Financial Statements and Business Decisions

Introduction to Accounting
NYUAD – Fall I – 2021
Anisa Shyti

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 Highly recommended…

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 Marc’s Car Transport Business…

Marc starts a business to transport expensive cars

• On December 1, 20X2:
– Receives $50,000 cash from issuing common stock
– Borrows $80,000 from bank and buys $100,000 truck
• Will be used for 48 mos., with a $4,000 salvage value
– Pays $12,000 cash upfront to rent office space for 1 year

• During December:
– Moves five cars, will get paid $50,000 within 30 days
– Pays employees $10,000 of wages

• December 31: Bank wants to see financial statements

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 Did the company “make money” during December?

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 Did the company “make money” during December?

Cash flows $ • On December 1, 20X2

• Stock 50,000 – Receives $50,000 cash from
issuing common stock
• Bank 80,000
– Borrows $80,000 from bank
• Truck ( 100,000) and buys $100,000 truck
• Rent ( 12,000) • Will be used for 48 mos., with a
$4,000 salvage value
• Wages ( 10,000)
– Pays $12,000 cash upfront to
• Customers 0 rent office space for 1 year

• Cash total 8,000 • During December

– Moves two cars, will get paid
$40,000 within 30 days
– Pays employees $10,000 of
wages

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 Did the company “make money” during December?
Cash flows $ • On December 1, 20X2
Operating
– Receives $50,000 cash from
• Rent ( 12,000) issuing common stock
• Wages ( 10,000) – Borrows $80,000 from bank
• Customers 0 and buys $100,000 truck
• CFO ( 22,000) • Will be used for 48 mos., with a
$4,000 salvage value
– Pays $12,000 cash upfront to
Investing
rent office space for 1 year
• Truck ( 100,000)
• CFI ( 100,000)
• During December
Financing – Moves two cars, will get paid
$50,000 within 30 days
• Stock 50,000
– Pays employees $10,000 of
• Bank 80,000
wages
• CFF 130,000

• Cash total 8,000

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 Statement of Cash Flows
Reports cash transactions over a period of time
Cash flows $
Operating Operating Activities
• Rent ( 12,000) • Transactions related to the provision of
• Wages ( 10,000) goods or services and other normal
• Customers 0 business activities
• CFO ( 22,000)

Investing
Investing Activities
• Truck ( 100,000)
• Transactions related to the acquisition
• CFI ( 100,000) or disposal of long-lived productive
assets
Financing
• Stock 50,000
• Bank 80,000 Financing Activities
• CFF 130,000 • Transactions related to owners or
creditors
• Cash total 8,000

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 Did the company “make money” during December?
Accounting income $ • On December 1, 20X2
• Revenue 50,000
– Receives $50,000 cash from
• Truck expense* ( 2,000) issuing common stock
• Rent expense * * ( 1,000) – Borrows $80,000 from bank
• Wages expense (10,000) and buys $100,000 truck
• NET INCOME 37,000 • Will be used for 48 mos., with a
$4,000 salvage value
– Pays $12,000 cash upfront to
rent office space for 1 year
• *Truck expense (100,000 – 4,000)/48
• **Rent expense 12,000/12
• During December
– Moves two cars, will get paid
$40,000 within 30 days
– Pays employees $10,000 of
wages

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 Income Statement
Reports cash transactions over a period of
Accounting income $
time
• Revenue 50,000
• Truck expense* ( 2,000) Recognition tied to business activities
• Rent expense * * ( 1,000) • Revenues: Increases in “owners’ equity”
• Wages expense (10,000) from providing goods or services
• NET INCOME 37,000
• Expenses: Decreases in “owners’ equity”
incurred in the process of generating
revenues
• *Truck expense (100,000 – 4,000)/48
• **Rent expense 12,000/12 • Net Income (or Earnings or Net Profit)
= Revenues – Expenses

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 What is financial position at end of the month?

Balance Sheet $
ASSETS
• Cash 8,000 (Cash in the bank on 12/31/20X2)
• Accounts receivable 50,000 (Cash owed by customers on 12/31/20X2)
• Prepaid rent 11,000 (Prepaid for 11 months of future space on 12/31/20X2)
• Truck 98,000 (100,000 original cost – 2,000 “depreciation”)
• TOTAL 167,000

LIABILITIES & STOCKHOLDERS’ EQUITY

• Bank debt 80,000 (Cash owed to the bank on 12/31/20X2)
• Common stocks 50,000 (Stockholder investment as of 12/31/20X2)
• Retained earnings 37,000 (Accounting Net Income – Dividends as of 12/31/20X2)
• TOTAL 167,000

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 Balance sheet
Reports the financial position (resources
Balance Sheet $
and obligations) on a specific date
ASSETS
• Cash 8,000 • Assets:
• Accounts receivable (50,000) • Resources, owned by a business,
• Prepaid rent (11,000) that are expected to provide future
• Truck (98,000) economic benefits
• TOTAL 167,000
• Liabilities:
• Claims on assets by creditors (non-
LIABILITIES & STOCKHOLDERS’ EQUITY
owners) that represent an obligation
• Bank debt 80,000 to make future payment of cash,
• Common stocks 50,000 good, or service
• Retained earnings 37,000
• TOTAL 167,000 • Stockholders’ Equity (Owners’ Equity)
• Claims on assets by owners of the
business
• Contributed capital (arises from sale
of shares)
• Retained earnings (arises from
business operations)
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 Statement of Stockholders’ Equity …

• Will get to this later...

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 Understanding the Business

Stakeholders
Investors (returns:
Creditors (returns:
dividends, higher future
interest)
stock prices)
Managers

Purchase
Manufacture
parts
product
and labor
The
Business
Collect cash
from Operations Sell
products
customers
to
and pay
customers
creditors

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 Business Activities

Financing Activities Investing Activities

Ex: Borrow money Ex: Purchase
from bank equipment

Operating Activities
Ex: Sell merchandise
to customers

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 The Accounting System
Collects and processes
financial information

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 The Accounting System - II

Focus Managerial Accounting Financial Accounting

Purpose: Help managers make decisions Communicate financial information
(relevance) (reliable)

Primary users: Managers throughout organization External stakeholders: Investors,

creditors, suppliers, customers, etc.

Type of Detailed plans and continuous Periodic financial statements and

information: performance reports (quick) related disclosures (complete)

Time Focus: Future oriented (mainly ST) Past oriented (but LT)

Time Span: Variable Annual/Quarter/…

Principles: Cost benefit GAAP US, IFRS

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 Definition of Accounting

Accounting is a system for recording information about business

transactions to provide summary statements of a company's financial
position and performance to users who require such information

Three sets of books:

• Financial accounting: Standardized reports for external stakeholders

• Tax accounting: IRS rules for computing taxes payable
• Managerial accounting: Custom reports for internal decision making

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 Who determines the rules?

Generally Accepted Accounting Principles (GAAP) established by:

• The SEC, US government agency
• Financial Accounting Standards Board (FASB) is currently recognized as
the body that formulates GAAP
q Emerging Issues Task Force (EITF)
q American Institute of CPA’s (AICPA)

International Financial Reporting Standards (IFRS) are established

by the IASB, and are required in over 100 countries:
• US GAAP is still required for US firms
• For Introduction to Accounting topics, there is a high degree of overlap in
the two standards

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 A bit of Accounting history…

Our accounting system has a long and distinguished history.

An Italian monk and mathematician named Luca Pacioli, first
published the elements of double-entry bookkeeping system in
1494.

Prior to 1933, the management teams of most companies were

largely free to choose their own financial reporting practices.

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 Generally Accepted Accounting Principles

Securities Act of 1933

Securities and Exchange Act of 1934

The Securities and Exchange Commission (SEC)

has been given broad powers to determine
measurement rules for
financial statements

Contemporary issues – Crowdfunding and the JOBS Act

(Jumpstart our Business Startups)

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 Who is responsible for financial reporting?

Management is responsible for preparing financial statements

• The Audit Committee of the Board of Directors provides oversight of management’s
process
• Auditors are hired by the Board to “express an opinion” about whether the statements
are prepared in conformity with GAAP

Companies incur the cost of preparing the financial statements

and bear the following economic consequences . . .
• Effects on the selling price of stock
• Effects on the amount of bonuses received by managers and other employees
• Loss of competitive information to other companies

The SEC and other regulators take action against the firm for any
violations of GAAP or other rules

Information intermediaries (stock analysts, institutional investors,

the media) may expose or flee firms with questionable accounting
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 Management Responsibility, Auditing, and Ethics

To ensure the accuracy of the company’s financial information,

management:
• Maintains a system of internal and other controls
• Hires outside independent auditors
• Forms a committee of the board of directors to review these two
safeguards

The American Institute of Certified Public Accountants (AICPA)

requires that all members adhere to a professional code of
ethics

A CPA’s reputation for honesty and competence is his/her most

important asset (CPAs have legal liability for malpractice)
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 Financial Reporting Requirements

The Securities and Exchange Commission (SEC) requires

periodic financial statement filings, prepared in accordance with
Generally Accepted Accounting Principles (GAAP):
• 10 – K: Annual report
• 10 – Q: Quarterly report
• 8 – K: Current report (material events)

Periodic filing requirements create much of the “tension” in

financial accounting
• Ship goods to a customer in one quarter, collect cash in the next
q When did the sale occur?
• Buy equipment in one quarter, use it for the next 23 quarters
q When does the expense occur?

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 Factors that Influence Financial Markets

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 Elon Musk

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 Example of Material Events…

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 Covid19 and stock markets

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 VIX Index: the “fear” or uncertainty index

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 VIX Index, August 2021

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 International Perspective
International Financial Reporting Standards

Since 2002, there has been substantial movement towards the

adoption of International Financial Reporting Standards (IFRS)
issued by the International Accounting Standards Board (IASB)

Examples of jurisdictions requiring the use of IFRS include:

• European Union
• United Arab Emirates
• Australia and New Zealand
• Hong Kong, India, Malaysia, and South Korea
• Israel and Turkey
• Brazil and Chile
• Canada and Mexico

In the United States, the Securities and Exchange Commission

now allows foreign companies whose stock is traded in the U.S.
to use IFRS and is considering requiring the use of IFRS for U.S.
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domestic companies...
 What if the numbers are wrong?

http://www.accounting-degree.org/scandals/

After it was determined that the financial statements for Le-Nature’s

were misleading, the consequences for the defendants were severe.

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 Employment in the Accounting Profession

Professional Public Accounting:

ØAudit and Assurance Services
Designations
ØManagement Consulting Services
ØTax Services

CPA
Employment by Organizations (in
CMA the Public and Not-for-Profit
Sector):
CIA ØInternal accounting
ØExternal reporting
ØTax planning
ØVarious other functions

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 Independent Auditors

• Auditors express an opinion as to the fairness of the financial

statements
• Independent auditors have responsibilities that extend to the
general public
• The PCAOB (Public Company Accounting Oversight Board)
issues detailed auditing standards that auditors must follow

• An audit involves . . .
– Examining the financial reports to ensure compliance with GAAP
– Examining the underlying transactions incorporated into the financial
statements
– Expressing an opinion as to the fairness of presentation of financial
information

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 Financial Statements Content

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 Four Basic Financial Statements

• Balance Sheet
– Reports financial position of an accounting entity on a specific date
(listing of resources or assets and obligations or liabilities or stockholders’
equity)

• Income Statement
– Reports the results of operations over a period of time (the accounting
period) using accrual accounting (i.e., recognition tied to business activities)

• Statement of Cash Flows

– Reports sources and uses of cash over a period of time (reports inflows
and outflows of cash, during the accounting period, for operating, investing, and
financing activities)

• Statement of Stockholders’ Equity

– Changes in stockholders’ equity over a period of time (e.g., how net
income and distribution of dividends affected the financial position of the
company during the accounting period)
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 The Accounting Equation

A = L + SE
(Assets) (Liabilities) (Stockholders’
Equity)

Sources of Financing or claims against company’s

Economic Economic Resources
Resources Liabilities: From Creditors
Stockholders’ Equity: From Stockholders

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 The Balance Sheet

Assets Liabilities
Cash Accounts Payable
Assets Accrued Expenses Liabilities
listed by Short-Term Investment listed by
Accounts Receivable Notes Payable
ease maturity
Notes Receivable Taxes Payable
of Unearned Revenue (due date)
conversion Inventory (to be sold)
Supplies Bonds Payable
to cash
Prepaid Expenses
Long-Term
Investments
Equipment Stockholders’ Equity
Buildings Contributed Capital
Land Retained Earnings
Intangibles

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 Balance Sheet

MAXIDRIVE CORP.
Balance Sheet
At December 31, 2010
(in thousands of dollars)

ASSETS
Cash $ 4,895
Accounts receivable 5,714
Inventories 8,517
Plant and equipment 7,154
Land 981
Total assets $ 27,261
LIABILITIES
Accounts payable $ 7,156
Notes payable 9,000
Total liabilities 16,156
STOCKHOLDERS' EQUITY
Contributed capital 2,000
Retained earnings 9,105
Total stockholders' equity 11,105
Total liabilities and stockholders' equity $ 27,261

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 The Income Statement

Revenues
Expenses Sales Revenue
Cost of Goods Sold Fee Revenue
Wages Expense Interest Revenue
Rent Expense Rent Revenue
Interest Expense
Depreciation Expense
Advertising Expense Net Income
Insurance Expense Revenues – Expenses
Repair Expense
Income Tax Expense >0
<0

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 Income Statement

MAXIDRIVE CORP.
Income Statement
For the Year Ended December 31, 2010
(in thousands of dollars)
Revenues
Sales revenue $ 37,436
Total revenues 37,436
Expenses
Cost of goods sold expense 26,980
Selling, general, and administrative expense 3,624
Research and development expense 1,982
Interest expense 450
Total expenses 33,036
Operating income 4,400
Income tax expense 1,100
Net income $ 3,300

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 Statement of Retained Earnings

Beginning Retained Earnings

Plus: Net Income
Less: Dividends
Ending Retained Earnings

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 Statement of Retained Earnings - Example

MAXIDRIVE CORP.
Statement of Retained Earnings
For the Year Ended December 31, 2010
(in thousands of dollars)
Retained earnings, January 1, 2010 $6,805
Net income for 2010 3,300
Dividends for 2010 (1,000)
Retained earnings, December 31, 2010 $9,105

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 Statement of Cash Flows
MAXIDRIVE CORP.
Statement of Cash Flows
For the Year Ended December 31, 2010
(in thousands of dollars)
Operating activities
Cash collected from customers $ 33,563
Cash paid to suppliers and employees (30,854)
Cash paid for interest (450)
Cash paid for taxes (1,190)
Net cash flow from operating activities 1,069
Investing Activities
Cash used to purchase equipment (1,625)
Net cash flow from investing activities (1,625)
Financing Activities
Cash received from bank loan 1,400
Cash dividends paid (1,000)
Net cash provided by financing activities 400
Net increase in cash (156)
Cash at beginning of year 5,051
Cash at end of year $ 4,895
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 Relationships Among the Statements

1. Net income from the income statement results in an

increase in ending retained earnings on the statement of
retained earnings

Income Statement
Revenues $ 37,436 Statement of Retained Earnings
Expenses 34,136 Beginning retained earnings $ 6,805
Net income $ 3,300 Net income 3,300
Dividends (1,000)
Ending retained earnings $ 9,105

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 Relationships Among the Statements

2. Ending retained earnings from the statement of retained

earnings is one of the two components of stockholders’
equity on the balance sheet.

Statement of Retained Earnings Balance Sheet

Beginning retained earnings $ 6,805 Cash $ 4,895
Net income 3,300 Other assets 22,366
Dividends (1,000) Total assets $ 27,261
Ending retained earnings $ 9,105 Liabilities $ 16,156
Contributed Capital 2,000
Retained earnings 9,105
Total liabilities and equity $ 27,261

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 Relationships Among the Statements

3. The change in cash on the statement of cash flows is added

to the beginning-of-year balance in cash to arrive at end-of-
year cash on the balance sheet.

Statement of Cash Flows Balance Sheet

Cash flows from operating activities $ 1,069 Cash $ 4,895
Cash flows from investing activities (1,625) Other assets 22,366
Cash flows from financing activities 400 Total assets $ 27,261
Change in cash $ (156) Liabilities $ 16,156
Beginning cash balance 5,051 Contributed Capital 2,000
Ending cash balance $ 4,895 Retained earnings 9,105
Total liabilities and equity $ 27,261

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 Notes

Notes are integral part of financial statements to understand

company’s financial health

All financial statements should be accompanied by notes

which provide the reader with supplemental information
about the financial condition and results of operations of
the company.

Three types of notes:

- Describing accounting rules on which financial statements are based
- Detail notes on a particular line
- Additional financial disclosure on items not listed on the Balance
Sheet

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 Management Uses of Financial Statements

Marketing managers and credit managers use customers’ financial

statements to decide whether to extend credit

Employees’ union and human resource managers use the company’s

financial statements as a basis for contract negotiations over pay
rates

Purchasing managers use suppliers’ financial statements to decide

whether suppliers have the resources to meet the demand for products

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 Summary of the Financial Statements

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 Using the Balance Sheet equation

• Assets = 200, Liabilities = 100. What is Stockholders’ Equity?

Assets (200) = Liabilities (100) + Stockholders’ Equity (X); X = 100

• Liabilities increase by 200 and Stockholders’ Equity is unchanged. What is the

change in Assets?
Assets (X) = Liabilities (+200) + Stockholders’ Equity (0); X = 200

• All noncash assets = 140, Total Liabilities = 120, Total Stockholders’ Equity = 60.
What is Cash?
Cash (X) + Noncash assets (140) = Liabilities (120) + Stockholders’ Equity (60)
X = 40

• Cash decreases by 20 and noncash Assets increase by 30. What is the change
in Liabilities?
Cash (-20) + Noncash assets (+30) = Liabilities (X) + Stockholders’ Equity (?)
Not enough information

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 Using the Balance Sheet equation - II

• Retained Earnings increase by 200, Dividends = 100. What is Net Income?

Retained Earnings – Prior Retained Earnings = Net Income (X) – Dividends (100)
200 = X – 100
X = 300
• Revenue increases by 200 and all other categories are unchanged, except
Assets. What is the change in Assets?

Assets (X) = Liabilities (0) + Contributed Capital (0) + Prior Retained

Earnings (0) + Revenues (+200) – Expenses (0) – Dividends (0)
X= 200

• Expenses increase by 120 and all other categories are unchanged, except
Cash. What is the change in Cash?

Cash (X) + Non-cash assets (0) = Liabilities (0) + Contributed Capital (0)
+ Prior Retained Earnings (0) + Revenues (0) – Expenses (+120) –
Dividends (0)
X= -120
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 Some extra slides…

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 Types of Business Entities

Sole Proprietorship

- Unincorporated business, owned by one person

- Business and owner (manager) not legally separated

Partnership

- Unincorporated owned by two or more individuals (partners)

- Partners in general partnerships have unlimited liability
- Business and owners not legally separated

Corporation

- Business incorporated under the laws of a particular state

- Owners are called shareholder or stockholders
- Ownership is represented by shares of capital, bought and sold freely
- The corporation and owners are legally separate entities
- Stockholders enjoy limited liability
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 Types of Business Entities - II

Advantages of a Corporation
• Limited liability
• Continuity of life
• Ease of transfer of ownership
• Opportunity to raise large amounts of money

Disadvantage of a Corporation
• Double taxation (once – when profit is produced, and again –
when the dividend is distributed)

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