econ 4 - part 1
TRANSCRIPT
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Economics 4 Lecture 1.1
Accounting, Business Professions, And a Reporting
Illustration
Michael Willoughby, Ph.D., CFA
© Michael G Willoughby 2008
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The Context
Scarcity: We want more than we have, or
… we need what we don’t have – a chunk of ca$h. Life Cycle: Time changes everything
… needs, wants, resources, and prices.Risk: Shit happens plus
…we seldom never know exactly what kind of shit it is - so CERTAINTY is more desirable than uncertainty.
Information helps! … unless it’s bad information.
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Money-related Professions (broadly)
Economics: decisions about the use of resources – what do we want most?
Finance: decisions about the inter-temporal allocation of money: lending & borrowing.
Risk-management: decisions about the management – purchase or sale – of risk.
Accounting – an information system for recording and reporting business financial performance & position.
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Money-related Professions (narrowly)
Economics: a) policy pro/prescriptions;b) purchasing of commodities (i.e., the SWAL fuel
futures);
c) production management. Finance: a) Banking - financial intermediation;b) Investment management (valuation)c) Financial planning..
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Money-related Professions (narrowly)
Accounting: a) Control (bookeeping & internal controls);b) Financial reporting;c) Auditing;d) Tax-planning. Risk-management:a) Consulting; practices & procedures,
systems design, policy implementation; b) Insurance; underwriting.
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Where? Economics: 1. The Federal Reserve Banks.2. DOC, DOL, DOT, all Legislatures.3. Big manufacturing firms.4. ? Banking: 1. Commercial banks: Citi, BofA, Wells Fargo.2. Investment banks: Goldman, Lehman, Bears?3. Credit Unions: NFCU, America First, SD
County.
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Where?
Accounting: 1. Ernst & Young.2. Deloitte & Touche.3. KPMG.4. Price-Coopers (PWC).5. Arthur Anderson R.I.P.And the Regionals1. Moss Adams.2. McGladry Pullen
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Where?
Insurance:1. Marsh & McLennan2. A.I.G.3. GEICO, All State, Farmer’s, Traveler’s.4. ? Risk-management: 1. Kroll, Inc.2. ?
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Who?
Economics:1. M.A.’s2. Ph.D.’s Finance: 1. CFA’s2. CFP’s3. CIRA’s4. RIA’s5. CFO – job title allows you to join the
FEA
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Who?
Accounting:1. CPA’s2. EA’s3. CMA’s
Insurance: 1. CLU’s2. ?3. AA’s
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Why accounting?
It’s a formal way of keeping track of cash, claims to cash, obligations, & stuff:
1. Transactions & inventory.
2. Promises & contracts.
3. Money – my investment in your efforts.
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Financial Reporting
A report card on a Company’s:1. Performance – profits – via the Income
Statement2. Position – assets & liabilities – via the
Balance Sheet3. Liquidity – the sources & uses of ca$h –
via the SCF
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Financial Reporting
To interested parties:Outsiders:
a) Investors – owners; Purchase company stock.b) Creditors – lenders; Purchase company bonds.c) Regulatorsd) Vendors – suppliers & employees.
Insiders:a) Managers
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Functions
#1Collection1. The transactions of AN ENTITY2. w/other Entities (persons and/or
organizations)3. Over a PERIOD of time – the Fiscal Year “FY”
and its 4 Quarters.
#2Measurement1. In a monetary unit “$” 2. Using some rules, guidelines, & judgment
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Functions
# 3 Classification: every transaction creates a number that will be “labelled”:
1. Asset 2. Liability 3. Equity 4. Revenue 5. Expense
And also1. Gain2. Loss
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Functions
#4Presentation – the reporting part
1. Income Statement – performance OVER the Period – lists Revenues and Expenses, sometimes Gains & Losses.
2. Balance Sheet – position AT A POINT, the end of the Period – lists all Assets, Liabilities, and Equity.
3. Statement of Cash Flows – translates the reported performance on the I/S and changes in the B/S into the most objective, most fungible, resource - CA$H.
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Starbuck’s “SBUX” Stock
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Financial Statements
Income Statement
Top-down presentation Sales or Revenue = inflows from Primary
Activities Less Expenses = outflows from Primary
Activities There are three categories of expenses and
many types, of Expenses ! = Earnings – a measure of profit There are several levels of profit ending (at the
bottom line) with Net Income.
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Sales = $7,998,265,000 1
1 Company-owned stores. The Company’s total sales (ttm) was $10,097,790,000.
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Financial Statements
Balance Sheet One of civilizations greatest achievements. Keeps the accounting system in order. Assets = Liabilities + Equity What we OWN = What we OWE
Everything must have = a Source Assets = Capital Assets = Trade Credit + IBD + PinK + Retained
Earnings
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Financial Statements
Balance Sheet
Yours’ Your Parents’ Your Employer’s Your Nation’s A Global Balance Sheet? – if Al Gore says
so.
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Financial Statements
Statement of Cash Flows
Only Cash is Cash ! A required Financial Statement since 1987 w/ SFAS
95. Three Sources and Uses of Cash:1. Operating2. Investing3. Financing Required because of the Accrual nature of accounting.
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Objectives of Financial Accounting
Useful to the providers of money capital:
1. Relevant2. Reliable: consistent & comparable3. Timely
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Capital Providers
Investors – provide equity capital
1. As initial Paid-in-Capital “PinK”2. As retained earnings from profitable
activities. Creditors – provide debt capital
1. Trade credit2. Interest-bearing Debt
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Capital Providers con’t
The source of money capital for companies
Investors & Creditors literally “Sell Cash” to Company’s in exchange for:
Financial claims:
1. Bonds – debt2. Stocks - equity
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Need Useful Information
Capital Providers want information: For Decision-making About starting, staying-the-course, ending A financial relationship … With what Companies? Comparability is the corner stone of GAAP
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Accounting Assumptions
One entity. Record-keeping for “a Period” of
time. On-going concern Conducting transactions that can be
measured in Dollar$
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Accounting’s Principles
Cost – historical Objectivity – b/w independent parties Realization – of Revenue ≡ Sales Matching – Expenses w/ Sales Materiality – don’t show the small
stuff
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Employees & Stores
172,000 employees worldwide; 144,000 U.S.A.
163,000 employees in Stores; 9,000 in Admin. 8,505 Company-owned Stores; 6,506
licensed.
Sales per store-employee in Company-owned stores?
$ 49,065
and $ 46,501 per total employees
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Profits
• Net Income = $ 672,640,000
• Per employee = $ 3,800
• Profit Margin = 7.15 %
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Two Methods of Accounting
Cash-basis Only collect &
report “cash” transactions only.
Accrual Collect &
measure & report all transactions.
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Cash-basis Accounting
We measure activity when “cash” is received and when it is disbursed.
The difference is cash-basis profit.
This is the basis for taxation of small businesses.
Cash-basis accounting is a rules-based measurement system.
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Accrual
What matters is completed
activities – selling goods/services
regardless of whether cash is
collected at the time or sale,
before, or after.
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Accrual
Is about measuring success in dollar units as they are associated with activities including claims and obligations created while selling.
Is a principles-based measurement system, using the realization & matching principles to recognize Revenue and Expenses.
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Once Upon a Time there was a little ranch in Wyoming
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With gentle tenant farmers
My parents
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Starting with $ 6,000 in cash from prior earnings (Retained)
Balance Sheet at 12/31/07.
Cash = $ 6,000
AR = $ 0
INV = $ 0
PrePd $ 0
LLA $ 0
(Accum DA)
UnER = $0
Pay = $0
AcEx = $0
IBD = $0
P-in-K = $0
RE = $ 6,000
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2008 Activities
Purchase ten 400# hefers and steers in
March.
Grass feed them for about 10 months.
Start selling them in when they each
weigh 1000# in about November.
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Next Stop: Ruth Chris’
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All Transactions: March-December
1. Purchase 10 animals @ $400 each = $4,000 cash.
2. Purchase salt & minerals: $ 400 cash.3. Agree to pay my father: $100/mo. x 10 = $1,000
but we forget to pay him for December.4. Sell 8 animals @ $1,000 each by the end of
December, but two customers don’t pay until January 2009.
5. What will my 2008 Financials look like?
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It depends
Do we measure success on a:
Cash-basis?Or by the
Accrual method?
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Cash-basis Income Statement for 2008
Revenue
(COGS)
GP
(G&A)
Profit
6,000 of cash sales = 6 x $1,000 cash received.
( 4,000) direct expenses – 10 x $400 cash paid.
2,000
( 1,300) $400 cash for supplies & $900 cash for labor,
700
Note: We have two $1,000 IOU’s plus a $100 labor obligation and two animals still in the barn.
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Accrual Income Statement for 2008
Revenue
(COGS)
GP
(G&A)
Profit
8,000 Revenue as $6,000 cash + $2,000 in IOU’s
( 3,200) match the 8 sole x $ 400 as Direct Expense
4,800
( 1,400) match $400 supplies cost + $1,000 labor cost
3,400
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Close the Balance Sheet at 12/31/08for the Accrual method: Fill-in these
numbers
Cash = $ ????
AR = $ ????
INV = $ ????
PrePd $ 0
LLA $ 0
(Accum DA)
UnER = $0
Pay = $0
AcEx = $0
IBD = $0
P-in-K = $ 0
RE = $ ????
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Make a Cash Journal
Beginning cash $ 6,000 12/31/2007Purchase animals ($ 4,000)Purchase supplies ($ 400)Pay for Labor ($ 900)Cash for Sales $ 6,000 Ending cash $ 6,700 11 Ending cash will be recorede on the 12/31/2008 Balance Sheet.
Also note that Ending Cash – Beginning Cash = Cash flow = $700
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Adjusting the Balance Sheet Accounts
Basic internal control formula.a) What you start withb) plus what you receive,c) less what you useequalsd) what you end with.
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Articulate Retained Earnings
The internal control formula.a) start with $ 6,000b) plus 2008 Profit of $ 3,400c) less nothingequalsd) ending Retained Earnings of $ 9,400.
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The Balance Sheet at 12/31/08for the Accrual method
Cash = $ 6,700
AR = $ 2,000
INV = $ 800
PrePd $ 0
LLA $ 0
(Accum DA)
UnER = $ 0
Pay = $ 0
AcEx = $ 100
IBD = $ 0
P-in-K = $ 0
RE = $ 9,400