session 4 handout

8/8/2019 Session 4 Handout

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objectives of financial reportingobjectives of financial reportingobjectives of financial reportingobjectives of financial reporting

FASB statement of Concepts No.1Objectives of financial reporting bybusiness enterprises

Information useful in investment andcredit decisions

information useful in assessing cash flow

prospects Information about enterprise resources,

Claim to those resources, and changes inthem


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qualities of accounting informationqualities of accounting informationqualities of accounting informationqualities of accounting information

What make accounting informationuseful?

RelevanceReliability

Understandability

Comparability

Consistency


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GAAPGAAPGAAPGAAP

Generally Accepted AccountingPrinciples - established rules,

principles, and concepts Formulated by Financial Accounting

Standards Board (FASB)


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PRINCIPLES/CONCEPTSTHATPRINCIPLES/CONCEPTSTHAT

INFLUENCETHEACCOUNTINGINFLUENCETHEACCOUNTING

PRACTICIESPRACTICIES

PRINCIPLES/CONCEPTSTHATPRINCIPLES/CONCEPTSTHAT

INFLUENCETHEACCOUNTINGINFLUENCETHEACCOUNTING

PRACTICIESPRACTICIES


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Entity ConceptEntity ConceptEntity ConceptEntity Concept

Accounting Entity organization thatstands apart as a separate economic

unit


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Accounting [time] periodAccounting [time] period

principleprinciple

Accounting [time] periodAccounting [time] period

principleprinciple Life span of a business is divided

into equal periods for the purpose

of reporting 12-month accounting period =

fiscal year

How this meets the requirement

of comparability?


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conservatism principleconservatism principleconservatism principleconservatism principle

Accountants tend to understateassets and income and overstate

expenses and liabilities And do not anticipate gains but do

anticipate losses


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disclosure principledisclosure principledisclosure principledisclosure principle

Accounting information coversevents in the past

Additional information needed tomake decision

It is required to be understandable

That is why disclosure is required!That is why disclosure is required!


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matching principlematching principlematching principlematching principle

Which attribute to the generation

of revenue this period must be

assigned for this period

Accrual basis accounting vs. Cash

basis accounting


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assets or expensesassets or expensesassets or expensesassets or expenses

When the cost is incurred?

When the cost brings in benefits to

the business?

What effects this identification has

up on the financial statement?


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materialitymaterialitymaterialitymateriality

Enough in $ amount to record?

Will it influence my decisions?

Return to the question of assets or

expenses


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Format of Statement of

Cash Flows


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The Primary Purpose of theThe Primary Purpose of theStatement of Cash FlowsStatement of Cash Flows

The Primary Purpose of theThe Primary Purpose of theStatement of Cash FlowsStatement of Cash Flows

To provide information about:

cash receipts,

cash payments, and

the net change in cash resulting from:

operating,

investing, and

financing activities of a companyduring a period.


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Usefulness of theUsefulness of the

Statement of Cash FlowStatement of Cash Flow

Usefulness of theUsefulness of the

Statement of Cash FlowStatement of Cash Flow The entitys ability to generate future

cash flows.

The entitys ability to pay dividendsand meet obligations.

The reason for the difference betweennet income and net cash provided

(used) by operating activities. The cash investing and financingtransactions during the period.


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Types of Business ActivitiesTypes of Business ActivitiesTypes of Business ActivitiesTypes of Business Activities

Operating activities

Investing activities

Financing activities

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Operating ActivitiesOperating ActivitiesOperating ActivitiesOperating Activities

Transactions that make up netincome

Also affect current assets and currentliabilities on the balance sheet

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Investing ActivitiesInvesting ActivitiesInvesting ActivitiesInvesting Activities

Transactions that increase anddecrease long-term assets

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Investing ActivitiesInvesting ActivitiesInvesting ActivitiesInvesting Activities

Inflows

Selling long-termproductive assets

Selling equityinvestments

Collecting ofprincipal on loans

Other

Outflows

Purchase long-termproductive assets

Purchase equityinvestments

Purchase debtinvestments

Make loans

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Financing ActivitiesFinancing ActivitiesFinancing ActivitiesFinancing Activities

Transactions involving obtaining cashfrom the owners or returningresources to them

Also involves obtaining cash fromcreditors and repaying the amountborrowed

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Financing ActivitiesFinancing ActivitiesFinancing ActivitiesFinancing Activities

Inflows

Issuing stock

Issuing bonds and

notes

Outflows

Cash dividends orwithdrawals by

owner Purchase treasury

stock

Repay cash loans

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Two acceptable methods forreporting cash flows from operatingactivities

1. Indirect method

2. Direct method

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Indirect MethodIndirect MethodIndirect MethodIndirect Method

Cash flows from operating activities:

Net income

Adjustments to reconcile net income to net cashprovided by operating activities:

+ Depreciation / amortization/depletion expense+ Loss on sale of long-term assets

- Gain on sale of long-term assets

- Increases in current assets other than cash

+ Decreases in current assets other than cash+ Increases in current liabilities

- Decreases in current liabilities

Net cash provided by operating activities

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practicespracticespracticespractices

E13-14, E13-16

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Direct MethodDirect MethodDirect MethodDirect Method

Cash flows from operating activities:Receipts:Collections from customersInterest received

Dividends receivedTotal cash receiptsPayments:To suppliersTo employees

For interestFor income tax

Total cash paymentsNet cash provided by operating activities

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Indirect MethodIndirect MethodIndirect MethodIndirect Method

Most companies favor the indirect method

for the following reasons:

it is easier to prepare

it focuses on the differences between net

income and net cash flow from operating

activities

it tends to reveal less company informationto competitors.


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TEAMWORKTEAMWORKTEAMWORKTEAMWORK

Article the language of Cash Flow

Discuss What are types of cash flows presented in a

statement of cash flows and meanings of these

information Relationship b/w statement of cash flows and the

other two statements (BS, IS)

What criterion was previously used to measure thepreformance of the firms?

Nowaday, what measure do investors prefer inassessing a firms performance? How to calculate?

What non-financial factors need to take intoconsideration when interpreting cash flowinformation?

session 4 handout

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