Lecture

1
Financial Accounting and
Financial Statements

Overview
Financial Accounting

By Vincent Chen

Whats Accounting?
Accounting is business language
An information system that collects and summarizes a
firms
firm
s economic activities
Then reports those processed information to users

By Vincent Chen

The
accounting
process

Economic
activities

Actions
(d i i
(decisions)
)

Accounting
links decision
makers
k
with
ith
economic
activities and
with the results of
their decisions.
decisions
Decision
D
i i
makers
By Vincent
Chen

Accounting
information

Wh Accounting
Why
A
ti iis needed?
d d?
Different users need different information

Stockholders: profitability
Debtholders: ability to repay interest, liquidity
Plant managers: cost allocation
Top management: profitability, financial position
Board of directors: overall performance
p
Government: taxable income

By Vincent Chen

T
Types
off Accounting
A
ti Information
I f
ti
Financial Accounting
Financial information produced that primarily used by external users,
such
h as ((potential)
t ti l) iinvestors,
t
d
debtholders,
bth ld
and
d regulators
l t

Managerial Accounting
Financial information produced that used by internal users within a firm,
such as plant managers and top management

T Accounting
Tax
A
ti
Financial information produced that used to fulfill obligations for tax or
regulatory agencies
By Vincent Chen

Financial Accounting
Since Accounting
g is an information system
y
Who sets the rules to run this system?
Financial Accounting Standard Board (FASB)
Rules are called Generally Accepted Accounting
Principles (GAAP)

Who should comply with GAAP?

Company/Corporations

Inputs to the system: economic transactions

Outputs to the system: financial statements
To ensure the system to be consistent with GAAP
Auditors
A dit
and
d iinternal
t
l control
t l mechanism
h i
iin place
l
By Vincent Chen

Financial Statements

By Vincent Chen

Financial Statements
Financial
Fi
i l St
Statements
t
t include:
i l d
Balance Sheet (Statement of Financial
Position)
Income Statement
Statement of Cash Flows
Statement of Owners Equity
Statement of Retained Earnings

Frequency: annual or quarterly

By Vincent Chen

Balance Sheet
It reports the financial positions (assets,
liabilities and owners equity) of a firm at a
particular point of time)
Elements of the balance sheet include assets
assets,
liabilities, and owners equity.
Assets = Liabilities + Owners Equity
By Vincent Chen

10

Balance Sheet
Assets: the economic resources owned or
controlled by the firm (cash, accounts
receivable, inventory, buildings, patent)
Current Assets: cash and other assets that can be
converted to cash within a year, e.g. cash, accounts
receivable and inventory.
Noncurrent assets: assets to be used or turned into
cash beyond a year (notes receivable, buildings, land
and patent)
By Vincent Chen

11

Balance Sheet
Liabilities
Liabilities: probable debts or obligations that will
ill
be paid for with assets or services (accounts
payable tax payable
payable,
payable, unearned revenue
revenue))
Current liabilities: obligations expected to be satisfied
by cash or services rendered within a year (accounts
payable, tax payable)
Long
Long-term
term liabilities:
liabilities debts or obligations to be paid
beyond a year (bank loan, bond payable)

By Vincent Chen

12

Balance Sheet
Owners equity: the owners claims on the assets
(net assets) of the firm:
Common stock: face value of issued common stocks
Additional p
paid-in capital:
p
the difference between face
value and the market value of common stocks when
issued
Retained earnings: the amount of accumulated net
income (earnings) that have not been distributed to
owners
owners.
By Vincent Chen

13

Income Statement
It reports
t the
th amountt off nett income
i
(revenue
(
minus expenses) earned by a firm during a
period of time
Elements of the income statement include
revenue, expenses and net income
Revenue Expenses = Net Income (loss)

By Vincent Chen

14

Income Statement
Revenue: Increase in the firms resources from
the sale of goods or services (e.g. sales
revenue).
revenue)
Expenses: Costs incurred in the normal course
of running the firm to generate revenues (e.g.
cost of goods sold, salary)
Net income (earnings): the excess of total
revenues over total expenses
p
By Vincent Chen

15

Statement of Cash Flows

It reports the amount of cash collected and paid
out by a firm during a period of time
Elements include cash flows from operating,
financing and investing activities
Cash (Beg. Balance) + Changes in Cash Flows
from operating
operating, financing and investing activities
= Cash (End. Balance)
By Vincent Chen

16

Statement of Retained Earnings

It reports the way net income and the distribution
of dividends affect retained earnings of a firm
during a period of time
Elements include retained earnings (beginning
and ending balances), net income, and
dividends
R/E (Beg) + N/I Dividends = R/E (End)
By Vincent Chen

17

Notes to the Financial Statements

Details of each line item (summary numbers) in
th fi
the
financial
i l statements
t t
t
Example: Property, Plant and Equipment (PPE)
Straight-line method and estimated useful lives of
PPE (2
(2-7
7 years for equipment and 30
30-40
40 years for
buildings)

By Vincent Chen

18

Underlying Assumptions and

Accounting Principles
Balance Sheet:
Cost principle: requires assets to be recorded
at their historical costs or exchange prices at
the transaction date
Going concern assumption: businesses are
assumed to continue to operate in the
foreseeable future
Objective principle
By Vincent Chen

19

Underlying Assumptions and

Accounting Principles
Income Statement:
Revenue recognition principle: revenues
sshould
ou d be recognized
ecog ed when
e 1)) goods o
or
services have been delivered or substantially
completed and 2) cash has either been
collected or collection is reasonably assured
Matching principle: all costs and expenses
incurred in generating revenues must be
recognized in the same reporting period as
the related revenue
By Vincent Chen

20

Articulation of the Financial

Statements
1. Net income affects the ending balance of
retained earnings
2. Ending balance of retained earnings is part of
elements of owners equity on the balance
sheet
3 Ending balance of cash from the statement of
3.
cash flows appear under current assets on the
balance sheet
By Vincent Chen

21

NUS Corporation
Statement of Cash Flows
For the Year Ended December 31, 2008
C h Fl
Cash
Flows ffrom O
Opearing
i A
Activities
ti iti

$ XXX

Cash Flows from Financing Activities

XXX

Cash Flows from Investing Activities

XXX

NUS Corporation
Balance Sheet
At December 31, 2008

Changes in Cash Flows

$XXX

Cash (Beg. Balance)

$XXX

Assets

Liabilities

Cash (End.
(End Balance)

$XXX

Current Assets

Current Liabilities

Cash

$XXX

Accounts Payable

Accounts Receivable

XXX

Inventory

XXX Long-term Liabilities

Prepaid Insurance Expenses

XXX

Total Current Assets

$XXX

Tax Payable

XXX

Bond Payable

XXX

$XXX Total Liabilities

$XXX

Owners' Equity

Noncurrent Assets
Property, Plant and Equipment

XXX

Common Stock

XXX

Goodwill

XXX

Retained Earnings

XXX

Total Noncurrent Assets

$XXX Total Owners' Equity

$XXX

T
Total
l Assets
A

$XXX Total
T
l Liabilities
i bili i & Owners'
O
' Equity
E i

$XXX

NUS Corporation
Income Statement
For the Year Ended December 31, 2008
Revenue:
Sales Revenue
Total Revenue
Expenses:
Wage Expenses
Utility Expenses
Rent Expenses
Total Expenses
Net Income

2
NUS Corporation
Statement of Retained Earnings
F the
For
th Year
Y
ended
d d December
D
b 31,
31 2008

$XXX
$XXX
XXX
XXX
XXX
$XXX
$XXX

Retained Earnings (Beg)

Net Income
Dividends
Retained Earnings (End)

By Vincent Chen

$XXX
XXX
XXX
$XXX

22

Summary
Whats accounting
acco nting and why
h we
e need it?
Constituents of Balance Sheet, Income
Statement, Statement of Cash Flows and
Statement of Retained Earnings
Assumptions and principles that are used to
prepare financial statements
statements.
Articulation of financial statements
By Vincent Chen

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