FinancialAccounting(JEB044)

CharlesUniversity,Prague

Recap
PurposeofAccounting accountingislanguageofbusiness captureskeyconsequencesofcomplexbusiness activitiesinaparsimonious andstandardized way allowstobuildunderstandingofafirms financialpositionandofitshistoricaland prospectivefinancialperformance standardsettersmust: prioritizebetweenusers(ownersandcreditors) tradeoffvariouscriteriaofaccountingquality (relevancevs.reliability)
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Lecture2
BalanceSheet

JiriNovak
IES,UK

Recap
Account Structure recordofallchangesinaparticularitemover oneperiod(accountofevents) Tshapeaccountsrecordincreasesononeside anddecreasesonother(nominuses) and decreases on other (no minuses) eachtransactionisrecorded onthedebit (=left)sideand onthecredit (=right)sideofanotheraccount accountingbooksmustalwaysbeinbalance debits = creditst

2.1FinancialStatements l

FinancialStatements

BalanceSheet
BalanceSheetComponents assets(As) whatthecompanyowns liabilities(Li) whatthecompanyowestoits creditorsandbusinesspartners equity(Eq) whatthecompanyowestoits owners(i.e.shareholders) BalanceSheet assets equity
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BalanceSheet capturesthefinancialpositionofacompanyat onepointintime IncomeStatement(P&L) summarizestheeconomicperformanceofthe i th i f f th companyoveranaccountingperiod StatementofCashFlow showshowmuchcashthecompanycollected andpaidoutoveranaccountingperiod StatementofShareholdersEquity detailsoutchangesinshareholdersequityover anaccountingperiod
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liabilities

JiriNovak,IESUK

FinancialAccounting(JEB044)

CharlesUniversity,Prague

IncomeStatement
IncomeStatement showswhatrevenuesacompanygeneratedand whatexpenseswereincurredinafiscalyear IncomeStatement expenses losses
earnings or netincome or profit
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StatementofCashFlow
StatementofCashFlow SCFreportsthecashreceiptsandoutlaysinthe periodoftheiroccurrence,classifiedinto operating,investingandfinancingactivities
StatementofCashFlow cashflowfromoperating activities

revenues gains
+/ cashflowfrominvesting activities +/ cashflowfromfinancing activities totalcashflow
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FinancialStatements
Creditvs.Debit assets,expenses foundonthedebitsideofBSof ISandsoincreasesarerecordedasdebits(Dr) anddecreasesascredits(Cr) liabilities,equity,revenues foundonthecredit sideofBSofISandsoincreasesarerecordedas credits(Cr)anddecreasesasdebits(Dr)
Assets Inventories Liabilities BankLoan Equity ContributedCapital
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FinancialStatements
December31,2000 BalanceSheet2000 cash noncashassets liabilities equity cash noncashassets IncomeStatement 2001 revenues expenses netincome December31,2001 BalanceSheet2001 liabilities equity

Expenses CostofGoodsSold

Revenues NetSales

StatementofCashFlow2001 operatingcashflow +/ investingcash flow +/ financingcashflow cash

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BalanceSheet
BalanceSheetComponents assets(As) whatthecompanyowns liabilities(Li) whatthecompanyowestoits creditorsandbusinesspartners equity(Eq) whatthecompanyowestoits owners(i.e.shareholders) BalanceSheet assets equity
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2.2BalanceSheet l h

liabilities

JiriNovak,IESUK

FinancialAccounting(JEB044)

CharlesUniversity,Prague

BalanceSheet
BalanceSheetEquation asaconsequenceofdoubleentryaccounting balancesheet(BS)mustalwaysbeinbalance yp ( ) atanypointintimetotalassets(As)mustbe equaltothesumofliabilities(Li)&equity(Eq)
Ast =Lit +Eqt t

BalanceSheet
balancesheetmustalwaysbeinbalance

assets
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liabilities equity
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BalanceSheet
BalanceSheet
notespayable cash marketablesecurities accountsreceivable currentassets inventories prepaidexpenses currentmaturitiesofltdebt accountspayable currentliabilities accruedliabilities unearnedrevenue

Classification

Assets assetsareclassifiedbasedonliquidity,easewith whichtheycanbeconvertedintocash (distinctionbetweencurrentor fixed) Liabilities liabilitiesareclassifiedbasedon: maturity timeuntiltheyarepayable (~liquidity:current or longterm) nature eitheroperating orfinancial

longtermliabilities
deferredtaxes property,plant&equipment intangibleassets

longtermdebt

fixedassets

contributedcapital retainedearnings
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equity

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Classification

Assets
BalanceSheet IncomeStatement

CurrentAssets shorttermassetsthatarecontinuallyturned overinthecourseofabusinessduringnormal businessactivity,thatswhy current cash and other assets expected to be converted cashandotherassetsexpectedtobeconverted tocash,sold,orconsumedeitherinayearorin theoperatingcycle,whicheverislonger FixedAssets longtermassetsthatareusedformorethanone yearorbusinesscycle thecostoftheseassetsisdistributedovertheir usefullifethroughdepreciation
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liabilities assets expenses revenues equity earnings

JiriNovak,IESUK

FinancialAccounting(JEB044)

CharlesUniversity,Prague

Assets
IntuitiveDefinition(broad) Athingorpersonofuseorvalue., i.e.anything thatisofvalueorfuturebenefit (OxfordEnglishDictionary) AccountingDefinition(narrower) everythingthatacompanyownsasa consequenceofpastbusinessactivitiesandcan benefitfrominthefuture e.g.land,buildings,machinery,equipment, motorvehicles,rawmaterials,finished products,receivables,cash,securities
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Assets
AccountingDefinition

Aresourcecontrolledbytheenterpriseasaresult y p ofpasteventsandfromwhichfutureeconomic benefitsareexpectedtoflowtotheenterprise. InternationalFinancialReportingStandards (IFRS)

Assets
Control abilityofanentitytobenefitfromtheassetandto denyorregulatetheaccessofotherstothebenefit mostly(butnotalways)ownershipofanobjector rightimpliescontroloverit Examples intellectualcapital mostlycannotberecognized asanassetduetolackofcontrolofthecompany ofitspersonnel leasing controlovertheleasedpropertyowned bythelessoristransferredtothelessee
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Assets
ResultofPastEvents specificationofapasteventdifferentiatesassets fromintentionstoacquireassets(notrecognized) existenceofapasttransactionimpliesacostor valueofanassetthatcanbemeasuredreliably Examples orders/agreements notrecognizedasassetsuntil theagreeduponexchangetakesplace

Assets

Liabilities
AccountingDefinition

ExpectedEconomicBenefits reasonablycertainpotentialtocontributetothe objectivesoftheentity Example researchanddevelopment(R&D)expendituresfail tomeetthecriteriabecauseitistoouncertain thatfutureeconomicbenefitswillarise intangibleassets recognizedonlyiftheyresult fromamergeroranacquisition(M&A)

Aliabilityisapresentobligationoftheenterprise arisingfrompastevents,thesettlementofwhichis ii f h l f hi h i expectedtoresultinanoutflowfromtheenterprise ofresourcesembodyingeconomicbenefits InternationalFinancialReportingStandards (IFRS)

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JiriNovak,IESUK

FinancialAccounting(JEB044)

CharlesUniversity,Prague

Liabilities
RecognitionCriteria presentobligations companyisliable totransfer benefitstootherparties(liability) probablefuturesacrificesofeconomicbenefit liabilitiescanbeseenasnegativeassets netassets=assets liabilities Examples loanfromabank,bondsheldbycreditors accountspayabletosuppliers,salariespayable, taxespayable
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Equity
BalanceSheet IncomeStatement

liabilities li bili i assets expenses revenues equity earnings

Equity
ResidualStake residual stakeofownersinfirmconsistingof: contributedcapital accumulatedowners p y investmentinthecompanyovertime retainedearnings accumulatedpastprofits notpaidoutasdividends(i.e.retained) LiquidationPerspective iffirmisliquidated,allassetsaresoldandcash proceedsusedtosettleall(ifpossible)liabilities; whateverleftbelongstoowners equity=differencebetweenassetsandliabilities
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Equity
AccountingDefinition

q y f Equityistheresidualinterestinthenetassetsof anentitythatremainsafterdeductingits liabilities FinancialAccountingStandardsBoard(FASB)

Equity
StatementofShareholdersEquity detailsoutchangesinequitycomponents: contributedcapital capitalinvestedbythe owners(+)incommonandpreferredstock retainedearnings netincomeoftheyear(+), dividendspaidouttotheowners() treasurystock repurchaseofacompanysown stock() othercomprehensiveincome unrealizedgains orlossesonavailableforsalesecurities(+/), foreigncurrencytranslationadjustments(+/)
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FinancialStatements
StatementofCashFlow2001 operatingcashflow +/ investingcash flow +/ financingcashflow cash IncomeStatement 2001 revenues expenses netincome StatementofEquity2001 contributedcapital +/ retainedearnings /+ treasurystock +/ otherincome +/ other income comprehensiveincome

BalanceSheet2000 cash noncashassets liabilities equity cash

BalanceSheet2001 liabilities equity noncashassets

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JiriNovak,IESUK

FinancialAccounting(JEB044)

CharlesUniversity,Prague

ExcitingAccounting
goodluckinthedeepwatersofaccounting!

2.3DoYouRecognizeThem? Y h

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Equity

Equity
AccumulatedRetainedEarnings netincome recordsallprofitsthefirmearnedinthepast equity~ownerswealth;thereforeifafirm generatesprofititincreasesowner swealth generates profit it increases owners wealth dividends ownerscanretrievesomeoftheaccumulated profitsbypayingoutdividends whendividendsarepaidoutownerswealth investedinthecompanyisreduced

ContributedCapital commonstock regulartypeofstock;claimsof commonstockholderstothefirmsassets,met througheitherdividendsorliquidation,are subordinatetotheclaimsofcreditorsand b di t t th l i f dit d preferredstockholders preferredstock numberofforms;theyhave liquidationanddividendpreferencerelativeto commonstock,butusuallyhavenovoting power

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Equity
TreasuryStock insteadofpayingdividendsafirmmaydecide todistributewealthtoownersbyrepurchasing someofitsownshares cash paid to owners who decide to sell their cashpaidtoownerswhodecidetoselltheir sharesrepresentsareductionininvestedwealth wealthdistributionthroughstockrepurchases (unlikedividends)isselective,whichis preferableduetotaxreasons

Equity
OtherComprehensiveIncome someeventsthataffectthecompanyvalue(i.e. equity),butarebeyondmanagerialcontroldo notaffectprofitandarerecordeddirectlytoEq foreign currency translation adjustments foreigncurrencytranslationadjustments whentranslatingvalueofforeignsubsidiaries thatuseadifferentaccountingcurrency unrealizedgainsorlossesonavailableforsale securities whenusingfairvalue(markedto market)accountingvaluefluctuationsare bookeddirectlyagainstequity

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JiriNovak,IESUK

FinancialAccounting(JEB044)

CharlesUniversity,Prague

Exercise2
Task classifyfollowingitemsasassets(As),liabilities (Li),equity(Eq)ornone() y ifnecessaryassumethediscountrateof10% Purpose tryyourgutfeelingsconcerningthe recognitionofassetsandliabilities itsfineifyouarenotsure;justmakeaguess afterconsideringtheprincipleswehave discussedinthislecture
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2.4DoYouRecognizeThem? Y h

Exercise2
Classifyfollowingitemsintoassets(As), liabilities(Li),equity(Eq),ornone()
cashonthecompanysbankaccountof100 lineofcreditopenforthefirmintheirbankwith maximumoverdraftof500;firmcurrentlyuses380 a computer purchased a year ago for 600 acomputerpurchasedayearagofor600 depreciatedlinearlyover3years amachinepurchased12yearsagofor800 depreciatedlinearlyover10years rawmaterialinwarehousepurchasedfor200that haslostinvalueandiscurrentlyworthonly180 salariesforlastmonthnotyetpaidoutworth650in fixedsalariesand150inbonuses preferredstockatparvalueof100issuedfor800 lastyearsprofitof500(nodividendspaidthisyear) stocksinanothercompanypurchasednowfor70
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Exercise2
Classifyfollowingitemsintoassets(As), liabilities(Li),equity(Eq),ornone()
bondsissuedbythecompanywithfacevalueof120 soldtodayatadiscountfor115 abankloanof1000obtainedayearagoafterpaying aninterestof80thisyear commonstocksissuedfor2000afterprofitof500 wasearnedandadividendof300hasbeenpaidout aninvoicefor100fromasupplier(payable)forraw materialitsuppliedtothecompanyonemonthago aninvoicefor130tothecustomer(receivable)for productsdeliveredtohim2monthago insurancefornextyear;theinsurancefeeof35was paidthisyear 240paidtothecompanythisyearforconsultation servicesthatitwillperformednextyear

Exercise2
Classifyfollowingitemsintoassets(As), liabilities(Li),equity(Eq),ornone()
aclaimafterthecompanymadebyitscustomers worth50fordamagecausedbyitsproducts(the companyexpectstolosethetrialwithPr=80%) aclaimthecompanyhasafteritssuppliersworth40 forsupplyingdefectivespareparts(thecompany f l i d f ti t (th expectstowinthetrialwithPr=80%) auniqueoptiontopurchase$2000for1000inone yearstimewhentodaysexchangerateis1.5 patentwithestimatedvalueof160obtainedduring anacquisition(i.e.M&A)ofasmallercompetitor technicalexpertiseusedinproductionthatcosted 300todevelopinternallyinthecompany askillfulmanagerafteracompanyinvested20last yearand30thisyearinhertraining

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JiriNovak,IESUK