and mortgage remain unchanged. Prepare a transaction analysis of 6. 11. using the balance 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 Preparing the Financial Statements Balance Sheet and Income Statement Statement of Stockholders' Equity Form 10K 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. Additional Sources of Information Form 8K Additional Sources of 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 incorporation Credit and Data Services Credit Analysis Standard & Poor's (StandardAndPoors.com) Moody's Investors Service (Moodys.com) Fitch Ratings (FitchRatings.com) Data Services Thomson Corporation (Thomson.com) 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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