BUSINESS ACQUISITIONS

BASIC ACCOUNTING CONCEPTS AND

FINANCIAL STATEMENTS

© 2006 Joseph D. Lehrer

PURPOSE FOR ACCOUNTING

• To Report Financial Results (Income Statement)– For a Period of Time (Usually One Year)– Revenue, Expenses and Profits

• To Report Financial Status (Balance Sheet)– Assets, Liabilities and Shareholders’ Equity

• To Report on the Sources and Uses of Cash (Statement of Cash Flows)

ACCOUNTING CONCEPTS

• Generally Accepted Accounting Principles (GAAP)

• Accrual vs. Cash Accounting

• Consolidation & Combination

CONCEPT OF GAAP

• Generally Accepted Accounting Principles (GAAP) are the General Accounting Rules used to Prepare Financial Statements

• Adopted by the Financial Accounting Standards Board (FASB) the American Institute of Certified Public Accountants and the Securities and Exchange Commission (SEC)

• Sarbanes Oxley Has Further Affected the Concept of GAAP by Instituting the Public Corporation Accounting Oversight Board (PCOAB)

SOX Accounting Provisions• §101,et. seq. Establishes PCAOB• Title II establishes Rules Relating to Auditor

Independence• §301 Places Accounting and Audit Oversight

Upon Audit Committee of the Board• §302 of SOX Requires Certification of Financial

Statements by the CEO and the CFO• §404 Requires Internal Audit Function, which is

Assessed by Management, which Assessment is Attested to and Confirmed by Independent Auditor

"GAAP" means generally accepted accounting principles set forth in the opinions and pronouncements of the Accounting Principles Board and the American Institute of Certified Public Accountants and statements and pronouncements of the Financial Accounting Standards Board or in such other statements by such other entity as may be approved by a significant segment of the accounting profession (and if the Company’s stock is registered and publicly traded, in accordance with pronouncements of the PCOAB and the Securities and Exchange Commission)

AS DEFINED IN ACQUISITION AGREEMENTS

CONCEPT OF ACCRUAL BASED ACCOUNTING

• Revenue From Selling a Good or Service Is Recognized in the Period in Which the Good Is Sold or the Service Is Performed – As Opposed to Cash Basis Accounting Where

Revenue Is Recognized Only When Cash Is Received

• Expenses Recognized When Incurred– As Opposed to Cash Basis Accounting Where

Expenses Are Recognized Only When Actually Paid

CONCEPT OF CONSOLIDATION

• All Companies which are Commonly Controlled are Reported on a Consolidated” Basis– This is a Requirement of GAAP– Generally, 50% or More Owned Subsidiaries

will be Consolidated with the Parent– Transactions among Companies which are

included in a Consolidated Statement will be Eliminated

BASIC ACCOUNTING STATEMENTS

• Balance Sheet

• Income Statement

• Statement of Cash Flows

Reports the success or failure of the company’s operations for a period of time.

Reports the success or failure of the company’s operations for a period of time.

Income Statement

Balance Sheet

Statement of Cash Flows

Reports assets and claims to

those assets at a specific point in

time.

Reports assets and claims to

those assets at a specific point in

time.

Income Statement

Balance Sheet

Statement of Cash Flows

Provides information about cash

receipts and cash payments of a business for a

specific period of time.

Provides information about cash

receipts and cash payments of a business for a

specific period of time.

Income Statement

Balance Sheet

Statement of Cash Flows

TIMING OF ACCOUNTING STATEMENTS

BALANCE SHEET

• Indicates the Financial Status of a Company

• At a Specific Point in Time

• Has a Listing of Assets– Current Assets (e.g., cash, inventory & receivables– Non-Current Assets (e.g., buildings, equipment)– Other Assets (e.g., intangibles, goodwill)

• Has a Listing of Liabilities– Current (e.g., accounts payable, accrued expenses)– Long Term (e.g., loans and debt)

BASIC BALANCE SHEET FORMULA

TOTAL ASSETS – ALL LIABILITES = NET WORTH

OR

ASSETS – LIABILITES = SHAREHOLDERS’ EQUITY

BALANCE SHEET FORMULA

ASSETS = LIABILITES + SHAREHOLDERS’ EQUITY

OR

WHAT THE BUSINESS OWNS =WHAT IS OWED TO OTHERS

+SHAREHOLDERS’ EQUITY

ASSETS – LIABILITIES = SHAREHOLDERS’ EQUITY

ASSETS – LIABILITIES = NET WORTH

OR

OR

BALANCE SHEET FORMULA(A Balance Sheet Must Balance)

CURRENT ASSETS Cash $xxxxxxxxx Receivables $xxxxxxxxx Inventory $xxxxxxxxxTotal Current $xxxxxxxxx

FIXED ASSETS Land Improvements $xxxxxxxxx Equipment $xxxxxxxxx Depreciation ($xxxxxxx)Total $xxxxxxxx

TOTAL ASSETS $xxxxxxxx

CURRENT LIABILITIES Trade Payables $xxxxxxx Accrued Expenses $xxxxxxx Current portion of Long-Term Debt $xxxxxxxTotal Current $xxxxxxxLong Term Debt $xxxxxxxTOTAL LIABILITES $xxxxxxxSHAREHOLDERS EQUITYPaid In Capital $xxxxxxxCapital Surplus $xxxxxxxRetained Earnings $xxxxxxxTotal $xxxxxxxTOTAL LIABIITIES &S-H EQUITY $ xxxxxx

CONSOLIDATED BALANCE SHEETSACME WIDGET CORPORATION

DECEMBER 31, 2004(In Thousands)

ASSETSCURRENT ASSETS:

Cash and cash equivalents $ 5,393Accounts Receivable, less allowances of $420 12,345Inventories 10,645Prepaid Expenses 1,272

Total Current Assets 29,665PROPERTY AND EQUIPMENT:

Land and land improvements 5,340Buildings 23,948Leasehold Improvements 2,327Fixtures and equipment 22,375Less-accumulated depreciation 12,983

41,007OTHER ASSETS

Cash surrender value of life insurance 575Goodwill 14,240

Total Other Assets 14,815$ 85,487

LIABILITIES AND SHAREHOLDERSINVESTMENTCURRENT LIABILITIES

Accounts payable $ 8,325Accrued expenses 3,848Revolving credit facility 6,256Current Maturities of long term debt 752

Total current liabilities 19,181

LONG TERM DEBT 21,118

SHAREHOLDERS EQUITYCommon stock 5,876Capital in excess of par value 8,121Retained Earnings 31,191

Total shareholders' investment 45,188$ 85,487

SHAREHOLDERS EQUITY• Two Major Categories

– Capital Stock– Retained Earnings

• Capital Stock– Stated Capital– Capital in Excess of Par Value

• Retained Earnings– Total Cumulative Amount of Earnings Retained

by the Company (Cumulative Profits less Cumulative Dividends)

• Reduced by “Treasury Stock” (Stock Which has been Redeemed)

INCOME STATEMENTa/k/a Statement of Operations

Gross Sales

Net Sales (net of allowances & returns)

Cost of Sales (COGS)

Gross Margin

Operating Expenses (R & D, Admin., Selling)

Operating Income

Other Income & Expense (e.g., Interest)

Taxes

Net Income

INCOME STATEMENT

CONSOLIDATED STATEMENTS OF OPERATIONSACME WIDGET CORPORATION

For the Fiscal Year Ending December 31, 2004(In Thousands)

Gross Sales $ 223,256Allowances and Rebates 5,211

Net Sales 218,045Cost of sales 165,714

Gross Profit 52,331Operating expenses

Product research and development 5,235Selling and marketing 10,876General and administrative 18,723

Total operating expenses 34,834Income from operations 17,497

Other income (expense):Interest expense (2,491)Interest income 213Other, net 11

Other expense, net (2,267)Income before income taxes 15,230

Provision for income taxes 5,787Net income $ 9,443

ACCRUAL BASED ACCOUNTING

• Revenue is Recognized On Sale is Made or Services Performed, even though Cash is Not Received– When Sale is Made on Credit, Account

Receivable is Recognized on Balance Sheet– Revenue is Booked so that Revenue is

Recognized

• Expenses are Recognized before Bill is Paid– An Incurred Expense is Shown on Balance

Sheet as Account Payable or Accrued Expense– Expense is Booked as Operating Expense

CASH BASIS ACCOUNTING• Not Often Used, and Used Primarily by

Service Firms (Law, Engineering, …Etc.)

• Revenue Is Not Recognized Until the Cash Is Actually Received From the Customer

• Therefore, a Balance Sheet Does Not Reflect Accounts Receivables.

• Expenses Are Not Recorded Until the Money Is Actually Paid

• Accrued Expenses Are Not Reflected on the Balance Sheet.

Statement of Cash Flows

Determine Changes In Cash By Reason Of:

Cash from Operations

Net Income + Depreciation +/- Working Capital Changes

Cash Flows from Investing (Purchases and Sales of Assets)

Cash Flow From Financing (From Debt and Payments of Debt and Dividends)

Because revenues reported do not always equal

cash collected. . .

. . . and expensesreported do not

always equalcash paid . . .

Income isusually not equal

to the changein cash forthe period.

STATEMENT OF CASH FLOWS IS NECESSARY

STATEMENT OF CASH FLOWS

+/- Cash Generated or Used as the Result of Operations

+/- Cash Invested or Provided from Investment or Capital Activities

+/- Cash Paid or Received as the Result of Financing Activities

= Increase or Decrease in Cash

ACME WIDGET CORPORATIONCOMBINED STATEMENTS OF CASH FLOWS

Cash flows from operating activities:Net income 9,443Adjustments to reconcile net income tonet cash provided (used) BY operations

Depreciation and Amortization 2,583Changes in operating assets andliabilities:

Accounts receivable (1,320)Payables 576Inventory (1,236)Accrued expenses 598Net cash provided (used) inoperations 10,644

Cash flows from investing activitiesPurchases of property and equipment (3,123)Acquisition of business, net of cashacquired (8,261)

Net cash used in investmentactivities (11,384)

Cash flows from financing activities:Increase in revolving credit facility 1,898Proceeds from term loans 5,000Payments on notes and term loans (2,327)Dividends paid (1,222)

Net cash provided by financingactivities 3,349

Net Increase in Cash 2,609Cash and equivalents at beginning of year 2,784Cash and equivalents at end of year 5,393