Objectives
Objectives of
of Financial
Financial Reporting
Reporting
Financial
Financial Statements
Statements and
and the
the
Annual
Report
Annual Report
(a)
(a) PROVIDE
PROVIDE USEFUL
USEFULINFORMATION
INFORMATION
Financial
Financialreporting
reportingshould
shouldprovide
provideinformation
informationthat
thatis
is
useful
usefulto
topresent
present and
andpotential
potentialinvestors
investors and
andcreditors
creditors
and
andother
other users
usersin
in making
makingrational
rationalinvestment,
investment,credit,
credit, and
and
similar
similar decisions.
decisions.
The
Theinformation
information should
shouldbe
becomprehensible
comprehensibleto
tothose
thosewho
who
have
of business
businessand
and
have aareasonable
reasonable understanding
understanding of
economic
economicactivities
activities and
and are
arewilling
willingto
to study
studythe
the
1
information
information with
with reasonable
reasonable diligence.
diligence.1
Chapter 2
1Statement of Financial Accounting Concepts (SFAC) No. 1
1Statement of Financial Accounting Concepts (SFAC) No. 1
Slide
2-1
ECON 3A UCSB ANDERSON
Slide
2-2
Objectives
Objectives of
of Financial
Financial Reporting
Reporting
(b)
(b) REFLECT
REFLECTINFORMATION
INFORMATIONON
ONCASH
CASHFLOWS
FLOWS
Financial
Financialreporting
reportingshould
shouldprovide
provideinformation
informationto
tohelp
help
present
presentand
andpotential
potentialinvestors
investorsand
and creditors
creditorsand
andother
other
users
usersin
inassessing
assessingthe
theamounts,
amounts,timing,
timing,and
anduncertainty
uncertaintyof
of
prospective
prospectivecash
cash receipts
receiptsfrom
from dividends
dividendsor
or interest
interestand
and
the
theproceeds
proceedsfrom
fromthe
thesale,
sale,redemption,
redemption, or
or maturity
maturityof
of
securities
securitiesor
or loans.
loans.
Since
Sinceinvestors'
investors'and
andcreditors'
creditors' cash
cash flows
flowsare
are related
relatedto
to
enterprise
enterprisecash
cashflows,
flows,financial
financialreporting
reportingshould
shouldprovide
provide
information
informationto
to help
helpinvestors,
investors,creditors,
creditors, and
andothers
othersassess
assess
the
theamounts,
amounts, timing,
timing,and
anduncertainty
uncertaintyof
ofprospective
prospectivenet
net
1
cash
cashinflows
inflowsto
tothe
therelated
relatedenterprise.
enterprise.1
LO 1
Describe the objectives of financial reporting.
ECON 3A UCSB ANDERSON
Objectives
Objectives of
of Financial
Financial Reporting
Reporting
(c)
(c) REFLECT
REFLECTTHE
THE FINANCIAL
FINANCIAL POSITION
POSITIONOF
OFTHE
THEENTITY
ENTITY
Financial
Financialreporting
reportingshould
shouldprovide
provideinformation
informationabout
about the
the
economic
economicresources
resourcesof
of an
anenterprise,
enterprise,the
theclaims
claimsto
tothose
those
resources
resources(obligations
(obligationsof
ofthe
theenterprise
enterpriseto
totransfer
transfer
resources
resourcesto
to other
otherentities
entitiesand
andowners'
owners'equity),
equity),and
andthe
the
effects
effectsof
oftransactions,
transactions,events,
events, and
andcircumstances
circumstances that
that
1
change
changeits
itsresources
resourcesand
andclaims
claimsto
to those
thoseresources.
resources.1
1Statement of Financial Accounting Concepts (SFAC) No. 1
1Statement of Financial Accounting Concepts (SFAC) No. 1
1Statement of Financial Accounting Concepts (SFAC) No. 1
1Statement of Financial Accounting Concepts (SFAC) No. 1
Slide
2-3
LO 1
Describe the objectives of financial reporting.
ECON 3A UCSB ANDERSON
Slide
2-4
LO 1
Describe the objectives of financial reporting.
ECON 3A UCSB ANDERSON
ASSUMPTIONS
PRINCIPLES
CONSTRAINTS
ASSUMPTIONS
PRINCIPLES
CONSTRAINTS
Economic entity
Historical cost
CostCost-benefit
Economic entity
Historical cost
CostCost-benefit
Going concern
Revenue recognition
Materiality
Going concern
Revenue recognition
Materiality
Monetary unit
Matching
Industry practice
Monetary unit
Matching
Industry practice
Periodicity
Full disclosure
Conservatism
Periodicity
Full disclosure
Conservatism
QUALITATIVE
CHARACTERISTICS
Relevance
Reliability
Comparability
Conceptual
Framework for
Financial
Reporting
Slide
2-5
LO 2
Consistency
Relevance
Relevance and
and Reliability
Reliability
ELEMENTS
Assets, Liabilities, and
Equity
Investments by owners
Distribution to owners
Comprehensive income
Revenues and
Expenses
Gains and Losses
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
Describe the qualitative characteristics of accounting information.
ECON 3A UCSB ANDERSON
QUALITATIVE
CHARACTERISTICS
Relevance
Reliability
Comparability
Conceptual
Framework for
Financial
Reporting
Slide
2-6
LO 2





Slide
2-7
Consistency/ Comparability: All companies for all
periods account for things the same
Monetary Unit: Only items which can be expressed
in money are reflected
Economic Entity: The entity can be separated.
Time Period/ Periodicity: At least annually
Historical Cost: Items are reported at their cost and
depreciated if appropriate…
appropriate… but changes in value
are excluded.
FAIR VALUES BECOMING MORE PREVALENT
Going Concern: Entity will continue in existence for
the foreseeable future. This is why historical cost is
acceptable…
acceptable… if there is no going concern, then
liquidation basis may be appropriate.
ECON 3A UCSB ANDERSON
• • Verifiability
Verifiability
• • Representational
Representationalfaithfulness
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
Describe the qualitative characteristics of accounting information.
ECON 3A UCSB ANDERSON
FUNDAMENTALS
FUNDAMENTALS OF
OF GAAP
GAAP

Consistency
Capable
Capableofofmaking
makingaadifference
difference
ininaadecision.
decision.
Fair
Fair Values:
Values:
Many items are now required to be reported/ disclosed at fair value,
value, such as:
 Financial instruments (these are common, such as debt and accounts
accounts
receivable)
 Impairments
 Many others, we just havent learned enough about accounting to discuss them
all yet!
Historical cost is very objective,
objective, BUT fair value is very subjective thus somewhat
contradicting the “consistency/ comparability”
comparability” objective of financial reporting.
Accordingly:
 New GAAP standard was written to provide guidance on how to determine
determine fair
value. The guidance is intended to result in more standardized fair value
measurements:

“Market Participant”
Participant” approach,
approach, using the most advantageous and active market, and
3 levels of input:
input:

Level 1: Active market for the item

Level 2: Active market for similar items

Level 3: “Unobservable”
Unobservable” Inputs.
STOP
STOP
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2-8
ECON 3A UCSB ANDERSON
Qualitative
Qualitative Characteristics
Characteristics
ASSUMPTIONS
PRINCIPLES
CONSTRAINTS
Economic entity
Historical cost
CostCost-benefit
Going concern
Revenue recognition
Materiality
Monetary unit
Matching
Industry practice
Periodicity
Full disclosure
Conservatism
Comparability
Comparability and
and Consistency
Consistency
True
True or
or False?
False?
Relevance
Relevance and
and reliability
reliability are
are the
the two
two primary
primary
qualities
that
make
accounting
information
qualities that make accounting information useful
useful
for
for decision
decision making.
making.
QUALITATIVE
CHARACTERISTICS
True
True
Comparability
Relevance
Reliability
Slide
2-9
LO 2
Describe the qualitative characteristics of accounting information.
ECON 3A UCSB ANDERSON
Slide
2-10
LO 2
True
Trueor
orFalse?
False?
Adherence
Adherence to
to the
the concept
concept of
of consistency
consistency
requires
that
the
same
accounting
requires that the same accounting principles
principles be
be
applied
to
similar
transactions
by
all
applied to similar transactions by all companies
companies
and
and for
for all
all periods?
periods?
TRUE
TRUE
LO 2
Describe the qualitative characteristics of accounting information.
ECON 3A UCSB ANDERSON
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
Describe the qualitative characteristics of accounting information.
ECON 3A UCSB ANDERSON
Qualitative
Qualitative Characteristics
Characteristics
Slide
2-11
Consistency
Conceptual
Framework for
Financial
Reporting
ASSUMPTIONS
PRINCIPLES
CONSTRAINTS
Economic entity
Historical cost
CostCost-benefit
Going concern
Revenue recognition
Materiality
Monetary unit
Matching
Industry practice
Periodicity
Full disclosure
Conservatism
QUALITATIVE
CHARACTERISTICS
Relevance
Reliability
Comparability
Conceptual
Framework for
Financial
Reporting
Slide
2-12
ELEMENTS
Assets, Liabilities, and
Equity
Investments by owners
Distribution to owners
Comprehensive income
Revenues and
Expenses
Gains and Losses
LO 2
Consistency
ELEMENTS
Assets, Liabilities, and
Equity
Investments by owners
Distribution to owners
Comprehensive income
Revenues and
Expenses
Gains and Losses
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
Describe the qualitative characteristics of accounting information.
ECON 3A UCSB ANDERSON
CPA
CPA Question,
Question, Nov.
Nov. 94,
94, FAR
FAR
What is the underlying concept that supports the
immediate recognition of a contingent loss?
a. Substance over form.
b. Consistency.
c. Matching.
d. Conservatism.
WHAT
WHAT IS
IS AN
AN OPERATING
OPERATING CYCLE?
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
owed
from their customer. The period of time it takes to accomplish
this is the “Operating Cycle”
Cycle”.
Accounts Payable
Inventory
Cash
Accounts receivable
Slide
2-13
LO 2
Describe the qualitative characteristics of accounting information.
ECON 3A UCSB ANDERSON
Slide
2-14
ECON 3A UCSB ANDERSON
ASSETS,
ASSETS, EXAMPLES
EXAMPLES AND
AND MORE
MORE
Balance
Balance Sheet
Sheet
CASH
PROCESS CULMINATES
Assets
Assets
ACCOUNTS RECEIVABLE,
RECEIVABLE, ON BALANCE SHEET BY:
SALES
OFF THE BALANCE SHEET WHEN:
COLLECTED, OR WRITTEN OFF
Assets
Assets are
are probable
probable future
future economic
economic benefits
benefits
obtained
obtained or
or controlled
controlled by
by aa particular
particular entity
entity as
as aa
result
result of
of past
past transactions
transactions or
or events.
events.
INVENTORY,
INVENTORY, ON BALANCE SHEET BY:
PURCHASES
OFF THE BALANCE SHEET WHEN:
SOLDSOLD- COGS
FIXED ASSETS,
ASSETS, ON BALANC SHEET BY:
PURCHASES
OFF THE BALANCE SHEET AS IT IS:
DEPRECIATEDDEPRECIATED- DEPRECIATION EXPENSE
PREPAID EXPENSES,
EXPENSES, ON BALANCE SHEET BY:
PAYMENT
OFF THE BALANCE SHEET AS IT IS:
CONSUMEDCONSUMED- “BENEFIT IS REALIZED”
REALIZED”- I.E INSURANCE EXPENSE
Slide
2-15
LO 3
Explain the concept and purpose of a classified balance sheet.
ECON 3A UCSB ANDERSON
Slide
2-16
ECON 3A UCSB ANDERSON
Balance
Balance Sheet
Sheet
Balance
Balance Sheet
Sheet
Current
Current Assets
Assets
Liabilities
Liabilities
Defined:
Defined:
An
An asset
asset that
that is
is expected
expected to
to be
be realized
realized in
in cash
cash or
or
sold
sold or
or consumed
consumed during
during the
the operating
operating cycle
cycle or
or within
within
one
one year
year if
if the
the cycle
cycle is
is shorter
shorter than
than one
one year.
year.
Liabilities
Liabilities are
are probable
probable future
future economic
economic sacrifices
sacrifices
obtained
obtained or
or controlled
controlled by
by aa particular
particular entity
entity as
as aa
result
result of
of past
past transactions
transactions or
or events.
events.
OR
OR more
more commonly
commonly stated:
stated:
An
asset
that
is
expected
An asset that is expected to
to be
be realized
realized in
in cash
cash or
or
sold
sold or
or consumed
consumed within
within one
one year
year or
or the
the operating
operating
cycle,
cycle, whichever
whichever is
is longer.
longer.
Slide
2-17
LO 3
Explain the concept and purpose of a classified balance sheet.
ECON 3A UCSB ANDERSON
Slide
2-18
LO 3
Explain the concept and purpose of a classified balance sheet.
ECON 3A UCSB ANDERSON
A
A Classified
Classified Balance
Balance Sheet
Sheet
Balance
Balance Sheet
Sheet
Company Name
Balance Sheet
As of DATE
Current
Current Liabilities
Liabilities
Current assets
Cash
etc.
Total current assets
Defined:
Defined:
An
An obligation
obligation that
that will
will be
be satisfied
satisfied within
within the
the next
next
operating
operating cycle
cycle or
or within
within one
one year,
year, if
if the
the cycle
cycle is
is
shorter
shorter than
than one
one year.
year.
xxx
xxx
xxx
Fixed assets
Other long term assets
Total assets
Current liabilities
Accounts payable
etc.
Total current liabilities
OR
OR more
more commonly
commonly stated:
stated:
An
An obligation
obligation that
that will
will be
be satisfied
satisfied within
within one
one year
year or
or
the
the operating
operating cycle,
cycle, whichever
whichever is
is longer.
longer.
xxx
xxx
xxx
xxx
Balances?
Long-term debt, excluding current portion
Equity
Common stock
APIC
Retained earnings
Total Liabilities & Equity
Slide
2-19
LO 3
Explain the concept and purpose of a classified balance sheet.
ECON 3A UCSB ANDERSON
Slide
2-20
ECON 3A UCSB ANDERSON
A
A Multiple
Multiple Step
Step Income
Income Statement
Statement
Analysis
Analysis using
using aa Classified
Classified Balance
Balance Sheet
Sheet
Company Name
Income Statement
FOR THE PERIOD ….
Revenue
Cost of Revenue
Gross Profit
xxx
xxx
xxx
Selling general & administrativ (SG&A) expense
Depreciation expense
Other operating expenses
xxx
xxx
xxx
Income before income tax provision
Tax provision
Income from continuing operations
xxx
xxx
xxx
Discontinued operations, net of tax
Income before extraordinary items
Extraordinary items, net of tax
NET INCOME OR LOSS
xxx
xxx
xxx
XXX
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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’
Company’s strive for a balance in managing its working
capital – not too much or too little.
$118,000
Slide
2-22
Analysis
Analysis using
using aa Classified
Classified Balance
Balance Sheet
Sheet
The
The current
current ratio
ratio indicates
indicates the
the amount
amount of
of current
current assets
assets
available
available at
at the
the balance
balance sheet
sheet date
date relative
relative to
to
obligations
obligations coming
coming due
due during
during that
that period.
period.
Current Ratio =
Current Assets
–
Current
assets
LO 4
$118,000
$59,900
Composition of current asset and current liabilities
important.
Slide
2-23
LO 4
Use a classified balance sheet to analyze a company’s financial position.
ECON 3A UCSB ANDERSON
=
$58,100
Working
capital
Current
liabilities
Use a classified balance sheet to analyze a company’s financial position.
ECON 3A UCSB ANDERSON
Statement
Statement of
of Retained
Retained Earnings
Earnings Exercise
Exercise
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.
Current Liabilities
1.97 to 1 =
59,900
2002
Beg. Retained earnings
Net income (loss)
$
2003
2004
0
$ 45,200
$130,520
145,480
85,200
125,320
Less: Dividends
(40,000)
(40,000)
End. Retained earnings
$45,200
Slide
2-24
LO 7
$130,520
(40,000)
$236,000
Prepare and identify the components of the statement of retained earnings.
ECON 3A UCSB ANDERSON
Elements
Elements of
of the
the Annual
Annual Report
Report
BASICBASIC- ALL AUDITED FINANCIAL STATEMENTS MUST
INCLUDE:



Financial statements
Notes to financial statements
Report of independent accountants
DATSALLFORTHISCHAPTER
PUBLIC COMPANIES ALSO MUST INCLUDE:

Management’
Management’s assertions (SOX 403)

Report of independent accountants on internal
controls (SOX 404)

Management discussion & analysis

Summary of financial data

Letter to stockholders
http://www.starbucks.com/
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2-25
ECON 3A UCSB ANDERSON
Slide
2-26
ECON 3A UCSB ANDERSON