1. 2 nd session: Introduction to Accounting

2. Firm of the Day 2

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. 3

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

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

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 6

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. 7

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 8

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

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

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 Expenses represent assets used or liabilities incurred to generate revenue by selling goods and/or services to others Net Income = Revenues - Expenses 11

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

13. Fiscal Year 2009 Report 13

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

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

16. How much merchandise did Best Buy purchase during FY 2009? Fiscal Year 2009 Report 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 16

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 17

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

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

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 20

21. 21

22. 22 Fiscal Year 2009 Report

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

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 24

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 25

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 26

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 27

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 28

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 29

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 30

31. Exercise I – Fill in the gaps 2009200820072006 Retained Earnings, January 1 $37,922$25,634 Net Income 4,9405,665 Dividends Declared and Paid 1,203 815 Retained Earnings, December 31 35,669 37,922 34,338 30,484 $30,484 1,086 $34,338 4,787 (1,050) 31

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

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 reliability of 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 33

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) 34

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 35

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

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