2 nd session: Introduction to Accounting

1. 2nd session:Introduction to Accounting

2. Firm of the Day

3. Goal of Today’s Class • Understand the four financial statements. • Understand which business processes and transactions are reflected in each financial statement. • Understand how the four financial statements fit together.

4. Obtain Financing Balance Sheet Liabilities & Owner’s Equity Issue debt and stock Make Investments Balance Sheet Assets Purchase land, bldgs, inventory, etc. Conduct Operations Income Statement Revenues & Expenses, Net income Sell goods and services to customers Pay employees, suppliers, creditors Reporting Business Activities

5. Desirable Characteristics of Accounting FASB Concept Statement #2 (See Figure 2.1 of LLS)

6. Balance Sheet • Describes the financial position of the firm at a given point in time • Assets are • resources owned or controlled by the firm • Future economic benefits or rights that are owned or controlled by the firm • Liabilities are • a source of claim against the resources of the firm • Fixed and unavoidable obligations to transfer cash or some other good or service to an outside party at some future time Assets = Liabilities + Shareholders’ Equity

7. Balance Sheet – Cont’d • Shareholders’ Equity – another source of and claim against the resources of the firm • Shareholders' equity represents amounts invested in the firm by it’s owners, either: a) directly => when they purchase shares from the company (i.e., contributed capital); b) indirectly => when they allow the firm to retain its earnings rather than requiring that it paying them out in the form of dividends.

8. Remember the Mandatory Reports? All SEC-mandated reports are available on EDGAR at: http://www.sec.gov/edgar.shtml Firms also post reports on their investor relations sites

9. What does Consolidated mean? Why this date? Why is this an asset? Why is this an asset? What must this be equal to? Fiscal Year 2009 Report Which one is the largest asset?

10. Why are these liabilities? What must this be equal to? Fiscal Year 2009 Report

11. Income Statement • Describes the financial results of the firm’s operations over a period of time • Revenues represent resources (assets) acquired or obligations (liabilities) satisfied by the firm in exchange for the goods or services sold by the firm to others • Expensesrepresent assets used or liabilities incurred to generate revenue by selling goods and/or services to others Net Income = Revenues - Expenses

12. Why the reference? Why are these expenses reported separately? What’s in either of them? Fiscal Year 2009 Report

13. Fiscal Year 2009 Report

14. Fiscal Year 2009 Report How much was the expense for employee stock compensation?

15. Fiscal Year 2009 Report • Bottom line: • primary statements are of limited use • footnotes contain the bulk of the details

16. Fiscal Year 2009 Report How much merchandise did Best Buy purchase during FY 2009? Best estimate: COGS: $34,017 Ending Inventory:$4,753 No need to buy what came from Beginning Inventory: -$4,708 $34,017 + 4,753 – 4,708 = $34,062

17. Statement of Cash Flows • Describes the flow of cash in and out of the firm during a period of time Three categories on statement 1. Operating: activities carried out on a day to day basis to meet the goals of the company 2. Investing: activities carried out periodically that alter the firm’s infrastructure, enabling it to carry out the operating activities 3. Financing: activities carried out to obtain (and repay) funds used in the other activities

18. Where does this number come from? Fiscal Year 2009 Report How were these 1.9 billion dollars used?

19. Where else can we find these numbers? Fiscal Year 2009 Report Check the Balance Sheet:

20. Statement of Shareholders’ Equity • Describes the amounts and changes in the components of the shareholders’ investment in the firm • Retained earnings provide a reconciliation between the income statement and the balance sheet

22. Fiscal Year 2009 Report

23. Balance sheet - Outline • Define • Assets • Liabilities • Shareholders’ Equity • Valuation • Balance sheet classification

24. The Balance Sheet • A “snap shot” of the investing and financing activities of a firm at a point in time. • Assets: economic resources that are expected to provide future economic benefits. • Liabilities: creditors’ claims on the assets of the firm. • Equity: owners’ claims on the assets of the firm. Assets = Liabilities + Equity

25. The Accounting Identity • Equates economic resources to the claims on those resources • Equity holders are the residual claimants: A – L = E Assets = Liabilities + Equity

26. Balance Sheet • Reports the financial condition of the firm at a given point in time • Assets = Liabilities + Shareholders’ Equity • Resources = Finances • Core financial statement • Other financial statements provide details of the changes in components of the balance sheet

27. Assets • A resource or right to future benefits • Must satisfy three conditions to be included in the balance sheet • Capacity to increase cash inflows or reduce cash outflows • Entity must be able to obtain the benefits and control others’ access to the benefits • Transaction must have occurred in the past. Probable and measurable future economic benefits controlled by an entity as a result of past transactions

28. Types of Assets • Tangible assets • Merchandise inventory • Property, plant and equipment • Monetary and financial assets • Accounts receivable • Marketable securities • Intangible assets • Patents • Trade name

29. Liabilities • Obligation to produce or transfer a good, or deliver a service in the future, in return for benefits received in the past • Claims against assets of the business • Accounts payable • Income taxes payable • Bonds payable • Pensions and other post-retirement benefits

30. Shareholders’ Equity (Owners’ or Stockholders’ Equity) • Amount invested in the company by owners either directly or indirectly • Residual interest in the assets of the firm after deducting the liabilities Contributed capital Retained earnings Beginning Retained Earnings + Net Income - Dividends (Declared) = Ending Retained Earnings

31. Exercise I – Fill in the gaps $34,338 $30,484 (1,050) 4,787 1,086 30,484

32. Balance Sheet Equation Assets – Liabilities = Shareholders’ Equity = Contributed Capital + R(etained) E(arnings) = Contributed Capital + REbeginning of period + Net Income – Dividend = Contributed Capital + REbeginning of period + Revenues – Expenses – Dividend

33. Valuation • Assets All assets are designed to provide future benefits (i.e., increase cash flow), but not all future benefits are recorded as assets • Because some future benefits involve a great deal of uncertainty, they may not be recorded as assets • This reflects a tradeoff between the relevance and reliabilityof accounting information • Because the historical cost of the asset is so reliable, it is frequently used to value the asset on the balance sheet, even though it may not be the most relevant measure of value

34. Valuation – Cont’d • Historical (original) cost – this is what we generally use. • Three exceptions • Inventory – lower of cost or market (Asymmetric) • Long-term asset impairments (Asymmetric) • Marketable securities (Symmetric)

35. Valuation – Cont’d • Liabilities • Present value of the cash outflows that will be made to satisfy the obligation • Shareholders’ Equity • Indirect – depends on how assets and liabilities are valued. Shareholders’ Equity = Assets – Liabilities

36. Balance Sheet Classification • Assets • Current Assets • Investments • Other Assets • Liabilities • Current Liabilities • Non-current (Long-term liabilities) • Shareholders’ Equity • Contributed capital • Retained earnings

37. Next Class… • Balance Sheet Concepts • The Accounting Process • Debits, Credits, and T-Accounts