Notes

Understanding the Business, a firm is connected with many players in the industry and therefore it has to carry on many different activities. First of all, the business of the firm can be described by following scheme:

• Managers
• Purchase parts and labor, such as Suppliers of raw materials (input) and Employees that provide the human capital.
• Manufacture products and Services, such as Infrastructures, Property, Plan and Equipment.
• Obtain Financial Resources from Debtholders (Bank, in exchange of interests), Shareholders (Equity, in exchange of dividends), and Internal (Selling Products).
• Sell Products to Customers, both Clients and Dealers.

When analyzing a business, we have to keep in consideration 3 types of Business Activities:

• Financing Activities (Firm interacts with Capital Providers), borrowing or paying back money to lenders and receiving additional funds from stockholders or paying them dividends.
• Investing Activities (Purchase of Property, Plant and Equipment), buying or selling items such as plant and equipment used in the production of beverages.
• Operating Activities (All transactions related to the core business of the company), day-to-day process of purchasing raw material from suppliers, manufacturing beverages, delivering them to customers, collecting cash from customers and paying suppliers.

A business is made up of many operations with diverse subjects, therefore keeping track of business transactions is fundamental:

For Managers:

• To fulfill contractual obligations;
• To understand whether the firm is doing well.

For External Subjects:

• To decide whether or not to invest in a company;
• To monitor whether the company is performing well;
• For contractual purposes.

There exist two type of Accounting System: Managerial Internal and Financial External. The accounting system collects and processes financial information and reports it to decision makers that can be Managers (Internal decision makers) or Investors and Creditors (External decision makers).

Ball and Brown, in an article of 1968 underlined the strict relation that occurs between Accounting Information and Financial Markets, indeed Equity Holders care about accounting statements, showing that there is a relation between profits of the firm and price of the shares. If a firm gains profits, it will more likely share dividends, therefore more people will be interested in buying that share, which will make raise the price.

The accounting system is an organised format used by companies to accumulate the dollar effects of transactions. There exist 4 basic Financial Statements:

• Income Statement, it includes all revenues earned from sales to customers and the expenses incurred to produce those revenues. It's the first financial statement that the company will prepare.
• Balance Sheet, it includes all resources (assets) owned and amounts owed (liabilities). The difference between the resources owned and the amounts owed represents the stockholders' equity in the business. Cash is the key asset, the first element in the balance sheet. A = L + SE.
• Statement of Cash Flows, it lists all sources and uses of cash. Cash is such an important asset, that it has its own financial statement. The company will show external subjects all the inflows and outflows of cash. How it is generated and used.
• Statement of Stockholders' Equity, it accumulates net earnings less the dividends paid to owners representing the reinvestments in the core business. It is exclusively for shareholders, because they are interested in the variation of their investment in the company, in particular in accounting retained earnings (the portion of net income that it is not distributed among shareholders).

The 4 Financial Statements are tightly related indeed a change in a parameter affects more than one statement.

Financial Statements are used by every subject that has interest in a company, they are useful for all stakeholders, because accounting information is used in contracts. For example, Marketing and Credit Managers use customer's financial statements to decide whether to extend credit. Purchasing Managers use suppliers' financial statements to decide whether suppliers have the resources to meet the demand for products. Employees' union and human resources managers use the company's financial statements as a basis for contract negotiations pay rates.

Accounting Principles A lot of business decisions are taken on the basis of financial statements. Two important aspects of them are

• The accounting information should truthfully reflect business operations.
• It has to be clear so that the receiver can understand it.

These two aspects are assured through firms' compliance to accounting principles. Accounting principles are accounting measurement rules that firms have to fulfill at the moment of redacting financial statements.

Absent the rules, firms would be free to record the business operations that they want and in the way they want.

Prior to 1933, management teams of most companies were free to choose the accounting principles used to keep track of its transactions.

In 1933, Securities Act of 1933 and Securities and Exchange Act of 1934 defined the Securities and Exchange Commission (SEC), which has been given broad powers to determine measurement rules for financial statements, and it has the role to control that firms are following the rules. The SEC has worked closely with the accounting profession to work out the detailed rules that have become known as GAAP. Currently, the Financial Accounting Standards Board (FASB) is recognized as the body to formulate GAAP.

Since 2002, there has been substantial movement to develop international financial reporting standards by the International Accounting Standards Board (IASB).

In 2002, the European Union agreed that from 1 January 2005, International Accounting Standards (IAS) would apply for the consolidated accounts of the EU listed companies.

The accuracy of financial statements is ensured by:

• Board of Directors monitoring managers' actions
• System of Internal Controls
• Outside Independent Auditors (Deloitte, Ernst&Young, PWC, KPMG). They are now 4, but they used to be 5 (Arthur Andersen), which went bankrupt after Enron's scandal.

They have to:

• Examine the financial reports to ensure compliance with GAAP. (Unqualified opinion)
• Examine the underlying transactions incorporated into the financial statements
• Express an opinion on the fairness of presentation of financial information.

Independent auditors have responsibilities that extend to the general public. A CPA's (Certified Public Accountant) reputation for honesty and competence is his/her most important asset.