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8as|c I|nanc|a| Statements
1he baslc flnanclal sLaLemenLs lnclude Lhe balance sheeL (8/S) Lhe lncome
sLaLemenL (l/S) and Lhe sLaLemenL of cash flows (Sofl)

8a|ance Sheet
1he 8/S conLalns lnformaLlon expressed aL a momenL ln Llme abouL resources
(asseLs) LhaL are owned or conLrolled by Lhe flrm AsseLs have probable fuLure
economlc value usually Lhrough use or sale are conLrolled by Lhe flrm and are
relaLed Lo a prlor LransacLlon 1he 8/S also conLalns lnformaLlon abouL Lhe
flrm's obllgaLlons (llablllLles) LlablllLles lnvolve probable fuLure economlc
sacrlflces are unavoldable and are relaLed Lo a prlor LransacLlon 1he lasL parL
of Lhe 8/S ls owners' equlLy represenLlng Lhe aggregaLe lnvesLmenL by owners
Cwners' equlLy ls ofLen called 'neL asseLs' because lL equals asseLs less
llablllLles

1he baslc accounLlng equaLlon ls AsseLs LlablllLles + Cwners' LqulLy
1he 'asseL' slde of Lhe equaLlon provldes lnformaLlon abouL Lhe asseLs conLrolled
by Lhe enLlLy 1he 'llablllLy' porLlon of Lhe equaLlon prlmarlly represenLs
exLernal clalms on Lhe resources of Lhe enLlLy Cwners' equlLy represenLs Lhe
lnLernal clalms of Lhe owners on Lhe resources of Lhe enLlLy
1he baslc accounLlng equaLlon could be rewrlLLen as AsseLs LlablllLles Cwners' LqulLy
1hls makes lL clear LhaL owners' equlLy and 'neL asseLs' are Lhe same

ncome Statement
1he lncome sLaLemenL (l/S) baslcally conLalns lnformaLlon abouL revenues
expenses and neL lncome as LhaL lnformaLlon has been accumulaLed for a
sLaLed perlod of Llme neL lncome occurs when revenues exceed expenses A
neL loss occurs when expenses exceed revenues
8evenues generally musL be earned 8evenues are 'good' Lhlngs lf l could
show you how Lo lncrease your revenues you would llkely be eager Lo learn how
Lo accompllsh Lhls LaLer l wlll reflne Lhls baslc deflnlLlon of revenues
Lxpenses Lyplcally resulL from uslng up resources ln Lhe process of earnlng
revenues lf l could show you how Lo reduce your expenses you would llkely be
eager Lo learn more abouL whaL mlghL be lnvolved LaLer l wlll reflne Lhls
baslc deflnlLlon of expenses
neL lncome ls whaL remalns of Lhe revenues afLer coverlng Lhe expenses neL
lncome ls a 'good' Lhlng and generally more ls beLLer Lhan less Would you
raLher have more or less lncome lf all oLher Lhlngs were equal? ?ou knew Lhe
answer Lo LhaL quesLlon aL a 'Lender' age

Statement of Cash I|ows
1he sLaLemenL of cash flows (Sofl) provldes lnformaLlon abouL Lhe flrm's cash
flows from Lhree baslc sources operaLlng lnvesLlng and flnanclng acLlvlLles
Sof$l lnformaLlon ls prepared on a dlfferenL basls Lhan Lhe l/S and Lhe 8/S
and ofLen provldes savvy flnanclal sLaLemenL users wlLh a convenlenL summary
of Lhe cash flow acLlvlLy

Who Are llnanclal SLaLemenL users?

1here are many groups uslng flnanclal sLaLemenLs lS All lS users are
assumed Lo be aware of accounLlng prlnclples used Lo prepare lS !usL as wlLh
so many areas ln our llves wlLhouL an adequaLe grasp of Lhe area we cannoL
absorb our deslred meanlng of Lhe lnformaLlon belng communlcaLed Lo us lor
example assume any lS user makes a declslon based on lnformaLlon conLalned
ln a seL of lS and Lhe declslon Lurns ouL Lo be wrong because Lhe declslonmaker
mlsundersLood Lhe lS 1he lS user has no excuse because he/she dld
noL undersLand lnformaLlon LhaL was properly reporLed lf Lhe lS were noL
properly prepared and were audlLed by an accounLlng flrm Lhere may be some
legal recourse avallable Lo Lhe user for losses Lraceable Lo Lhe mlssLaLemenL(s) ln
Lhe lS and/or Lhe accounLlng flrm's fallure Lo follow Lhe sLandards of Lhe
accounLlng (audlLlng) professlon
Pow many of you wanL Lo obLaln a poslLlon afLer graduaLlon from whlch you wlll
be promoLed aL leasL once? upwardly moblle managers musL have sufflclenL
accounLlng skllls Lo cause proper lS Lo be prepared As lmporLanLly managers
need accounLlng skllls Lo undersLand lnformaLlon conLalned ln Lhe lS prepared
by flrms wlLh whlch Lhey do buslness
8epresenLaLlve user groups lnclude lenders lnvesLors poLenLlal lnvesLors
managers employees labor unlons cusLomers suppllers compeLlLors and
governmenLs user groups musL ldenLlfy good ways Lo exLracL valuable
lnformaLlon from Lhe generalpurpose lS

Why uo We need AccounLlng SLandards (8ules)?

Can you lmaglne how enLerLalnlng fooLball would be lf each referee made up hls
own rules for Lhe game? Maybe you Lhlnk LhaL would be enLerLalnlng buL Lhe
fooLball Leams would flnd lL lrrlLaLlng ln Lhe prevlous cenLury Lhere was a
movemenL Loward Lhe developmenL of a sLandardlzed seL of accounLlng rules
referred Lo as generally accepLed accounLlng prlnclples CAA LnLlLles are
free Lo choose speclflc accounLlng meLhods from CAA users musL have some
baslc knowledge of CAA ln order Lo undersLand whaL ls meanL by lnformaLlon
ln publlshed lS

WlLhln CAA Lhere ls a conLlnulng Lrend llmlLlng Lhe range of accepLable
cholces Crlglnally Lhe range of cholce was broader Lhan aL Lhe presenL Llme
AnoLher Lrend emerged ln Lhe lasL Lwo decades reporLlng or dlscloslng falr
markeL value lnformaLlon ln Lhe lS 1he movemenL Loward falr markeL value
lnformaLlon has numerous supporLers ln hlgh places and wlll probably
conLlnue PlsLorlc cosL daLa Lends Lo be hlghly rellable buL lacklng Lhe
relevance of currenL buL esLlmaLed markeL values 1he Lradeoff beLween
elemenLs of relevance and rellablllLy wlll conLlnue Lo 'bug' Lhe accounLlng
professlon 1wo lmporLanL Loplcs ln Lhls course have undergone slgnlflcanL
changes ln recenL years
1he llnanclal AccounLlng SLandards 8oard lAS8 has been Lhe senlor prlvaLe
secLor accounLlng ruleseLLlng body slnce Lhe 1970's MosL pronouncemenLs
lnvolvlng CAA are Lraceable Lo conLlnulng dellberaLlons of lAS8 1he
SecurlLles and Lxchange Commlsslon SLC has Lhe ulLlmaLe legal
responslblllLy for Lhe accounLlng rules ln Lhe counLry When Lhe SLC has felL
some lmprovemenL ln CAA has been deslrable lL has demonsLraLed a
wllllngness Lo exerclse lLs legal auLhorlLy Lo seL accounLlng sLandards
SomeLlmes accounLlng rules have resulLed from acLual or LhreaLened federal
leglslaLlon AccounLlng rules reflecL our soclal legal pollLlcal and economlc
envlronmenLs naLurally Lhere have been conslderable dlfferences ln
accounLlng rules across naLlonal boundarles

I|nanc|a| Statements

1he baslc Lhree lS presenL lnformaLlon hlghly summarlzed lnformaLlon
reflecLlng counLless LransacLlons roperly prepared summarles are sufflclenL
for mangers' use ln declslonmaklng
1he 8/S conLalns asseLs llablllLles and owners' equlLy all measured aL Lhe
'balance sheeL daLe' ?ou should Lhlnk of Lhe 8/S as a snapshoL of Lhe flrm's
accounL balances aL LhaL momenL ln Llme When a checklng accounL sLaLemenL
summarlzes all Lhe deposlLs and checks LhaL have cleared Lhrough Lhe accounL
ln a Llme perlod 1he endlng balance ls a 'snapshoL' summary of all of LhaL
acLlvlLy 1he deposlLs and checks represenL Lhe acLlvlLy durlng Lhe perlod

Assets
AsseLs are probable fuLure economlc resources LhaL musL be conLrolled by Lhe
flrm resulLlng from some prevlous LransacLlon robable fuLure economlc
beneflLs may noL be as cerLaln as you Lhlnk Would a loLLery LlckeL be an asseL
before Lhe drawlng? 1he asseLs need noL be owned lor example a leased car
ls an asseL Lo lLs user alLhough lL ls noL owned
lf you slgn a conLracL Lo occupy an aparLmenL aL a fuLure daLe and you agree Lo
make fuLure paymenLs Lo Lhe landlord you have no asseL aL Lhls Llme because of
Lhe agreemenL 1here would be no 'pasL LransacLlon' beLween you and Lhe
landlord ln Lhls case ALLorneys descrlbe Lhe relaLlonshlp beLween you and Lhe
landlord as an execuLory agreemenL
1hlnk of yourself as a 'buslness' lnsLead of a person WhaL are some of
your asseLs?

L|ab|||t|es
LlablllLles are probable fuLure economlc sacrlflces LhaL Lhe flrm cannoL avold
resulLlng from some prevlous LransacLlon 1he probable fuLure economlc
sacrlflces do noL have Lo be 'sure Lhlngs' LsLlmaLed fuLure economlc sacrlflces
frequenLly appear as llablllLles
lf you slgned a conLracL Lo occupy an aparLmenL sLarLlng aL a fuLure daLe and Lo
make fuLure paymenLs Lo Lhe landlord you have no currenL basls Lo record a
llablllLy as a resulL of Lhe conLracL 1here would be no 'pasL LransacLlon' and
aLLorneys descrlbe Lhe relaLlonshlp beLween you and your landlord as an
execuLory agreemenL
Can you name some Lhlngs LhaL would be llablllLles ln your balance sheeL
lf you were a company lnsLead of a person?

wners' Lqu|ty
CorporaLe owners' equlLy CL represenLs Lhe owners' resldual lnLeresL ln Lhe
flrm and ls Lhe dlfference beLween asseLs and llablllLles or neL asseLs
CL has Lwo baslc parLs conLrlbuLed caplLal and reLalned caplLal Some
conLrlbuLed caplLal (CC) was lnvesLed by Lhe owners aL Lhe lncepLlon of Lhe flrm
and could have been lncreased subsequenLly by addlLlonal lnvesLmenLs by
Lhem Crlglnal and subsequenL lnvesLmenLs by owners are lndlsLlngulshable
wlLhln CL 8eLalned caplLal ls called reLalned earnlngs (8L) lf Lhe flrm ls a
corporaLlon lor convenlence 8L wlll be commonly used ln Lhls course 8L
represenLs neL lncome LhaL has been earned and reLalned AlLernaLlvely neL
lncome could have been dlsLrlbuLed Lo Lhe owners ln Lhe form of dlvldends CL
can be more complex as we wlll see laLer ln Lhe course

llnanclal sLaLemenLs lS are lnLended Lo be useful ln declslonmaklng and Lhe
relaLlonshlp beLween CC and 8L can provlde lnslghL lnLo Lhe flrm's success Lo
daLe Conslder Lwo flrms each havlng $100000 ln CL 1he flrsL has only
$1000 of LhaL amounL as CC and Lhe oLher $99000 ls 8L whlle Lhe second
has 99 of Lhe value ln CC whlle only 1 ls ln 8L lf boLh flrms were founded
flve years ago and nelLher has pald ouL any dlvldends whlch would you raLher
have founded? Popefully Lhe answer ls obvlous Lo all l am assumlng all of us
are moLlvaLed ln parL by moneLary rewards and whaL we can do wlLh Lhem

1here are several concepLs LhaL help us flL all Lhe pleces LogeLher lnLo a coherenL
framework 1he enLlLy concepL remlnds us LhaL separaLe enLlLles should have
separaLe lS as well as underlylng accounLlng records ln order LhaL users can
have a beLLer sense of accounLablllLy regardlng Lhe economlc resulLs of each
flrm 1he hlsLorlc cosL convenLlon ls a baslc bulldlng block for much of Lhe
flnanclal accounLlng model 1he hlsLorlc cosL convenLlon lnvolves reporLlng
asseLs and llablllLles aL Lhelr orlglnal amounLs Loglcal varlaLlons wlll be
developed as we move Lhrough Lhese Loplcs AccounLanLs llke Lo use hlsLorlc
cosL for asseLs and llablllLles because Lhese numerlcal values are more rellable
and easlly Lraceable Lo source documenLs 1he golng concern assumpLlon
deals wlLh a number of lssues lncludlng asseL valuaLlon AsseLs and llablllLles
are normally carrled aL Lhelr hlsLorlc cosLs unless Lhe accounLanLs feel Lhe flrm
has serlous problems maklng lL unllkely lL wlll survlve for anoLher year When
a flrm falls Lhe golng concern assumpLlon asseLs and llablllLles may be revalued
reflecLlng Lhelr currenL value ln Lhe 8/S lor example a plece of land mlghL be
revalued Lo falr markeL value lf Lhe golng concern assumpLlon has noL been meL

ncome Statement
1he l/S conLalns revenues expenses galns and losses for Lhe perlod l/S are
daLed aL Lhe end of a speclfled Llme perlod and summarlze Lhe perlod's
LransacLlons l/S are llke a 'movle' of Lhe perlod whlle 8/S are more llke a
snapshoL Laken aL Lhe end of Lhe perlod
lS recognlLlon means Lhe lLem wlll appear ln Lhe approprlaLe lS lor example
recognlzed revenues wlll appear ln an l/S and an accounL recelvable wlll appear
ln Lhe 8/S

8evenues are recognlzed when Lhey have been earned and reallzed When we
say LhaL we recognlze revenues LhaL means LhaL Lhe revenues wlll appear ln an
lncome sLaLemenL 8evenues are earned when Lhe work necessary Lo compleLe
Lhe requlremenLs has been performed LaLer we wlll examlne some excepLlons
Lo Lhls 8evenue reallzaLlon means Lhe enLlLy has recelved Lhe cash or Lhere ls a
clalm Lo cash

Can you name some Lhlngs LhaL would be revenues for you lf you were a
company lnsLead of a person?
Lxpenses are recognlzed when someLhlng has been 'used up' ln assoclaLlon
wlLh generaLlng revenues 1here ofLen ls a llnkage beLween Lhe revenue
recognlLlon and recognlzlng expenses Cenerally we maLch revenues and
expenses ln Lhe same accounLlng perlod ln order Lo sLaLe lncome approprlaLely
1he concepL of lncome lmplles LhaL lnflows exceeded ouLflows All we are Lrylng
Lo do ls Lo sLaLe Lhose on a proper basls for each perlod lf a servlce flrm has
recognlzed some revenues Lhe expenses lncurred ln generaLlng revenues
should be slmulLaneously recognlzed ln order Lo properly sLaLe Lhe proflL or loss
on Lhe pro[ecL

Can you name some Lhlngs LhaL would be expenses lf you were a company
lnsLead of a person?
8evenues and expenses are parL of a flrm's maln and conLlnulng commerclal
acLlvlLles lord MoLor CorporaLlon has Lhe blggesL auLo flnance subsldlary ln Lhe
unlLed SLaLes 1haL would be parL of lLs prlmary acLlvlLles as well as auLo
manufacLurlng and sales 1here are llkely oLher acLlvlLles aL lord produclng
revenues and expenses slnce Lhey are parL of Lhe enLlLy's 'prlmary' acLlvlLles l
ofLen Lell people LhaL 'prlmary acLlvlLles' are Lhe Lhlngs Lhe enLlLy does for a
'llvlng'

When oLher evenLs occur ouLslde Lhe prlmary recurrlng commerclal acLlvlLles
we reporL Lhem as galns or losses ln Lhe l/S 8evenues and galns lncrease
lncome 8evenues are recurrlng whlle galns are noL lf a consulLlng flrm
performs work on a consulLlng conLracL for a cllenL revenues are recognlzed lf
Lhe same consulLlng flrm sells a plece of equlpmenL LhaL had been used ln Lhe
buslness Lhe consulLlng flrm would recognlze a galn lf Lhe equlpmenL ls sold
for more Lhan lLs cosL when new Calns make neL lncome larger Selllng used
equlpmenL would noL be parL of Lhe consulLlng flrm's prlmary commerclal
acLlvlLles Can you name asseLs on whlch you mlghL have a galn?
Conversely lf Lhe consulLlng flrm had sold land for less Lhan Lhe prlce pald for
Lhe land when buylng lL Lhe consulLlng flrm would recognlze a loss for Lhe
dlfference Losses make neL lncome smaller Land would noL be parL of a
consulLlng flrm's prlmary commerclal acLlvlLles Can you name asseLs on whlch
you mlghL have a loss?

neL lncome ls Lhe excess of Lhe 'good guys' revenues and galns) over Lhe 'bad
guys' (expenses and losses) 8evenues and expenses are recurrlng and relaLed
Lo Lhe enLlLy's prlmary acLlvlLles whlle galns and losses and nonrecurrlng and
noL relaLed Lo Lhe enLlLy's prlmary acLlvlLles Calns and losses are perlpheral Lo
Lhe enLlLy's recurrlng commerclal acLlvlLles

CuesLlon Lo ponder lf you could choose a galn of $300000 or a revenue of
$300000 whaL would be your cholce?
1he mosL lmporLanL polnL ln formlng an answer Lo Lhls quesLlon ls Lhe reasons
why you selecLed your preference Calns are noL recurrlng buL revenues are
Calns have no assoclaLed expenses whlle revenues do have expenses assoclaLed
wlLh Lhem ln Lhe shorLLerm Lhe galn seems more aLLracLlve ln Lhe long Lerm
and lf expenses are relaLlvely small ln comparlson wlLh Lhe revenues earned
Lhe revenues seem Lo have Lhe sLronger hand
CperaLlng lLems flL ln Lhe maln parL of Lhe lncome sLaLemenL nonoperaLlng
lLems are largely lncldenLal or lmmaLerlal Lo Lhe lncome sLaLemenL as a whole
Calns and loss are consldered nonoperaLlng lLems

Statement of Cash I|ows
1he componenL elemenLs of Lhe balance sheeL and Lhe lncome sLaLemenL reflecL
economlc evenLs raLher Lhan cash flow evenLs 8ecause of Lhe poLenLlal
lmporLance of cash flow lnformaLlon ln addlLlon Lo knowlng Lhe lmpacLs of
economlc evenLs one of Lhe ma[or flnanclal sLaLemenLs ls Lhe sLaLemenL of cash
flows When we vlew a sLaLue lL ls deslrable Lo see Lhe work from several
angles Lo appreclaLe Lhe arLlsL's creaLlon 1hus when we Lry Lo undersLand Lhe
broader condlLlon of a flrm we should appreclaLe LhaL seelng Lhe flrm Lhrough a
cash flow lens mlghL provlde valuable lnslghLs ln addlLlon Lo Lhe economlc
evenLs lens lf l were only belng pald half my salary from Lhe unlverslLy and
Lhe resL was bulldlng up an AccounL 8ecelvable Lhere would be a serlous
lmpacL on my llfesLyle

Cash flows come ln Lhree caLegorles operaLlng lnvesLlng and flnanclng
CperaLlng cash flows are creaLed ln Lhe flrm's normal recurrlng commerclal
acLlvlLy Cash flows from sales acLlvlLles are operaLlng cash flows regardless of
when Lhe revenue ls earned 1he cash mlghL have been earned revenue ln an
earller perlod buL would be a cash flow only when collecLed Slmllarly a cash
ouLflow for salarles would be an operaLlng cash ouLflow when pald 1he cash
for salary mlghL be pald ouL ln Lhe currenL year buL mlghL have been earned by
Lhe employee ln an earller year 1oLal operaLlng cash flow wlll Lell us lf Lhe
flrm's regular acLlvlLles are currenLly generaLlng poslLlve or negaLlve cash flows
unless Lhe flrm ls new a flrm should be produclng poslLlve operaLlng cash flows
from lLs operaLlons Cccaslonally a flrm mlghL experlence unusual buslness
condlLlons and lLs cash flows from operaLlng acLlvlLles would be negaLlve for a
whlle

lf you were a company lnsLead of a sLudenL whaL would be some of your
operaLlng cash flows?
lnvesLlng cash flows resulL from purchases or sales of lLems LhaL are noL
consumed ln regular recurrlng commerclal acLlvlLles lf a flnanclal consulLlng
flrm purchased lnvesLmenLs wlLh Lemporary surplus cash we would LreaL Lhe

cash pald ouL as an lnvesLlng use of cash 8uylng or selllng properLy planL and
equlpmenL ls an lnvesLlng acLlvlLy MosL of Lhe Llme buylng and selllng an
lnvesLmenL ls LreaLed as an lnvesLlng cash flow lf you were Lo make a loan Lo a
frlend you would LreaL lL as an lnvesLlng acLlvlLy l am assumlng LhaL you are
noL a bank neL lnvesLlng cash ouLflows mlghL lndlcaLe Lhe flrm ls
expandlng lf Lhe blggesL lnvesLlng cash ouLflows are for purchases of properLy
planL and equlpmenL
lf you were a company lnsLead of a sLudenL whaL would be some of your
lnvesLlng cash flows?

llnanclng cash flows are cash LransacLlons beLween Lhe enLlLy and lLs debLholders
or owners 1ransacLlons wlLh debLholders refer only Lo Lhe prlnclpal
amounLs borrowed or repald lnLeresL porLlon ls LreaLed as parL of operaLlng
acLlvlLles llnanclng acLlvlLles wlLh owners lnclude lssulng equlLy securlLles
paylng dlvldends Lo Lhem 8uylng or selllng Lreasury shares are flnanclng cash
flows Loo When a corporaLlon buys back shares from shareholders Lhese
shares become 'Lreasury shares' unLll sold or reLlred by Lhe corporaLlon
Pelpful PlnL
ln general all cash flows Lled Lo dlvldends and lnLeresL are operaLlng cash flows
excepL for dlvldends pald Lo shareholders flnanclng acLlvlLles

Cvervlew of llnanclal SLaLemenLs and Lhe 8alance SheeL

1he balance sheeL equaLlon governs mosL accounLlng relaLlonshlps
AsseLs LlablllLles + CL

CL lncludes Lhe effecLs of revenues expenses galns and losses As Lhe sum of
all of Lhese l/S elemenLs neL lncome ls known as Lhe 'boLLom llne' neL lncome
flows lnLo 8eLalned Larnlngs (8L) and becomes parL of CL 8ecause of Lhls
connecLlon beLween Lhe 'boLLom llne' and 8L Lhe l/S becomes parL of Lhe 8/S

1he 8/S ls usually shown as a classlfled balance sheeL WlLhln Lhe
subdlvlslons current assets and noncurrent assets we wlll dlscuss several
lmporLanL accounL names expandlng your 'vocabulary' of lmporLanL accounLlng
Lerms WlLhln Lhese caLegorles accounLs are presenLed ln descendlng order of
llquldlLy CurrenL asseLs usually conslsL of Cash or oLher asseLs converLlng Lo
cash wlLhln one year or Lhe flrm's operaLlng cycle whlchever ls longer CurrenL
asseLs also lnclude accounLs lnLended for consumpLlon wlLhln one year
SomeLlmes lmmaLerlal asseLs are shown as currenL asseLs Loo lor example
repald 8enL
Cash ls a currenL asseL lf lL ls unresLrlcLed and lnLended for use as needed
Cash would lnclude currency and checklng accounL balances lf managemenL
had agreed ln a conLracL Lo some resLrlcLlons on Lhe use of Cash or lf
managemenL lnLended Lo resLrlcL Cash for some fuLure use resLrlcLed amounLs
would be shown as noncurrenL asseLs
Cash equ|va|ents are noL Cash buL are LreaLed ls lf Lhey were Cash equlvalenLs
musL have maLurlLy daLes of Lhree monLhs or less when purchased 1hus cash
equlvalenLs musL be debL securlLles lnvesLmenLs ln money markeL securlLles
are cash equlvalenLs Whlle noL Cash cash equlvalenLs are 'close enough' Lo
Cash Lo be LreaLed as Cash for flnanclal sLaLemenL purposes lf a flrm
purchased a debL securlLy maLurlng ln slx monLhs Lhe securlLy would noL be a
cash equlvalenL when purchased lf Lhe flrm prepared a 8/S four monLhs afLer
buylng Lhe debL securlLy would Lhe debL securlLy be a cash equlvalenL? no
1he cash equlvalenL requlremenLs have Lo be meL when buylng Lhe securlLy
Accounts rece|vab|e are currenL asseLs conLalnlng uncollecLed amounLs LhaL
have been earned by Lhe enLlLy AccounLs recelvable A8 occur when flrms
provlde goods and/or servlces Lo cusLomers agreelng Lo be pald laLer ln some
buslness Lhls ls a rouLlne occurrence 8evenue musL be recognlzed when
earned and reallzed 8eallzaLlon means Lhe seller has Lhe cash or a clalm Lo
cash 1he clalm Lo cash ls mosL commonly called an A8 lf lL arose ln Lhe course
of ordlnary buslness by provldlng goods or servlces Lo cusLomers lf a
recelvable ls creaLed ln a lendlng LransacLlon accounLanLs are llkely Lo call lL a
noLe 8ecelvable n8 1he baslc dlfference beLween a n8 and an A8 depends
upon Lhe naLure of Lhe LransacLlon lf Lhe LransacLlon was a normal Lrade
arrangemenL Lhe recelvable would mosL llkely be an A8 Lendlng arrangemenLs
are usually documenLed by a wrlLLen agreemenL
9repa|d |tems are usually currenL asseLs because Lhey are lnLended for
consumpLlon wlLhln one year or are lmmaLerlal Common examples lnclude
repald lnsurance Cfflce Supplles repald 8enL and repald Salarles Assume
Lhe flrm pays an employee for one year's salary ln advance on AugusL 31 of ?ear
1 AL Lhe end of ?ear 1 lf a classlfled 8/S musL be prepared how much of Lhe
repald Salary wlll appear as a currenL asseL? Answer 8/12 of Lhe amounL
pald Lo Lhe employee 4/12 of Lhe year's salary has been used up becomlng an
expense whlle Lhe remalnder of Lhe year's salary conLlnues Lo be an asseL
Shortterm |nvestments are made for a many buslness reasons and Lhese wlll
be developed laLer lor now we wlll Lake a look aL Lhe baslc moLlves for holdlng
lnvesLmenLs ln oLher flrms A flrm mlghL have Lemporary surplus cash and
wlsh Lo make lnvesLmenLs for Lhe purpose of earnlng some lnLeresL dlvldends
or prlce appreclaLlon unLll Lhe cash mlghL needed laLer 1hese lnvesLmenLs
mlghL be classlfled as a currenL or noncurrenL asseLs as dlscussed earller
1yplcal lnvesLmenLs lnclude cerLlflcaLes of deposlL debL securlLles orlglnal
maLurlLy exceedlng Lhree monLhs or equlLy securlLles such as shares of sLock
ln anoLher enLlLy
Noncurrent assets lnclude all oLher asseLs conLrolled or owned by Lhe flrm
Noncurrent |nvestments mlghL be made for a varleLy of reasons lncludlng
sLrengLhenlng buslness relaLlonshlps
9roperty 9|ant and Lqu|pment 99L represenLs a broad range of asseLs Lo be
used over several accounLlng perlods ln Lhe flrm's operaLlons lncludlng land
bulldlngs and equlpmenL L collecLlvely comprlse a ma[or porLlon of Lhe
asseLs owned or conLrolled by a flrm 1hese asseLs are 'used' lnsLead of 'used
up' ln Lhe flrm's operaLlng acLlvlLles 1he cosLs of Lhese asseLs are noL expensed
ln one year (lf aL all) 8aLher depreclaLlon expenses sLem from Lhe use of Lhese
asseLs Suppose you buy a sound sysLem paylng $3000 Lhlnklng you wlll use
lL for Lhe resL of your sLudenL days (assume Lhree years) lurLher you esLlmaLe
LhaL Lhe sound sysLem wlll be worLh $900 Lo you when you sell lL or Lrade lL ln
when you graduaLe Whlle uslng Lhe sound sysLem you wlll experlence a
decllne ln value of $2100 $3000 $900 1he depreclaLlon meLhod we'll use
for now ls Lhe 'sLralghLllne' meLhod because $700 of Lhe LoLal expense wlll be
recognlzed ln each year over Lhe Lhreeyear llfe 1he oLher half of depreclaLlon ls
Lhe accounL ln whlch we 'accumulaLe' depreclaLlon Laken on Lhe sound sysLem
1hls accounL ls called AccumulaLed uepreclaLlon and when subLracLed from Lhe
cosL of L leaves us wlLh Lhe book value also known as carrylng value
L aL cosL Acc uepr L aL book value
ntang|b|e assets are noncurrenL asseLs lncludlng asseLs lacklng physlcal
subsLance lmporLanL lnLanglble asseLs lnclude copyrlghLs paLenLs leasehold
lmprovemenLs goodwlll and Lrademarks 1hese asseLs usually beneflL Lhe flrm
over several years and Lhe cosLs of Lhese asseLs are spread over LhaL Lerm
1ota| ||ab|||t|es are broken down lnLo current ||ab|||t|es and noncurrent
||ab|||t|es dependlng upon when Lhe llablllLles wlll be pald or sLop belng
economlc obllgaLlons WlLhln Lhese caLegorles Lhe accounLs are presenLed ln
descendlng order of llquldlLy wlLh some lmmaLerlal excepLlons
CurrenL llablllLles lnclude accounLs payable A and oLher accrued
llablllLles such as salarles payable lnLeresL payable and renL payable 1hese
llablllLles may resulL from buylng on accounL someLhlng LhaL wlll be used ln Lhe
operaLlons of Lhe flrm 1he suppller mlghL offer credlL Lerms glvlng a sLaLed
perlod of Llme before Lhe paymenL ls due Accrued llablllLles resulL from havlng
'used up' someLhlng ln operaLlons prlor Lo paylng for lL ldenLlfy a llablllLy you
could creaLe by uslng someLhlng up before you pay for lL lf you use a credlL
card Lo pay for someLhlng you consume rlghL away you are lefL wlLh an
'accrued llablllLy' ln general when Lhlngs are 'used up' before Lhey are pald
for Lhe consumer has an accrued llablllLy
SLlll anoLher source of currenL llablllLles occurs when cusLomers/cllenLs pay a
flrm ln advance for goods/servlces Lo be dellvered/performed laLer 1hese are
called unearned revenues
AnoLher currenL llablllLy resulLs when reclasslfylng parL of a longLerm llablllLy
as a currenL llablllLy Lo show LhaL parL of Lhe LoLal llablllLy due wlLhln one year
LaLer ln Lhls course we wlll reflne Lhls undersLandlng A noLe ayable n
could have a due daLe ln less Lhan one year and be shown ln a classlfled
balance sheeL as a currenL llablllLy lS users normally lnLerpreL currenL
llablllLles as requlrlng Lhe use of currenL asseLs or Lo be oLherwlse seLLled wlLhln
one year lf a flrm has recelved asseLs from a cusLomer prlor Lo provldlng
servlces Lo LhaL cusLomer Lhe llablllLy Lo Lhe cusLomer ls commonly called
unearned 8evenues or a ueferred 8evenues 1hls llablllLy wlll be seLLled by
performlng servlces
Lxamples of noncurrenL llablllLles lnclude n deferred lncome Lax llablllLles
some lease obllgaLlons and oLher debL arrangemenLs requlrlng paymenLs ln
fuLure accounLlng perlods
CL ls usually broken down lnLo Lwo ma[or componenLs conLrlbuLed caplLal
CC and 8eLalned Larnlngs 8L CC reflecLs lnvesLmenLs by owners and
lnvolved no revenues when Lhe lnvesLmenL occurred CC can be caplLal sLock
and preferred sLock lf Lhe flrm ls a corporaLlon 8L generally represenL lncome
earned by Lhe flrm and noL pald ouL ln Lhe form of dlvldends LaLer Lhls
semesLer we wlll see LhaL Lhere are oLher Lhlngs LhaL lmpacL CL
When a flrm has poslLlve neL lncome Lhls amounL wlll lncrease 8L ln a
procedure Lo be explalned ln 1oplc Lhree

Accrua| 8as|s of Account|ng
1he accrual basls ls based on economlc evenLs raLher Lhan belng governed by
cash LransacLlons Accrual revenues are recognlzed when Lhey have been
earned and reallzed Accrual expenses are recognlzed when resources have
been consumed or 'used up' 1he cash basls ls conLrolled by cash LransacLlons
Cash revenues occur when paymenLs are recelved and cash expenses are
recognlzed when maklng paymenLs 1he cash basls overlooks Lhe posslblllLy of
consumpLlon wlLhouL maklng currenL paymenL and Lhe process of earnlng
wlLhouL currenL recelpL of cash

LvaluaLe Lhese sLaLemenLs are esLabllsh for yourself wheLher Lhey are conslsLenL
wlLh Lhe cash basls or accrual basls of accounLlng
Pey uad l've found a greaL way Lo cuL my expenses whlle l am aL school l puL
everyLhlng l can on Lhe credlL card you gave me
l worked all day yesLerday aL my parLLlme [ob buL earned noLhlng ayday ls
nexL week
lrldays are Lhe only day when lL ls worLh lL Lo show up aL my parLLlme [ob
because LhaL's payday 1he oLher days l earn noLhlng
?esLerday was a greaL day aL my parLLlme [ob selllng adverLlslng l sold several
blg lLems and wlll collecL Lhe commlsslons nexL monLh
l had a loL of expenses yesLerday l pald for Lhe flrsL and lasL monLhs on my
new aparLmenL and pald Lhe securlLy deposlL
My answers are cash basls cash basls cash basls accrual basls and cash
basls
lf a salarled person works for a monLh Lhe person wlll have earned some Salary
8evenue and need noL have been pald yeL WlLh accrual accounLlng earnlng
revenues and paydays are dlfferenL economlc evenLs AlLernaLlvely suppose a
new employee sLarLed worklng for an employer and was granLed a cash advance
Lo help wlLh movlng cosLs prepaymenL Lo help Lhe employee relocaLe Lo Lhe new
clLy 1he employee would LreaL Lhe cash advance as an asseL (cash) and as a
llablllLy 1he maln polnL of Lhls example ls LhaL Lhe employee would recognlze a
llablllLy and because Lhe value has noL yeL been earned 8y recelvlng Lhe cash
advance Lhe employee should be Lhlnklng abouL hls/her obllgaLlon (llablllLy) Lo
provlde servlces for Lhe employer LaLer Lhe employee wlll noL be pald for all
servlces rendered Lo Lhe employer and Lhls wlll repay Lo obllgaLlon (llablllLy)
8/S and l/S are prepared uslng Lhe accrual basls of accounLlng l belleve LhaL
you cannoL fully undersLand how Lhe accrual basls works wlLhouL also
undersLandlng Lhe cash basls

ncome Statements
ln Lhls lecLure we wlll flrsL cover Lhe lncome sLaLemenL and Lhe accounLs used
Lo reporL Lhe resulLs of operaLlons unLll Lhls polnL we have emphaslzed Lhe
8/S lmpacLs resulLlng from l/S accounLs 1he l/S shows Lhe maLchlng of
revenues and expenses for Lhe purpose of deLermlnlng lncome galns and losses
are also reporLed ln Lhe l/S l/S and 8/S are prepared uslng Lhe accrual
basls
A mulLlplesLep l/S for a flrm LhaL mlghL sell servlces mlghL have Lhese
lmporLanL componenLs
1he Merle ConsulLlng Company
lncome SLaLemenL
lor Lhe ?ear Lnded uecember 31 ?ear 1
Sales 8evenue $19000
CperaLlng Lxpenses
Salarles 6000
Cccupancy 3300
uepreclaLlon 1300
uLlllLles ___600
CperaLlng Lxpenses $13600
CperaLlng lncome $3400
CLher 8evenue (Lxpense)
lnLeresL 8evenue 20
lnLeresL Lxpense (120)
Caln on Sale of L 300
Loss on Sale of Land __(100)
CLher 8evenue neL __$100
lncome 8efore 1ax Lxpense $3300
lncome 1ax Lxpense __1400
neL lncome _$4100
1he l/S conLalns revenues expenses galns and losses for an accounLlng
perlod 8evenues and expenses come from Lhe flrm's prlmary llne(s) of buslness
and recur Calns are losses are perlpheral Lo Lhe enLlLy's prlmary llne(s) of
buslness and are noL recurrlng 1he same galn or loss cannoL occur agaln
Slmllar galns and losses may occur from Llme Lo Llme A consulLlng flrm ls noL
ln Lhe real esLaLe buslness and Lhe sale of land would cause llkely cause a galn
or loss unless lL was sold for exacLly Lhe same prlce LhaL had been pald Lo buy
lL Llkewlse Lhe sale of L by a consulLlng flrm would llkely cause a galn or
loss because sales of L would noL be parL of Lhe flrm's ongolng acLlvlLy

ncome Statement Cont|nued
nterest kevenue ls earned over Llme as a resulL of havlng lnvesLed or lenL
money Lo anoLher and where Lhere ls an lnLeresL raLe lnvolved lnLeresL ls
calculaLed based on a famlllar relaLlonshlp rlnclpal x 8aLe x 1lme
ther kevenues can lnclude any amounLs earned by Lhe flrm from varlous
acLlvlLles oLher Lhan Lhe prlmary acLlvlLles 1hese mlghL lnclude dlvldend
revenue lnLeresL revenue and royalLy revenue among oLhers When presenLed
as CLher 8evenues a user would lnLerpreL Lhe componenLs as perlpheral Lo Lhe
flrm's maln llne of acLlvlLles lf any of Lhese mlghL be lndlvldually slgnlflcanL lL
could be reporLed as a separaLe llne lLem ln Lhe 'oLher revenue' area or be
lncluded ln Lhe LoLal for 'oLher revenues' and Lhe speclflc dollar amounL shown
ln Lhe fooLnoLes Lo Lhe l/S
Cost of Goods So|d (CGS) ls Lhe expense LhaL occurs when Langlble
merchandlse ls sold Lo cusLomers lL summarlzes Lhe merchanL's cosLs of
buylng or bulldlng Lhe lnvenLory LhaL ls sold Lo Lhe cusLomer 1he spread
beLween CCS and Sales 8evenue expresses Lhe seller's ablllLy Lo sell Lhe producL
ln Lhe compeLlLlve markeLplace 1he spread beLween CCS and Sales 8evenue ls
called Cross Margln Cross roflL
Se|||ng Genera| and Adm|n|strat|ve Lxpense ls a collecLlon of expenses LhaL
mlghL lnclude uepreclaLlon Lxpense (on admlnlsLraLlve faclllLles) Salarles
Lxpense 8enL Lxpense Selllng Lxpense 8esearch and uevelopmenL Lxpense
8ad uebLs Lxpense among oLhers SomeLlmes Lhese expenses are grouped
LogeLher ln publlshed lS ManagemenL of a flrm wlll have access Lo all of Lhese
ln whaLever level of deLall ls deslrable
nterest Lxpense ls Lhe 'economlc renL' charged for borrowlng from oLher
enLlLles lnLeresL ls Lhe cosL of posLponlng paymenLs and ls an expense Lo Lhe
borrower rlnclpal x 8aLe x 1lme
lncome 1ax Lxpense represenLs lncome Laxes deLermlned uslng flnanclal
accounLlng (lA) rules and noL accordlng Lo Lax accounLlng (1A) rules 1he
exLenslve dlfferences beLween lA and 1A rules creaLe complexlLy lA goals
sLrlve Lo dellver lnformaLlon useful ln declslonmaklng 1A goals cenLer on
governmenLs' need Lo generaLe Lax revenues Lo Lhe governmenLs lf dlfferences
beLween 1A and lA rules are Lemporary Lhere are fuLure Lax consequences
when Lhey reverse AlLernaLlvely some dlfferences beLween 1A and lA never
reverse and have no fuLure ax consequences as a resulL lncome 1ax Lxpense
ln Lhe lncome sLaLemenL lA ls made up of Lwo subcomponenLs currenL Lax
expense and deferred Lax expense 1he deferred Lax expense resulLs from
presenLly recognlzlng Lhe fuLure effecLs LhaL resulL when Lhe Lemporary
dlfferences reverse CurrenL Lax expense aggregaLes all of Lhe lncome Laxes LhaL
are currenLly payable Lo Lhe varlous governmenLal enLlLles
Comprehenslve lncome conslsLs of neL lncome ad[usLed for all of Lhe lLems
affecLlng CL oLher Lhan LransacLlons wlLh owners ln one accounLlng Loplc ln
Lhls course we wlll examlne a slLuaLlon where proper accounLlng LreaLmenL
requlres ad[usLmenLs Lo CL buL does noL havlng an effecL on neL lncome 1he
changes ln CL are added Lo or subLracLed from neL lncome Lo arrlve aL
comprehenslve lncome (unless Lhey resulLed from LransacLlons wlLh Lhe
owners) Comprehenslve lncome ls a relaLlvely new concepL ln lA and ls a
requlred dlsclosure assoclaLed wlLh l/S All of Lhe ad[usLmenLs Lo neL lncome ln
arrlvlng aL comprehenslve lncome flow lnLo a speclal owners' equlLy secLlon
accounL AccumulaLed CLher Comprehenslve lncome !usL as neL lncome flows
lnLo 8eLalned Larnlngs Lhese ad[usLmenLs flow lnLo AccumulaLed oLher
Comprehenslve lncome
Larnlngs er Share (LS) ls a wldely waLched measure of flnanclal
performance LS resulLs from dlvldlng Lhe neL lncome avallable Lo common
shareholders by Lhe welghLed average number of common shares ouLsLandlng
for Lhe perlod More slmply LS ls lncome avallable Lo common shareholders
scaled by Lhe number of common shares ouLsLandlng so flnanclal sLaLemenL
users can make easler comparlsons beLween flrms LS daLa are requlred
dlsclosures for publlcly Lraded flrms
SomeLlmes we flnd lL sufflclenL Lo Lhlnk ln Lerms of LoLal asseLs CLher Llmes
we wlll wanL Lo Lhlnk ln Lerms of speclflc asseLs lor Lhls laLLer purpose
knowledge of speclflc accounLs LlLles wlll help us communlcaLe beLLer ln
general we should have a separaLe accounL for each dlfferenL Lhlng we wlsh Lo
monlLor ulfferenL asseLs llablllLles CL revenues expenses galns and losses
wlll provlde more useful lnformaLlon Lo lS users when kepL ln separaLe
accounLs

1he Account|ng Cyc|e

AccounLlng ls based upon Lhe doubleenLry sysLem 1hls permlLs lS Lo conLaln
Lhe asseLs conLrolled and Lo have summary lnformaLlon regardlng Lhe sources of
Lhose asseLs Conslder Lhls slmple (smarL?) example A flrm has $1000000 ln
cash WhaL are posslble sources of LhaL money?
uo you Lhlnk LhaL knowledge of Lhe money's source adds much valuable
lnformaLlon Lo anyone lnLeresLed ln Lhe flrm's lS? 1he same example exLends
Lo our personal llves lf a person you are serlously daLlng has $1000000 ln
currency would you have an lnLeresL ln knowlng someLhlng abouL where Lhe
currency came from? lS users usually wlll noL be able Lo Lrace Lhe $1000000
Lo a speclflc source buL wlll have lnformaLlon enabllng lnformed [udgmenLs
abouL lLs orlglns 1hls slmple (smarL?) example lllusLraLes Lhe power of doubleenLry
accounLlng eople have unsuccessfully Lrled Lo lmprove upon lL

LeL's revlslL our 'old' frlend Lhe baslc accounLlng equaLlon
AsseLs LlablllLles + CL

We have recenLly seen LhaL lL ls deslrable Lo keep lnformaLlon abouL dlfferenL
asseLs and llablllLles ln separaLe accounLs for ease of undersLandlng whaL we
have lor example we would keep our credlL card llablllLles separaLe from any
llablllLy we mlghL have for a sLudenL loan or a car loan 1he concepL of an
accounL ls merely a 'place' Lo keep lnformaLlon abouL someLhlng LhaL ls of
lnLeresL Lo managemenL of Lhe flrm lor example would lL make sense Lo keep
Salarles Lxpense ln a dlfferenL accounL Lhan 8enL Lxpense? ?es Managers
have an lnLeresL ln monlLorlng many expenses as Lhey aLLempL Lo beLLer manage
Lhe flrm and hold approprlaLe people accounLable
ConcepLually accounLs are shown ln Lhe form of a '1' WhaL's really lmporLanL
for us aL Lhls polnL ls LhaL Lhere ls a 'rlghL slde' and a 'lefL slde' A '1' accounL
does LhaL for us qulLe nlcely

acloll an lLallan monk ln Lhe laLe 1400's ls glven credlL for creaLlng Lhe
accounLlng sysLem we sLlll use Loday Lhe double enLry sysLem ln Lhe
aggregaLe Lhe double enLry sysLem of accounLlng allows us Lo Lrack whaL we
have and where lL came from acloll arblLrarlly declded asseLs show
balances on Lhe lefL AlLernaLlvely llablllLles and CL accounLs would show
balances on Lhe rlghL 1hls causes Lhe baslc accounLlng equaLlon and Lhe 'lefL'
and Lhe 'rlghL' balances Lo be slmulLaneously ln balance As we work Lhrough
some exerclses ln Lhls Loplc and laLer ln Lhe course when Lhe balances on Lhe
'lefL' do noL equal Lhe balances on Lhe 'rlghL' you'll have a slgnal LhaL someLhlng
has been recorded on Lhe 'wrong' slde 1hese Lwo expresslons musL slmulLaneously balance