Module 1: Module 1:

Financial Financial Accounting Accounting

for MBAsfor MBAs

Business ActivitiesBusiness Activities

Financial Accounting Financial Accounting Information: Demand & Information: Demand &

SupplySupply Demand for financial accounting Demand for financial accounting

information extends to numerous users information extends to numerous users that include:that include: Managers and employeesManagers and employees Investment analysts and information Investment analysts and information

intermediariesintermediaries Creditors and suppliersCreditors and suppliers Shareholders and directorsShareholders and directors Customers and strategic partnersCustomers and strategic partners Regulators and tax agenciesRegulators and tax agencies Voters and their representativesVoters and their representatives

Supply of Accounting Supply of Accounting InformationInformation

Primary SEC filing requirements:Primary SEC filing requirements: Form 10-K: annual Form 10-Q: quarterly

Benefits and costs of disclosure.Benefits and costs of disclosure.

Financial StatementsFinancial Statements

The Accounting EquationThe Accounting Equation

Berkshire Hathaway’s Berkshire Hathaway’s Balance SheetBalance Sheet

Walgreen’s

Investing ActivitiesInvesting Activities

Financing ActivitiesFinancing Activities

Initial Questions about the Initial Questions about the Balance SheetBalance Sheet

• What are the trade-offs in financing a company by owner versus nonowner financing?

• Most assets and liabilities are reported on the balance sheet at their acquisition price, called historical cost. Would reporting assets and liabilities at current market values be more informative? What problems might reporting balance sheets using current market value cause?

Income StatementIncome Statement An An income statementincome statement reports on reports on

operating activities. operating activities. It lists amounts for sales (and It lists amounts for sales (and

revenues) less all expenses (and revenues) less all expenses (and costs) over a period of time. costs) over a period of time.

Sales less expenses yield the “bottom-Sales less expenses yield the “bottom-line” net income amount.line” net income amount.

Berkshire Hathaway’s Berkshire Hathaway’s Income StatementIncome Statement

Walgreen’s

Initial Questions about the Initial Questions about the Income StatementIncome Statement

• Assume that a company sells a product to a customer who promises to pay in 30 days. Should the seller recognize the sale when it is made or when cash is collected?

• Should a company record the cost of a truck that it purchases as an expense when it is acquired?

• Employees commonly earn wages that are yet to be paid at the end of a particular period. Should their wages be recognized as an expense in the period that the work is performed, or when the wages are paid?

Statement of EquityStatement of Equity

The The statement of equitystatement of equity reports on reports on changes in the accounts that changes in the accounts that makeup equitymakeup equity Contributed capitalContributed capital Earned capital (retained earnings and Earned capital (retained earnings and

accumulated other comprehensive accumulated other comprehensive income)income)

Berkshire Hathaway’s Berkshire Hathaway’s Statement of Stockholders’ Statement of Stockholders’

EquityEquity

Walgreen’s

Statement of Cash FlowsStatement of Cash Flows

The The statement of cash flowsstatement of cash flows reports on reports on cash flows for operating, investing, and cash flows for operating, investing, and financing activities over a period of time. financing activities over a period of time.

Walgreen’s

Initial Questions about the Initial Questions about the Statement of Cash FlowsStatement of Cash Flows

• What is the usefulness of companies providing the statement of cash flows?

• Is it important for a company to report net cash inflows (positive amounts) relating to operating activities over the longer term?

• How might the composition of operating, investing and financing cash flows change over a company’s life cycle?

• Is the bottom line increase in cash flow the key number? Why or why not?

Financial Statement Financial Statement LinkagesLinkages

The income statement and the balance sheet are linked via retained earnings.

Retained earnings, contributed capital, and other equity balances appear both on the statement of stockholders’ equity and the balance sheet.

The statement of cash flows is linked to the income statement as net income is a component of operating cash flow.

Information Beyond Information Beyond Financial StatementsFinancial Statements

Management Discussion and Management Discussion and Analysis (MD&A)Analysis (MD&A)

Independent Auditor ReportIndependent Auditor Report Financial Statement FootnotesFinancial Statement Footnotes Regulatory Filings and Proxy Regulatory Filings and Proxy

StatementsStatements

Profitability AnalysisProfitability Analysis

Profit Margin, Asset Turnover, and Profit Margin, Asset Turnover, and Return on Assets for Selected Return on Assets for Selected

IndustriesIndustries

Competitive AnalysisCompetitive Analysis

Industry competition Bargaining power of buyers Bargaining power of suppliers Threat of substitution Threat of entry

Five Forces of Competitive Five Forces of Competitive IntensityIntensity

Oversight of Financial Oversight of Financial AccountingAccounting SEC oversees all publicly traded SEC oversees all publicly traded

companiescompanies Financial Accounting Standards Financial Accounting Standards

Board (FASB)Board (FASB) Public Company Accounting Public Company Accounting

Oversight Board (PCAOB)Oversight Board (PCAOB)

Audit ReportAudit Report Financial statements present fairly, in all

material respects a company’s financial condition, in conformity with GAAP.

Financial statements are management’s responsibility. Auditor responsibility is to express an opinion on those statements.

Auditing involves a sampling of transactions, not investigation of each transaction.

Audit opinion provides reasonable assurance that the statements are free of material misstatements, not a guarantee.

Auditors review accounting policies used by management and the estimates used in preparing the statements.

Sarbanes-Oxley Act Sarbanes-Oxley Act The SEC requires the CEO and CFO of a The SEC requires the CEO and CFO of a

company to personally sign a statement company to personally sign a statement attesting to the accuracy and completeness of attesting to the accuracy and completeness of the company’s financial statements. the company’s financial statements.

The statements signed by both the CEO and The statements signed by both the CEO and CFO contain the following commitments:CFO contain the following commitments: The CEO and CFO have personally reviewed the annual The CEO and CFO have personally reviewed the annual

reportreport There are no untrue statements of a material fact or There are no untrue statements of a material fact or

failure to state a material fact necessary to make the failure to state a material fact necessary to make the statements not misleadingstatements not misleading

The financial statements fairly present in all material The financial statements fairly present in all material respects the financial condition of the company respects the financial condition of the company

All material facts are disclosed to the company’s All material facts are disclosed to the company’s auditors and Board of Directorsauditors and Board of Directors

No changes to the company’s system of internal No changes to the company’s system of internal controls are made unless properly communicatedcontrols are made unless properly communicated

Financial Accounting: Financial Accounting: not an exact sciencenot an exact science

GAAP allows companies choices in GAAP allows companies choices in preparing financial statements preparing financial statements (inventories, property, and (inventories, property, and equipment). equipment).

Companies must choose among the Companies must choose among the alternatives that are acceptable alternatives that are acceptable under GAAP. under GAAP.

Financial statements also depend on Financial statements also depend on countless estimates.countless estimates.