Financial Accounting Environment The primary focus of financial accounting is on the information needs of investors and creditors. Who provides financial information? Who uses financial information? Financial accounting & managerial accounting What is financial information?

Financial Accounting Environment Providers of financial information Profit-oriented companies Not-for-profit entities Households Financial accounting Governmental and nonprofit accounting

Financial Accounting Environment Users of financial information (external) Investors Creditors (banks, bondholders) Employees Labor unions Customers Suppliers Government regulatory agencies (Securities and Exchange Commission) Financial intermediaries (financial analysts, credit-rating organizations…) Primary users

Financial Accounting Environment Users of financial information (external) Users of financial information (internal) Managers, CFO, CEO the board of directors Financial Accounting Managerial Accounting

Financial Accounting Environment Financial information: financial statements and related disclosure notes Financial statements: Balance sheet or statement of financial position The income statement or statement of operation The statement of cash flows The statement of shareholders’ equity

Objective of Financial Accounting The objective of financial accounting is to provide financial information about the reporting entity that is useful to present and potential equity investors, lenders, and other creditors in making decisions in their capacity as capital providers. Who: Reporting entity Do what: Provide financial information (useful in decision-making) To whom: Capital providers

Objective of Financial Accounting Useful information: Provide insight into future cash flow (future performance) helps decision makers identify the company’s financial strengths and weaknesses and assess liquidity and solvency. Financial information (financial reports): three major financial statements

Objective of Financial Accounting Capital providers: investors + creditors (lenders) From creditors by borrowing Liability Acquired capital From investors in exchange for ownership Shareholders’ equity

Cash VS. Accrual Accounting Two accounting methods: Cash Basis Accounting Accrual Basis Accounting

Cash Basis Accounting 收付实现制 One of the accounting methods Revenue is recorded when cash is received, expenses are recorded when cash is paid out. Net operating cash flow=cash receipts-cash disbursement 净经营性现金流量=现金收入-现金支出 NOCF>0 A major drawback: over short periods of time, operating cash flows may not be indicative of the company’s long-run cash-generating ability. 企业短期的经营性现金流量可能不能很好反映其长期获取现金的能力。

Cash Basis Accounting 1 2 3 Total Sales (on credit) 100,000 300,000 Cash receipts 50,000 125,000 Three years’ rent -60,000 salaries -50,000 -150,000 Utilities -5,000 -15,000 -10,000 -30,000 NOCF -65,000 60,000 65,000

Accrual Basis Accounting One of the accounting methods Revenue is recorded when earned, expenses are recorded when incurred. Net income=revenues-expenses 净利润=收入-费用 （or net loss if expenses are greater than revenues.） Net income ≠ Net operating cash flow

Accrual Basis Accounting 1 2 3 Total Revenues 100,000 300,000 Cash receipts 50,000 125,000 Rent -20,000 -60,000 Salaries -50,000 -150,000 Utilities -10,000 -30,000 Net income 20,000 60,000

Exercise 1 2 Revenues 170,000 220,000 Cash receipts 160,000 190,000 Salaries -90,000 -100,000 Utilities -30,000 -40,000 Purchase of insurance -60,000 The company incurred utility costs of $35,000 in year one, and the insurance covers a three-year period.

Qualitative Characteristics of Financial Reports Overriding objective Decision usefulness Relevance 相关性 Faithful representation 如实反映 Primary characteristics

Qualitative Characteristics of Financial Reports Relevance 相关性 Faithful representation 如实反映 Predictive Value 预测价值 Predictive Value 预测价值 Confirmatory Value 验证价值 Completeness 完整性 Free from material error 无重大错报 Neutrality 中立性 Neutrality 中立性

Qualitative Characteristics of Financial Reports Overriding objective Decision usefulness Primary characteristics Relevance 相关性 Faithful representation 如实反映 Comparability 可比性 Verifiability 可验证性 Timeliness 及时性 Understandability 可理解性 Enhancing characteristics

Constraints to Achieving Qualitative Characteristics Two constraints: 两个约束条件 Cost Effectiveness 成本效益原则 Segment report Materiality 重要性 Dollar amount of an item (bad debts) Nature of an item (unlawful transaction) One practical justification: 一个实务判断 Conservatism 谨慎性

Elements of Financial Statements In America, it has 10 elements of financial statements. Assets Liabilities Equity (or net assets) Investments by owners 业主投资 Distributions to owners 业主派得 Comprehensive income 综合收益 Revenues Expenses Gains 利得 Losses 损失

Elements of Financial Statements Assets Future economic benefits Obtained or controlled 拥有或控制 Our company purchased a building. (obtain) Capital lease (control) Past transactions or events Our company is planning to purchase an equipment next year. (future transaction)

Elements of Financial Statements Liabilities Future sacrifices of economic benefits Present obligations 现时义务 Exp. Company A purchased $100,000 of inventories on credit from company B. Company A has the obligation to pay $100,000 to company B. Past transactions or events

Elements of Financial Statements Equity (or net assets) shareholders’ equity or stockholders’ equity residual interest 剩余权益 (equity=assets-liabilities). Exp. We open a new company. Its total assets are $10 million. All the assets are coming from two capital providers: one part is from creditor, $4 million; the other part is from investor, $6 million.

Elements of Financial Statements At the beginning: $4 million from creditor $10 million $6 million from investor After two years: $4 million from creditor $10 million $8 million from creditor liabilities $12 million Is it still $6 million?? equity Equity is the residual interest, Equity=Assets- Liabilities=$12-$8=$4≠$6 Stockholders’ equity is decreasing during two years.

Elements of Financial Statements Revenues Inflows/enhancements of assets/settlements of its liabilities （收入的产生可以是现金流入/资产的增加/负债的减少） Inflows: sell $1000 products in cash. Enhancements of assets: sell $1000 products on credit. Settlements of its liabilities: Company A planned to sell $1000 products to Company B. On Jan. 2, Company B paid $1000 to Company A in advance. On Jan. 10, Company A delivered the products to Company B.

Elements of Financial Statements Revenues & Gains 收入&利得 They are all benefits for the company. Revenues are coming from the company’s ongoing major or central operations. 收入来源于公司持续经营的主营业务。 Exp 1. BMW sells $1000 million of cars on credit. Gains are coming from peripheral or incidental transactions of a company. 利得来源于公司的非主营活动或偶然交易。 Exp 2. BMW sold its old equipment, and got $6 million in cash.

Elements of Financial Statements Expenses Outflows/using up of assets/incurrence of liabilities （费用的产生可以是现金流出/资产的减少/负债的增加） Outflows: pay $1000 interest expense in cash. Using up of assets: $100 depreciation Incurrence of liabilities: on Jan. 31, the company should pay $1000 wages to employee, but wages will be paid on Feb. 4.

Elements of Financial Statements Expenses & Losses They are all decrease in benefits for the company. Expenses are coming from the company’s ongoing major or central operations. 费用来源于公司持续经营的主营业务。 Losses are coming from peripheral or incidental transactions of a company. 损失来源于公司的非主营活动或偶然交易。 Exp. Failure in lawsuit （诉讼败诉）, it cost the company $10 million (paid in cash).

Recognition and Measurement concepts Two important concepts in accounting: Recognition 会计确认 Measurement 会计计量

Recognition Recognition 会计确认 Four criteria in “recognition”: 会计确认的四个标准 Refers to the process of admitting information into the basic financial statement. 将信息加以记录并列入财务报表的过程。 Simply, “recognition” is which economic events should be recorded. Four criteria in “recognition”: 会计确认的四个标准 Definition Measurability Relevance Reliability

Recognition Definition 可定义性 The item meets the definition of an element of financial statement. 被确定的项目应符合财务报表某个要素的定义。 Our company purchased an equipment today. Can bring future benefits Obtained by our company Resulting from past events This item meets the definition of “which element”? The equipment meets the definition of “Assets”.

Recognition Measurability 可计量性 The item has a relevant attribute measurable with sufficient reliability. 被确定的项目应具有相关的计量属性，足以充分可靠地予以计量。 Our company purchased an equipment today. It cost $100 million. The equipment is measurable.

Recognition Measurability 可计量性 Our company hired an engineer (工程师) today. Can bring future benefits Controlled by our company Resulting from past events The engineer meets the definition of “Assets”. But is the engineer measurable or not?

Recognition Relevance 相关性 The information about it is capable of making a difference in user decisions. 被确定的会计要素应当对信息的使用者有用。 Only the useful information should be recorded. (information must be relevant to the decision.)

Recognition Reliability 可靠性 The information is representationally faithful, verifiable, and neutral. 被确定的会计信息是如实反映的、可验证的和不偏不倚的。

Measurement Measurement 会计计量 Two elements in “measurement”: 会计计量的两个要素 is the process of associating numerical amounts to the elements. 确定会计要素金额的过程。 Simply, “measurement” is: at what amount economic events should be measured? Two elements in “measurement”: 会计计量的两个要素 Unit of measurement 计量单位 Attribute of measurement 计量属性

Measurement Unit of measurement 计量单位 The unit of measurement used in financial statements is nominal units of money without any adjustment for changes in purchasing power. 财务报表中用名义货币作为计量单位，不调整不同时期货币的购买力。 Without considering the influence of inflation 不考虑通货膨胀的影响

Measurement Attribute of measurement 计量属性 Some commonly-used attributes: 一些常用的计量属性 Historical cost Net realizable value Present value Fair value

Measurement Historical cost 历史成本 The original cost (or the price) of an asset when acquired by the company. 企业购置资产时的初始成本或买价。 Exp. The equipment is purchased at the price of $100 million. $100 million is the historical cost.

Measurement Net realizable value 可变现净值 Net realizable value is usually used to evaluate the inventory. 可变现净值常用于估计存货的价值。 Net realizable value of inventory=selling price of the inventory - estimated costs of completion – disposal costs 存货净现值=存货售价-至完工时估计将要发生的成本-处置成本(销售费用) Exp. At a company’s year end, inventory is expected to sell for $100, but it will take an additional $20 to complete and $10 of disposal costs. NRV=$100-$20-$10=$70

Measurement Net realizable value 可变现净值 Net realizable value can also be used to measure the accounts receivable. 可变现净值也可用来衡量应收账款的价值。 Net realizable value of AR=all the AR – allowance for bad debts 应收账款净现值=应收账款总额 – 坏账准备 Exp. At a company’s year end, the company has $1,000,000 of AR, and the allowance for bad debts is $100,000 in that year. NRV of AR=$1,000,000-$100,000=$900,000

Measurement Present value 现值 The current worth of future cash flows given a specified interest rate. 在给定的利率水平下，未来的现金流量折现到现在时刻的价值。 Exp. On Jan. 1, 2011, our company bought an equipment, we signed a note requiring $50,000 to be paid on Dec. 31, 2012. (suppose the annual interest rate is 10%.) On Jan. 1, was the equipment worth $50,000? $50,000 will be paid two years from now, we should use the present value as the cost of this equipment. The cost of equipment=$50,000×0.8264=$41,320

Measurement Fair value 公允价值 The price that would be received to sell assets or paid to transfer a liability in an orderly transaction between market participants at measurement date. 公平交易中，熟悉情况的双方自愿进行的资产交换和债务清偿的金额。 Companies usually value some of its financial assets and liabilities at fair value. 公司通常对金融资产和金融负债以公允价值入账。 Exp. Our company bought 1000 shares of stock, the stock price is $10 per share. Fair value of the stock=$10×1000=$10,000

Four basic assumptions The economic entity assumption The going concern assumption The periodicity assumption The monetary unit assumption

Economic Entity Assumption 经济主体假设 Economic Entity Assumption: all economic events can be identified with a particular economic entity. 记录的会计业务应为某个特定的经济主体服务。 From whose perspective 站在谁的角度 Exp. Dell sold 10 computers to KFC, KFC promised to pay $50,000 ten days later. From Dell’s perspective, $50,000 is accounts receivable. From KFC’s perspective, $50,000 is accounts payable.

Economic Entity Assumption 经济主体假设 Legal entity & accounting entity 法律主体&会计主体 Exp. Suppose Dell is a group company (集团公司). It has one parent (母公司) and three subsidiaries (子公司). One parent and three subsidiaries are four legal entities, also four accounting entities. Dell (the group company) is not the legal entity but is the accounting entity. Legal entity is definitely the accounting entity, but accounting entity may not be the legal entity. 法律主体一定是会计主体，但会计主体不一定是法律主体。

Economic Entity Assumption 经济主体假设 the distinction between the economic activities of owners and those of the company. Exp. Uncle Jim opened a company. He bought 10 computers for the company. He then spent $10 million to buy a house for personal use. In this case, buying 10 computers is the company’s economic activity, which should be recorded in accounting. Buying a personal house is uncle Jim’s economic activity, which should not be recorded in accounting.

Economic Entity Assumption 经济主体假设 Exercise: right or wrong? Don Smith is the sole owner of a company called Hardware City. The company recently paid a $150 utility bill for Smith’s personal residence and recorded a $150 expense.

Going Concern Assumption 持续经营假设 Going Concern Assumption: it is anticipated that a business entity will continue to operate indefinitely. 企业的生产经营活动将无限期地延续下去。 historical costs & current liquidation values Exp. If we expect that the company will continue to operate forever, then we can measure all the assets using historical costs. But, if we know that the company will go bankrupt (破产) next year, then assets should be measured at their current liquidation values (当前清算价值). Exp. Depreciation If depreciation of a building covers 20 years, that means the company should operate at least 20 years.

Periodicity Assumption 会计分期假设 The periodicity assumption allows the life of a company to be divided into artificial time periods to provide timely information. 会计分期假设将公司的持续经营活动人为地划分为若干个会计期间以提供及时的会计信息。 Corporations should provide financial information to the market on a quarterly and annual basis. calendar year 日历年度 & fiscal year 会计年度 In China, calendar year = fiscal year In America, fiscal year may ends at the end of January.

Monetary Unit Assumption 货币计量假设 The monetary unit assumption states that financial statement elements should be measured in terms of the United States dollar. In China, financial statement elements should be measured in terms of RMB.

Broad Accounting Principles 会计基本原则 Four important broad accounting principles: The historical cost principle The realization principle (also known as the revenue recognition principle) The matching principle The full-disclosure principle

Broad Accounting Principles 会计基本原则 Historical cost principle 历史成本原则 It says asset and liability measurements should be based on the amount given or received in the exchange transaction. 企业的资产和负债在取得时应该按实际成本计量。 Sometimes, a departure from historical cost valuation is allowed. 有时，资产的价值也可能偏离历史成本。 Exp. Our company sells $10,000 products on credit. So, $10,000 is the historical cost for accounts receivable. One year later, we estimates $2,000 in bad debts. Then, AR should be valued at $8,000. (net realizable value)

Broad Accounting Principles 会计基本原则 Realization principle 收入实现原则 Two criteria should be satisfied before revenue can be recognized: 收入确认时应满足的两个条件 The earnings process is judged to be complete or virtually complete. (the selling activity is finished) There is reasonable certainty as to the collectibility of the asset to be received. (almost 100% sure that we can receive the cash)

Broad Accounting Principles 会计基本原则 Realization principle 收入实现原则 Critical event before revenue can be recognized: 收入可以被确认的关键性事件 The goods or services sold to the buyer are delivered. Exercise: right or wrong? Davis Bicycle Company received a large order for the sale of 1,000 bicycles at $100 each. The customer paid Davis the entire amount of $100,000 on March 15. however, Davis did not record any revenue until April 17, the date the bicycles were delivered to the customer.

Broad Accounting Principles 会计基本原则 Exercise: right or wrong? At the end of its 2011 fiscal year, Dower Company received an order from a customer for $45,350. The product will be shipped early in 2012. Because the sale was made to a long-time customer, the accountant recorded the sale in 2011. The Klingon Company sells farm machinery. Revenue from a large order of machinery from a new buyer was recorded the day the order was received.

Broad Accounting Principles 会计基本原则 Matching principle 配比原则 It says that expenses are recognized in the same period as the related revenues. 费用应该与其相关的收入在同一会计期间被确认。 Expenses should match to related revenues.

Broad Accounting Principles 会计基本原则 Four methods used to recognize expenses: Based on an exact cause-and-effect relationship between a revenue and expense event. 收入和费用基于因果关系上的配比 Exp. On March 12, the company sold $2000 products to a customer (cash sale). Products were delivered on that day. The cost of products was $1600. In this case, expenses and revenues have a cause-and-effect relationship. They both should be recognized on the same day.

Broad Accounting Principles 会计基本原则 Four methods used to recognize expenses: By associating an expense with the revenues recognized in a specific time period. 费用被记录在某一特定期间（时间意义上的配比） Exp. At the end of April, the company paid one-month salary, which was $1000, to the employee. The employee provided one-month services to the company. (provide one-month benefits) The company should recognized $1000 as expenses in the same month. (wages expense)

Broad Accounting Principles 会计基本原则 Four methods used to recognize expenses: By a systematic and rational allocation to specific time periods. 费用被合理地分摊到若干个期间 （时间意义上的配比） Exp. Our company bought an equipment, which cost $100,000. The useful life for this equipment was 10 years. This equipment can provide services (provide benefits) to our company for 10 years. So, the cost of equipment should be allocated into 10 years. (depreciation expense)

Broad Accounting Principles 会计基本原则 What is the difference between ② and ③? By associating an expense with the revenues recognized in a specific time period. 费用被记录在某一特定期间（时间意义上的配比） Expense is recorded in one single time period. By a systematic and rational allocation to specific time periods. 费用被合理地分摊到若干个期间 （时间意义上的配比） Expenses are recorded for several time periods.

Broad Accounting Principles 会计基本原则 Four methods used to recognize expenses: In the period incurred, without regard to related revenues. 在费用发生当期一次性确认，而不需要考虑与之相关的收入。 Exp. Our company spent $1 million for advertising. This $1 million should be recognized as expenses immediately, without regard to any related revenues. (advertising expense)

Broad Accounting Principles 会计基本原则 Exercise: right or wrong? Golden Book Company purchased a large printing machine for $1,000,000 (a material amount) and recorded the purchase as an expense. Cypress Manufacturing Company purchased machinery having a five-year life. The cost of the machinery is being expensed over the life of the company. At the beginning of its 2011 fiscal year, Rossi Imports paid $48,000 for a two-year lease on a warehouse (仓库两年的租金). The company recorded the expense equally over the two-year period of the lease.

Broad Accounting Principles 会计基本原则 Full-disclosure principle 完全披露原则 It says that the financial reports should include any information that could affect the decisions made by external users. 财务报告应该包含所有可能影响外部使用人决策的信息。 Completeness 完整性 Benefits of information>costs of providing the information (cost effectiveness)

Summary of the Structure

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