Economics 4 Lecture 1.

Accounting, Business Professions,

And a Reporting Illustration

Michael Willoughby, Ph.D., CFA

© Michael G Willoughby 2008

 The Context
Scarcity: We want more than we have, or
… we need what we don’t have – a chunk of ca$h.
Life Cycle: Time changes everything
… needs, wants, resources, and prices.
Risk: Shit happens plus
…we seldom never know exactly what kind of shit it is -
so CERTAINTY is more desirable than uncertainty.
Information helps!
… unless it’s bad information.
 Money-related Professions
(broadly)
 Economics: decisions about the use of
resources – what do we want most?
 Finance: decisions about the inter-temporal
allocation of money: lending & borrowing.
 Risk-management: decisions about the
management – purchase or sale – of risk.
 Accounting – an information system for
recording and reporting business financial
performance & position.
 Money-related Professions
(narrowly)
 Economics:
n policy pro/prescriptions;
n purchasing of commodities (i.e., the SWAL fuel futures);
n production management.
 Finance:
n Banking - financial intermediation;
n Investment management (valuation)
n Financial planning.
.
 Money-related Professions
(narrowly)
 Accounting:
b) Control (bookeeping & internal controls);
c) Financial reporting;
d) Auditing;
e) Tax-planning.
 Risk-management:
g) Consulting; practices & procedures, systems
design, policy implementation;
h) Insurance; underwriting.
 Where?
 Economics:
2. The Federal Reserve Banks.
3. DOC, DOL, DOT, all Legislatures.
4. Big manufacturing firms.
5. ?
 Banking:
7. Commercial banks: Citi, BofA, Wells Fargo.
8. Investment banks: Goldman, Lehman, Bears?
9. Credit Unions: NFCU, America First, SD
County.
 Where?

 Accounting:
2. Ernst & Young.
3. Deloitte & Touche.
4. KPMG.
5. Price-Coopers (PWC).
6. Arthur Anderson R.I.P.
And the Regionals
8. Moss Adams.
9. McGladry Pullen
 Where?
 Insurance:
2. Marsh & McLennan
3. A.I.G.
4. GEICO, All State, Farmer’s, Traveler’s.
5. ?
 Risk-management:
7. Kroll, Inc.
8. ?
 Who?
 Economics:
2. M.A.’s
3. Ph.D.’s
 Finance:
5. CFA’s
6. CFP’s
7. CIRA’s
8. RIA’s
9. CFO – job title allows you to join the FEA
 Who?
 Accounting:
2. CPA’s
3. EA’s
4. CMA’s

 Insurance:
7. CLU’s
8. ?
9. AA’s
 Why accounting?
It’s a formal way of keeping track of cash,
claims to cash, obligations, & stuff:
2. Transactions & inventory.

3. Promises & contracts.

4. Money – my investment in your efforts.

 Financial Reporting
 A report card on a Company’s:
 Performance – profits – via the Income
Statement
 Position – assets & liabilities – via the Balance
Sheet
 Liquidity – the sources & uses of ca$h – via the
SCF
 Financial Reporting
 To interested parties:
Outsiders:
c) Investors – owners; Purchase company stock.
d) Creditors – lenders; Purchase company bonds.
e) Regulators
f) Vendors – suppliers & employees.
Insiders:
h) Managers
 Functions
#1 Collection
 The transactions of AN ENTITY
 w/other Entities (persons and/or organizations)
 Over a PERIOD of time – the Fiscal Year “FY”
and its 4 Quarters.

#2 Measurement
7. In a monetary unit “$”
8. Using some rules, guidelines, & judgment
 Functions

# 3 Classification: every transaction creates a

number that will be “labelled”:
 Asset
 Liability
 Equity
 Revenue
 Expense

And also
8. Gain
9. Loss
 Functions

#4 Presentation – the reporting part

1. Income Statement – performance OVER the Period –

lists Revenues and Expenses, sometimes Gains &
Losses.
2. Balance Sheet – position AT A POINT, the end of the
Period – lists all Assets, Liabilities, and Equity.
3. Statement of Cash Flows – translates the reported
performance on the I/S and changes in the B/S into the
most objective, most fungible, resource - CA$H.
Starbuck’s “SBUX” Stock
 Financial Statements
Income Statement
 Top-down presentation
 Sales or Revenue = inflows from Primary Activities
 Less Expenses = outflows from Primary Activities
  There are three categories of expenses and many types,
of Expenses !
 = Earnings – a measure of profit
  There are several levels of profit ending (at the bottom
line) with Net Income.
 Sales = $7,998,265,000 1

1
Company-owned stores. The Company’s total sales (ttm)
was $10,097,790,000.
 Financial Statements
Balance Sheet
 One of civilizations greatest achievements.
 Keeps the accounting system in order.
 Assets = Liabilities + Equity
 What we OWN = What we OWE
 Everything must have = a Source
 Assets = Capital
 Assets = Trade Credit + IBD + PinK + Retained Earnings
 Financial Statements

Balance Sheet
 Yours’
 Your Parents’
 Your Employer’s
 Your Nation’s
 A Global Balance Sheet? – if Al Gore says so.
 Financial Statements
 Statement of Cash Flows
 Only Cash is Cash !
 A required Financial Statement since 1987 w/ SFAS 95.
 Three Sources and Uses of Cash:
6. Operating
7. Investing
8. Financing
 Required because of the Accrual nature of accounting.
 Objectives of Financial
Accounting
 Useful to the providers of money capital:

3. Relevant
4. Reliable: consistent & comparable
5. Timely
 Capital Providers
 Investors – provide equity capital
2. As initial Paid-in-Capital “PinK”
3. As retained earnings from profitable
activities.

 Creditors – provide debt capital

6. Trade credit
7. Interest-bearing Debt
 Capital Providers con’t
 The source of money capital for
companies
 Investors & Creditors literally “Sell Cash”
to Company’s in exchange for:
 Financial claims:
 Bonds – debt
 Stocks - equity
 Need Useful Information
Capital Providers want information:
 For Decision-making
 About starting, staying-the-course, ending
 A financial relationship …
 With what Companies?
 Comparability is the corner stone of GAAP
 Accounting Assumptions
 One entity.
 Record-keeping for “a Period” of time.
 On-going concern
 Conducting transactions that can be
measured in Dollar$
 Accounting’s Principles
 Cost – historical
 Objectivity – b/w independent parties
 Realization – of Revenue ≡ Sales
 Matching – Expenses w/ Sales
 Materiality – don’t show the small stuff
 Employees & Stores
 172,000 employees worldwide; 144,000 U.S.A.
 163,000 employees in Stores; 9,000 in Admin.
 8,505 Company-owned Stores; 6,506 licensed.

Sales per store-employee in Company-owned

stores?
$ 49,065
and $ 46,501 per total employees
 Profits

• Net Income = $ 672,640,000

• Per employee = $ 3,800
• Profit Margin = 7.15 %
Two Methods of Accounting
Cash-basis Accrual
 Only collect &  Collect & measure
report “cash” & report all
transactions only. transactions.
 Cash-basis Accounting
 We measure activity when “cash” is
received and when it is disbursed.
 The difference is cash-basis profit.
 This is the basis for taxation of small
businesses.
 Cash-basis accounting is a rules-based
measurement system.
 Accrual

 What matters is completed activities –

selling goods/services regardless of
whether cash is collected at the time or
sale, before, or after.
 Accrual
 Is about measuring success in dollar
units as they are associated with
activities including claims and
obligations created while selling.
 Is a principles-based measurement
system, using the realization & matching
principles to recognize Revenue and
Expenses.
Once Upon a Time there was a little
ranch in Wyoming
With gentle tenant farmers

My parents
Starting with $ 6,000 in cash from prior
earnings (Retained)
Balance Sheet at 12/31/07.

Cash = $ 6,000
AR = $0
UnER = $0
INV = $ 0
Pay = $0
PrePd $ 0
AcEx = $0
IBD = $0
LLA $0
(Accum DA) P-in-K = $0
RE = $ 6,000
 2008 Activities

 Purchase ten 400# hefers and steers in March.

 Grass feed them for about 10 months.
 Start selling them in when they each weigh
1000# in about November.
Next Stop: Ruth Chris’
 All Transactions: March-December

1. Purchase 10 animals @ $400 each = $4,000 cash.

2. Purchase salt & minerals: $ 400 cash.

 Agree to pay my father: $100/mo. x 10 = $1,000 but
we forget to pay him for December.
 Sell 8 animals @ $1,000 each by the end of
December, but two customers don’t pay until
January 2009.
 What will my 2008 Financials look like?
 It depends
Do we measure success on a:

 Cash-basis?
Or by the

 Accrual method?
 Cash-basis Income Statement for 2008

Revenue 6,000 of cash sales = 6 x $1,000 cash

received.
(COGS)
( 4,000) direct expenses – 10 x $400 cash
GP paid.
(G&A) 2,000
Profit ( 1,300) $400 cash for supplies & $900 cash for
labor,

700
 Accrual Income Statement for 2008

Revenue 8,000 Revenue as $6,000 cash + $2,000 in

IOU’s
(COGS)
( 3,200) match the 8 sole x $ 400 as Direct
GP Expense

(G&A) 4,800
Profit ( 1,400) match $400 supplies cost + $1,000
labor cost

3,400
 Close the Balance Sheet at 12/31/08
for the Accrual method: Fill-in these numbers

Cash = $ ????
AR = $ ????
UnER = $0
INV = $ ????
Pay = $0
PrePd $ 0
AcEx = $0
IBD = $0
LLA $0
(Accum DA) P-in-K = $ 0
RE = $ ????
 Make a Cash Journal
Beginning cash $ 6,000 12/31/2007
Purchase animals ($ 4,000)
Purchase supplies ($ 400)
Pay for Labor ($ 900)
Cash for Sales $ 6,000
Ending cash $ 6,700 1
1
Ending cash will be recorede on the 12/31/2008 Balance Sheet.
Also note that Ending Cash – Beginning Cash = Cash flow =
$700
 Adjusting the Balance Sheet
Accounts
 Basic internal control formula.
a) What you start with
b) plus
what you receive,
c) less what you use
equals
d) what you end with.
 Articulate Retained Earnings
 The internal control formula.
a) start with $ 6,000
b) plus
2008 Profit of $ 3,400
c) less nothing
equals
d) ending Retained Earnings of $ 9,400.
 The Balance Sheet at 12/31/08
for the Accrual method

Cash = $ 6,700
AR = $ 2,000
UnER = $ 0
INV = $ 800
Pay = $ 0
PrePd $ 0
AcEx = $ 100
IBD = $ 0
LLA $0
(Accum DA) P-in-K = $ 0
RE = $ 9,400