Financial Accounting: Class
Notes
,Corporate Acquisitions: Class notes
1. Lecture 1
1.1 Financial Accounting -
- Class 1
o Three homework assignments
- Accounting
o “language of business”
o Collection, processing and reporting of info about activities and events that affect the
organization
- Three types of accounting users
o Financial Accounting and Reporting: recording financial transactions, position and results and
communicating it to outside stakeholders
o Managerial Accounting and Reporting: communicating the position and results of firm
internally.
o Tax Accounting and Reporting: recording and reporting financial position to IRS.
- Accounting Principles
o Generally Accepted Accounting Principles (GAAP)
▪ SEC has authority to set GAAP
• SEC delegates this authority to the Financial Accounting Standards Board
(FASB)
• FASB rules are called Statements of Financial Accounting Standards
(SFAS) – currently over 150 rules
▪ Attributes of ideal accounting system
• Reliability – verifiable by an independent party
• Relevance – it has to be timely, and have feedback value and predictive
ability to a certain extent (you may want to use the info to make future
decisions)
▪ Other important accounting concepts
• Conservatism – report bad news but not good news if there is uncertainty
• Materiality – if tracking an account is costly and reporting it doesn’t change
decisions, it is not worth it.
- Accounting Qualities
o Decision Usefulness
▪ Relevance
• Timely
• Feedback value – tells you about the past (evaluate the managers of the
firm); feedback on past performance and management performance
• Predictive value
▪ Reliability
• Verifiability
• Representational faithfulness
• Neutral (compare firm across years and compare across firms)
▪ Comparability
▪ Materiality
o Understandability
- Assumptions Underlying Financial Accounting
o Three Assumptions
▪ Entity Concept – parent company and any subsidiaries controlled by the parent;
independent subsidiaries are not part of the firm
• Arm’s length transaction
▪ Monetary measurement concept -
▪ Going concern assumption
o Discretion – accounting information is subject to discretion.
Page 2
,Corporate Acquisitions: Class notes
▪ Accounting numbers = economic truth + measurement error + incentives
o Changes to Accounting Rules and Regulation – can change due to lobbying, political
pressure, economics and technological change
- Principal Activities of a Firm
o Sources of capital
▪ Creditors
▪ Owners
o Investing Activities
▪ Inventory
▪ PPE
o Operating Activities
▪ Creates value
o Value creation
▪ Earnings, profits, etc.
▪ How can a firm return value?
• Dividends
• Reinvest earnings into investing activities of the firm
• Repay your creditors
o FINANCIAL STATEMENTS PROVIDE INFORMATION ON EACH STEP
- Role of Financial Reporting
o Who is interested in information about the firm?
▪ S/Hs, potential S/Hs
▪ Creditors
▪ Suppliers
▪ IRS
▪ Analysts, other intermediaries
o What types of information about the firm?
▪ Performance
• Revenue, expenses,
• Ratios
• Cash flow
• Assets & liabilities
o Supply
▪ Mandatory disclosures –
• Annual audited filings with the SEC (10Ks)
• Quarterly unaudited SEC filings (10Qs)
▪ Annual reports – sent to shareholders
- Key Players in Financial Reporting
o Preparers
▪ SEC – oversight role – delegated to FASB
▪ FASB – rule-making body
▪ GAAP – set of rules created by FASB
▪ Directors – audit committee responsible for reporting of the firm
▪ Auditors – attest to the credibility of the financial reports
▪ (Sarbanes-Oxley Act (SOX) – July 30, 2002 – in response to Enron, WorldCom,
etc.)
o Users
▪ Analysts/Media – third party information providers
▪ Investors – large institutions and individuals
- International Financial Reporting Standards (IFRS)
o Set of global accounting standards for the preparation of public company financial statements
o Developed by the International Accounting Standards Board (IASB)
o IASB is an independent accounting standard-setting body based in London
o 12,000 companies in almost 100 nations have adopted IFRS. Many more will transition in
2011
Page 3
, Corporate Acquisitions: Class notes
o FASB and IASB are working towards convergence of US GAAP and IFRS
o SEC Roadmap
▪ 2011: decision whether US Firms are required to use IFRS
▪ 2014: implementation year in case of positive decision
- Financial Statements
o Basic Financial Statements
▪ Balance Sheet
▪ Income Statement
▪ Statement of Cash Flows
o Supplemental information about the financial condition of a company
▪ Statement of Shareholder’s Equity
▪ Notes to Financial Statements – footnotes are very important
▪ Auditor’s Report
- The Balance Sheet
o A point in time snapshot of the investing and financial activities of the firm
o Balance sheet identity
▪ ASSETS = LIABILITIES + SHAREHOLDERS’ EQUITY
▪ E.g.
• Investments = financial arrangements
• Resources = claims on resources
• Owns = owes
- The Income Statement
o A schedule that presents the results of operations of a firm for a specific period of time.
o NET INCOME = REVENUES – EXPENSES
▪ Revenues – inflows of assets from selling and providing goods or services
▪ Expenses – outflows of assets used in generating revenues
o Note: there is nothing in these definitions that referto cash
o Balance Sheet vs. Income Statement
▪ Income statement links the balance sheet at the beginning of the period with the
balance sheet at the end of the period
▪ Retained Earnings (RE) is increased each period by the net income of the period and
decreased by any dividends declared during the period
• RE (end of period) = RE (beginning of period) + NET INCOME –
DIVIDENDS
- Statement of Cash Flows
o A schedule that reports the details of where cash came from and where cash went for a
period of time.
o Cash flows are categorized into:
▪ Operating: Providing goods and services
▪ Investing: Choice of assets used to run operations
▪ Financial: Raising capital to pay for assets
- Financial Statements: The Link
o CASH + NONCASH ASSETS = LIABILITIES + CONTRIBUTED CAPITAL +
RETAINED EARNINGS
- Other Financial Reporting Items
o Statement of Shareholders’ Equity – schedule that reconciles the change in S/Hs equity
accounts during a period of time
o Notes to financial statements
o Auditors’ opinion
o Financial highlights, including trends
o Management’s Discussion and Analysis
o CEO/CFO Certification
- CHAPTER 2
- The Balance Sheet (p59-61 – nice summary of balance sheet accounts)
- Assets
Page 4
Notes
,Corporate Acquisitions: Class notes
1. Lecture 1
1.1 Financial Accounting -
- Class 1
o Three homework assignments
- Accounting
o “language of business”
o Collection, processing and reporting of info about activities and events that affect the
organization
- Three types of accounting users
o Financial Accounting and Reporting: recording financial transactions, position and results and
communicating it to outside stakeholders
o Managerial Accounting and Reporting: communicating the position and results of firm
internally.
o Tax Accounting and Reporting: recording and reporting financial position to IRS.
- Accounting Principles
o Generally Accepted Accounting Principles (GAAP)
▪ SEC has authority to set GAAP
• SEC delegates this authority to the Financial Accounting Standards Board
(FASB)
• FASB rules are called Statements of Financial Accounting Standards
(SFAS) – currently over 150 rules
▪ Attributes of ideal accounting system
• Reliability – verifiable by an independent party
• Relevance – it has to be timely, and have feedback value and predictive
ability to a certain extent (you may want to use the info to make future
decisions)
▪ Other important accounting concepts
• Conservatism – report bad news but not good news if there is uncertainty
• Materiality – if tracking an account is costly and reporting it doesn’t change
decisions, it is not worth it.
- Accounting Qualities
o Decision Usefulness
▪ Relevance
• Timely
• Feedback value – tells you about the past (evaluate the managers of the
firm); feedback on past performance and management performance
• Predictive value
▪ Reliability
• Verifiability
• Representational faithfulness
• Neutral (compare firm across years and compare across firms)
▪ Comparability
▪ Materiality
o Understandability
- Assumptions Underlying Financial Accounting
o Three Assumptions
▪ Entity Concept – parent company and any subsidiaries controlled by the parent;
independent subsidiaries are not part of the firm
• Arm’s length transaction
▪ Monetary measurement concept -
▪ Going concern assumption
o Discretion – accounting information is subject to discretion.
Page 2
,Corporate Acquisitions: Class notes
▪ Accounting numbers = economic truth + measurement error + incentives
o Changes to Accounting Rules and Regulation – can change due to lobbying, political
pressure, economics and technological change
- Principal Activities of a Firm
o Sources of capital
▪ Creditors
▪ Owners
o Investing Activities
▪ Inventory
▪ PPE
o Operating Activities
▪ Creates value
o Value creation
▪ Earnings, profits, etc.
▪ How can a firm return value?
• Dividends
• Reinvest earnings into investing activities of the firm
• Repay your creditors
o FINANCIAL STATEMENTS PROVIDE INFORMATION ON EACH STEP
- Role of Financial Reporting
o Who is interested in information about the firm?
▪ S/Hs, potential S/Hs
▪ Creditors
▪ Suppliers
▪ IRS
▪ Analysts, other intermediaries
o What types of information about the firm?
▪ Performance
• Revenue, expenses,
• Ratios
• Cash flow
• Assets & liabilities
o Supply
▪ Mandatory disclosures –
• Annual audited filings with the SEC (10Ks)
• Quarterly unaudited SEC filings (10Qs)
▪ Annual reports – sent to shareholders
- Key Players in Financial Reporting
o Preparers
▪ SEC – oversight role – delegated to FASB
▪ FASB – rule-making body
▪ GAAP – set of rules created by FASB
▪ Directors – audit committee responsible for reporting of the firm
▪ Auditors – attest to the credibility of the financial reports
▪ (Sarbanes-Oxley Act (SOX) – July 30, 2002 – in response to Enron, WorldCom,
etc.)
o Users
▪ Analysts/Media – third party information providers
▪ Investors – large institutions and individuals
- International Financial Reporting Standards (IFRS)
o Set of global accounting standards for the preparation of public company financial statements
o Developed by the International Accounting Standards Board (IASB)
o IASB is an independent accounting standard-setting body based in London
o 12,000 companies in almost 100 nations have adopted IFRS. Many more will transition in
2011
Page 3
, Corporate Acquisitions: Class notes
o FASB and IASB are working towards convergence of US GAAP and IFRS
o SEC Roadmap
▪ 2011: decision whether US Firms are required to use IFRS
▪ 2014: implementation year in case of positive decision
- Financial Statements
o Basic Financial Statements
▪ Balance Sheet
▪ Income Statement
▪ Statement of Cash Flows
o Supplemental information about the financial condition of a company
▪ Statement of Shareholder’s Equity
▪ Notes to Financial Statements – footnotes are very important
▪ Auditor’s Report
- The Balance Sheet
o A point in time snapshot of the investing and financial activities of the firm
o Balance sheet identity
▪ ASSETS = LIABILITIES + SHAREHOLDERS’ EQUITY
▪ E.g.
• Investments = financial arrangements
• Resources = claims on resources
• Owns = owes
- The Income Statement
o A schedule that presents the results of operations of a firm for a specific period of time.
o NET INCOME = REVENUES – EXPENSES
▪ Revenues – inflows of assets from selling and providing goods or services
▪ Expenses – outflows of assets used in generating revenues
o Note: there is nothing in these definitions that referto cash
o Balance Sheet vs. Income Statement
▪ Income statement links the balance sheet at the beginning of the period with the
balance sheet at the end of the period
▪ Retained Earnings (RE) is increased each period by the net income of the period and
decreased by any dividends declared during the period
• RE (end of period) = RE (beginning of period) + NET INCOME –
DIVIDENDS
- Statement of Cash Flows
o A schedule that reports the details of where cash came from and where cash went for a
period of time.
o Cash flows are categorized into:
▪ Operating: Providing goods and services
▪ Investing: Choice of assets used to run operations
▪ Financial: Raising capital to pay for assets
- Financial Statements: The Link
o CASH + NONCASH ASSETS = LIABILITIES + CONTRIBUTED CAPITAL +
RETAINED EARNINGS
- Other Financial Reporting Items
o Statement of Shareholders’ Equity – schedule that reconciles the change in S/Hs equity
accounts during a period of time
o Notes to financial statements
o Auditors’ opinion
o Financial highlights, including trends
o Management’s Discussion and Analysis
o CEO/CFO Certification
- CHAPTER 2
- The Balance Sheet (p59-61 – nice summary of balance sheet accounts)
- Assets
Page 4
