; . N Credits and Debits ~\ * An increase in equity is a credit, a decrease is a debit — Anything that balances an increase in equity is a debit + Increase in assets or + Decrease in liability + $1000 drops from the sky and ~ Increase in assets by $1000, balanced by ~ Increase in equity by $1000 — Anything that balances a decrease is a credit + Decrease in assets or + Increase in liability. Lose a $1000 bet — Liability (bet to be paid) up $1000 ~ Equity down by $1000 + Debits go on left side of T, credits on right — Left: assets, liability |, equity | — Right side is assets], liability |, equity | |Introduction to Financial Statements Purpose of Financial Statements Financial statements are a structured representation of the financial position (Balance Sheet) and financial performance (Income Statement) of an entity. The objective of financial statements is to provide information about the financial position, financial performance and cash flows of an entity that is useful to a wide range of users in making economic decisions. Financial statements also show the results of management’s stewardship of the resources entrusted to it. To meet this objective, financial statements provide information about an entity’s:Introduction to Financial Statements ) assets ) liabilities c) equity ) income and expenses, including gains and losses °) other changes in equity; and £) cash flows ESSS a ( ( ( ( ( ( This information, along with other information in the notes, assists users of financial statements in predicting the entity’s future cash flows and, in particular, their timing and certainty.“Cental ais Accounting Only measurable things count Generally, measure assets by cost, not current value All probabilit “If you will probably have to pay $1,000,000 in damages, ability of one million es are ane or zero +f you might but will probably not, habilty of zero *Compare to tort Law All probabilities are one or zero Someone sues you for ten million dollars sIf probability of guilt is 4, you owe nothin sIF-6, you owe ten million Damages tend to be limited to ccuniary, medical costs, lost earings ‘less willing to include pain and suffering and the like +In both cases, we have to make decisions with a very erude process —Makit costs, 2 legal outcomes depend on thi 2s in complicated ways is likely to raise litigation uncertainty, Easier to prove a doctor's bill than a pain, Accounting aims at sufficiently clear cut decision rules +So that finns can't easily manipulate the outeome make them look good *Orreduce their taxes. *Ata considerable cost in avouracyThree ways of Summarizing lance sheet Shows condition of a firm at an instant (or several instants) Assets, liabilities and equity Assets = liabiliti s+ equity Fundamental Equation — Value of firm, net of liabilities and equity, must be zero. Because ... ? Income statement rts with revenue Then subtracts out expenses in order of how immediately related they are Ends with net income *Summary of cash flows — Starts with income — Adjust by everything that directs income ito a form other than cash — Adjust by everything that increases cash without increasing income End up with increase or decrease of cash over the year + By convention, ($100) = -$100Balance Sheet Photograph of the firm at an instant—compare two dates Show a list of assets, most liquid at the top, at two periods —‘probable future economic benefit from past ... events” —group into current assets, total them and long term ("property, plant and equipment"), total them —total the two totals for total assets Similar list of liability and owner's equity liability a negative asset «probable sacrifice of economic benefit ... , «why do you put equity with liabilities? —How much wealth does the firm itself (as opposed to stockholders and others) have? —the fundamental equation.Income Statement Designed to show the changes over a period of time Money coming in: Sales revenue (or equivalent for other sorts of firms) Costs — cost of goods sold—raw material, labor, etc. — operating expenses: Costs not attributable to particular output — interest expense ~ income tax expense 2 At each stage, you have a net to that point And end up with net incomeCash Flow Statement Money comes in as net income, but ... If part of the "income" is accrued but not received ... it goes into accounts receivable, not cash, so less cash reverse if some ac counts from last year are paid, increasing cash So subtract from income the increase in accounts receivable Accounts payable the same thing in the other direction Wwe subtracted out expenses in calculating income, but if some expenses were accrued but not paid ~ we still have the cash We subtracted out depreciation in calculating net income—but that didn't use up any cash. Add back in. Also cash flows from — borrowii increases cash) ~ paying dividends (uses up cash) — er.Introduction to Financial Statements — Component of Financial Statements Components of Financial Statements: A complete set of financial statements comprises: a balance sheet, an income statement; a statement of changes in equity showing either: — all changes in equity, or ~ changes in equity other than those arising from transactions with equity holders acting in their capacity as equity holders; acash flow statement; and notes, comprising a summary of significant accounting policies and other explanatory notes.Introduction to Financial Statements — Reporting Framework The reporting frame work is applicable in Pakistan while preparing and presenting of financial statements is as follows Applicable Laws and Regulations Regulating Authority Listed Companies other than, Insurance, NBFCS! Modarab and Bank Companies Ordinance 1984, slnuerational Financial Reporting Framework (IFRS) a applicable in Pakistan ‘Stock Exchange Listing Regulations Securities an Exchange ‘Commission of Pakistan (sec?) Banking Companies ‘International Finaneial Reporiing Framework (IFRS) as applicable in Pakistan Companies Ordinance 1983 *Siock Exchange Listing Regulations Particularly Code of Corporate overmance) ‘Banking Ordinance 1962 Prudential Regulations (Corporate, SMEs’ and Consumers) Securities and Exchange Commission of Pakistan and State Bank of Pakistan, Insurance Companies “International Finaneial Reporting Framework IFRS) as applicable Tn Pakistan Companies Onlnance 1984 ‘Stock Fchange Listing Regulations slnsurance Onlin Securities and Exchange ‘Commission of Pakistan,Introduction to Financial Statements — Reporting Framework Applicable Laws and Regul Regulating Authority Non Banking Finance Companies, “International Financial Reporting Framework (IFRS). *Companies Ordinance 1984 ‘Stock Exchange Listing Regulations (Particularly Code of Corporate Governance) sNBFC Rules. +Prudential Regulations for NBECs? +Prudential Regulations for Leasing Company Securities and Exchange Commission Pakistan Modarba ‘International Financial Reporting Framework (IFRS) Companies Ordinance 1984, +Stock Exchange Listing Regulations (Particularly Code of Corporate Governance) *Modarba Act and Rules Securities and Exchange Commission 0 Pakistan and Registrar of N°Introduction to Financial Statements — User of Financial Statements User of the financial statements Interest of the user Equity investors (existing and potential) They are interested whether buy, hold or sell the shares in hand and also enable them in payment of dividends. 1s ie, existing and potential hholders of debentures and loan stock, and providers of short-term loans The umount willbe paid when due and for continuation of the business. Employees (existing, potential and past) Business contaets including customers, trade creditors, competitors and potential take-over bidders, Interested in stability and profitability for employment opportunities, remuneration and retirement benefits. ‘Whether the payment of loan will be made in due dates and tenable sustainability of business for future business with the centenprise Government, including tax authorities, ‘government departments and loc authorities Inter sted in allocation of resources and also to regulate the activities of an enfteprise and determining tax policies and as a basis for national income. Public, including tax payers, ratepayers and yamental groups Trends and recent development in the prosperity ofthe entity and range ofits activities,