Corey Fink

Touro University International

BUS509-Executive Tools for Decision Makin
Mr! Elias "#ourusto$
Mo%ule & Case' Financial Statements
The terms that were given in this case are vital parts incorporated into financial
statements. The terms: Generally Accepted Accounting Principles, Historical Cost,
Accrual Basis vs. Cash Basis Accounting, and Current Assets and ia!ilities vs. "on#
Current $tems, all play a ma%or role in the reasoning toward financial statements.
$ remem!er when $ too& Accounting classes toward my undergraduate degree, they
told me that one thing to remem!er is to a!ide !y the Generally Accepted Accounting
Principles 'GAAP(. Generally Accepted Accounting Principles is a term used to descri!e
!roadly the !ody of principles that governs the accounting for financial transactions
underlying the preparation of a set of financial statements. Generally accepted principles
are derived from a variety of sources, including promulgations of the )inancial
Accounting *tandards Board and its predecessor, the Accounting Principles Board, and
the American $nstitute of Certified Pu!lic Accountants. +ther sources include the general
!ody of accounting literature consisting of te,t!oo&s, articles, papers, etc. They are a set
of guidelines or principles used in the -nited *tates, which are compiled from specific
rules. These rules are generated !y a series of authoritative private sector !odies. The
current private sector !ody is the )inancial Accounting *tandards Board ')A*B(. These
rules are important, !ecause without them accountants would !e doing their own thing
and not following any rules on how to prepare financial statements.
Historical cost is defined as the consideration given up when the asset was
ac.uired/ it0s the amount originally paid for an asset. +ne of the foundations of American
accounting is the so#called Historical Basis approach, under which assets are presented
on the !alance sheet at their value at the time of ac.uisition 'generally represented !y the
purchase cost(. But in an era mar&ed !y the widespread use of complicated financial
instruments and ris& management strategies that may render yesterday0s prices o!solete,
some people are as&ing if historical cost should !e a!andoned or modified, and replaced
!y a current#cost system. $t could lead to more accurate financial reporting, or it could
lead to chaos. Here0s why. -nder the historical cost doctrine, assets are generally carried
on the !alance sheet at their ac.uisition cost 'ad%usted for depreciation and, in some
cases, impairment(, and lia!ilities are usually carried at the prices at which they were
incurred. )or many years this model, which reflects the profession0s traditionally
conservative approach, was sufficient. $n recent years, however, some accountants as well
as investors and others who use financial statements have .uestioned this approach,
as&ing if accuracy would !e !etter achieved if selected assets and lia!ilities were valued
under a fair mar&et model that would reflect current valuations. 1hile deli!erations !y
the )A*B, along with such other accounting standards !oards as the $nternational
Accounting *tandards Committee, do not suggest that all assets and lia!ilities should !e
valued at current mar&et prices, the organi2ations are considering a model that would
present an entity0s financial instruments at current value.
The Cash Basis focus is, as its name implies, on the flow of cash. That is to say,
whenever cash is collected, revenue is recogni2ed as having !een earned. A similar !asis
for the recognition of e,penses is used, namely whenever cash is paid out, or dis!ursed,
the related e,pense is recogni2ed as having !een incurred. This !asis is simple and
straightforward. Beginning accounting students have little trou!le with it. 3any smaller
!usiness entities use it. However, it has many flaws that interfere with the real
measurement of an entity4s economic activities. Those activities are measured in terms of
the short run, as though they will not !e in e,istence in the future and thus will not, in the
future, receive any !enefit from current activities. The Accrual Basis does ta&e into
account the fact that a !usiness entity4s life will e,tend into the future, !eyond the current
period. This line of thought is em!edded in the concept of GAAP/ which simply stated
says that evidence to the contrary, a !usiness entity is e,pected to have a life that will
e,tend into the future. Therefore, the real test under this !asis of accounting is the
determination of when revenues are to !e recogni2ed, independent of any cash flow. The
test for revenues is when it is earned. That gives cause to a discussion as to when a
!usiness actually earns it revenue. 5evenue is generated as a result of a !usiness4s
performance in an economic e,change. That is to say a !usiness enters into a contractual
agreement to e,change a performance for a consideration, which will ultimately
culminate in the receipt of cash. 1hen it completes that performance, it is entitled to
receive that cash it has earned it as revenue. At that time revenue is recogni2ed. The
recognition of e,penses follows in a similar manner.
Assets and lia!ilities are grouped into two main categories: current and non#
current. Current assets are those assets that can readily !e converted to cash. Ban&
accounts are of course most readily converti!le, !ut any assets that can !e converted to
cash within a short time are current assets. Current lia!ilities are those lia!ilities that have
to !e paid off within a short time. *hort time for !oth current assets and current lia!ilities
usually means one year or less. )or some companies, it may !e their normal !usiness
cycle. "on#current assets are further divided into fi,ed assets and other assets. 6ven
though items of machinery and other assets may !e sold in less than one year, fi,ed assets
are still non#current. This is !ecause they are intended to help operate the !usiness for
periods of greater than a year. $f an asset is !ought with the intent to sell for a profit, then
it is inventory and is a current asset. This is important to financial statements !ecause the
company and consumers !oth have accurate information of when their assets were
purchased and how much they depreciate.
"e,t $ e,amined the three financial statements from the following corporations:
)ord 3otor Company, 3icrosoft, and 6,,on 3o!il. $ found that most items were very
similar in all three sheets. +!viously, you will have different e,penses and assets !ecause
they are three different companies, offering different products.
1ith the income statements/ there was always a revenue section, which included
the operating e,penses/ there was a total of income !efore income ta,es, along with the
provision for income ta,es/ there was also a section that was either la!eled $ncome !efore
accounting change or income !efore e,traordinary item/ and of course there was a tally of
the total net income.
As far as the !alance sheets were concerned/ there was a section of assets, even
though the type differed/ there was also a section of lia!ilities, current and long term/ and
lastly there was a section of stoc&holder0s e.uity.
astly, the statement of cash flows also had many similarities/ in contains many
items under the su!heading of operating activities/ also contains a section of investing
activities/ and the other section contains amounts from financing activities. All of the
added and su!tracted give the amount of cash and cash e.uivalents for the year.
$ did find that )ord 3otor Company differed from the other two, and that was
!ecause )ord0s financial statements were !ro&en down into a lot more detail/ they had
separate sections for Automotive and )inancial *ervices.
$ also feel that cash from operating activities is a more accurate calculation within
the financial statements. 7ou have to use the net income in the calculation of cash from
operating activities, so it ta&es it a little further. 3y predictions for the companies would
!e the following: )ord 3otor Company has an increasingly steady flow from the past
three years of cash and cash e.uivalents, proving that it0s corporation is still going strong/
same holds true for 3icrosoft Corporation, even after facing many law suits/ and my
thoughts on 6,,on 3o!il Corporation is that the cash seemed to fall at year end of 899:,
and that might have something to do with the war. $ thin& all the companies analy2ed in
this case are staying strong, despite the economic hardships that might have come a!out
in the past few years.
Bi#liora()y
)ile:;;6:<3odules<3odule98<Bac&ground.htm. Bac&ground 3aterials.
www.a%.com
www.cfo.com =Historical Cost vs. Current Cost>.
www.lectlaw.com;def;g9?@.htm. =egal Aefinition of Generally Accepted Accounting
Principles>.