What is accounting?

Set of methods for producing info for decision making. Reliable and reliable (or auditable).

  • Financial: External users (investors, creditors)
  • Managerial: Insiders (managers)

Business activities:

  • Financing (borrowing from creditors)
  • Investing (purchase resources)
  • Operating (day to day activities)

Fixed costs and variable costs

Fixed cost

Variable costs

  • Gross Profit Total revenue minus the cost of making product/providing service
  • Net Profit Gross Profit minus sales, administrative and general expenses (SG&A)

Depreciation vs Amortization

  • Depreciation: Decline value of a long-term asset. In Tangigle assets.
  • Amortization: Decline value of a long-term asset. In Intangible assets.

The four basic financial statements

  • Balance sheet:
  • Income statement
  • Statement of stockholders equity:
  • Statement of cash flows:

Other:

  • Accounting transaction: Economic event that affects assets, liabilities or SE.
  • Journal transaction: Expressing the effects of transactions on accounts.
  • General journal
  • T-accounts
  • General ledger
  • Trial balance
  • Adjusted trial balance
  • Income statement
  • Close temporary accounts
  • Balance sheet

sec.gov/edgar website Search for company filings 10-k annual finiancial reporting. google finance or yahoo finance to find ratios easily

TTM trailing

The disclosure process

SEC regulation FD, for “fair disclosure” requires that companies ..

Good news = earnings per share.

Prior years, same quarter

Financial analysts, market research, specialized in industries, the provide analysts forecasts.

Market expectation in media usually means the mean (analyst consensus) /median of all available forecasts.

Many companies report their own forecasts. The company has more information. Management forecasts means that the companies voluntarily (voluntary disclosure).

Some papers report that outsider analysts are better at forecasting than management forecasts.

graph LR A[Business strategy] --> B[Operating decisions] B --> C[Transactions] C --> D[Financial statements]

Gross profit for Costco is around 10%.

It is intentional that Costco to have low gross profit.

Current ratio = current assets/current liability.

current means that 1 year of business cycle.

The value of a company is coming from operations (finance activities does not add value to the company). Companies cannot add value from financial activities, just from operating activities.

How stock price is determined

Value of a co or stock price is decided by discounted sum all future expected dividends.

Operating cash flow.

100 dollars in the bank at interest rate r.
100 x (1.1) = 110
100 x (1.1)^2 = 121

Because many companies don’t do dividends, many professors with (bSE + NI - div = eSE).

Accounting valuation model

Real stock price is computed based on the number of transactions.

Financial assets cannot generate money above interest rate.

Ratios

ROE => Financial leverage

The DuPont Model

ROE = Net Profit Margin * Total asset turnover * Financial leverage

ROCE: The scheme

Profitability of overall company

Return on common equite

Accounting for value - Stephen Penman.

Financial statement

Preparing financial statement

                         2018
    |-------------------------------------------|
 12/31                                        12/31
  2017                                         2018
   B/S                                         eB/S

Many transactions happened in 2018. We want to summarize all those and prepare ending balance sheet

We can write that in the income statement.

Depreciation expense ( debit expense ^ , accumulated depreciation is a contra-asset).

With the closing process we get retained earnings and that we can put in the balance sheet.

Accounting for Net Sales Revenue

Economic resources that require sacrifice of … benefit.

Revenue recognition

Revenue recognition => when we can report in the income statement. Reporting revenues in the income statement.

We can do that Realized (cash is collected) or realizable AND earned (product delivered)

Account receivable. Is an asset, right to collect cash in the future.

The benefit of selling something on account is increasing revenue.

When companies accept credit cards, they cannot collect 100% (uncollectable receivables, called credit losses) if they become uncollectable as bad debt expense.

Expense recognition principle / matching principle

Under current GAAP. Based on recognition principle, report on the same period on when the revenue is recorded.

Revenues generated by this expense.

Match expense with revenue. US GAP requires certain method to report expenses in this way. Allowance method.

1. AR 1000 (company sold something on account)
   REV 1000

AR = 1,000 (some of these will not be collectable, the ammount of uncollectable ammount will be x) Lets say 5% of this AR will not be collectable.

The 5% goes to another account called allowance. This is when we recognize bad debt expense.

(Based on estimation)

2. Bad debt expense 50    Allowance 50
  • Expense = small thing / windshield / starbucks cup of coffee
  • Capitalize = turbo charger / milk

Once it actually happened:

3. Allowance 50    AR 50

Matching principle

The revenue and the expense must be reported in the same period.

2018   1. AR 1000       Rev       1000
   2. Bad debt 50   Allowance 50

2019   3. Allowance 50  AR        50

Let’s say the company that was bankrupt we realize we can now collect.

4. AR 30  Allowance 30
   Cash 30   AR 30

Inventory

  • Merchandisers: WalMart, Costco = Purchase finished goods from suppliers. Ready for re-sale.
    • Finished goods inventory
  • Manufacturers: Boeing, Toyota
  • Raw materials inventory
  • Work in process inveontory
  • Finished goods inventory

Inventory costs includes the costs to bring an article to usable or salable condition and location.

Actual flow. Cost flow. (Assumed flow, based on assumptions)

Inventory costing methods

  • Specific identification (diamonds)
  • First-in, first-out
  • Last-in, first-out
  • Average cost

Merrimack Tractors and Mowers Cost flows might not be the same as actual flow. Assumptions of inventory can be LIFO, FIFO, average.

Beginning balance + Purchases - CGS = Ending balance

For Merrimack case 8. We need to change the beginning balance assumption from LIFO to FIFO.

LIFO reserve, companies need to report the LIFO reserve.

Beginning balance in LIFO = 13.5M
Beginning balance in FIFO = 13.5M + 5.5M = 19M
  • Inflation: Prices go up. You want to buy right away because prices will go up.
  • Deflation: Prices go down. If you expect prices to go down then people will NOT buy because they will always wait (to get a cheaper price).

Program Cost Accounting

EDGAR: https://www.sec.gov/edgar/searchedgar/companysearch.html

Revenue recognition principle

  • Goods and services have been transferred to customers.
  • The appropriate amount of revenue to record is the amount the seller expects to receive.

Allowance method

Inventory cost assumptions (FIFO, LIFO)

  • Merchandisers
  • Manufacturers

Program cost accounting