Slide 2-1 ECON 3A UCSB ANDERSON Financial Statements and the Annual Report Chapter 2

Slide 2-1

ECON 3A UCSB ANDERSONECON 3A UCSB ANDERSON

Financial Statements and Financial Statements and the Annual Reportthe Annual Report

Financial Statements and Financial Statements and the Annual Reportthe Annual Report

Chapter 2Chapter 2

Slide 2-2


Objectives of Financial ReportingObjectives of Financial ReportingObjectives of Financial ReportingObjectives of Financial Reporting

(a)(a) PROVIDE USEFUL INFORMATIONPROVIDE USEFUL INFORMATION

Financial reporting should provide information that is Financial reporting should provide information that is useful to present and potential investors and useful to present and potential investors and creditors and other users in making rational creditors and other users in making rational investment, credit, and similar decisions. investment, credit, and similar decisions.

The information should be comprehensible to those The information should be comprehensible to those who have a reasonable who have a reasonable understanding understanding of business of business and economic activities and are willing to study the and economic activities and are willing to study the information with reasonable diligence.information with reasonable diligence.11

(a)(a) PROVIDE USEFUL INFORMATIONPROVIDE USEFUL INFORMATION

Financial reporting should provide information that is Financial reporting should provide information that is useful to present and potential investors and useful to present and potential investors and creditors and other users in making rational creditors and other users in making rational investment, credit, and similar decisions. investment, credit, and similar decisions.

The information should be comprehensible to those The information should be comprehensible to those who have a reasonable who have a reasonable understanding understanding of business of business and economic activities and are willing to study the and economic activities and are willing to study the information with reasonable diligence.information with reasonable diligence.11

LO 1 Describe the objectives of financial reporting.

1Statement of Financial Accounting Concepts (SFAC) No. 11Statement of Financial Accounting Concepts (SFAC) No. 1

Slide 2-3



(b)(b) REFLECT INFORMATION ON CASH FLOWSREFLECT INFORMATION ON CASH FLOWS

Financial reporting should provide information to help Financial reporting should provide information to help present and potential investors and creditors and present and potential investors and creditors and other users in assessing the amounts, timing, and other users in assessing the amounts, timing, and uncertainty of prospective cash receipts from uncertainty of prospective cash receipts from dividends or interest and the proceeds from the sale, dividends or interest and the proceeds from the sale, redemption, or maturity of securities or loans. redemption, or maturity of securities or loans.

Since investors' and creditors' cash flows are related Since investors' and creditors' cash flows are related to enterprise cash flows, financial reporting should to enterprise cash flows, financial reporting should provide information to help investors, creditors, and provide information to help investors, creditors, and others assess the amounts, timing, and uncertainty of others assess the amounts, timing, and uncertainty of prospective net cash inflows to the related enterprise.prospective net cash inflows to the related enterprise.11

(b)(b) REFLECT INFORMATION ON CASH FLOWSREFLECT INFORMATION ON CASH FLOWS

Financial reporting should provide information to help Financial reporting should provide information to help present and potential investors and creditors and present and potential investors and creditors and other users in assessing the amounts, timing, and other users in assessing the amounts, timing, and uncertainty of prospective cash receipts from uncertainty of prospective cash receipts from dividends or interest and the proceeds from the sale, dividends or interest and the proceeds from the sale, redemption, or maturity of securities or loans. redemption, or maturity of securities or loans.

Since investors' and creditors' cash flows are related Since investors' and creditors' cash flows are related to enterprise cash flows, financial reporting should to enterprise cash flows, financial reporting should provide information to help investors, creditors, and provide information to help investors, creditors, and others assess the amounts, timing, and uncertainty of others assess the amounts, timing, and uncertainty of prospective net cash inflows to the related enterprise.prospective net cash inflows to the related enterprise.11



Slide 2-4



(c)(c) REFLECT THE FINANCIAL POSITION OF THE ENTITYREFLECT THE FINANCIAL POSITION OF THE ENTITY

Financial reporting should provide information about Financial reporting should provide information about the economic resources of an enterprise, the claims the economic resources of an enterprise, the claims to those resources (obligations of the enterprise to to those resources (obligations of the enterprise to transfer resources to other entities and owners' transfer resources to other entities and owners' equity), and the effects of transactions, events, and equity), and the effects of transactions, events, and circumstances that change its resources and claims to circumstances that change its resources and claims to those resources.those resources.11

(c)(c) REFLECT THE FINANCIAL POSITION OF THE ENTITYREFLECT THE FINANCIAL POSITION OF THE ENTITY

Financial reporting should provide information about Financial reporting should provide information about the economic resources of an enterprise, the claims the economic resources of an enterprise, the claims to those resources (obligations of the enterprise to to those resources (obligations of the enterprise to transfer resources to other entities and owners' transfer resources to other entities and owners' equity), and the effects of transactions, events, and equity), and the effects of transactions, events, and circumstances that change its resources and claims to circumstances that change its resources and claims to those resources.those resources.11



Slide 2-5


ASSUMPTIONSASSUMPTIONS

Economic entityEconomic entity

Going concernGoing concern

Monetary unitMonetary unit

PeriodicityPeriodicity

PRINCIPLESPRINCIPLES

Historical costHistorical cost

Revenue recognitionRevenue recognition

MatchingMatching

Full disclosureFull disclosure

CONSTRAINTSCONSTRAINTS

Cost-benefitCost-benefit

MaterialityMateriality

Industry practiceIndustry practice

ConservatismConservatism

OBJECTIVESOBJECTIVES1. Useful in investment and credit 1. Useful in investment and credit

decisionsdecisions

QUALITATIVE QUALITATIVE CHARACTERISTICSCHARACTERISTICS

RelevanceRelevance

ReliabilityReliability

ComparabilityComparability

ConsistencyConsistency

ELEMENTSELEMENTSAssets, Liabilities, and Assets, Liabilities, and

EquityEquityInvestments by ownersInvestments by ownersDistribution to ownersDistribution to owners

Comprehensive incomeComprehensive incomeRevenues and Revenues and

ExpensesExpensesGains and LossesGains and LossesConceptual

Framework for Financial Reporting 2. Useful in assessing future 2. Useful in assessing future

cash flowscash flows

3. About enterprise resources, 3. About enterprise resources, claims to resources, and claims to resources, and

changes in themchanges in them

LO 2 Describe the qualitative characteristics of accounting information.

Slide 2-6










MatchingMatching








RelevanceRelevance




Relevance and ReliabilityRelevance and ReliabilityRelevance and ReliabilityRelevance and Reliability

Conceptual Framework for Financial Reporting

• VerifiabilityVerifiability• Representational faithfulnessRepresentational faithfulness• NeutralityNeutrality

• VerifiabilityVerifiability• Representational faithfulnessRepresentational faithfulness• NeutralityNeutrality


decisionsdecisions2. Useful in assessing future 2. Useful in assessing future




Capable of making a difference Capable of making a difference in a decision.in a decision.

Capable of making a difference Capable of making a difference in a decision.in a decision.


Slide 2-7


FUNDAMENTALS OF GAAPFUNDAMENTALS OF GAAPFUNDAMENTALS OF GAAPFUNDAMENTALS OF GAAP

Consistency/ Comparability:Consistency/ Comparability: All companies for all All companies for all periods account for things the sameperiods account for things the same

Monetary Unit:Monetary Unit: Only items which can be expressed Only items which can be expressed in money are reflectedin money are reflected

Economic Entity:Economic Entity: The entity can be separated. The entity can be separated. Time Period/ Periodicity:Time Period/ Periodicity: At least annually At least annually Historical Cost:Historical Cost: Items are reported at their cost and Items are reported at their cost and

depreciated if appropriate… but changes in value depreciated if appropriate… but changes in value are excluded.are excluded.

Going Concern:Going Concern: Entity will continue in existence for Entity will continue in existence for the foreseeable future. This is why historical cost is the foreseeable future. This is why historical cost is acceptable… if there is no going concern, then acceptable… if there is no going concern, then liquidation basis may be appropriate.liquidation basis may be appropriate.

Slide 2-8


Relevance and reliability are the two primary Relevance and reliability are the two primary qualities that make accounting information qualities that make accounting information useful for decision making.useful for decision making.

Relevance and reliability are the two primary Relevance and reliability are the two primary qualities that make accounting information qualities that make accounting information useful for decision making.useful for decision making.

True or False?True or False?True or False?True or False?

TrueTrueTrueTrue

Qualitative CharacteristicsQualitative CharacteristicsQualitative CharacteristicsQualitative Characteristics


Slide 2-9










MatchingMatching








RelevanceRelevance







ExpensesExpensesGains and LossesGains and Losses

Comparability and ConsistencyComparability and ConsistencyComparability and ConsistencyComparability and Consistency

Conceptual Framework for Financial Reporting







Slide 2-10


Qualitative CharacteristicsQualitative CharacteristicsQualitative CharacteristicsQualitative Characteristics


Adherence to the concept of consistency Adherence to the concept of consistency requires that the same accounting principles requires that the same accounting principles

be applied to similar transactions by all be applied to similar transactions by all companies and for all periods?companies and for all periods?

Adherence to the concept of consistency Adherence to the concept of consistency requires that the same accounting principles requires that the same accounting principles

be applied to similar transactions by all be applied to similar transactions by all companies and for all periods?companies and for all periods?

True or False?True or False?True or False?True or False?

TRUETRUETRUETRUE

Slide 2-11










MatchingMatching








RelevanceRelevance







ExpensesExpensesGains and LossesGains and LossesConceptual

Framework for Financial Reporting







Slide 2-12


What is the underlying concept that supports What is the underlying concept that supports the immediate recognition of a contingent the immediate recognition of a contingent loss?loss?

a.a. Substance over form.Substance over form.

b.b. Consistency.Consistency.

c.c. Matching.Matching.

d.d. Conservatism.Conservatism.

CPA Question, Nov. 94, FARCPA Question, Nov. 94, FARCPA Question, Nov. 94, FARCPA Question, Nov. 94, FAR


Slide 2-13


WHAT IS AN OPERATING CYCLE?WHAT IS AN OPERATING CYCLE?WHAT IS AN OPERATING CYCLE?WHAT IS AN OPERATING CYCLE?

The operating cycle is how long it takes a company to initiate, The operating cycle is how long it takes a company to initiate, perform, and deliver their primary product or service.perform, and deliver their primary product or service.

Take a wholesaler for instance. First they buy inventory, then Take a wholesaler for instance. First they buy inventory, then they sell it on account, and ultimately they collect the cash owed they sell it on account, and ultimately they collect the cash owed from their customer. The period of time it takes to accomplish from their customer. The period of time it takes to accomplish this is the “this is the “Operating CycleOperating Cycle”.”.

Accounts Payable

Inventory

Accounts receivable

Cash

Slide 2-14


Assets are probable future economic benefits Assets are probable future economic benefits obtained or controlled by a particular entity as a obtained or controlled by a particular entity as a result of past transactions or events.result of past transactions or events.

Assets are probable future economic benefits Assets are probable future economic benefits obtained or controlled by a particular entity as a obtained or controlled by a particular entity as a result of past transactions or events.result of past transactions or events.

AssetsAssetsAssetsAssets

Balance SheetBalance SheetBalance SheetBalance Sheet

LO 3 Explain the concept and purpose of a classified balance sheet.

Slide 2-15


ASSETS, EXAMPLES AND MOREASSETS, EXAMPLES AND MOREASSETS, EXAMPLES AND MOREASSETS, EXAMPLES AND MORECASHCASH

PROCESS CULMINATESPROCESS CULMINATES

ACCOUNTS RECEIVABLEACCOUNTS RECEIVABLE, ON BALANCE SHEET BY:, ON BALANCE SHEET BY:SALESSALES

OFF THE BALANCE SHEET WHEN:OFF THE BALANCE SHEET WHEN:COLLECTED, OR WRITTEN OFFCOLLECTED, OR WRITTEN OFF

INVENTORYINVENTORY, ON BALANCE SHEET BY:, ON BALANCE SHEET BY:PURCHASESPURCHASES

OFF THE BALANCE SHEET WHEN:OFF THE BALANCE SHEET WHEN:SOLD- COGSSOLD- COGS

FIXED ASSETSFIXED ASSETS, ON BALANC SHEET BY:, ON BALANC SHEET BY:PURCHASESPURCHASES

OFF THE BALANCE SHEET AS IT IS:OFF THE BALANCE SHEET AS IT IS:DEPRECIATED- DEPRECIATION EXPENSEDEPRECIATED- DEPRECIATION EXPENSE

PREPAID EXPENSESPREPAID EXPENSES, ON BALANCE SHEET BY:, ON BALANCE SHEET BY:PAYMENTPAYMENT

OFF THE BALANCE SHEET AS IT IS:OFF THE BALANCE SHEET AS IT IS:CONSUMED- “BENEFIT IS REALIZED”- I.E INSURANCE EXPENSECONSUMED- “BENEFIT IS REALIZED”- I.E INSURANCE EXPENSE

Slide 2-16


OR more commonly stated:OR more commonly stated:

An asset that is expected to be realized in cash or An asset that is expected to be realized in cash or sold or consumed within one year or the operating sold or consumed within one year or the operating cycle, whichever is longer.cycle, whichever is longer.


An asset that is expected to be realized in cash or An asset that is expected to be realized in cash or sold or consumed within one year or the operating sold or consumed within one year or the operating cycle, whichever is longer.cycle, whichever is longer.

Defined:Defined:

An asset that is expected to be realized in cash or An asset that is expected to be realized in cash or sold or consumed during the operating cycle or sold or consumed during the operating cycle or within one year if the cycle is shorter than one year.within one year if the cycle is shorter than one year.

Defined:Defined:

An asset that is expected to be realized in cash or An asset that is expected to be realized in cash or sold or consumed during the operating cycle or sold or consumed during the operating cycle or within one year if the cycle is shorter than one year.within one year if the cycle is shorter than one year.

Current AssetsCurrent AssetsCurrent AssetsCurrent Assets



Slide 2-17


Liabilities are probable future economic sacrifices Liabilities are probable future economic sacrifices obtained or controlled by a particular entity as a obtained or controlled by a particular entity as a result of past transactions or events.result of past transactions or events.

Liabilities are probable future economic sacrifices Liabilities are probable future economic sacrifices obtained or controlled by a particular entity as a obtained or controlled by a particular entity as a result of past transactions or events.result of past transactions or events.

LiabilitiesLiabilitiesLiabilitiesLiabilities



Slide 2-18


Defined:Defined:

An obligation that will be satisfied within the next An obligation that will be satisfied within the next operating cycle or within one year, if the cycle is operating cycle or within one year, if the cycle is shorter than one year.shorter than one year.

Defined:Defined:

An obligation that will be satisfied within the next An obligation that will be satisfied within the next operating cycle or within one year, if the cycle is operating cycle or within one year, if the cycle is shorter than one year.shorter than one year.

Current LiabilitiesCurrent LiabilitiesCurrent LiabilitiesCurrent Liabilities




An obligation that will be satisfiedAn obligation that will be satisfied within one year within one year or the operating cycle, whichever is longer.or the operating cycle, whichever is longer.


An obligation that will be satisfiedAn obligation that will be satisfied within one year within one year or the operating cycle, whichever is longer.or the operating cycle, whichever is longer.

Slide 2-19


A Classified Balance SheetA Classified Balance SheetA Classified Balance SheetA Classified Balance Sheet

Current assetsCash xxxetc. xxx

Total current assets xxx

Fixed assetsOther long term assets

Total assets xxx

Current liabilitiesAccounts payable xxxetc. xxx Balances?

Total current liabilities xxx

Long-term debt, excluding current portion

EquityCommon stockAPICRetained earnings

Total Liabilities & Equity

Company NameBalance Sheet

As of DATE

Slide 2-20


A Multiple Step Income StatementA Multiple Step Income StatementA Multiple Step Income StatementA Multiple Step Income Statement

Revenue xxxCost of Revenue xxxGross Profit xxx

Selling general & administrativ (SG&A) expense xxxDepreciation expense xxxOther operating expenses xxx

Income before income tax provision xxxTax provision xxxIncome from continuing operations xxx

Discontinued operations, net of tax xxxIncome before extraordinary items xxxExtraordinary items, net of tax xxx

NET INCOME OR LOSS XXX

Company NameIncome Statement

FOR THE PERIOD ….

Slide 2-21


LiquidityLiquidity = the ability of a company to pay its debts as = the ability of a company to pay its debts as they come due.they come due.

A comparison of current assets and current liabilities is a A comparison of current assets and current liabilities is a starting point in evaluating the ability of a company to starting point in evaluating the ability of a company to meet its obligations.meet its obligations.

Working CapitalWorking Capital = Current Assets – Current Liabilities = Current Assets – Current Liabilities

Company’s strive for a balance in managing its working Company’s strive for a balance in managing its working capital – not too much or too little.capital – not too much or too little.

Analysis using a Classified Balance Analysis using a Classified Balance SheetSheetAnalysis using a Classified Balance Analysis using a Classified Balance SheetSheet

LO 4 Use a classified balance sheet to analyze a company’s financial position.

$58,100$58,100

Current Current assetsassets

Current Current liabilitiesliabilities

Working Working capitalcapital

$118,000$118,000 – – 59,90059,900 = =

Slide 2-22


Current Assets

Current Liabilities

Current Ratio =

$118,000

$59,900 1.97 to 1

=

The current ratio indicates the amount of current The current ratio indicates the amount of current assets available at the balance sheet date relative assets available at the balance sheet date relative to obligations coming due during that period. to obligations coming due during that period.

The current ratio indicates the amount of current The current ratio indicates the amount of current assets available at the balance sheet date relative assets available at the balance sheet date relative to obligations coming due during that period. to obligations coming due during that period.

Analysis using a Classified Balance Analysis using a Classified Balance SheetSheetAnalysis using a Classified Balance Analysis using a Classified Balance SheetSheet

Composition of current asset and current liabilities Composition of current asset and current liabilities important.important.

LO 4 Use a classified balance sheet to analyze a company’s financial position.

Slide 2-23


Landon Corporation was organized on January 2, 2002, with the Landon Corporation was organized on January 2, 2002, with the investment of $100,000 by each of its two stockholders. Net investment of $100,000 by each of its two stockholders. Net income for its first year of business was $85,200. Net income income for its first year of business was $85,200. Net income increased during 2003 to $125,320 and to $145,480 during increased during 2003 to $125,320 and to $145,480 during 2004. Landon paid $20,000 in dividends to each of the two 2004. Landon paid $20,000 in dividends to each of the two stockholders in each of the three years.stockholders in each of the three years.

Statement of Retained Earnings Statement of Retained Earnings ExerciseExerciseStatement of Retained Earnings Statement of Retained Earnings ExerciseExercise

Beg. Retained earnings

2002 2003 2004

$ 0

Net income (loss)

85,200

Less: Dividends (40,000)

End. Retained earnings

$45,200

$ 45,200125,320

(40,000)

$130,520

$130,520145,480

(40,000)

$236,000

LO 7 Prepare and identify the components of the statement of retained earnings.

Slide 2-24


BASIC- ALL AUDITED FINANCIAL STATEMENTS MUST BASIC- ALL AUDITED FINANCIAL STATEMENTS MUST INCLUDE:INCLUDE:

Financial statementsFinancial statements Notes to financial statements Notes to financial statements Report of independent accountantsReport of independent accountants

PUBLIC COMPANIES ALSO MUST INCLUDE:PUBLIC COMPANIES ALSO MUST INCLUDE: Management’s assertions (SOX 403)Management’s assertions (SOX 403) Report of independent accountants on internal Report of independent accountants on internal

controls (SOX 404)controls (SOX 404) Management discussion & analysisManagement discussion & analysis Summary of financial dataSummary of financial data Letter to stockholdersLetter to stockholders

Elements of the Annual ReportElements of the Annual ReportElements of the Annual ReportElements of the Annual Report

http://www.starbucks.com/

Slide 2-25


DATSALLFORTHISCHAPTER

Documents

Slide 2-1 ECON 3A UCSB ANDERSON Financial Statements and the Annual Report Chapter 2