Module 1:
Basics of Financial
Statements
Balance Sheet Equation
• Assets: companies own cash, receivables, inventories, real
estate, equipment, securities, and intangibles—must have
future value to the company
• Liabilities: Companies’ obligations to employees,
suppliers, governments, bankers, lenders, bondholders
• Equity: The owners’ remaining investment in the
company
Balance Sheet Equation
• Balance Sheet: Everything a company owns was
purchased with money from creditors or owners.
• Who owns what?
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Company owns the assets
Investors (owners) purchase shares of stock in the company,
including a share of earnings
Creditors own promises of future payment from companies
Financial Statements
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FINANCIAL STATEMENTS INCLUDE:
Balance Sheet: List of assets, obligations, and owners’ equity on a date.
Income Statement: Change in owners’ equity due to operating the business.
• Revenues, expenses, profits, and losses=net income
Cash Flows: Change in cash balance due to (1) operating the business, (2) buying
or selling long-term assets, and (3) financing the company (cash flows to/from
lenders and owners).
Stockholders’ Equity: Change in owners’ accounts from beginning of the period
to end of the period.
Financial Accounting Information
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DEMAND: Who needs to know about the
finances of companies? Almost everyone!
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Managers, employees, investment analysts,
shareholders and directors, customers, regulators
and tax agencies, voters and their representatives…
However, readers must be knowledgeable before
they can understand financial reports because
they are written in the language of business.
Accounting provides the language.
Supply of Accounting Information
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SEC filing requirements:
Form 10-K: annual report
 Form 10-Q: quarterly
 Form 8-K: additional
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Benefits of disclosure.
 Lower costs of funds because reliable information supports
trust in the company
 Increases stock prices overall, reduces risk
Costs of disclosure.
 Preparation and dissemination, competitive disadvantages,
litigation potential, and political costs
Berkshire Hathaway’s Balance Sheet
Berkshire Hathaway’s
Income Statement
Berkshire Hathaway’s
Statement of Stockholders’ Equity
Statement of Cash Flows
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The statement of cash flows reports on cash flows for
operating, investing, and financing activities over a period
of time.
Information Related to Financial
Statements
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Management Discussion and Analysis
Independent Auditor’s Report
Financial Statement Footnotes
Report on Internal Controls
Profitability Analysis
Oversight of Financial Accounting
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SEC oversees all publicly traded companies
Financial Accounting Standards Board
(FASB) and has delegated authority from
SEC
Congress and federal courts can overrule the
SEC or the FASB
Module 2:
Introducing Financial
Statements and
Transaction Analysis
Balance Sheet
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Reflects the Accounting Equation
Assets = Liabilities + Equity
Uses of funds = Sources of funds
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Assets are listed in order of liquidity
Liabilities are listed in order of maturity
Equity consists of Contributed Capital and
Retained Earnings
Assets
To be reported on a balance sheet, an asset must
1.
Be owned (or controlled) by the company
2.
Must possess expected future economic benefits
Examples of Current Assets
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Cash—currency, bank deposits, and investments with an
original maturity of 90 days or less (called cash equivalents);
Marketable securities—short-term investments that can be
quickly sold to raise cash;
Accounts receivable, net—amounts due to the company from
customers arising from the sale of products and services on
credit (“net” refers to uncollectible accounts explained in
Module 6);
Inventory—goods purchased or produced for sale to customers;
Prepaid expenses—costs paid in advance for rent, insurance,
advertising or other services.
Examples of Long-term Assets
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Property, plant and equipment (PPE), net—land, factory
buildings, warehouses, office buildings, machinery, motor
vehicles, office equipment and other items used in operating
activities (“net” refers to subtraction of accumulated
depreciation, the portion of the assets’ cost that has been
transferred from the balance sheet to the income statement,
which is explained in Module 6);
Long-term investments—investments that the company does
not intend to sell in the near future;
Intangible and other assets—assets without physical
substance, including patents, trademarks, franchise rights,
goodwill and other costs the company incurred that provide
future benefits.
Examples of Current Liabilities
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Accounts payable—amounts owed to suppliers for goods and
services purchased on credit.
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Accrued liabilities—obligations for expenses that have been
incurred but not yet paid; examples are accrued wages payable (wages
earned by employees but not yet paid), accrued interest payable
(interest that is owing but has not been paid), and accrued income
taxes (taxes due).
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Unearned revenues—obligations created when the company
accepts payment in advance for goods or services it will deliver in the
future; also called advances from customers, customer deposits, or
deferred revenues.
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Short-term notes payable—short-term debt payable to banks or
other creditors.
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Current maturities of long-term debt—principal portion of
long-term debt that is due to be paid within one year.
Net Working Capital
Examples of Noncurrent Liabilities
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Long-term debt—amounts borrowed from creditors that are
scheduled to be repaid more than one year in the future; any
portion of long-term debt that is due within one year is
reclassified as a current liability called current maturities of long-term
debt. Long-term debt includes bonds, mortgages, and other long-term
loans.
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Other long-term liabilities—various obligations, such as
pension liabilities and long-term tax liabilities, that will be settled
a year or more into the future. We discuss these items in later
modules.
Equity
Equity consists of:
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Contributed Capital (cash raised from the
issuance of shares)
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Earned Capital (retained earnings). Retained
Earnings is updated each period as follows:
Examples of Equity Accounts
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Common stock—par value received from the original sale of common
stock to investors.
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Preferred stock—value received from the original sale of preferred
stock to investors; preferred stock has fewer ownership rights compared
to common stock.
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Additional paid-in capital—amounts received from the original sale
of stock to investors in addition to the par value of common stock.
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Treasury stock—amount the company paid to reacquire its common
stock from shareholders.
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Retained earnings—accumulated net income (profit) that has not been
distributed to stockholders as dividends.
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Accumulated other comprehensive income or loss—accumulated
changes in equity that are not reported in the income statement (explained
in Module 9).
Income Statement
When are Revenues and Expenses Recognized?
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Accrual Accounting:
Revenue Recognition Principle—recognize
revenues when earned
 Matching Principle—recognize expenses when
incurred
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Operating vs. Nonoperating
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Operating expenses are the usual and
customary costs that a company incurs to
support its main business activities
Nonoperating expenses relate to the
company’s financing and investing activities
Statement of Cash Flows
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Statement of cash flows (SCF) reports cash inflows
and outflows
Cash flows are reported based on the three business
activities of a company:
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Cash flows from operating activities - Cash flows from
the company’s transactions and events that relate to its
operations.
Cash flows from investing activities - Cash flows from
acquisitions and divestitures of investments and long-term
assets.
Cash flows from financing activities - Cash flows from
issuances of and payments toward borrowings and equity.
Cash Flow from Operations
Articulation of Financial Statements
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Financial statements are linked within and
across time – they articulate.
Balance sheet and income statement are
linked via retained earnings.
Recording transactions
• Understand basic recording of transactions.
• Pay $100 wages in cash:
• Cash assets are reduced by $100, and wage expense of $100 is
reflected in the income statement, which reduces income and
retained earnings by that amount.
Wages Expense
$100
Cash
$100
• All transactions incurred by the company during the accounting
period are recorded similarly.
Adjusting Accounts
Global Accounting
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Balance Sheet The most visible difference is that the typical
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IFRS-based balance sheet is presented in reverse order of
liquidity.
Income Statement The most visible difference is that GAAP
requires three years’ data on the income statement whereas IFRS
requires only two.
Module 3:
Accounting
Adjustments and
Constructing Financial
Statements
The Accounting Cycle
T-Accounts and Journal Entries
Capital Investment
Asset (Inventory) Transaction
Cash Dividends
• All transactions between the company and its shareholders are
considered financing transactions. This includes payment of
dividends, the issuance of stock, and any subsequent stock
repurchase.
• Financing transactions affect only the balance sheet; they do not
affect the income statement.
Adjusting Accounts
Types of Adjustments
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Cash received or paid before recognition of
revenue or expense:
Prepaid expenses
 Unearned revenues
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Cash received or paid after recognition of
revenue or expense
Accrued expenses
 Accrued revenues
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Prepaid Expenses (Assets)
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Assume that Apple pays $200 to purchase time on MTV for future i
ads.
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Apple’s cash account decreases by $200, and an asset called prepaid
advertising increases by the same amount.
When the ad is aired, the prepaid asset is “used up” and is removed from the
balance sheet and recognizing the cost as an expense.
Unearned Revenues (Liabilities)
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Assume that Apple receives $400 cash from a
customer as advance payment on a multi-unit
iPod sale to be delivered next month.
Recognition of Unearned Revenue
as Earned Revenue
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Assume that Apple delivers the iPods a month
later (but still within the fiscal quarter).
Accrued Expenses (Liabilities)
Assume that Apple’s sales staff earns $100
of sales commissions this period that will
not be paid until next period.
 When paid, the liability is reduced as is cash.
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Accrued Revenues (Assets)
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Assume that Apple delivers iPods to a customer
in Germany who will pay next quarter. The sales
price for those units is $500 and the cost is $400.
Trial Balance
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The trial balance is a listing of all accounts and
their balances at a point in time.
Its purpose is to prove the mathematical equality
of debits and credits, provide a useful tool to
uncover any accounting errors, and help prepare
the financial statements.
Adjusted Trial Balance For Apple
Preparation of the
Financial Statements
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Income Statement
Preparation of the
Financial Statements
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Retained Earnings Computation
Preparation of the
Financial Statements
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Balance Sheet
Preparation of the
Financial Statements
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Statement of Stockholders’ Equity
Statement of Cash Flows –
Indirect Method
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Operating cash flows
Changes to Working Capital Accounts
Formal Presentation of Apple’s SCF
Closing Process
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The closing process refers to the ‘zeroing out’
of revenue and expense accounts (the temporary
accounts) by transferring their ending balances
to retained earnings.
Balance sheet accounts carry over from period
to period and are called permanent accounts.)
The result is that all income statement accounts
begin the next period with zero balances.
Closing Process Journal Entries