Financial reporting

Session 1 The Financial Statements

Financial Accounting is the fundamental language of business

● Communicates information from firms to external stakeholders
● Offers a basis for managing decisions

The financial reporting process:

Who are interested in FS?

What goes into an annual

report?
Balance hee
Income a emen
S a emen of
ca hflo
S a emen of o ne eq i

The Accounting equation:

A e Liabili ie Eq i

Assets:
● Something that is controlled by the company and has the ability to provide future
economic benefits
● Ex.
o Cash / Inventory / Land / Buildings / copyrights etc.

Tangible assets:
● Assets which you can touch: supplies, truck, cash etc.
Intangible assets:
● Assets which you can´t touch: software, patented technology, internet domains etc.

Liabilities:
● Are Obligations that the company must pay in the future
● Ex.
o Salaries payable / Taxes payable / Warranty obligations / Mortgage / Bonds
payable

Owner´s Equity:
● Assets – Liabilities The wealth of the company
● Here you either have share capital or retained earnings
What kind of assets are there?
Current assets:
● Cash
● Marketable securities – bonds / shares (assets which can made to cash fast)
● Inventories (physical materials like raw materials or own products)
● Accounts receivable – money which the company is still awaiting from customers for
example
Long term assets:
● Land, Buildings etc.

The 4 Basic financial statements:

Balance hee
o Statement of current financial po i ion
o Reports the amo n of a e liabili ie and ockholde eq i of an
entity at that point of time
o A e liabili ie S ockholde Eq i

Income a emen
o Revenue – Expenses Net Income
o Shows how profitable a firm is over time

S a emen of e ained ea ning

o Reports the a ha ne income and he di ib ion of di idend affec ed
the financial po i ion of the company

S a emen of ca h flo
o Reports inflows and outflows of cash during the accounting period
o Identifies if the firm is generating enough cash to finance operations and
acquire assets needed
 o Identifies if the firm needs funding from lenders or owners?

There are 3 kinds of cash flows:

● Operating cash flow
o Cash from customers / cash paid during operation
● Investing Cash flow
o Cash from selling long term assets / cash from buying long – term assets
● Financing cash flow
o Cash from issues of long-term debt - dividends

Session 2: the Balance Sheet Double entry

How to journalize report journal entry´s:

When do write a Journal entry?

● Only when a transaction happened!

Asset recognition:
● Assets are only recognized when:
 o The firm owns or controls the right to use it
o The right arises from a past transaction/event
o The future benefit can be measured with reliability

Liabilities recognition:
● Item represents a present obligation
● Obligation exists because of a past transaction or event
● Obligation must be quantifiable with enough reliability

Shareholder equity:
● Owners´ equity Assets – liabilities
Shareholder’s equity accounts:
o Contributed capital – contributions by owners
o Retained earnings – profits that have not yet been paid dividends

Session 3 Income statement and double entry

REVENUE EXPENSES = NET INCOME

Revenues: Inflo s of assets from selling goods and services to customers

o Revenues are increases in net assets earned by a firm for providing goods or services

Expenses: Outflo s of assets consumed for generating revenues

o Assets are used up in generating revenues
o Therefore, expenses are simply asset consumption

Income statement vs. Cashflow statement

● Income statement is more fundamental because cash flow is only the actual present
cash flow which is considered. Unearned revenue and payments which are not yet
due are not stated in the cashflow statement

Cash accounting vs Accrued accounting

● Cash accounting:
o Measure revenue when ca h is received expenses when cash is paid
● Accrued accounting:
o Measure e en e when it´s earned and expenses when they are incurred
o Accrual “Rückstellung” (for things that will happen but not yet happened)
E ample:

What 4 criteria must be met in accrual accounting?

● Proof of A angemen
● Deli e of a product or service
● P ice must be fixed
● Collec abili must be assured that revenue can be collected
There are two criteria s when revenue is recognized:
● Selle m have substantially pe fo med i obliga ion o he c ome
● Seller m ha e ob ained an a e f om the c ome that it can reliably mea e
● R le come f om IFRS GAAP

Revenue recognition example:

How do we recognize expenses?

● Matching expense from transaction that leads to revenue recognition

● Period expense results from passage over time

o Ex. Apple buys advertisement services for (in the future)

Adjusting entries
● Recorded at the end of the accounting period in order to make the net income figure
timely

Result from:
o passage of time
o noncash events that occurred during the period

Adjusting entries are made to ensure that

● Expenses are recognized in the period in which they incurred
● Revenues are recorded in the period in which services are performed
● Statements of financial position and income statements have corrected balances at
the end of the accounting period

The 4 types of Adjusting entry s

● Revenues:
o Deferred (unearned) Revenue
o Accrued Revenue
● Expenses
 o Deferred (prepaid) expenses
o Accrued Expenses

Closing accounts:

Session 4 Reporting Sales and Receivables

Why do we care about Sales?

● Revenue is the key input for any company that can be manipulated under accrual
accounting

Some events might affect revenues recognized at the time of sales:

● Returns
● Credit card sales
● Sales discounts

How to incentivize sales?

C edi ca d ale
Credit card sale of $100,000 ith 3% financing fee

Sale di co n

Sale e n and allo ance

How does it work rap up:

An example of how company´s change their footnotes to show higher revenues in the
financial statement:

What are uncollectible accounts?

Account receivable is an asset that represents a promise to pa
. This means that customers may not be able/willing to pay in the end…
o If that happens, accounts receivable must be credited to its new lower value:

The allo ance method: (aging approach)

The percentage of Sales method allowance method:

Important Formulas:
Recei able no e

A e age collec ion Pe iod

Go p ofi ma gin

Session 6 Inventories and costs of sales:

What is inventory?
● Are tangible items that are either:
o Held for sale
o Used to produce goods or services for sale
● When a firm sells inventory, the carrying amount of that inventory becomes an
expense COGS (Cost of goods sold)

Inventory Equations:
Ending In en o

Sold In en o

The two inventory accounting systems:

Pe pe al in en o em
o Cost of goods solds recorded at the time of sale
Real time information
Enhanced inventory control
Better planning capabilities
Pe iodic in en o em
o Costs of goods sold (and inventory) computed only at regular intervals, not
continuously
Types of inventories in the balance sheet:
Ra materials and consumables materials, needed for production
Work in progress value during production
Maturing inventories process until product is finished in inventor ( ine to ripe)
Finished goods and goods for resale end product, aiting to be sold

The different inventor costing methods:

● Specific unit costs
o Units and their costs are specifically identified (eg. Real estate properties or
jewelry)
● FIFO – First in First out
o Costs of first units acquired are assigned to COGS and most recent costs in
inventory
o Calculate:
Inventory all purchase – (items
sold - total amount * last amount)
● Weighted average
o COGS and inventory calculated based on
average costs of period
o Calculate:
Costs of goods total/sum of
products sold average unit cost
Cost of goods total – last amounts
* average unit costs
● LIFO – Last in First out

Ho to calculate FIFO and Weighted average:

Lower of cost or market method:

Not 360 365

Session 7&8 long

lived assets
What are long lived assets?
● Property and equipment, net
● Intangible assets, net
● Goodwill
● Property and equipment, net

PPE property, plant, equipment

● Are recorded at the historical cost
● The costs consists of all expenditures necessary to acquire the asset and make it
ready for us
E ample:

What is depreciation?
● The process of allocating the cost of a tangible asset over its useful (service) life

Accumulated Depreciation? accumulates the total depreciation to date

The methods of depreciation:

S aigh line Me hod
o method of calculating depreciation and amortization, the process of
e pen ing an a e o e a longe pe iod of ime than when it was purchased
Uni of p od c ion Me hod
o a method of calculating the depreciation of the value of an asset over time. It
becomes useful when an asset s value is more closely related to the number
of units it produces rather than the number of years it is in use.
Do ble declining Me hod
o an accelerated depreciation method that counts as an expense more
rapidly (when compared to straight-line depreciation that uses the same
amount of depreciation each year over an asset s useful life)
 Wha I he Declining
Balance Me h d?
The declining balance method is an accelerated depreciation system of recording
larger depreciation expenses during the earlier years of an asset’s useful life and
recording smaller depreciation expenses during the asset's later years.

Double declining: useful life e . 8 ears = 1/8 2 (double declining) = = 25%

What is an Asset Disposal?

● Asset disposal is the removal of a long-term asset from the company s accounting
records
Example:
What is Asset impairment
● If an asset is not expected to generate future cash flow, it must be impaired
● Example. Car crash – car, Thunderstorm – machine broken can´t be used

Session 8 Long lived Assets II

What are Intangible Assets?

● Intangible assets are rights, privileges and gi e compe i i e ad an age that arise
from owning long-term assets. They are recorded at costs.

● Examples of intangible assets:

o Patents, Copyrights, Goodwill, Trademarks
In acco n ing, Good ill in acco n ing i an in angible a e ha a i e hen a b e
acq i e an e i ing b ine

Internall developed intangibles do not appear as assets on the compan s balance sheet.
the are e pensed as incurred!

Intangible assets ith finite life are amorti ed al a s straight-line method

What is Amortization?
● Am i a i n i he ac ice f eading an in angible a e' c e
ha a e' ef l life.

Formulas for Assets turnover and Fixed assets turnover:

Session 9: Liabilities

What are liabilities?

● Liabilities are claim on a e b c edi o (not owners) – that ep e en a p e en
obliga ion o make f e pa men of cash, goods or services
● Less than a year current liabilities
● More than a year non-current liabilities

Is it a liability?
● Payments from customer in advance of providing goods and services? – Yes!
● Debit: Cash / Credit: unearned Revenue
o Deferred revenue ad ance pa men a compan ecei e fo p od c o
e ice that are to be delivered or performed in the future
o Ex. Prepayments, subscriptions which you pay at the beginning of the year

● Product warranties? – Yes!

o Is a liability which could occur in the future
Recorded at time of sale
Estimated from the company from historic data (past experience)
E amples:

Liabilities can onl be registered/reported if the happened or ou are 100% sure that the
ill:

The Economic value:

● Would you rather choose today or next year?
● Choice is influenced by Timing and uncertainty
Accounting for Long-term notes payable:

Ca h pa men a he ame h o gho

In e e e pen e
Red c ion of p incipal A B
P incipal Balance f omm D DC

What are Leases?

● The agreement in which the tenant (lessee) receives the right to use specific property
in return for cash payments owner

What are Bonds payable?

● Bonds are debt of the issuing company to raise money
● Types of Bonds?

Some ratios:
Session 10 Owners Equity

What is IPO?
Initial public offering:
● a public offering in which shares of a company are sold to institutional investors and
usually also retail (individual) investors. ... Most companies undertake an IPO with the
assistance of an investment banking firm acting in the capacity of an underwriter.

What is direct listing?

● A Direct Public Offering (DPO), also known as a direct listing, is a way for companies
to become publicly traded without a bank-backed Initial Public Offering (IPO)

The difference bet een IPO and direct listing:

● One of the main differences between a direct listing vs IPO is that through a
traditional IPO, a company issues new shares of its stock, while companies that
choose direct listings sell only existing shares

Negative aspects of going public:

● Increase of regulatory compliance
● Long and expensive process
● Everyone has access to quarterly earnings
 ● Shareholder meetings – loss of control
● Higher potential of a volatile stock price

Positive aspects of going public:

● Permanent and liquid source of capital
● Branding opportunity
● Legitimacy and stability for shareholders

How can firms issue shares?

. Directly to investors
. Indirectly, through an investment bank (underwriter) that buys the shares from the
corporation at a stipulated price and resells them to investors.

What is:
Authorized stock:
● Maximum of stock a corporation is allowed to sell as authorized – have to list on BS

Issued stock:
● No. of shares originally sold to stockholders
● Repeated offerings

Outstanding stock:
● No. of shares hold by stockholder
● Circulating shares

Shared issued shares required = treasury stock

Classes of stock:
● Common stock:
o Most basic form of capital stock / voting right
● Preferred stock:
o Dividends are priority. Priority to asset in case of liquidation / no voting rights

Journal entr :

What is a treasury stock?

● Treasury stock is a company’s own shares that has issued and later reacquired. B
back of o n ha e Shares outstanding Issued shares – Treasury stock

The ea on fo ock ep cha e

● To reuse for employee stock compensations plans
● To increase trading in the company’s stock
To increase earnings per share
Journal entry of repurchase of shares:

What is retirement of stocks?

● Stock retirement involves purchasing stock and removing it from the issued status.
● Retired shares cannot be reissued.

Journal Entry:

The prefect payday

Backdating = pretending the options ere granted on an earlier, more convenient date.

What are dividends?

● Dividends are a corporation’s distribution of cash or stock to its shareholders on a
proportional to ownership basis.

To pay dividends a company must have:

● Enough retained earnings
● Enough cash!

TAKE IT FROM RETAINED EARNINGS

What are stock dividends?

● Stock dividends are a proportional distribution by a corporation of its own stock to
the stockholders

Exercise on stock dividends:

What are stock splits?
● A stock split increases the number of shares in a company. A stock split causes a
decrease of market price of individual shares, not causing a change of total market
capitalization of the company
I a c g d?
One side says a c ag db g d ca , signaling the company's
share price is increasing and doing well. While this may be true, a stock split simply
has no effect on the fundamental value of the stock and poses no real advantage to
investors.
Im an F m la :

Ea g e ha e:

f ha e

Session 11 - Financial statement analysis

What are financial Ratios?

● They standardize financial data to identify economic relations between quantities in
the financial statements

Financial ratios by category

The two ways to use ratio analysis:

● Time series
o Same firms across periods
● Cross sectional
o Compare different firms in the same period
Downside on ratios:
● No generally accepted
 ● No ratio tells the whole story
● Managers can manipulate

What is ROA Return on Assets

Measures a firm’s performance in ing a e in gene a ing income

What is return on equity?

Measures a firm’s performance in ing e o ce p o ided b ha eholde in
gene a ing income

Financial Leverage = ROE ROA

Drivers of profitability:
● Profit Margin
● Asset’s turnover

● Liquidity solvency

Other important formulas:

Liquidity ratios:
Solvency ratios:

Market tests:

Accounts receivable turnover:

Formula: Sales/Average accounts receivable

Inventory turnover:
Formula: COGS/average inventory

Dept to assets:
Deb - -A e Ra = T a Deb / T a A e
Working capital = current assets current liabilities

What can be done to prevent corporate fraud in the company?

● The impact of the culture and the leadership style (e.g., existence of code of ethics)
● Role of internal auditing (e.g., to whom internal auditors report to)
● Existence of internal controls (e.g., control of access to general ledgers)
● Role of the Board of Directors (e.g., effective, meeting frequency, independent
members, an audit committee, etc.)
● External auditors (independence of auditors)

Suma Equity
● What is private equity?
o Investment funds which buy companies and restructure them and Exit (sell or
IPO)
o Restructure financial, operations or governance
o Venture capital – investing through equity / investing in companies with high
risk
o Private Equity – investing through loans etc.