Financial Reporting – Nova SBE

Russell Lundholm
Sauder School of Business
Vancouver Canada
The Plan for Class
1. Introduction to Financial Reporting
2. Accounts Receivable
3. Inventory
4. Property, Plant and Equipment and Intangibles
Looks like he is just
5. Leases working down the balance
6. Financial Assets sheet

7. Consolidations
8. Operating Liabilities
9. Financial Obligations
10. Taxes and Classifications on the Income Statement
11. The Statement of Cash Flows
12. Carbon Accounting
typical class
discuss questions from previous class
introduction of next topic
in-class exercise

If I hear myself doing all the talking I might ask a

rhetorical question to the room – someone has to
answer

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accounting in six weeks?
…

4
Organizational Details
Come to class or go to the library
study accounting at least a little EVERY DAY

No required textbook because the material is online

Google IFRS, Inventory
or ask ChatGPT
useINTERNATIONALFINANCIALREPORTING
STANDARDS: A PRACTICALGUIDE.pdf
 on general page of our MOODLE
or https://www.deloitteifrslearning.com
 (this is a VERY DETAILED class on all of
IFRS)
ASSESSMENT
In-Class Quiz 35%
closed book
date February 29 (an auspicious day!)

Final Exam 65%

comprehensive
closed book
date March 21
so let’s dive in!

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 Basics of Accounting
 startwith a simple story: You and a
fellow student decide to go into the
watch business.
– Each contribute $50

 Three
necessary ingredients to have
a meaningful accounting problem:
1. separation of ownership and mgt
2. demand for periodic reporting
3. need for a common denominator
 The Lisboa Watch Company
annual letter
 At t0 had $100 cash
 At t1 have t1 t0
 $50 cash 50 100
 4 finished watches 80
 $20 IOU to bank -20
 2 good sales prospects 0
110
100
 Hard to compare stuff on the list until
everything is in terms of common currency.
– But WHAT amounts? (amt paid, estimated selling
price?)
– WHEN was the value increased? (when sold?
when built? when sales prospect is found?)
 The Accounting System
 How does the accounting system
capture all the activity of the year
and cast it in terms of euros?

 Three types of transactions

– With the owners
– Rearranging the Balance Sheet
– Recording increases and decreases in
wealth
 Keeping the Books
Assets = Liabilities +
Equity
CASH INVENTORY NOTES PAYABLE CE

BB +100 = +100
Borrow
Money +20 = +20
Buy 6 $20
Watches -120 +120 =
Sell 2
Watches +50 = +50
for $25 income statement

-40 = -40
EB 50 80 = 20 110
 Financial Statements
Balance Sheet Income Statement
t1 t0 for period t0 to t1
Assets Revenues
Cash 50 100 Sales 50
Inventory 80 0
Expenses
Liabilities CGS 40
Notes Pay. 20 0
Net Income 10
Common Equity
CE 110 100
 Statement of Cash Flows
Cash from operations
Net Income 10
- increase in inventory -80
Cash from operations -70
Cash for investing 0
Cash from financing 20
Net Change in Cash -50
accounting is the answer to the
Lisboa Watch Company’s
problem
who cares about a company’s
financial statements?
Owners
stock holders of public companies
 how well is professional management doing?

stock holders of private companies

 how well is your
Dad/Mom/Son/Daughter/Uncle/Aunt/Nephew/Niece
doing at running the business
Creditors
will the company be able to pay back the loan
Government, The People, Labor Unions, Competitors,
… 15
My favourite use of financial statements…
 Taken from Odlum Brown Research Stock recommendations:
ATMEL: Strong Buy
FY05E sales ↑ 5-9% + margins trending up
Balance sheet improving
Material discount to close peers (2-6x EV/Sales)
Syntel: Buy
4 consecutive quarters of revenue growth
Recurring EPS = $0.95
Strong cash position: $4.18 / share in cash + no debt
Returns excellent: 23.6% ROE
Kepco: Buy
EPS ↑ 24%
Sales of electrical power ↑ 5%
Debt down, BV/Share ↑ to 30.11
Cheap! Less than ½ book, 6x PE, 4% yield
from Smartmoney.com
Sturm's Screen
Paul's Picks Prove Profitable
Three of my four other market-beating portfolios are
variations on academic themes — in some cases repeats of screens I've
used before. My second-best relative results came in May, when I touted the virtues of
P/CFO (price divided by cash flow from operations), a value yardstick based on cash
earnings instead of on accounting earnings. This added a twist to several previous
columns I've written about Richard Sloan , the University of Michigan professor
who emphasizes the importance of the noncash component of earnings, or accruals. My
Sloan-style portfolio increased by 18%.
 I revisited another of my old favorites in June, when I updated a screen based on the work
of Joseph Piotroski , a University of Chicago professor. I first wrote about
Piotroski's use of accounting ratios to find bargains among value stocks more than three
years ago. Since then his ideas have attracted considerable attention. Judging from my
Piotroski — style portfolio — it gained 8% during a period when the broader market
declined-the approach still provides a useful way to separate jewels from junk.
 My third research-based success was an attempt in April to piggyback on a paper written
by Russell Lundholm , another University of Michigan professor. Lundholm
and two colleagues studied the market's reaction to extreme earnings surprises. Among
their conclusions: Stocks that beat consensus estimates by wide margins can perform well
for months, even years, after the initial bounce that follows the good news. My test of
their strategy worked well, with an average gain of better than 10% and only one loser out
of eight companies.
what do we want to know?
We want to know the “amount, timing, and
uncertainty surrounding future cash flows…”
equity holders want to know flows they will receive as
residual claimants on the firm’s cash
creditors want to know if the company is in compliance
with its lending agreement
labor unions want to know if there money to grab with a
strike
government wants to know if you are gouging the public
competitors want to know whether to enter market
This is mostly about the future, but all we get is the
past!
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pop quiz!
what predicts future cash flows better?
current cash flows
 or
current net income

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 Content of Financial Reports
• The Auditor’s Report
• The Management Letter
• The Financial Statements:
Balance Sheet
Income Statement
Statement of Cash Flows
Statement of Shareholders’ Equity
Statement of Comprehensive Income
• The Footnotes
• Management Discussion and Analysis
My examples will often come from The Navigator Company and
Jerónimo-Martins
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 The Navigator Company
The Navigator Company is an integrated producer of forest,
pulp, paper, tissue, sustainable packaging solutions, and
bioenergy,
The Company is the third largest exporter in Portugal and the
largest generator of National Added Value, representing
approximately 1% of national GDP, around 3% of national
exported goods, and more than thirty thousand direct, indirect,
and generated jobs. In 2022
Navigator became the first Portuguese company, and one of the
first in the world, to make the ambitious commitment to move
towards carbon neutrality at its industrial facilities
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Jerónimo-Martins
Jerónimo Martins is a Group that holds assets in the Food area,
mostly in Distribution, with market leadership positions in
Poland and Portugal.

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Other than the financial
statements, what other cool
things are included in Financial
Reporting?
Audit Report

Management Discussion

Important contracts

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 The Auditor’s Report
The auditor’s report is a statement to the
board of directors of the company and to
the shareholders of the company.

It expresses an opinion as to whether the

financial statements present fairly the
financial activities of the company and
whether the financials were prepared in
accordance with IFRS
international financial accounting standards 24
”...give a true and fair view...”
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lots and lots of numbers….
But what do they all mean?

Financial Reporting is a set of tools that help to

understand the business in terms of financial data in
order to reveal the underlying economics.

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all the forces surrounding financial statements

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given all the uses of financial
statements, what keeps the
system “honest?”

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 Corporate Governance
and Capital Markets
• Capital markets value the publicly traded
equity and debt securities.
• so you can “vote with your feet.”

• The financials are a component of the

information that the markets use to value
companies securities, along with a number of
nonfinancial measures.

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 Debt Covenants and Management
Compensation Contracts
• Debt covenants are part of debt contracts
between the company and creditors.
Violation of debt covenants may lead to more
costly debt terms. Covenants are written in
terms of accounting numbers.

• Management compensation contracts often

base pay on certain income or stock price
goals. Management compensation contracts
are written in terms of accounting numbers
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Regulations and Standards

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Professional Reputation and Ethics
• Ethical behavior is in the long-run interest of
managers, shareholders, and auditors.

• Many companies, universities, and

professional organizations have enacted
increased emphasis on ethics.

• Auditors’ reputations are integral to their

ability to perform their duties. High ethical
conduct is imperative to their continued
success.
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 The nitty gritty.
Financial Accounting
and
Its Economic Context

Accounting is the language of...

Business;
as such, there are
vocabulary words and grammar rules
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Business Management Activities
Business activities are reflected in financial
statements; business activities include:

Financing activities – issue and

retirement/repayment of liabilities and equity.

Investing activities – acquisition and sale of

productive assets.

Operating activities – production and sale of

goods and services.
 the business of selling coffee

raise money
open stores
operate the stores
buy inventory of coffee
hire employees

close underperforming stores

raise more money to open more stores…

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 The Balance Sheet
• The balance sheet reports the financial
position at a point in time (end of the quarter
or year).

• The Balance Sheet is also called Statement of

Financial Position

• The components of the Balance Sheet are:

• Assets
• Liabilities
• Shareholders’ Equity (also called owners’ equity,
common equity, or book value)

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 The Balance Sheet
The balance sheet is represented by the
fundamental accounting equation:
Assets = Liabilities + Equity

A = L + E

The effects of all business transactions may be

represented in this formula.
Asset and Liability accounts are typically grouped
into more detailed classifications.

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 Assets
• Definition: Assets are items that have an expected
future benefit and are objectively measurable

• Current assets – benefit realized within 1 year

• Cash
• Short-term investments
• Accounts receivable
• Inventory
• Prepaid expenses

• Long-term investments
• Property, plant, and equipment
• Intangible assets
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Balance Sheet – the assets

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economically valuable things that aren’t
assets…
because they aren’t objectively measureable

CocaCola trademarks:
vitaminwater=$4.2B
Monster=$2.2B
CocaCola=$0

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are happy employees worth anything?
the balance sheet says NO

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how do “worthless” assets ultimately
affect the financial statements?
if “assets” represent future
economic benefits then the value of
of those happy and productive
employees will show up in future
financial statements.

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Assets are where the action is
the amount and mix of assets is a primary decision for
management.
how efficiently are they being used?
what is the turnover ratio on each asset?

this is where accounting manipulation occurs

ask yourself, what are the companies most important

assets and how are they being accounted for.
what requires estimation?
what assets are ‘missing’ from the balance sheet?

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 Liabilities
Definition: probable future economic sacrifices arising from
present obligations that were the result of past transactions

Current liabilities – expected to be relieved within 1 year

 Accounts payable
 Interest payable
 Short-term notes payable
 Current maturities of long-term debt
 Deferred revenues

Long-term liabilities
 long-term debt
 pension obligations
 deferred taxes

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Balance Sheet – the liabilities and equity

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obligations not on the books
These are more dangerous than assets not
on the books!
operating leases are the best example
obligations of subsidiaries that were not
consolidated into the companies books
the unknown results of future events
lawsuits

earthquakes

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For liabilities extending beyond one year, we
need to take into account “time value”

Moving money through time has value

Buying a house
Saving for college
The cost of moving money through time is
called Interest
the Present Value of a future debt obligation
is LESS than the sum of payments
gets smaller the higher the interest rate
gets smaller the further out in the future
Shareholders’ Equity
Definition: interest of the owners after liabilities have been
relieved.

Contributed capital – assets contributed by owners

Shareholders’ equity (par or stated value)
Paid-in capital in excess of par value

Earned capital
Earned Capital has 2 components:

Retained earnings represent the excess earnings

retained in the company after dividends have been paid
to shareholders. This represents the equity generated by
the company for the shareholders over time.

OCI represents stuff that was odd enough that regulators

couldn’t agree to call it earnings. 48
remember the 3 types of transactions:
1) give examples of transactions that swap one balance
sheet item for another. changing the balance sheet

2) give examples of transactions with the owners

changing statement of shareholders’ equity

3) give examples of transactions that chronicle the

creation of wealth….that is, transactions that affect the
income statement.

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 The Income Statement
Operating revenues  Operating revenues
Sales and expenses: usual
Interest Income and frequent
Operating expenses
Cost of goods sold  Operating expenses
Selling, General and match to operating
revenues (kinda)
Administrative expense
Depreciation expense
 Other revenues and
Amortization expense expenses: unusual or
infrequent

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51
52
The Statement of Cash Flows
• Cash flows from operating activities:
• Cash flows associated with the acquisition and sale of a
company’s products and services
• examples?

• Cash flow from investing activities:

• Cash flows associated with the purchase and sale of a company’s
investments.
• examples?

• Cash flow from financing activities:

• Cash flows associated with a company’s two sources of outside
capital: debt and equity
• examples?

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Statement of Cash Flows – operating cash
flows

54
statement of cash flow – investing
and financing sections

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Relationships Among the Financial
Statements

BS says: A = L + SE

IS says: DSE = NI – DIV

SCF says:
Dcash = -Dnoncash Assets + DL + NI – DIV

DAssets = DL + DSE
 The Mechanics of
Financial Accounting

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The Mechanics of Financial Accounting
The star of the show is

Assets = Liabilities + Equity

Cash Inv… AP Debt… PIC RE...

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In class exercise: Suppose
1) Owners contribute $30,000 in cash to company
2) purchased land for $20,000
3) borrowed $9000
4) provided services for contracted amount of $8000,
but have not yet been paid
5) paid $5500 cash for miscellaneous expenses
6) paid $500 dividend to owners

Use A = L + E to record these transactions

Create BS and IS

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Imagine a book-keeping spreadsheet
Cash + A/R + Land = N/P + Cont.Capital + RE
1. 30,000 = 30,000

2. (20,000) 20,000 =
3. 9,000 =9,000
4. 8,000 = 8,000 Rev.

5. (5,500) = (5,500) Exp.

6. _____
(500) _____ _____ = _____ _____ (500) Div.
_____
Tot. 13,000 + 8,000 + 20,000 = 9,000 + 30,000 + 2,000

the income
statement 60
create Financial Statements
Income Statement
Revenues $8,000
Expenses 5,500
Net Income$2,500

Statement of Retained Earnings

RE (beginning) $ 0
Add: Net Income 2,500
Less: Dividends (500)
RE (ending) $2,000
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 Balance Sheet
Assets
Cash $13,000
A/R 8,000
Land 20,000
Total $41,000

Liabilities and S.E.

N/P $ 9,000
CS 30,000
RE (ending) 2,000
Total $41,000

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this is tedious!

accounting was invented by Early Man

 imagine you are the Emperor’s bookkeeper

the transaction analysis was relatively simple with

a few transactions and a few accounts. However,
with thousands of transactions and hundreds of
accounts, the spreadsheet program is inefficient.

Therefore accountants use a “double entry”

system based on debits and credits.

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Double Entry Accounting
 The journal entry is an efficient representation of economic
events and how they affect the accounting equation.

 Debit (dr) - means an entry to the left hand side of an account.

 Credit (cr) - means an entry to the right hand side of an

account.

 Note that a debit or credit, per se, does not indicate increase
or decrease.

 To decide the effect of a debit or credit, the type of account

must be considered.

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three bookkeeping
rules!

1. A = L + E
2. lefts = rights (debits = credits)
3. increase assets on the left (debit)
implies that decreases of assets are on the right
implies the increases in liabilities are on the right
implies that increases in equity are on the right
implies that revenues are on the right
implies that expenses are on the left
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and if the lefts ≠ rights

66
a cheat sheet for debits/credits

67
The Format of a Journal Entry
To initially record transactions, we use a journal
entry to represent the debits and credits.
For example, Item 1:
Debit Credit
Cash 30,000
Common Stock 30,000

Note that the debit is to the left and the credit is

to the right. First we list the account (left hand
entry on top), then the amount.

now YOU practice on the rest.

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prepare the other journal entries:
2: Purchased land for $20,000 cash.
Land 20,000
Cash 20,000

3: Borrowed $9,000 cash from bank.

Cash 9,000
Notes Payable 9,000

69
prepare the other journal entries:
4: Provided services (on account) $8,000.
Accts. Receivable 8,000
Service Revenue 8,000

5: Paid $5,500 cash for expenses.

Expenses 5,500
Cash 5,500

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prepare the other journal entries:
6: Paid $500 cash dividend to owners.
retained earnings 500
Cash 500

Note that dividends reduce retained earnings.

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T-Accounts
Running tally of the affect of transactions
on an account.
By recording the running tally from journal
entries we can complete the financial
statements.
cash
beg. bal.

collections dispersements

end. bal.
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Posting
Now post transactions (for cash) to “T” account:

Cash

30,000 20,000
9,000
5,500
500

Bal. 13,000

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there are only 3 types of transactions:
1) give examples of transactions that swap one balance
sheet item for another

2) give examples of transactions with the owners

3) give examples of transactions that chronicle the

creation of wealth….that is, transactions that affect the
income statement.

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Exercise - practice your vocabulary
Balance Sheet (B) or Income Statement (I)
a. Property, Plant and Equipment B
b. Revenue I
c. Retained Earnings B
d. Wage Expense I
e. Patent B
f. Cost of Goods Sold I
g. Common Stock B
h. Dividend Payable B
i. Accumulated Depreciation B
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 Exercise continued
Balance Sheet (B) or Income Statement (I)
j. Prepaid Expense B
k. Gain on Sale of Short-term Investment I
l. Rent Revenue I
m. Supplies Inventory B
n. Accounts Receivable B
o. Land Rights B
p. Insurance Expense I
q. Interest Payable B
r. Deferred Revenue B

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That’s all until ....
remember that Thursday Class is
B005 and Friday Class is D-107

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