Accounting for Lawyers November 6, 2010
Agenda • Accounting Overview • Financial Statements – Balance Sheet – Income Statement – Cash Flow Statement
• Accounting Fundamentals – – – –
Double Entry Accounting Cash v. Accrual Accounting Chart of Accounts Journal Entries
• Litigation and Other Disclosures • Financial Statement Sources – e.g. SEC Filings 1
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Agenda
• Accounting Overview
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Accounting Overview Journal Entries: Record the transactions of the business using the company’s chart of accounts (e.g. cash, accounts payable, accounts receivable, interest expense, sales revenue, etc.).
General Ledger: The accounting database that contains the Journal Entry data.
Balance Sheet
Income Statement + Revenues -
Assets
Expenses
=
= Net Income -
Cash Flow Statement
Liabilities +
Dividends
Owners Equity
= Retained Earnings
+ Net Income + Net Operating Cash Flows + Net Investing Cash Flows
The Cash Flow Statement is developed using and reordering the information in the Income Statement and the Balance Sheet
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+ Net Financing Cash Flows = Increase or (decrease) in Cash
Private and Confidential
Agenda
• Financial Statements – Balance Sheet – Income Statement – Cash Flow Statement
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Financial Statements - Overview Income Statement
Balance Sheet Assets = Structure
Liabilities + Owners Equity
+ Net Income
-
+ Net Operating Cash Flows
Expenses
= Net Income
+ Net Investing Cash Flows
-
+ Net Financing Cash Flows
Dividends
= Retained Earnings
Period
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= Increase or (decrease) in Cash
•
A report that shows a company’s assets, liabilities, and owners equity. In other words, what the company owns and how it financed what it owns.
•
A report that details a company’s operating and non-operating revenue and expenses along with what cash the company distributed to its owners
•
A report that shows a company’s sources and uses of cash by activity type (operations, investing, and financing)
•
Reporting Period: As of a specific date (e.g. as of 12/312009)
•
Reporting Period: Over a specific time period (usually for a year or some portion of a year)
•
Reporting Period: Over a period of time (e.g. annual, quarterly, monthly)
Purpose
Reporting
Cash Flow Statement
+ Revenues
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The Balance Sheet Assets Current Assets • • • • •
Liabilities Current Liabilities
Cash and Marketable Securities Accounts Receivable Inventories Other Current Assets Investments
• Accounts Payable • Short-Term Borrowings • Other Current Liabilities Long Term Liabilities • Long-Term Debt • Deferred Tax • Provisions
Fixed Assets
Owners Equity
• Plant, Property & Equipment • Intangible Assets
• • • •
Total Assets
Preferred Stock Common Stock Share Premium Retained Earnings
Total Financing
Items are listed in declining order of liquidity
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The Income Statement
Revenue Gross Revenue
Gross Revenue - Adjustments
-
Net Revenue
Net Revenue
Income Statement
Less: Expenses - Cost of Goods Sold - Operating Expenses - Other Expenses Net Income Less: Dividends Retained Earnings
Sales Returns Sales Allowances Trade Discounts Cash Discounts Sales Tax
Expenses Cost of Goods Sold • Material Costs • Labor Costs • Transportation & Other Costs Operating Expenses • Selling, General, and Administrative • Research & Development • Depreciation & Amortization Other Expenses • Interest • Income Tax
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The Cash Flow Statement
Operating Cash Flows • Net Income • Depreciation & Amortization
Cash Flow Statement
• (Gain)/Loss on Sale of Property, Plant, & Equipment • Other Non-Cash Expense/(Income)
Net Income
• (Increase)/Decrease in Accounts Receivable
+ Net Operating Cash Flows
• (Increase)/Decrease in Inventory • Increase/(Decrease) in Accounts Payable
+ Net Investing Cash Flows g Cash Flows + Net Financing Increase or (Decrease) in Cash
Cash Flow from Investing Activities • (Capital Expenditures) • (Investments) • Sale of Property, Plant, & Equipment • (Acquisitions) • Divestments
Cash Flow from Financing Activities • Share Issue / (Repurchase) Note: The purple items are based on information in the Income Statement while all other items are based on information in the Balance Sheet
• (Cash Dividends) • Debt Issue • (Debt – Interest Payments) • (Debt Repayment)
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Agenda
• Accounting Fundamentals – Double Entry Accounting – Cash vs. Accrual Accounting – Chart of Accounts – Journal Entries
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Key Principle - Double Entry Bookkeeping Double entry book-keeping is the foundation for how accounting works – all transactions must have equal, and offsetting entries (debits/credits) in the books
• Each transaction entry that is made has an equal and opposite entry (total
debits must equal total credits) • This is why the two sides of the balance sheet
must always balance • Another way to think about it:
A Assets t
Liabilities and Owners Equity
$20,000
$20,000
- If an entity owns assets it must have paid for them in some way Total Resources (Assets)
Total Funding (Liabilities and Owner Funds)
=
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$$ Auto Loan
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Key Principle - Cash v. Accrual Accounting Of the two primary forms of accounting, the accrual basis better matches revenues and expenses to the period in which most of the efforts to generate the sales were made Cash Basis of Accounting
Accrual Basis of Accounting
• Recognizes revenues in the period when cash is received from customers and expenses in the period when cash expenditures are made m
• Recognizes revenues in the period when goods are sold or services are rendered. Expenses are recognized in the period when the revenues that the expenses help generate are booked
• The cash basis of accounting has two major weaknesses:
• The accrual basis of accounting provides a superior measure of operating performance to the cash basis for the two following reasons:
– Does not match the costs of efforts required in generating revenues with those particular revenues – Unnecessarily postpones the recognition of revenue
– Sales activity during a given period are more accurately reflected – Period expenses are more closely matched to revenue
• The cash basis of accounting is used, for example, in the preparation of personal income tax returns • Example: Cash flow statement
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• Most clients use the accrual basis of accounting • Examples: Balance Sheet and Income Statement
Sample Chart of Accounts: Balance Sheet
Income Statement
100-199 Assets
400-499 Revenues
100-109 Cash 101 Cash – Regular Checking 102 Cash – Payroll Checking
Product Sales 401 Store #1 Sales 402 Store #2 Sales 403 Store #3 Sales
110-119 Receivables 111 Accounts Receivable 112 Notes Receivable
Other Income 411 Interest Revenue
120-129 Property, Plant, and Equipment 121 Buildings 122 Equipment q p
500-599 Expenses Direct Expenses 501 Materials 502 Labor 503 Payroll Tax Expense 504 Freight
200-299 Liabilities 200-209 Current Liabilities 201 Notes Payable 202 Accounts Payble 203 Wages and Salaries Payable 204 Taxes Payable
Indirect Expenses (Overhead) 501 Salaries & Wages, Office & Sales 502 Accounting 503 Advertising 504 Legal Fees 505 Utilities 506 Office Supplies
210-219 Long-term Liabilities 211 Mortgage Loan Payable 212 Bonds Payable 300-399 Owner’s Equity 300-309 Stock 301 Paid-In Capital 302 Retained Earnigs 12
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Journal Entry Examples and the Impact on the Financial Statements 1. On 1/1/10, Bill Buzzard deposits $25,000 in a bank account in the name of Buzzards, Inc. 2. On 1/31/10, Buzzards, Inc. purchases $500 in supplies and pays $200 cash and agrees to pay $300 to the supplier in the near future (on account). 3. On 1/31/10, Buzzards, Inc. pays $800 for February rent. 4. On 2/15/10, Buzzards, Inc. sells $1,000 worth of stuffed buzzards. Payment is due in 30 days. 5. On 2/28/10, Buzzards, Inc. records rent expense for February, $800.
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Journal Entry and the Impact on the Financial Statements 1. On 1/1/10, Bill Buzzard deposits $25,000 in a bank account in the name of Buzzards, Inc. Journal Entry: Entry Number 1
Date 1/1/2010
Account Number 100 500
Account Type Asset Owners Equity
Account Title Cash Paid-In Capital
Debit 25,000
Credit 25,000
Record Bill Buzzard's contribution to Buzzards, Inc.
Balance Sheet: Cash Balance (1) Entry Balance
Supplies
0 25,000 25,000
Assets Accounts Receivable
0
0
Income Statement: (no impact) Revenues Balance (1) Entry Balance
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Expenses
0
0
Prepaid Rent
0
Total Assets 0 25,000 25,000
=
Liabilities Accounts + Payable
Owners Equity Paid-In Capital 0 25,000 25,000
Journal Entry and the Impact on the Financial Statements 2. On 1/31/10, Buzzards, Inc. purchases $500 in supplies and pays $200 cash and agrees to pay $300 to the supplier in the near future (on account). Journal Entry: Entry Number 2
Account Number 100 100 200
Date 1/31/2010
Account Type Asset Asset Liability
Account Title Supplies Cash Accounts Payable
Debit
Credit 500 200 300
Purchase of supplies on account and with cash.
Balance Sheet: Cash Balance (1) Entry (2) Entry Balance
Supplies
0 25,000 -200 24,800
Assets Accounts Receivable
500 500
Prepaid Rent
0
0
Total Assets
=
Liabilities Accounts + Payable
0 25,000 300 25,300
Owners Equity Paid-In Capital 0 25,000
300 300
25,000
Income Statement: (no impact) Revenues
Expenses
Balance (1) Entry (2) Entry Balance 15
0
0
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Journal Entry and the Impact on the Financial Statements 3. On 1/31/10, Buzzards, Inc. pays $800 for February rent. Journal Entry: Entry Number 3
Account Number 100 100
Date 1/31/2010
Account Type Asset Asset
Account Title Prepaid Rent Cash
Debit 800
Credit 800
February 2010 rent payment.
Balance Sheet: Cash Balance (1) Entry (2) Entry (3) Entry Balance
Supplies
0 25,000 -200 -800 24,000
Assets Accounts Receivable
Prepaid Rent
500 500
0
800 800
Total Assets
=
Liabilities Accounts + Payable
0 25,000 300 0 25,300
Owners Equity Paid-In Capital 0 25,000
300 300
25,000
Income Statement: (no impact) Revenues Balance (1) Entry (2) Entry (3) Entry Balance
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Expenses
0
0
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Journal Entry and the Impact on the Financial Statements 4. On 2/15/10, Buzzards, Inc. sells $1,000 worth of stuffed buzzards. Payment is due in 30 days. Journal Entry: Entry Number 4
Date 2/15/2010
Account Number 100 600
Account Type Asset Revenue
Account Title Accounts Receivable Sales Revenue
Debit 1,000
Credit 1,000
Sale of stuffed buzzards net 30.
Balance Sheet: Cash Balance (1) Entry (2) Entry (3) Entry (4) Entry Balance
Supplies
0 25,000 -200 -800 24,000
Assets Accounts Receivable
500 800 1,000 1,000
500
Income Statement: Revenues Balance (1) Entry (2) Entry (3) Entry (4) Entry Balance 17
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1,000 1,000
Prepaid Rent
Expenses
0
800
Total Assets 0 25,000 300 0 1,000 26,300
=
Liabilities Accounts + Payable
Owners Equity Paid-In Retained Capital Earnings 0 25,000
300
300
25,000
1,000 1,000
Journal Entry and the Impact on the Financial Statements 5. On 2/28/10, Buzzards, Inc. records rent expense for February, $800. Journal Entry: Entry Number 5
Date 2/28/2010
Account Number 700 100
Account Type Expense Asset
Account Title Rent Expense Prepaid Rent
Debit 800
Credit 800
February 2010 rent expense.
Balance Sheet: Cash Balance (1) Entry (2) Entry (3) Entry (4) Entry (5) Entry Balance
Supplies
0 25,000 -200 -800
Assets Accounts Receivable
Prepaid Rent
500 800 1,000
24,000
500
1,000
-800 0
Total Assets 0 25,000 300 0 1,000 -800 25,500
=
Liabilities Accounts + Payable
Owners Equity Paid In Paid-In Retained Capital Earnings 0 25,000
300
300
25,000
1,000 -800 200
Income Statement: Revenues Balance (1) Entry (2) Entry (3) Entry (4) Entry (5) Entry Balance 18
Expenses
1,000 1,000
-800 -800
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Agenda
• Litigation and Other Disclosures – Notes to the Financial Statements
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Litigation Disclosures: 10-K Table of Contents PART I • Item 1. Business • Item 1A. Risk Factors • Item 1B. Unresolved Staff Comments • Item 2. Properties • Item 3. Legal Proceedings • Item 4. Submission of Matters to a Vote of Security Holders PART II • Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities • Item 6. Selected Financial Data • Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations • Item It 7A. 7A Quantitative Q tit ti and d Qualitative Q lit ti Disclosures Di l Ab Aboutt M Market k t Ri Risk k • Item 8. Financial Statements and Supplementary Data • Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure • Item 9A. Controls and Procedures • Item 9B. Other Information PART III • Item 10. Directors, Executive Officers and Corporate Governance • Item 11. Executive Compensation • Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters • Item 13. Certain Relationships and Related Transactions, and Director Independence • Item 14. Principal Accountant Fees and Services PART IV •
Item 15. Exhibits and Financial Statement Schedules
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Litigation Disclosure - Example ABC Restaurant 10-K Item 3. Legal Proceedings Labor Related Matters On February 5, 2004, a former employee of ours, on behalf of herself, and allegedly other employees, filed a class action complaint in Los Angeles County, California, Superior Court, and on March 16, 2004, filed an amended complaint, alleging causes of action for: (1) failure to pay reporting time minimum pay; (2) failure to allow meal breaks; (3) failure to allow rest breaks; (4) waiting time penalties; (5) civil penalties; (6) reimbursement for fraud and deceit; (7) punitive damages for fraud and deceit; and and, (8) disgorgement of illicit profits. On June 28, 2004, the plaintiff stipulated to dismiss her second, third, fourth and fifth causes of action. During September 2004, the plaintiff stipulated to binding arbitration of the action. On March 2, 2008, and on March 19, 2008, one of Plaintiff’s attorneys filed a notice with the California Labor and Workforce Development Agency, alleging failure to keep adequate pay records and to pay Plaintiff minimum wage. To our knowledge, the Agency has not responded to either of these notices. In November 2008, the parties agreed to settle this matter subject to approval from the arbitrator and/or the court. The terms of this proposed settlement are not considered by us to be material to our consolidated financial position.
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The Financial Statement Notes contain detailed information that are vital to the understanding / interpretation of the company’s accounts Other Notes
Key Notes • Litigation disclosure
• Research & Development
• Accounting policies
• Pension liabilities and other provisions
• Segmental analysis of revenue, profits and assets
• E&P activities (for Upstream companies)
• Various operating cost items • Personnel expenses • Financial income / expense • Exceptional items • Taxation • Acquisitions / disposals • Asset and liabilities analysis • Financial instruments (debt) 22
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Agenda
• Financial Statement Sources – Company Websites – SEC Filings
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• Risk exposures, derivative positions, etc. (especially for financial services companies) • Post balance sheet events • Share based payments / stock options • Credit rating • Board make-up • Other governance matters
Financial Statement Sources • All publicly traded companies will have financial information publicly available • Most have them in PDF format on their websites – check under “investor relations” • In the US, under SEC requirements, quoted companies must produce: – An Annual Report (10-K) is one of the most comprehensive, published sources of financial information (3 months after close of fiscal year) – A 10-Q Quarterly Report contains more limited information (45 days after end of fiscal quarter) – An 8-K Current Report is intended to reflect important events (e.g. change in control, acquisitions and divestitures, resignation of directors)
• SEC requirements for foreign registrants – May elect to file registration and reporting forms used domestically – Filing requirements for foreign firms is less stringent • •
20-F’s (similar to 10-K) due six months after close of fiscal year, optional quarterly reports and little segment disclosure 20-F’s must identify accounting methods used, identify material differences from GAAP and reconcile reported income to GAAP
• Companies which both have primary listings in London and ADRs* on NYSE must meet both SEC and UK filing requirements • European companies are usually required to present an annual report and interim statements (abbreviated and non-audited)
*American Depository Receipts 24
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Useful Resources • SEC Edgar (for financial filings) (www.sec.gov)
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Kurt Needles, CPA
Rona Seams
Needles & Associates, LLC
Charles River Associates
350 Interlocken Blvd. Suite 220
One South Wacker Drive, Suite 3400
Broomfield, CO 80021
Chicago, IL 60606
303-430-4225
312-377-9213
www.needles-audit.com
[email protected]
Private and Confidential