Hello, I'm professor Brian Bouche.

And welcome to the first video in

An Introduction to Financial Accounting.
In this video,
we're going to provide an overview of
the financial reporting landscape.
What's required in financial reporting,
who makes the rules,
who enforces the rules, what are the basic
set of financial statements.
We've got a lot to get to in this course,
and I'm really excited, so
let's get started.
Let's start with a definition.
Accounting is a system for recording
information about business transactions
to provide summary statements of
a company's financial position and
performance to users who
require such information.
>> Wow, please tell me the whole
video won't be this boring.
>> [LAUGH] I sure hope not, but
to spice things up a little bit,
I will bring in some virtual
students every now and
then to ask questions or
to make pithy comments.
Anyway, this definition has three parts.
The first part is recording transactions.
This part turns out to be a big deal,
as not everything a business does gets
recorded in the financial statements,
and sometimes it'll seem like nothing's
happening, yet
we'll need to record a transaction anyway.
The second part is about
providing summary statements.
Large companies have billions and
billions of transactions every year.
If they made them available to you in
a gigantic database, your first question
would be, how can I summarize all
this into one or two summary numbers?
And the third part focuses on users,
because different user groups would
want different summary numbers.
So most companies have to
keep three sets of books.
Our focus in this course will be the first
set of books, or financial accounting.
This standardized set of
statements is geared toward
external users like investors,
creditors, customers, suppliers,
competitors and any other stakeholder or
person that has interest in the company.
However, these financial statements
are not used to determine taxes.
There is a separate set

of books based upon

tax rules that are used to compute
how much taxes a company has to pay.
These rules are often quite different from
what we do in the financial statements.
Finally, there's managerial accounting.
This provides customized reports for
internal decision making.
We're not going to cover this
topic in this course, but
I wanted to make you aware of the fact
that the financial accounting that
we do talk about it is generally not
used for internal decision making.
Instead, there are other kinds
of numbers that are looked at.
So what are the financial
reporting requirements?
The Securities and
Exchange Commission, or SEC,
requires periodic financial
statement filings.
Companies must file an annual report,
or 10-K once a year.
This includes a full set of financial
statements with a substantial amount of
additional disclosure.
This thing generally runs 200-300 pages.
The other three-quarters of the year,
firms must file a quarterly report,
or 10-Q, which has a full set
of financial statements but
less required disclosure
than the annual report.
If anything material happens
between quarter ends,
companies must file an 8K,
or current report.
Material information is generally viewed
as anything important enough to move stock
price, which means companies
file these quite often.
They don't require the financial
statements, just an update of whatever
major corporate event has happened,
something like a top manager resigns or
you lose a big customer or there's
a lawsuit or something along those lines.
All of these filings have to be prepared
in accordance with generally accepted
accounting principles, or GAAP.
>> Excuse me, does this stuff
only apply to US companies?
>> That's a good question.
I should note that this
will be a US-centric
course because I'm at
a US business school.
However, the things that we cover
will be applicable globally.

So for instance,
even though we're talking about SEC filing
requirements in the US, every country in
the world that has a securities market has
filing requirements like an annual report.
The only difference you might see
internationally is instead of a quarterly
report, some countries require
semi-annual reporting.
This also only formally
applies to public companies.
But private companies that need
to go to a bank to borrow money
oftentimes are required to provide
financial statements on a quarterly or
annual frequency because the banks are so
used to getting
financial statement information in
that format and in that frequency.
So this is a pretty universal set of
filing requirements that apply to public
and private companies around the world.
These periodic filing requirements
create much of the tension in financial
accounting.
For example, let's say we ship goods
to a customer in one quarter, but
we collect cash in the next quarter.
When did the sale occur?
Was it when we shipped the goods or
collected the cash?
And let's say we buy some
equipment in one quarter, and
then use it to manufacture goods
over the next 23 quarters.
When does the expense occur?
When we pay cash to buy the equipment or
as we use it over the next 23 quarters?
A lot of what we're going to do in
this course is try to figure out
what quarter to put various
business activities into
when we put together
the financial statements.
So who makes the rules?
Generally accepted accounting principles,
or
GAAP, are established by the US Congress,
but they're usually too
busy trying to do things like
investigating steroids in baseball or
figuring out whether they should
shut down the US government again.
They don't have time to deal
with accounting standards, so
they delegate to the Securities and
Exchange Commission.
But they're often too busy
trying to catch the bad guy, so
they don't have time to make the rules.

So they delegate to
the Financial Accounting Standards Board,
of FASB,
which is a seven-person board in Norwalk,
Connecticut, that has the authority to
make the accounting rules in the US.
And sometimes they're even too
busy to make all the rules, and so
there's an emerging issues task force and
the AICPA that can also have
a hand in making accounting rules,
or US GAAP.
Now this is just in the US.
Internationally, there are international
financial reporting standards, or
IFRS, that are established by the
International Accounting Standards Board,
or IASB, which is based in London, and
are now required in over 100
countries including all of the EU.
But as of now,
US GAAP is still required for US firms.
So basically there are two big sets
of accounting standards in the world.
But the good news is, for
almost all of the introductory accounting
topics that we look at in this course,
there's a very high degree of
overlap in the two standards.
>> Why doesn't the US just switch to IFRS?
Do you think there will ever be
one global accounting standard?
>> Actually, in the summer of 2008,
the SEC came out with a roadmap that would
move US firms to IFRS by basically now.
But then what happened was,
Lehman Brothers went bankrupt,
the financial crisis hit and the roadmap
dropped way off the SEC's radar screen.
So for the foreseeable future,
we're going to have two big sets of
standards in the world, US GAAP and IFRS.
But as I just mentioned,
the good news is the two standards are
getting closer to each other all the time.
The FASB and IASB are working
together on any new standards.
So, all the stuff that we talk about
that's under US GAAP in this course
will be very similar to what
you would see under IFRS.
So who's responsible for
financial reporting?
Management is responsible for
preparing financial statements.
>> Wait!
What?
That is like a professor allowing students
to give themselves their own grade.
Everyone gets an A plus.

>> Yes, that's correct.

We allow managers to put together their
own financial statements because they have
the most information about
what happened in the company.
And we hope that they use their discretion
in financial reporting to better
communicate their activities.
However, it is important to remember that
they may use this discretion to try to
manipulate the perceptions, and
we need to be on the lookout for
such opportunistic behavior.
So we put in a number of checks and
balances to try to curb managers'
opportunistic behavior.
First, the Audit Committee of the Board
of Directors provides oversight of
management's accounting process.
However, this is not a foolproof
check on managers' behavior.
You know, one of the biggest finance
statement frauds ever was Enron, and
the head of their audit committee was,
was a guy whose full-time job
was accounting professor.
Which means you could put
someone like me on the board and
still have these kinds of problems.
So then the auditors are hired by the
board to express an opinion about whether
the statements are prepared in accord,
accordance with GAAP.
This again is not foolproof, because in
the case of Enron, their au, auditor,
Arthur Anderson, signed off on some of
the more aggressive things they did,
and part of the reason was
because they were being hired
by Enron to approve their accounting.
If they lost Enron because of
a disagreement over their accounting,
then they would have lost
the biggest company in Houston and
would have had to go to the second
biggest company in Houston which is uhh.
Exactly!
Who knows what the second
biggest company in Houston is?
And that's why they want
to make sure to keep Enron.
The next line of defense is the SEC and
other regulators who will take action
against the firm if any violations
of GAAP or other rules are found.
Now these bodies tend to be very
reactive instead of proactive,
and it's oftentimes after someone else
has brought the fraud to the public's
attention that they launch

their investigation.
So by and large, it's information
intermediaries like stock analysts,
institutional investors and the media that
provide the biggest check on managers'
behavior by either exposing or fleeing
firms with questionable accounting.
But by the time one of these parties
get involved, it's a very public issue,
the stock price drops and
you're in bad shape if you're
an investor or employee of the company.
So in the end, the only party
that's really going to look out for
your interest in terms of understanding
and trusting financial statements is you.
Which is why it is really important
that you learn some basics in terms of
reading financial statements.
So what are the required
financial statements?
Well, there's four of them.
First, there's a balance sheet, which
gives a company's financial position,
which is its listing of all its resources
and obligations on a specific date.
Then there's the income statement,
which provides the results
of operations over a period of
time using accrual accounting.
By over a period of time we mean
between two balance sheets, so
either a quarter or a year.
And by accrual accounting, it means we're
going to recognize things in the income
statement based on business activities,
not based on cash flows.
Because we have a separate statement for
cash flows, the statement of cash flows,
which will give you all the sources and
uses of cash over a period of time.
And then finally, there's
the statement of stockholder's equity,
which provides changes in stockholder's
equity over a period of time.
>> Okay.
Could we get an example?
This is pretty abstract.
>> Yes, in fact I have an extended example
where we go through a simple business and
see what the different financial
statements can tell us about what's going
on at the business.
But it takes another ten minutes or so, so
to avoid this being a long first video,
why don't we cut it off here and
we'll pick it up in the next video.
I'll see you then.
>> See you next video.