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Module1: FrameworkforAnalysisand Valuation

BusinessActivities

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FinancialAccountingInformation:Demand &Supply
Demandforfinancialaccountinginformation extendstonumeroususersthatinclude: extends to numerous users that include:
Managersandemployees Investmentanalystsandinformation intermediaries Shareholdersanddirectors Customers and strategic partners Customersandstrategicpartners Regulatorsandtaxagencies Votersandtheirrepresentatives

SupplyofAccountingInformation
PrimarySECfilingrequirements:
F Form10K:annual 10 K l Form10Q:quarterly

Benefitsofdisclosure.
Lowercostsoffundsandlabor Economicbenefitsformreliabledisclosures

Costsofdisclosure.
Preparationanddissemination,competitive disadvantages,litigationpotential,andpolitical costs

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FinancialStatements

TheAccountingEquation

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BerkshireHathawaysBalanceSheet

Walgreens

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InvestingActivities

FinancingActivities

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InitialQuestionsaboutthe BalanceSheet
Many investment-type companies such as Berkshire Hathaway and high-tech companies such as Cisco Systems carry high levels of cash. Why is that? Is there a cost to holding too much cash? Is it costly to carry too little cash? The relative proportion of short-term and long-term assets is largely dictated by companies business models. Why is this the case? Why is the composition of assets on balance sheets for companies in the same industry similar? By what degree can a companys asset composition safely deviate from industry norms? What are the trade-offs in financing a company by owner versus nonowner financing? If nonowner financing is less costly, why dont we see companies financed entirely with borrowed money? How do shareholders influence the strategic direction of a company? How can long-term creditors influence strategic direction? Most assets and liabilities are reported on the balance sheet at their acquisition price, called historical cost. Would reporting assets and liabilities at fair values be more informative? What problems might fair-value reporting cause?

IncomeStatement
Anincomestatement reportsonoperating activities. Itlistsamountsforsales(andrevenues)less allexpenses(andcosts)overaperiodoftime. Saleslessexpensesyieldthebottomline netincomeamount.

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BerkshireHathaways IncomeStatement

Walgreens

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InitialQuestionsabouttheIncomeStatement
Assume that a company sells a product to a customer who promises to pay in 30 days. Should the seller recognize the sale when it is made or when cash is collected? When a company purchases a long-term asset such as a building, its cost is reported on the balance sheet as an asset. Should a company, instead, record the cost of that building as an expense when it is acquired? If not, how should a company report the not cost of that asset over the course of its useful life? Manufacturers and merchandisers report the cost of a product as an expense when the product sale is recorded. How might we measure the costs of a product that is sold by a merchandiser? By a manufacturer? If an asset, such as a building, increases in value, that increase in value is not reported as income until the building is sold, if ever. What concerns arise if we record increases in asset values as part of income, when measurement of that increase is based on appraised values? Employees commonly earn wages that are yet to be paid at the end of a particular period. Should their wages be recognized as an expense in the period that the work is performed, or when the wages are paid? Companies are not allowed to report profit on transactions relating to their own stock. That is, they dont report income when stock is sold, nor do they report an expense when dividends are paid to shareholders. Why is this the case?

StatementofEquity
Thestatementofequity reportsonchangesin theaccountsthatmakeupequity th t th t k it
Contributedcapital Earnedcapital(retainedearningsand accumulatedothercomprehensiveincome) Other(typicallyaccumulatedother comprehensiveincomeandminorityor noncontrollinginterest).

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BerkshireHathaways StatementofStockholdersEquity

Walgreens

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StatementofCashFlows
Thestatementofcashflows reportsoncashflowsfor operating,investing,andfinancingactivitiesovera operating investing and financing activities over a periodoftime.

Walgreens

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InitialQuestionsabouttheStatementofCashFlows
What is the usefulness of the statement of cash flows? Do the balance sheet and income statement provide sufficient cash flow information? What types of information are disclosed in the statement of cash flows and why are they important? Wh t ki d of activities are reported in each of the operating, investing and What kinds f ti iti t di h f th ti i ti d financing sections of the statement of cash flows? How is this information useful? Is it important for a company to report net cash inflows (positive amounts) relating to operating activities over the longer term? What are the implications if operating cash flows are negative for an extended period of time? Why is it important to know the composition of a companys investment activities? What kind of information might we look for? Are positive investing cash flows favorable? Is it important to know the sources of a companys financing activities? What questions might that information help us answer? How might the composition of operating, investing and financing cash flows change over a companys life cycle? Is the bottom line increase in cash flow the key number? Why or why not?

FinancialStatementLinkages
Theincomestatementandthebalancesheet arelinkedviaretainedearnings. are linked via retained earnings Retainedearnings,contributedcapital,and otherequitybalancesappearbothonthe statementofstockholdersequityandthe balancesheet. Th t t Thestatementofcashflowsislinkedtothe t f h fl i li k d t th incomestatementasnetincomeisa componentofoperatingcashflow.

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FinancialStatementLinkagesforBerkshire Hathaway
The income statement and the balance sheet are linked via retained earnings. For Berkshire Hathaway, the $13,213 million increase in g y retained earnings (reported on the balance sheet) equals its net income (reported on the income statement) plus a $28 million adjustment relating to adoption of a new accounting standard. Berkshire Hathaway did not pay dividends in 2007. Retained earnings, contributed capital, and other equity balances appear both on the statement of stockholders equity and the balance sheet. The statement of cash flows is linked to the income statement as net income is a component of operating cash flow. The statement of cash flows is also linked to the balance sheet as the change in the balance sheet cash account reflects the net cash inflows and outflows for the period.

InformationBeyondFinancialStatements
ManagementDiscussionandAnalysis (MD&A) IndependentAuditorReport FinancialStatementFootnotes RegulatoryFilingsandProxyStatements

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ProfitabilityAnalysis

ProfitMargin,AssetTurnover,andReturnon AssetsforSelectedIndustries

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CompetitiveAnalysis
Industrycompetition Bargainingpowerofbuyers Bargainingpowerofsuppliers Threatofsubstitution y Threatofentry

FiveForcesofCompetitiveIntensity

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OversightofFinancialAccounting
SEC oversees all publicly traded companies FinancialAccountingStandardsBoard(FASB) PublicCompanyAccountingOversightBoard (PCAOB)

AuditReport
Financialstatementsaremanagementsresponsibility. Auditorresponsibilityistoexpressanopiniononthose statements. Auditinginvolvesasamplingoftransactions,not investigationofeachtransaction. Auditopinionprovidesreasonableassurancethatthe statementsarefreeofmaterialmisstatements,nota guarantee. Auditorsreviewaccountingpoliciesusedbymanagement andtheestimatesusedinpreparingthestatements. Financialstatementspresentfairly,inallmaterialrespects acompanysfinancialcondition,inconformitywithGAAP.

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SarbanesOxleyAct
TheSECrequirestheCEOandCFOofacompanyto personallysignastatementattestingtotheaccuracyand completenessofthecompany sfinancialstatements. completeness of the companys financial statements ThestatementssignedbyboththeCEOandCFOcontainthe followingcommitments:
BoththeCEOandCFOhavepersonallyreviewedtheannualreport. Therearenountruestatementsofamaterialfactthatwouldmake thestatementsmisleading. Financialstatementsfairlypresentinallmaterialrespectsthe financialconditionofthecompany. Allmaterialfactsaredisclosedtothecompanysauditorsandboard ofdirectors. Nochangestoitssystemofinternalcontrolsaremadeunless properlycommunicated.

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FinancialAccounting: notanexactscience
GAAPallowscompanieschoicesinpreparing financialstatements(inventories,property, fi i l t t t (i t i t andequipment). Companiesmustchooseamongthe alternativesthatareacceptableunderGAAP. Financial statements also depend on countless Financialstatementsalsodependoncountless estimates.

AccessingSECFilingsusing

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AccessingSECFilingsusing

AccessingSECFilingsusing

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AccessingSECFilingsusing

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