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Statement of Cash Flows
Week 3
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Relation Between Balance Sheet and Income
Statement
Liab- Shareholders’
Assets = +
ilities Equity
Contri-
Liab- Retained
Assets = + buted +
ilities Earning
Capital
Contri- Retained
Liab- Earning Net Income Dividends
Assets = ilities + buted + Beginning + for period - for period
Capital of Period
Contri- Retained
Liab- Earning Revenues Expenses Dividends
Assets = ilities + buted + Beginning + for period - for period - for period
Capital of Period
5 Steps to Prepare an IS
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Miller Example – Matched Expense
• Transaction 2:
Dr. Advance from Customer 3,000
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Adjusting Entries for Incurred Expense
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Adjusting Entries for Incurred Expense
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Closing Entries
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Groupon’s Accounting Controversy 1
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June 2011 Prospectus
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September 2011 Revised Prospectus
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Accrual v.s. Cash Basis Accounting
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Why is SCF important?
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Accrual Accounting
• Both revenue and expense recognitions are independent of cash.
• Revenue recognition criteria
The firm has performed all, or most of, the services it expects to
provide;
The firm has received cash or some other assets such as
rule).
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Accrual accounting and adjusting entries
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Example 1: deferral-unearned revenue
• A firm may receive prepayment from customers. Since it hasn’t
provided the service yet, it recognizes the prepayment as a liability,
such as magazine subscription and insurance premium.
• As the firm gradually fulfills its obligation, it recognizes the revenue
and writes down the liability at the end of an accounting period in
proportion to the amount of services provided.
• At the beginning of the year, Time magazine receives $12,000 cash for
the subscription of the entire year.
Dr. Cash 12,000
• When the firm pays for insurance policy with half a year coverage:
Dr. Prepaid Insurance 1,000
o Cr. Cash 1,000
• At the end of the first quarter:
Dr. Expense - Insurance 500
o Cr. Prepaid Insurance 500
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Example 2.2: depreciation
• Depreciation is a long-term form of a prepaid service. An asset may
last many years. As the asset is used, it is expensed.
• One simple form of depreciation is straight-line. The original cost of
the asset is expensed over the useful life in equal amounts over time.
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Example 3: accrual-earned revenue
• When a firm has rendered service but hasn’t received cash, it
recognizes a non-cash asset, such as receivables.
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Example 4: accrual-accrued expense
• A firm receives services but may not pay it at the end of the accounting
period.
• Since it incurs an obligation to pay for them, accrual accounting calls
for recognizing the proportion of service received as an expense.
• Goldman Sachs promises bonus to employees but the bonus is not paid
this year. On 12/31/2009, it recognize the expected bonus payout.
Dr. Expense – Compensation 6,000,000,000
o Cr. Bonus Payable 6,000,000,000
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Prepare a SCF
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Ambiguities in Classifying Cash Flows
23
Ambiguities in Classifying Cash Flows
24
The Key to Prepare a SCF
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Notations
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Cash Change Equation #1 – Indirect Method
A = L + SE
Cash + CA+LA=CL+LL + SE
Cash = SE – ( CA - CL) - LA + LL
= CC+ (NI-Div) - WC + D&A - ( LA+ D&A) + LL
=(NI + D&A - WC) - ( LA+ D&A) + ( CC+ LL-Div)
=CFO+CFI+CFF
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Reporting components of CFO
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Illustration: Indirect Method
1. A firm purchase inventory for $27 cash and sell it for 40 on credit
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Depreciation, CFO and Net Income
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Add $5 Depreciation Expense
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Cash Change Equation #2 – Direct Method
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Cash Payment to Supplier
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Add $5 Depreciation Expense
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Earnings v.s. Pro Forma Earnings
• In general, pro forma earnings refer to net income excluding the effects
of “unusual and nonrecurring transactions.” Although they are often
labeled as cash earnings, they are not.
• Pro forma earnings are supposed to give investors more relevant
information to assess future corporate prospects.
• However, firms have abused the discretion to exclude special charges
from net income. Many firms emphasize on pro forma earnings to
explain away their (often poor) GAAP net income and pro forma
earnings are typically much better than GAAP earnings.
• Remember: Pro forma earnings are non-GAAP earnings.
• EBIT (operation earnings), EBITDA, CFO (cash earnings), Non-cash
charges
• Pro forma financial statement has less stigma than pro forma earnings.
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Groupon’s Accounting Controversy 2
• June 2011 “We believe Adjusted CSOI is an important
measure of the performance of our business as it excludes
expenses that are non-cash or otherwise not indicative of
future operating expenses. In 2010 and the first quarter of
2011, we generated Adjusted CSOI of $60.6 million and
$81.6 million, respectively. ”
• September 2011 “We believe CSOI is an important
measure for management to evaluate the performance of
our business as it represents the operating results of our
segments and, as reported under U.S. GAAP, does not
include certain non-cash expenses. In 2010 and the first
half of 2011, our CSOI was $(181.0) million and $(160.6)
million, respectively.
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Adjust CSOI in June 2011 Prospectus
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CSOI in September 2011 Revised Propsectus
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