Overview of week 1

Accounting
Prof: Jim Wallace
TA: Golf


Overview of Week 1
Administrative stuff
 What is financial accounting?
 Some Myths
 Accrual versus Cash-based
 Financial statements
 GAAP
 Auditing



Administrative Stuff
Who am I
 Who is your T.A.
 Teaching philosophy
 Syllabus
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Homework

Calculator

Web Access to Class Info
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The site should contain:

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Syllabus
PowerPoint slides
Handouts
Homework solutions

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What is Financial
Accounting?
A method to communicate financial
information to interested external
parties.
 Users include capital providers,
regulators, customers, suppliers,
employees, etc


• Capital suppliers include debt and equity
providers


Financial accounting is used for both
prediction and control


Accounting is rigid and
yields the truth


Generally-accepted accounting principles,
or GAAP, are a set of rigid rules that, if
followed correctly, will lead to a unique,
“correct” representation of the financial
performance and health of a firm.



The basic financial statements, consisting of
a balance sheet, an income statement, and
a statement of cash flows, reflect a
complete, accurate, and timely portrayal of
the financial performance and well-being of
a firm


Accounting is the sole
product of accountants



GAAP is created from a
comprehensive analytical process,
which is free from political influence.


It is all there


All of a firm’s identifiable assets and
liabilities appear on the balance
sheet, and the difference between a
firm’s assets and its liabilities
represents the value of the firm.


The statements stand alone


Each of the financial statements is
independent, with each reflecting a
different aspect of the firm’s
performance and financial health.


Cash is King!


Cash flow is ultimately what matters

to a firm and its investors; therefore,
it is not really necessary to worry
about the definition of earnings used
in the preparation of the income
statement. Rather, one need only
consider the sources and uses of
cash as reflected on the firm’s
statement of cash flows.


Some additional myths
 Accounting

is useless.
 Accounting is hard!
 Accountants are boring.


Other Types of Accounting
 Managerial
 Non-profit
 Tax


Accrual Accounting


Accrual accounting rests on two guiding
principles:
Revenue Recognition Principle – record

revenue when





Matching Principle – record expenses when




Earned
Realized or Realizable
Incurred

Neither the recognition of revenue nor the
recording of expense necessarily involves the
receipt or payment of cash


How do you define a rich
person?
Has a lot of valuable stuff (worth more
than what is owed).
 Makes a lot of money



The Financial Statements
The accounting equation

 Balance Sheet
 Income Statement
 Statement of Cash Flows
 Statement of Owners Equity




Statement of retained earnings


Balance Sheet
Mirrors the Accounting Equation
Assets = Liabilities + Equity
Uses of funds = Sources of funds
 Assets are listed in order of liquidity
 Current and non-current
 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.
2.

Be owned or controlled by
the company
Must possess expected
future benefits


Most Assets are Reported at
Historical Cost


Historical Cost is
Objective
 Verifiable
 Therefore, not subject to bias


However, historical cost is not
particularly “relevant” to most readers
of the balance sheet
 “Relevance vs. Reliability” is an
important issue with accountants.



Liabilities


Liabilities are listed in order of
maturity

Current Liabilities come due in less
than a year.
 Noncurrent liabilities come due
after a year.




Companies desire more current
assets than current liabilities – this
difference is called net working
capital


Equity
Equity consists of:
Contributed Capital (cash raised from the
issuance of shares)
Earned Capital (retained earnings).
Retained Earnings is updated each period
as follows:



Market Value vs. Book
Value
Stockholders’ equity = Company book
value
 Book value is determined using GAAP.
 Book value is not the same as Market

Value.
 Market Value = # of Shares x Price per
share
 On average, US company book value is
roughly two-thirds of market value.


Income Statement


Statement of Stockholders’
Equity
Statement of Equity is a
reconciliation of the beginning and
ending balances of stockholders’
equity accounts.
 Main equity categories are:


Contributed capital
 Retained earnings (including Other
Comprehensive Income or OCI)
 Treasury stock



Statement of Cash Flows




Statement of cash flows (SCF) reports
cash inflows and outflows
Cash flows are reported based on the
three business activities of a company:
1.

2.
3.

Operating activities: transactions
related to the operations of the
business.
Investing activities: acquisitions and
divestitures of long-term assets
Financing activities: issuances and
payments toward equity, borrowings,
and long-term liabilities.


Articulation of Financial
Statements
Financial statements are linked
within and across time – they
articulate.
 Balance sheet and income
statement are linked via retained
earnings.
 Absent of equity transactions such
as stock issuances and purchases

and dividend payments, the change
in stockholders’ equity equals the
income or loss for the period.
