BITS Pilani

presentation
BITS Pilani Krishna M
Economics and Finance
Pilani Campus

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 BITS Pilani
Pilani Campus

FIN ZC415 / MBA ZC415

Financial and Management Accounting
Lecture 2
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 Learning Objectives
 Case study
 Generally Accepted Accounting Principles (GAAP)
 Balance Sheet Principles
 Money Measurement Concept
 Business Entity Concept
 Going Concern Concept
 Cost Concept
 Dual Aspect Concept
 Income Statement concepts
 Accounting Period Concept
 Conservatism Concept
 Realization Concept
 Matching Concept
 Consistency Concept
 Materiality Concept

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 Accounting Equation
 Enron: The Fall Of A Wall Street
Darling

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 The rise of Enron: a brief history
Founded by Kenneth Lay (economics professor) in 1985, former
CEO of Houston Natural Gas (merger between two companies)
Houston Natural Gas Co
InterNorth Inc: largest pipeline company in the country

Business units:
Electricity
Natural gas
Pulp and paper,
Communications companies

In 1984 the Federal Energy Regulatory Commission

Eased some of the pricing restrictions on natural gas.
Allowed local gas distribution companies to buy gas from
2-5 anywhere and anyone
 The rise of Enron: a brief history

In 1990, Jeffrey Skilling, a consultant with McKinsey & Co.,

joined a new division -- Enron Finance Corp.
The Gas Bank- a new way to market natural gas
Intermediary between buyers and suppliers (traded as a
commodity)

Skilling: President and Chief Operating Officer of Enron in 1997

From the pipeline sector, Enron began moving into new fields
In 1999, the company launched its
Broadband services unit and
Enron Online
the company's website for trading commodities,
It became the largest e-commerce site in the world.
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 Marketing and Promotion of Enron

"America's Most Innovative Company" by Fortune magazine for

six consecutive years [1996 – 2001]

In 1994
The company reported revenue of $9 billion.
Ranking 129

In 2000
the company's annual revenue reached$100 billion ,
Ranked seventh-largest company on the Fortune 500

And the sixth-largest energy company in the world.

The company's stock price peaked at $90 US.

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 Enron: Peak of Stock Price

Stock Price
100
90
80
70
60
50
40
30
20
10
0

between 2/1/1998 and 17/8/2000

2-8 Source: Drawn by Krishna M based on Historical data

 Enron: Revenue

Enron' Fortune 500 climb

Revenue (in billion $)
160
138.7
140

120
100.8
100

80

60
40.1
40 31.3
20.3
20 13.3
9 9.2

0
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

2-9 *Revenue for the year 2001 includes the first 9 months
 Fall of Enron in 2001

1999 to mid-2001:
Enron executives and directors receive $1.1 billion by selling 17.3
million shares
April 17, 2001:
Enron reports first quarter profits of $536 million
August 14, 2001:
Jeffrey K. Skilling abruptly resigns (after selling 450,000 shares for
around $33 million) citing “personal reasons,” Mr. Lay reassume the
position of CEO
October 16, 2001:
Enron reports a third-quarter loss of $618 million— its first
quarterly loss in four years
Arthur Andersen,
was tempted to ignore the issues
December 2, 2001: Enron files for bankruptcy protection
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 Enron: Decline of Stock Price

Stock price
100
90
80
70
60
50
40
30
20
10
0

Period between 17/08/2000 and 31/12/2001

Source: Drawn by Krishna M based on Historical data
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 The Real Reasons Enron Failed

•Reporting is not reality. The stock market values high returns far
more highly than rapid book income growth.
•Use of prepaid agreements

•Mark-to-market,
•It is an easily-abused accounting method that readily morphs into two
deviant versions

•It had shifted billions of dollars in debt off its balance sheet and into
an array of complex partnerships
•Special purpose entities (SPE):
•Nov 8 2001: Restating previously reporting net income for the
year 1997-2000

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 Bankruptcy of Enron

Investors in pension fund lost more than 25 billion

Creation of the U.S. Sarbanes-Oxley Act (SOX), signed into

law on July 30, 2002
Sanjay Anand

the dissolution of the Arthur Andersen accounting firm, one of

the top five accounting firms in the world

On Dec. 2, 2001, it filed for bankruptcy protection

More than 5,000 people were laid off at Enron's Houston

headquarters
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 Enron: The Smartest Guys in the Room

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 Financial Reporting Concepts

The Standard-Setting Environment

Generally Accepted Accounting Principles (GAAP) - A set of
rules and practices, having substantial authoritative support, that
the accounting profession recognizes as a general guide for
financial reporting purposes.
Standard-setting bodies determine these guidelines:
► Securities and Exchange Commission (SEC) International Note
Over 115 countries
► Financial Accounting Standards Board (FASB) use international
standards (called
► International Accounting Standards Board (IASB) IFRS).

► Public Company Accounting Oversight Board (PCAOB)

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 Financial Reporting Concepts

Basic accounting concepts: Balance sheet

Monetary Measurement concept Business Entity

Requires that only those things
States that every economic
that can be expressed in
entity can be separately
money are included in the
identified and accounted for.
accounting records.
(Separate from its owners)

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 Money Measurement
 Scenario: 1 A business owns
 Rs30,000 of cash
 6000 pounds of raw materials
 50,000 square feet of building space
 Can’t be added together
 Scenario 2: A business own
 Rs30,000 of cash
 Rs9000 of raw materials
 Rs150,000 of trucks
 Rs40000 of building
 Can be added together
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 Financial Reporting Concepts

Basic accounting concepts: Balance sheet

Periodicity Going Concern

States that the life of a The business will remain in
business can be divided into operation for the
artificial time periods. foreseeable future.

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 Financial Reporting Concepts

Basic accounting concepts: Balance sheet

Dual aspect (Double

Cost concept entry system)
Actual cost paid. Record the
assets at their costs. (instead Debit and credit.
of the current value)

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 Financial Reporting Concepts

Income statement concepts

Accounting Conservatism Realization

period Amount of revenue
Recognizing expenses
and liabilities as soon should be recognized
Accounting
as possible when there from a given sale.
measures activities Realization: inflows of
is uncertainty about the
for a specific outcome, but to only cash or claims to cash
interval of time. recognize revenues and (e.g. account receivable)
One year is the usual assets when they are A customer buys Rs50
reasonable certain. worth of items at a
accounting year
Eg: unearned Rs100 grocery store.
Interim report –quarterly

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 Financial Reporting Concepts

Income statement concepts

Matching Consistency Materiality

concept concept concept
When a given event Once an entity has Insignificant events may
affects both revenues decided on one be disregarded, but
and expenses, the accounting method, it there must be full
effect on each should should use the same disclosure of all
be recognized in the method for all important information.
same accounting subsequent events of (no agreement on the
period. the same character line separating material
First revenue and then unless it has a sound events from immaterial
costs reason to change events).

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 Key Points

 IFRS recommends but does not require the use of the title
“statement of financial position” rather than balance sheet.

 The format of statement of financial position information is often

presented differently under IFRS. Most companies that follow
IFRS present statement of financial position information in this
order:
1. Noncurrent assets
2. Current assets
4. Noncurrent liabilities
3. Equity
5. Current liabilities

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 Accounting Equation

Analyzing Transactions
The process of identifying the specific effects of economic
events on the accounting equation.

Basic Accounting Equation

Stockholders’
Assets = Liabilities + Equity

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 Accounting Equation

Analyzing Transactions

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 The Classified Balance Sheet

 Presents a snapshot at a point in time.

 To improve understanding, companies group similar

assets and similar liabilities together.

Standard Classifications

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 The Classified Balance Sheet
Current Assets
 Assets that a company expects to convert to cash or use
up within one year or the operating cycle, whichever is
longer.

 Common types of current assets are

 (1) cash,
 (2) investments,
 (3) receivables,
 (4) inventories, and
 (5) prepaid expenses.

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 The Classified Balance Sheet
Current Assets
Microsoft balance sheet
MICROSOFT CORP (MSFT) BALANCE SHEET
Fiscal year ends in June. USD in 2013- 2014- 2015- 2016- 2017-
millions except per share data. 06 06 06 06 06
Assets
Current assets
Cash
Cash and cash equivalents 3804 8669 5595 6510 7663
Short-term investments 73218 77040 90931 106730 125318
Total cash 77022 85709 96526 113240 132981
Receivables 17486 19544 17908 18277 19792
Inventories 1938 2660 2902 2251 2181
Deferred income taxes 1632 1941 1915
Other current assets 3388 4392 5461 5892 4897
Total current assets 101466 114246 124712 139660 159851

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 The Classified Balance Sheet

Non-current assets

(1) Long-term Investments

 Investments in stocks and bonds of other corporations that are

held for more than one year.

 Long-term assets : Investment in real estate

 Long-term notes receivable.

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 The Classified Balance Sheet

2. Property, Plant, and Equipment

 Long useful lives.
 Currently used in operations.
Alternative Terminology
Property, plant, and equipment is
sometimes called fixed assets or
plant assets.

 Includes land, buildings, equipment, delivery vehicles, and

furniture.

 Depreciation - allocating the cost of assets to a number of years.

 Accumulated depreciation - total amount of depreciation

expensed thus far in the asset’s life.

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 The Classified Balance Sheet

3. Intangible Assets

 Assets that do not have physical substance.

 Includes goodwill, patents, copyrights, and
trademarks or trade names.

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 Microsoft

Non-current assets Year Year Year Year Year

2013-06 2014-06 2015-06 2016-06 2017-06
Gross property, plant and equipment 22504 27804 32337 38156 47913
Accumulated Depreciation -12513 -14793 -17606 -19800 -24179
Net property, plant and equipment 9991 13011 14731 18356 23734
Equity and other investments 10844 14597 12053 10431 6023
Goodwill 14655 20127 16939 17872 35122
Intangible assets 3083 6981 4835 3733 10106
Other long-term assets 2392 3422 2953 3642 6250
Total non-current assets 40965 58138 51511 54034 81235
Total assets 142431 172384 176223 193694 241086

Fiscal year ends in June

USD in Million except per share data
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 The Classified Balance Sheet

Current Liabilities

 Obligations the company is to pay within the next year

or operating cycle, whichever is longer.

 Common examples are accounts payable, salaries and

wages payable, notes payable, interest payable, and
income taxes payable.

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 The Classified Balance Sheet

Long-Term Liabilities

 Obligations a company expects to pay after one year.

 Include bonds payable, mortgages payable, long-term

notes payable, lease liabilities, and pension liabilities.

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 Microsoft

Liabilities and stockholders' equity

Liabilities
Current liabilities 2013-06 2014-06 2015-06 2016-06 2017-06
Short-term debt 2999 2000 7484 12904 10121
Accounts payable 4828 7432 6591 6898 7390
Taxes payable 592 782 606 580 718
Accrued liabilities 4117 4797 5096 5264 5819
Deferred revenues 20639 23150 23223 27468 34102
Other current liabilities 4242 7464 6858 6243 6377
Total current liabilities 37417 45625 49858 59357 64527

Non-current liabilities 2013-06 2014-06 2015-06 2016-06 2017-06

Long-term debt 12601 20645 27808 40783 76073
Deferred taxes liabilities 1709 2728 2835 1476 531
Deferred revenues 1760 2008 2095 6441 10377
Other long-term liabilities 10000 11594 13544 13640 17184
Total non-current liabilities 26070 36975 46282 62340 104165
Total liabilities 63487 82600 96140 121697 168692
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 The Classified Balance Sheet

Stockholders’ Equity
 Common stock - investments of assets into the business by
the stockholders.

 Retained earnings - income retained for use in the business.

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 Statement of Retained Earnings

Assets = Liabilities + Paid-in capital + Retained earnings

Retained earnings

Beginning balance + Revenue – Expenses – Dividends

Ending retained earnings balance

A company income statement reveals revenue of Rs 1,00,000 and expenses of Rs

80,000. Its balance sheet showed that retained earnings grew from 30,000 at the
beginning of the year to Rs 34,000 at the end of the year. What is the dividend
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 Ford Corporation
Adjusted Trail Balance data
December 31, 2009
The following data were taken from the adjusted trial balance of Ford Corporation.
Prepare a classified balance sheet at December 31, 2009. (Ignore income taxes)

Accounts Payable Rs Note payable (due in 5 40,000

12,000 years)
Accounts receivable 13,000 Office supplies 1,000
Accumulated Depreciation - 6,000 Prepaid insurance 3,000
Building
Accumulated Depreciation- 9,000 Retained earnings (January 23,000
Furniture and Fixtures 1, 2009)
Building 60,000 Salaries payable 2,000
Common Stock 40,000 Service revenue 85,000
Cash 24,000 Salaries expense 28,000
Copyrights 22,000 Utilities expense 2,000
Dividends Declared 12,000 Depreciation expense 5,000
Furniture and Fixtures 15,000 Insurance expense 2,000
Land 25,000 Office supplies expense 1,000
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Interest expense 4,000