1. Slide 2-1 ECON 3A UCSB ANDERSON Financial Statements and the Annual Report Chapter 2

2. Slide 2-2 ECON 3A UCSB ANDERSON Objectives of Financial Reporting (a)PROVIDE USEFUL INFORMATION Financial reporting should provide information that is useful to present and potential investors and creditors and other users in making rational investment, credit, and similar decisions. The information should be comprehensible to those who have a reasonable understanding of business and economic activities and are willing to study the information with reasonable diligence. 1 (a)PROVIDE USEFUL INFORMATION Financial reporting should provide information that is useful to present and potential investors and creditors and other users in making rational investment, credit, and similar decisions. The information should be comprehensible to those who have a reasonable understanding of business and economic activities and are willing to study the information with reasonable diligence. 1 LO 1Describe the objectives of financial reporting. 1 Statement of Financial Accounting Concepts (SFAC) No. 1

3. Slide 2-3 ECON 3A UCSB ANDERSON Objectives of Financial Reporting (b)REFLECT INFORMATION ON CASH FLOWS Financial reporting should provide information to help present and potential investors and creditors and other users in assessing the amounts, timing, and uncertainty of prospective cash receipts from dividends or interest and the proceeds from the sale, redemption, or maturity of securities or loans. Since investors' and creditors' cash flows are related to enterprise cash flows, financial reporting should provide information to help investors, creditors, and others assess the amounts, timing, and uncertainty of prospective net cash inflows to the related enterprise. 1 (b)REFLECT INFORMATION ON CASH FLOWS Financial reporting should provide information to help present and potential investors and creditors and other users in assessing the amounts, timing, and uncertainty of prospective cash receipts from dividends or interest and the proceeds from the sale, redemption, or maturity of securities or loans. Since investors' and creditors' cash flows are related to enterprise cash flows, financial reporting should provide information to help investors, creditors, and others assess the amounts, timing, and uncertainty of prospective net cash inflows to the related enterprise. 1 LO 1Describe the objectives of financial reporting. 1 Statement of Financial Accounting Concepts (SFAC) No. 1

4. Slide 2-4 ECON 3A UCSB ANDERSON Objectives of Financial Reporting (c)REFLECT THE FINANCIAL POSITION OF THE ENTITY Financial reporting should provide information about the economic resources of an enterprise, the claims to those resources (obligations of the enterprise to transfer resources to other entities and owners' equity), and the effects of transactions, events, and circumstances that change its resources and claims to those resources. 1 (c)REFLECT THE FINANCIAL POSITION OF THE ENTITY Financial reporting should provide information about the economic resources of an enterprise, the claims to those resources (obligations of the enterprise to transfer resources to other entities and owners' equity), and the effects of transactions, events, and circumstances that change its resources and claims to those resources. 1 LO 1Describe the objectives of financial reporting. 1 Statement of Financial Accounting Concepts (SFAC) No. 1

5. Slide 2-5 ECON 3A UCSB ANDERSON ASSUMPTIONS Economic entity Going concern Monetary unit PeriodicityPRINCIPLES Historical cost Revenue recognition Matching Full disclosure CONSTRAINTSCost-benefitMateriality Industry practice Conservatism OBJECTIVES 1. Useful in investment and credit decisions QUALITATIVE CHARACTERISTICS RelevanceReliabilityComparabilityConsistencyELEMENTS Assets, Liabilities, and Equity Investments by owners Distribution to owners Comprehensive income Revenues and Expenses Gains and Losses Conceptual Framework for Financial Reporting 2. Useful in assessing future cash flows 3. About enterprise resources, claims to resources, and changes in them LO 2Describe the qualitative characteristics of accounting information.

6. Slide 2-6 ECON 3A UCSB ANDERSON ASSUMPTIONS Economic entity Going concern Monetary unit PeriodicityPRINCIPLES Historical cost Revenue recognition Matching Full disclosure CONSTRAINTSCost-benefitMateriality Industry practice Conservatism QUALITATIVE CHARACTERISTICS RelevanceReliabilityComparabilityConsistency Relevance and Reliability Conceptual Framework for Financial Reporting Verifiability Verifiability Representational faithfulness Representational faithfulness Neutrality Neutrality Verifiability Verifiability Representational faithfulness Representational faithfulness Neutrality Neutrality OBJECTIVES 1. Useful in investment and credit decisions 2. Useful in assessing future cash flows 3. About enterprise resources, claims to resources, and changes in them Capable of making a difference in a decision. LO 2Describe the qualitative characteristics of accounting information.

7. Slide 2-7 ECON 3A UCSB ANDERSON FUNDAMENTALS OF GAAP Consistency/ Comparability: All companies for all periods account for things the same Consistency/ Comparability: All companies for all periods account for things the same Monetary Unit: Only items which can be expressed in money are reflected Monetary Unit: Only items which can be expressed in money are reflected Economic Entity: The entity can be separated. Economic Entity: The entity can be separated. Time Period/ Periodicity: At least annually Time Period/ Periodicity: At least annually Historical Cost: Items are reported at their cost and depreciated if appropriate… but changes in value are excluded. Historical Cost: Items are reported at their cost and depreciated if appropriate… but changes in value are excluded. Going Concern: Entity will continue in existence for the foreseeable future. This is why historical cost is acceptable… if there is no going concern, then liquidation basis may be appropriate. Going Concern: Entity will continue in existence for the foreseeable future. This is why historical cost is acceptable… if there is no going concern, then liquidation basis may be appropriate.

8. Slide 2-8 ECON 3A UCSB ANDERSON Relevance and reliability are the two primary qualities that make accounting information useful for decision making. True or False? TrueTrue Qualitative Characteristics LO 2Describe the qualitative characteristics of accounting information.

9. Slide 2-9 ECON 3A UCSB ANDERSON ASSUMPTIONS Economic entity Going concern Monetary unit PeriodicityPRINCIPLES Historical cost Revenue recognition Matching Full disclosure CONSTRAINTSCost-benefitMateriality Industry practice Conservatism QUALITATIVE CHARACTERISTICS RelevanceReliabilityComparabilityConsistencyELEMENTS Assets, Liabilities, and Equity Investments by owners Distribution to owners Comprehensive income Revenues and Expenses Gains and Losses Comparability and Consistency Conceptual Framework for Financial Reporting OBJECTIVES 1. Useful in investment and credit decisions 2. Useful in assessing future cash flows 3. About enterprise resources, claims to resources, and changes in them LO 2Describe the qualitative characteristics of accounting information.

10. Slide 2-10 ECON 3A UCSB ANDERSON Qualitative Characteristics LO 2Describe the qualitative characteristics of accounting information. Adherence to the concept of consistency requires that the same accounting principles be applied to similar transactions by all companies and for all periods? True or False? TRUETRUE

11. Slide 2-11 ECON 3A UCSB ANDERSON ASSUMPTIONS Economic entity Going concern Monetary unit PeriodicityPRINCIPLES Historical cost Revenue recognition Matching Full disclosure CONSTRAINTSCost-benefitMateriality Industry practice Conservatism QUALITATIVE CHARACTERISTICS RelevanceReliabilityComparabilityConsistencyELEMENTS Assets, Liabilities, and Equity Investments by owners Distribution to owners Comprehensive income Revenues and Expenses Gains and Losses Conceptual Framework for Financial Reporting OBJECTIVES 1. Useful in investment and credit decisions 2. Useful in assessing future cash flows 3. About enterprise resources, claims to resources, and changes in them LO 2Describe the qualitative characteristics of accounting information.

12. Slide 2-12 ECON 3A UCSB ANDERSON What is the underlying concept that supports the immediate recognition of a contingent loss? a.Substance over form. b.Consistency. c.Matching. d.Conservatism. CPA Question, Nov. 94, FAR LO 2Describe the qualitative characteristics of accounting information.

13. Slide 2-13 ECON 3A UCSB ANDERSON WHAT IS AN OPERATING CYCLE? The operating cycle is how long it takes a company to initiate, perform, and deliver their primary product or service. Take a wholesaler for instance. First they buy inventory, then they sell it on account, and ultimately they collect the cash owed from their customer. The period of time it takes to accomplish this is the “Operating Cycle”. Accounts Payable Inventory Accounts receivable Cash

14. Slide 2-14 ECON 3A UCSB ANDERSON Assets are probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events. AssetsAssets Balance Sheet LO 3Explain the concept and purpose of a classified balance sheet.

15. Slide 2-15 ECON 3A UCSB ANDERSON ASSETS, EXAMPLES AND MORE CASH PROCESS CULMINATES ACCOUNTS RECEIVABLE, ON BALANCE SHEET BY: SALES OFF THE BALANCE SHEET WHEN: COLLECTED, OR WRITTEN OFF INVENTORY, ON BALANCE SHEET BY: PURCHASES OFF THE BALANCE SHEET WHEN: SOLD- COGS FIXED ASSETS, ON BALANC SHEET BY: PURCHASES OFF THE BALANCE SHEET AS IT IS: DEPRECIATED- DEPRECIATION EXPENSE PREPAID EXPENSES, ON BALANCE SHEET BY: PAYMENT OFF THE BALANCE SHEET AS IT IS: CONSUMED- “BENEFIT IS REALIZED”- I.E INSURANCE EXPENSE

16. Slide 2-16 ECON 3A UCSB ANDERSON OR more commonly stated: An asset that is expected to be realized in cash or sold or consumed within one year or the operating cycle, whichever is longer. OR more commonly stated: An asset that is expected to be realized in cash or sold or consumed within one year or the operating cycle, whichever is longer. Defined: An asset that is expected to be realized in cash or sold or consumed during the operating cycle or within one year if the cycle is shorter than one year. Defined: Current Assets Balance Sheet LO 3Explain the concept and purpose of a classified balance sheet.

17. Slide 2-17 ECON 3A UCSB ANDERSON Liabilities are probable future economic sacrifices obtained or controlled by a particular entity as a result of past transactions or events. LiabilitiesLiabilities Balance Sheet LO 3Explain the concept and purpose of a classified balance sheet.

18. Slide 2-18 ECON 3A UCSB ANDERSON Defined: An obligation that will be satisfied within the next operating cycle or within one year, if the cycle is shorter than one year. Defined: Current Liabilities Balance Sheet LO 3Explain the concept and purpose of a classified balance sheet. OR more commonly stated: An obligation that will be satisfied within one year or the operating cycle, whichever is longer. OR more commonly stated: An obligation that will be satisfied within one year or the operating cycle, whichever is longer.

19. Slide 2-19 ECON 3A UCSB ANDERSON A Classified Balance Sheet

20. Slide 2-20 ECON 3A UCSB ANDERSON A Multiple Step Income Statement

21. Slide 2-21 ECON 3A UCSB ANDERSON Liquidity = the ability of a company to pay its debts as they come due. A comparison of current assets and current liabilities is a starting point in evaluating the ability of a company to meet its obligations. Working Capital = Current Assets – Current Liabilities Company’s strive for a balance in managing its working capital – not too much or too little. Analysis using a Classified Balance Sheet LO 4Use a classified balance sheet to analyze a company’s financial position. $58,100 Current assets Current liabilities Working capital $118,000 – 59,900 =

22. Slide 2-22 ECON 3A UCSB ANDERSON Current Assets Current Liabilities Current Ratio = $118,000 $59,900 1.97 to 1 = The current ratio indicates the amount of current assets available at the balance sheet date relative to obligations coming due during that period. Analysis using a Classified Balance Sheet Composition of current asset and current liabilities important. LO 4Use a classified balance sheet to analyze a company’s financial position.

23. Slide 2-23 ECON 3A UCSB ANDERSON Landon Corporation was organized on January 2, 2002, with the investment of $100,000 by each of its two stockholders. Net income for its first year of business was $85,200. Net income increased during 2003 to $125,320 and to $145,480 during 2004. Landon paid $20,000 in dividends to each of the two stockholders in each of the three years. Statement of Retained Earnings Exercise Beg. Retained earnings 200220032004 $ 0 Net income (loss) 85,200 Less: Dividends (40,000) End. Retained earnings $45,200 125,320 (40,000) $130,520 145,480 (40,000) $236,000 LO 7 Prepare and identify the components of the statement of retained earnings.

24. Slide 2-24 ECON 3A UCSB ANDERSON BASIC- ALL AUDITED FINANCIAL STATEMENTS MUST INCLUDE: ü Financial statements ü Notes to financial statements ü Report of independent accountants PUBLIC COMPANIES ALSO MUST INCLUDE: ü Management’s assertions (SOX 403) ü Report of independent accountants on internal controls (SOX 404) ü Management discussion & analysis ü Summary of financial data ü Letter to stockholders Elements of the Annual Report http://www.starbucks.com/

25. Slide 2-25 ECON 3A UCSB ANDERSON DATSALLFORTHISCHAPTER