Accounting 101

Fall 2012

INTRODUCTION TO
FINANCIAL ACCOUNTING
 Objectives of ACCT 101
• Understand how financial accounting
statements are constructed
• Develop the ability to read, analyze and
interpret financial statements
• Provide you with tools for economic
decision making
– Where to find information
– How the information got there
– Map economic events to transactions
 Course Topics
Overview of Financial Statements Long-Lived Assets

Liabilities – Present Value, Notes,

Balance Sheet Concepts
and Mortgages
Income Statement Concepts Liabilities – Bonds

The Accounting Cycle Liabilities – Leases

Statement of Cash Flows Shareholders’ Equity

Revenue Recognition Deferred Taxes

Cash and Receivables Intercorporate Investments

Inventories – Cost Methods

 Rules of the Game
• Read the syllabus carefully – CONTRACT
– Updated syllabus available on Canvas
• Attend the recitation sections
• Come to class on time
– Cannot walk-out early!
• Turn in your homework on time
• Turn off cell phones, laptops, and
other communication devices
 Textbook and Registration
• Registration:
– Register for both the lecture and one of the
recitations
• Text (RECOMMENDED NOT REQUIRED)
– Introduction to Financial Accounting by
Horngren, Sundem, Elliott, and Philbrick (10th
Edition)
– Custom Manual with Solutions available in
bookstore
 Course Website & E-mail

• Website (Canvas System):

– https://wharton.instructure.com/login
– Homeworks posted/collected online
– Lecture notes will be posted
– Helpful discussion board (only for students)
– Non-Wharton access: courseware@wharton.upenn.edu

• Email:
– accounting101@wharton.upenn.edu
 Grading Scheme

• Final grades will be determined by the

following scheme:

– Homework 10%
– Quiz 1: 20%
– Quiz 2: 30%
– Quiz 3: 40%
 Grading Scheme
• Grades will be assigned across the sections
approximately as follows:

 25% - 35% As
 35% - 40% Bs
 15% - 20% Cs
 5% - 10% Ds, Fs
 Homeworks
• Four homeworks
• Posted online at least one week prior to due date
• Allowed to work in groups
• Submit your answers individually on the web
– no hard copies accepted!

• Due by 9 am on due date

– NO EXCEPTIONS
– SERVER/COMPUTER CRASH IS NOT AN EXCUSE
 QUIZ SCHEDULE
QUIZ 1 – Monday, October 8th (In Class)
QUIZ 2 – Monday, November 5th (In Class)
QUIZ 3 – Wednesday, December 5th (In Class)

• All Quizzes are multiple choice.

• Cannot reschedule or take make-up quiz because
of travel plans!
• Note the make-up quiz policy – clearly outlined
in the syllabus.
 TAs/Recitations
• Who?
– Natalia Alihashkina (MBA 2013)
– Kwame Danso (MBA 2013)
– Oren Isacoff (MBA 2013)
– Tanja Magas (MBA 2013)
– Frederick Shern (MBA 2013)
– David Tsui (Doctoral student & head TA)

• Why?
– The role of recitations
• Not another lecture
• Answer questions, get help
• Review assigned problems
• Review homeworks, quizs

• Where/When?
– Recitations on Fridays
– Office hours
 Today’s Class

• Overview of “accounting” in general and

“financial accounting” in particular

• Discussion of accounting terminology

• Mandatory financial reporting (including

the financial statements)
 Big Picture Regarding Accounting
Accounting is not (just) about recording transactions. It is about:
(1) understanding and reporting how transactions impact firm or
divisional financial performance, and
(2) ensuring the reliability of financial performance reports

Report of -Tax
Financial performance and -Internal decisions
records financial position -External decisions

Reliability
check
 Financial Reporting
(what this class is about)

Providing useful information about the financial health of a firm to

external parties of interest (stakeholders)
Key element here is that information is for external use
Who are the stakeholders of a firm that consume financial
information that is produced and presented by firm management?
Because people and agencies outside of a firm rely on this
information for potentially large financial decisions, there is very
strict standardization and enforcement of how this information is
produced and presented
 Other Types of Accounting
(not covered in this course)

• Tax Accounting
– Tax Preparation and Compliance is pretty self-explanatory

• Managerial Accounting (e.g. ACCT 102)

– Internal Information Systems and Reporting provides firm
managers useful, real-time performance information to help
with decision making
– Information systems are designed specifically to cater to a single
firm’s managers’ needs, hence there is little standardization
– Information is for internal use only
– Therefore, there are typically few rules to govern how this
“should be” done
Who needs to know Accounting?
Financial Analyst
Money Manager
Investment Banker
Business Consulting
General Management
Internal Controls Auditing and Consulting
Tax Preparation and Compliance
Financial Statement Preparation and Auditing
 Why do publicly-traded corporations have to
file financial reports?
Corporations need cash, savers can supply cash. They trade at public
capital markets. However, public capital markets are like markets
for second-hand cars…
Risk of Adverse Selection
Car/firm
value

- Rules about the frequency and

format of such information
- Third-party monitoring (SEC,
Average auditors, analysts, investment
value
funds)

Car/firm
Average
quality quality
Why do publicly-traded corporations have to
file financial reports?

Separation of ownership (shareholders) and control (hired

managers) presents a classic principal-agent problem
(agency theory)

Agency theory suggests that, without proper monitoring

and incentives, agents will extract perquisites (Jensen and
Meckling, 1976)

Financial reports are one mechanism to help monitor

managers’ actions
 Financial Reporting
(Key Players)
• Regulatory Agencies (SEC) and Standard Setters (FASB/IASB)

• Financial Accountant
– Hired by a firm to help prepare the firm’s financial reports
– Usually works beneath the senior supervision of the Chief Financial Officer
– Head Financial Accountant is usually called the Controller

• Auditor
– Independent Agent hired by the firm to regularly assess and attest to the
financial reporting quality of the firm
– Maintains an on-going relationship with the firm (the audit client) to allow for
regular inspection of financial processes and internal controls over financial
processes
– Typically works for a “CPA Firm”

• Users
– Investors and affiliated third-parties
– Demand information about health and performance of company
– Understand accounting rules and treatments, understand how economic events
map into financial statements (and vice-versa)
 Mandatory reports and enforcement
The Securities and Exchange Commission (SEC) is a regulatory agency
commissioned by Congress to monitor and enforce legal and fair
behavior in the U. S. capital (stock and debt) markets

The SEC mandates that all publicly-traded firms will file regular
financial reports with the Commission
Major reports include:
10-Q: Quarterly financial report (filed at the end of each of 3 fiscal
quarters)
10-K: Annual financial report (filed at the end of the last fiscal quarter)

These reports are filed electronically and kept on file at the SEC
They are available online through “edgar”: www.sec.gov/edgar.shtml
They are available on each firm’s corporate website
They are available in paper form by request from the company’s
investor relations department
Mandatory reports and enforcement (contd.)
The SEC has legal authority to enact civil or criminal penalties for lack of
compliance or suspicion of fraud

SEC Pursues Civil Case Against Scrushy

Stephen Taub, CFO.com
July 08, 2005
The Securities and Exchange Commission asked a federal judge for
permission to pursue civil charges against Richard Scrushy — co-
founder, former chairman, and former chief executive officer of
HealthSouth Corp. — one week after a jury found him not guilty of
criminal charges, according to published reports.
The SEC asserted in a filing in U.S. District Court in Birmingham that
Scrushy's acquittal on criminal accounting fraud charges offers "no legal
or factual basis" to strike its claims that Scrushy directed a massive
accounting fraud at HealthSouth and engaged in insider trading and
other violations, according to Reuters.
 What is in these mandatory reports?

Detailed summaries of current firm financial status and a summary of

changes that occurred throughout the reported time period
Basic financial statements:
1. Balance Sheet: End of reporting period snapshot of what is
owned, what is owed, and what is left for owners
2. Income Statement: Summary of inflows and outflows over
the period (a.k.a. Statement of Continuing Operations)
Why might these two show different amounts during the period?
3. Statement of Cash Flows: Summary of the change in cash
on hand from the beginning of the period to the end of the period
4. Statement of Owners’ Equity: Summary of the change in
owners’ (shareholders’) claims on the firm from the beginning of
the period to the end of the period
What is in these mandatory reports (contd)?
Also included:
“Footnotes”: Specific details about line items presented in the
major financial statements
Management Discussion & Analysis (MD&A): Management’s
personal views about the prior period and expectations for the future
Audit Opinion: Opinion regarding the financial reports as well
as an assessment of internal controls
Unqualified: Financial statements appear to be presented fairly and in
accordance with Generally Accepted Accounting Principles (GAAP);
internal controls appear to be adequate
Qualified: Generally, financial statements appear to be presented fairly
and in accordance with Generally Accepted Accounting Principles
(GAAP), but there is some material issue that needs to be addressed;
there is an issue that needs to be addressed regarding internal controls
Adverse: There is a high probability of material errors within the
financial statements; there are material weaknesses in internal controls
Unqualified opinion regarding financial statements

Adverse opinion regarding internal controls

What are Generally Accepted Accounting Principles
(GAAP)?
Financial reporting standards that are created by an independent
standards-setting agency and enforced by the audit profession and
the Securities and Exchange Commission.

The Financial Accounting Standards Board (FASB) is responsible

for developing GAAP within the United States.
It is very important to note that virtually every country has its own
GAAP standard-setting board. Standards are NOT YET completely
consistent across borders. What are the implications of this?
There has been a recent push towards GAAP convergence.

There is aggressive development of International Financial

Reporting Standards (IFRS) that are issued by the International
Accounting Standards Board (IASB)

European Union, Australia, and others have already adopted

IFRS; FASB and IASB are working towards U. S. GAAP
convergence with IFRS
Critical definitions of terms used throughout
this course
Assets: items owned by the firm
Liabilities: items the firm owes to creditors
(One source of funds available to purchase or create assets)
Net Assets: Assets minus Liabilities (the assets left over after paying off
debt)

Owners’ Equity: the owners’ claims to the assets

Owners’ Equity = Net Assets. Why?
These are the fundamental concepts for the Balance Sheet

Assets = Liabilities
(what is owned) (what is owed)
Provide
funds for Owners’ Equity
(owners’ claims)
Critical definitions of terms used throughout
this course (contd.)
Accounting Equation: Assets = Liabilities + Owners’ Equity

Cash + Other Assets = Liabilities

(what is owned) (what is owed)

Owners’ Equity
(owners’ claims)

Retained Earnings Contributed Capital

(cumulative profits kept within (Stock Issues)
the firm) (note this is a second source of funds
for purchasing or creating assets)

Revenues Expenses
(inflows of resources) (outflows of resources)
Columbia Sportswear Company
Consolidated Balance Sheet

Total assets $1,148,236

Total liabilities + owners’ equity $1,148,236

Critical definitions of terms used throughout this course
(contd.)
Revenues: inflows to the firm (from providing services or sales)
Expenses: outflows by the firm that are generated to help create
revenues
Gains: increases in value of firm assets
Losses: decreases in value of firm assets
Net Income: “profit” earned during the period

Revenues Note: the difference between these

classifications is often subtle and confusing
- Expenses
+ Gains Generally, “revenues” and “expenses” are
associated with fundamental operational
- Losses
transactions
= Net income “Gains” and “losses” are associated with
tangential transactions
These are the fundamental In N’ Out Burger’s sales of hamburgers
concepts for the would generate “revenues”
Income Statement In N’ Out Burger’s sales of a delivery truck
might generate a “gain” or a “loss”
Critical definitions of terms used throughout this course
(contd.)
Income Statement: summary of revenues and expenses for the period

Revenues
 Cost of sales (Cost of goods sold)
= Gross margin Operations Section
 Selling and administration expenses
= Income from operations
 Interest expense
 Other expenses or losses
 Other revenues or gains Non operations Section
= Income before taxes
 Income tax expense
= Income before irregular items
 Loss or gain from discontinued operations (net of tax)
 Loss or gain from extraordinary items (net of tax)
 Loss or gain from change in accounting principle (net of tax)
= Net income
Irregular Items Section We’ll cover this in more detail later…
 Columbia Sportswear Company
Consolidated Statement of Operations

Revenues $1,317,835

Expenses $1, 222,788

Net income $95,047

Critical definitions of terms used throughout this
course (contd.)
Dividend: periodic payment back to the owners; a
distribution of profits

Now, let’s put this all together…

 Big Picture Review
The firm also borrows
funds to purchase or
create assets

Assets Liabilities
(what is owned) (what is owed)
Owners’ funds are
used to purchase Owners’ equity
or create firm (owners’
assets
claims)

Investors (owners)
contribute funds to create a
firm
 Big Picture Review

Assets Liabilities
(what is owned) (what is owed)
Assets are used up (expenses)
to generate revenues Owners’ equity
which nets to Net income (owners’ claims)
Net income (Revenues –
Expenses) is collected
within the firm (as Retained earnings
Retained earnings)

Some proportion of
Retained earnings is
distributed to owners
We’ll cover this in more detail later… as a dividend
 Next Class…

Overview of the financial statements.

More detailed discussion of the balance sheet