Financial statements Flashcards
Usefulness of accounting
This is where accounting is useful, so we can see underlying profit, dealing with the issue of money owed
Cash based accounting
Dollars in vs dollars out, looking at cash inflows or outflows. Does not look at the substance of transaction, e.g. customer who will pay in the future with great certainty
Typically used by small businesses
Accrual based accounting
Captures underlying profit irrespective of how much cash went in and out. Capture true underlying substance to give true profit. Use this to remove distortions of only using cash based
Required by GAAP for public comapnies. This provides a long term image of profitability, which is benefical for investors as it leads to simpler calculations. Match expenses with associated revenue
Accounting
Shows us underlying or Accrual -based profit which is distinct from cash profit. Takes transactions and organises them into the three financial statements to analyse the performance of a firm in accoradnce with a set of rules and standards
Income statement
Shows earning/ profit over a period of time (underlying earnings, not simply cash)
Balance sheet
Where our balances stand at a point in time. Cumulative accounts. How much we owe and how much we are owed
Cash flow statement
Income statement doesn’t show cash, so we take the underlying profit from income statement and obligations and assets to assess how much cash flows through the company
Core accounting critical principles
Accrual
Record transactions according to their substance, not when cash flows
Core accounting critical principles
Revenue Recognition
Record revenue when revenue is earned and complete and not when cash is earned. For example, when paying using credit card
* Creates the distinction between accural and cash accounting
E.g. If you sell tickets in November for a Janurary concert, you cannot record revenue until Janurary, where firm has fufilled its obligation
Core accounting critical principles
Matching principle
Record expenses with the revenue they helped to create. Record cost with revenue even before cash has moved
Core accounting critical principles
Historical cost
All assets, liabilities and equity is recorded at the original purchase price and not the current price
Core accounting critical principles
Conservatism
Need to be conservative in all recordings. Record as soon as we can and typically at a lower value.
Core accounting critical principles
Cost principle
Core accounting critical principles
Consistency
Adopt rules and stick to them
Core accounting critical principles
Economic entity
Business is an entity. Recording business activity separate from the owner.
Core accounting critical principles
Growing concern
Assume business has the ability to continue to operate in the future, unless there is contrasting evidence.This allows businesses to take in debt and depreciate assets
Core accounting critical principles
Materiality
Not going to report things that do not meaningfully impact numbers.
Core accounting critical principles
Monetary unit
Lay everything out in quantifiable terms, in a monetary form, everything has to be tangible/ currency based
Core accounting critical principles
Reliability
Need to record based on reliable information
Core accounting critical principles
Time period
Need to record in consistent time periods.
The accounting equation
Creates a system to comprehensively aggregate all the transactions we have recorded
Revenue recognition (Record transaction when the customer pays at the time of sale and if they say that they will pay later) and match principle (E.g. Make a sale and therefore record expense but if we tell the supplier we will pay later, we still incurr the expenses. Capture expenses in the same revenue they helped to create.) and matching principle in action. Capture expenses in the same revenue they helped to create.
****Assets= Liabilities + Owners equity****
GAAP & SEC
- GAAP - Account standarsds used to prepare financial statements
- SEC protecting investors interests and the stcok market through requiring all public companies publsh their financial statements in accordance with GAAP
Different k (E.g. 8k, 10k)
8k: Notify investors of master events
10k: Abbuak report that provides comprehensive information about a comapny’s financial information
Item 1: Business
* Industry
* Products and services
* Target customers
* Competiton
Item 7:
* Significanct events affecting sales
* Revenue of products and sales
* Operating performance by region
* Company mergers
Item 8
* Income statements: Shows profitability
* Balance sheet: Shows how assets are paid for
* Cash flow statement: How much cash is in possession
Assets
Assets: What we own or are owed (E.g. Equipment)
* Anything that a company owns that has future economic value and can converted into cash or used to generate revenue. There are two types current (e.g. accounts receivable ) and non-current (PP&E and long terms investments such as stocks and bonds in other companies). Provide image of a companies an image of a companies financial strength. Stronger asset base = stronger place to invest in
Operating assets: Assets that a company uses in its day-to-day operations to generate revenue. Essential to carry our core business activiites and directly linked to the companies profits. Examples include
* PP&E: Tangible assets that a company uses to produce goods or services such as machinery
* Inventory: This includes raw materials, work in progress adn finished goods that the company holds for sale in the ordinary course of business
* Accounts recievables: These are the amounts owed to a company by its cutsomers for goods or services provided on credit
* Intangible assets: These are non-physical assets that hold value such as patents, trademarks and copyrights
Non- operating assets: Not directly involved in a company’s core business operations. They do not contribute to the company’s revenue generation and are not essential for the company’s day to day function. Examples include:
* Investments: Financial asstes that a company holds for the purpose of generating income or capital appreciation such as stock, bonds or real estate.
* Excess cash: This is cash a company holds above its operating requirements. Excess cash is not required for the company’s day to day operations and can be used for other purposes, such as paying down debt or making acquisitions.
* Non-operating real estate: This includes any real estate that a company owns but does not use in its core business operations such as vacant land
