Definition of Accounting

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. Three sets of books
Financial accounting
Standardized reports for external stakeholders

Tax accounting
IRS rules for computing taxes payable

Managerial accounting
Custom reports for internal decision making

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What are the financial reporting requirements?

The Securities and Exchange Commission (SEC) requires periodic financial statement filings:
10 K: Annual report 10 Q: Quarterly report 8 K: Current report (material events) Must be prepared in accordance with Generally Accepted Accounting Principles (GAAP)

Periodic filing requirements create much of the tension in financial accounting

Ship goods to a customer in one quarter, collect cash in the next
When did the sale occur?

Buy equipment in one quarter, use it for the next 23 quarters

When does the expense occur?

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Who makes the rules?

Generally Accepted Accounting Principles (GAAP) established by:
U.S. Congress, but they delegate to: The SEC, but they delegate to: Financial Accounting Standards Board (FASB)
Emerging Issues Task Force (EITF) American Institute of CPAs (AICPA)

International Financial Reporting Standards (IFRS) are established by the IASB and are required in over 70 countries, including the EU
US GAAP is still required for US firms For intro accounting topics, there is a high degree of overlap in the two standards

Standard setting is a political process

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Who is responsible for financial reporting?

Management is responsible for preparing financial statements
The Audit Committee of the Board of Directors provides oversight of managements process Auditors are hired by the Board to express an opinion about whether the statements are prepared in conformity with GAAP

The SEC and other regulators take action against the firm if any violations of GAAP or other rules are found Information intermediaries (stock analysts, institutional investors, the media) may expose or flee firms with questionable accounting

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What are the required financial statements?

Balance Sheet
Financial position (listing of resources and obligations) on a specific date

Income Statement
Results of operations over a period of time using accrual accounting (i.e., recognition tied to business activities)

Statement of Cash Flows

Sources and uses of cash over a period of time

Statement of Stockholders Equity

Changes in stockholders equity over a period of time

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Example: Daves Car Transport Service

Dave starts a business to transport expensive cars On December 1, 2012
Receives $50,000 cash from issuing common stock Borrows $80,000 from bank and buys $100,000 truck
Will be used for 48 mos., with a $4,000 salvage value

Pays $12,000 cash upfront to rent office space for 1 year

During December
Moves two cars, will get paid $40,000 within 30 days Pays employees $10,000 of wages

December 31: Bank wants to see financial statements

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Did the company make money during December?

Cash Flows Stock Bank Truck Rent Wages Cash 50,000 80,000 (100,000) (12,000) (10,000) 0 8,000
On December 1, 2012 Receives $50,000 cash from issuing common stock Borrows $80,000 from bank and buys $100,000 truck Will be used for 48 mos., with a $4,000 salvage value Pays $12,000 cash upfront to rent office space for 1 year During December Moves two cars, will get paid $40,000 within 30 days Pays employees $10,000 of wages

Customers

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Did the company make money during December?

Cash Flows Operating Rent Wages CFO Investing Truck CFI Stock Bank CFF Cash (100,000) (100,000) 50,000 80,000 130,000 8,000
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(12,000) (10,000) 0 (22,000)

Customers

On December 1, 2012 Receives $50,000 cash from issuing common stock Borrows $80,000 from bank and buys $100,000 truck Will be used for 48 mos., with a $4,000 salvage value Pays $12,000 cash upfront to rent office space for 1 year During December Moves two cars, will get paid $40,000 within 30 days Pays employees $10,000 of wages

Financing

Statement of Cash Flows

Dec 2012 Cash Flows Operating Rent Wages CFO Investing Truck CFI Stock Bank CFF Cash (100,000) (100,000) 50,000 80,000 130,000 8,000
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Reports cash transactions over a period of time Operating Activities

Transactions related to the provision of goods or services and other normal business activities

(12,000) (10,000) 0 (22,000)

Customers

Investing Activities
Transactions related to the acquisition or disposal of long-lived productive assets

Financing

Financing Activities
Transactions related to owners or creditors

Did the company make money during December?

Accounting Income Revenue 40,000 Truck Expense Rent Expense Net Income (2,000) (1,000) 27,000
On December 1, 2012 Receives $50,000 cash from issuing common stock Borrows $80,000 from bank and buys $100,000 truck Will be used for 48 mos., with a $4,000 salvage value Pays $12,000 cash upfront to rent office space for 1 year During December Moves two cars, will get paid $40,000 within 30 days Pays employees $10,000 of wages

Wages Expense (10,000)

Notes: Truck expense (depreciation) = (100,000-4,000)/48 Rent expense is one month at $1000/mo.

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Income Statement
Dec 2012 Accounting Income Reports results of operations over a period of time using accrual accounting Revenue 40,000 Recognition tied to business activities Truck Expense (2,000) Rent Expense Net Income (1,000) 27,000

Revenues
Increases in owners equity from providing goods or services

Wages Expense (10,000)

Expenses
Notes: Truck expense (depreciation) = (100,000-4,000)/48 Rent expense is one month at $1000/mo. Decreases in owners equity incurred in the process of generating revenues

Net Income (or Earnings or Net Profit)

= Revenues Expenses
=> DOES NOT EQUAL CHANGE IN CASH!!!

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Did the company make money during December?

Dec 2012 Cash Flows Operating Rent Wages CFO Investing Truck CFI Stock Bank CFF Cash (100,000) (100,000) 50,000 80,000 130,000 8,000
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Dec 2012 Accounting Income Revenue 40,000 Truck Expense Rent Expense Net Income (2,000) (1,000) 27,000

(12,000) (10,000) 0 (22,000)

Customers

Wages Expense (10,000)

Notes: Truck expense (depreciation) = (100,000-4,000)/48 Rent expense is one month at $1000/mo.

Financing

What is financial position at end of the month?

Balance Sheet Assets Cash Accounts Receivable Prepaid Rent Truck Total 8,000 40,000 11,000 98,000 157,000 (Cash in the bank on 12/31/2012) (Cash owed by customers on 12/31/2012) (Prepaid for 11 months of future space on 12/31/2012) (100,000 original cost 2,000 depreciation)

Liabilities & Stockholders Equity Bank Debt 80,000 (Cash owed to the bank on 12/31/2012) Common Stock Retained Earnings Total 50,000 27,000 157,000 (Stockholder investment as of 12/31/2012) (Accounting Net income Dividends as of 12/31/2012)

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Balance Sheet
Dec 12, 2012 Balance Sheet Assets Cash Accounts Receivable Prepaid Rent Truck Total 8,000 40,000 11,000 98,000 157,000

Reports financial position (resources and obligations) on a specific date Assets

Resources owned by a business that are expected to provide future economic benefits

Liabilities
Claims on assets by creditors (non-owners) that represent an obligation to make future payment of cash, goods, or services

Liabilities & Stockholders Equity Bank Debt 80,000 Common Stock Retained Earnings Total 50,000 27,000 157,000

Stockholders Equity (Owners Equity)

Claims on assets by owners of business
Contributed Capital (arises from sale of shares) Retained Earnings (arises from operations)

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Statement of Stockholders Equity

Well get to this later

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