Economy and Politics

• Highlight various current economy parameters which really correlates the finance industry.

• Spot the political outcomes which directly or indirectly affect the industry.

• Conclude the comments based on the current affairs and economic numbers.

The Accounting Cycle

Journal Entry

Ledger Posting

Trial BalanceAdjusted Trial Balance

Periodical Adjustments

Financial Statements

Accounting Cycle

Introduction• Financial statements are a snapshot of a company's well being at a

specific point in time. • The length of time (the accounting period) that these financial

statements represent varies; • The timing and the methodology used to record revenues and

expenses may also impact the analysis and comparability of financial statements across companies.

• Accounting statements are prepared in most cases on the basis of these three basic premises:1. The company will continue to operate (going-concern assumptions).2. Revenues are reported as they are earned within the specified accounting period (revenues-recognition principle).3. Expenses should match generated revenues within the specified accounting period (matching principle).

Financial statement analysis framework

Consist of six steps:

1) Sate the objective and context: Determine what questions the analysis seeks to answer, the form in which this information needs to be presented, and what resources and how much time are available to perform the analysis.

2) Gather Data: Acquire the company’s financial statements and other relevant data on its industry and the economy. Ask questions of the company’s management, suppliers and customers and visit company sites.

3) Process the data: Make any appropriate adjustments to the financial statements, calculate ratios. Prepare exhibits such as graphs and common-size balance sheet.

4) Analyze and interpret the data: Use the data to answer the questions stated in the first step. Decide what conclusions or recommendations the information supports.

5) Report the conclusion or recommendations: Prepare a report and communicate it to its intended audience. Be sure the report and its dissemination comply with the code and standards that relate to investments analysis and recommendations.

6) Update the analysis: Repeat these steps periodically and change the conclusions or recommendations when necessary.

Business Environment, Accounting and Financial Statements

Business EnvironmentLabor Markets

Capital Markets

Product Markets:• Suppliers• Customers

• Competitors

Business Regulations

Business StrategyScope of Business:

• Degree of Diversification• Type of Diversification

Competitive Positioning:

• Cost Leadership• Differentiation

Key Success Factors & Risks

Accounting EnvironmentCapital Market Structure

Contracting & Governance

Accounting Conventions & Regulations

Tax & Financial Accounting Linkage

Independent Auditing

Legal System for Accounting Disputes

Accounting StrategyChoice of:• Accounting Policies

• Accounting Estimates• Reporting Formats• Supplementary

Disclosures

Business ActivitiesOperating

Investment

Financing

Accounting SystemMeasure & Report

Economic Consequences of

Business Activities

Financial Statements

Basic Accounting Methods• Cash-basis accounting – This method consists of recognizing

revenue (income) and expenses when payments are made (checks issued) or cash is received (deposited in the bank).

• Accrual accounting – This method consists of recognizing revenue in the accounting period in which it is earned (revenue is recognized when the company provides a product or service to a customer, regardless of when the company gets paid). Expenses are recorded when they are incurred instead of when they are paid.

• Benefits of Cash Accounting: It is easy to use and implement because the company records income only when it gets paid and records expenses only when it pays them.

• Benefits of Cash Accounting: If accepted by the IRS (limited cases only), the company is taxed when it has money in the bank.

• Benefits of Cash Accounting: On average, fewer transactions will be recorded (bookkeeping).

• Biggest drawback of cash accounting: Cash accounting can distort a company's actual income and expenses, especially if it extends credit to its customers, purchases raw materials on credit from its suppliers or keeps inventory.

Benefits of Accrual Accounting

• Generally, it provides a clearer picture of the financial performance (income statement) and financial health (balance sheet).

• It allows management to keep track of accounts receivables and payables more efficiently.

• It is more representative of the economic reality of the business. A service provider may not require upfront payment for an annual service; this revenue will be recorded as it is performed, not when it is paid. Similarly, expenses that are paid in advance - such as property taxes, which are paid semiannually - will be recognized on a monthly basis.

• It enhances comparability of performance (income statement) and financial stability (balance sheet) from one period to the next.

• There is a smoother earning stream. • There is enhanced predictability of future cash flow.

Cash Basis AccountingTaken as is, the financial statements in Figure 6.1 below indicate that XYZ Corporation is not doing well, with a net loss of $43,200, and may not be a good investment opportunity. Figure 6.1: XYZ Corporation's Financial Statements using Cash Basis Accounting

Accrual Basis Accounting:

Armed with some additional information, let's see what the income statement would look like if the accrual-basis accounting method was used. Additional Information:

A1. June 12, 2005 – The company received a rush order for $80,000 of wood panels. The order was delivered to the customer five days later. The customer was given 30 days to pay. (With the cash-basis method, sales are not recorded in the income statement and not recorded in accounts receivables: no cash, no record).A2. June 13, 2003 – The company received $60,000 worth of wood panels to replenish their inventory, and $40,000 was related to the rush order. The company paid the invoice in full to take advantage of a 2% early-payment discount. (With the cash-basis method, this is recorded in full on the income statement, and there is no record of inventory on hand).A3. June 1, 2005 – The company launched an advertising campaign that will run until the end of August. The total cost of the advertising campaign was $15,000 and was paid on June 1, 2005.

XYZ Corporation's Restated Financial Statements using Accrual Basis Accounting