ACCOUNTING 1

Assets

*first shown on the balance sheet *things helping the firm to generate money *Cash: calculating how much cash I have at the end of the year -Accounts -Receivable Notes -Receivable Inventory (to be sold) -Supplies -Prepaid Expenses -Long-Term Investments Equipment -Buildings -Land -Intangibles *represent investing activities of the firm

Elements of the Income Statement

* Revenues: Increases in assets or settlement of liabilities from ongoing operations. [amount of money firm makes by selling products/services] * Expenses: Decreases in assets or increases in liabilities from ongoing operations. [costs incurred to generate revenues] -Revenues and expenses are an integral part of the ongoing operations of the business. [= are generated from operating activities] * Gains: Increases in assets or settlement of liabilities from peripheral transactions. [amount of money firm receives from incidental transactions] * Losses: Decreases in assets or increases in assets or settlement of liabilities from peripheral transactions. [amount of money firm loses from incidental transactions] -Gains and losses are only incidental to the operations of the business. -incidental/peripheral transactions: are not part of integral operations/main business of the firm *Structure: oincludes firm's name, FS title, the time period and monetary unit for reporting ofirst: revenues and expenses for operating activities -always start with revenues [first line always!] -then report different costs and expenses incurred due to operating activities ooperating income: revenues - expenses [net amount of money the firm makes from operating activities] osecond: other gains and losses [peripheral activities] -investment income: money made by investing in other firms [revenues from other companies] -interest expense: money borrowed from bank and so the interest must be paid by the firm [outflow of money from the firm] -net income: income before income taxes - income tax expense oborrowing = loss, not an expense -it's an outflow of money from the firm -expense isn't an outflow

Revenue Recognition Principle

*A company must recognize revenue: -when the company transfers promised goods/services to customers -in the amount it expects to be entitled to receive *Example: Face mask business · you're selling face masks to customers · Accrual Accounting: when you sell these masks, you get the revenues and they are recorded · the revenues are received either before or after the delivery [3 different scenarios] - might be at different times · there's a mismatch between the moment the revenue is generated and when it's recorded, that's why we're using AA · the revenue must be recorded in the amount it expects to be entitled to receive -> total amount of money expected to receive is the total amount of revenue generated *Scenario 1: If cash is received before the company delivers goods or services, the liability account UNEARNED REVENUE is recorded. •cash received before the product is delivered to the customer •we need to create the liability account called UNEARNED REVENUE owhy is it a liability account? it's an obligation of the firm to deliver these products to the customers in the future ocash received and company delivery have different timelines • on the day the cash is received, the journal entry needs to be debit cash because the firm already received the cash and the unearned revenue needs to be credit cash, which shows the firm needs to deliver these products in the future • when the firm delivers the product/services, unearned revenue account is not there anymore cause it's delivered the product already -> how to get rid of this account? -> on the day of delivery, the revenue is recorded [increase in the revenue] and the unearned revenue decreases • revenue and unearned revenue offset each other • delivery = recording the revenue *Scenario 2: If cash is received on the date the revenue is earned=the delivery happens, the following entry is made [simplest scenario]: •debit cash because the cash has increased = firm increases its cash •credit revenue because the firm has earned its revenue orevenue has its credit balance *Scenario 3: If cash is received after the company delivers goods or services, an asset ACCOUNTS RECEIVABLE is recorded • cash received after the delivery happens • mismatch in the timeline • the revenue is earned • remember: revenues are credited when we have increases in revenue but otoh when the cash is not received, we don't have anything to record on the assets increase even tho the firm has earned something but the actual cash cannot be recorded • so the accounts receivable is created to show the amount that will be received in the future, not yet = it's an asset account because it represents resources received in the future but they cannot be touched yet • on the day when the cash is received, 2 things happen: o cash will increase -> cash is debited [=increase in assets] o cash has been received by the firm so the accounts receivables are decreased -> AR are credited [=decrease in assets] • Assets reflecting revenues earned but not yet received in cash include [examples of 3rd scenario]:

Journal Entry

*A journal is a detailed account that records all the financial transactions of a business. *A journal states: • the date of a transaction, [when it happened] • which accounts were affected, • the monetary amounts of the effects *Usually all these recordings are recorded by a double-entry bookkeeping method *Structure 1) reference 2) account titles: debited accounts on top, credited on bottom 3) debited amounts on the left, credited amounts on the right

Double-entry book-keeping method

*Double-entry book-keeping is the technique used to record a business' transactions and their effects; is an artificial system invented by accountants *It shows the duality concept of accounting: every transaction has AT LEAST 2 effects on the firm's account (money coming from somewhere and going somewhere else) •Reminder: Every transactions affects the accounting records more than once. •In a closed financial system, money can not just come from or disappear to nowhere. If money is received by someone, it must have come from someone. *It is done through debit and credit system - debit & credit always have to move in opposite directions

Trial Balance

*The trial balance is a listing of the ending balance in each account in the general ledger. *List accounts in financial statement order (assets, liabilities, stockholders' equity, revenues and expenses). *The purpose of the trial balance is to make sure the debits and credits are equal (accounting equation holds) •A = L + SE •Dr = Cr o we do keep the double-entry book keeping system (debit & credit) o we put every account in it and then record the ending balance of this account o if the accounting equation holds, all the debit and all the credit should be equal -> otherwise, a mistake has been made

Notes in the financial statement

*an integral part of these financial statements *All financial statements should be accompanied by notes that provide the reader with explanatory and supplemental information to help the reader better understand the financial statements. *are VERY DETAILED *The notes are also called footnotes.

Account

*an organized format used by companies to accumulate the dollar effects of transactions. -different transactions affect different accounts, including notes payable, cash, inventory, equipment -in the process of accounting, we use accounts to help us organize information about various transactions. -These transactions can be both external and internal.

Statement of Stockholders' Equity

*reports the change in each stockholders' equity account during the period. *structure: beginning balance + increases - decreases = ending balance

Receivables

*represent amounts owed by (receivable from) customers and others to the business *always assets

Payables

*represent amounts owed by the company to be paid to others in the future *always liabilities

Prepaid Expenses

*represent amounts paid in advance by the company to others for future benefits, such as future insurance coverage, rental of property or advertising *always assets

Unearned

*represent amounts paid in the past to the company by others who expect future goods/services from the company *always liabilities

The Asset Section of the Classified Balance Sheet

*starts with the name of the company and title of the particular financial statement (ex: balance sheet) *always states the unit of monetary measurement •can be in millions (usually) *LHS: all the basic accounts the firm has as assets •important: it's always arranged into 2 basic categories: current assets (what we hope to own in the next year) and non-current ones (what we hope to own in more than next year) *you must list the account balance for more than a year so that investors can compare the balance sheet info of the firm from a historical point of view

Direction of Transaction Effects (debiting & crediting)

*the left side of the T-account is always the debit side *the right side of the T-account is always the credit side

Key Ratio Analysis

- Financial Leverage Retio = average total assets/ average SE *tells us how well management is using debt to increase assets the company employs to earn income · average: what we have from last year and at the end of this year and then taking an average value out of it - A=L+SE once again · the firm engages into investing activities so it receives money either from stakeholders (SE)=owners=invest in the firm in the firm increases in stock price / or debtholders (L) o they are different money o shareholders don't have to be repaid, they just sell the stocks o liabilities for debtholders = money borrowed from them = money need to be repaid -> firm has to be sure to repay those money in the future o if a company has a lot of debt in comparison to SE, we say it's highly levered (has a high leverage=firm is more risky as has to repay all debt in the future) · and then the firm uses all the money it receives to invest in assets

GAAP: International Perspective

- one GAAP = IFRS (Int. Financial Reporting Standards) established by a movement (don't remember the name) for many countries across the world -> make the FS as much comparable as possible - Examples of jurisdictions requiring the use of IFRS: · the European Union · Australia and New Zealand · Hong Kong, Malaysia, and Republic of Korea · Israel and Turkey · Brazil and Chile · Canada and Mexico · China - In the U.S., the SEC now allows foreign companies whose stock is traded in the United States to use IFRS.

Corporate Social Responsibility

-Business practices that incorporate sustainability into a company's business model to generate positive impacts on society, environment, and other various stakeholders of the business [wider group of stakeholders] (Schooley, 2019). · it's very different from Friedman's shareholder's responsibility -Integration of social and environmental concerns in their business operations and interactions with their stakeholders (Commission of the European Communities, 2001).

GAAP: Why do we need it?

-Effective communication means that the recipient understands what the sender intends to convey -> Consistent accounting measurement and communication rules (to assess companies can be compared based on the same determinants, investors can better understand info and decide between investing in different companies) -Firms need to ensure that information are USEFUL -> people who are reading FS and who are decision-makers, can actually use these information

Accounting Equation

-Every transaction affects at least two accounts (duality of effects). -The accounting equation must remain in balance after each transaction. -Assets = Liabilities + Stockholder's Equity -> why? the firm receives money by financing itself and then uses this money to invest in assets (the money comes from somewhere and goes somewhere) • Assets: Economic resources with probable future benefits owned or controlled by the entity. (what the business owNs) • Liabilities: Debts or obligations (claims to a company's resources) that result from a company's past transactions and will be paid with assets or services. Entities that a company owes money to are called creditors. (what the business owEs) • Stockholder's Equity: The financing provided by the owners and the operations of the business. = way of financing itself (what the business owEs) *money from investors and creditors and then is used to purchase assets (the money comes from somewhere and goes somewhere)

Duality of effects

-Most transactions with external parties involve an exchange where the business entity gives up something but receives something in return. *ex: you sell me face masks (giving up inventory), I give you cash *you give up some assets, but receive some assets *duality effect: increase and decrease *in effect, every transaction affects at least two accountsB

GAAP: How are they determined?

-Our accounting system has a long and distinguished history. An Italian monk named Luca Pacioli, published the first elements of double-entry bookkeeping in 1494. • represents the accounting system we use now around the world -Prior to 1933, the management teams of most companies were free to choose the accounting principles used to keep track of its transactions.

Balancing the Accounting Equation

-The accounting equation must remain in balance after each transaction. -Step 1: Ask - What was received and what was given? (reference: duality effect) · Identify each account affected by title (e.g., Cash and Notes Payable -> check what type of account was affected). o Make sure at least two accounts change. (due to duality effect) · Afterwards, classify each account by type: Asset (A), Liability (L), or Stockholders' Equity (SE) o (e.g. Cash is an asset and Notes Payable is a liability). · Determine the direction of the effect: The account increased (+) or decreased (−) o (e.g. Cash increased and Notes Payable increased). -Step 2: Verify - Is the accounting equation in balance? (A = L + SE) · if yes, your answer is correct

Business Activities

1) operating activities: the day-to-day operations of the business, such as purchasing materials from suppliers, delivering products and services to customers, collecting cash from customers, etc. 2) financing activities: borrowing/paying back money to lenders and receiving additional funds from stockholders or paying them dividends; needed to provide money for the business 3) investing activities: buying/selling items such as plant and equipment = helps to generate the future profit * the activities are all connected: the business of face masks - you borrow money from someone or someone buys shares in my firm - you use these money to invest in assets (e.g. machines producing face masks) - you use the machine and sell those masks to customers, making profit

The operating cycle [cash-to-cash cycle]

1) purchase goods and services used to produce their products [raw materials] on credit from suppliers 2) pay cash to suppliers 3) sell goods and services to customers 4) receive cash from customers Using the cash received to buy more raw materials from suppliers •Going on & on... *Operating activities: The activities of a business that are directly related to providing its goods and/or services to the market. -These are the company's core business activities, such as manufacturing, distributing, marketing, and selling a product or service. *Assumption: transaction is cash-based *This cycle describes basic operating activities of the firm -> will be reflected in the firm's income statement using the accounting system oMost successful firms operate for a long period of time, while managers and investors need financial information on a timely basis. *it's a cycle: so how can we break things up? firms must publish their statements at the end of accounting period -> and therefore reporting needs to be on periodic basis

Accounting Cycle

1. During the period: -analyze transactions -record journal entries in the general journal -post amounts to the general ledger 2. End of the Period: -prepare a trial balance (check if debits = credits) -adjust revenues and expenses and related balance sheet accounts (record in journal and post to ledge) -prepare a complete set of financial statements. Disseminate statements to users. -close revenues, gains, expenses and losses to retained earnings.

2 accounting systems

1. managerial accounting reports -detailed plans & continuous performance reports -for internal decision makers who run the company 2. financial accounting reports -periodic financial statements & related disclosures -for external decision makers [creditors/investors] who evaluate the company

Daily activities of a business

1. purchase parts & labor 2. manufacture products 3. sell products to customers 4. collect cash from customers and pay creditors

Common Stock

Amounts invested in the business by stockholders. *beginning common stock + stock issuance = ending common stock *stock's intangible, but is just a construct *let's assume u have a firm and wanna take it public -> to do that, you need to have money -> if I wanna become a stakeholder, I invest some money in your firm = equity is what I invest in it to have some shares *stock=share=equity -> amount invested by stockholders in the firm

Expanded Transaction Analysis Model

Assets = Liabilities + SE Retained Earnings within the SE = Revenues - Expenses § shows the link between the balance sheet and income statement § ASSETS = LIABILITIES + SHAREHOLDERS' EQUITY § the accounting equation already showed how it can reflect the basic elements in the balance sheet § you put the income statement into the accounting equation through retained earninigs by making the retained earnings = revenues - expenses § retained earnings: all earnings [wealth] the firm has accumulated during the history of its operations [ex: firm being in operations for 3 years, earning 100 in 1st year, 50 in 2nd year and -50 in 3rd year, the retained earnings is 100] · losses are included! § SE has a credit balance because it represents the sources of a firm's money; every part of SE also has a credit balance · ex: retained earnings o if we have increase in RE, we need to credit this account o if we have decrease in RE, we need to debit this account · if we hold expenses constant, then increase in revenues would mean increase in RE because the firm makes more money o so increase in revenues should be credited to revenues account · if we hold revenues constant, then increase in expenses means the firm's making fewer profits o do there is a decrease in RE o the account is debited

Expanded Accounting Equation

Assets = Liabilities + SE [that includes contributed capital and retained earnings] *shows how the equity part is changing based on the operating activities of the year and, if we have dividends, also financing activities

How to communicate all the steps to the outsider of the firm as an employer?

by accounting!

different financial statements if company operates in different countries?

depends on where the company is listed -> ex: Apple is US company and so only prepares the financial statement in English for US audience -> everyone investing in Apple, needs to understand US financial market

Is caring for society at the expense of profit?

o From a short-term perspective, it can be. Investments in CSR can incur high expenses, which hurt short-term earnings. o From a long-term perspective, not necessarily. Investments in CSR can make a firm and the society more sustainable, and support long-terms future growth.

Stakeholders

o Members of "groups without whose support the organization would cease to exist" (Bowie, 1988, 112) § include shareholders [provide capital for the firm to exist] + other entitites § ex: suppliers, employees, customers § don't have to own the firm

Cost of Goods Sold

the amount of money a firm spent to buy or produce the products it sold during the period to which the income statement applies *always expense

Retained Earnings

Past earnings generated by the firm and not distributed to stockholders/anyone -> those money stay in the firm and become part of SH's wealth even tho the money is not with the stakeholder, but with the firm o change during the period o dividend: way to repay their shareholders for their investment o part of dividend comes from retained earnings o it's an actual cash coming into hand of stakeholders o beginning retained earnings + net income - dividends declared = ending retained earnings *dividends decrease RE *net income increases RE

Expenses

Resources used to earn period's revenues; money that needs to be paid to generate these revenues oExamples: -Cost of Goods Sold -Wages Expense -Rent Expense -Depreciation Expense -Insurance Expense -Repair Expense -Income Tax Expense

T-account

Structure: - starts with a beginning balance - uses the same reference as in the journal entry -draw a line when you're ready to compute the ending balance -put the ending balance amount on the side of the T-account that it represents · one way to arrange the effects of transactions by different types of account · it's designed to show the double entry book keeping system o debit on the left, credit on the right · beg. balance: where the firm starts (here: 186) · (a): whatever effect the cash account has during a year (here: 300) -> this specific transaction (a) is increasing the cash balance of the firm · end. balance: how many cash the firm has at the end of the year · increase in cash would be debit (+) · decrease in cash would be credit (-) all of it shows up on the balance sheet

BALANCE SHEET

a financial snapshot of a business at a specific point in time; used to show the detailed movements of the share to shareholders *includes assets, liabilities, shareholders' equity *structure: assets = liabilities + stockholders' equity

Income statement

a measure of performance of the business = how much income it generated; linked to operating activities closely (producing products=making expenses and after producing products, selling products=generating revenues) *structure: revenues - expenses = net income

Stockholders' Equity

a) Contributed Capital Account -Common Stock -Additional Paid-in Capital b) Retained Earnings *represent financing activities of the firm

External Events - business transactions

exchanges of assets and liabilities between the business and one or more other parties · ex: firm borrows cash from a bank · ex: selling a land/equipment of a firm in return for money

Liabilities

future obligations the firm needs to repay -Accounts Payable -Accrued Expenses -Notes Payable -Taxes Payable -Unearned Revenue -Bonds Payable *represent financing activities of the firm

Internal events - business transactions

not an exchange between the business and other parties but have a direct effect on the accounting entity. · ex: loss due to fire damage

If CSR is so good, why don't all companies (fully) pursue it?

o Because it costs money § when sb runs a business, they want the benefit to be bigger than the cost, otherwise economically it's stupid § if the cost of engaging in CSR > benefit from it, the people treat is as a bad investment § costs a lot at the beginning stage o Because managers want to pursue high earnings, and can be short-sighted. § managers are compensated on the financial basis: if the company performs well, they can receive more bonuses and higher salaries § so many managers don't care about CSR because it's not related to their personal interest § ex: in the US firms need to report quarterly financial performance, in Europe interim (6 months) financial performance · within this time, the firms need to show investors how they've been making money or how they reduce loss compared to previous periods · if firms invest in CSR, it's gonna show up at firm's financial statement at a really big cost and the revenues coming out of it only in a longer time [returns will be received only after 5, 10 years] -> the benefit from CSR could take too long for the firm to be able to finally see it, such as building trust from customers for example · benefits that may be caused by CSR are neither quantitative nor can be directly reflected on accounts, which generates risks or uncertainty o Because some do not believe climate change is real. § or people just don't care

Why study accounting?

o Corporations are not the only organizations that uses accounting. o NGOs use accounting to communicate their financials: - Human Rights Watch financials - Human Rights Watch 2019 financial statements o Governments use accounting to communicate financials: - State of New York 2019 annual report o Accounting knowledge is also useful for personal life: watch this. o Employment in Accounting Profession: Career Opportunities - Public Accounting · Audit or Assurance Services · Management Consulting or Advisory Services · Tax Services - Employment by Organizations · Internal Accounting · External Reporting · Tax Planning - Various Other Functions · Employment in the Public and Not-for-Profit Sector · Not-for-Profit hospitals and universities · Government agencies and financial market regulators

GAAP: Rules that Determine Content of Financial Statements -generally accepted accounting principles

o Decision makers need to understand the measurement rules applied in computing the numbers on the financial statements. - rules telling people what FS should look like: what's the format, content, structure etc

Purpose and responsibility of corporations: Stakeholder Theory by Edward Freeman

o Proposed by Edward Freeman in the 1980s. § Friedman was in 1970s o A view of capitalism that stresses the interconnected relationships between a business and its customers, suppliers, employees, investors, communities and others who have a stake in the organization. § Shareholders are merely one of many stakeholders of a company. o A firm should create value for all stakeholders, not just shareholders. o Examples: § Customers: They buy products. Companies need to ensure the quality and safety of products. [their responsibility] § Employees: They engage in company operations. Companies need to protect employees' rights. § Society and community: Companies exist in the society and local communities. § The environment: Company operations can have impacts on the environment. ...... And other stakeholders depending on the nature of the company.

Expense recognition principle (matching principle)

o Resources consumed to earn revenues in an accounting period should be recorded in that period, regardless of when cash is paid. - we match expenses used to generate revenues with the same income statements - this is a part of Accrual Accounting: regardless of when cash is paid [record expense when it happens] -regardless of when rescources are used, the money the firm spends to purchase these recources can happen before/after/at the same time when this happens -3 scenarios exist once again o1st scenario: If cash is paid before the company receives goods or services, an asset account, PREPAID EXPENSE is recorded. -we create an asset account called PREPAID EXPENSE -we need to reduce cash account [credit it] and we need to increase the account PE [debit it] because the firm already paid the cash but not received anything from the supplier -the account shows the firm will receive these resources in the future -some day in the future, the expense will be incurred and when this happens the pre-paid expense needs to be reduced [credited; prepaid expenses go down] and actual expenses need to be recorded [debited; actual expense goes up] -> meaning expense has the debit balance -the opposite of what we've been doing with revenue o 2nd scenario: If cash is paid on the date the expense is incurred, the following entry is made [simplest scenario]: - increase in expense [debit the expense account] - decrease in cash because the firm pays cash at the same time [credit the cash account] o 3rd scenario: If cash is paid after the company receives goods or services from a supplier, a liability PAYABLE is recorded - the company has to pay the company in the future, implying an obligation = we need to create a liability account called PAYABLE - expense has been already incurred so the expense account needs to be debited to show the increase - the obligation is recorded by crediting the payable [decreasing its amount] - it's the opposite of the first scenario - the firm pays the cash at some point in the future so we will have to eliminate the payable account: when the cash is paid the payable is reduced -> the payable account is debited [decreases] but we don't do anything with the expense account because it has been already done at the point in the past when the expense was incurred; the cash is credited

Accrual Basis Accounting

o Revenues and expenses are recognized when the transaction that causes them occurs, not necessarily when cash is paid or received. § associates revenues/expense transactions with specific time periods when they occured o Revenues are recognized when they are earned and expenses are recognized when they are incurred to generate revenues. o If you look at financial reports of public firms, they all use Accrual Accounting because it is required by Generally Acceptable Accounting Principles (GAAP)

Cash Basis Accounting

o Revenues is recorded only when cash from customers is received. o Expenses are recorded when cash is paid for the suppliers. o The cash basis may be adequate for organizations that do not need to report to external users, such as small businesses -> it doesn't accurately portray the operations of the firms § example: people buy and sell things for credit, revenues should be recorded but they don't receive the cash right away [people don't see it as a liability, they only see when the cash is received] § recognition problem o Cash basis accounting may lead to an incorrect interpretation of future company performance.GAAP does not allow the cash basis of accounting.

Financial Statement Time Period & Structure

o The four basic financial statements can be prepared at any point in time such as: - End of the year (for the year ended, annual reports) - Quarterly (for the quarter ended, quarterly reports) · ex: in the US - Monthly (for the month ended, monthly reports) · if firms have energy and resources - Half-year (interim financial statements) · ex: in the European companies o The financial statement heading includes: - Name of the entity (Company name) - Title of the statement (e.g., Balance Sheet) - Specific date of the statement (e.g., at December 31, 2018) - Unit of measure (in millions of dollars) • for public firms: typically, millions

Why do companies care about CSR?

o To change the world (for the better) [some firms REALLY care] § CSR is rooted in (some) companies' primary goal/mission/vision. § For example, Tesla: It's not all about making money by selling cars. § Elon Musk states many times that his goal is to change the world - renewable energy, making the human race a multi-planetary species, etc. § Tesla invests heavily into research (which burns a lot of cash) to push the progress of their products. only last year, the firm started to make real profit for shareholders o Reputation § CSR is an essential part of corporate reputation. [better opinion of firms with CSR program] marketing-related o Brand differentiation § marketing-related; consumers differentiate based on the CSR program § CSR is a battlefield to claim market share § Ex: The non-stopping "war(s)" between Coca-Cola & PepsiCo · Originally: The taste war. · Apparently, no one is really winning or losing this war · These two companies keep finding new ways ("fighting new wars") to differentiate from the other, including: o The CSR/sustainability/green "war" o Improving financial performance § Doing well by doing good: CSR activities improve firm financial performance. § that's something managers and investors really care about § firms engaging in more CSR program have better financial performance during the crisis periods because they have more trust from the public and investors, more social capital § better financial performance = more profits = more investors = more money -> extra money can be used for additional CSR activities that will generate additional money in the future · doing well by doing good is a never-ending cycle

The operating cycle - time period assumption

o To provide timely information, accountants divide the life of the business into relatively short, arbitrary time periods. o Time Period Assumption: The long life of a company can be reported over a series of shorter time periods [accounting periods] § the assumption established by the accountant to divide the life of the business into time periods. o Two issues arise when reporting periodic income [preparing the statement] - when and how much: § Recognition Issue · When should the effects of operating activities be recognized (recorded)? § Measurement Issues: · What monetary amounts should be recognized on the firm's accounts? · it's not about the unit, but about the AMOUNT of money recognized

The Liabilities & SE Section of the Classified Balance Sheet

o also must include current and non-current liabilities -> if liabilities have to be repaid within 1 year = current, otherwise non-current o current/non-current system doesn't apply for stockholder's equity because SE of the firm are more or less just WEALTH of the firm (the firm just holds on to it) o SE we separate by: o common stock -> contributed capital -> short and long term o special stocks -> retained earnings (all historical losses and gains of the firm) -> not divided into long and short term o dividends payable -> missing in the year before (-) o this can happen for some special account o the firm can choose whether its paying a dividend in a specific year or not o dividens payable: dividend that is TO BE paid but the firm hasn't paid it yet o missing value = the firm didn't decide to pay dividends o Note: the asset section and the liabilities sections' totals are equal because A=L+SE

salaries and benefits to employees expenses

o expenses related to providing salaries to employees o part of operating activities becaue the firm cannot operate without their employees

Revenues

o future and potential cash and promises received from delivery of goods and services o Examples: -Sales Revenue -Fee Revenue -Interest Revenue -Rent Revenue

What can investors do to promote CSR? Social responsibility from an investment perspective: Social investing

o in many places in the world, CSR is not directly required but voluntarily provided by the companies - why? o answer: it's social investing, meaning that some investors demand CSR information o Responsible Investment § Responsible investment refers to investments that include some consideration of environmental, social and governance (ESG) factors, with the expectation of some financial returns. § in the financial market investors use these 3 ESG factors to assess the sustainability and social impact of an investment o ESG investing in practice: Investing in corporate diversity § ex: Refinitiv announces the 2019 D&I Index Top 100 most diverse & inclusive organizations globally · currently, the no. of indexes of this sort is growing o ESG investing in practice: Investing in the environment § ex: US Vegan Climate Index - addresses the concerns of vegans, animal lovers, and environmentalists by avoiding investments in companies whose activities contribute to animal suffering, destruction of natural environment, and climate change

Statement of Cash Flows

o reports inflows and outflows of cash during the accounting period (flows from all 3 types of activities reported!) -expenses/revenues vs. cash inflows/outflows o Analyze cash flow from operations in order to check the following: -Ability to repay creditors -Opportunity for expansion -Ability to distribute cash dividends oIs super important for creditors -> they need to know if the firm has the cash to pay them back -> a firm must generate enough cash to repay its debts *structure: o+/- Cash Flows from Operating Activities (CFO) o+/- Cash Flows from Investing Activities (CFI) o+/- Cash Flows from Financing Activities (CFF) = change in cash

cost of sales expenses

o very common o expenses related to selling raw food, materials to produce franchise etc.

Basic Financial Statements

oBALANCE SHEET - reports the financial position (amount of assets, liabilities, and stockholders' equity) of an accounting entity at a point in time. oINCOME STATEMENT - reports the revenues less the expenses during the accounting period. -reports income and how it is generated oSTATEMENT OF STOCKHOLDERS' EQUITY - reports the changes in each of the company's stockholders'(=owners) equity accounts, including the change in the retained earnings balance caused by net income and dividends, during the reporting period. -ex: how much new shares the firm issued during the accounting period; what's the change in earnings oSTATEMENT OF CASH FLOWS - reports inflows and outflows of cash during the accounting period in the categories of operating, investing, and financing. •The notes are an integral part of these financial statements. - notes explain the financial statement and need to be included in it

Operating Expenses

outflows or the using up of assets or increases in liabilities from ongoing operations incurred to generate revenues during the period *expenditure = outflows of cash for any purpose [debt payments, assets purchases, expenses] =/ expense not all cash expenditures are expenses!! *expenses are specific; expenditures are more of a general umbrella term

Investors

people buying shares in the firm, consequently becoming owners of the firm; shareholders/stockholders; people involved in financing activities

Creditors

people who lent money to the business; e.g. banks, individuals who buy corporate bonds; people involved in financing activities

Operating Revenues

revenues generates by the major operations of the business: the sale of goods/rendering of services as the central focus of the business

depreciation

shows how firm is losing value

what is accounting?

the language of business; way of communication among business parties; financial accounting speaks mainly to external info users

Transaction Analysis

things to consider acc. to revenues & expenses recognition principles: § Step 1: Ask → Was a revenue earned by delivering goods or services? · If so, credit the revenue account and debit the appropriate accounts for what was received. [revenue has to be recorded] § or Ask → Was an expense incurred to generate a revenue in the current period? [matching principle] · If so, debit the expense account and credit the appropriate accounts for what was given. · if you have a revenue, there must be an expense to generate this revenue § or Ask → If no revenue was earned or expense incurred, what was received and given? · Identify the accounts affected by title (e.g., Cash and Notes Payable). Remember: Make sure that at least two accounts change. · Classify them by type of account: asset (A), liability (L), stockholders' equity (SE), revenue/gain (R), or expense/loss (E). · Determine the direction of the effect. Did the account increase (+) or decrease (−)? § Step 2: Verify → Is the accounting equation in balance? (A = L + SE)

How do companies keep track of account balances?

through: -Journal entries (more important: if you know how to do it, you know how to do T-accounts) -T-accounts *general journal: a gigantic list of transactions daily *then this list is put into either GL or T-accounts *and so here we move from transaction to account level

Debit & Credit

§ A bit of history: · Double entry and the DR & CR concepts were created by Venetian merchants in the 15th century. · Luca Pacilio, an Italian mathematician (AKA the father of accounting), documented this accounting system in a book, which was written in Latin. · Decere: to owe (debit) · Credre: to entruste (credit) (Assets are owed to the owners of the company. The owners' equity is entrusted to the company.) o shareholder's equity has a credit balance o assets has a debit balance § Debit & Credit are English terms that translated from Latin. DR & CR do NOT simply indicate "increase & decrease" or "plus & minus". § Since 15th century, English has evolved dramatically. The terms debit and credit have developed various meanings other than the original ones coined by Luca Pacilio. § The meanings of DR & CR in accounting are unique to accounting: DR on the left-hand side; CR on the right-hand side. § To help you understand DR & CR in accounting:Do not link these terms to their other meanings in everyday English (e.g. debit/credit card). § DR & CR are a recording system that ensures the accounting equation (i.e. Assets = liabilities + Equity) holds. · "Debit" the destination/use of money. o receiving money from SH/bank -> investing them into assets to generate future revenues o those assets represent the destination/use of money o and we debit these assets=destinations · "Credit" the source of money. o invest the money o possible sources of money: investments from SH/loans from bank o liabilities/equity=sources of the money § DR on the left-hand side; CR on the right-hand side. § 1st step: Remember the basics: · Assets increase: DR (because assets are on the left-hand side) o if we debit the destination, it means the assets have a debit balance (Assets up:DR) o so when assets increase, we debit the balance account o in the DBS, assets is on the left in the equation but also debit is always on the left (skojarz to) · Liabilities / Equity increase : CR (because they are on the right- hand side) § 2nd step: Understand the others · Revenues increase : CR (because revenues lead to increase in equity) · Expenses increase: DR (because expenses lead to decreasein revenues) • the accounting equation always balances -> accountants develop debit and credit system to understand how it balances • assets have a debit balance, L or SE have credit balance

Corporate CSR disclosure

§ A company's systematic disclosure of information on its social performance in a systematic manner § The term social performance is understood in a broad sense and refers to social, environmental, and governance issues that are typically not covered by financial performance metrics. § CSR disclosures primarily address external stakeholders. · not only shareholders! § Today, most public companies and many small- and medium-sized companies publish CSR reports. Such disclosure has taken place in the form of specific sections in annual reports, corporate websites, or stand-alone CSR reports. § Currently, in different markets, in absence of universal formal mandatory rules, CSR reports significantly vary in form (design, distribution media, reporting frequency, etc.) and content (scope, quality, etc.).

Earnings Per Share (EPS)

§ Corporations are required to disclose earnings per share (EPS) on the income statement or in the notes to the financial statements. · typically as the bottom line, after net income § calculated as: the total value of net income divided by the weighted average number of common shares outstanding § represents for each share earned how much income the firm is generating § the higher EPS, the higher income [the better] § is it connected to the share price? · when EPS increases, the stock price increases, so yes · but EPS isn't connected to the stock price in a mechanical way · but it's connected because when the firm reports an increase in its EPS means the firm has an increase in its income compared to the last year o and it's good news because it means the firm has a stronger ability to generate income compared to the past, pushing the stock price up [people wanna invest in firms that make revenues] o and it works also the other way around

Income Tax Expense

§ Corporations are taxable entities § Income tax expense computed as Income Before Income Taxes*Tax Rate (Federal, State, Local or Foreign)

Corporate CSR disclosure: EU - Directive 2014/95/EU

§ EU law requires large companies to disclose certain information on the way they operate and manage social and environmental challenges. · EU as a pioneer in CSR disclosures -- but we're still at a very early stage § This helps investors, consumers, policy makers and other stakeholders to evaluate the non-financial performance of large companies and encourages these companies to develop a responsible approach to business. · a combination of different experts is so important § Directive 2014/95/EU (AKA the non-financial reporting directive, NFRD) - lays down the rules on disclosure of non-financial and diversity information by large companies. · first disclosure regulation in the world § example: Fineco bank - Sustainability Report · provides business model, strategy, mission & value of the company · financial stability and economic performance included · integrity in business conduct, governance system included · etc. many other sections · directly addresses the stakeholders

Net Profit Margin Ratio

§ NPM: net revenues/operating revenues · measures how much profit the firm can get for each dollar of sales revenue it generates · captures how effective the firm is in generating profits · shows how you can get the different pieces of info from the income statement, combine them together and analyze info in more effective way § profit [earnings/income]: revenues - expenses § typically for manufacturing firms/firms that sell products, net sales is sales revenue minus any returns from customers and other reductions · but for service providers, it's also very similar *net sales: revenue - returns from customers & other reductions

Effect of Operating Activities on Cash Flows

§ Recall from Chapter 1: Firms report cash inflows and outflows in their statement of cash flows. · firms badly need cash for any activities that's why we're discussing it § This statement categorizes all transactions that affect cash into three categories: operating, investing, and financing activities. § When Cash is involved in a transaction, it will be reported on the statement of cash flows. · prepared on the cash basis of accounting § Only transactions affecting cash are reported on the Statement of Cash Flows. § Cash flows from operating activities are primarily cash received from customers and cash paid to suppliers and others involved in operations.

· Purpose and responsibility of corporations: Traditional/conventional (old) theory by Milton Friedman

§ The primary goal for a company is to earn profit and to increase the wealth of its owners (i.e. shareholders) by paying dividends and/or increasing the stock price. · Shareholder value maximization. · The company and its managers are only responsible for shareholders. § This idea came from a Nobel Prize Winner Milton Friedman · American economist who received the 1976 Nobel Prize in Economic Science · "There is one and only one social responsibility of business -- to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud." - The Social Responsibility of Business is to Increase its Profits, article in NYT · there are different voices on this topic tho: o some say it's the world's dumbest idea (Steve Denning)

Classified Income Statement

§ heading: we have firm's name, statement name, accounting period and unit of measurement § always start with revenue & calculating total revenues § then all cost and expenses calculations & total costs and expenses § calculate the operating income: total revenues - total costs and epenses § then calculate the other revenues and gains · ex: investment income and gain on sale of land § then include income before income taxes & income tax expense · no taxes in this course tho* § then we have net income § then we have earnings per share · net income/number of shares · ex: here = 0.68 = $680 o the higher, the better for shareholders

Purpose and responsibility of corporations

§ to profit § to outcompete others § to survive § to create value for the shareholders § to create social value

How do business activities affect the income statement?

· 3 business activities the firm can engage in: investing activity operating activity, financing activity · balance sheet is about financing activity and investing activity income statement is mainly about operating activity

Elements to Be Measured and Reported in the Financial Statement:

· Assets, Liabilities, Stockholders' Equity, Investments by Owners, and Distributions to Owners · Revenues, Expenses, Gains, and Losses

Recognition, Measurement, and Disclosure Concepts -> we need them to do accounting:

· Assumptions: o Separate Entity, Going Concern, and Monetary Unit, Time Period - Going Concern: those who prepare the FS need to have reasons to believe that the firm will be going in the future · Principles: o Mixed-Attribute Measurement o Revenue Recognition and Expense Recognition

Inventory

· why revenues, as a resource of the firm that the firm earns, don't have a debit balance? it has to do with the inventory · inventory: current asset of the firm o the firm buys the products from suppliers and store them in an inventory o the firm sells these products from the inventory to the customers and in return it gets a revenue o it shows a decrease in the firm's current assets because it uses these assets to generate money [future resources] o the firm uses these products stored in inventory as resources/assets used to generate revenues o it means a decrease in current assets and an increase in revenues within the inventory · revenues isn't an asset of the firm so it doesn't have a credit balance

GAAP: US perspective

• Securities Act of 1933 • Securities Exchange Act of 1934 -The Securities and Exchange Commission (SEC) has been given broad powers to determine financial statements (GAAP) in the U.S. -has power to regulate financial markets -SEC has worked closely with the accounting profession to work out the detailed rules that have become known as GAAP -Currently, the Financial Accounting Standards Board (FASB) is recognized as the body to formulate US GAAP. -makes the accounting rules in the US -Since 2002, there has been substantial movement to develop international financial reporting standards by the International Accounting Standards Board (IASB) -> Aim: company financial statements are comparable across international boundaries. -International Financial Reporting Standards (IFRS) are accounting standards issued by IASB and the IFRS Foundation. IFRS have replaced many different national accounting standards around the world; but have not replaced the U.S. GAAP in the United States.

Fundamental Qualitative Characteristics of Useful Information

•Relevance ((information is relevant for information-users' decisions) including materiality -> ex: cash flow's relevant for creditors) and Faithful Representation (can be accused of misreporting its numbers) oAttributes That further Enhance Qualitative Characteristics: •Comparability (including consistency), •Verifiability, (numbers can be verified) •Timeliness (complete) •Understandability (ex: improved by the notes)

Objective of Financial Reporting

•To provide financial information about the reporting entity that is useful to existing and potential investors, lenders, and other creditors in making decisions about providing resources to the entity othis info allows the company to grow *useful information - requires qualititative characteristics: -relevancy -faithful representation -comparability -verifiability -timeliness -understandability *elements of statements: -asset -liability -stockholders' equity -revenue -expense -gain -loss •firm needs to conduct the C-B analysis: Pervasive Cost-Benefit Constraint: Benefits of providing information should outweigh its costs o if b>c, company should go for it