Accounting can be defined as the process of recording, summarizing, and analyzing financial

transactions. Financial Accounting can be classified into two categories:

 Financial accounting—designed primarily for decision makers outside of the company
 Managerial accounting—designed primarily for decision makers within the company
Who Uses Financial Accounting Information?
Demand for financial accounting information derives from numerous users including:
 Shareholders and potential shareholders
 Creditors and suppliers
 Managers and directors
 Financial analysts
 Other users

NOTES that can be asked on multiple choices:

1) A corporation is a form of business organization that is characterized by a large number
of owners who are not involved in managing the day-to-day operations of the company.
2) The owners of a corporation are referred to as shareholders or stockholders.
3) One of the principle advantages of a corporation over sole proprietorships and
partnerships is the ability to raise large amounts of cash by issuing (selling) stock.
4) Corporations with stock traded on public exchanges (ictimai birja) are known as publicly
traded corporations or simply public corporations.
5) Financial statements are typically required when a business requests a bank loan.
6) Financial statements and the accompanying footnotes provide information on the risk and
return associated with owning shares of stock in the corporation, and they reveal how
well management has performed.
7) Creditors are interested in the potential borrower’s ability to repay. They use financial
accounting information to help determine loan terms, loan amounts, interest rates, and
collateral.
8) Suppliers use financial information to establish credit sales terms and to determine their
longterm commitment to supply-chain relationships.
9) A well-managed company earns a good return for its shareholders, and this is reflected
in the financial statements.
10) Publicly traded corporations are required by law to have a board of directors.
 Directors are elected by the shareholders to represent shareholder interests and
oversee management.
 Directors use financial accounting information to review the results of operations,
evaluate future strategy, and assess management performance.
11) Financial Assistants help to identify and assess risk, forecast performance, establish
prices for new issues of stock, and make buy or sell recommendations to investors.
12) Other Users:
 Prosective Employees
 Labor unions
 Customers
 Tax agencies
 Government agencies
Costs and Benefits of Disclosure
The act of providing financial information to external users is called disclosure. As with every
decision, the benefits of disclosure must be weighed against the costs of providing the
information.
Advantage of disclosure- is lowers financing and operating costs. For example, when a
company applies for a loan, the bank uses the company’s financial statements to help determine
the appropriate interest rate.
Disadvantage of disclosure- It is common practice for managers to scrutinize the financial
statements of competitors to learn about successful products, new strategies, innovative
technologies, and changing market conditions. Thus, disclosing too much information can place
a company at a competitive disadvantage. Disclosure can also raise investors’ expectations about
a company’s future profitability. If those expectations are not met, they may bring litigation
against the managers.

Business activities
Planning Activities- A company’s goals, and the strategies adopted to reach those goals, are the
product of its planning activities. Most business’s primary goal is to create value for its owners,
the shareholders. How the company plans to do so is the company’s strategy. A company’s
The plan’s success
strategic (or business) plan describes how it plans to achieve its goals.
depends on an effective review of market conditions. The plan must also
include competitive analyses, opportunity assessments, and
consideration of business threats.
 Competitive analyses: This involves identifying and studying competitors in the market.
Companies should evaluate their strengths, weaknesses, market share, pricing strategies,
and unique offerings.
 Opportunity assessments: Businesses need to identify new opportunities for growth,
such as emerging market segments, gaps in the current market, or technological
advancements that could be leveraged.
 Consideration of business threats: Along with opportunities, companies must be aware
of potential threats that could impact their success. These could include economic
downturns, new competitors, changing regulations, or shifts in consumer behavior.
Mitigating these risks is key to long-term success.
Investing Activities- Investing activities consist of acquiring and disposing of the resources
needed to produce and sell a company’s products and services. The relative proportion of short-
term and long-term investments depends on the type of business and the strategic plan that
the company adopts. For instance, a retail clothing store hopes to sell its spring and summer
goods before purchasing more inventory for the fall and winter. Buildings are typically used for
several decades.
Financing Activities- financing activities refer to the methods companies use to fund those
investments. Financial management is the planning of resource needs, including the proper mix
of financing sources. There are two sources of financing activities:
  Equity/owner financing (equity) refers to the funds contributed to the company by its
owners along with any income retained by the company. One form of equity financing is
the cash raised from the sale (or issuance) of stock by a corporation.
 Creditor (or debt) financing (liabilities) is funds contributed by nonowners, which
create liabilities. Liabilities are obligations the company must repay in the future. One
example of a liability is a bank loan. We have the following basic relation: investing
equals financing. This equality is called the accounting equation.

Operating Activities- refer to the production, promotion, and selling of a company’s products
and services. These activities extend from a company’s input markets, involving its suppliers, to
its output markets, involving its customers.
 Input markets generate operating expenses (or costs) such as inventory, salaries,
materials, and logistics.
 Output markets generate operating revenues (or sales) from customers.
When operating revenues exceed operating expenses, companies report operating income, also
called operating profit or operating earnings. When operating expenses exceed operating
revenues, companies report operating losses.
Revenue is the increase in equity resulting from the sale of goods and services to customers.
An expense is the cost incurred to generate revenue, including the cost of the goods and services
sold to customers as well as the cost of carrying out other business activities. (Xərc müştərilərə
satılan mal və xidmətlərin dəyəri, eləcə də digər biznes fəaliyyətinin həyata keçirilməsi xərcləri
daxil olmaqla, gəlir əldə etmək üçün çəkilən xərcdir).

Financial Statement
 Balance sheet, which lists the company’s investments and sources of financing using the
accounting equation; A point in time
 Income statement, which reports the results of operations;
 Statement of stockholders’ equity, which details changes in owner financing;
 Statement of cash flows, which details the sources and uses of cash.
First one reports the company’s position a point in time. Other one’s report over a period of
time.
A one-year, or annual, reporting period is common, which is called the accounting, or fiscal
year.
Calendar-year companies have a reporting period that begins on January 1 and ends on
December 31.
BALANCE SHEET
It summarizes the result of the company’s investing and financing activities by listing amounts
for assets, liabilities, and equity. It provides us with information about the resources available to
management and the claims against those resources by creditors and shareholders. Balance
sheet equation:

Assets = Liabilities +Equity

INCOME STATEMENT
The income statement reports the results of a company’s operating activities over a period of
time. It details amounts for revenues and expenses, and the difference between these two
amounts is net income.
 The income statement is a financial document that tells us how well a company is doing
in terms of making money.
 It shows the increases in money (revenues) and the decreases in money (expenses) that
come from the company's day-to-day operations.
Difference between balance sheet and income statement: The amounts listed in the balance sheet
carry over from the end of one fiscal year to the beginning of the next fiscal year, while the
amounts listed in the income statement do not carry over from one year to the next.
Net income= revenues minus expenses equal net income
Net Income= Revenues- Expenses
Statement of Stockholders’ Equity
The statement of stockholders’ equity, or simply statement of equity, reports the changes in the
equity accounts over a period of time. These changes can be divided into 3 categories:
 Contributed capital (includes common stock, and additional paid-in capital). It
represents the net amount received from issuing stock to shareholders (owners).
 Retained earnings (includes cumulative net income or loss, and deducts dividends).
Retained earnings (also called earned capital) represents the income the company has
earned since its inception, minus the dividends it has paid out to shareholders.
(Bölüşdürülməmiş mənfəət (həmçinin qazanılmış kapital adlanır) şirkətin yarandığı
gündən səhmdarlara ödədiyi dividendlər çıxılmaqla əldə etdiyi gəliri əks etdirir.)
 Other stockholders’ equity refers to changes in equity that are not recorded in income.

Total Equity= Contributed Capital+ Retained Earnings+ Other stockholders’

equity
Statement of Cash Flows
The statement of cash flows reports net cash flows from operating, investing, and financing
activities over a period of time.

Financial Statement Linkages

It is referred to as the articulation of the financial statements. Three of the key linkages are:
 The statement of cash flows links the beginning and ending cash in the balance sheet.
 The income statement links the beginning and ending retained earnings in the
statement of stockholders’ equity.
 The statement of stockholders’ equity links the beginning and ending equity in the
balance sheet.
EXAMPLE: NIKE
1. Statement of Cash Flows: This document tells us how a company's cash changed during
the year because of its day-to-day operations, borrowing and lending money, and buying
or selling investments. In this case, the cash decreased by $1,124 million.
 2. Balance Sheets: These are like snapshots of a company's financial health at the
beginning and end of the year. At the start of the year, the company had $3,079 million in
cash, but by the end of the year, it only had $1,955 million.
3. Net Income: This is the profit the company made during the year, which in this case was
$2,133 million. This profit is important because it affects the company's overall financial
picture.
4. Statement of Stockholders' Equity: This document explains how the ownership value
of the company, called equity, changed during the year. At the beginning of the year, the
company's equity was worth $9,754 million, and by the end of the year, it increased to
$9,843 million.
In summary, the company made a profit of $2,133 million during the year, but its cash decreased
by $1,124 million. However, its overall value, or equity, increased from $9,754 million to $9,843
million due to various financial activities.

Reports include the following:

 Management Discussion and Analysis (MD&A)
 Independent Auditor Report
 Financial statement footnotes
 Regulatory filings, including proxy statements and other SEC filings

Importance of Financial Statements

 Financial statements affect the prices paid for equity securities and interest rates
attached to debt securities.
 To the extent that financial performance and condition are accurately communicated to
business decision makers, debt and equity securities are more accurately priced.
 By extension, financial reporting plays a crucial role in efficient resource allocation
within and across economies.
 Accounting information contributes to the efficient operation of securities markets, labor
markets, commodity markets, and other markets.
Financial statements illustrate the importance of reliable financial reporting.

Generally Accepted Accounting Principles

GAAP is not a set of immutable laws. Instead, it is a set of standards and accepted practices,
based on underlying principles, that are designed to guide the preparation of the financial
statements. GAAP is subject to change as conditions warrant (GAAP şərtlərə uyğun olaraq
dəyişdirilə bilər).
Auditors
1. The financial statements of publicly traded corporations must be audited by an
independent audit firm.
 2. The auditors provide an opinion as to whether the statements present fairly and in all
material respects a company’s financial condition and the results of its operations.
3. The audit opinion is not a guarantee. Auditors only provide reasonable assurance that the
financial statements are free of material misstatements.

ANALYZING FINANCIAL STATEMENTS

Ratios- using financial statement information to summarize the data in a form that is easier to
interpret. Ratios also allow us to compare the performance and condition of different companies
even if the companies being compared are dramatically different in size. Ratios also help
analysts spot trends or changes in performance over time (Nisbətlər həmçinin analitiklərə
zamanla meylləri və ya performans dəyişikliklərini aşkar etməyə kömək edir).

 Profitability Analysis
Profitability reveals whether or not a company is able to bring its product or service to the
market in an efficient manner, and whether the market values that product or service.

A key profitability metric is company return on equity. This metric compares the level of net
income with the amount of equity financing used to generate that income.

While comparing ratios of different companies, it is essential to understand that:

1. Compare Apples to Apples: When you're comparing financial ratios, it's important to
compare companies that are in the same kind of business. For example, if you're looking
at ratios for companies in the fashion industry, you shouldn't compare them to companies
in a completely different industry like technology.

2. Different Customers and Suppliers Matter: Companies can be affected by the type of
customers they have or where they get their supplies. This can make their financial ratios
look different even if they're in the same industry.

3. Management Choices Matter: How a company's management handles their assets (like
inventory) and liabilities (like loans) can also affect the ratios. Sometimes, companies
 might make short-term decisions that make their financial ratios look better for now, but
it could harm their future performance. For example, delaying buying inventory or
shipping products early can make the current profits look good but might not be good for
the long-term health of the company.

 Risk Analysis
When you invest your money or lend it to a company, there's always some level of risk involved.
Risk means there's a chance you might not get all your money back or earn a profit. The more
risky an investment is, the more profit you'd want to make to justify taking that risk (İnvestisiya
nə qədər risklidirsə, bu riski götürməyə haqq qazandırmaq üçün bir o qədər çox qazanc əldə
etmək istəyərsiniz). One important factor is a company’s long-term solvency.

 Solvency refers to the ability of a company to remain in business and avoid bankruptcy or
financial distress.
 One such measure is the debt-to-equity (D/E) ratio- Ümumi borcun kapitala nisbəti

Important note: Solvency is closely related to the extent a company relies on creditor
financing.

 As the amount of creditor financing increases, the possibility of bankruptcy also

increases.
 Short of bankruptcy, a company that has borrowed too much will occasionally find
that the required interest payments are hurting the company’s cash flow.
 The debt-to equity ratio is an important measure used by analysts and others to assess a
company’s ability to make the necessary interest and principal payments on its debt.

Interpretation of D/E ratio in respect of Nike:

1. Steady D/E Ratio: Nike has had a consistent D/E ratio of around 0.50 over the past three
years. This ratio shows the company's level of debt compared to its ownership (equity). A
D/E ratio of 0.50 means that for every dollar of equity, Nike has borrowed 50 cents.
 2. Drop in the Ratio: The ratio went down in 2009 and 2010. In 2009, Nike's profits
decreased because of some unusual expenses, but they were still making enough money
to increase their retained earnings and total equity (the ownership part of the company)
more than their total liabilities (the debt part of the company). This drop in the ratio was
due to one-time expenses like a reorganization charge, which the company doesn't expect
to happen again.

3. Consistent Low Ratio: Nike's D/E ratio has generally stayed low and stable. This low
ratio is reasonable because most of Nike's production happens outside the United States
(overseas), so they don't rely heavily on borrowing money.

In simple terms, Nike's D/E ratio has been steady, and it went down temporarily because of some
unusual expenses in the past. But overall, the company has a low D/E ratio, which makes sense
because they don't rely heavily on borrowing money, especially since most of their production is
done overseas.

Objectives of Financial Reporting

A fundamental goal of financial accounting is to provide information that promotes the efficient
allocation and use of economic resources. To this end, the FASB established several objectives
of financial reporting which are summarized here.

1. Financial accounting should provide information that is useful to investors, creditors, and
other decision makers who possess a reasonable knowledge of business activities and
accounting.
2. Financial accounting should provide information to help investors and creditors assess
the amount, timing, and uncertainty of cash flows. This includes the information
presented in the cash flow statement as well as other information that might help
investors and creditors assess future dividend and debt payments.
3. Financial accounting should provide information about economic resources and financial
claims on those resources. This includes the information in the balance sheet and any
supporting information that might help the user assess the value of the company’s assets
and future obligations.
4. Financial accounting should provide information about a company’s financial
performance, including net income and its components (i.e., revenues and expenses).
5. Financial accounting should provide information that allows decision makers to monitor
company management to evaluate their effective, efficient, and ethical stewardship of
company resources. (Maliyyə uçotu qərar qəbul edənlərə şirkət rəhbərliyinə onların
effektiv, səmərəli və şirkət resurslarının etik qaydada idarə olunmasını qiymətləndirmək
 üçün nəzarət etməyə imkan verən məlumat verməlidir.)

Benefits > Costs- This characteristic implies that if the benefit to the economy does not exceed
the cost, the information does not meet the test of usefulness.
Materiality- Materiality refers to whether or not a particular amount is large enough to affect a
decision. Some financial items are so small that they don't need to be reported because they
wouldn't really affect a reasonable decision-maker's judgment. To decide if something is
material, accountants compare it to bigger, more important numbers like total assets, sales
revenue, or net income. If the small item is really tiny compared to these big numbers, it might
not be considered important enough to report separately. Some items, even if they are small, still
have to be reported because they are crucial for understanding how the company is doing.

Understandability and Decision Usefulness- Accounting information should be presented so

that a knowledgeable reader can understand how it relates to the decision problem at hand.

Relevance -Accounting information must have the ability to make a difference in a decision.
Such information may be useful in making predictions about future performance of the company
or in providing feedback to evaluate past events.

 Timeliness: The information must be available to decision makers before it loses its
capacity to influence decisions. That is, information that is reported after a decision is
made is not relevant to that decision.
 Predictive value: Refers to the ability of the information to increase the accuracy of a
forecast.
 Feedback value: Refers to the quality of information that enables users to confirm or
correct prior expectations.

Reliability- Accounting information should be accurate and free of misstatement or bias. It must
be reasonably neutral, verifiable, and possess representational faithfulness.
Representational faithfulness: Accounting information should reflect the underlying economic
events it purports to measure. (Mühasibat uçotu məlumatları ölçmək istədiyi əsas iqtisadi
hadisələri əks etdirməlidir.)

Verifiability: This characteristic implies that consensus among measures assures that the
information is free of error.

Neutrality: Information must be free of any bias intended to attain a predetermined result or to
induce a particular mode of behavior.

Comparability- Accounting information should enable users to identify similarities and

differences between sets of economic phenomena. For instance, the financial statements of
different companies should be presented in a way that allows users to make comparisons across
companies concerning their activities, financial condition, and performance.

 One of the consequences of comparability is that firms in the same business (industry)
should use the same, or similar, reporting techniques.

Consistency- The information supplied to decision makers should exhibit conformity from one
reporting period to the next with unchanging policies and procedures. Companies can choose to
change accounting methods, and sometimes they are required to do so by standard setters.
Accounting changes should be rare and supported as the better means of reporting the
organization’s financial condition and performance (Mühasibat uçotunda dəyişikliklər nadir
olmalıdır və təşkilatın maliyyə vəziyyəti və fəaliyyəti haqqında hesabat vermək üçün daha yaxşı
vasitə kimi dəstəklənməlidir).

Reporting Financial Condition

Assets
An asset is a resource that is expected to provide a company with future economic benefits. An
asset must possess two characteristics to be reported on the balance sheet:
1. It must be owned or controlled by the company. - It implies that the company has legal title
to the asset or has the unrestricted right to use the asset. The cost to acquire the asset has been
incurred, either by paying cash, by trading other assets, or by assuming an obligation to make
future payments.

2. It must possess expected future benefits that can be measured in monetary units. – It
indicates that the company expects to receive some future benefit from ownership of the asset.
Benefits can be the expected cash receipts from selling the asset or from selling products
produced by the asset. It also requires that a monetary value can be assigned to the asset.
To create shareholder value, assets must yield income that is in excess of the cost of the funds
utilized to acquire the assets (Səhmdar dəyərini yaratmaq üçün aktivlər aktivləri əldə etmək üçün
istifadə olunan vəsaitlərin dəyərindən artıq gəlir gətirməlidir).

Assets categorized into two parts:

 Current Assets
 Non-current Assets

Current Assets- The most liquid assets are called current assets. Current assets are assets
expected to be converted into cash or used in operations within the next year, or within the next
operating cycle. Examples of currents assets:

■ Cash—currency, bank deposits, certificates of deposit, and other cash equivalents;

■ Marketable securities—short-term investments that can be quickly sold to raise cash; (■

Bazar qiymətli kağızları — pul vəsaitlərini artırmaq üçün tez satıla bilən qısamüddətli
investisiyalar;)

■ Accounts receivable—amounts due to the company from customers arising from the sale of
products or services on credit;

■ Inventory—goods purchased or produced for sale to customers;

■ Prepaid expenses—costs paid in advance for rent, insurance, or other services. (■ Əvvəlcədən
ödənilmiş xərclər – icarə, sığorta və ya digər xidmətlər üçün əvvəlcədən ödənilmiş xərclər.)

Non-current Assets- Noncurrent assets (long-term assets) include the following asset accounts:

■ Long-term financial investments—investments in debt securities or shares of other firms that

management does not intend to sell in the near future; (Uzunmüddətli maliyyə investisiyaları —
rəhbərliyin yaxın gələcəkdə satmaq niyyətində olmadığı borc qiymətli kağızlarına və ya digər
firmaların səhmlərinə investisiyalar)

■ Property, plant, and equipment (PPE)—includes land, factory buildings, warehouses, office
buildings, machinery, office equipment, and other items used in the operations of the company;

■ Intangible and other assets—includes patents, trademarks, franchise rights, goodwill, and
other items that provide future benefits, but do not possess physical substance.

Measuring Assets

1. Historical Cost: When a company buys something like inventory or property, it records
it on the balance sheet at the original price they paid for it. This is called the historical
cost. This is done because it's a reliable way to measure the value of these items.

2. Advantage of Historical Cost: Historical cost is reliable because it's easy to figure out
how much cash was spent to buy an asset. It's a clear and objective measure.

3. Disadvantage of Historical Cost: The downside is that sometimes the historical cost
doesn't reflect the true current value of an asset. For instance, if a company bought a
 piece of land a long time ago, its value might have gone up a lot, but it's still listed on the
balance sheet at the original lower cost.

4. Unrecognized Intangible Assets: Some valuable things a company owns, like logos,
brand names, or a skilled team, are not listed on the balance sheet if the company created
them themselves. These are called unrecognized intangible assets. They only appear on
the balance sheet if the company buys them from someone else.

5. Example: The Mickey Mouse image, despite being extremely valuable for Disney,
doesn't show up on Disney's balance sheet because they created it internally. It only
appears if they had bought it from someone else.

Liabilities
Liabilities represent the firm’s obligations for borrowed funds from lenders or bond investors, as
well as obligations to pay suppliers, employees, tax authorities, and other parties.
A liability must be reported in the balance sheet when each of the following three conditions is
met:
1. The future sacrifice is probable.
2. The amount of the obligation is known or can be reasonably estimated.
3. The transaction or event that caused the obligation has occurred.
When conditions 1 and 2 are satisfied, but the transaction that caused the obligation has not
occurred, the obligation is called an executory contract and no liability is reported.

Current Liabilities: Obligations that are due within one year or within one operating cycle
are called current liabilities.
■ Accounts payable—amounts owed to suppliers for goods and services purchased on credit.
■ Accrued liabilities—obligations for expenses that have been recorded but not yet paid.
Examples include accrued compensation payable (wages earned by employees but not yet paid),
accrued interest payable (interest on debt that has not been paid), and accrued taxes (taxes due).
■ Short-term borrowings—short-term debt payable to banks or other creditors.
■ Deferred (unearned) revenues—an obligation created when the company accepts payment in
advance for goods or services it will deliver in the future. Sometimes also called advances from
customers or customer deposits. (Təxirə salınmış (qazanılmamış) gəlirlər - şirkət gələcəkdə
təqdim edəcəyi mal və ya xidmətlər üçün əvvəlcədən ödənişi qəbul etdikdə yaranan öhdəlikdir.
Bəzən müştərilərdən avanslar və ya müştəri depozitləri də deyilir.)
■ Current maturities of long-term debt—the current portion of long-term debt that is due to be
paid within one year.

Noncurrent liabilities- Noncurrent liabilities are obligations to be paid after one year.
■ Long-term debt—amounts borrowed from creditors that are scheduled to be repaid more than
one year in the future. Any portion of long-term debt that is due within one year is reclassified as
a current liability called current maturities of long-term debt.
■ Other long-term liabilities—various obligations, such as warranty and deferred
compensation liabilities and long-term tax liabilities.

Stockholders’ Equity
Equity represents capital that has been invested by the shareholders, either directly via the
purchase of stock, or indirectly in the form of earnings that are reinvested in the business and not
paid out as dividends (retained earnings). Residual interest is that stockholders have a claim on
any assets that are not needed to meet the company’s obligations to creditors.( Qalıq faiz odur ki,
səhmdarların şirkətin kreditorlar qarşısında öhdəliklərini yerinə yetirmək üçün lazım olmayan
hər hansı aktivlərə dair iddiası var). Example items of stockholder’s equity:
Contributed Capital:
Contributed capital is the net funding that a company has received from issuing and reacquiring
its equity shares. That is, the funds received from issuing shares less any funds paid to
repurchase such shares. (Şirkətin öz səhmlərinin buraxılmasından və yenidən alınmasından əldə
etdiyi xalis maliyyədir. Yəni, bu cür səhmlərin geri alınması üçün ödənilən hər hansı vəsait
çıxılmaqla, səhmlərin buraxılmasından əldə edilən vəsait.)
■ Common stock—the capital received from the primary owners of the company. Total
common stock is divided into shares. One share of common stock represents the smallest
fractional unit of ownership of a company.
■ Additional paid-in capital—amounts received from the primary owners in addition to the par
value or stated value of the common stock. (Əlavə ödənilmiş kapital — adi səhmin nominal
dəyərinə və ya qeyd edilmiş dəyərinə əlavə olaraq əsas sahiblərdən alınan məbləğlər).
■ Treasury stock—the amount paid for its own common stock that the company has reacquired,
which reduces contributed capital.
Earned Capital:
Earned capital is the cumulative net income (and losses) retained by the company (not paid out
to shareholders as dividends). - Qazanılmış kapital şirkət tərəfindən saxlanılan (səhmdarlara
dividend kimi ödənilməyən) məcmu xalis gəlir (və zərərlər) dir.
■ Retained earnings— the accumulated earnings that have not been distributed to stockholders
as dividends. (Bölüşdürülməmiş mənfəət — səhmdarlara dividend kimi bölüşdürülməmiş
yığılmış mənfəət.)
■ Accumulated other comprehensive income or loss—accumulated changes in equity that are
not reported in the income statement.

Ending Retained Earnings= Beginning Retained Earnings + Net Income (or –Net
Loss)- Dividends
Double-entry accounting system (dual effects)
A transaction might increase assets and increase equity by equal amounts. Another transaction
might increase one asset and decrease another asset, while yet another might decrease an asset
and decrease a liability (Əməliyyat aktivləri artıra və kapitalı bərabər məbləğdə artıra bilər.
Başqa bir əməliyyat bir aktivi artıra və digər aktivi azalda bilər, digəri isə aktivi və öhdəliyi
azalda bilər).
Account titles are commonly grouped into five categories: assets, liabilities, equity, revenues,
and expenses.

Note: What is the difference between wages payable and wage expense?
A wage expense is an expense account that appears on the income statement while the wages
payable account is a liability account that appears on the balance sheet.

Example: Natural Beauty Supply, Inc. (NBS).

Transaction 1: On November 1, investors contributed $20,000 in cash to start Natural Beauty
Supply, Inc. In exchange for their investment, they received 10,000 shares of NBS stock.
Now, let's see how this transaction affects the financial statements of NBS:
1. Balance Sheet (Statement of Financial Position):
  Assets: NBS receives $20,000 in cash from the investors. So, the Cash account increases
by $20,000.
 Equity: NBS issues 10,000 shares of stock, which represents ownership in the company.
The investors' $20,000 cash investment increases the Equity section of the balance sheet.
This is known as "contributed capital" because it's the money contributed by the investors
to the company.
So, after this transaction, the balance sheet would look like this:
Balance Sheet (as of November 1, 2013):
 Assets: Cash $20,000
 Liabilities: None (because there are no debts yet)
 Equity: Common Stock $20,000
2. Income Statement (Profit and Loss Statement):
 This transaction doesn't directly affect the income statement at this point because it
represents the initial investment and not the company's ongoing operations. The income
statement typically shows revenue and expenses from regular business activities, which
haven't started yet.
3. Cash Flow Statement:
 The cash flow statement would show an increase in cash from the $20,000 investment
made by the investors. This is categorized as "financing activities" because it involves
raising money to fund the business.
So, in simple terms, the first transaction means that NBS received $20,000 from investors and
issued them 10,000 shares of stock. This increased the company's cash and equity. The cash is
what they have available to run the business, and the equity represents the ownership stake of the
investors in the company.

Assets (cash) and equity (common stock) increased by the same amount, and the accounting
equation remains in balance (as it always must).

In the second transaction, Natural Beauty Supply borrowed cash by signing a note (loan
agreement) with a family member. This transaction increased cash (an asset) and increased notes
payable (a liability) by the same amount. The notes payable liability recognizes the obligation to
repay the family member.
Also on November 1, 2013, Natural Beauty Supply arranged for rental of a location and paid a
security deposit which it expects to be returned at a future date. This transaction decreased
cash (an asset) and increased security deposits (another asset). We’ll assume that
Natural Beauty Supply hopes to move to a more upscale location within a year, so the security
deposit is considered a current asset.
Note: The security deposit they paid is like a kind of savings. If they take good care of the rental
place and follow the rules, they will get this money back in the future when they move out.

Finally, Natural Beauty Supply purchased and received $17,000 of inventory on credit. This
transaction increased inventory (an asset) by $17,000 and increased accounts
payable (a liability) by $17,000, recognizing the obligation to the supplier.
At the end of the day on November 1, 2013, Natural Beauty Supply’s balance sheet appears as
follows:

Reporting Financial Statement

Revenue and Expenses
Revenues result from increases in net assets (assets minus liabilities) that are caused by the
company’s operating activities.
Expenses result from decreases in net assets (assets minus liabilities) that are caused by the
company’s revenue-generating activities, including:
 costs of products and services sold
  operating costs like depreciation
 wages
 advertising
 non-operating costs like interest on debt and
 taxes on income
Net income when revenues exceed expenses.
Net loss when expenses exceed revenues.

Operating Expenses: are usual and customary costs that a company incurs to support its
main business activities. These include:
 cost of goods sold
 selling expenses
 depreciation expense
 amortization expense
 research and development expense.
Depreciation Expense: When a company buys things like buildings, machinery, or vehicles, it
pays cash for them. However, instead of recognizing the full cost of these items as expenses all
at once when they buy them, they spread the cost over time. This is called "depreciation." It
means they consider how long they expect to use these items and then deduct a portion of the
cost each year as an expense. So, the expense is recognized over the item's useful life, not just
when they buy it.

For example, imagine you buy a computer for your business for $1,000. Instead of saying, "I
spent $1,000 today," you might say, "I'll spread that $1,000 expense over 5 years, so each year,
I'll recognize $200 as an expense."
Compensation Expense: When a company has employees, they often perform work before they
receive their paychecks. The passage mentions "compensation expense," which is the cost of
paying employees for their work. Companies recognize this expense in their financial statements
in the period when the work is done, not necessarily when they hand out the paychecks.
For example, if you have employees who work in January but get paid in February, you would
recognize the compensation expense in January because that's when they did the work.
As for the specific numbers from Walgreens in 2011, their total operating expenses were
$68,253 million. This includes all the various expenses they incurred in running their business,
like paying employees, buying supplies, and handling depreciation on assets. The breakdown
provided shows that $16,561 million of those expenses were related to depreciation (the
spreading of asset costs over time), and the rest were other expenses such as compensation, rent,
utilities, and more. This information helps investors and analysts understand how the company's
money is being spent to operate the business.

Non-operating revenues and expenses relate to the company’s financing and investing
activities, and include interest revenue and interest expense.

Accrual Accounting for Revenues and Expenses

Cost of goods sold (cost of sales) is an expense item in the income statements of manufacturing
and merchandising companies. It represents the cost of products that are delivered to customers
during the period. The difference between revenues (at selling prices) and cost of goods sold (at
purchase price or manufacturing cost) is called gross profit. Gross profit for merchandisers and
manufacturers is an important number as it represents the remaining income available to cover
all of the company’s overhead and other expenses (selling, general and administrative expenses,
interest, and so on).
COGS- mallarııın maya dəyərini və ya alış qiymətini əks etdirir. Məsələn, müəssisəsənin satdığı
malın maya dəyəri 100 manatdır (cost of goods sold), lakin müəssisə həmin malı 120 manat satır
(revenue- satış qiyməti).
Gross profit- gəlirdən malın maya dəyərinin çıxılmasıdır. Yəni, bu şirkətin bütün qaimə
xərclərini və digər xərclərini (satış, ümumi və inzibati xərclər, faizlər və s.) ödəmək üçün
mövcud qalan gəliri təmsil edir.

Gross Profit= Revenue (sales) - Cost of Goods Sold

Question 1: Suppose that the company sells its product on credit (also denoted as on account)
rather than for cash. Does the seller still report sales revenue?
Answer: The answer is yes. Under GAAP, revenues are reported when a company has earned
those sales. Earned means that the company has done everything required under the sales
agreement. Credit sales mean that companies can report substantial sales revenue and assets
without receiving cash. The collection of a receivable merely involves the decrease of one asset
(accounts receivable) and the increase of another asset (cash), with no resulting increase in
net assets.

Question 2: Assume that the company sells gift cards to customers for $9,500. Should the
$9,500 received in cash be recognized as revenue?
Answer: No. Even though the gift cards were sold and cash was collected, the revenue has not
been earned. The revenue from gift cards is recognized when the product or service is
provided. For example, revenue can be recognized when a customer purchases an item of
merchandise using the gift card for payment. Hence, the $9,500 is then recorded as an increase
in cash and an increase in unearned revenue, a liability, with no resulting increase in net assets.

Question 3: Suppose that a company sells products to the customers. customers will pay for
the products ten days after they were delivered. Should NBS recognize revenue on these sales?
Answer: Yes. The products have been delivered, so the revenue has been earned. Therefore, the
sompany should recognize that it has a new asset—accounts receivable—equal for example,
$2,400, and that it has earned revenue in the same amount.

A resource that produces benefits in the future (for example, merchandise inventory for future
sale), it recognizes an asset. When inventory is delivered to a customer, we recognize that the
asset no longer belongs to the selling company. The inventory asset is decreased, and cost of
goods sold is recognized.
Gift cards:
Gift cards are like pre-paid cards or certificates that people buy and give as gifts to others. These
cards represent a certain amount of money that can be spent at a particular store or business.
Natural Beauty Supply (NBS) sold gift certificates (which are like gift cards) to customers for
$300 in cash.
When NBS sells these gift certificates, they receive $300 in cash from the customers who buy
them.
Unearned Revenue:
 To account for this, NBS doesn't recognize the $300 as revenue on their income
statement right away. Instead, they consider it as a liability called "unearned revenue."
 Unearned revenue represents the obligation NBS has to provide goods or services to the
gift card holders in the future.

Important: So, the $300 goes on the balance sheet as a liability under "unearned revenue"
because NBS still owes something to the customers who hold those gift certificates. It will not go
to the income statement as revenue until the customers actually redeem the gift certificates and
NBS provides the promised services or products. At that point, the revenue will be recognized on
the income statement.

Note: When a company pays for the insurance, they haven't used the insurance coverage yet.
They've paid for future protection. In accounting, this payment is recorded as an increase in a
noncash asset called "prepaid insurance." This asset represents the amount of insurance coverage
they have already paid for but haven't used yet. For example, NBS paid an annual insurance
premium of $1,680 for coverage beginning December 1. NBS will receive the benefits of the
insurance coverage in the future, so insurance expense will be recognized in those future periods.
At this time, a noncash asset titled prepaid insurance is increased by $1,680, and cash is
decreased by the same amount.
 Prepaid insurance is an asset because it represents something of value that NBS has
already paid for but hasn't used yet. This asset is recorded on the balance sheet because it
reflects the financial position of the company at a specific point in time.
 As time passes and NBS benefits from the insurance coverage, they gradually recognize
the expense associated with it on the income statement.
  For example, if NBS paid for one year of coverage, they might recognize 1/12th of the
prepaid insurance cost as an expense each month over that year.

Additional notes:

Service revenue is the net income a company earns from the services provided. It refers to all
activities a company performs to generate economic benefits to the business and its customers.
Service revenue doesn't include interest income or income earned from product shipments.
For finding net income= Service revenue- operating expenses

ANNUITY
An annuity is a series of equal cash inflows or outflows made at fixed intervals. These payments
can be monthly, quarterly, annually, or at any other regular interval. The key is that the payments
are consistent in size and timing.
If payments occur at the end of each period, then we have an ordinary (or deferred) annuity.
Payments on mortgages, car loans, and student loans are generally made at the ends of the
periods and thus are ordinary annuities. If the payments are made at the beginning of each
period, then we have an annuity due. Rental lease payments, life insurance premiums, and
lottery payoffs (if you are lucky enough to win one!) are examples of annuities due.
THE FUTURE VALUE OF ANNUITY
The future value of an annuity is a financial concept that helps you determine how much a series
of equal payments or cash flows, made at regular intervals, will be worth in the future. It's a way
to calculate the total value of these payments when considering the effects of interest or
investment returns over time.
To calculate the future value of an annuity, you can use the following formula:

Where:
 FV stands for the future value of the annuity.
 PMT represents the regular payment or cash flow.
  r is the interest rate per period (expressed as a decimal).
 n is the number of periods.
An example:
Suppose you plan to save $1,000 at the end of each year for the next 5 years into an investment
account that offers an annual interest rate of 5%.
1. PMT (Payment): $1,000
2. r (Interest Rate per Period): 5% or 0.05 (expressed as a decimal)
3. n (Number of Periods): 5 years
Now, these values added into the formula:

FV = $5,527.63
So, the future value of your annuity will be approximately $5,527.63 after 5 years, assuming you
continue to make $1,000 payments at the end of each year and earn a 5% annual interest rate on
your savings.
PRESENT VALUE OF ORDINARY ANNUITIES AND ANNUITIES DUE
Ordinary Annuity

OR

Suppose you are considering a lease that requires you to make annual payments of $1,000 at the
end of each year for the next 5 years, and you want to know the value of these payments in
today's terms, assuming a discount rate of 8%.
1. PMT (Payment): $1,000
 2. r / I (Interest Rate per Period): 8% or 0.08 (expressed as a decimal)
3. n (Number of Periods): 5 years

So, the present value of the ordinary annuity, representing the current worth of the future
payments, is approximately $3,992.70 when discounted at an 8% annual interest rate.

PRESENT VALUE OF ANNUİTİES DUE

“Because each payment for an annuity due occurs one period earlier, the payments will all be
discounted for one less period. Therefore, the PV of an annuity due must be greater than that of a
similar ordinary annuity.”
 For an ordinary annuity, the first payment is received at the end of the first period, and it's
already considered to be in today's terms (no discounting needed). The second payment is
discounted for one year, the third for two years, and so on.
 For an annuity due, the first payment is received at the beginning of the first period, so it
is considered to be in the future. To bring it to today's terms, you need to discount it for
one less period (one period earlier).
Therefore, all payments in an annuity due are discounted for one less period compared to an
ordinary annuity. This is why the present value of an annuity due is greater than that of a similar
ordinary annuity. The additional time value of money makes the payments at the beginning of
each period more valuable in today's terms.
The formula of PV of Annuity Due

The present value of an annuity due tells us the current value of a series of expected annuity
payments. In other words, it shows what the future total to be paid is worth now. (Ödəniləcək
annuitetin cari dəyəri bizə bir sıra gözlənilən annuitet ödənişlərinin cari dəyərini bildirir. Başqa
sözlə desək, o, gələcəkdə ödəniləcək ümumi məbləğin indi nə qədər olduğunu göstərir).
Example: Just for understanding
So, the present value of the annuity due, which represents the current worth of the future lease
payments, is approximately $2,673.33 when discounted at a 6% annual interest rate.
This means that if you were to make lease payments of $1,000 at the beginning of each year for
three years and you want to know their equivalent value in today's terms, it would be
approximately $2,673.33. This is higher than the future value of the same payments due to the
time value of money, as the payments are received at the beginning of each year and are more
valuable in today's dollars.

Finding Annuity Payments, PMT

We need to accumulate $10,000 and have it available 5 years from now. We can earn 6% on our
money. Thus, we know that FV = 10,000, PV = 0, N = 5, and I/YR = 6. We can enter these
values in a financial calculator and then press the PMT key to find our required deposits.
However, the answer depends on whether we make deposits at the end of each year (ordinary
annuity) or at the beginning (annuity due), so the mode must be set properly.
Thus, you must put away $1,773.96 per year if you make payments at the end of each year, but
only $1,673.55 if the payments begin immediately.
Finally, note that the required payment for the annuity due is the ordinary annuity
payment divided by (1 + I): $1,773.96/1.06 = $1,673.55.

Finding the number of Periods

Finding the number of periods in an ordinary annuity involves calculating how many periods it
would take for a series of equal payments or cash flows, occurring at regular intervals, to reach a
desired future value, given an interest rate. This calculation is useful for planning how long it
will take to save a certain amount or pay off a loan with regular payments.
The formula to find the number of periods in an ordinary annuity is as follows:

Where:
 n is the number of periods (the unknown we're trying to solve for).
 FV is the desired future value.
 PMT represents the regular payment or cash flow.
 r is the interest rate per period (expressed as a decimal).
Example:
Suppose you want to save for a vacation, and you plan to deposit $500 at the end of each month
into a savings account that earns 5% interest per month. Your goal is to accumulate $10,000 for
your vacation. How many months will it take to reach this goal?
  PMT (Payment): $500
 FV (Future Value): $10,000
 r (Monthly Interest Rate): 5% or 0.05 (expressed as a decimal)

So, it will take approximately 144 months (rounded up) to accumulate $10,000 for your vacation
by depositing $500 at the end of each month into an account that earns a 5% monthly interest
rate.
Finding the Interest Rate of Ordinary Annuity
Finding the interest rate of an ordinary annuity involves calculating the interest rate required for
a series of equal payments or cash flows, occurring at regular intervals, to accumulate to a
desired future value over a specified number of periods. This calculation is useful for
determining the interest rate needed to achieve a financial goal with regular payments.
The formula to find the interest rate of an ordinary annuity is as follows:

Where:
 r is the interest rate per period (the unknown we're trying to solve for), expressed as a
decimal.
 FV is the desired future value.
 PMT represents the regular payment or cash flow.
 n is the number of periods.
Example:
Suppose you plan to save for a down payment on a house, and you want to save $20,000 by
making monthly payments of $500. If you want to achieve this goal in 5 years, what interest rate
do you need to earn on your savings?
PMT (Payment): $500
FV (Future Value): $20,000
n (Number of Periods): 60 months (5 years, with 12 months per year)
Now, you can use the formula to find the interest rate (r):

So, to accumulate $20,000 by making monthly payments of $500 over 5 years, you need to earn
an interest rate of approximately 0.65 per month, which is equivalent to 7.8% per year (0.65
multiplied by 12).

PERPETUITIES
1. Annuity: An annuity is a financial arrangement where a fixed sum of money is paid or
received at regular intervals (e.g., monthly, annually) for a specific number of periods.
Annuities have a finite duration, and the payments stop after a predetermined number of
periods.
2. Consol or Perpetuity: A consol, also known as a perpetuity, is like an annuity in that it
provides regular payments, but the crucial difference is that the payments continue
indefinitely. There is no set end date or termination point for the payments in a consol or
perpetuity. They go on forever.
A consol, or perpetuity, is simply an annuity whose promised payments extend out forever. Since
the payments go on forever, you can’t apply the step-by-step approach.
NOTE: These examples demonstrate an important point: When interest rates change, the prices
of outstanding bonds also change, but inversely to the change in rates. Thus, bond prices decline
if rates rise, and prices increase if rates fall. This holds for all bonds, both consols and those
with finite maturities.

UNEVEN, OR IRREGULAR, CASH FLOWS

Uneven Cash Flows: Uneven cash flows refer to cash flows that do not have a regular or
consistent pattern in terms of the timing and/or amount of the payments. In other words, these
cash flows may vary in the size and frequency of the payments. Imagine you have money
coming in, but the amounts change and don't follow a regular pattern. For instance, you might
receive $1,000 one month, $2,000 the next, and $3,000 the month after. These changing amounts
are considered uneven cash flows.
Irregular Cash Flows: Irregular cash flows, on the other hand, primarily refer to cash flows that
do not follow a regular, predictable schedule in terms of their timing. These cash flows may be
unpredictable or sporadic, and there might be no clear pattern to when the cash is received or
paid. Irregular cash flows are about the timing of the money. It means that the money doesn't
come in on a regular schedule. You might get paid $5,000 one month, then nothing for a while,
and then $3,000 later. There's no fixed pattern to when the money comes in.

There are two important classes of uneven cash flows:

(1) those in which the cash flow stream consists of a series of annuity payments plus an
additional final lump sum in Year N, and
(2) all other uneven streams.

Stream 1. Annuity plus additional final payment:

An "Annuity Plus Additional Final Payment" refers to a specific type of cash flow pattern
where you have a series of regular, equal payments (which is the annuity part) along with one
extra, usually larger payment at the end (which is the additional final payment). This is often
seen in financial scenarios like loans, leases, or investments.
Formula: Annuity Payment (A) + Additional Final Payment (F)
 Annuity Payment (A): You make regular monthly payments, and the formula to calculate
this payment is often given by the formula for the present value of an annuity:
A = P / [(1 - (1 + r)^(-n)) / r]
Where:
 P is the principal amount (the total amount you're financing, e.g., $20,000).
  r is the monthly interest rate (convert the annual interest rate to a monthly rate,
e.g., if the annual rate is 6%, the monthly rate is 6% / 12 months = 0.5% or 0.005
as a decimal).
 n is the total number of payments (number of months, e.g., 4 years * 12 months =
48 months).
 Additional Final Payment (F): At the end of the 4 years, you have a final lump sum
payment due to clear the remaining balance. Let's say this final payment is $5,000.
So, your monthly payments (annuity payments) cover the cost of the car and some interest, and
then you make a final payment (the additional final payment) to settle the remaining balance.
Example Calculation: Suppose you're financing a $20,000 car with a 6% annual interest rate
over 4 years.
1. Calculate the Monthly Payment (A):
 P = $20,000
 r = 0.005 (6% annual interest rate converted to a monthly rate)
 n = 48 (4 years * 12 months)
A = $20,000 / [(1 - (1 + 0.005)^(-48)) / 0.005] A ≈ $471.78
2. Calculate the Additional Final Payment (F):
 This is set at $5,000.
So, you'd make regular monthly payments of approximately $471.78 for 4 years, and then you'd
make a final payment of $5,000 to clear the remaining balance. This combination of regular
payments plus the final payment is what's meant by "Annuity Plus Additional Final Payment" in
financial terms.
Another Example
Imagine you take out a loan to buy a car. The loan agreement states that you'll make monthly
payments for 5 years. These monthly payments are of the same amount and are considered the
annuity part. This regular payment covers the cost of the car and the interest on the loan.
For example, if you borrow $20,000 at a 5% interest rate and agree to make monthly payments,
your monthly payment could be approximately $377.42. You'll pay this amount every month for
5 years.
Now, the "Additional Final Payment" part comes at the end of the loan term. In this example,
let's say that at the end of the 5 years, you need to make a final payment, often called a "balloon
payment." This final payment is usually larger than your regular monthly payments and is meant
to cover any remaining balance on the loan.
So, after making 60 regular monthly payments (5 years x 12 months), you might have a final
payment of, for instance, $5,000. This final payment clears the remaining balance on the loan
and concludes the loan agreement.
Stream 2. Irregular cash flows:
An "Irregular Cash Flow Stream" refers to a series of cash flows that do not follow a regular or
predictable pattern in terms of their timing and amounts. These cash flows can vary significantly
from one period to the next, and there may be no fixed schedule for when the money is received
or paid.

Examples of irregular cash flows:

1. Business Income: Your business earns money, but the income varies from month to
month. Some months, you might make $5,000 in sales, while in other months, you could
make $10,000 or even just $2,000. The income isn't consistent or predictable.
2. Expenses: Your business has various expenses, such as rent, utilities, and salaries. These
expenses don't occur on a regular schedule. For instance, rent is due on the 1st of each
month, but utility bills can vary month by month.
3. Investment Returns: You have investments in stocks or other assets. Some months, your
investments might generate substantial returns, while in other months, they might show
losses or minimal gains. The timing of these returns is irregular.

FUTURE VALUE OF AN UNEVEN CASH FLOW STREAM

The future value of an uneven cash flow stream is the total value of all the cash flows at a
specific point in the future, taking into account their individual timing and amounts. This can be
calculated using the following formula:
Future Value (FV) of an Uneven Cash Flow Stream:
FV = CF1 / (1 + I)^N1 + CF2 / (1 + I)^N2 + CF3 / (1 + I)^N3 + ... + CFx / (1 + I)^Nx
OR

Where:
 FV is the future value of the cash flow stream.
 CF1, CF2, CF3, ... CFn are the individual cash flows at times N1, N2, N3, ... Nx.
 I is the discount rate (the rate at which future cash flows are discounted back to the
present).
 n1, n2, n3, ... tn are the time periods in which the cash flows occur.
Example:
Let's say you have the following uneven cash flow stream for an investment:
 Year 1: You receive $1,000.
 Year 2: You receive $1,500.
 Year 3: You receive $2,000.
The discount rate (r) is 5%.
To calculate the future value of this uneven cash flow stream at the end of Year 3, you would use
the formula:
FV = $1,000 / (1 + 0.05)^1 + $1,500 / (1 + 0.05)^2 + $2,000 / (1 + 0.05)^3
FV = $952.38 + $1,360.47 + $1,863.84
FV = $3,176.69
So, the future value of this uneven cash flow stream at the end of Year 3, with a 5% discount
rate, is approximately $3,176.69. This represents the total value of all the cash flows when they
are considered in the future, accounting for the time value of money (the fact that a dollar
received in the future is worth less than a dollar received today due to the opportunity cost of not
having that money to invest or earn interest).
NOTE: ^- is used to indicate exponentiation in mathematics and is commonly used to raise a
number to a power. For example, if you see "1 + 2^3," it means 2 raised to the power of 3,
which is 2 * 2 * 2, resulting in 8. So, "1 + 2^3" equals 9.