Corporate Financial Reporting

Session-1 IIMC-PGP-2013: Prof. Arpita Ghosh

Introduction to the Course

Accounting, Users of financial statements, Objectives of corporate financial reporting, Qualitative characteristics, basic concepts and assumptions and the basic Accounting equation Accounting Cycle: Mechanics of recording transactions in Journal, Ledger and Trial balance Preparation and Understanding of Financial statements:
Profit and loss Statement, Balance sheet, Statement of retained earnings and Cash flow statement

Week 1&2

Week 3,4,5,6 Week 7

Using some tools for Analyzing the Financial statements

Common-Size, Trend, Ratio analysis

GAAP related to revenue recognition, inventory, accounting for tangible fixed assets and liabilities (deferred tax, lease)

Week 8,9, 10
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The Dos, the Donts , & the Grading

The Dos Go through the problems specified in the course outline and try to solve them before you come to the class Prepare for the case before coming to the class based on case-questions (will be provided to you) Form study-groups : For learning together and for Project submission By next Monday, send me the details of the groups (Name, Section, Reg number, email-id, group number) Contact me when in doubt or have any query : Office- K-410 (Extension-153), arpita.ghosh@gmail.com. Send me an email or call me before you want to come. The Donts Dont be late for the class, Dont postpone your work Dont violate academic integrity Heavy Penalties Grading: Quizzes (20%), Mid term (30%), End Term (30%), Project (15%), Case (5%)

Learning Goals - Session 1

Why should you learn Financial Accounting ? What is Accounting ? Users and uses of accounting information Business Goals and Business Activities Primary forms of business organization Basic Accounting Equation, Event Vs Transaction Effect of transactions on accounting equation Financial Statements and Interrelationships

Why should you learn Financial Accounting ?

Accounting is the Language of Business Company uses the language to speak about its financial performance, position and cash flows Analysts, investors and other users understand the language and rely on the information to make their decisions A manager needs to understand the business language so that He can understand information communicated
Example: Sales Target

He can use the language to communicate what he intends to do Example: Increase in ROI in southern markets He can understand the implications of his actions and the way his actions are going to be evaluated Example: Performance bonus Why was Maria not able to tell her father how was her business going?
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Language:
From Annual Report of

Directors Report, News

Angel Brokings May 14,2013 report: For DRL, we expect net sales to report a 14.9% CAGR to Rs15,350cr and adjusted EPS to record a 10.8% CAGR to Rs126.8 over FY2013-15. We recommend a buy on the stock.

News: TCS, INFY REVENUE GAP TRIPLES IN LAST FOUR FISCALS (with TCS reporting revenue of Rs62,989 crore against Infosys' Rs40,352 crore) Source: Financial Express. Apr 18, 2013; pg 4 "The average price of coking coal was $186 a tonne in 2012-13, which has come down to $150 a tonne currently. Despite this, our margins have shrunk, mainly because of the dip in the rupee and selling prices," SAIL chairman and managing director CS Verma told Business Standard.
Source: Business Standard June 21, 2013

Infosys has dipped almost 4% to Rs 2,206, its lowest price since August 2012 on BSE, after reporting a lower-than-expected revenue and operating margin for the quarter ended March 2013 and disappointing Dollar revenue guidance for the current fiscal.
Source: http://www.business-standard.com/article/markets/infosys-hits-eight-month-low-stock-tanks-24-in-two-days-113041500108_1.html

What is Accounting
An information system that measures, processes, and communicates financial information about an economic entity to help users make decisions
Financial Statements

Business Activities: (Transactions) Operating Investing Financing

Data

Balance Sheet

Accounting Measure, Process, & communicate

For

Income Statement Cash Flow Statement Retained Earnings Statement

Users/ Decision Makers Internal Users External Users

Decisions/Actions

Accounting is a link between Business activities & Decision makers

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Business Goals and Business Activities

A Business is defined as: An economic unit that aims to sell goods and services to customers at prices that will provide an adequate return to its owners Business Goals Profitability : The ability to earn enough income to attract and hold investors. Liquidity: The ability to earn enough funds available (cash) to pay debts when they are due. Business Activities used to achieve the goals: Financing Investing Operating
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Forms of Business Organization

Proprietorship

Partnership

Corporation

Generally owned by one person Simple to establish Owner controlled

(Owner takes all profits/losses, is liable for all obligations)

Two or more owners Simple to establish Shared profits/ losses and control

Owned by Shareholders, Legally separate from owners Requires Incorporation Control through elected Board of directors

Difficult to finance Personal Liability Transfer of ownership may be difficult

Broader skills and resources Personally and joint liability Transfer of ownership may be difficult Dissolves if partner leaves/ dies

Easier to raise funds No personal liability Easier to transfer ownership continues

Business Activities
Financing Activities Includes obtaining funds to begin operations and continue operating

Borrowings : Party to whom amounts are owed are Creditors /Lenders Amounts owed are called Liabilities Issuing shares Amounts paid by stockholders to buy shares gives rise to Common Stock - Payments to stockholders are called Dividends

Investing Activities Spending funds in productive ways that help it achieve its objectives : Purchase of resources a company needs to operate

Buying Land, Buildings, Equipment , Furniture etc. Resources owned by a business are called Assets

Operating Activities - Once a business has the assets it needs, it can begin its operations. Includes Selling goods and services to customers - Amounts earned from sale of products are called Revenues Employing & paying managers and workers, buying & producing goods and services, paying taxes - These are Expenses 10

Users: Who uses accounting information ?

Accounting is a link between Business activities & Decision makers

Decision Makers/ Users

INSIDERS Management Human Resources Marketing Operations Production Finance

OUTSIDERS Those with Direct Financial Interest Investors Creditors Those with Indirect Financial Interest Tax Authorities Regulatory Agencies Labour Unions Customers Economic Planners
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Uses
Questions Asked by Insiders

Questions Asked by Outsiders

Investors: Are the earnings adequate? Is the competitor doing better ? Creditors: Does it have enough cash to pay its obligations as they come due? Tax Auth. : Does it comply with tax laws ? Regulatory Agencies like SEBI: Is it operating within prescribed rules? Labour Unions : Is it possible to negotiate for higher wages? Customers: Does it have the ability to supply quality goods in time

HR: Can we afford to give our employees a pay raise? Marketing: What price for our product will maximize net income? Production: Which product line is most profitable? Finance: Is cash sufficient to pay dividends?

Management Accounting: Facilitates planning and control

Financial Accounting: Promotes Exchange of Resources

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Accounting is complex
An information system that measures, processes, and communicates financial information about an economic entity to help users make decisions
GAAP: Concepts, Standards Management Choice

Financial Statements
Balance Sheet Income Statement Cash Flow Statement Statement of Retained Earnings

Business Activities: (Transactions) Operating Investing Financing

Data

Accounting Measure, Process, & communicate

For

Users/ Decision Makers Internal Users External Users

Auditors, Board, Companies Law, Market Regulator

Analysts, CRA , Media

Decisions/Actions

Accounting is a link between Business activities & Decision makers

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Event Vs Transaction
What does accounting measure ? Business transactions A Business Transaction: An economic event that affects the financial position of a business It can be an exchange of value (like Purchase, Sale, Payment, Collection, Loan) It can be an event that have the same effect as an exchange of value (nonexchange transaction like Loss from fire, flood, theft, Physical wear and tear on equipment, Accumulation of interest) Every transaction affects the BASIC ACCOUNTING EQUATION and has a dual effect i.e. it affects at least two items in the accounting equation All transactions are events. But all economic events are not transactions. Only Transactions are recorded.

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Whether Transaction ?
Are the following events recorded in the accounting records as transactions?
Event 1 2 3 4 5 6 7 8 9 10 XYZ ltd purchases an office building GAP announces a new marketing strategy Shaadi Mubarak receives a contract for organising a wedding Tech Mahindra hires new employees Customer buys a product ACC receives delivery of the products ordered Infosys pays wages to its workers Kundu travels discusses a guided trip with a potential customer Cost of Supplies used by ABC Ltd Indian Airlines pilots go on strike Criterion Is the financial position (assets, liabilities, or stockholders equity) of the company changed? Record/ dont Record Record Dont Record Dont Record Dont Record Record Record Record Dont Record Record Dont Record
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Financial Position: Basic Accounting Equation

Economic Resources (OWNED) = Equities (OWED) Economic Resources = Creditors Equities + Stockholders (or Owners) Equity Assets Assets = Liabilities + Owners Equity

= Liabilities + Contributed Capital + Retained Earnings Common Stock + Additional Paid-in Capital

The accounting equation must always balance

the two sides of the equation must always be equal It is important to identify the specific effects of every transaction on the accounting equation. The process is called Transaction Analysis. This is the first step of accounting cycle.
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Basic Accounting Equation

Assuming stocks were issued at par, we can re-write the equation as: Assets = Liabilities + Common Stock + Retained Earnings (RE)

Change in Retained earnings during the year ( RE ) = (Revenues t Expenses t Dividends t ) Retained Earnings at the end of the year (REt) = RE t-1 + RE = RE t-1 + (Revenues t Expenses t Dividends t ) = (Revenues Expenses Dividends) accum over the life of the entity
Thus, Assets = Liabilities + Common stock + (Revenues - Expenses - Dividends) Or re-arranging we can write: Assets + Expenses + Dividends = Liabilities + Common Stock + Revenues
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Income Statement
Weiss Consultancy, Inc. Income Statement For the Month Ended December 31, 2012 Date reflects revenues Revenues and expenses incurred Commissions over a period of time earned Expenses $2,800 Equipment rental expense Wages expense 1,600 Utilities expense 1,200 Total expenses Income before income taxes Income taxes expense Net income Net income figure used to prepare statement of retained earnings

Summarizes revenues earned & expenses incurred over an accounting period Shows if the entity has earned profits Net income if Revenues > Expenses, o.w. Net Loss Flow Report Use : Past net income provides information for predicting future net income investors, lenders

$14,000

5,600 $8,400 1,200 $7,200

Statement of Retained Earnings

Weiss Consultancy, Inc. Statement of Retained Earnings For the Month Ended December 31, 2012 Retained earnings, December 1, 2012 Net income for the month Subtotal Less dividends Retained earnings, December 31, 2012 $0 7,200 $7,200 2,400 $4,800 Shows changes in retained earnings over an accounting period

Ending balance of retained earnings used to prepare the balance sheet

Net income figure comes from income statement

Balance Sheet
Reports

assets and claims to assets at a specific point in time. = Liabilities + Stockholders Equity. or stock

Date reflects account balances as Weiss Consultancy, Inc. of a certain date

Balance Sheet 31-Dec-2012

Assets

Assets
Cash Accounts receivable Supplies Land Building

Liabilities
$61,200 Accounts payable $2,400 4,000 2,000 Stockholders Equity 40,000 $200,000 100,000 Common stock Retained earnings 4,800 Total stockholders equity 204,800 $207,200 Total liabilities and stockholders equity $207,200

Status

report
Use:

Evaluate reliance on debt vs. equity in funding its assets, Cash

Total assets

Ending balance of Retained Earnings comes from statement of retained earnings

Statement of Cash Flows

Where did cash come from during the period? How was cash used during the period? What was the change in the cash balance during the period? Cash effect of Operating, Financing and Investing

Weiss Consultancy, Inc. Statement of Cash Flows For the Month Ended December 31, 2012

Cash flows from operating activities Net income Adjustments to reconcile net income to net cash flows from operating activities Increase in accounts receivable ($4,000) Increase in supplies (2.000) Increase in accounts payable 2,400 Net cash flows from operating activities Cash flows from investing activities Purchase of land ($40,000) Purchase of building (100,000) Net cash flows from investing activities Cash Flows from financing activities Investments by stockholders $200,000 Dividends (2,400) Net cash flows from financing activities Net increase (decrease) in cash Cash at beginning of month Cash at end of month Cash at end of month should be

Begins with a net income figure from income statement

$ 7,200

(3,600) $ 3,600

(140,000)

197,600 $61,200 0 $61,200

the same as Cash account balance on balance sheet

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Case Questions: Week 1 - On Maria

State the transactions which took place during the two months of operations of Marias Business For each transaction, analyze in the following lines: Name the accounts which might be involved and classify them as A, L or SE Show how each of the transactions affect the accounting equation Segregate the transactions involving Cash Classify them into Operating, Financing and Investing Activities Segregate the transactions involving Revenues and Expenses. Calculate: total revenues total expenses. Check if the accounting equation still holds after it is affected by all the transactions. Compare the accounting equation at the beginning and at the end of the two months period.
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Thank You

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