Frontmatter

Homework 1 should be submitted soon
- Submit on eLearn if you haven’t
Homework 2 due next week
- Looking through real annual reports
- Somewhat open ended and will be graded for completion
- Look for it on eLearn

Learning objectives

Financial Statements (Ch 3)

Appreciate annual reports as a communication tool
Understand the presentation of the Statements of:
- Financial Position
- Comprehensive Income
- Changes in Equity

Equity (Chapter 10)

Learn about the share structure of a corporation
Account for changing capital structure and dividends

Annual reports

What’s included

Corporate information
- Name(s), history, key management/directors, structure
- Awards, company description, operating statistics
Letter to shareholders
- Written by CEO
Management Discussion and Analysis (MD&A)
- Management writes this section
- Often discuss:
  - The year’s performance
  - Possible future risks

What’s included

Explicit and unreserved statement of compliance to financial reporting standards.
Accounting statements
- Statement of financial position
- Statement of comprehensive income
- Statement of changes in equity
- Statement of cash flows
Statement notes
- Often quite long, substance focused
- Discusses important but difficult matters
- Cannot rectify inappropriate accounting treatments
Acknowledgement of responsibility by management

Why are these important?

If you ever need information about a company’s financial standing, the annual and quarterly reports are your primary source.
If you get information elsewhere (Bloomberg, Morningstar, etc.)…
- They got it from there
  - Or from someone else who got it from there
Contains a lot of other useful information about the companies

What you can find

Financials
Risks to the company going forward
Legal issues
Corporate strategy
The company’s major customers
- Good for checking out competitors…
Plenty more!

Case: A good report (DBS)

Case: A bad report (Groupon)

SEC filing S-1 1 a2203913zs-1

We use adjusted consolidated segment operating income, or Adjusted CSOI, and free cash flow as key non-GAAP financial measures. Adjusted CSOI and free cash flow are used in addition to and in conjunction with results presented in accordance with GAAP and should not be relied upon to the exclusion of GAAP financial measures.

General requirements

Name of reporting entity, date ended, currency used, level of rounding
- Or individual entity (“Consolidated report for…”)
Can group similar accounts together if immaterial
- Not disclosing separately has no impact on F/S users
- Cannot offset liabilities with assets, unless allowed
  - IAS 16, IAS 18
  - Foreign exchange gains and losses
Must be done at least yearly (fiscal year)
Usually provide comparative information for the past two periods

Statement of financial position

Also known as a balance sheet
Presents:
- Non-current assets (> 1 year in life)
  - PP&E, Inventories, Intangible assets
- Current assets
  - Cash (and equiv), trade, other financial assets, biological assets, inventory, receivables
- Long term (> 1 year until paid off), then current liabilities
  - Provisions, other financial liabilities
- Equity
  - Non-controlling equity interests, issued capital, reserves
  - Retained earnings

Presents companies’ stock of assets, liabilities, and equity

How to construct a SFP

Start with an adjusted trial balance
List all long term assets and sum
List all short term assets and sum
Total all assets
List all long term liabilities and sum
List all short term liabilities and sum
Total all liabilities
List retained earnings
List capital accounts
Total all equity accounts
Sum Total liabilities and equities
Verify $A = L + E$
Frequently include past year’s amounts in a second column

Statement of Comprehensive Income

Also known as an Income Statement
Presents:
- Revenue
- Expenses, categorized by nature or function
  - Operating expenses
  - Non operating expenses
- Net income
- Below or separately it presents:
  - Gains and Losses
  - Called other comprehensive income (OCI)

While taxes are always included, you will not be asked to calculate taxes for this course. If no taxes are mentioned, assume they are 0.

Constructing an SCI

Start with an adjusted trial balance
List revenue
List cost of goods sold (COGS)
Calculate gross profit (revenue - COGS)
List other expenses (except interest and taxes)
List other revenues (except interest and other holdings)
Calculate operating profit
List other non-tax expenses and incomes
- That aren’t included above
Calculate income before taxes
List taxes
Calculate net income (loss)
(Optional) start a new page
List OCI items (gains and losses)
List tax on OCI
Calculate OCI, net of tax
Calculate total comprehensive income
- OCI, net of tax + net income (loss)
Often includes the prior year as well

Statement of Changes in Equity

Reconciles from period start to end
- Per IAS 1,must reconcile each equity item separately as well as the total
Shows all transactions with owners
Shows all dividends paid (can be as a note)
This statement often relies on information that is contained outside the adjusted trial balance

You won’t be required to construct this statement for exams.

Constructing an SCE

List all equity items across the top as columns
- Generally includes: share capital, APIC, retained earnings, treasury stock, total equity
Put “balance as of [beginning date]” as the first row
List all items that effected 1 of the columns values for the year as the rows
- Generally includes: share issuance, treasury share sales, dividends paid, net income
Put “balance as of [ending date]” as the last row
Fill out all changes
Often includes the prior year as well

Statement of Cash flows

We’ll get back to this…
- Sessions 10 and 11
- Chapter 11

Practice

Practice problem on eLearn for Coffee Corp (last week’s company)

Construct a Statement of Financial Position
- Use the adjusted trial balance
- Do for both years
Construct a Statement of Comprehensive income
- Use the adjusted trial balance
- Do for both years
- Ignore taxes

There is an Excel file on eLearn with the adjusted trial balances for 20X8 and 20X9.

Financing types

Equity vs debt

Equity:

Advantages:
- No legal obligation to distribute profits
  - Great for growth
- All profit can be reinvested
Disadvantages:
- Dilutes existing shareholders’ ownership
  - Decreases the % of the company they own
- More expensive
- Can only be issued by a corporation

Debt:

Advantages
- Shareholders maintain ownership
- Can be quicker to receive financing
Disadvantages
- Often need to pay periodic interest
  - Requires cash on hand to pay
  - Solvency risk $\Rightarrow$ bankruptcy

Articles of Incorporation

Equity is governed by a coproations articles of incorporation
- Also known as a corporate charter
Written at the time of incorporation
- When the company is created
Governs:
- Nature of business activities
- NUmber of shares of stock
- Intial board of directors

Corporations

Advantages

Can raise both equity and debt
Continuous life
Ownership is liquid
Limited liability for owners

Disadvantages

Separation of ownership and management
- Leads to conflicts of interest
Other tax policies apply
- Double taxation: A corporation’s income is taxed and dividends to investors are taxed
  - Generally not an issue in Singapore
More government regulation

Corporations

Public

Public investment
No cap on # of shareholders
Increased reculation

Private

No public investment
- Some exceptions to this
Fewer shareholders
Less regulated

Shareholder rights

Voting

For board of directors
For important events

Dividends

Right to share in profits (when dividends are declared)

Liquidation

Right to share in asset value if company liquidates
- After lenders get their share of value

Limited liability

Can only lose what was originally invested

How shareholders protect themselves

Equity details

Corporate charter stipulates the number of shares
- Rare that a company has all such shares issued
Investors hold shares
The company holds treasury shares
- Shares the company has bought back
Unissued shares have never been issued
- Can issue in an Initial Public Offering (IPO) or Secondary/Seasoned Equity Offering (SEO)
  - Requires government and exchange approval

Number of shares

Equity financing example: Facebook

Source: https://techcrunch.com/2011/01/10/facebook-5/

Issuing shares

Companies can issue shares from treasury or unissued shares
Factors in issuing shares:
1. Company’s current health
2. Company’s outlook
3. Expected dividends
4. Economy health
5. Market factors (liquidity)

Accounting for common stock

Singapore does not allow the par value method
- Still allowed in many countries
- The book uses this mostly, so ignore the book on this topic!!!
Simpler treatment in Singapore
Note: The book uses the account name Common stock, which is common in the U.S.

Situation: The company issued 1 million ordinary shares at $15 each.

Par value method (NOT ALLOWED IN SG)

Separate accounts for par capital and above-par capital
Note: The book uses the account name Additional Paid-in Capital, which is common in the U.S.

Situation: 1) The company issued 1 million ordinary shares at $15 each with par value of $15.
2) The company issued 1 million ordinary shares at $15 each with par value of $1.

Par value

Par value is a value of a share of stock stipulated in the corporation’s articles of incorporation
- It has no relationship with the market value of the stock (stock price)
- Ex.: Facebook has a par value of USD 0.000006/share
Not used in Singapore since 2005

Preferred stock

Separate account from common stock
- Treated the same way
- Append “preferred shares” to account names
Fixed dividend (almost always)
First call on dividends
Earlier call on assets than common stock
- Useful in bankruptcy
No or limited voting rights
Not actively traded

Accounting for preferred stock

Using the same numbers as the common stock example
Note: The book uses the U.S. account name, Preferred stock

Situation: The company issued 1 million preferred shares at $15 each.

We almost always treat preferred shares as equity

The exception (IAS 32) is for redeemable shares with fixed redemption date and fixed dividend payments

Treasury stock

Common stock that has been repurchased
Reasons for repurchasing:
1. To issues incentive compensation
2. Increase stock price
  - Distribute cash to shareholders
3. Use in trading
4. Increase EPS
5. Remove a shareholder (defensive)

Treasury stock: Retirement

Retirement removes the shares from share capital entirely

Situation: The company purchased 20,000 shares at $20 each, and then retired them.

Treasury shares: contra equity account, decreasing equity

Treasury stock: Reissuing at a profit

Situation: The company purchased 20,000 shares at $20 each, and then sold them in 2 transactions: 10,000 for $25 each and 10,000 for $15 each.

Treasury stock: Reissuing at a loss

Situation: The company purchased 20,000 shares at $20 each, and then sold them in 2 transactions: 10,000 for $15 each and 10,000 for $25 each.

Treasury shares: Summary

Treasury shares is a contra equity, representing the issued shares held by the firm itself

“Profit” from treasury shares

Not considered actual profit (won’t hit the I/S)
Can fill in prior “losses” in retained earnings
Can add to Additional Paid-in Capital (APIC)

“Losses” from treasury shares

Not considered an actual loss (won’t hit the I/S)
Subtracts from APIC
If APIC hits 0, subtract from Retained earnings

All treasury shares transactions are based on actual amounts paid (market value)

Treasury stock: Putting it all together

Situation: The company purchased 20,000 shares at $20 each, and then sold them in 3 transactions: 5,000 for $15 each, 5,000 for $26 each, and 10,000 for $18 each.

Real world Example

https://rmc.link/101class3

Dividends

Cash dividends
- Final dividend: year end, policy voted on by shareholders
- Interim dividends: declared by board of directors
- Need to have enough retained earnings on hand to declare the dividend
- Need to have enough cash on hand to pay the dividend
Share dividends
- Proportional distribution of shares to shareholders
- Shifts retained earnings to share capital
  - Increases number of outstanding shares

Dividends timeline

Recording cash dividends

Situation: declared $0.10 per share of dividends on Jan 1, with record date of Jan 15 and payment date of Jan 30. 100,000 shares are outstanding.

Stock split

Exchange all common shares at a certain ratio
- Such as a 2 for 1 stock split: receive an additional 1 share for every share owned
- Not substantively different from a stock dividend
  - Just a larger change in the number of shares outstanding
No accounting effects
No journal entry

Summary of transactions

Transaction	Asset (↑=DR)	Liability (↑=CR)	Equity (↑=CR)
Issue shares	↑	–	↑
Purchase treasury shares	↓	–	↓
Sell treasury shares	↑	–	↑
Declare dividends	–	↑	↓
Pay dividends	↓	↓	–
Issue share dividends	–	–	–
Stock split	–	–	–

Practice Questions

Take 5-10 minutes to work on this in groups

Caffeine & Co had 50,000 shares outstanding as of Jan 1, 20X8. The following transactions occurred throughout the year. Prepare the journal entries for each transaction.

On January 30, Caffeine & Co purchased 10,000 shares for $10 per share.
On March 30, Caffeine & Co sold 2,000 treasury shares at $8 per share.
On April 1, Caffeine & Co declared a dividend of $0.05 per share. The date of record was April 15th, with payment on May 30th.
On May 1, Caffeine & Co sold 6,000 treasury shares at $15 per share.
On May 30, Caffeine & Co paid the previously declared dividend
On October 31, Caffeine & Co sold its remaining 2,000 treasury shares at $8 per share.

For next week

Recap the reading for this week
Read the pages for next week
- Control Systems (Chapter 5)
Homework to turn in next week
- Available on eLearn
- Submit on eLearn
Practice on eLearn
- Extra Excel practice on B/S and I/S
- Practice quizzes on both F/S and equity
  - Automatic feedback provided

Packages used for these slides

curl
kableExtra
knitr
quantmod
revealjs

Custom code

# Pull and cache stock quotes
library(quantmod)
library(curl)
Quote <- function(name) {
  if(has_internet()) {
    quote <- getQuote(name)
    saveRDS(quote, paste0(name,'_quote.rds'))
  } else {
    quote <- readRDS(paste0(name,'_quote.rds'))
  }
  quote
}

ACCT 101: Financial Statements; Equity

Session 3

Dr. Richard M. Crowley

Frontmatter

Frontmatter

Learning objectives

Annual reports

What’s included

What’s included

Why are these important?

What you can find

Case: A good report (DBS)

Case: A bad report (Groupon)

Financial statements

General requirements

Statement of financial position

How to construct a SFP

Statement of Comprehensive Income

Constructing an SCI

Statement of Changes in Equity

Constructing an SCE

Statement of Cash flows

Practice

Financing

Financing types

Equity vs debt

Articles of Incorporation

Corporations

Corporations

Share types

Shareholder rights

Equity details

Number of shares

Equity financing example: Facebook

Accounting for Equity

Issuing shares

Accounting for common stock

Par value method (NOT ALLOWED IN SG)

Par value

Preferred stock

Accounting for preferred stock

Treasury stock

Treasury stock: Retirement

Treasury stock: Reissuing at a profit

Treasury stock: Reissuing at a loss

Treasury shares: Summary

Treasury stock: Putting it all together

Real world Example

Dividends

Dividends timeline

Recording cash dividends

Recording share dividends

Stock split

Summary of transactions

Practice Questions

For next week

Packages used for these slides

Custom code