Financial Acumen for Non-Financial

Managers
Overview of Financial Reporting

Richard A. Lambert, Professor of Accounting

10

Definition of Accounting

• Accounting is a system for recording information about business

transactions and events
• To provide summary statements of a company's financial position and
performance to users who require such information
• Three sets of books
• Financial accounting
• Standardized reports for external stakeholders
• Tax accounting
• IRS rules for computing taxes payable
• Managerial accounting
• Custom reports for internal decision making
11

Financial Reporting Requirements

• Each country has its own financial reporting requirements

• In the U.S., The Securities and Exchange Commission (SEC) requires
periodic financial statement filings:
• 10 – K: Annual report (within 60 days for big firms)
• 10 – Q: Quarterly report (within 40 days for big firms)
• 8 – K: Current report (material events)
• Proxy, registration, and insider trading statements
• In other countries, firms file semi-annual reports instead of quarterly reports
• Firms supplement filings with voluntary disclosure
• Conference calls, press releases, forecasts, presentations at
brokerage conferences
12

Who Makes the Accounting Rules?

• Generally Accepted Accounting Principles (GAAP) are established by:

• U.S. Congress, but they delegate to:
• The SEC, but they delegate to:
• Financial Accounting Standards Board (FASB)
• International Financial Reporting Standards (IFRS) are required in over
100 countries, including the EU
• The two sets of rules are increasingly similar, but are not the same
13

Financial Statements Provide Information

About Firms’ Economic Activities

Raise Produce Collect Distribute

Acquire
Capital From Goods and From Funds to
Resources
Investors Services Customers Investors

Reinvest in the Firm

14

More Timely Information Requires More Estimation

• Accounting systems slice the firm’s life into arbitrary periods (quarters and
years)
• This allows for the generation of more timely information
• But many activities and decisions made to date aren’t done – they still
have implications for future cash flows
15

Annual Report Contents

• Discussion of
• Firm’s strategy, products, competitive environment
• Financial statistics
• Management discussion and analysis (MD&A)
• Financial statements
• Footnotes
• These explain the accounting procedures used by the firm and discuss
various assumptions regarding how the numbers were calculated
16

What are the Required Financial Statements?

• Balance Sheet
• Financial position (listing of resources & obligations) on a specific date
• Assets = Liabilities + Stockholders’ Equity
• Income Statement
• Result of operations over a period of time
• Net income = Revenues – Expenses
• Statement of Cash Flows
• Sources and uses of cash during a period of time
• Operating, Investing, and Financing Activities
• Statement of Stockholders’ Equity
• Change in stockholders’ equity over a period of time
Role of Financial Reporting
Regulators
Other Factors (FASB,SEC,IRS,
Auditors)

Recognition
Rules & Concepts
Measurement

Financial Statements
Management’s Economic Events Management’s (Balance Sheet,
Strategy Decisions (Cash & Noncash) Accounting Choices Income Statement,
Cash Flow)
Other Other
Communications Shape
Incentives Communications

Resources Board of Directors – External Decision Makers

(Capital, Labor, etc) Governance (Capital markets, product
and Oversight markets, labor markets)

Provide Resources
Financial Acumen for Non-Financial
Managers
The Balance Sheet Equation

Richard A. Lambert, Professor of Accounting

19

Balance Sheet Equation

• Balance Sheet
• Statement of financial position
• Key components
• Assets
• Liabilities
• Shareholders’ Equity
• Describes the resources (assets)
• Describes claims on the resources (liabilities)
20

Balance Sheet Equation

Assets = Liabilities + Shareholders’ Equity

Resources = Claims on Resources by

Outsiders + Owners

• Virtually everything in accounting is driven by this (seemingly simple)

relation
21

Equivalent View

• Assets = Liabilities + Shareholders’ Equity

• Shareholders’ Equity = Assets – Liabilities
• Sometimes you’ll see the term “Net Worth” or “Net Assets”

House = Asset
Mortgage on the house = Liability
$1 Million House - $300k Mortgage = 700k
Asset Liability Shareholders’ Equity
22

Balance Sheet Equation

• Just because a balance sheet balances, does not mean financial position
is okay
• Every transaction or event that is recorded in the financial statements must
preserve the balance sheet equation
• This means each transaction must balance
• If one account is impacted, at least one other must be as well (Double
Entry Bookkeeping)
• Examples:
• One asset goes up and one asset goes down
• One asset goes up and one liability goes down
• One asset goes up and one shareholders’ equity account goes down
23

Presentation Format

• The balance sheet equation must hold for firms using GAAP as well as for
those using IFRS
24

Presentation of Balance Sheet Items – US Firms

ASSETS CLAIMS ON ASSETS

• Current Assets • Liabilities

• Cash • Current Liabilities
• Receivables • Long Term Liabilities
• Inventories • Stockholders’ Equity
• Long Term Assets • Common Stock
• Property Plant & Equipment • Retained Earnings
• Intangibles
• Goodwill = Total Liabilities +
• Total Assets Stockholders’ Equity
25

Presentation of Balance Sheet Items – IFRS Firms

ASSETS CLAIMS ON ASSETS

• Long Term Assets • Liabilities

• Property Plant & Equipment • Current Liabilities
• Intangibles • Long Term Liabilities
• Goodwill • Stockholders’ Equity
• Current Assets • Common Stock
• Cash • Retained Earnings
• Receivables
• Inventories = Total Liabilities +
• Total Assets Stockholders’ Equity
26

Presentation of Balance Sheet Items – IFRS Firms

ASSETS CLAIMS ON ASSETS

• Long Term Assets • Stockholders’ Equity

• Property Plant & Equipment • Common Stock
• Intangibles • Retained Earnings
• Goodwill • Liabilities
• Current Assets • Current Liabilities
• Cash • Long Term Liabilities
• Receivables
• Inventories = Total Liabilities +
• Total Assets Stockholders’ Equity
27

Relationship Between Financial Statements

• The balance sheet shows the resources and claims on the resources AT A
POINT IN TIME
• The income statement and cash flow statement provides information about
how the balance sheet changes OVER A PERIOD OF TIME
• The cash flow statement tells you how the CASH account on the
balance sheet changes over time
• The income statement tells you about how the RETAINED EARNINGS
account on the balance sheet changes over time
28

Relationship Between Financial Statements

Balance Sheet at 12/31/00

Assets = Liabilities + Shareholders’ Equity
Cash + Noncash assets = Liabilities + Contributed Capital + Retained Earnings

Statement of Cash Flows Income Statement

for year ended 12/31/01 for year ended 12/31/01
(minus dividends)

Cash + Noncash assets = Liabilities + Contributed Capital + Retained Earnings

Balance Sheet at end of year

Financial Acumen for Non-Financial
Managers
Assets, Liabilities, Shareholders’ Equity

Richard A. Lambert, Professor of Accounting

30

Balance Sheet

• Balance Sheet:
• Assets are resources
• Liabilities are claims on the resources
• Stockholders’ equity are claims on unclaimed resources
• Balance Sheet Equation
• Assets = Liabilities + Shareholders’ equity
31

Issues in Recording Assets and Liabilities

• Recognition
• Should an asset or liability be recognized in the financial statements?
• Measurement
• How should asset and liability values be initially measured?
• Do we adjust the values over time?
• When do we remove them?
• Historical Cost – how much did you pay to acquire the assets?
• Objective, easy to measure, but can get out of date
• Fair value – what is the asset worth today?
• Potentially of greater relevance, but often difficult to estimate
32

Assets

• An ASSET is a resource that is expected to provide future economic

benefits (i.e. generate future cash inflows or reduce future cash outflows).
• An asset is recognized when:
• It is acquired in a past transaction or exchange
• The value of its future benefits can be measured with a reasonable
degree of precision
33

Assets

• Coca-Cola
• No line item that says “brand value”
• Hard to measure
• If Pepsi bought Coca-Cola
• Would be an exchange that would show on the balance sheet
• ”People” will never be a line item on a balance sheet
34

Examples

• Financial (usually measured at market value)

• Real (Physical) – often measured at historical cost
• Intangible – usually measured at historical cost
• Contractual: license, patent
• Indefinite life: brand name
• Goodwill (only recognized as a part of acquisitions)
• Accounting rules are reluctant to recognized internally developed intangible
assets
• Research and development costs are expensed
• Advertising costs are expensed
• IFRS is more willing to recognize these “softer” assets
35

Which of the Following are Recognized as Assets on Balance

Sheets?
• Cash
• Accounts receivable
• Customers’ promises to buy products in the future
• Prepaid insurance
• Inventory
• Brand name
• Discovery of a new medicine
• Competitor goes bankrupt
• Hire a new CEO
36

Liabilities

• A LIABILITY is a claim on assets by “creditors” (non-owners) that

represents an obligation to make future payment of cash, goods, or
services
• Not all liabilities will show up on the balance sheet
• Liabilities to be settled more than a year in advance are generally
measured at their present value
37

Which of the Following are Liabilities?

• Accounts payable
• New customer signs a contract to buy product in the future
• Receipt of payment in advance of providing service
• Long-term debt
• Product warranties
• Employee pensions
• Lawsuit is filed against the company
38

Shareholders’ Equity

• SHAREHOLDERS’ EQUITY is the residual claim on assets after settling

claims of creditors (i.e. assets – liabilities)
• Types of Shareholders’ Equity:
• Contributed capital
• Common stock (IFRS calls this Share Capital)
• Additional paid-in-capital (IFRS calls this Share Premium)
• Retained Earnings
• Retained Earningsxx01 = Retained Earningsxx00 + Net Incomexx01 –
Dividendsxx01
• Treasury Stock (Repurchase some of our Own Shares)
39

Capital Structure

• Capital Structure is the way the firm has financed its assets
40

Differences Between Debt and Equity

• Contractual
• Payments to debt-holders are usually contractually specified (interest
and principal)
• Equity holders are “hoping” to get something (dividends & capital gains)
• Voting
• Equity holders get to vote
• Priority of Claims
• Debt holders get paid first but their return is capped
• Equity holders get nothing if the firm does poorly but get all the upside if
the firm does well
41

Financial Statement Differences Between

Payments to Debt Holders vs Equity Holders
• Interest is subtracted in the calculation of net income, dividends are not
• Interest is tax-deductible, dividends are not
42

Leverage

• The amount of debt vs equity in the capital structure

Financial Acumen for Non-Financial
Managers
Case 1, Part 1 – Balance Sheet Transactions

Richard A. Lambert, Professor of Accounting

44

Recording Transactions – Acme Inc.

• For each transaction, we will

1. Decide whether to record the transaction in the financial statements
2. Record the transaction (if appropriate)
3. After recording the transaction, make sure that
Assets = Liabilities + Stockholders’ Equity
45

Issue Shares

a) Shareholders begin a new business, Acme, Inc., on the first day of the
year. The firm raises $60,000 of cash in exchange for 1,000 shares of
common stock.
ASSETS = LIABILITIES + OWNERS’ EQUITY

+60,000 Cash + 60,000 Common Stock

(or Paid in Capital)
NOTE: Even though Owners’ Equity went up, there is no impact on Net
Income here! WHY NOT?
46

Purchase Land and Building

b) Acme, Inc. purchases land and a building for $50,000 in cash. Of the total
cost, $14,000 is allocated to land and $36,000 to the building
ASSETS = LIABILITIES + OWNERS’ EQUITY
- 50,000 Cash
+14,000 Land
+36,000 Building
NOTE: Even though cash has been spent, there is no impact on Net Income
or Owners’ Equity.
Accounting distinguishes between:
• cash outflows that are assets (they still have a future benefit)
• cash outflows that are expenses (the benefit has been used up or received)
47

Purchase Inventory on Credit

c) Merchandise for resale (inventory) was purchased for $30,000 on account

(for credit rather than cash). The goods were marked to sell for $50,000.
ASSETS = LIABILITIES + OWNERS’ EQUITY

+30,000 Inv. +30,000 Accts Pay

Inventory is not marked at $50,000

Mark to market accounting allow you to record in income and

owners’ equity before actual sale
48

Hire Employees

d) On the first day of the month, three employees were hired. Their expected
wages for the first year were $45,000 or $3,750 per month.
ASSETS = LIABILITIES + OWNERS’ EQUITY

No Entry
49

Account Balances to Date

Summary of Acme Transactions

Shareholder Equity
Asset Accounts Liability Accounts Accounts
Accts Wages Common Retained
Cash Receiv Inventory Land Build Accts Pay Pay Div Pay Stock Earnings
(a) 60,000 60,000
(b) -50,000 14,000 36,000
(c ) 30,000 30,000
(d)

Balance 10,000 0 30,000 14,000 36,000 30,000 0 0 60,000 0

90,000 30,000 60,000

Financial Acumen for Non-Financial
Managers
Application to Real World Financial Statements
Large U.S-Based Multinational Consumer Goods Company
Richard A. Lambert, Professor of Accounting
51
52

Goodwill

• When you make an acquisition, you assign the purchase price to all the
individual assets and liabilities that you have acquired
• Value them at what you think their current fair value is (not the amount they
were listed on the other company’s books)
• This also means assign a value to any intangibles you’ve acquired (brand
names, patents, etc.)
• If the total purchase price exceeds the sum of the above individual fair
values (and it usually does), the rest is allocated to Goodwill
53

Liabilities

• Short Term – due within one year

• Long Term – due more than a year from now
• The footnotes will usually give you more information about when they’re
due
54
55

Common Sized Balance Sheet

• Very useful tool in analyzing financial statements

• Divide everything on the balance sheet by that year’s total assets
• Tells you the percent of your total assets in each category
• Helps illuminate structure of your assets
• Especially useful in comparing companies of different size
• For Xsite
• Goodwill is 40% of total assets
• Other intangibles are 22%
56

Xsite – Common Size Balance Sheet – Assets

Assets 2xx3 2xx2

CURRENT ASSETS
Cash and cash equivalents 4.3% 3.4%
Accounts Receivable 4.7% 4.6%
Inventories 5.0% 5.1%
Deferred income taxes 0.7% 0.8%
Prepaid expenses and other 2.6% 2.8%
TOTAL CURRENT ASSETS 17.2% 16.6%

PROPERTY, PLANT and EQUIPMENT 15.6% 15.4%

GOODWILL 39.6% 40.7%
TRADEMARKS AND OTHER INTANGIBLES 22.7% 23.4%
OTHER NONCURRENT ASSETS 4.9% 3.9%
TOTAL ASSETS 100.0% 100.0%
57

Xsite – Common Size Balance Sheet – Liabilities and

Shareholders’
58

Income

• Income (Profitability) is a measure of the performance of the company during a

period of time
• The Income Statement helps link CHANGES IN BALANCE SHEETS
• Income feeds into the Retained Earnings Account on the balance sheet
• Retained Earnings Represents the CUMULATIVE INCOME of the firm (net of what
has been paid out as a dividend)

Retained Earningsend = Retained Earningsbeg + Income This Year – Dividends this Year
59

Relationship Between Financial Statements

Balance Sheet at 12/31/00

Assets = Liabilities + Shareholders’ Equity
Cash + Noncash assets = Liabilities + Contributed Capital + Retained Earnings

Income Statement
For the Year
(Minus Dividends)

Cash + Noncash assets = Liabilities + Contributed Capital + Retained Earnings

Balance Sheet at 12/31/01

60

Accrual Accounting

• Income is not the same as cash flow

• ACCRUAL ACCOUNTING - the recognition that revenues and expenses
are tied to business activities, not necessarily to cash flow
• Income measures the increase in economic value from a transaction or
event
• Cash flow measures the receipt of that value in the form of cash
• The difference is one of TIMING
61

Income Statement Format

The Income Statement generally has the following format:

Revenue (or Sales)
- Cost of Goods Sold
Gross Profit
- Operating (SG&A) Expense
Operating Income
- Interest, Other Gains, and Losses
Pre-tax Income
- Income Tax Expense
Net Income
62

Revenue

• Revenue is an increase in shareholders’ equity (not necessarily cash) from

providing goods or services
• Revenue is recognized when both:
• It is earned (i.e. goods or services are provided) and
• It is realized (i.e. payment for goods or services received in cash or
something that can be converted to a known amount of cash)
63

Expenses

• Expenses are the decreases in shareholders’ equity (not necessarily cash)

that arise in the process of generating revenues
• Expenses are recognized when either:
• Related revenues are recognized (product costs) or
• Incurred, if difficult to match with revenues (period costs and unusual
events)
• The underlying recognition concepts are the
• Matching principle (product vs. period costs)
• Conservatism principle: recognize anticipated losses immediately,
recognize anticipated gains only when realized
Financial Acumen for Non-Financial
Managers
Income, Revenue, and Expenses

Richard A. Lambert, Professor of Accounting

65

Income

• Income (Profitability) is a measure of the performance of the company during a

period of time
• The Income Statement helps link CHANGES IN BALANCE SHEETS
• Income feeds into the Retained Earnings Account on the balance sheet
• Retained Earnings Represents the CUMULATIVE INCOME of the firm (net of what
has been paid out as a dividend)

Retained Earningsend = Retained Earningsbeg + Income This Year – Dividends this Year
66

Relationship Between Financial Statements

Balance Sheet at 12/31/00

Assets = Liabilities + Shareholders’ Equity
Cash + Noncash assets = Liabilities + Contributed Capital + Retained Earnings

Income Statement
For the Year
(Minus Dividends)

Cash + Noncash assets = Liabilities + Contributed Capital + Retained Earnings

Balance Sheet at 12/31/01

67

Accrual Accounting

• Income is not the same as cash flow

• ACCRUAL ACCOUNTING - the recognition that revenues and expenses
are tied to business activities, not necessarily to cash flow
• Income measures the increase in economic value from a transaction or
event
• Cash flow measures the receipt of that value in the form of cash
• The difference is one of TIMING
68

Income Statement Format

The Income Statement generally has the following format:

Revenue (or Sales)
- Cost of Goods Sold
Gross Profit
- Operating (SG&A) Expense
Operating Income
- Interest, Other Gains, and Losses
Pre-tax Income
- Income Tax Expense
Net Income
69

Revenue

• Revenue is an increase in shareholders’ equity (not necessarily cash) from

providing goods or services
• Revenue is recognized when both:
• It is earned (i.e. goods or services are provided) and
• It is realized (i.e. payment for goods or services received in cash or
something that can be converted to a known amount of cash)
70

Expenses

• Expenses are the decreases in shareholders’ equity (not necessarily cash)

that arise in the process of generating revenues
• Expenses are recognized when either:
• Related revenues are recognized (product costs) or
• Incurred, if difficult to match with revenues (period costs and unusual
events)
• The underlying recognition concepts are the
• Matching principle (product vs. period costs)
• Conservatism principle: recognize anticipated losses immediately,
recognize anticipated gains only when realized
Financial Acumen for Non-Financial
Managers
Case 1, Part 2 – Revenue and Expense Transactions

Richard A. Lambert, Professor of Accounting

72

Recording Transactions – Acme Inc.

• For each transaction, we will

1. Decide whether to record the transaction in the financial statements
2. Record the transaction (if appropriate)
• Determine which “accounts” are affected
• Determine how much they are increased or decreased
3. After recording the transaction, make sure that
Assets = Liabilities + Stockholders’ Equity
73

Sale of Inventory for Cash

e) Merchandise that had cost $5,000 was sold for $8,000 in cash.

ASSETS = LIABILITIES + OWNERS’ EQUITY

- 5,000 Inventory
+ 8,000 Cash +3,000 Ret Earnings
(we would record this as
Revenue of $8,000 and
Cost of Goods Sold of $5,000)
74

Partial Payment to Supplier

f) The supplier from whom the merchandise was purchased (in transaction
c) was paid $17,000 cash on account. At the same time, orders were
placed for additional merchandise at a cost of $9,000.

ASSETS = LIABILITIES + OWNERS’ EQUITY

-17,000 Cash -17,000 Accounts Payable

No Entry for the new order (yet)

75

Sale for Cash and Credit

g) Inventory that had cost $15,000 was sold for $25,000. This time, only
$6,000 of the sale price was received in cash; the balance was due in 30
days.

ASSETS = LIABILITIES + OWNERS’ EQUITY

- 15,000 Inventory
+ 6,000 Cash
+19,000 Accts Receivable +10,000 Retained Earn

Revenue of $25,000
Cost of Goods Sold of $15,000
76

Collect From Customers

h) $2,000 in cash was received from customers on account.

ASSETS = LIABILITIES + OWNERS’ EQUITY

+2,000 Cash
- 2,000 Accounts Receivable
77

Receive Inventory

i) The inventory ordered previously (transaction f) was received, but it was

not paid for yet.

ASSETS = LIABILITIES + OWNERS’ EQUITY

+9,000 Inventory +9,000 Accts Payable

78

Pay Dividend

j) At the end of January, the directors declared and paid a dividend of

$3,000.

ASSETS = LIABILITIES + OWNERS’ EQUITY

-3,000 Cash -3,000 Retained Earn

Note: that this does not reduce net income; it is a direct deduction from retained
earnings
A dividend is a not a cost of generating income; it is a distribution of income back
to shareholders
Account Balances To Date

Summary of Acme Transactions

Shareholder Equity
Asset Accounts Liability Accounts Accounts
Accts Wages Common Retained
Cash Receiv Inventory Land Build Accts Pay Pay Div Pay Stock Earnings
(a) 60,000 60,000
(b) -50,000 14,000 36,000
(c ) 30,000 30,000
(d)
(e) 8,000 -5,000 3,000
(f) -17,000 -17,000
(g) 6,000 19000 -15000 10000
(h) 2,000 -2000
(i) 9000 9000
(j) -3000 -3000

End Bal 6,000 17,000 19,000 14,000 36,000 22,000 0 0 60,000 10,000

92,000 22,000 70,000

Financial Acumen for Non-Financial
Managers
Adjusting Entries

Richard A. Lambert, Professor of Accounting

81

Adjusting Entries

• The way events for which there are no underlying transactions or where no
cash has exchanged hands - are recorded
• Often done at the end of the period to record
• Tricky to keep track of because they generally don’t involve a specific
transaction or have any cash to point to
• Done when the firm already knows how good a year (or quarter) they’ve
had
82

Are There Other Things We Need to Record?

• Depreciation
• We don’t charge the entire purchase price of an asset to the period in
which it was bought if it will provide benefits beyond that
• Useful Life – benefit period of an asset
• Straight-line Depreciation
• Takes the purchase price of the asset and spreads it out evenly over the
useful life
Depreciation Expense = (Original Cost – Salvage Value) / Useful Life
83

Depreciation

• Straight-Line Depreciation
• To calculate, you need an estimate of what the salvage value is and
how long the asset is going to live
• Accounting convention for recording depreciation is not deducted from
the asset value directly
• Record the original asset cost and the accumulated depreciation in
separate accounts
• Net Book Value – the difference between the two
84

Adjusting Entries

• Allowance for Uncollectibles

• Allowance for Returns
• Income Tax Expense
• Mark to Market Adjustments
• Impairment Charges (Write Downs)
• Accrued Interest Expense or Income
Financial Acumen for Non-Financial
Managers
Case 1, Part 3 – Adjusting Entries

Richard A. Lambert, Professor of Accounting

86

Are There Other Things We Need to Record?

• Some events occur during a period for which

• There is no explicit transaction
• There is no cash flow (this period)
87

Recording Transactions – Acme Inc.

• For each transaction, we will

1. Decide whether to record the transaction in the financial statements
2. Record the transaction (if appropriate)
• Determine which “accounts” are affected
• Determine how much they are increased or decreased
3. After recording the transaction, make sure that
Assets = Liabilities + Stockholders’ Equity
88

Accrued Wages

k) The employees worked for one month and their total wages were $4,000,
payable the first day of the following month. Each employee received a
raise of $100 per month effective on the first day of the next month.

ASSETS = LIABILITIES + OWNERS’ EQUITY

+4,000 Wages Pay -4,000 Ret Earnings

No Entry for the Raise (yet)

89

Depreciation

l. Acme, Inc. estimated that it expected to use the building (transaction b) for
ten years before replacing it. During the first month the market value of
the real estate had increased two percent.

ASSETS = LIABILITIES + OWNERS’ EQUITY

- 300 Building - 300 Retained Earnings

Building Cost $36,000 / 10 years = $3,600 of depreciation per year, or $300

per month
What do we do about the market value increase?
90

Accounting Self-Corrects Over Time

• What if we keep depreciating the building $300 per month?

• At the end of 10 years, the book value is now zero
• What if we sell it at that point for $100,000?
• We’d record a gain on sale of $100,000
• The cumulative impact on income we reported was depreciation expense of
$36,000 & a gain on sale of $100,000, for total income of $64,000
• This exactly matches the difference between what we paid for it and what
we’d sold it for
• If instead, we’d depreciated it down to $10,000 and sold it for $100,000
• We’d have a gain on sale of $90,000, & total depreciation over the years
would have been $26,000. The total again matches the net cash flow
• Any errors accounting makes will eventually self-correct, but sometimes it
can take a long time
Summary of Transactions
Summary of Acme Transactions
Shareholder Equity
Asset Accounts Liability Accounts Accounts
Accts Wages Common Retained
Cash Receiv Inventory Land Build Accts Pay Pay Div Pay Stock Earnings
(a) 60,000 60,000
(b) -50,000 14,000 36,000
(c ) 30,000 30,000
(d)
(e) 8,000 -5,000 3,000
(f) -17,000 -17,000
(g) 6,000 19000 -15000 10000
(h) 2,000 -2000
(i) 9000 9000
(j) -3000 -3000
(k) 4000 -4000
(l) -300 -300

End Bal 6,000 17,000 19,000 14,000 35,700 22,000 4,000 0 60,000 5,700

91,700 26,000 65,700

92

Balance Sheet – U.S.

Assets Liabilities and Shareholders’ Equity

Current Assets Current Liabilities
Cash $6,000 Accounts Payable $22,000
Accounts Receivable $17,000 Wages Payable $4,000
Inventory $19,000 Total Current Liabilities $26,000
Total Current Assets $42,000 Long Term Liabilities $0
Long Term Assets Total Liabilities $26,000
Land $14,000
Building: Shareholders’ Equity
Original Cost $36,000 Common Stock $60,000
Less Accum Deprec 300 $35,700 Retained Earnings $5,700
Total Long Term Assets $49,700 Total Shareholders’ Equity $65,700
Total Assets $91,700 Total Liabilities Plus Shareholders’ Equity $91,700
93

Income Statement - Acme

Revenue $33,000
Cost of Goods Sold 20,000
Gross Profit $13,000

Wages Expense $4,000

Depreciation Expense 300
Other Expenses 0

NET INCOME $8,700

94

Statement of Stockholders’ Equity

Common Retained Total

Stock Earnings
Beginning Balance $0 $0 $0

Shares Issued +$60,000 +$60,000

Net Income +$8,700 +$8,700
Dividends Paid -$3,000 -$3,000

Ending Balance +$60,000 +$5,700 +$65,700

Financial Acumen for Non-Financial
Managers
Application to Real World Financial Statements
Large U.S.-Based Multinational Consumer Goods Company
Richard A. Lambert, Professor of Accounting
96

Income Statement (Statement of Earnings)

• Tells us the profitability during a period of time (a year)

97
98
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Year to Year Comparison

• Sales in increasing
• Earnings are positive, but growth is up and down
100

Recurring vs Non-Recurring Items

• Earnings reports things that happened, but not all of them are likely to recur
• Recurring items are more important from a valuation (looking ahead)
perspective
• Analysts try to separate recurring from non-recurring items
• What is an Impairment Charge (write down)?
• Review assets to re-evaluate and write them down to actual lower value
• Writing them down means the asset and owner’s equity moves down
101

Margin Analysis

• Take the Income Statement and divide everything by that year’s Sales
Revenue
• This gives each expense item as a percent of revenue
• It helps reveal the structure of your costs
• It tells you how each dollar of sales gets “eaten up” by different kinds of
costs and how much is left over for profits
Margin Analysis (Common Size Income Statement)

Xsite Inc.
Consolidated Statement of Earnings
2xx3 2xx2 2xx1
Net Sales 100.0% 100.0% 100.0%
Cost of Products Sold 50.4% 50.7% 48.5%
Selling, general and administrative expense 32.0% 31.6% 31.1%
Goodwill and indefinite-lived asset impairment 0.4% 1.9% 0.0%
OPERATING INCOME 17.2% 15.9% 20.4%
Interest Expense 0.8% 0.9% 1.0%
Interest Income 0.1% 0.1% 0.1%
Other non-operating income, net 1.1% 0.2% 0.3%
EARNINGS FROM CONTINUING OPERATIONS 17.6% 15.3% 19.8%
Income Taxes on Continuing Operations 4.1% 4.1% 4.0%
NET EARNINGS FROM CONTINUING OPERATIONS 13.5% 11.1% 15.8%