Financial Statement Literacy: The Story Behind the Numbers

OR: Why Accounting really is the most fascinating topic you will ever study

Objectives of Financial Statement Reporting: To provide information… Useful to present and potential investors, creditors, and other users for decision-making

To help assess amounts, timing, and uncertainty of prospective cash flows (interest/dividends, liquidation)

About economic resources of an enterprise, claims on those resources, and the effects of transactions, events, and circumstances that change these resources and claims to them

 

 

The Economic Resources of an Enterprise Assets

Fairly liquid – current Long term - productive capacity that supports

more than one year of operating activity

In total these are the resources management has available for its use in operations to accomplish the goals of the organization

Claims on Those Resources

Liabilities – borrowed funds Also segregated between current and long-term

based on whether satisfying the underlying obligation will require cash outflows within the next operating cycle, or beyond

Equity – contributions of owners There is no repayment obligation to owners

This investment risk is undertaken with anticipation of superior returns

Equity also includes income earned and retained by the firm

Fundamental Accounting Equation Assets =

The resources available to the firm for current and ongoing operations

What do we have?

Liabilities + Equity

Borrowed, contributed, and earned financing for firm resources

Where did we get it?

 

 

The Balance Sheet and its Supporting Schedules Income Statement - explains in greater

detail the major source of changes in one Balance Sheet account - Retained Earnings

Statement of Cash Flows - explains in greater detail the changes of one Balance Sheet account - Cash

Statement of Stockholders’ Equity - explains in greater detail changes of one section of the Balance Sheet - Equity

Effects of Transactions That Change Those Resources

Sources of Complexity in Accounting Many transactions are other than exchange

of goods/services for specified cash amounts On what basis should these be valued?

Current market value? Should these be adjusted at the end of the accounting period if market value changes (investments in equity securities, for example)?

Future cash flows? When cash exchange is far in the future (30 year bonds, for example) is the future cash exchange amount a meaningful value for use today?

Complex, but…Controversial? Intense corporate lobbying to get ‘favorable’

standards Mostly that means discretionary choices

New business transactions always evolving Substance over form is the goal

Prescriptive rules versus conceptual principles Interesting international differences