Objectives of Financial Reporting

Financial Statements and the Annual Report

(a) PROVIDE USEFUL INFORMATION Financial reporting should provide information that is useful to present and potential investors and creditors and other users in making rational investment, credit, and similar decisions. The information should be comprehensible to those who have a reasonable understanding of business and economic activities and are willing to study the information with reasonable diligence.1

Chapter 2

1Statement

of Financial Accounting Concepts (SFAC) No. 1

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LO 1

Describe the objectives of financial reporting.

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Objectives of Financial Reporting

(b) REFLECT INFORMATION ON CASH FLOWS Financial reporting should provide information to help present and potential investors and creditors and other users in assessing the amounts, timing, and uncertainty of prospective cash receipts from dividends or interest and the proceeds from the sale, redemption, or maturity of securities or loans. Since investors' and creditors' cash flows are related to enterprise cash flows, financial reporting should provide information to help investors, creditors, and others assess the amounts, timing, and uncertainty of prospective net cash inflows to the related enterprise.1
1Statement

Objectives of Financial Reporting

(c) REFLECT THE FINANCIAL POSITION OF THE ENTITY Financial reporting should provide information about the economic resources of an enterprise, the claims to those resources (obligations of the enterprise to transfer resources to other entities and owners' equity), and the effects of transactions, events, and circumstances that change its resources and claims to those resources.1

1Statement

of Financial Accounting Concepts (SFAC) No. 1

of Financial Accounting Concepts (SFAC) No. 1 Describe the objectives of financial reporting.
ECON 3A UCSB ANDERSON
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LO 1

LO 1

Describe the objectives of financial reporting.

ECON 3A UCSB ANDERSON

ASSUMPTIONS Economic entity Going concern Monetary unit Periodicity

PRINCIPLES Historical cost Revenue recognition Matching Full disclosure

CONSTRAINTS Cost-benefit Materiality Industry practice Conservatism

ASSUMPTIONS Economic entity Going concern Monetary unit Periodicity

PRINCIPLES Historical cost Revenue recognition Matching

CONSTRAINTS Cost-benefit Materiality

Relevance and Reliability

Industry practice Conservatism Full disclosure QUALITATIVE CHARACTERISTICS Relevance Reliability Comparability Capable of making a difference in a decision. Verifiability Representational faithfulness Neutrality

QUALITATIVE CHARACTERISTICS Relevance Reliability Comparability

ELEMENTS
Assets, Liabilities, and Equity Investments by owners Distribution to owners Comprehensive income Revenues and Expenses Gains and Losses

Conceptual Framework for Financial Reporting

Consistency

OBJECTIVES 1. Useful in investment and credit decisions 2. Useful in assessing future cash flows 3. About enterprise resources, claims to resources, and changes in them

Conceptual Framework for Financial Reporting

Consistency

OBJECTIVES 1. Useful in investment and credit decisions 2. Useful in assessing future cash flows 3. About enterprise resources, claims to resources, and changes in them

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LO 2

Describe the qualitative characteristics of accounting information.

ECON 3A UCSB ANDERSON

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LO 2

Describe the qualitative characteristics of accounting information.

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FUNDAMENTALS OF GAAP
Consistency/ Comparability: All companies for all periods account for things the same Monetary Unit: Only items which can be expressed in money are reflected Economic Entity: The entity can be separated. Time Period/ Periodicity: At least annually Historical Cost: Items are reported at their cost and depreciated if appropriate but changes in value are excluded. Going Concern: Entity will continue in existence for the foreseeable future. This is why historical cost is acceptable if there is no going concern, then liquidation basis may be appropriate.
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Qualitative Characteristics
True or False?
Relevance and reliability are the two primary qualities that make accounting information useful for decision making.

True

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LO 2

Describe the qualitative characteristics of accounting information.

ECON 3A UCSB ANDERSON

ASSUMPTIONS Economic entity Going concern Monetary unit Periodicity

PRINCIPLES Historical cost Revenue recognition Matching

CONSTRAINTS Cost-benefit Materiality

Qualitative Characteristics

Comparability and Consistency

Industry practice Conservatism Full disclosure

True or False?

QUALITATIVE CHARACTERISTICS Relevance Reliability Comparability

ELEMENTS
Assets, Liabilities, and Equity Investments by owners Distribution to owners Comprehensive income Revenues and Expenses Gains and Losses

Conceptual Framework for Financial Reporting

Consistency

Adherence to the concept of consistency requires that the same accounting principles be applied to similar transactions by all companies and for all periods?
TRUE

OBJECTIVES 1. Useful in investment and credit decisions 2. Useful in assessing future cash flows 3. About enterprise resources, claims to resources, and changes in them
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LO 2

Describe the qualitative characteristics of accounting information.

ECON 3A UCSB ANDERSON

LO 2

Describe the qualitative characteristics of accounting information.

ECON 3A UCSB ANDERSON

ASSUMPTIONS Economic entity Going concern Monetary unit Periodicity

PRINCIPLES Historical cost Revenue recognition Matching Full disclosure

CONSTRAINTS Cost-benefit Materiality Industry practice Conservatism

CPA Question, Nov. 94, FAR What is the underlying concept that supports the immediate recognition of a contingent loss? a. Substance over form. b. Consistency. c. Matching. d. Conservatism.

QUALITATIVE CHARACTERISTICS Relevance Reliability Comparability

ELEMENTS
Assets, Liabilities, and Equity Investments by owners Distribution to owners Comprehensive income Revenues and Expenses Gains and Losses

Conceptual Framework for Financial Reporting

Consistency

OBJECTIVES 1. Useful in investment and credit decisions 2. Useful in assessing future cash flows 3. About enterprise resources, claims to resources, and changes in them
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LO 2

Describe the qualitative characteristics of accounting information.

ECON 3A UCSB ANDERSON

LO 2

Describe the qualitative characteristics of accounting information.

ECON 3A UCSB ANDERSON

WHAT IS AN OPERATING CYCLE?

The operating cycle is how long it takes a company to initiate, perform, and deliver their primary product or service. Take a wholesaler for instance. First they buy inventory, then they sell it on account, and ultimately they collect the cash owed from their customer. The period of time it takes to accomplish this is the Operating Cycle.

Balance Sheet
Assets
Assets are probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events.

Accounts Payable Cash Accounts receivable

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Inventory

LO 3

Explain the concept and purpose of a classified balance sheet.

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ASSETS, EXAMPLES AND MORE

CASH PROCESS CULMINATES ACCOUNTS RECEIVABLE, ON BALANCE SHEET BY: SALES OFF THE BALANCE SHEET WHEN: COLLECTED, OR WRITTEN OFF INVENTORY, ON BALANCE SHEET BY: PURCHASES OFF THE BALANCE SHEET WHEN: SOLD- COGS FIXED ASSETS, ON BALANC SHEET BY: PURCHASES OFF THE BALANCE SHEET AS IT IS: DEPRECIATED- DEPRECIATION EXPENSE PREPAID EXPENSES, ON BALANCE SHEET BY: PAYMENT OFF THE BALANCE SHEET AS IT IS: CONSUMED- BENEFIT IS REALIZED- I.E INSURANCE EXPENSE
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Balance Sheet
Current Assets
Defined:
An asset that is expected to be realized in cash or sold or consumed during the operating cycle or within one year if the cycle is shorter than one year.

OR more commonly stated:

An asset that is expected to be realized in cash or sold or consumed within one year or the operating cycle, whichever is longer.
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LO 3

Explain the concept and purpose of a classified balance sheet.

ECON 3A UCSB ANDERSON

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Balance Sheet
Liabilities
Liabilities are probable future economic sacrifices obtained or controlled by a particular entity as a result of past transactions or events.

Balance Sheet
Current Liabilities
Defined:
An obligation that will be satisfied within the next operating cycle or within one year, if the cycle is shorter than one year.

OR more commonly stated:

An obligation that will be satisfied within one year or the operating cycle, whichever is longer.

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LO 3

Explain the concept and purpose of a classified balance sheet.

ECON 3A UCSB ANDERSON

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LO 3

Explain the concept and purpose of a classified balance sheet.

ECON 3A UCSB ANDERSON

A Classified Balance Sheet

Company Name Balance Sheet As of DATE Current assets Cash etc. Total current assets Fixed assets Other long term assets Total assets Current liabilities Accounts payable etc. Total current liabilities Long-term debt, excluding current portion Equity Common stock APIC Retained earnings Total Liabilities & Equity
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A Multiple Step Income Statement

Company Name Income Statement FOR THE PERIOD .
xxx xxx xxx

Revenue Cost of Revenue Gross Profit Selling general & administrativ (SG&A) expense Depreciation expense Other operating expenses
Balances?

xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx XXX
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xxx xxx xxx xxx

Income before income tax provision Tax provision Income from continuing operations Discontinued operations, net of tax Income before extraordinary items Extraordinary items, net of tax NET INCOME OR LOSS

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Analysis using a Classified Balance Sheet

Liquidity = the ability of a company to pay its debts as they come due.
A comparison of current assets and current liabilities is a starting point in evaluating the ability of a company to meet its obligations.

Analysis using a Classified Balance Sheet

The current ratio indicates the amount of current assets available at the balance sheet date relative to obligations coming due during that period.
Current Ratio = Current Assets Current Liabilities $118,000 $59,900

Working Capital = Current Assets Current Liabilities

Companys strive for a balance in managing its working capital not too much or too little. $118,000
Current assets
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1.97 to 1 =

59,900
Current liabilities

$58,100
Working capital
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Composition of current asset and current liabilities important.

LO 4 Use a classified balance sheet to analyze a companys financial position.
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LO 4

Use a classified balance sheet to analyze a companys financial position.

Statement of Retained Earnings Exercise

Landon Corporation was organized on January 2, 2002, with the investment of $100,000 by each of its two stockholders. Net income for its first year of business was $85,200. Net income increased during 2003 to $125,320 and to $145,480 during 2004. Landon paid $20,000 in dividends to each of the two stockholders in each of the three years. 2002 Beg. Retained earnings Net income (loss) Less: Dividends End. Retained earnings $ 0 85,200 (40,000) $45,200 2003 $ 45,200 125,320 (40,000) $130,520 2004 $130,520 145,480 (40,000) $236,000

Elements of the Annual Report

BASIC- ALL AUDITED FINANCIAL STATEMENTS MUST INCLUDE: Financial statements Notes to financial statements Report of independent accountants PUBLIC COMPANIES ALSO MUST INCLUDE: Managements assertions (SOX 403) Report of independent accountants on internal controls (SOX 404) Management discussion & analysis Summary of financial data Letter to stockholders
http://www.starbucks.com/
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LO 7

Prepare and identify the components of the statement of retained earnings.

ECON 3A UCSB ANDERSON

ECON 3A UCSB ANDERSON

DATSALLFORTHISCHAPTER

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