11

FinancialStatementsandBusiness Decisions
Chapter1
Financial Accounting ACC1002X Lecture 1 Semester 2 of Academic Year 2011/2012

WhatisAccounting?
Accounting is the language of business
Managers (internal decision makers)

Reports information to decision makers

Collects and processes financial information

Investors and Creditors (external decision makers)

2

12

WhoCaresaboutAccounting?
Accountinginformationisusefultoanyonemaking decisionsthathaveeconomicconsequences.

Management Employees CustomersandSuppliers CreditorsandInvestors(Shareholders) GovernmentRegulatoryAgencies TaxingAuthorities

3

WhydoYOUcare?
Top3Reasonstolearnaccounting:
Tobeanaccountant Togetajobinbusiness Toinvestinthestockmarketorotherventures

13

HowDoesAccountingWork?
Accountinginformationhelpsdecisionmakersby
showingwhereandwhenacompanyspendsmoney evaluatingfinancialperformance helpingpredictthefutureeffectsofdecisions

Business event

Analyze, measure and record

Financial Reports

Users

HowDoesAccountingWork?

14

TheAnnualReport
Mostcommonsourceoffinancialinformationfordecisionmakers outsidethecompany Componentsoftheannualreportinclude: Descriptionofthebusiness Managementsdiscussionandanalysis(MD&A) Reportfromindependentauditor FinancialStatements
BalanceSheet IncomeStatement StatementofCashFlows StatementofRetainedEarnings Notes
7

TheFourBasicFinancialStatements
1. BALANCESHEET reportstheamountofresourcesabusinessentity ownsandobligationsitowestooutsidersatonepointintime. 2. INCOMESTATEMENT reportstherevenuesgeneratedandthe expensesincurredduringtheaccountingperiod. 3. STATEMENTOFRETAINEDEARNINGS reportstheportionofnet incomethecompanyretains(orkeepsforuseinthebusiness) duringtheaccountingperiod. 4. STATEMENTOFCASHFLOWS reportsinflowsandoutflowsofcash duringtheaccountingperiod inthecategoriesofoperating, investing,andfinancing.
8

15

BalanceSheet
TypicalAccountTitles

Assets Cash Short-Term Investment Accounts Receivable Notes Receivable Inventory (to be sold) Supplies Prepaid Expenses Long-Term Investments Equipment Buildings Land Intangibles

Liabilities Accounts Payable Accrued Expenses Notes Payable Taxes Payable Unearned Revenue Bonds Payable Stockholders Equity Contributed Capital Retained Earnings
9

TheAccountingEquation

10

16

BalanceSheet
Sole-Man Shoe Repair, Inc. Balance Sheet As of December 31, 2010 (in dollars) Assets Cash Accounts Receivable Plant and Equipment, net Land $ 815 300 700 100 Liabilities Wages Payable $ Tax Payable Long-term debt Total Liabilities 90 166 450 706

Stockholders' Equity Contributed Capital 1,000 Retained Earnings 209 Total S.E. 1,209 Total Assets $ 1,915 Total Liab & S.E. $ 1,915

11

IncomeStatement
TypicalAccountTitles

Revenues Sales Revenue Fee Revenue Interest Revenue Rent Revenue

Expenses Cost of Goods Sold Wages Expense Rent Expense Interest Expense Depreciation Expense Advertising Expense Insurance Expense Repair Expense Income Tax Expense

12

17

IncomeStatement

Revenues Expenses +Gains Losses NetIncome

13

IncomeStatement
Sole-Man Shoe Repair, Inc. Income Statement For Year Ended December 31, 2010 (in dollars) Revenues Expenses Cost of Goods Sold Wage Expense Office Supplies Expense Gas Expense Depreciation Advertising Expense Other Expenses Total Expenses Pretax Income Income Tax Expense Net Income $ 2,000

200 505 120 250 200 200 50 1,525 475 166 309
14

18

StatementofRetainedEarnings
BeginningRetainedEarning Plus:NetIncome Less:Dividends EndingRetainedEarnings

15

StatementofRetainedEarnings
Sole-Man Shoe Repair, Inc. Statement of Retained Earnings For Year Ended December 31, 2010 (in dollars) Retained Earnings, January 1, 2010 Add: Net Income for the year Less: Dividends Retained Earnings, December 31, 2010 $ 309 309 (100) $ 209

16

19

StatementofCashFlows
Threemajorcomponents: Operatingactivities: Everyday businessactivitieswith customers,suppliersand employees InvestingActivities: Buyingor sellinglongtermassetsthatare usedtorunthebusiness(e.g., acquiringequipment) FinancingActivities:Companies raisefundsbyissuingstockand borrowingmoney;payingback loans

StatementofCashFlows
Sole-Man Shoe Repair, Inc. Statement of Cash Flows For Year Ended December 31, 2010 (in dollars) Cash flows from operating activities Cash collected from customers Cash paid to suppliers and vendors Cash paid to employees Cash paid for interest Cash paid for taxes Net cash flows from operating activities Cash flows from investing activities Cash paid to purchase plant, equipment, land Net cash flows from investing activities Cash flows from financing activities Cash proceeds from long-term debt Cash proceeds from stock issuance Cash paid for dividends Net cash flows from financing activities Total Change in Cash Cash at beginning of year Cash at end of year $ 1,700 (200) (415) (570) (50) 465

(1,000) $ (1,000) 450 1,000 (100) 1,350 815 815

18

$ $ $ $

110

RelationshipsAmongtheStatements

19

RelationshipsAmongtheStatements
1. Netincomefromtheincomestatementresults inanincreaseinendingretainedearningson thestatementofretainedearnings.

IncomeStatement Revenues $2,000 1,691 Expenses Netincome $309

StatementofRetainedEarnings Beginningretainedearnings $0 Netincome 309 Dividends (100) Endingretainedearnings $209

20

111

RelationshipsAmongtheStatements
2. Endingretainedearningsfromthestatementof retainedearningsisoneofthetwocomponents ofstockholdersequityonthebalancesheet.
StatementofRetainedEarnings Beginningretained earnings $0 Netincome 309 Dividends (100) Endingretainedearnings $209 BalanceSheet Cash Otherassets Totalassets Liabilities ContributedCapital Retainedearnings Totalliabilitiesand equity $815 1,100 $1,915 $706 1,000 209 $1,915

21

RelationshipsAmongtheStatements
3. Thechangeincashonthestatementofcash flowsisaddedtothebeginningofyearbalance incashtoarriveatendofyearcashonthe balancesheet.
StatementofCashFlows Cashflowsfromoperatingactivities $465 Cashflowsfrominvestingactivities (1,000) Cashflowsfromfinancingactivities 1,350 Changeincash $815 Beginningcashbalance Endingcashbalance 0 $815 BalanceSheet Cash Otherassets Totalassets Liabilities ContributedCapital Retainedearnings Totalliabilitiesandequity $815 1,100 $1,915 $706 1,000 209 $1,915
22

112

Notes
Allfinancialstatements shouldbeaccompanied bynoteswhichprovide thereaderwith supplementalinformation aboutthefinancial conditionandresultsof operationsofthe company.

23

UsersofFinancialStatements
Marketingmanagersandcreditmanagersuse customersfinancialstatementstodecidewhetherto extendcredit.

Purchasingmanagersusesuppliersfinancial statementstodecidewhethersuppliershavethe resourcestomeetthedemandforproducts.

Employeesunionandhumanresourcemanagersuse thecompanysfinancialstatementsasabasisfor contractnegotiationsoverpayrates.

24

113

AccountingRules
Generallyacceptedaccountingprinciples(GAAP)are therulesthatgovernhowaccountantsoperate Setbyregulatorsandvariesbycountry SingaporeFinancialReportingStandards(FRS)are basedoninternationalGAAP(IFRS) Theprimaryobjectiveoffinancialreportingisto provideinformationusefulformakinginvestmentand lendingdecisions! Relevance
Reliability
25

AccountingRules
UnitedStates Standards GenerallyAccepted AccountingPrinciples (GAAP) FinancialAccounting StandardsBoard(FASB) SecuritiesExchange Commission(SEC) International InternationalFinancial ReportingStandards (IFRS) International AccountingStandards Board(IASB) n.a. Singapore FinancialReporting Standards(FRS) [modeledonIFRS] AccountingStandards Committee(ASC) MonetaryAuthorityof Singapore(MAS); SecuritiesIndustry Council(SIC);SGX SingaporeExchange (SGX)(formerlythe StockExchangeof Singapore(SES))

Standards Setter Financial Markets Regulator Securities Exchanges

AMEX,NYSE,NASDAQ, ChicagoStockExchange, PhiladelphiaStock Exchange

n.a.

26

114

TypesofBusinessOrganizations
SoleProprietorship:ownedbyasingleindividual. Partnership:ownedbytwoormoreindividuals. Corporation:ownershiprepresentedbysharesofstock. AdvantagesofaCorporation Limitedliability Continuityoflife Easeoftransferofownership Opportunitytoraiselargeamountsofmoney DisadvantageofaCorporation Doubletaxation

Privatevs.PublicCorporations

PrivatelyownedCorporation
Ownedbyrelativelyfewindividuals;sharesin ownershiparenotsoldtothegeneralpublic.

PubliclyownedCorporation
Ownedbythepublic;sharesinownershiparesold tothepubliconastockexchange(SGX,NYSE, NASDAQ);firmcanhavemanythousandsof shareholders. Ownersareshareholders(stockholders,investors)
28

115

FinancialReportingRequirements
Publiccompaniesfilefinancialreportswithfinancial marketsregulators,quarterly(three10Qs)and/or annually(one10K).
InSingapore,onlytheannualreportisrequired

Beforefiling,afirmhasitsannualfinancialstatements audited,anditsquarterlyreportsreviewedby independentauditors. Publiclyavailableinformation:

Companywebsite(InvestorRelations) Companypressreleases,conferencecalls Regulators'websites.E.g.,www.sgx.com,www.sec.gov
29

ManagementResponsibilityandthe DemandforAuditing
Toensuretheaccuracyofthecompanysfinancialinformation, management: Maintainsasystemofcontrols. Hiresoutsideindependentauditors. Formsacommitteeoftheboardofdirectorstoreview thesetwosafeguards.

30

116

TheRoleofAccounting
Privateaccounting:Employedbyabusiness,governmentor nonprofitorganization
Preparingfinancialstatements InternalAudit/InternalControl Budgeting CostAccounting

Publicaccounting:Employedbyaccountingfirm
Auditing(AssuranceServices) TaxPreparation Consulting FinancialPlanning
31

CredibilityandIndependentAuditors
Auditors examineacompanystransactionsandthe resultingfinancialstatementsandprovideassurances aboutthecredibility ofthestatements. Theseassurancesshouldmaketheinvestorsmore comfortableaboutusingtheinformationtoguide theirinvestingactivity.

32

117

CredibilityandIndependentAuditors
Auditorsexpressanopinionas tothefairnessofthefinancial statements. Independentauditorshave responsibilitiesthatextendto thegeneralpublic. Auditorsmustfollowauditing standardssetbyanoversight board.

Overall, I believe these financial statements are fairly stated.

33

EthicalConsiderations
Accountingisnotanexactscience! Ethicalstandardsinaccountingaredesignedto produceaccurateinformationfordecisionmaking TheInstituteofCertifiedPublicAccountantsofSingapore (ICPAS)requiresthatallmembersadheretoaprofessional codeofethics Earningsmanagement misrepresentingfinancial informationtofinancialstatementusers,mostoften tomeetestablishedgoalsorbudgets
34

118

TodaysMainIdeas
Question
Whatisthecompanys financialpositionattheend oftheperiod? Howwelldidthecompany performduringtheperiod? Howdidthecompanys retainedearningschange duringtheperiod?

Answer
Assets=Liabilities+OwnersEquity Revenues Expenses =NetIncome BeginningR.E. +NetIncome Dividends =EndingR.E. Operatingcashflows +/ Investingcashflows +/ Financingcashflows =ChangeinCash

FinancialStmt Balance Sheet Income Statement Statementof Retained Earnings

Howmuchcashdidthe companygenerateand spendduringtheperiod?

Statementof CashFlows

ReviewProblem1
Assets=$90atthebeginningoftheyear Ownersequity=$15atthebeginningoftheyear Assetsincreased$30duringtheyear Liabilitiesdecreased$22duringtheyear Whatistheyearendbalanceinownersequity?

36

119

ReviewProblem2
Giventhefollowinginformation,computenetincome: Interestexpense 3,100 Revenue 110,000 Rentexpense 3,000 Wagesexpense 80,000 Suppliesexpense 4,000 Interestincome 7,100

37

ReviewProblem2(continued)

38

120

ReviewProblem3
FortheyearendedMay31,2006,Nike hadrevenuesof$14,955millionandtotal expensesof$13,563million.Nikes retainedearningswere$4,397millionat thebeginningoftheyearand$4,713 millionattheendoftheyear. 1. Computenetincomefortheyear. 2. Computedividendsfortheyear.
39

ReviewProblem3(continued)

40