Moore accounting for financial reporting week db 2

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

for MBAs

Financial
Accounting

Eighth Edition

Module
Introducing
Financial Statements

2

© Cambridge Business Publishers, 2021

Learning Objective

Examine and interpret
a balance sheet.

© Cambridge Business Publishers, 2021

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Balance Sheet Basics

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 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

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 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

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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.

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Apple Inc.
Balance Sheet―Assets

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Current Assets

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 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

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 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

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Measuring Assets

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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

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Liabilities

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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

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Stockholders’ Equity

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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

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Current Liabilities

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 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

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Net Working Capital

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 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

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Operating Cycle

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Companies buy
inventory with cash
and supplier credit

(accounts payable)

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Operating Cycle

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Companies sell
inventory either on
credit (accounts

receivable) or for cash

Operating Cycle

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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

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Cash Conversion Cycle
Apple & 3M

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 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

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 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

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 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

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Stockholders’ Equity
Earned Capital

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 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

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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

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 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

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Market Value vs. Book Value

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Learning Objective

Examine and interpret
an income statement

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Income Statement

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 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)

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Apple’s Income Statement

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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

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 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

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 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

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Revenue Recognition Principle

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 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

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 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

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 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.

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Common Size Income Statement

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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

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 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.

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Apple’s Liabilities and Equity

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Statement of Stockholders’ Equity

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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

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Learning Objective

Describe a statement of cash flows.

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Statement of Cash Flows

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 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

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 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

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Apple’s Statement of Cash Flows

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AKA: Total cash flow

Learning Objective

Construct and apply linkages
among the four financial
statements.

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Financial Statement Linkages

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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

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Financial Statement Linkages

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Learning Objective

Locate and use additional
financial information
from public sources.

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Additional SEC Information

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 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

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Other Information Sources

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 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

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 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