Economics 4 Lecture 1.1 Accounting, Business Professions, And a Reporting Illustration Michael Willoughby, Ph.D., CFA © Michael G Willoughby 2008
Economics 4 Lecture 1.1
Accounting, Business Professions, And a Reporting
Illustration
Michael Willoughby, Ph.D., CFA
© Michael G Willoughby 2008
The Context
Scarcity: We want more than we have, or
… we need what we don’t have – a chunk of ca$h. Life Cycle: Time changes everything
… needs, wants, resources, and prices.Risk: Shit happens plus
…we seldom never know exactly what kind of shit it is - so CERTAINTY is more desirable than uncertainty.
Information helps! … unless it’s bad information.
Money-related Professions (broadly)
Economics: decisions about the use of resources – what do we want most?
Finance: decisions about the inter-temporal allocation of money: lending & borrowing.
Risk-management: decisions about the management – purchase or sale – of risk.
Accounting – an information system for recording and reporting business financial performance & position.
Money-related Professions (narrowly)
Economics: a) policy pro/prescriptions;b) purchasing of commodities (i.e., the SWAL fuel
futures);
c) production management. Finance: a) Banking - financial intermediation;b) Investment management (valuation)c) Financial planning..
Money-related Professions (narrowly)
Accounting: a) Control (bookeeping & internal controls);b) Financial reporting;c) Auditing;d) Tax-planning. Risk-management:a) Consulting; practices & procedures,
systems design, policy implementation; b) Insurance; underwriting.
Where? Economics: 1. The Federal Reserve Banks.2. DOC, DOL, DOT, all Legislatures.3. Big manufacturing firms.4. ? Banking: 1. Commercial banks: Citi, BofA, Wells Fargo.2. Investment banks: Goldman, Lehman, Bears?3. Credit Unions: NFCU, America First, SD
County.
Where?
Accounting: 1. Ernst & Young.2. Deloitte & Touche.3. KPMG.4. Price-Coopers (PWC).5. Arthur Anderson R.I.P.And the Regionals1. Moss Adams.2. McGladry Pullen
Where?
Insurance:1. Marsh & McLennan2. A.I.G.3. GEICO, All State, Farmer’s, Traveler’s.4. ? Risk-management: 1. Kroll, Inc.2. ?
Who?
Economics:1. M.A.’s2. Ph.D.’s Finance: 1. CFA’s2. CFP’s3. CIRA’s4. RIA’s5. CFO – job title allows you to join the
FEA
Who?
Accounting:1. CPA’s2. EA’s3. CMA’s
Insurance: 1. CLU’s2. ?3. AA’s
Why accounting?
It’s a formal way of keeping track of cash, claims to cash, obligations, & stuff:
1. Transactions & inventory.
2. Promises & contracts.
3. Money – my investment in your efforts.
Financial Reporting
A report card on a Company’s:1. Performance – profits – via the Income
Statement2. Position – assets & liabilities – via the
Balance Sheet3. Liquidity – the sources & uses of ca$h –
via the SCF
Financial Reporting
To interested parties:Outsiders:
a) Investors – owners; Purchase company stock.b) Creditors – lenders; Purchase company bonds.c) Regulatorsd) Vendors – suppliers & employees.
Insiders:a) Managers
Functions
#1Collection1. The transactions of AN ENTITY2. w/other Entities (persons and/or
organizations)3. Over a PERIOD of time – the Fiscal Year “FY”
and its 4 Quarters.
#2Measurement1. In a monetary unit “$” 2. Using some rules, guidelines, & judgment
Functions
# 3 Classification: every transaction creates a number that will be “labelled”:
1. Asset 2. Liability 3. Equity 4. Revenue 5. Expense
And also1. Gain2. Loss
Functions
#4Presentation – the reporting part
1. Income Statement – performance OVER the Period – lists Revenues and Expenses, sometimes Gains & Losses.
2. Balance Sheet – position AT A POINT, the end of the Period – lists all Assets, Liabilities, and Equity.
3. Statement of Cash Flows – translates the reported performance on the I/S and changes in the B/S into the most objective, most fungible, resource - CA$H.
Starbuck’s “SBUX” Stock
Financial Statements
Income Statement
Top-down presentation Sales or Revenue = inflows from Primary
Activities Less Expenses = outflows from Primary
Activities There are three categories of expenses and
many types, of Expenses ! = Earnings – a measure of profit There are several levels of profit ending (at the
bottom line) with Net Income.
Sales = $7,998,265,000 1
1 Company-owned stores. The Company’s total sales (ttm) was $10,097,790,000.
Financial Statements
Balance Sheet One of civilizations greatest achievements. Keeps the accounting system in order. Assets = Liabilities + Equity What we OWN = What we OWE
Everything must have = a Source Assets = Capital Assets = Trade Credit + IBD + PinK + Retained
Earnings
Financial Statements
Balance Sheet
Yours’ Your Parents’ Your Employer’s Your Nation’s A Global Balance Sheet? – if Al Gore says
so.
Financial Statements
Statement of Cash Flows
Only Cash is Cash ! A required Financial Statement since 1987 w/ SFAS
95. Three Sources and Uses of Cash:1. Operating2. Investing3. Financing Required because of the Accrual nature of accounting.
Objectives of Financial Accounting
Useful to the providers of money capital:
1. Relevant2. Reliable: consistent & comparable3. Timely
Capital Providers
Investors – provide equity capital
1. As initial Paid-in-Capital “PinK”2. As retained earnings from profitable
activities. Creditors – provide debt capital
1. Trade credit2. Interest-bearing Debt
Capital Providers con’t
The source of money capital for companies
Investors & Creditors literally “Sell Cash” to Company’s in exchange for:
Financial claims:
1. Bonds – debt2. Stocks - equity
Need Useful Information
Capital Providers want information: For Decision-making About starting, staying-the-course, ending A financial relationship … With what Companies? Comparability is the corner stone of GAAP
Accounting Assumptions
One entity. Record-keeping for “a Period” of
time. On-going concern Conducting transactions that can be
measured in Dollar$
Accounting’s Principles
Cost – historical Objectivity – b/w independent parties Realization – of Revenue ≡ Sales Matching – Expenses w/ Sales Materiality – don’t show the small
stuff
Employees & Stores
172,000 employees worldwide; 144,000 U.S.A.
163,000 employees in Stores; 9,000 in Admin. 8,505 Company-owned Stores; 6,506
licensed.
Sales per store-employee in Company-owned stores?
$ 49,065
and $ 46,501 per total employees
Profits
• Net Income = $ 672,640,000
• Per employee = $ 3,800
• Profit Margin = 7.15 %
Two Methods of Accounting
Cash-basis Only collect &
report “cash” transactions only.
Accrual Collect &
measure & report all transactions.
Cash-basis Accounting
We measure activity when “cash” is received and when it is disbursed.
The difference is cash-basis profit.
This is the basis for taxation of small businesses.
Cash-basis accounting is a rules-based measurement system.
Accrual
What matters is completed
activities – selling goods/services
regardless of whether cash is
collected at the time or sale,
before, or after.
Accrual
Is about measuring success in dollar units as they are associated with activities including claims and obligations created while selling.
Is a principles-based measurement system, using the realization & matching principles to recognize Revenue and Expenses.
Once Upon a Time there was a little ranch in Wyoming
With gentle tenant farmers
My parents
Starting with $ 6,000 in cash from prior earnings (Retained)
Balance Sheet at 12/31/07.
Cash = $ 6,000
AR = $ 0
INV = $ 0
PrePd $ 0
LLA $ 0
(Accum DA)
UnER = $0
Pay = $0
AcEx = $0
IBD = $0
P-in-K = $0
RE = $ 6,000
2008 Activities
Purchase ten 400# hefers and steers in
March.
Grass feed them for about 10 months.
Start selling them in when they each
weigh 1000# in about November.
Next Stop: Ruth Chris’
All Transactions: March-December
1. Purchase 10 animals @ $400 each = $4,000 cash.
2. Purchase salt & minerals: $ 400 cash.3. Agree to pay my father: $100/mo. x 10 = $1,000
but we forget to pay him for December.4. Sell 8 animals @ $1,000 each by the end of
December, but two customers don’t pay until January 2009.
5. What will my 2008 Financials look like?
It depends
Do we measure success on a:
Cash-basis?Or by the
Accrual method?
Cash-basis Income Statement for 2008
Revenue
(COGS)
GP
(G&A)
Profit
6,000 of cash sales = 6 x $1,000 cash received.
( 4,000) direct expenses – 10 x $400 cash paid.
2,000
( 1,300) $400 cash for supplies & $900 cash for labor,
700
Note: We have two $1,000 IOU’s plus a $100 labor obligation and two animals still in the barn.
Accrual Income Statement for 2008
Revenue
(COGS)
GP
(G&A)
Profit
8,000 Revenue as $6,000 cash + $2,000 in IOU’s
( 3,200) match the 8 sole x $ 400 as Direct Expense
4,800
( 1,400) match $400 supplies cost + $1,000 labor cost
3,400
Close the Balance Sheet at 12/31/08for the Accrual method: Fill-in these
numbers
Cash = $ ????
AR = $ ????
INV = $ ????
PrePd $ 0
LLA $ 0
(Accum DA)
UnER = $0
Pay = $0
AcEx = $0
IBD = $0
P-in-K = $ 0
RE = $ ????
Make a Cash Journal
Beginning cash $ 6,000 12/31/2007Purchase animals ($ 4,000)Purchase supplies ($ 400)Pay for Labor ($ 900)Cash for Sales $ 6,000 Ending cash $ 6,700 11 Ending cash will be recorede on the 12/31/2008 Balance Sheet.
Also note that Ending Cash – Beginning Cash = Cash flow = $700
Adjusting the Balance Sheet Accounts
Basic internal control formula.a) What you start withb) plus what you receive,c) less what you useequalsd) what you end with.
Articulate Retained Earnings
The internal control formula.a) start with $ 6,000b) plus 2008 Profit of $ 3,400c) less nothingequalsd) ending Retained Earnings of $ 9,400.
The Balance Sheet at 12/31/08for the Accrual method
Cash = $ 6,700
AR = $ 2,000
INV = $ 800
PrePd $ 0
LLA $ 0
(Accum DA)
UnER = $ 0
Pay = $ 0
AcEx = $ 100
IBD = $ 0
P-in-K = $ 0
RE = $ 9,400