2. Intr. fin. Statements and Other Fin. Reporting Topics.ppt

Introduction to Financial
Statements and Other
Financial Reporting Topics
Chapter 2
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duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter 2, Slide #2
Sole
Proprietorship Partnership Corporation
Number of owners 1
2 or more
(partners)
Numerous
(shareholders)
Legally separate from
owners
No No Yes
Owners liable for
business debts
Yes Yes No
Profits taxable To the owner
To the
owners
To the
corporation as
earnings;
to the owners
when dividends
are received
Modified form
“LLC”
limits liability of owner; may
increase income tax
exposure
“Subchapter S”
profits are
taxed at
ownership level
only
Forms of Business Entities

Chapter 2, Slide #3
• Income statement
• Statement of stockholders’ equity
• Balance sheet
• Statement of cash flows
• Support for the financial statements is
provided by notes
The Financial Statements

Chapter 2, Slide #4
• Dated for a specific
period
• Summarizes
revenues and
expenses
• Reports net income
– Excess of revenues
over expense
• Net income
increases retained
earnings
Income Statement
For the Year Ended Dec. 31, 2011
Revenue $ 120,000
Expenses (100,000)
Net Income $ 20,000
Income Statement

Chapter 2, Slide #5
Income Statement
For Year Ending December 31, 2011
Revenue $ 120,000
Expenses (100,000)
Net Income $ 20,000
Statement of Stockholders’ Equity
For Year Ending December 31, 2011
Capt. Stk. Ret. Earn.
Beginning Balance $40,000 $ 25,000
Issue stock 10,000
Net income 20,000
Dividends (10,000)
Ending Balance $50,000 $ 35,000
• Dated for a specific
period
• Reconciles
beginning and
ending balances of
the stockholders’
equity accounts
– Capital Stock
– Retained Earnings
– Etc.
• Links the income
statement and the
balance sheet

Chapter 2, Slide #6
Shows the financial condition
of an entity as of a particular
date
– Assets: the resources of
the business
– Liabilities: the debts of
the business
– Equity: the owners’
interest in the business
The Accounting Equation:
Assets = Liabilities +
Stockholders’ Equity
Assets = Liabilities +
Capital Stock +
Retained Earnings
Balance Sheet
Assets $110,000
Liabilities 25,000
Stockholders’ Equity
Capital Stock 50,000
Retained Earnings 35,000
Tot Liab. & Equity $110,000
Income Statement
Revenue $ 120,000
Expenses (100,000)
Net Income $ 20,000
Capt. Stk. Ret. Earn.
Beginning Balance $40,000 $ 25,000
Issue stock 10,000
Net income 20,000
Dividends (10,000)
Ending Balance $50,000 $ 35,000

Chapter 2, Slide #7
• Covers the same period as the income
statement
• Three sections
– Cash flows from operating activities
– Cash flows from investing activities
– Cash flows from financing activities
– Interrelationship of Statements . See Page 48
book 12th Edition FS$R C. H. Gibson
Statement of Cash Flows

Chapter 2, Slide #8

Chapter 2, Slide #9
• An integral part of the financial statements
• Required presentation
– Summary of significant accounting policies
– Contingent liabilities are dependent on the occurrence or
nonoccurrence of one or more future events to confirm the
liability. The settlement of litigation or the ruling of a tax court
would be examples of the confirmation of a contingent
liability.
– Subsequent events relating to conditions that existed at the
balance sheet date
• Disclose and adjustment of the financial statements
Notes

Chapter 2, Slide #10
1. Recording transactions
2. Recording adjusting entries
3. Preparing the financial statement
The Accounting Cycle

• Internal or external event that causes a
change in a company’s assets, liabilities, or
stockholders’ equity
• Recorded in a journal (journal entry)
• Posted to general ledger accounts
• Double-entry system
 Debit: left side of an account
 Credit: right side of an account
 Debits = Credits
Account Title
Debit Credit
Recording Transactions

Permanent Temporary
Account
types
Assets
Liabilities
Equity
Revenues, Gains
Expenses, Losses
Dividends
Balances Carry forward to
the next fiscal
period
Closed to retained
earnings at year-end
Represent the
accounting
equation
Accounting System Components

• Required by the accrual basis of accounting
• Prepared at the end of the fiscal period
• Records (recognizes) for the current period
– Expenses incurred
– Revenues earned
• Recorded in the general journal
• Posted to the general ledger
Accounting System Components

RECORDING ADJUSTING ENTRIES
• The accrual basis needs numerous adjustments to
account balances at the end of the accounting
period.
• For example, $1,000 paid for insurance on October
1 for a one-year period (October 1–September 30)
could have been recorded as a debit to Insurance
Expense ($1,000) and a credit to Cash ($1,000). If
this company prepares financial statements on
December 31, it would be necessary to adjust
Insurance Expense because not all of the
insurance expense should be recognized in the
three month period October 1–December 31.

• The output of the accounting system
• Based on the adjusted general ledger
account balances
• Directly from the general ledger
– Income statement
– Balance sheet
• From analysis of general ledger accounts
– Statement of cash flows
Preparing the Financial Statements

• Treadway Commission is the popular name for the National
Commission on Fraudulent Reporting named after the first
chairman , former SEC Commissioner James C. Treadway.
• Voluntary private sector organization (Treadway)
• Committee of Sponsoring Organizations (COSO)
– Internal control reports
– Standard framework for evaluating internal control
• Need for internal control emphasized by
– Sarbanes-Oxley Act §404
– Management's Report on Internal Control
– Independent auditor’s opinion on management’s
assessment of internal control
Treadway Commission

• Audit is conducted by CPAs
• The audit report is the formal statement of
audit opinion
– Unqualified opinion
– Qualified opinion
– Adverse opinion
– Disclaimer of opinion
Auditor’s Opinion

• The financial statements present fairly
– The financial position
– Results of operations
– Cash flows
• In conformity with generally accepted
accounting principles
• For the user: the highest degree of reliability
Unqualified Opinion

• Except for the matter to which the exception
relates
• The financial statements present fairly
– Cash flows
• For the user: determine the significance of
the exception
Qualified Opinion

• The financial statements do not present
fairly
– Cash flows
• For the user: reliability of financial statements
need to be seriously questioned
Adverse Opinion

• The auditor does not express an opinion
• Auditor
– Has not preformed an audit sufficient in scope to
form an opinion or
– Is not independent
• For the user: auditor’s statement conveys no
indication of financial statement reliability
Disclaimer of Opinion

• Paragraph #1:
– Financial statements have been audited
– Financial statements are responsibility of
management
– Auditors have responsibility to express or disclaim
an opinion
Unqualified Auditor’s Report

• Paragraph #2
– Audit conducted in accordance with the standards
of the (U.S.) Public Accounting Oversight Board
– Auditor is required to plan and perform the audit
• Obtain reasonable assurance
• Financial statements are free from material
misstatement
– Audit provides a reasonable basis for opinion
• Examining evidence
• Assessing accounting principles and estimates
Unqualified Auditor’s Report (cont’d)

• Paragraph #3
• Opinion: in conformity with generally accepted (U.S.)
• Also: for public companies, reference to the audit of internal
control effectiveness
• In accordance with the (U.S.) Public Accounting
Oversight Board
 In this paragraph, / Explanatory paragraph
• may be a departure from a designated principle,
• describe a material uncertainty,
• detail a change in accounting principle,
• or express doubt as to the ability of the entity to continue as a
going concern.
Unqualified Auditor’s Report (cont’d)

• Required by Sarbanes-Oxley
• May be combined with audit opinion report
• Paragraphs
1. Scope
2. Responsibility and procedures
3. Opinion
4. Reference to financial statement audit
Auditor’s Report on Internal Control

Some of the reasons for private companies
to follow the law are the following:
1. Owners hope to sell the company or take it
public.
2. Directors who sit on public company boards
see the law’s benefits.
3. Executives believe strong internal controls
will improve efficiency.
4. Customers require strong internal controls.
5. Lenders are more likely to approve loans.

Auditors – who do they play for?
• Auditors were established as somewhat of a private
sector police force to uphold accounting integrity.
Securities Act of 1933/34
• Auditors perform the “ATTEST” function
– They assume responsibility for fairness & dependability
• Yet, auditors are hired by and paid for by the
Company
– Audit committee (Mgmt Control vs.. Independent)
• Through 2000, consulting fees were lucrative

Axiomate, Inc.
Auditor’s Opinion - Unqualified
To Aspen Technology, Inc.:
We have audited the accompanying consolidated balance sheets of Aspen Technology, Inc. (a Delaware
corporation) and subsidiaries as of June 30, 2000 and 2001, and the related consolidated statements of
operations, stockholders’ equity and comprehensive income (loss) and cash flows for each of the three
years in the period ended June 30, 2001. These consolidated financial statements are the responsibility of
the Company’s management. Our responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States.
Those standards require that we plan and perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our audits provide a reasonable
basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material
respects, the financial position of Aspen Technology, Inc. and subsidiaries as of June 30, 2000 and 2001,
and the results of their operations and their cash flows for each of the three years in the period ended
June 30, 2001 in conformity with accounting principles generally accepted in the United States.

Understanding The Auditor’s Opinion (the
Defense?)
Only the Opinion Page Belongs to the
Auditors (not our job to prepare statements)
Our work is sufficient to have
REASONABLE assurance statements are
free of MATERIAL misstatement
The Statements prepared on consistent basis
and Present FAIRLY the financial condition

Axiomate, Inc.
Auditor’s Opinion - Qualified
To the Board of Directors and Stockholders of
Aspen Technology, Inc.:
We have audited the accompanying consolidated balance sheet of Aspen Technology, Inc. and
subsidiaries as of June 30, 2002, and the related consolidated statements of operations, stockholders’
equity, and cash flows for the year then ended. These financial statements are the responsibility of the
Company’s management. Our responsibility is to express an opinion on the financial statements based on
our audit. The financial statements of Aspen Technology, Inc. and subsidiaries as of June 30, 2001 and for
each of the two years in the period then ended were audited by other auditors who have ceased operations.
Those auditors expressed an unqualified opinion on those financial statements in their report dated
August 3, 2001.
We conducted our audit in accordance with auditing standards generally accepted in the United States of
America. Those standards require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our audit provides a reasonable
basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the
financial position of Aspen Technology, Inc. and subsidiaries as of June 30, 2002, and the results of their
operations and their cash flows for the year then ended in conformity with accounting principles generally
accepted in the United States of America.
As discussed above, the financial statements of Aspen Technology, Inc. and subsidiaries as of June 30,
2001 and for the year then ended were audited by other auditors who have ceased operations. As described
in Note 2(p), those financial statements have been reclassified to reflect reimbursements from customers for
“Out-of-Pocket” expenses incurred as revenue rather than as a reduction of expenses. We audited the
adjustments described in Note 2(p) that were applied to reclassify the 2001 financial statements. In our
opinion, such adjustments are appropriate and have been properly applied. However, we were not engaged
to audit, review, or apply any procedures to the 2001 financial statements of the Company other than with
respect to such adjustments and, accordingly, we do not express an opinion or any other form of assurance
on the 2001 financial statements taken as a whole.
Qualification

• Review: A review consists principally of inquiries
made to company personnel and analytical
procedures applied to financial data.
– Less in scope than an audit and opinion is not expressed
– Not aware of any material misstatements or required
modifications”
• Compilation
• when the outside accountants present only financial
information as provided by the management , he or she is said
have compiled financial report.
• Presents only financial information provided by management
• No opinion or any other assurance is given
Review and compilation

• Management is responsible for
– The preparation of the financial statements
– The integrity of the financial statements
• Management’s Statement of Responsibility
– May be included in the annual report
Management’s Responsibility

Required filings
– 10-K: annual filing (audited)
• Includes financial statements plus
– Information on the business entity
– Market information
– Management discussion and analysis
– Directors, executive officers, and their compensation
– Related party transactions
– 10-Q: quarterly filing (unaudited)
– 8-K: “current report”
• To report the occurrence of any material events or
corporate changes
The SEC’s Integrated Disclosure System

• In addition to the Form 10-K and Form
10-Q, a Form 8-K must be submitted to
the SEC to report special events. Some
events required to be reported are
changes in principal stockholders,
changes in auditors, acquisitions and
divestitures, bankruptcy, and
resignation of directors. The Form 8-K is
due 15 days following the event.

In addition to the company’s primary
financial statements, the Form 10-K must
include the following:
1. Information on the market for holders of common
stock and related securities, including high and low
sales price, frequency and amount of dividends,
and number of shares.
2. Five-year summary of selected financial data,
including net sales or operating revenues, income
from continuing operations, total assets, long-term
obligations, redeemable preferred stock, and cash
dividends per share.

the Form 10-K must include the following:
3. Management’s discussion and analysis (MDA) of
financial condition and results of operations.
Specifically required is discussion of liquidity,
capital resources, and results of operations.
4. Two years of audited balance sheets and three years
of audited income statements and statements of
cash flow.
5. Disclosure of the domestic and foreign components of
pretax income, unless foreign components are
considered to be immaterial.

• Proxy
– Notice and authorization of shareholder voting
rights on corporate actions
– Content and form governed by the SEC
• Summary Annual Report
– Highly condensed financial information
– Must be accompanied by a proxy containing full
financial information
– Not adequate for financial analysis
Additional Reporting Venues

• Capital markets generate security prices that
reflect worth
• Publicly available information is reflected in
share prices
• Investors will be harmed if full disclosure is
not made
• Method of disclosure does not impact value
– Body of the financial statements
– Notes to the financial statements
• Benefit of making disclosure outweighs the
cost
The Efficient Market Hypothesis

Caring
Honesty
Accountability
Promise keeping
Pursuit of excellence
Loyalty
Fairness
Integrity
Respect for others
Responsible citizenship
Essential values in interpersonal relationships
Ethics

1. Determine the facts
2. Define the ethical issues
3. Identify major principles, rules, and values
4. Specify the alternatives
5. Compare norms, principles, and values with
alternatives
6. Assess the consequences
7. Make your decision
AAA Ethical Decision Framework

• Enacted under Sarbanes-Oxley Act
• Applicable to chief financial officers
• Disclosure requirements
– Whether a code of ethics has been adopted
– If not, why not
– Code is published in the annual report or on the
firm’s web site
SEC Requirement: A Code of Ethics

• Accounting standards can vary by country
– Development is often in response to domestic
needs
• International accounting standards set by
– IASC (1973 – 2000)
– IASB (2001 to present) has no enforcement
power
• In the U.S.
– SEC requires registrants to report in U.S. GAAP
– FASB is participating in the harmonization project
Harmonization of
International Accounting Standards

Harmonization of
International Accounting Standards
• IASB issues (IFRS) International Financial
Reporting Standards.
• 2002 Norwalk agreement – FASB and IASB
commit to high-quality, compatible accounting
standards.
• 2007 agreement between US and European
Union to allow companies to drop US GAAP if
financials were prepared by IFRS.

• Parent consolidates with subsidiary
– Report results of operations separately
– Sum subsidiary and parent results of operations
• Legal control vs. effective control
• Consolidation occurs when parent has
effective control over the subsidiary
– Holds a majority of risks, rewards, and decision-
making ability
Consolidated Financial Statements

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