100chap1.ppt

ACCT 100

Chapter 1

Accounting Activities and Financial Statements

The Financial Statements 2

Objectives of the Chapter

1. Principal activities of business firms.

2. Understanding four financial statements.

3. The users of financial statements.

4. The financial reporting reform.

5. The types of business entity.

6. The authorities who prescribe accounting standards and the need for international accounting standards.

7. Accounting concepts and principles.

Overview of Financial Statements 3

I. Principal Activities of Business Firms Establishing Corporate Goals and Strategies

Obtaining Financing (from owners and creditors)

Making Investments (i.e., Investments, Purchase of Property, Plant and Equipment, Purchase of Intangibles, etc.)

Carrying Out Operations (i.e., purchase of materials/inventory, production, marketing and administration)

1.


2. Understanding Four Financial Statements Q1: What is accounting?

An information system to account for business transactions and to communicate the financial information to users.

Q2: How do accountants communicate financial information to users?


Annual Financial Reports

Public firms communicate their financial information via the annual report to shareholders. The content of an annual report includes:

1. A letter to shareholders from the CEO.

2. Management’s Report on the effectiveness of Internal Control(required by Sarbanes-Oxley Act of 2002).


Annual Financial Reports (contd.)

1. Management’s Discussion and Analysis (MD&A)

2. Audited Financial Statements and Notes.

3. Report of an Independent Certified Public Accounting Firm.


The Four Financial Statements

1. Consolidated Income Statement 2. Consolidated Statement of Retained

Earnings 3. Consolidated Balance Sheet 4. Consolidated Statement of Cash Flows


The Content of Four Financial Statements The Income Statement: reports the

operating results of a firm for a period of time.

Accounts reported include revenue, expenses, gains, losses, the net income and the earnings per share.


The Content of Four Financial Statements (Contd.) The Statement of Retained Earnings:

reports the earnings not distributed to shareholders.

Accounts reported include beginning balance of retained earnings, current year’s net income, dividends distributed for the reporting period and the ending balance of retained earnings.


The Content of Four Financial Statements (contd.) The Balance Sheet Statement:

reports the financial position of a firm on a particular date.

Accounts reported include assets, liabilities and stockholders’ equity.


The Content of Four Financial Statements (contd.) The Statement of Cash Flows:

reports cash flows from three business activities and the net increase (or decrease) of the cash during the year.

Business activities affect cash flows: operating, investing and financing.


Exhibit 1-1 (from Financial Accounting by Harrison and Horngren)

For the fiscal years ended (In thousands) 2/2/2006 1/27/2005 1. Net sales $1,031,548 $992,106 2. Cost of sales 588,017 571,265 3. Gross profit 443,531 420,841 4. Selling, general, and admin. exps. 392,484 357,516 5. Charges from sale of subsidiary 1,882 3,500 6. Income from operations 49,165 59,825 7. Other income (expense): 8. Interest expense (2,771) (1,769) 9. Interest income 253 307 10. Other 4,278 1,300 11. Total other income (expense), net 1,760 (162) 12. Income before income taxes 50,925 59,663 13. Income tax provision 20,370 23,567 14. Net income $ 30,555 $ 36,096

LANDS’ END, INC. & SUBSIDIARIESConsolidated Statement of Operations

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For the fiscal years ended (In thousands) 2/2/2006 1/27/2005 Retained Earnings 1. Beginning balance $229,554 $193,460 2. Net income 30,555 36,096 3. Cash dividends paid --- --- 4. Issuance of treasury stock --- (2) 5. Ending balance $260,109 $229,554

LANDS’ END, INC. & SUBSIDIARIESConsolidated Statement of Retained Earnings

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Exhibit 1- 3(from Financial Accounting by Harrison and Horngren)

(In thousands) 2/2/2006 1/27/2005ASSETS Current assets: 1. Cash $17,176 $5,426 2. Receivables 8,046 4,459 3. Inventory 164,816 168,652 4. Prepaid advertising and other exp. 32,033 19,631 5. Total current assets 222,089 198,168 Property, plant & equip., at cost: 6. Land and buildings 72,248 69,798 7. Fixtures and equipment 83,880 74,745 8. Leasehold improvements 2,912 1,862 9. Total property, plant & equipment 159,040 146,405 10. Less accum. depr. & amortization 60,055 49,414 11. Property, plant, & equipment, net 98,985 96,991 12. Intangibles, net 2,423 2,453 13. Total assets $323,497 $297,612

LANDS’ END, INC. & SUBSIDIARIESConsolidated Balance Sheet

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Exhibit 1- 3 (contd.)LIABILITIES AND SHAREHOLDERS’ INVESTMENT Current liabilities: 14. Lines of credit $ 9,319 $7,539 15. Accounts payable 62,380 52,762 16. Reserve for returns 4,555 5,011 17. Accrued liabilities 23,751 25,959 18. Accrued profit sharing 1,483 1,679 19. Income taxes payable 13,256 9,727 20. Current maturities of long-term debt --- 40 21. Total current liabilities 114,744 102,717 22. Deferred income taxes 7,212 5,379 23. Long-term liabilities 349 388 Shareholders’ investment: 24. Com. stock, 40,221 shares issued 26,567 26,219 25. Retained earnings 260,109 229,554 26. Other (85,484) (66,645)27. Total shareholders’ investment 201,192 189,128 28. Total liabilities & shareholders’ inv. $323,497 $297,612

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Exhibit 1- 4 (from Financial Accounting by Harrison and Horngren)

For the fiscal years ended (In thousands) 2/2/2006 1/27/2005 Cash flows from operating activities:1. Cash received from customers $1,027,943 $991,291 2. Cash received from interest 253 307 3. Cash paid to suppliers & employees (967,075) (926,714)4. Cash paid for interest (2,833) (2,828)5. Cash paid for income taxes (16,896) (27,595)6. Net cash flows from operating activities 41,392 34,461 Cash flows from investing activities: 7. Cash paid for capital additions

and businesses acquired (13,904) (32,102)8. Proceeds from divestiture 1,665 --- 9. Net cash flows used for investing activities (12,239) (32,102)

LANDS’ END, INC. & SUBSIDIARIESConsolidated Statement of Cash Flows

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Exhibit 1-4 (contd.)

Cash flows form financing activities: 10. Proceeds from short-term and

long-term debt 1,780 $7,539 11. Payment of long-term debt (40) (40)12. Purchases of treasury stock (20,001) (27,979)13. Issuance of treasury stock 858 1,978 14. Cash dividends paid --- --- 15. Net cash flows used for financing activities (17,403) (18,502)16. Net increase (decrease) in cash 11,750 (16,143)17. Beginning cash 5,426 21,569 18. Ending cash $ 17,176 $ 5,426

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Net income …………………………….. $ 30,555

Income Statement -- Fiscal Year 2006(Details given in Exhibit 1-8)

Beginning retained earnings …………..

$229,554Net income ………………………………

30,555Cash dividends ………………………….

---Ending retained earnings ………………

$260,109

Statement of Retained Earnings -- Fiscal Year 2006

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Exhibit 1- 5 (contd.)

Beginning retained earnings ……………...$229,554

Net income ………………………………….30,555

Cash dividends ……………………………..---

Ending retained earnings ………………….$260,109

Statement of Retained Earnings -- Fiscal Year 2006

ASSETSCash ……………………………………...

$ 17,176 All other assets ………………………….

306,321 Total assets ……………………………...

323,497 LIABILITIES

Total liabilities …………………………...

$122,305 STOCKHOLDERS’ EQUITY

Common stock ………………………….

26,567 Retained earnings ……………………...

260,109 Other equity ……………………………..

(85,484)Total liabilities & stockholders’ equity …

$323,497

Balance Sheet Statement - Fiscal Year 2006

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Exhibit 1- 5 (contd.)

ASSETSCash ……………………………………...

$ 17,176 All other assets ………………………….

306,321 Total assets ……………………………...

323,497 LIABILITIES

Total liabilities …………………………...$122,305

STOCKHOLDERS’ EQUITYCommon stock ………………………….

26,567 Retained earnings ……………………...

260,109 Other equity ……………………………..

(85,484)Total liabilities & stockholders’ equity …

$323,497

Balance Sheet Statement -- Fiscal Year 2006

Net cash flows from operating activities …...

$41,392 Net cash flows used for investing activities ..

(12,239)Net cash flows used for financing activities ..

(17,403)Net increase in cash ………………………….

11,750 Beginning cash ………………………………..

5,426 Ending cash ……………………………………

$17,176

Statement of Cash Flows - Fiscal Year 2006

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Definitions of Assets, Liabilities and Equity (all are presented on a balance sheet statement)

Assets: the economic resources of a business that are expected to be of benefit to the business entity in the future.

Examples: cash, office supplies, inventories, accounts receivable, buildings, equipment, etc.)


Definitions of Assets, Liabilities and Equity (contd.)

Liabilities: claims to assets; legal obligations required future payments of assets or services as a result of a business entity’s past transactions.

Examples: accounts payable, bonds payable…

Equity: residual claims to a business entity from stockholders.


Definitions of Revenues and Expenses

Revenues: increase or inflow of assets; will eventually increase stockholders’ equity (i.e., sales revenue)

Expenses: decrease or outflow of assets; will eventually decrease stockholders’ equity.

Gains: increase in assets from incidental transactions not related to the major operation.

Losses: decrease in assets from incidental transactions.


The Accounting Equation and the Computation of Accounting Net Income

Assets = Liabilities + Stockholders’ Equity

Balance Sheet

Assets Liabilities

Equity

Net Income = Revenues - Expenses + Gains - Losses


3. Users of Accounting Information

Internal users: mangers; managerial accounting produce internal accounting reports for mangers to make decisions.

External users: investors, creditors, IRS, SEC, etc.; financial accounting produce financial statements for these users.


External Users and Usage of Financial Statements

Group Mainly

Interestd In ReaseonWhat They Look for

Stockholders Net Income

Stockholders enhance their personal wealth through an increase in market price of the company's stock, and dividends received. Net income affects both stock prices and dividends.

Steadily rising level of net income over time means the company's profits look solid

Cash FlowsCash flows report how the company generates and uses its cash. Wise use of cash produces net income and more cash.

Operating activities should be the main source of cash.

Bankers and other creditors

Assets and liabilities

Liabilities indicate how much the company owes other creditors. Assets show what the company can pledge as collateral that a creditor can take if the company fails to pay its debts.

Assets far in excess of liabilities, or assets increasing faster than liabilities over time.

Net incomeProfitable companies can usually pay their debts

Same as for stockholders.

Cash flowssame as for stockholders Same as for stockholders.

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Why Are Financial Statements Important ?

Assess the risks (i.e., credit risk, asset risk). Provide an economic history. Thus, financial statement can be used for

various purposes: Analytical tool (i.e., to assess liquidity, efficiency

of using financial resources, profitability and solvency of companies.)

Management report card Early warning signal Basis for prediction

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3. The Financial Reporting Reform

The collapse of Enron and the accounting scandals of some high-profile firms severely damaged public confidence in the accounting profession and the financial reporting.

At the demand of the public, Sarbanes and Oxley Act was passed in 2002 to restore the public confidence in the credibility of the financial reports.


Key Provisions of Sarbanes and Oxley Act

Creating the Public Company Accounting Oversight Board: establish auditing standards.

Increasing Corporate Executive Accountability.

Prohibition of Non-Audit Services.

Evaluation of Internal Control.


5. Types of Business

1. Proprietorships

2. Partnerships

3. Corporations


Types of Business (contd.)

Proprietorship Partnership Corporation

Owner(s)Proprietor -- one owner

partners -- two or more owners

Stockholders -- generally many owners

Life of entityLimited by owner's choice or death

Limited by owners' choice or death

Indefinite

personal liability of owner(s) for business debts

Proprietor is personally liable

Partners are personally liable

Stockholders are not personally liable

Accounting status

Accounting entity is separate from proprietor

Accounting entity is separate from partners

Accounting entity is separate from stockholders


Corporations

A business entity formed under a state law.

A corporation is a legal entity by itself. It has all the rights of a person (i.e., pay taxes, own properties, can sue or be sued, can sign contract,…) except the rights of voting and marriage.


Corporations (contd.)

The ownership of a corporation is divided by shares.

To be an owner of a corporation, an individual just need to buy shares from stock markets.

Owners of a corporation have limited liability. The most an owner can lose is what he (she) invested.



The stockholders elect “board of directors” who sets business policies for the corporation.

The board elects a chairman (usually is also the chief executive officer (CEO), and designates a president who is in charge of daily operations (COO).



The board also appoints vice presidents who are in charge of different areas (i.e., marketing, accounting, finance...).


6. The Authorities prescribing the Accounting Standards

Financial Statements (F/S) are prepared based on generally accepted accounting principles (GAAP).

The authorities prescribe the accounting standards include:


The Authorities prescribing the Accounting Standards (contd.)

the Financial Accounting Standards Board (FASB, a private agency),

the Securities and Exchange Commission (SEC, a public agency).


A Historical Perspective of Authorities prescribing the Accounting Standards

1934 Congreess Official Prouncements

SECRegulation S-X, ASR , FRR and Staff Accounting Bulletins

1938 Accounting ProfessionAICPA

1938-1959 CAP ARBs(51)1959-1973 APB APB Opinion (31)

1973 FASB1. Statements of Financial Accounting Standard2. Interpretations3. Concepts of Financial Accounting4. Technique Bulletins5. Statement of EITF

Environment and Theoretical Structure of Financial Accounting 39

The Need for International Accounting Standards

Companies doing business in more than one nation found that it is hard to comply with more than one set of accounting standards established by authorities in different nations.

In response to this problem, International Accounting Standards Committee (IASC) was formed in 1973 to develop a single set of global accounting standards.


The History of International Accounting Standard Setting (cont.)

41 International Accounting Standards (IAS) was issued by IASC.

IASC created International Accounting Standards Board (IASB) in April, 2001 to be in charge of prescribing the standards.

IASB endorsed 41 IAS and named its pronouncement as International Financial Reporting Standard (IFRS).


Convergence of the U.S. Accounting Standards and the International Accounting Standards

To increase the international comparability and the quality of US accounting standards, the FASB has been engaged in activities to increase the convergence of the accounting standards.

The FASB is working closely with the IASB toward the convergence of accounting standards (i.e. to develop a single set of standards).


Short-Term International Convergence (source: FASB Project Updates)

Both IASB and FASB acknowledged that convergence of IFRS and U.S. GAAP is a primary objective of both Boards.

To achieve this objective and to improve the financial reporting in the US, the FASB started a short term project, conducted jointly with the IASB, to eliminate narrow differences between US GAAP and IFRS (or IAS) in October, 2002.

A Single Global Accounting Language- International financial reporting standards?

The Securities and Exchange Commission (SEC) proposed a roadmap for the US issuers to prepare financial statements in accordance with “IFRS” for the purposes of their filings with the SEC.

This roadmap, if achieved, could lead to the required use of IFRS by U.S. issuers in 2014.

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Current Compliances

Since there is no single set of high-quality accounting standards, domestic (U.S.) firms filing reports with the SEC must use U.S. GAAP.

Foreign issuers filing reports with the SEC can use U.S. GAAP, the international standards or the GAAP of its home country.

If foreign firms chose not to use U.S. GAAP, they must file reports with reconciliation to U.S. GAAP.


7. Accounting Concepts and Principles

1. The entity concept

2. The going-concern concept

3. The stable-monetary unit concept

4. The cost principle

5. The reliability principle

100chap1.ppt

Documents

fiscal years

subsidiaries

497liabilities

financial

international

annual financial

cash dividends

net cash flows