Accounting: Chapter 2

The general group of ___________ owned by the \n firm are its assets

The general group of ___________ owned by the \n firm are its assets

Resources

An asset is anything of _________________ that \n can somehow help the firm provide its goods and services to its customers, either directly or \n indirectly

Economic Value

Characteristics of an asset: \n • It must be owned or ____________ by the company \n • It must provide expected ___________ benefits

Controlled;

Future

Liabilities represent the _____________ that a firm has to outside creditors

obligations

A liability should be reported if the following three conditions are met:

1. The future sacrifice is ____________;

2. The amount of the obligation is known or can be reasonably ____________ (“estimable”); and

3. The transaction or event that caused the obligation has _______________ (“in the past”)

Probable';

estimated

occurred

Owner’s equity

is the value of the firm to its owners

____________________ capital – amounts paid \n directly to the firm in exchange for shares of \n ownership

Contributed

\n ___________________ (“earned” capital) – the \n portion of the income that the firm has earned \n over the years that has not been distributed to \n the owners in the form of dividends

Retained Earnings

Retained earnings represent a claim on a portion of the firm’s assets and are

not an asset themselves

An important point that I want to reinforce is that “equity” refers to the ___________________– that is, what the owners have a claim to. Consider the example of a home purchase.

ownership stake

Equity refers to the ____________: owners don’t have a claim to the value of the entire asset – only to the portion of the asset value that isn’t owed to other parties (i.e., the residue)

residual claim

This formula can be restated as

Assets = Liabilities + Stockholders’ Equity

Left-hand side shows the firm’s _______________

resources

Right-hand side shows the ____________ of the \n resources \n

• Liabilities and stockholders’ equity both represent legal ownership claims on the firm’s assets

sources

In order to answer this question, you have ask the person to clarify: over what ______________ do you want to know how much lemonade we’ve sold?

period of time

So the question of how much lemonade we have is one that can only be addressed at a given _________ in time: e.g., right now, at the beginning of the year, etc.

point

But the question about how much lemonade we’ve sold is one that can only be addressed for a given period of time: e.g., this month, this year, since the inception of the business, etc.

Important distinction: “stocks” versus “flows”

One key intuition here is that the balance in a stock is changed over time by inflows and outflows:

Beg balance + inflows – outflows = End balance

So the balance of a stock at any given point in time is a function of all the prior ___________________

E.g.: the KwH of energy in my car battery right now equals all the prior KwH from charging less all the KwH I’ve used driving \n

So there are different ways to determine the stock balance

inflows and outflows

Another key intuition is that stocks and flows have different ________________________•

These are very different things and it’s important to “see” the difference between them

measurement units

In accounting, we report the “at a given _________ in time” stocks on the Balance Sheet, and we report the major “for a given ______________” flows on the Income Statement

point;

time period

The balance sheet indicates the financial position of the firm at a particular point in time (“stocks”)

• Point in time is the end of their “fiscal” period \n • Either the last day of the quarter or of the fiscal year

It illustrates the basic accounting equation at that point in time

Assets = Liabilities + Stockholders’ Equity

Assets are presented on the B/S in order of \n ___________ (the asset’s nearness to cash)

• Current assets are cash or will become cash or be used up within one year

Liquidity

_____________Assets: used/turned to cash within one year

• Cash and cash equivalents \n • Accounts receivable (see supplier-customer relationship) \n • Inventory (see supplier-customer relationship)

Current

___________ Assets (long-term assets):

• Property, plant and equipment (PP&E, “fixed assets”) (e.g., land, factories, office buildings, machinery, etc.) LT Investments and Intangibles

Non-Current

Now, let’s say that in July our lemonade stand posted our record high in sales, and we had a big pizza party (paid out of the company’s funds) to celebrate. Would we consider the \n cost of the pizza party to be an asset to the company? \n

No; the expected future benefits are nebulous and cannot be \n __________________________

Reasonably Measured

Let’s say that under my long-term contract as the CEO of the company, my salary is far less than either what I could earn elsewhere or what I contribute to the company. In this scenario, is my contract an asset to the company? \n

No; in economic terms there may be an intangible asset, but under financial accounting rules you cannot record ____________ ____________ intangible assets as assets

Internally Generated

Assets may be tangible or intangible \n

Tangible assets have a ____________ and \n substance \n

Intangible assets do not have any physical form – they consist of such items as customer databases, patents, copyrights, or trademarks

Physical Form

Accountants do not allow internally-developed \n intangible assets to be recorded

(e.g., benefits from a pizza party, or excess value on my contract)

Intangibles are recorded if they have a clearly \n __________ value and were acquired from another company (or if the company itself was acquired)

Measurable

Another intangible asset may arise from the \n _____________ of a company

Acquisition

Say Apple buys a company for $500M whose \n identifiable net assets are $400M. Did Apple overpay for the company?

No; a sales price between arms-length parties is sacred

There must be value that we can’t ___________ identify

Specifically

Similar to dark matter in physics → “dark value”

This includes, e.g., the good credit standing, reputation for quality, skilled set of employees, etc. of the target

\n After an M&A, the amount paid in excess of the market value of the identified net assets is called ___________, and may be recorded as an asset \n

• Specific intangibles (e.g. patents) included in net assets

Goodwill

You cannot record your ________ goodwill as an asset

OWN

Each liability item is presented on the B/S in order of ______________ (when the obligation is due)

maturity

__________ Liabilities: must be paid within one year

• Accounts payable (see supplier-customer relationship) \n

• Accrued liabilities (e.g., accrued/unpaid wages)

Current

______________ Liabilities (long-term, > 1 year):

• Long-term debt \n

• Other long-term liabilities (e.g., pensions)

Non-Current

•The income statement measures the firm’s \n performance over a period of time (“flows”)

•E.g. “For the Year Ending December 31, 2017”

•____________ are the monies the firm has \n received or is entitled to receive in exchange for \n goods and services

Revenues

•____________ are the costs incurred in order to \n generate revenues

Expenses

Revenues – Expenses = Net Income (profit, \n earnings) \n

This again shows the owners’ ______________

Residual Claim