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Accounting And Financial Statements For Lawyers Outline

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Accounting & Financial Statements Fall 2015 University of Virginia School of Law Financial Statements:
? Decision usefulness: (1) reliability (faithful representation) , (2) relevance (timeliness) , and (3) comparability (entities) /consistency (years, org) . (Lemons problem: judgments, asymmetric information, really what worth?) o Convenience/Objectivity/Relevance/Reliability/Conservatism/Consistency/Comparability
/Faithful-Representation
? Conservatism: use method least likely to overstate value, recognize revenues too early, expenditures too late, or understate liabilities
? Users: management/investors/debt-holders/government/shareholders
? BALANCE SHEET: financial position at point in time using accounting equation (statement of financial position/condition) o Assets (liabilities): entity's probable future (sacrifices of) economic benefit (from present obligations to transfer assets/provide services to other entity in future) from past transaction/event
? Current Assets: expected conversion to cash within 1yr or operating cycle
? Cash
? Accounts Receivable
? Inventory
? Prepaid obligations
? Marketable securities
? Short term investments
? Noncurrent (Capital) Assets
? Property, plant and equipment
? Net of accumulated depreciation
? Intangible assets
? Net of accumulated amortization
? Land (never depreciated)
? Deferred tax assets: Current/Noncurrent
? Goodwill
? Fixed assets o Liabilities:
? Current liabilities (payment w/in 1yr/accounting period)
? Accounts Payable/Wages/Interest/Taxes/Current Loans Payable
? Noncurrent Liabilities/Long-term debt
? Bonds/Taxes/Noncurrent Loans Payable
? Deferred Tax Liability o Shareholders' Equity; residual interest in assets after deducting liabilities
? Contributed Capital
? Common Stock
? Par Value
? Additional Paid in Capital
? Preferred Stock

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Accumulated other comprehensive income/loss: unrealized gain/loss b/c item not settled Treasury Stock at cost (contra): purchase back, intent re-distribute Earned Capital
? [?]Retained Equity=Net Income-dividends
? Income Statement: revenue--expenses for fiscal year (statement of earnings, statement of operations) o Revenue Operating revenue Revenue from peripheral activities E.g. Continued Operations, other peripheral activities (separate from normal business, or discontinued (e.g. selling business) o (Cost of revenue/goods sold) o Gross profit o (Operating expenses) Wages, salaries, etc. Cost of discontinued activities Depreciation and amortization E.g. Continued Operations, other(separate from normal business, or discontinued(e.g. selling business) o Operating Income o (Interest Expense) o (Taxes) o Net Income: before dividends paid o Extraordinary gains (losses): "unusual nature/infrequent occurrence" - reported after income from continued operations, less taxes (store closing, class action, regulatory/accounting changes, earthquakes)
? Statement of Cash Flows o Start w/last year's Balance Sheet cash, end w/this year's o Methods: Cash Flow activity groups
? Operating activity (either direct or indirect)
? Financing activity (only direct)
? Investing activity (only direct) Direct: add cash from all activities (~10% companies do for operations, required for investing/financing)
? Cash Flows from Operating Activities: indirect->direct method
? Cash from Sales (Revenues - Accounts Receivable)
? -Cash for Cost of Goods Sold (=Cost of Goods Sold + increase in inventory-[?]Accounts Payable- [?]depreciation)
? -Cash for Operating Expenses
? -Cash paid for investing activities (only if part of revenues)
? -Cash for Interest
? -Cash for Income tax=(Income tax-tax payable) Indirect: start with Net Income/earnings and then subtract non-cash assets, add non-cash liabilities.
? Operating/Investing/Financing Separate

Subtract positives contributions to Net Income that weren't cash from operations
? Accounts Receivable
? Increase in inventory
? Prepayments
? Decrease in liabilities
? Extraordinary gain
? Investment gain
? Inventory
? Add back negatives that weren't cash
? Depreciation/Amortization (in Cost of Goods Sold)
? Accounts Payable
? Noncash compensation
? Deferred tax liability
? Add/subtract things not on Income Statement that were cash(because we use the accrual method)
? Retainer for future years
? Other non-accrued gains/losses o General Balance Sheet to Cash Flows activity category correspondence Current assets-------------------operating Noncurrent asset----------------investing/operating Current liabilities----------------operating Noncurrent liabilities------------financing Capital stock----------------------financing Retained Equity-----------------------------------operating/financing o Examples of Activities: Operating
? Current Assets and Liabilities
? From Customers
? Payments: Inventory/Wages/Taxes/Interest/Advertising
? Pension Obligations Investing
? Dividends received
? Marketable Securities
? Buying/selling land/businesses/investments (see above for operating activities) Financing
? Dividends paid
? Cash from stock issuance/sale
? Loans/bonds
? Principal Payments o Alternatives: EBITDA: earnings before interest taxes depreciation amortization (earnings before bad stuff(EBBS) , pro forma earnings) -->uncommon, must disclose Free Cash Flows: Cash Flows from operations-capital expenditures
? Leftover after maintaining assets??????

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Discretionary Cash Flows: Cash Flows from operations-required debt payments- dividend payments
? Generated cash available for discretionary value-creating actions
? Statement of Shareholders' Equity o Contributed Capital: Common Stock: amount received from stock sales/(balance asset side) o Earned Capital: Retained Equity: Net Income - Dividends

RATIOS Benchmarking: compare w/competitors Return on Equity Analysis
? ROE=(ROS) x(Asset Turnover) x(Financial Leverage) =(Net Income) /Shareholders' Equity o =(Net Income/Net Sales) x(Net Sales/Total Assets) x(Total Assets/Shareholders' Equity) o Net sales=remove discounts/returns) o Financial Leverage: Higher=more debt, 2: Shareholders' Equity=L Other
? ROA=Net Income/total assets
? Old rule: want current ratio at 2:1, but industry specific---Dominion more like 1:1
? Price-to-earnings multiple=market price per share/earnings per share o Market's assessment---amount investors willing to pay per dollar of future earnings o High: confidence in firm. Low: investors want higher ROI
? Cash collection period=inventory-on-hand period + receivable collection period-days' payable period o Average time from inventory cash outlay, through sale, until cash collection for sale
? Cash-Conversion-Ratio: (cash from sales) /(net sales)
? Operating Cash Flow to Current Liabilities
? Operating-Funds-Ratio: Cash Flows from Operations/Net Income Financial Risk
? Long-term debt-to-equity: want lower because not relying on debt, but equity o Large corps can more easily finance w/equity
? Financial Leverage
? Total-debt-to-assets: can pay debt w/assets?
? Interest Coverage: can pay debt costs w/income?
Shareholder Analysis:
? Earning-per-common-share: o Basic (Factual):(Net Income-Preferred Stock dividends) /weighted-average-Common Stock shares o Diluted (Hypothetical/Conservative):Net Income/All possible shares (weighted-averageoutstanding + convertible securities + stock options, etc.) ,(don't subtract preferred dividends) Common-size statements

?Common-size Balance Sheet: expressed as percentage of total assets Common-size Income Statement: expressed as percentage of net-sales/net-revenue (=grossrevenue - allowances for sales - discounts & returns)

%Change Statements
? (New-Old) /Old Revenue Recognition:
? Principles: (1) earned (legally obligated to pay) and (2) collectible (received or high prospect of receiving cash) o SEC SAB101 gives more detail (majority of securities fraud are w/revenue recognition) . o Generally recognized when
? (1) Persuasive evidence sales arrangement exists
? (2) Delivery of goods/performance of services (not PO/Contract)
? (3) Seller's price fixed/determinable
? (4) Cash collectability reasonably assured
? But see historical practice o Examples:
? Spread revenue over contract-life life time gym, wireless-activation-fee (predictability of costs?)
? Not recognize revenue when returnable because trial period
? Middlemen only recognize net-revenue
? Consignment: if you retain title, not recognizable until consignee sells
? Rev-Rec-Points-Timeline o Commodities: harvested/finished, in storage for sale ([?]buyer) o POS o Percentage-of-completion
? Engineering/construction
? Percent estimated total-cost incurred o Cash-Collection
? Riskier sales (conservative) o Completed-Contract Method
? No installment payments recognized until K completed
? for products w/limited market (jets) Bad Debts:
? Methods: o Percentage-of-Credit-Sales Method:
? Calculate %new credit sales not collected, put into ADA contra Accounts Receivable o Aging:
? Basket Accounts Receivable by days since sale, older account-->higher rate into ADA (historical/industry data)
? ADA o ADA carries over year-to-year o at year end, adjust ADA, recognize bad debt expenses in Retained Equity to reflect expected uncollectible Accounts Receivable
? Writing-off doubtful accounts: matching bad debts to actual sales

o o

Reduce Accounts Receivable, subtract that from ADA, no effect on NET Accounts Receivable if correctly estimated Wrong Estimate?
? Overestimated: positive balance
? less bad-debt-expense next year
? Underestimated: negative balance
? more bad-debt-expense next year

Monetizing Accounts Receivable
? Receiving: cash collection
? Factoring: selling right to collect to third party at reduced rate o W/o-recourse: factor responsible for non-collection of debt o W/recourse: if factor cannot collect debt, he can come back to the entity o Need cash NOW
? Pledging: borrowing, pay back later/post-collection
? Securitizing: company buy receivables and sells it to others o Good Cash Flows o Must report at Fair Market Value, even if=zero Calculating inventory and Cost of Goods Sold
? Sell good? must determine cost required to sell it. Match the cost-incurred w/benefit received in same period. o Matching Costs->Revenues Models
? Direct
? Match costs for each item sold directly to production cost
? Construction
? Ex: specific ID below
? Systematic
? Consistently write-off costs (like depreciation/amortization)
? Judgment
? Decide when to deduct
? Multi-year bonus, R&D costs
? Immediate Recognition
? Uncertainty? Deduct/expense immediately (conservative: advertising, R&D in US)
? Inventory: on Balance Sheet at lower of cost or market (replacement cost) o Prevents delay of loss due to changed Fair Market Value for obsolete goods o Do cost when below because accuracy
? When Revenue Recognized: subtract Cost of Goods Sold (using a method) to get Income Statement gross profit-->Reduce Balance Sheet inventory by Cost of Goods Sold
? Inventory methods: o Specific ID: for discrete items (e.g. cars, jewelry) o LIFO (FISH): assuming inflation-->deferred profit & tax
? More current method of matching costs2revenue
? Inventory understated because Cost of Goods Sold overstated

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