Accounting And Financial Statements For Lawyers Outline

Accounting & Financial Statements

Fall 2015

University of Virginia School of Law

Financial Statements:

• Decision usefulness: (1) reliability (faithful representation) , (2) relevance (timeliness) , and (3) comparability (entities) /consistency (years, org) . (Lemons problem: judgments, asymmetric information, really what worth?)

  • Convenience/Objectivity/Relevance/Reliability/Conservatism/Consistency/Comparability/Faithful-Representation

• Conservatism: use method least likely to overstate value, recognize revenues too early, expenditures too late, or understate liabilities

• Users: management/investors/debt-holders/government/shareholders

• BALANCE SHEET: financial position at point in time using accounting equation (statement of financial position/condition)

  • Assets (liabilities): entity’s probable future (sacrifices of) economic benefit (from present obligations to transfer assets/provide services to other entity in future) from past transaction/event

    • Current Assets: expected conversion to cash within 1yr or operating cycle

      • Cash

      • Accounts Receivable

      • Inventory

      • Prepaid obligations

      • Marketable securities

      • Short term investments

    • Noncurrent (Capital) Assets

      • Property, plant and equipment

        • Net of accumulated depreciation

      • Intangible assets

        • Net of accumulated amortization

      • Land (never depreciated)

    • Deferred tax assets: Current/Noncurrent

    • Goodwill

    • Fixed assets

  • Liabilities:

    • Current liabilities (payment w/in 1yr/accounting period)

      • Accounts Payable/Wages/Interest/Taxes/Current Loans Payable

    • Noncurrent Liabilities/Long-term debt

      • Bonds/Taxes/Noncurrent Loans Payable

      • Deferred Tax Liability

  • Shareholders’ Equity; residual interest in assets after deducting liabilities

    • Contributed Capital

      • Common Stock

        • Par Value

        • Additional Paid in Capital

      • Preferred Stock

    • Accumulated other comprehensive income/loss: unrealized gain/loss b/c item not settled

    • Treasury Stock at cost (contra): purchase back, intent re-distribute

    • Earned Capital

      • Retained Equity=Net Income–dividends

• Income Statement: revenue--expenses for fiscal year (statement of earnings, statement of operations)

  • Revenue

    • Operating revenue

    • Revenue from peripheral activities

    • E.g. Continued Operations, other peripheral activities (separate from normal business, or discontinued (e.g. selling business)

  • (Cost of revenue/goods sold)

  • Gross profit

  • (Operating expenses)

    • Wages, salaries, etc.

    • Cost of discontinued activities

    • Depreciation and amortization

    • E.g. Continued Operations, other(separate from normal business, or discontinued(e.g. selling business)

  • Operating Income

  • (Interest Expense)

  • (Taxes)

  • Net Income: before dividends paid

  • Extraordinary gains (losses): “unusual nature/infrequent occurrence” – reported after income from continued operations, less taxes (store closing, class action, regulatory/accounting changes, earthquakes)

• Statement of Cash Flows

  • Start w/last year’s Balance Sheet cash, end w/this year’s

  • Methods:

    • Cash Flow activity groups

      • Operating activity (either direct or indirect)

      • Financing activity (only direct)

      • Investing activity (only direct)

    • Direct: add cash from all activities (~10% companies do for operations, required for investing/financing)

      • Cash Flows from Operating Activities: indirect->direct method

        • Cash from Sales (Revenues - Accounts Receivable)

        • -Cash for Cost of Goods Sold (=Cost of Goods Sold + increase in inventory–Accounts Payable– depreciation)

        • -Cash for Operating Expenses

        • -Cash paid for investing activities (only if part of revenues)

        • -Cash for Interest

        • -Cash for Income tax=(Income tax–tax payable)

    • Indirect: start with Net Income/earnings and then subtract non-cash assets, add non-cash liabilities.

      • Operating/Investing/Financing Separate

      • Subtract positives contributions to Net Income that weren’t cash from operations

        • Accounts Receivable

        • Increase in inventory

        • Prepayments

        • Decrease in liabilities

        • Extraordinary gain

        • Investment gain

        • Inventory

      • Add back negatives that weren’t cash

        • Depreciation/Amortization (in Cost of Goods Sold)

        • Accounts Payable

        • Noncash compensation

        • Deferred tax liability

      • Add/subtract things not on Income Statement that were cash(because we use the accrual method)

        • Retainer for future years

        • Other non-accrued gains/losses

  • General Balance Sheet to Cash Flows activity category correspondence

    • Current assets-------------------operating

    • Noncurrent asset----------------investing/operating

    • Current liabilities----------------operating

    • Noncurrent liabilities------------financing

    • Capital stock----------------------financing

    • Retained Equity-----------------------------------operating/financing

  • Examples of Activities:

    • Operating

      • Current Assets and Liabilities

      • From Customers

      • Payments: Inventory/Wages/Taxes/Interest/Advertising

      • Pension Obligations

    • Investing

      • Dividends received

      • Marketable Securities

      • Buying/selling land/businesses/investments (see above for operating activities)

    • Financing

      • Dividends paid

      • Cash from stock issuance/sale

      • Loans/bonds

      • Principal Payments

  • Alternatives:

    • EBITDA: earnings before interest taxes depreciation amortization (earnings before bad stuff(EBBS) , pro forma earnings) -->uncommon, must disclose

    • Free Cash Flows: Cash Flows from operations–capital expenditures

      • Leftover after maintaining assets

    • Discretionary Cash Flows: Cash Flows from operations–required debt payments–dividend payments

      • Generated cash available for discretionary value-creating actions

• Statement of Shareholders’ Equity

  • Contributed Capital:

    • Common Stock: amount received from stock sales/(balance asset side)

  • Earned Capital:

    • Retained Equity: Net Income - Dividends

RATIOS

Benchmarking: compare w/competitors

Return on Equity Analysis

• ROE=(ROS) x(Asset Turnover) x(Financial Leverage) =(Net Income) /Shareholders’ Equity

  • =(Net Income/Net Sales) x(Net Sales/Total Assets) x(Total Assets/Shareholders’ Equity)

  • Net sales=remove discounts/returns)

  • Financial Leverage: Higher=more debt, 2: Shareholders’ Equity=L

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