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Understanding Financial Information and Accounting

17
1-1 17-1

Nickels

McHugh

McHugh

McGraw-Hill/Irwin Understanding Business, 8e

2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

CHAPTER

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Importance of Accounting Information

DefinitionAccounting Audiences
Managers Government Investors, Suppliers & Creditors
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The Accounting System

17-3

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The Influence of Accounting Information

Managers- Financial reports pinpoint problems/opportunities Government- assists with tax collection Investors, Suppliers, & Creditors- provides a means to analyze business

17-4

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Areas of Accounting
Managerial Accounting
Inside Organization

Financial Accounting
Annual Report Private Accountant Public Accountant

C.M.A.

Tax Accounting Government & Not-for-profit Accounting

C.P.A.

Auditing
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Top Business Uses of Accountants

Valuation, Merger, Acquistion Personal Financial Planning Market Strategy & Planning Cash Mgmt. & Forecasting Tax/Auditing 0% 20% 40% 60% 80% 100% 120%

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How to Read a Corporate Annual Report

Read managements discussion of changes in operations. Try to identify strengths or weaknesses. Review the firms consolidated balance sheet. (Its assets, liabilities, and owners equity.) Analyze the Income Statement. Look beyond the year. (Sales drops can spell trouble.)

Review the statement of changes in cash flows.

Review auditors opinion.
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Types of Accountants
Public
Auditing

Private
Management Accounting Government Accounting

Tax Consulting & Compliance

Management Consulting

Academia

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Cooking the Books

Early Recognition of Revenue Late Recognition of Expense Inadequate Reserves for Bad Debts, Returns, & Liabilities Changing Inventory Valuation Methods- 1 Time Boost to Income Phony Transactions With Partnerships
Courtesy of B. Lilly- De Anza College

17-9

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5 Tips To Be Ahead of Sneaky Accountant Tricks

1. Whos who
2. Pick out the bad apples

3. Dont fall for rapid refund

4. Know their loyalty

5. Watch what you sign

Source: CNNMoney.com, March 17, 2006

17-10

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5 Ways to Avoid More Enrons

1. Bring hidden liabilities back onto the balance sheet 2. Highlight the things that matter 3. List the risks and assumptions built into the numbers 4. Standardize operating income 5. Provide aid in figuring free-cash flow
Source: Business Week, February 18, 2002

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Sarbanes-Oxley Timeline
Effective
July 30, 2002 August 29, 2002 January 26, 2003 April 26, 2003

Requirements
Prohibit personal loans to officers/directors. CEOs/CFOs return incentive-based compensation after erroneous financial report. CEOs/CFOs must certify annual/quarterly reports. Officers must make certifications regarding companys internal controls. Responsibilities for attorneys/audit firms increased. Disclosure requirements for offbalance sheets transactions tightened. Audit committees must: be independent directors, be responsible for compensation & oversight of certifying accountants.
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Not-for-Profits Policies Due to Sarbanes-Oxley

70% 60% 50% 40% 30% 20% 10% 0%
Conflict-ofAudit Committee RecordsCode-of-Ethics Interest Policy Charter Retention Policy Statement Whistle-blower Policy

Source: USA Today

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How can Sarbanes-Oxley be Improved?

80% 70% 60% 50% 40% 30% 20% 10% 0%
No changes Exempt smaller Scale it back or Separate Provide better companies remove it pervasive guidance completely control matters

Source: USA Today

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45% 40% 35% 30% 25% 20% 15% 10% 5% 0%

Steps to Control Accounting Practices

Review Change Create/Expand Hire Independent Restructure Current Internal Audits Firm for Executive Procedures Consulting Compensation Source: USA Today, Snapshots, Section B, pg. 1, March 26, 2003 Plans
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Bookkeeping vs. Accounting

Bookkeeping
Start of Accounting Record/Journalize

Accounting
Analyze Recommend

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Steps In The Accounting Cycle

Analyze Source Documents Take a Trial Balance

Record Transactions in Journals

Prepare Financial Statements Analyze Financial Statements

17-17

Post Journal Entries to Ledger

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Computers & Accounting

Tool Not Decision Maker Simplification Accounting Packages Up-To-the-Minute Information Less Monotony

17-18

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Financial Statements
Balance Sheet- Statement of Financial Position
Income Statement- Statement of Revenues & Expenses Statement of Cash Flows Statement of Cash Receipts & Disbursements

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Accounting Equation
Assets

= Liabilities + Owners Equity

Owned = Owed + Owners Claims

Very Vegetarian Company

$826,000 = $613,000 + $213,000

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Very Vegetarians Balance Sheet (Assets)

Period ending 12/31/07 Assets
Current Assets Cash Accounts Receivable Notes Receivable Inventory Total Current Assets Fixed Assets Land Buildings (net) Equipment & Vehicles (net) Furniture & Fixtures (net) Total Fixed Assets Intangible Assets Goodwill Total Intangible Assets $ 15,000 200,000 50,000 335,000 $600,000 $ 40,000 110,000 40,000 16,000 $206,000 $ 20,000 $ 20,000

Total Assets

$826,000
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* * Very Vegetarians Balance Sheet (Liabilities & Owners Equity) *

Period ending 12/31/07
Liabilities & Owners Equity Current Liabilities Accounts Payable Notes Payable Accrued Taxes & Salaries Total Current Liabilities Long-term Liabilities Notes Payable Bonds Payable Total Long-term Liabilities Total Liabilities Owners Equity Common Stock (1M shares) Retained Earnings Total Owners Equity Total Liabilities & Owners Equity

$ 40,000 8,000 240,000 $ 35,000 290,000

$288,000

$325,000 $613,000

$100,000 113,000

$213,000 $826,000
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Very Vegetarian Income Statement

Period Ending 12/31/07
Revenue Net Sales $ 700,000 Cost of Goods Sold Beginning Inventory $ 200,000 Net Purchases $ 440,000 Cost of Goods $ 640,000 Less: Ending Inventory - $ 230,000 Less: Cost of Goods Sold - $ 410,000 Gross Profit (Gross Margin) $ 290,000
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Very Vegetarians Income Statement (contd)

Gross Profit Operating Expenses Selling Expenses Salaries Advertising & Supplies Total Selling Expenses General Expenses Office Salaries Depreciation Insurance Rent Utilities Miscellaneous Total General Expenses Less: Total Operating Expenses Net Income (Profit) Before Taxes Less: Income Tax Expenses Net Income (Profit) After Taxes $290,000 $ 90,000 $ 20,000 $ 110,000

$ 67,000 $ 1,500 $ 1,500 $ 28,000 $ 12,000 $ 2,000 $ 112,000

- $ 222,000 $ 68,000 - $ 19,000 $ 49,000
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Very Vegetarians Statement of Cash Flow

Net Cash Flow from Operations Net Cash Flows from Investments Net Cash Flow from Financing $ 52,000 ( 6,000) (19,000)

Net Change in Cash & Equivalents

Beginning Cash Balance Ending Cash Balance

$ 27,000
( 2,000) $ 25,000 =========
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Liquidity Ratios
Current Ratio
Current Assets Current Liabilities

Quick (Acid-Test) Ratio

Cash + Marketable Securities + Receivables Current Liabilities

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Very Vegetarian Current Ratio

$600,000 = 2.08 $288,000

Quick (Acid-Test) Ratio

$265,000 $288,000

= 0.92
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Leverage Ratios
Debt-to-Owners Equity Ratio

Total Liabilities Owners Equity

$613,000 = 287% $213,000

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Profitability Ratios
Profitability = Operating Success Return on Sales
Net Income Net Sales

Return on Equity
Net Income After Tax Total Owners Equity

Basic Earnings Per Share

Net Income After Taxes Number of Common Stock Shares Outstanding
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Profitability Ratios
Return on Sales $ 49,000 = 7% $700,000

Return on Equity $ 49,000 = 23% $213,000 Earnings per Share $ 49,000 = $.049 $1,000,000
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Activity Ratios
Inventory Turnover
Cost of Goods Sold Average Inventory

Inventory Turnover $410,000 = 1.9 $215,000

17-31