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Overview of Week 1
Administrative stuff What is financial accounting? Some Myths Accrual versus Cash-based Financial statements GAAP Auditing
Administrative Stuff
Who am I Who is your T.A. Teaching philosophy Syllabus
Homework
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http://www.cgu.edu/pages/3472.asp
Generally-accepted accounting principles, or GAAP, are a set of rigid rules that, if followed correctly, will lead to a unique, correct representation of the financial performance and health of a firm.
The basic financial statements, consisting of a balance sheet, an income statement, and a statement of cash flows, reflect a complete, accurate, and timely portrayal of the financial performance and well-being of a firm
GAAP is created from a comprehensive analytical process, which is free from political influence.
It is all there
All of a firms identifiable assets and liabilities appear on the balance sheet, and the difference between a firms assets and its liabilities represents the value of the firm.
Each of the financial statements is independent, with each reflecting a different aspect of the firms performance and financial health.
Cash is King!
Cash flow is ultimately what matters to a firm and its investors; therefore, it is not really necessary to worry about the definition of earnings used in the preparation of the income statement. Rather, one need only consider the sources and uses of cash as reflected on the firms statement of cash flows.
Accrual Accounting
Accrual accounting rests on two guiding principles: Revenue Recognition Principle record revenue when
Neither the recognition of revenue nor the recording of expense necessarily involves the receipt or payment of cash
Balance Sheet
Mirrors the Accounting Equation Assets = Liabilities + Equity Uses of funds = Sources of funds Assets are listed in order of liquidity Current and non-current Liabilities are listed in order of maturity Equity consists of Contributed Capital and Retained Earnings
Assets
To be reported on a balance sheet, an asset must:
1.
2.
Historical Cost is
Objective Verifiable Therefore, not subject to bias
However, historical cost is not particularly relevant to most readers of the balance sheet Relevance vs. Reliability is an important issue with accountants.
Liabilities
Companies desire more current assets than current liabilities this difference is called net working capital
Equity
Equity consists of:
Contributed Capital (cash raised from the issuance of shares) Earned Capital (retained earnings). Retained Earnings is updated each period as follows:
Income Statement
Contributed capital Retained earnings (including Other Comprehensive Income or OCI) Treasury stock
Statement of cash flows (SCF) reports cash inflows and outflows Cash flows are reported based on the three business activities of a company:
1.
2.
3.
Operating activities: transactions related to the operations of the business. Investing activities: acquisitions and divestitures of long-term assets Financing activities: issuances and payments toward equity, borrowings, and long-term liabilities.
Change in Cash
Cash
Cash
Liabilities ____
Shareholders equity
--------
Shareholders equity
Dividends
Other assets
In Class Example
Baron Coburg
Versus comparability
Question?
Financial statements must contain objective and verifiable numbers if they are to be useful. Yet, many estimates and subjective assumptions are required for the preparation of these reports. Please reconcile these apparently inconsistent statements.
Materiality
Only transactions with amounts large enough to make a difference are considered material Non-material transactions can be treated in the easiest manner
Audit Report
Financial statements present fairly and in all material respects company financial condition. Financial statements are prepared in conformity with GAAP Financial statements are managements responsibility. Auditor responsibility is to express an opinion on those statements Auditing involves a sampling of transactions, not investigation of each transaction Audit opinion provides reasonable assurance that the statements are free of material misstatements Auditors review accounting policies used by management and estimates used in preparing the statements
Question?
The SEC requires all publicly traded companies to have their financial statements audited. Prior to this requirement many companies voluntarily had their statements audited. Given the cost and inconvenience, why would they do this?
Takeaways
Financial statements that are produced are the result of one possible set of rules that have resulted from a political process. Users need to be aware of these limitations. Users should read the notes to the financial statements since these contain a lot of useful guidance to interpreting the statements.
Other possibilities include cost, net realizable value, replacement cost, price level adjusted
Ethical Question
See
textbook