Moore Accounting for Financial Reporting Week DB 2

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MooreWeek2DBAccountingforFinancialReporting.docx

Reflect on what we have studied this week. Discuss an aspect of what we studied this week. How have you used this concept in the your current business? Or how do you see using a particular concept in the future? Did you find anything of particular interest to you? Please explain

Week2Module02PowerPoint.pdf

1/17/2023

Peter D. Easton John J. Wild Robert F. Halsey Mary Lea McAnally

for MBAs

Financial Accounting

Eighth Edition

Module Introducing Financial Statements

Learning Objective

Examine and interpret a balance sheet.

1/17/2023

Balance Sheet Basics

4© Cambridge Business Publishers, 2021

 The balance sheet has three sections:  Assets  Liabilities  Stockholders’ equity

ASSETS = LIABILITIES + STOCKHOLDERS’ EQUITY

 The balance sheet reports the assets, liabilities, and equity at a point in time.  Balance sheet accounts are permanent accounts

because their balance carries over from period to period.

AKA: Owners’ equity Shareholders’ equity

Flow of Costs

5© Cambridge Business Publishers, 2021

 When a cost creates an immediate benefit, we record the cost in the income statement as an EXPENSE.  When a cost creates a future economic benefit, we

record it on the balance sheet as an ASSET.  As an asset is used up, its cost moves from the balance

sheet to the income statement, where it is recognized as an EXPENSE.

Capitalized: added to the balance sheet as an asset

Assets

6© Cambridge Business Publishers, 2021

An ASSET confers expected future economic benefits.

An asset must meet the following two conditions to be reported on the balance sheet:

1. It must be owned or controlled by the company. 2. It must arise from a past transaction or event.

1/17/2023

Apple Inc. Balance Sheet―Assets

Current Assets

8© Cambridge Business Publishers, 2021

 Cash—currency and bank deposits  Cash equivalents—investments with an original

maturity of 90 days or fewer  Short-term investments—marketable securities the

company expects to sell within the year  Accounts receivable, net—amounts due from

customers arising from the sales on credit

 Inventories—goods purchased or produced for sale to customers  Prepaid expenses—costs paid in advance for rent,

insurance, advertising, and other services

NET: After uncollectible accounts have been subtracted

Long-Term Assets

9© Cambridge Business Publishers, 2021

 Property, plant, and equipment (PPE), net—land, buildings, and equipment

 Long-term investments—investments the company does not intend to sell within the year  Intangible and other assets—assets without physical

substance such patents, trademarks, franchise rights, and goodwill

NET: After accumulated depreciation has been subtracted

1/17/2023

Measuring Assets

10© Cambridge Business Publishers, 2021

Most assets are reported at historical cost―the original acquisition cost and NOT at current market value.  If a company cannot value an asset with relative

certainty, it does not recognize an asset on the balance sheet.  This means that significant “assets” are not reflected

on a balance sheet.  Excluded assets often relate to knowledge-based or

intellectual property (IP) assets, such as a strong management team, a solid supply chain, or superior technology.

Effects of “Missing” Assets

Liabilities

12© Cambridge Business Publishers, 2021

Liabilities are future economic sacrifices.

A liability has the following two characteristics: 1. It is an unavoidable obligation for the company 2. It must arise from a past transaction or event

A liability represents an amount that must be repaid and can be: 1. Interest bearing―as in a bank loan 2. Non-interest bearing―as to a vendor or partner

1/17/2023

Stockholders’ Equity

13© Cambridge Business Publishers, 2021

Stockholders’ equity represents capital that has been invested by the stockholders.  Directly via the purchase of stock  Indirectly in the form of retained earnings that reflect

earnings that are reinvested in the business and not paid out as dividends

Apple’s Liabilities and Equity

Current Liabilities

15© Cambridge Business Publishers, 2021

 Accounts payable—amounts owed to suppliers for goods and services purchased on credit

 Accrued liabilities—obligations for expenses that have been incurred but not yet paid (such as wages earned by employees but not yet paid)

 Unearned revenues—cash received from a customer in advance for goods or services to be delivered later

 Short-term debt—short-term loans owing to banks or other lenders

 Current maturities of long-term debt—principal portion of long-term debt that is due to be paid within one year

AKA: Accrued expenses

AKA: Deferred revenues

AKA: Current portion

1/17/2023

Net Working Capital

16© Cambridge Business Publishers, 2021

 Net working capital Net working capital = Current assets – Current Liabilities

 The net working capital required to conduct business depends on the company’s operating cycle, which is the time between paying cash for goods and receiving cash from customers.

AKA: Working capital

AKA: Cash Cycle Cash Conversion Cycle (CCC)

Operating Cycle

Companies buy inventory with cash and supplier credit

(accounts payable)

1/17/2023

Operating Cycle

Companies sell inventory either on credit (accounts

receivable) or for cash

Operating Cycle

When receivables are collected, a portion of the cash received is used to

repay accounts payable. The remainder goes to the cash

account for the next operating cycle.

Operating Cycle

1/17/2023

Cash Conversion Cycle Apple & 3M

22© Cambridge Business Publishers, 2021

 Apple’s cash conversion cycle is negative.  Apple can invest the cash it receives from customers

for 73.6 days before paying suppliers.  3M’s cash conversion cycle is positive which is more

typical.

Noncurrent Liabilities

23© Cambridge Business Publishers, 2021

 Noncurrent liabilities—obligations due after one year  Long-term debt—principal loan amounts that are

scheduled to be repaid more than one year hence  Long-term debt includes bonds, notes, debentures,

mortgages, and other long-term loans  Other long-term liabilities—such as pension liabilities

and long-term tax liabilities, that will be settled a year or more into the future

Stockholders’ Equity Contributed Capital

24© Cambridge Business Publishers, 2021

 Common stock—par value received from the original sale of common stock to investors

 Additional paid-in capital—amounts received from the original sale of stock to investors in excess of the par value of stock

 Preferred stock—value received from the original sale of preferred stock to investors

 Treasury stock—amount the company paid to reacquire its common stock from shareholders. Treasury shares are “held” by the company for potential resale on the open market.

AKA: Capital in excess of par

1/17/2023

Stockholders’ Equity Earned Capital

25© Cambridge Business Publishers, 2021

 Retained earnings—cumulative net income that has not been distributed to stockholders via dividends or share repurchases

 Accumulated other comprehensive income or loss— cumulative changes in asset and liability fair values that are not reported in the income statement

Common Size Balance Sheet

26© Cambridge Business Publishers, 2021

Common Size, aka, Vertical analysis or Right-sizing

 What?  Expresses the balance sheet in % terms  Every line item on the balance sheet (A, L & Eq) divided by

total assets

 WHY?  Compare a company across two or more years  Compare two or more companies―adjusts for size and currency

differences  Compare a company to industry or other benchmark

Book Value vs. Market Value

27© Cambridge Business Publishers, 2021

 Stockholders’ Equity―the “value” of the company per GAAP

 Market value = Number of common shares outstanding × Company’s stock price

 Book value ≠ Market value  GAAP reports assets and liabilities at historical costs, whereas

the market attempts to estimate fair values.  GAAP excludes assets that cannot be reliably measured.  Market value adjusts for companies’ market characteristics.  GAAP does not consider expected future performance.

AKA: Book Value Book value of equity

AKA: Market capitalization Market cap

1/17/2023

Market Value vs. Book Value

Learning Objective

Examine and interpret an income statement

Income Statement

30© Cambridge Business Publishers, 2021

 The income statement reports  Revenues earned during a period  Expenses incurred to produce those revenues  Net income or loss (Revenue – Expenses)

 The general structure of the income statement: AKA: Net revenue, Sales

AKA: Cost of sales, Cost of revenues

AKA: Earnings before interest and taxes (EBIT)

1/17/2023

Apple’s Income Statement

Operating Expenses

usual and customary costs a company incurs

to support its operating activities

Nonoperating Income / Expenses

relate to the company’s financing and

investing activities

Accrual Accounting

32© Cambridge Business Publishers, 2021

 Revenues and expenses recognized on the income statement are NOT determined by the cash received or paid.  Two principles are the foundation of accrual

accounting 1. Revenue recognition principle 2. Expense recognition principle

Expense Recognition Principle

33© Cambridge Business Publishers, 2021

 Recognize expenses when incurred  Expense recognition may or may not coincide with

cash payment 1. Expense recognized & cash paid simultaneously 2. Cash paid in advance & expense recognized later 3. Expense recognized in current period & cash paid later

1/17/2023

Revenue Recognition Principle

34© Cambridge Business Publishers, 2021

 Recognize revenue when a performance obligation is satisfied by transferring to a customer a promised good or service.  Good or service is transferred when the customer

obtains control of that good or service.  Revenue is the amount the company expects to

receive.  Revenue recognition may or may not coincide with

cash received. 1. Revenue recognized & cash received simultaneously 2. Revenue recognized in current period & cash received later 3. Cash received in advance & revenue recognized later

Income Statement

35© Cambridge Business Publishers, 2021

 The income statement reports  Revenues earned during a period  Expenses incurred to produce those revenues  Net income or loss (Revenue – Expenses)

 The general structure of the income statement:

Discontinued Operations

36© Cambridge Business Publishers, 2021

 Discontinued operations―A disposal of a business unit that represents a strategic shift that has, or will have, a major effect on the company’s financial results  Two components on the income statement (often

combined) 1. Net income / loss from the business prior to sale 2. Any gain or loss on the actual sale of the business

 Segregating Discontinued operations from Continuing operations helps analysts to better isolate the core reoccurring profit and cash flow of the business.

1/17/2023

Common Size Income Statement

37© Cambridge Business Publishers, 2021

Common Size, aka, Vertical analysis or Right-sizing

 What?  Every line item on the income statement divided by total

revenue  Express the income statement in % terms

 WHY?  Compare a company across two or more years  Compare two or more companies―adjusts for size and currency

differences  Compare a company to industry or other benchmark

Two Important Margins

38© Cambridge Business Publishers, 2021

 Gross profit margin  Gross profit / Sales  The gross profit margin is influenced by both the selling price of

the company’s products and the cost to make or buy those products.

 Operating expense margins  Operating expense / Sales  Analysis of operating expenses over time and compared with

peer companies

Learning Objective

Examine and interpret a statement of stockholders’ equity.

1/17/2023

Apple’s Liabilities and Equity

Statement of Stockholders’ Equity

41© Cambridge Business Publishers, 2021

Statement of stockholders’ equity reconciles the beginning and ending balances of stockholders’ equity accounts.

 Common stock and additional paid-in capital increase by the proceeds from the sale of stock.

 Retained earnings increase by net income and decrease by dividends to shareholders and by stock repurchased and retired.

 Accumulated other comprehensive income increases and decreases by changes in asset and liability fair values that are not reported in the income statement.

Apple’s Statement of Stockholders’ Equity

1/17/2023

Learning Objective

Describe a statement of cash flows.

Statement of Cash Flows

44© Cambridge Business Publishers, 2021

 The income statement measures income using GAAP principles and provides information about the economic viability of the company’s products and services.  The statement of cash flows provides information

about the company’s ability to generate cash from those same transactions.

Statement of Cash Flows Format

45© Cambridge Business Publishers, 2021

 Cash flows from operating activities―cash flows from the company’s transactions and events that relate to its operations  Cash flows from investing activities―cash flows from

acquisitions and divestitures of investments and long- term assets  Cash flows from financing activities―cash flows from

issuances of and payments toward borrowings and equity

1/17/2023

Apple’s Statement of Cash Flows

AKA: Total cash flow

Learning Objective

Construct and apply linkages among the four financial statements.

Financial Statement Linkages

48© Cambridge Business Publishers, 2021

AKA, Financial statement articulation.

 What?  Connections among the four financial statements that link

activity during the period to the balances at the beginning and end of the period

 WHY?  Point out the interconnection among profit, cash flow and the

balance sheet  Help managers and external financial statement users assess

the impact of potential transactions

1/17/2023

Financial Statement Linkages

Learning Objective

Locate and use additional financial information from public sources.

Additional SEC Information

51© Cambridge Business Publishers, 2021

 Form 10-K / 10Q  Annual / quarterly report

 Form 20-F  Non-GAAP or IFRS companies’ annual report, provides a table that

reconciles net income as reported to U.S. GAAP net income.  Form 40-F  Same as 20-F but for Canadian companies

 Form 8-K  Wide range of corporate events, reported within 4 days  Entry into or termination of a material definitive agreement (including petition

for bankruptcy)  Exit from a line of business or impairment of assets  Change in the company’s certified public accounting firm  Change in control of the company  Departure of the company’s executive officers  Changes in the company’s articles of incorporation or bylaws

1/17/2023

Other Information Sources

52© Cambridge Business Publishers, 2021

 Equity Analyst Reports―sell-side analysts provide clients with:  Objective analysis of company activities  Forecasts for revenues and EPS  Stock price target

 Credit Reports―credit rating agencies provide:  Objective credit analysis that evaluates a company’s creditworthiness  Credit rating (alphanumeric score)

 Data Services―a number of companies supply financial statement data in easy-to-download spreadsheet formats

Global Accounting GAAP vs. IFRS

53© Cambridge Business Publishers, 2021

 Balance Sheet―the most visible difference is that many IFRS-based balance sheets are presented in reverse order of liquidity.  Income Statement―the most visible differences are:  GAAP requires three years’ of data on the income statement

whereas IFRS requires only two.  IFRS firms can classify expenses by function (cost of sales,

SG&A, R&D, etc.) or by type (raw materials, labor, depreciation, etc.)

Cambridge Business Publishers www.cambridgepub.com

for MBAs

Financial Accounting

Eighth Edition

Week2Module02PowerPoint.pdf

1/17/2023

Peter D. Easton John J. Wild Robert F. Halsey Mary Lea McAnally

for MBAs

Financial Accounting

Eighth Edition

Module Introducing Financial Statements

Learning Objective

Examine and interpret a balance sheet.

1/17/2023

Balance Sheet Basics

4© Cambridge Business Publishers, 2021

 The balance sheet has three sections:  Assets  Liabilities  Stockholders’ equity

ASSETS = LIABILITIES + STOCKHOLDERS’ EQUITY

 The balance sheet reports the assets, liabilities, and equity at a point in time.  Balance sheet accounts are permanent accounts

because their balance carries over from period to period.

AKA: Owners’ equity Shareholders’ equity

Flow of Costs

5© Cambridge Business Publishers, 2021

 When a cost creates an immediate benefit, we record the cost in the income statement as an EXPENSE.  When a cost creates a future economic benefit, we

record it on the balance sheet as an ASSET.  As an asset is used up, its cost moves from the balance

sheet to the income statement, where it is recognized as an EXPENSE.

Capitalized: added to the balance sheet as an asset

Assets

6© Cambridge Business Publishers, 2021

An ASSET confers expected future economic benefits.

An asset must meet the following two conditions to be reported on the balance sheet:

1. It must be owned or controlled by the company. 2. It must arise from a past transaction or event.

1/17/2023

Apple Inc. Balance Sheet―Assets

Current Assets

8© Cambridge Business Publishers, 2021

 Cash—currency and bank deposits  Cash equivalents—investments with an original

maturity of 90 days or fewer  Short-term investments—marketable securities the

company expects to sell within the year  Accounts receivable, net—amounts due from

customers arising from the sales on credit

 Inventories—goods purchased or produced for sale to customers  Prepaid expenses—costs paid in advance for rent,

insurance, advertising, and other services

NET: After uncollectible accounts have been subtracted

Long-Term Assets

9© Cambridge Business Publishers, 2021

 Property, plant, and equipment (PPE), net—land, buildings, and equipment

 Long-term investments—investments the company does not intend to sell within the year  Intangible and other assets—assets without physical

substance such patents, trademarks, franchise rights, and goodwill

NET: After accumulated depreciation has been subtracted

1/17/2023

Measuring Assets

10© Cambridge Business Publishers, 2021

Most assets are reported at historical cost―the original acquisition cost and NOT at current market value.  If a company cannot value an asset with relative

certainty, it does not recognize an asset on the balance sheet.  This means that significant “assets” are not reflected

on a balance sheet.  Excluded assets often relate to knowledge-based or

intellectual property (IP) assets, such as a strong management team, a solid supply chain, or superior technology.

Effects of “Missing” Assets

Liabilities

12© Cambridge Business Publishers, 2021

Liabilities are future economic sacrifices.

A liability has the following two characteristics: 1. It is an unavoidable obligation for the company 2. It must arise from a past transaction or event

A liability represents an amount that must be repaid and can be: 1. Interest bearing―as in a bank loan 2. Non-interest bearing―as to a vendor or partner

1/17/2023

Stockholders’ Equity

13© Cambridge Business Publishers, 2021

Stockholders’ equity represents capital that has been invested by the stockholders.  Directly via the purchase of stock  Indirectly in the form of retained earnings that reflect

earnings that are reinvested in the business and not paid out as dividends

Apple’s Liabilities and Equity

Current Liabilities

15© Cambridge Business Publishers, 2021

 Accounts payable—amounts owed to suppliers for goods and services purchased on credit

 Accrued liabilities—obligations for expenses that have been incurred but not yet paid (such as wages earned by employees but not yet paid)

 Unearned revenues—cash received from a customer in advance for goods or services to be delivered later

 Short-term debt—short-term loans owing to banks or other lenders

 Current maturities of long-term debt—principal portion of long-term debt that is due to be paid within one year

AKA: Accrued expenses

AKA: Deferred revenues

AKA: Current portion

1/17/2023

Net Working Capital

16© Cambridge Business Publishers, 2021

 Net working capital Net working capital = Current assets – Current Liabilities

 The net working capital required to conduct business depends on the company’s operating cycle, which is the time between paying cash for goods and receiving cash from customers.

AKA: Working capital

AKA: Cash Cycle Cash Conversion Cycle (CCC)

Operating Cycle

Companies buy inventory with cash and supplier credit

(accounts payable)

1/17/2023

Operating Cycle

Companies sell inventory either on credit (accounts

receivable) or for cash

Operating Cycle

When receivables are collected, a portion of the cash received is used to

repay accounts payable. The remainder goes to the cash

account for the next operating cycle.

Operating Cycle

1/17/2023

Cash Conversion Cycle Apple & 3M

22© Cambridge Business Publishers, 2021

 Apple’s cash conversion cycle is negative.  Apple can invest the cash it receives from customers

for 73.6 days before paying suppliers.  3M’s cash conversion cycle is positive which is more

typical.

Noncurrent Liabilities

23© Cambridge Business Publishers, 2021

 Noncurrent liabilities—obligations due after one year  Long-term debt—principal loan amounts that are

scheduled to be repaid more than one year hence  Long-term debt includes bonds, notes, debentures,

mortgages, and other long-term loans  Other long-term liabilities—such as pension liabilities

and long-term tax liabilities, that will be settled a year or more into the future

Stockholders’ Equity Contributed Capital

24© Cambridge Business Publishers, 2021

 Common stock—par value received from the original sale of common stock to investors

 Additional paid-in capital—amounts received from the original sale of stock to investors in excess of the par value of stock

 Preferred stock—value received from the original sale of preferred stock to investors

 Treasury stock—amount the company paid to reacquire its common stock from shareholders. Treasury shares are “held” by the company for potential resale on the open market.

AKA: Capital in excess of par

1/17/2023

Stockholders’ Equity Earned Capital

25© Cambridge Business Publishers, 2021

 Retained earnings—cumulative net income that has not been distributed to stockholders via dividends or share repurchases

 Accumulated other comprehensive income or loss— cumulative changes in asset and liability fair values that are not reported in the income statement

Common Size Balance Sheet

26© Cambridge Business Publishers, 2021

Common Size, aka, Vertical analysis or Right-sizing

 What?  Expresses the balance sheet in % terms  Every line item on the balance sheet (A, L & Eq) divided by

total assets

 WHY?  Compare a company across two or more years  Compare two or more companies―adjusts for size and currency

differences  Compare a company to industry or other benchmark

Book Value vs. Market Value

27© Cambridge Business Publishers, 2021

 Stockholders’ Equity―the “value” of the company per GAAP

 Market value = Number of common shares outstanding × Company’s stock price

 Book value ≠ Market value  GAAP reports assets and liabilities at historical costs, whereas

AKA: Book Value Book value of equity

AKA: Market capitalization Market cap

1/17/2023

Market Value vs. Book Value

Learning Objective

Examine and interpret an income statement

Income Statement

30© Cambridge Business Publishers, 2021

 The income statement reports  Revenues earned during a period  Expenses incurred to produce those revenues  Net income or loss (Revenue – Expenses)

 The general structure of the income statement: AKA: Net revenue, Sales

AKA: Cost of sales, Cost of revenues

AKA: Earnings before interest and taxes (EBIT)

1/17/2023

Apple’s Income Statement

Operating Expenses

usual and customary costs a company incurs

to support its operating activities

Nonoperating Income / Expenses

relate to the company’s financing and

investing activities

Accrual Accounting

32© Cambridge Business Publishers, 2021

 Revenues and expenses recognized on the income statement are NOT determined by the cash received or paid.  Two principles are the foundation of accrual

accounting 1. Revenue recognition principle 2. Expense recognition principle

Expense Recognition Principle

33© Cambridge Business Publishers, 2021

 Recognize expenses when incurred  Expense recognition may or may not coincide with

cash payment 1. Expense recognized & cash paid simultaneously 2. Cash paid in advance & expense recognized later 3. Expense recognized in current period & cash paid later

1/17/2023

Revenue Recognition Principle

34© Cambridge Business Publishers, 2021

 Recognize revenue when a performance obligation is satisfied by transferring to a customer a promised good or service.  Good or service is transferred when the customer

obtains control of that good or service.  Revenue is the amount the company expects to

receive.  Revenue recognition may or may not coincide with

cash received. 1. Revenue recognized & cash received simultaneously 2. Revenue recognized in current period & cash received later 3. Cash received in advance & revenue recognized later

Income Statement

35© Cambridge Business Publishers, 2021

 The income statement reports  Revenues earned during a period  Expenses incurred to produce those revenues  Net income or loss (Revenue – Expenses)

 The general structure of the income statement:

Discontinued Operations

36© Cambridge Business Publishers, 2021

combined) 1. Net income / loss from the business prior to sale 2. Any gain or loss on the actual sale of the business

 Segregating Discontinued operations from Continuing operations helps analysts to better isolate the core reoccurring profit and cash flow of the business.

1/17/2023

Common Size Income Statement

37© Cambridge Business Publishers, 2021

Common Size, aka, Vertical analysis or Right-sizing

 What?  Every line item on the income statement divided by total

revenue  Express the income statement in % terms

 WHY?  Compare a company across two or more years  Compare two or more companies―adjusts for size and currency

differences  Compare a company to industry or other benchmark

Two Important Margins

38© Cambridge Business Publishers, 2021

 Gross profit margin  Gross profit / Sales  The gross profit margin is influenced by both the selling price of

the company’s products and the cost to make or buy those products.

 Operating expense margins  Operating expense / Sales  Analysis of operating expenses over time and compared with

peer companies

Learning Objective

Examine and interpret a statement of stockholders’ equity.

1/17/2023

Apple’s Liabilities and Equity

Statement of Stockholders’ Equity

41© Cambridge Business Publishers, 2021

Statement of stockholders’ equity reconciles the beginning and ending balances of stockholders’ equity accounts.

 Common stock and additional paid-in capital increase by the proceeds from the sale of stock.

 Retained earnings increase by net income and decrease by dividends to shareholders and by stock repurchased and retired.

 Accumulated other comprehensive income increases and decreases by changes in asset and liability fair values that are not reported in the income statement.

Apple’s Statement of Stockholders’ Equity

1/17/2023

Learning Objective

Describe a statement of cash flows.

Statement of Cash Flows

44© Cambridge Business Publishers, 2021

about the company’s ability to generate cash from those same transactions.

Statement of Cash Flows Format

45© Cambridge Business Publishers, 2021

 Cash flows from operating activities―cash flows from the company’s transactions and events that relate to its operations  Cash flows from investing activities―cash flows from

acquisitions and divestitures of investments and long- term assets  Cash flows from financing activities―cash flows from

issuances of and payments toward borrowings and equity

1/17/2023

Apple’s Statement of Cash Flows

AKA: Total cash flow

Learning Objective

Construct and apply linkages among the four financial statements.

Financial Statement Linkages

48© Cambridge Business Publishers, 2021

AKA, Financial statement articulation.

 What?  Connections among the four financial statements that link

activity during the period to the balances at the beginning and end of the period

 WHY?  Point out the interconnection among profit, cash flow and the

balance sheet  Help managers and external financial statement users assess

the impact of potential transactions

1/17/2023

Financial Statement Linkages

Learning Objective

Locate and use additional financial information from public sources.

Additional SEC Information

51© Cambridge Business Publishers, 2021

 Form 10-K / 10Q  Annual / quarterly report

 Form 20-F  Non-GAAP or IFRS companies’ annual report, provides a table that

reconciles net income as reported to U.S. GAAP net income.  Form 40-F  Same as 20-F but for Canadian companies

 Form 8-K  Wide range of corporate events, reported within 4 days  Entry into or termination of a material definitive agreement (including petition

1/17/2023

Other Information Sources

52© Cambridge Business Publishers, 2021

 Equity Analyst Reports―sell-side analysts provide clients with:  Objective analysis of company activities  Forecasts for revenues and EPS  Stock price target

 Credit Reports―credit rating agencies provide:  Objective credit analysis that evaluates a company’s creditworthiness  Credit rating (alphanumeric score)

 Data Services―a number of companies supply financial statement data in easy-to-download spreadsheet formats

Global Accounting GAAP vs. IFRS

53© Cambridge Business Publishers, 2021

whereas IFRS requires only two.  IFRS firms can classify expenses by function (cost of sales,

SG&A, R&D, etc.) or by type (raw materials, labor, depreciation, etc.)

Cambridge Business Publishers www.cambridgepub.com

for MBAs

Financial Accounting

Eighth Edition

MooreWeek2DBAccountingforFinancialReporting.docx

Week2Module02PowerPoint.pdf

1/17/2023

Peter D. Easton John J. Wild Robert F. Halsey Mary Lea McAnally

for MBAs

Financial Accounting

Eighth Edition

Module Introducing Financial Statements

Learning Objective

Examine and interpret a balance sheet.

1/17/2023

Balance Sheet Basics

4© Cambridge Business Publishers, 2021

 The balance sheet has three sections:  Assets  Liabilities  Stockholders’ equity

ASSETS = LIABILITIES + STOCKHOLDERS’ EQUITY

 The balance sheet reports the assets, liabilities, and equity at a point in time.  Balance sheet accounts are permanent accounts

because their balance carries over from period to period.

AKA: Owners’ equity Shareholders’ equity

Flow of Costs

5© Cambridge Business Publishers, 2021

 When a cost creates an immediate benefit, we record the cost in the income statement as an EXPENSE.  When a cost creates a future economic benefit, we

record it on the balance sheet as an ASSET.  As an asset is used up, its cost moves from the balance

sheet to the income statement, where it is recognized as an EXPENSE.

Capitalized: added to the balance sheet as an asset

Assets

6© Cambridge Business Publishers, 2021

An ASSET confers expected future economic benefits.

An asset must meet the following two conditions to be reported on the balance sheet:

1. It must be owned or controlled by the company. 2. It must arise from a past transaction or event.

1/17/2023

Apple Inc. Balance Sheet―Assets

Current Assets

8© Cambridge Business Publishers, 2021

 Cash—currency and bank deposits  Cash equivalents—investments with an original

maturity of 90 days or fewer  Short-term investments—marketable securities the

company expects to sell within the year  Accounts receivable, net—amounts due from

customers arising from the sales on credit

 Inventories—goods purchased or produced for sale to customers  Prepaid expenses—costs paid in advance for rent,

insurance, advertising, and other services

NET: After uncollectible accounts have been subtracted

Long-Term Assets

9© Cambridge Business Publishers, 2021

 Property, plant, and equipment (PPE), net—land, buildings, and equipment

 Long-term investments—investments the company does not intend to sell within the year  Intangible and other assets—assets without physical

substance such patents, trademarks, franchise rights, and goodwill

NET: After accumulated depreciation has been subtracted

1/17/2023

Measuring Assets

10© Cambridge Business Publishers, 2021

Most assets are reported at historical cost―the original acquisition cost and NOT at current market value.  If a company cannot value an asset with relative

certainty, it does not recognize an asset on the balance sheet.  This means that significant “assets” are not reflected

on a balance sheet.  Excluded assets often relate to knowledge-based or

intellectual property (IP) assets, such as a strong management team, a solid supply chain, or superior technology.

Effects of “Missing” Assets

Liabilities

12© Cambridge Business Publishers, 2021

Liabilities are future economic sacrifices.

A liability has the following two characteristics: 1. It is an unavoidable obligation for the company 2. It must arise from a past transaction or event

A liability represents an amount that must be repaid and can be: 1. Interest bearing―as in a bank loan 2. Non-interest bearing―as to a vendor or partner

1/17/2023

Stockholders’ Equity

13© Cambridge Business Publishers, 2021

Stockholders’ equity represents capital that has been invested by the stockholders.  Directly via the purchase of stock  Indirectly in the form of retained earnings that reflect

earnings that are reinvested in the business and not paid out as dividends

Apple’s Liabilities and Equity

Current Liabilities

15© Cambridge Business Publishers, 2021

 Accounts payable—amounts owed to suppliers for goods and services purchased on credit

 Accrued liabilities—obligations for expenses that have been incurred but not yet paid (such as wages earned by employees but not yet paid)

 Unearned revenues—cash received from a customer in advance for goods or services to be delivered later

 Short-term debt—short-term loans owing to banks or other lenders

 Current maturities of long-term debt—principal portion of long-term debt that is due to be paid within one year

AKA: Accrued expenses

AKA: Deferred revenues

AKA: Current portion

1/17/2023

Net Working Capital

16© Cambridge Business Publishers, 2021

 Net working capital Net working capital = Current assets – Current Liabilities

 The net working capital required to conduct business depends on the company’s operating cycle, which is the time between paying cash for goods and receiving cash from customers.

AKA: Working capital

AKA: Cash Cycle Cash Conversion Cycle (CCC)

Operating Cycle

Companies buy inventory with cash and supplier credit

(accounts payable)

1/17/2023

Operating Cycle

Companies sell inventory either on credit (accounts

receivable) or for cash

Operating Cycle

When receivables are collected, a portion of the cash received is used to

repay accounts payable. The remainder goes to the cash

account for the next operating cycle.

Operating Cycle

1/17/2023

Cash Conversion Cycle Apple & 3M

22© Cambridge Business Publishers, 2021

 Apple’s cash conversion cycle is negative.  Apple can invest the cash it receives from customers

for 73.6 days before paying suppliers.  3M’s cash conversion cycle is positive which is more

typical.

Noncurrent Liabilities

23© Cambridge Business Publishers, 2021

 Noncurrent liabilities—obligations due after one year  Long-term debt—principal loan amounts that are

scheduled to be repaid more than one year hence  Long-term debt includes bonds, notes, debentures,

mortgages, and other long-term loans  Other long-term liabilities—such as pension liabilities

and long-term tax liabilities, that will be settled a year or more into the future

Stockholders’ Equity Contributed Capital

24© Cambridge Business Publishers, 2021

 Common stock—par value received from the original sale of common stock to investors

 Additional paid-in capital—amounts received from the original sale of stock to investors in excess of the par value of stock

 Preferred stock—value received from the original sale of preferred stock to investors

 Treasury stock—amount the company paid to reacquire its common stock from shareholders. Treasury shares are “held” by the company for potential resale on the open market.

AKA: Capital in excess of par

1/17/2023

Stockholders’ Equity Earned Capital

25© Cambridge Business Publishers, 2021

 Retained earnings—cumulative net income that has not been distributed to stockholders via dividends or share repurchases

 Accumulated other comprehensive income or loss— cumulative changes in asset and liability fair values that are not reported in the income statement

Common Size Balance Sheet

26© Cambridge Business Publishers, 2021

Common Size, aka, Vertical analysis or Right-sizing

 What?  Expresses the balance sheet in % terms  Every line item on the balance sheet (A, L & Eq) divided by

total assets

 WHY?  Compare a company across two or more years  Compare two or more companies―adjusts for size and currency

differences  Compare a company to industry or other benchmark

Book Value vs. Market Value

27© Cambridge Business Publishers, 2021

 Stockholders’ Equity―the “value” of the company per GAAP

 Market value = Number of common shares outstanding × Company’s stock price

 Book value ≠ Market value  GAAP reports assets and liabilities at historical costs, whereas

AKA: Book Value Book value of equity

AKA: Market capitalization Market cap

1/17/2023

Market Value vs. Book Value

Learning Objective

Examine and interpret an income statement

Income Statement

30© Cambridge Business Publishers, 2021

 The income statement reports  Revenues earned during a period  Expenses incurred to produce those revenues  Net income or loss (Revenue – Expenses)

 The general structure of the income statement: AKA: Net revenue, Sales

AKA: Cost of sales, Cost of revenues

AKA: Earnings before interest and taxes (EBIT)

1/17/2023

Apple’s Income Statement

Operating Expenses

usual and customary costs a company incurs

to support its operating activities

Nonoperating Income / Expenses

relate to the company’s financing and

investing activities

Accrual Accounting

32© Cambridge Business Publishers, 2021

 Revenues and expenses recognized on the income statement are NOT determined by the cash received or paid.  Two principles are the foundation of accrual

accounting 1. Revenue recognition principle 2. Expense recognition principle

Expense Recognition Principle

33© Cambridge Business Publishers, 2021

 Recognize expenses when incurred  Expense recognition may or may not coincide with

cash payment 1. Expense recognized & cash paid simultaneously 2. Cash paid in advance & expense recognized later 3. Expense recognized in current period & cash paid later

1/17/2023

Revenue Recognition Principle

34© Cambridge Business Publishers, 2021

 Recognize revenue when a performance obligation is satisfied by transferring to a customer a promised good or service.  Good or service is transferred when the customer

obtains control of that good or service.  Revenue is the amount the company expects to

receive.  Revenue recognition may or may not coincide with

cash received. 1. Revenue recognized & cash received simultaneously 2. Revenue recognized in current period & cash received later 3. Cash received in advance & revenue recognized later

Income Statement

35© Cambridge Business Publishers, 2021

 The income statement reports  Revenues earned during a period  Expenses incurred to produce those revenues  Net income or loss (Revenue – Expenses)

 The general structure of the income statement:

Discontinued Operations

36© Cambridge Business Publishers, 2021

combined) 1. Net income / loss from the business prior to sale 2. Any gain or loss on the actual sale of the business

 Segregating Discontinued operations from Continuing operations helps analysts to better isolate the core reoccurring profit and cash flow of the business.

1/17/2023

Common Size Income Statement

37© Cambridge Business Publishers, 2021

Common Size, aka, Vertical analysis or Right-sizing

 What?  Every line item on the income statement divided by total

revenue  Express the income statement in % terms

 WHY?  Compare a company across two or more years  Compare two or more companies―adjusts for size and currency

differences  Compare a company to industry or other benchmark

Two Important Margins

38© Cambridge Business Publishers, 2021

 Gross profit margin  Gross profit / Sales  The gross profit margin is influenced by both the selling price of

the company’s products and the cost to make or buy those products.

 Operating expense margins  Operating expense / Sales  Analysis of operating expenses over time and compared with

peer companies

Learning Objective

Examine and interpret a statement of stockholders’ equity.

1/17/2023

Apple’s Liabilities and Equity

Statement of Stockholders’ Equity

Statement of stockholders’ equity reconciles the beginning and ending balances of stockholders’ equity accounts.

 Common stock and additional paid-in capital increase by the proceeds from the sale of stock.

 Retained earnings increase by net income and decrease by dividends to shareholders and by stock repurchased and retired.

 Accumulated other comprehensive income increases and decreases by changes in asset and liability fair values that are not reported in the income statement.

Apple’s Statement of Stockholders’ Equity

1/17/2023

Learning Objective

Describe a statement of cash flows.

Statement of Cash Flows

about the company’s ability to generate cash from those same transactions.

Statement of Cash Flows Format

 Cash flows from operating activities―cash flows from the company’s transactions and events that relate to its operations  Cash flows from investing activities―cash flows from

acquisitions and divestitures of investments and long- term assets  Cash flows from financing activities―cash flows from

issuances of and payments toward borrowings and equity

1/17/2023

Apple’s Statement of Cash Flows

AKA: Total cash flow

Learning Objective

Construct and apply linkages among the four financial statements.

Financial Statement Linkages

AKA, Financial statement articulation.

 What?  Connections among the four financial statements that link

activity during the period to the balances at the beginning and end of the period

 WHY?  Point out the interconnection among profit, cash flow and the

balance sheet  Help managers and external financial statement users assess

the impact of potential transactions

1/17/2023

Financial Statement Linkages

Learning Objective

Locate and use additional financial information from public sources.

Additional SEC Information

 Form 10-K / 10Q  Annual / quarterly report

 Form 20-F  Non-GAAP or IFRS companies’ annual report, provides a table that

reconciles net income as reported to U.S. GAAP net income.  Form 40-F  Same as 20-F but for Canadian companies

 Form 8-K  Wide range of corporate events, reported within 4 days  Entry into or termination of a material definitive agreement (including petition

1/17/2023

Other Information Sources

 Equity Analyst Reports―sell-side analysts provide clients with:  Objective analysis of company activities  Forecasts for revenues and EPS  Stock price target

 Credit Reports―credit rating agencies provide:  Objective credit analysis that evaluates a company’s creditworthiness  Credit rating (alphanumeric score)

 Data Services―a number of companies supply financial statement data in easy-to-download spreadsheet formats

Global Accounting GAAP vs. IFRS

whereas IFRS requires only two.  IFRS firms can classify expenses by function (cost of sales,

SG&A, R&D, etc.) or by type (raw materials, labor, depreciation, etc.)

Cambridge Business Publishers www.cambridgepub.com

for MBAs

Financial Accounting

Eighth Edition

Week2Module02PowerPoint.pdf

1/17/2023

Peter D. Easton John J. Wild Robert F. Halsey Mary Lea McAnally

for MBAs

Financial Accounting

Eighth Edition

Module Introducing Financial Statements

Learning Objective

Examine and interpret a balance sheet.

1/17/2023

Balance Sheet Basics

 The balance sheet has three sections:  Assets  Liabilities  Stockholders’ equity

ASSETS = LIABILITIES + STOCKHOLDERS’ EQUITY

 The balance sheet reports the assets, liabilities, and equity at a point in time.  Balance sheet accounts are permanent accounts

because their balance carries over from period to period.

AKA: Owners’ equity Shareholders’ equity

Flow of Costs

 When a cost creates an immediate benefit, we record the cost in the income statement as an EXPENSE.  When a cost creates a future economic benefit, we

record it on the balance sheet as an ASSET.  As an asset is used up, its cost moves from the balance

sheet to the income statement, where it is recognized as an EXPENSE.

Capitalized: added to the balance sheet as an asset

Assets

An ASSET confers expected future economic benefits.

An asset must meet the following two conditions to be reported on the balance sheet:

1. It must be owned or controlled by the company. 2. It must arise from a past transaction or event.

1/17/2023

Apple Inc. Balance Sheet―Assets

Current Assets

 Cash—currency and bank deposits  Cash equivalents—investments with an original

maturity of 90 days or fewer  Short-term investments—marketable securities the

company expects to sell within the year  Accounts receivable, net—amounts due from

customers arising from the sales on credit

 Inventories—goods purchased or produced for sale to customers  Prepaid expenses—costs paid in advance for rent,

insurance, advertising, and other services

NET: After uncollectible accounts have been subtracted

Long-Term Assets

 Property, plant, and equipment (PPE), net—land, buildings, and equipment

 Long-term investments—investments the company does not intend to sell within the year  Intangible and other assets—assets without physical

substance such patents, trademarks, franchise rights, and goodwill

NET: After accumulated depreciation has been subtracted

1/17/2023

Measuring Assets

Most assets are reported at historical cost―the original acquisition cost and NOT at current market value.  If a company cannot value an asset with relative

certainty, it does not recognize an asset on the balance sheet.  This means that significant “assets” are not reflected

on a balance sheet.  Excluded assets often relate to knowledge-based or

intellectual property (IP) assets, such as a strong management team, a solid supply chain, or superior technology.

Effects of “Missing” Assets

Liabilities

Liabilities are future economic sacrifices.

A liability has the following two characteristics: 1. It is an unavoidable obligation for the company 2. It must arise from a past transaction or event

A liability represents an amount that must be repaid and can be: 1. Interest bearing―as in a bank loan 2. Non-interest bearing―as to a vendor or partner

1/17/2023

Stockholders’ Equity

Stockholders’ equity represents capital that has been invested by the stockholders.  Directly via the purchase of stock  Indirectly in the form of retained earnings that reflect

earnings that are reinvested in the business and not paid out as dividends

Apple’s Liabilities and Equity

Current Liabilities

 Accounts payable—amounts owed to suppliers for goods and services purchased on credit

 Accrued liabilities—obligations for expenses that have been incurred but not yet paid (such as wages earned by employees but not yet paid)

 Unearned revenues—cash received from a customer in advance for goods or services to be delivered later

 Short-term debt—short-term loans owing to banks or other lenders

 Current maturities of long-term debt—principal portion of long-term debt that is due to be paid within one year

AKA: Accrued expenses

AKA: Deferred revenues

AKA: Current portion

1/17/2023

Net Working Capital

 Net working capital Net working capital = Current assets – Current Liabilities

 The net working capital required to conduct business depends on the company’s operating cycle, which is the time between paying cash for goods and receiving cash from customers.

AKA: Working capital

AKA: Cash Cycle Cash Conversion Cycle (CCC)

Operating Cycle

Companies buy inventory with cash and supplier credit

(accounts payable)

1/17/2023

Operating Cycle

Companies sell inventory either on credit (accounts

receivable) or for cash

Operating Cycle

When receivables are collected, a portion of the cash received is used to

repay accounts payable. The remainder goes to the cash

account for the next operating cycle.

Operating Cycle

1/17/2023

Cash Conversion Cycle Apple & 3M

 Apple’s cash conversion cycle is negative.  Apple can invest the cash it receives from customers

for 73.6 days before paying suppliers.  3M’s cash conversion cycle is positive which is more

typical.

Noncurrent Liabilities

 Noncurrent liabilities—obligations due after one year  Long-term debt—principal loan amounts that are

scheduled to be repaid more than one year hence  Long-term debt includes bonds, notes, debentures,

mortgages, and other long-term loans  Other long-term liabilities—such as pension liabilities

and long-term tax liabilities, that will be settled a year or more into the future

Stockholders’ Equity Contributed Capital

 Common stock—par value received from the original sale of common stock to investors

 Additional paid-in capital—amounts received from the original sale of stock to investors in excess of the par value of stock

 Preferred stock—value received from the original sale of preferred stock to investors

 Treasury stock—amount the company paid to reacquire its common stock from shareholders. Treasury shares are “held” by the company for potential resale on the open market.

AKA: Capital in excess of par

1/17/2023

Stockholders’ Equity Earned Capital

 Retained earnings—cumulative net income that has not been distributed to stockholders via dividends or share repurchases

 Accumulated other comprehensive income or loss— cumulative changes in asset and liability fair values that are not reported in the income statement

Common Size Balance Sheet

Common Size, aka, Vertical analysis or Right-sizing

 What?  Expresses the balance sheet in % terms  Every line item on the balance sheet (A, L & Eq) divided by

total assets

 WHY?  Compare a company across two or more years  Compare two or more companies―adjusts for size and currency

differences  Compare a company to industry or other benchmark

Book Value vs. Market Value

 Stockholders’ Equity―the “value” of the company per GAAP

 Market value = Number of common shares outstanding × Company’s stock price

 Book value ≠ Market value  GAAP reports assets and liabilities at historical costs, whereas

AKA: Book Value Book value of equity

AKA: Market capitalization Market cap

1/17/2023

Market Value vs. Book Value

Learning Objective

Examine and interpret an income statement

Income Statement

 The income statement reports  Revenues earned during a period  Expenses incurred to produce those revenues  Net income or loss (Revenue – Expenses)

 The general structure of the income statement: AKA: Net revenue, Sales

AKA: Cost of sales, Cost of revenues

AKA: Earnings before interest and taxes (EBIT)

1/17/2023

Apple’s Income Statement

Operating Expenses

usual and customary costs a company incurs

to support its operating activities

Nonoperating Income / Expenses

relate to the company’s financing and

investing activities

Accrual Accounting

 Revenues and expenses recognized on the income statement are NOT determined by the cash received or paid.  Two principles are the foundation of accrual

accounting 1. Revenue recognition principle 2. Expense recognition principle

Expense Recognition Principle

 Recognize expenses when incurred  Expense recognition may or may not coincide with

cash payment 1. Expense recognized & cash paid simultaneously 2. Cash paid in advance & expense recognized later 3. Expense recognized in current period & cash paid later

1/17/2023

Revenue Recognition Principle

 Recognize revenue when a performance obligation is satisfied by transferring to a customer a promised good or service.  Good or service is transferred when the customer

obtains control of that good or service.  Revenue is the amount the company expects to

receive.  Revenue recognition may or may not coincide with

cash received. 1. Revenue recognized & cash received simultaneously 2. Revenue recognized in current period & cash received later 3. Cash received in advance & revenue recognized later

Income Statement

 The income statement reports  Revenues earned during a period  Expenses incurred to produce those revenues  Net income or loss (Revenue – Expenses)

 The general structure of the income statement:

Discontinued Operations

combined) 1. Net income / loss from the business prior to sale 2. Any gain or loss on the actual sale of the business

 Segregating Discontinued operations from Continuing operations helps analysts to better isolate the core reoccurring profit and cash flow of the business.

1/17/2023

Common Size Income Statement

Common Size, aka, Vertical analysis or Right-sizing

 What?  Every line item on the income statement divided by total

revenue  Express the income statement in % terms

 WHY?  Compare a company across two or more years  Compare two or more companies―adjusts for size and currency

differences  Compare a company to industry or other benchmark

Two Important Margins

 Gross profit margin  Gross profit / Sales  The gross profit margin is influenced by both the selling price of

the company’s products and the cost to make or buy those products.

 Operating expense margins  Operating expense / Sales  Analysis of operating expenses over time and compared with

peer companies

Learning Objective

Examine and interpret a statement of stockholders’ equity.

1/17/2023

Apple’s Liabilities and Equity

Statement of Stockholders’ Equity

Statement of stockholders’ equity reconciles the beginning and ending balances of stockholders’ equity accounts.

 Common stock and additional paid-in capital increase by the proceeds from the sale of stock.

 Retained earnings increase by net income and decrease by dividends to shareholders and by stock repurchased and retired.

 Accumulated other comprehensive income increases and decreases by changes in asset and liability fair values that are not reported in the income statement.

Apple’s Statement of Stockholders’ Equity

1/17/2023

Learning Objective

Describe a statement of cash flows.

Statement of Cash Flows

about the company’s ability to generate cash from those same transactions.

Statement of Cash Flows Format

 Cash flows from operating activities―cash flows from the company’s transactions and events that relate to its operations  Cash flows from investing activities―cash flows from

acquisitions and divestitures of investments and long- term assets  Cash flows from financing activities―cash flows from

issuances of and payments toward borrowings and equity

1/17/2023

Apple’s Statement of Cash Flows

AKA: Total cash flow

Learning Objective

Construct and apply linkages among the four financial statements.

Financial Statement Linkages

AKA, Financial statement articulation.

 What?  Connections among the four financial statements that link

activity during the period to the balances at the beginning and end of the period

 WHY?  Point out the interconnection among profit, cash flow and the

balance sheet  Help managers and external financial statement users assess

the impact of potential transactions

1/17/2023

Financial Statement Linkages

Learning Objective

Locate and use additional financial information from public sources.

Additional SEC Information

 Form 10-K / 10Q  Annual / quarterly report

 Form 20-F  Non-GAAP or IFRS companies’ annual report, provides a table that

reconciles net income as reported to U.S. GAAP net income.  Form 40-F  Same as 20-F but for Canadian companies

 Form 8-K  Wide range of corporate events, reported within 4 days  Entry into or termination of a material definitive agreement (including petition

1/17/2023

Other Information Sources

 Equity Analyst Reports―sell-side analysts provide clients with:  Objective analysis of company activities  Forecasts for revenues and EPS  Stock price target

 Credit Reports―credit rating agencies provide:  Objective credit analysis that evaluates a company’s creditworthiness  Credit rating (alphanumeric score)

 Data Services―a number of companies supply financial statement data in easy-to-download spreadsheet formats

Global Accounting GAAP vs. IFRS

whereas IFRS requires only two.  IFRS firms can classify expenses by function (cost of sales,

SG&A, R&D, etc.) or by type (raw materials, labor, depreciation, etc.)

Cambridge Business Publishers www.cambridgepub.com

for MBAs

Financial Accounting

Eighth Edition

other Questions(10)