Communicating and Interpreting

Accounting Information
Chapter 05

PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA

McGraw-Hill/Irwin
5-1

Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

Players in the Accounting

Communication Process

5-2

Regulators
Securities and Exchange Commission

Primary Responsibility
Protect investors and maintain the integrity of the securities market.

Financial Accounting Standards Board

Primary Responsibility
Set Generally Accepted Accounting Standards (GAAP).

Public Company Accounting Oversight Board

Primary Responsibility
Sets auditing standards for independent auditors (CPAs)
of public companies.

Stock Exchanges

5-3

Primary Responsibility
Along with state governments, set overall corporate governance
standards.

Managers
Management

Primary
Primary Responsibility
Responsibility
Responsible
Responsible for
for the
the information
information in
in the
the financial
financial statements
statements
and
and disclosures.
disclosures.

Chief
Chief Executive
Executive Officer
Officer (CEO):
(CEO): highest
highest officer
officer of
of the
the
company
company

Chief
Chief Financial
Financial Officer
Officer (CFO):
(CFO): highest
highest officer
officer associated
associated
with
with the
the financial
financial and
and accounting
accounting side
side of
of the
the business
business

Accounting
Accounting Staff:
Staff: prepare
prepare the
the details
details of
of the
the reports
reports and
and
bear
bear professional
professional responsibility
responsibility for
for the
the accuracy
accuracy of
of the
the
information.
information.

5-4

Board of Directors (Audit Committee)

Board
Board of
of Directors
Directors

Primary
Primary Responsibility
Responsibility
Responsible
Responsible for
for ensuring
ensuring that
that processes
processes are
are in
in place
place for
for
maintaining
maintaining the
the integrity
integrity of
of the
the companys
companys accounting,
accounting, financial
financial
statement
statement preparation,
preparation, and
and financial
financial reporting.
reporting.

Board
Board of
of Directors
Directors (Audit
(Audit Committee)
Committee)

Primary
Primary Responsibility
Responsibility
Is
Is composed
composed of
of non-management
non-management (independent)
(independent) directors
directors with
with
financial
financial knowledge
knowledge and
and is
is responsible
responsible for
for hiring
hiring the
the companys
companys
independent
independent auditors.
auditors. They
They also
also meet
meet separately
separately with
with the
the
auditors
auditors to
to discuss
discuss managements
managements compliance
compliance with
with their
their
financial
financial reporting
reporting responsibilities.
responsibilities.
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Auditors
Independent
Independent Auditors
Auditors

Primary
Primary Responsibility
Responsibility
Follow
Follow established
established auditing
auditing standards
standards to
to assess
assess the
the fairness
fairness of
of
the
the financial
financial statements
statements and
and related
related presentations
presentations

An
An unqualified,
unqualified, or
or clean,
clean,
opinion
opinion states
states that
that the
the
financial
financial statements
statements are
are
fair
fair presentations
presentations in
in all
all
material
material respects
respects in
in
conformity
conformity with
with GAAP.
GAAP.
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Unqualified
Opinion

Information Intermediaries: Financial

Analysts and Information Services
Information
Information Intermediaries
Intermediaries

Analysis
Analysis and
and Advice
Advice
1.
1.Receive
Receive accounting
accounting reports
reports and
and other
other information
information about
about the
the
company
company from
from electronic
electronic information
information services
services
2.
2.Gather
Gather information
information through
through conversations
conversations with
with company
company
executives
executives and
and visits
visits to
to company
company facilities
facilities and
and competitors
competitors
3.
3.Results
Results of
of their
their analyses
analyses are
are combined
combined into
into analysts
analysts reports.
reports.

5-7

Users: Institutional and Private

Investors, Creditors, and Other
Institutional
Institutional Investors
Investors

Includes
Includes pension,
pension, mutual,
mutual, endowment
endowment and
and other
other funds
funds that
that invest
invest on
on the
the
behalf
behalf of
of others
others

Private
Private Investors
Investors

Individuals
Individuals who
who purchase
purchase shares
shares in
in companies
companies

Lenders
Lenders or
or Creditors
Creditors

Suppliers,
Suppliers, banks,
banks, commercial
commercial credit
credit companies,
companies, and
and other
other financial
financial
institutions
institutions that
that lend
lend money
money to
to companies
companies

5-8

Guiding Principles for Communicating

Useful Information
Primary
Primary Objective
Objective of
of External
External Financial
Financial Reporting
Reporting
To
To provide
provide economic
economic information
information to
to external
external users
users for
for
decision
decision making.
making.
Primary
Primary Qualitative
Qualitative Characteristics
Characteristics
Relevance:
Relevance: Timely
Timely and
and Predictive
Predictive Feedback
Feedback Value
Value
Reliability:
Reliability: Accurate,
Accurate, Unbiased,
Unbiased, and
and Verifiable
Verifiable
Secondary
Secondary Qualitative
Qualitative Characteristics
Characteristics
Comparability:
Comparability: Across
Across businesses
businesses
Consistency:
Consistency: Over
Over time
time
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Differences in Accounting Methods

5-10

Annual Reports
For privately held companies, annual
reports are simple documents that include:
1. Four basic financial statements.
2. Related notes (footnotes).
3. Report of independent accountants (auditors

opinion) if the statements are audited.

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Annual Reports
For
For public
public companies,
companies, annual
annual reports
reports are
are elaborate
elaborate
due
due to
to SEC
SEC reporting
reporting requirements:
requirements:
1.
1. Nonfinancial
Nonfinancial Section
Section
Includes
Includes aa letter
letter to
to the
the stockholders,
stockholders, aa description
description of
of
managements
managements philosophy,
philosophy, products,
products, successes,
successes, etc.
etc.

2.
2. Financial
Financial Section
Section
SEC
SEC sets
sets minimum
minimum disclosure
disclosure standards
standards for
for the
the
financial
financial section
section for
for public
public companies.
companies.

5-12

Annual Reports
1.
1. Summarized
Summarized financial
financial
data
data for
for 55- or
or 10-years.
10-years.
2.
2. Management
Management Discussion
Discussion
and
and Analysis
Analysis (MD&A).
(MD&A).
3.
3. The
The four
four basic
basic financial
financial
statements.
statements.
4.
4. Notes
Notes (footnotes).
(footnotes).
5.
5. Independent
Independent Accountants
Accountants
Report
Report and
and the
the
Management
Management
Certification.
Certification.

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6.
6. Recent
Recent stock
stock price
price
information.
information.
7.
7. Summaries
Summaries of
of the
the
unaudited
unaudited quarterly
quarterly
financial
financial data.
data.
8.
8. Lists
Lists of
of directors
directors and
and
officers
officers of
of the
the company
company
and
and relevant
relevant addresses.
addresses.

Quarterly Reports
Usually
Usually begin
begin with
with short
short letter
letter to
to stockholders
stockholders
Condensed
Condensed unaudited
unaudited income
income statement
statement and
and
balance
balance sheet
sheet for
for the
the quarter.
quarter.
Often,
Often, cash
cash flow
flow statement
statement and
and statement
statement of
of
stockholders
stockholders equity
equity are
are omitted
omitted.. Some
Some notes
notes to
to
the
the financial
financial statements
statements also
also may
may be
be omitted.
omitted.

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SEC Reports 10-K, 10-Q, 8-K

Form
Form 10-K
10-K Annual
Annual Report
Report
Due
Due within
within 90
90 days
days of
of the
the fiscal
fiscal year-end.
year-end.
Contains
Contains audited
audited financial
financial statements.
statements.
Form
Form 10-Q
10-Q Quarterly
Quarterly Report
Report
Due
Due within
within 45
45 days
days of
of the
the end
end of
of the
the quarter.
quarter.
Financial
Financial statements
statements can
can be
be unaudited.
unaudited.
Form
Form 8-K
8-K Current
Current Report
Report
Due
Due within
within 15
15 days
days of
of the
the major
major event
event date.
date.
Financial
Financial statements
statements can
can be
be unaudited.
unaudited.

5-15

Classified Balance Sheet

Assets used of turned into

cash within one year.
Assets used of turned into
cash beyond one year.

Obligations paid of
settled within one year.
Obligations paid of
settled after one year.
Contributed capital..
Reinvested earnings.
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Classified Income Statement

Income Statements are prepared using the
following basic structure.

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Consolidated Income Statement

Operating
activities the
focus of the
business.

5-18

Net Income Average Number of Shares Outstanding

Nonrecurring Items
Income
Income statements
statements may
may contain
contain three
three sections:
sections:
1.
1.
2.
2.

Continuing
Continuing operations
operations
Nonrecurring
Nonrecurring Items
Items

a)
a)
b)
b)

Discontinued
Discontinued operations
operations
Extraordinary
Extraordinary items
items

3.
3. Earnings
Earnings per
per share
share

5-19

Earnings Per Share

EPS =

Net Income*
Average Number of Shares of Common Stock
Outstanding During the Period

Basic EPS
*IfIf there
there are
are preferred
preferred dividends,
dividends, the
the
amount
amount is
is subtracted
subtracted from
from the
the Net
Net
Income
Income in
in the
the numerator.
numerator.
5-20

Statement of Cash Flows

1.
1.
2.
2.
3.
3.

Recall
Recall that
that the
the Statement
Statement of
of Cash
Cash Flows
Flows is
is
divided
divided into
into three
three major
major sections.
sections.
Cash
Cash flows
flows from
from operating
operating activities.
activities.
Cash
Cash flows
flows from
from investing
investing activities.
activities.
Cash
Cash flows
flows from
from financing
financing activities.
activities.

We will examine the indirect method of preparing the statement.

This format begins with a reconciliation of accrual income to cash
flows from operations.

5-21

Cash flows
associated with
earning income.

Cash flows related to

purchase and sale of
productive assets
and investments.
Cash flows related to
borrowing and
repaying loans and
issue and repurchase
of stock.
Change in the cash
account.
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5-23

Notes to Financial Statements

Descriptions of the key accounting rules
that apply to the companys statements.
Additional detail supporting reported
numbers.
Relevant financial information not
disclosed on the statements.

5-24

Accounting Rules Applied in the

Companys Statements
One of the first notes to the financial statements is usually
the statement of significant account policies.

This particular note relates to the Callaway Golfs policies

regarding depreciation of Property, Plant, and Equipment.
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Additional Detail Supporting

Reported Numbers
The second category of notes provides supplemental
information concerning the data shown on the financial
statements.

5-26

Relevant Financial Information Not

Disclosed on the Statements
The final category includes information that impacts the
company financially but is not shown on the statements.

5-27

Return on Assets (ROA) Analysis

ROA measures how much the firm earned for each

dollar of investment.

(In complex calculations, interest expense (net of tax) and minority interest
are added back to net income.

(beginning total assets + ending total assets) 2

5-28

ROA Profit Driver Analysis

Net Income
Average
Total Assets

5-29

Net Income
Net Sales

Net Sales
Average
Total Assets

Profit Drivers and Business Strategy

High-Value or Product-Differentiation
Rely on R&D and product promotion to
convince customers of the superiority of
your product.

Low-Cost Strategy
Rely on efficient management of accounts
receivable, inventory and productive assets
to produce high asset turnover.

5-30

Chapter Supplement: Nonrecurring

Items

In addition, companies may have nonrecurring items.

These nonrecurring items may include:
1. Discontinued operations
2. Extraordinary items
These items are reported separately because they are not
useful in predicting future income of the company.
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Discontinued Operations
Sale
Sale or
or abandonment
abandonment of
of aa segment
segment of
of aa
business.
business.

Income
Income or
or loss
loss on
on
segments
segments operation
operation for
for
the
the period.
period.

Gain
Gain or
or loss
loss on
on
disposal
disposal of
of the
the
segment.
segment.

Show net of applicable taxes.

5-32

Extraordinary Items

Unusual

Infrequent

Show net of applicable taxes.

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Reporting Extraordinary Items and

Discontinued Operations

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End of Chapter 05

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