2nd session:
Introduction to Accounting
Firm of the Day
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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.
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Reporting Business Activities
Obtain Financing
Balance Sheet
Issue debt and stock
Liabilities & Owner’s Equity
Make Investments
Purchase land, bldgs, inventory, etc.
Balance Sheet
Assets
Conduct Operations
Income Statement
Sell goods and services to customers
Pay employees, suppliers, creditors
Revenues & Expenses,
Net income
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Desirable Characteristics of Accounting
FASB Concept Statement #2
(See Figure 2.1 of LLS)
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Balance Sheet
• Describes the financial position of the firm at a given
point in time
Assets = Liabilities + Shareholders’
Equity
• 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
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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.
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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
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Fiscal Year 2009 Report
What does Consolidated mean?
Why this date?
Why is this an asset?
Which one is the largest asset?
Why is this an asset?
What must this be equal to?
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Fiscal Year 2009 Report
Why are these liabilities?
What must this be equal to?
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Income Statement
• Describes the financial results of the firm’s operations
over a period of time
Net Income = Revenues - Expenses
• 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
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Fiscal Year 2009 Report
Why the reference?
Why are these
expenses reported
separately? What’s in
either of them?
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Fiscal Year 2009 Report
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Fiscal Year 2009 Report
How much was the
expense for employee
stock compensation?
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Fiscal Year 2009 Report
Bottom line:
• primary statements are of limited use
• footnotes contain the bulk of the details
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Fiscal Year 2009 Report
How much
merchandise did
Best Buy purchase
during FY 2009?
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
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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
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Fiscal Year 2009 Report
Where does this
number come from?
How were these 1.9
billion dollars used?
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Fiscal Year 2009 Report
Check the Balance Sheet:
Where else can we
find these numbers?
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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
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Fiscal Year 2009 Report
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Balance sheet - Outline
• Define
– Assets
– Liabilities
– Shareholders’ Equity
• Valuation
• Balance sheet classification
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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
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The Accounting Identity
Assets = Liabilities + Equity
• Equates economic resources to the claims
on those resources
• Equity holders are the residual claimants:
A–L=E
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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
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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
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Types of Assets
• Tangible assets
– Merchandise inventory
– Property, plant and equipment
• Monetary and financial assets
– Accounts receivable
– Marketable securities
• Intangible assets
– Patents
– Trade name
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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
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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
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Exercise I – Fill in the gaps
2009
2008
2007
2006
$30,484
$25,634
4,787
4,940
5,665
1,203
1,086
37,922
34,338
Retained Earnings,
January 1
$37,922 $34,338
Net Income
(1,050)
Dividends Declared
and Paid
Retained Earnings,
December 31
1,203
35,669
815
30,484
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Balance Sheet Equation
Assets – Liabilities =
Shareholders’ Equity
= Contributed Capital + R(etained) E(arnings)
= Contributed Capital + REbeginning of period +
Net Income – Dividend
= Contributed Capital + REbeginning of period + Revenues – Expenses – Dividend
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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
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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)
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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
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Balance Sheet Classification
• Assets
– Current Assets
– Investments
– Other Assets
• Liabilities
– Current Liabilities
– Non-current (Long-term liabilities)
• Shareholders’ Equity
– Contributed capital
– Retained earnings
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Next Class…
• Balance Sheet Concepts
• The Accounting Process
• Debits, Credits, and T-Accounts
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