Financial Statement Literacy: The Story Behind the Numbers OR: Why Accounting really is the most fascinating topic you will ever study

Objectives of Financial Statement Reporting: To provide information… Useful to present and potential investors, creditors, and other users for decision-making To help assess amounts, timing, and uncertainty of prospective cash flows (interest/dividends, liquidation) About economic resources of an enterprise, claims on those resources, and the effects of transactions, events, and circumstances that change these resources and claims to them

The Economic Resources of an Enterprise Assets  Fairly liquid – current  Long term - productive capacity that supports more than one year of operating activity In total these are the resources management has available for its use in operations to accomplish the goals of the organization

Claims on Those Resources Liabilities – borrowed funds  Also segregated between current and long-term based on whether satisfying the underlying obligation will require cash outflows within the next operating cycle, or beyond Equity – contributions of owners  There is no repayment obligation to owners This investment risk is undertaken with anticipation of superior returns Equity also includes income earned and retained by the firm

Fundamental Accounting Equation Assets = The resources available to the firm for current and ongoing operations What do we have? Liabilities + Equity Borrowed, contributed, and earned financing for firm resources Where did we get it?

The Balance Sheet and its Supporting Schedules Income Statement - explains in greater detail the major source of changes in one Balance Sheet account - Retained Earnings Statement of Cash Flows - explains in greater detail the changes of one Balance Sheet account - Cash Statement of Stockholders’ Equity - explains in greater detail changes of one section of the Balance Sheet - Equity

Effects of Transactions That Change Those Resources

Sources of Complexity in Accounting Many transactions are other than exchange of goods/services for specified cash amounts  On what basis should these be valued? Current market value? Should these be adjusted at the end of the accounting period if market value changes (investments in equity securities, for example)? Future cash flows? When cash exchange is far in the future (30 year bonds, for example) is the future cash exchange amount a meaningful value for use today?

Complex, but…Controversial? Intense corporate lobbying to get ‘favorable’ standards  Mostly that means discretionary choices New business transactions always evolving  Substance over form is the goal Prescriptive rules versus conceptual principles  Interesting international differences