ACCT 2610 Lecture 3: Financial Statements

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Washington University in St. Louis
Accounting ACCT 2610
Lemayian Zawadi

Lectures 1-3: The Financial Statements I. Intro to Accounting A. Basics 1. What is accounting? a. A system that collects and processes financial info about an organization and reports that info to decision makers 2. History a. 1494: Italian monk Luca Pacioli published the first elements of double-entry book keeping (I get a $, someone else loses a $), after this accounting grows b. ~1900: Industrial revolution c. 1929: Stock Market Crash, reactionary Bluesky laws to have some initial regulation d. 1934: The Security and Exchange Act of 1934: creation of the SEC e. 1973: Financial Accounting and Standards Board (FASB) created to make standards, SEC delegated authority for rules to FASB f. 1973: Generally Accepted Accounting Principles (GAAP), all public companies must follow, put out by the FASB g. Post-2012: internationalization, before each country had own standards, but international standards now playing a role 3. Accounting a. Financial accounting: info for external decision makers b. Managerial accounting: info for internal decision makers 4. Lots of Acronyms a. CPA = certified professional accountant b. Big 4 (top 4 acct firms) = PWC, E&Y, Delloite, KPMG c. SOX = serbanes-oxley act d. IASB = international accounting standards board e. IFRS = international financial reporting standards f. Dr. (debit) and Cr. (credit) 5. Financial Accounting a. Purpose is to identify, record, report, and analyze economic transactions to provide useful information so that interested parties can make informed decisions b. Not all acct info is reliable and useful 6. Who uses financial accounting? a. Managers (CEOs, CFOs) to gauge company, to report to others about firm b. Investors to measure risk/return profile to see if investment works for them c. Creditors to see if a company can pay back (liquidity of borrowing party) d. Suppliers to make sure to get paid back, to determine quantity to supply e. Government for firms to comply with standards, think IRS and taxes (of income etc) 7. Current Topics in Accounting a. Fair value (quality and circumstance in account if in market today) vs. historical cost accounting (what you paid/transaction) b. IFRS vs. GAAP • Lots of political roadblocks on both sides and both sides think their own system is superior • Main difference is that IFRS is more principle based, GAAP is more specific with transactions B. Creating a Company 1. Why? a. A company is created to provide a service or product to other individuals for monetary compensation b. This service or product provides value to those consuming it 2. How can individuals raise capital (money) to start a company? a. Those who generate the idea can contribute money • Pros: keep all business, not accountable to anyone, own vision • Cons: stakes are higher, less security, less ideas to check, fewer resources b. Investors outside the company can purchase ownership of the company • Pros: a lot more capital opportunities, grow faster • Cons: investors have more say, cede some control of company, tension in visions, potential signaling problems (ie if investors pull out), share the money you make in the end c. Borrow money from banks or other individuals • Pros: not giving up equity, access to funds, no cession of control, can pay back later • Cons: collateral and risk with contracts, interest on loans, principal and interest payments (cost of borrowing) 3. When the company is running, how do the individuals raise capital to grow the company? a. Use the profits generated by the company’s operations (reinvesting profits) b. All other options above are also available • Also selling stock, borrowing from public or bank • More credible once established paper trail and may be easier to secure capital 4. Company owners a. The company owners (investors, stockholders, or shareholders) look for two sources of possible gain b. (1) sell ownership interest in the future for more than they paid c. (2) receive a portion of the company’s earnings in cash (dividends) 5. Creditors a. A creditor lends money to a company for a specific length of time and gains by charging interest on the money loaned b. Ex: Bank gives loan, lender must pay back principal (original loan amount) + interest 6. Role of Financial Accounting a. Accounting systems collect and process financial information about the company’s sales, purchases, and salaries b. Then report info to decision makers and monitoring agencies • Includes creditors and suppliers, investors and shareholders, company managers (internal), and government c. To provide useful info to decision makers so they can make informed decisions • Must understand the underlying economic business transactions of the company d. What would we need to understand? • What are company’s credit terms with its suppliers? • How do customers pay for goods? On credit or with cash? • How did the company raise funds to purchase or lease the facilities? • How much is the equipment and facilities worn down over a year? • Are employees full-time or part-time? Are they paid hourly or salary? II. Financial Statements A. Basics 1. All publicly traded companies must prepare financial statements and provide them to the SEC a. Financial statements are typically prepared at the end of each quarter and year b. Private companies don’t have to prepare financial statements unless required by shareholders or creditors 2. 4 basic financial statements a. Balance sheet: reports the economic resources firm owns and sources of financing for those resources • Assets (economic resources) = Liabilities (L) + Stockholder’s Equity (SE) • L + SE = sources of financing • Liabilities are the company’s debts or obligations • SE is the amount of financing provided by owners of the business and earnings b. Income statement: tracks profitability (revenues less expenses) of the accounting period • Revenues are recognized in the period in which goods and services are provided, not necessarily in the period the cash is received • An expense is recognized in the period in which goods and services are provided or when revenue is earned, not necessarily the period cash is paid • Expense
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