Ch. 5 - p. 1 Ch. 5 Synchronotes for Fundamentals of Financial Accounting, 3e by Phillips/Libby/Libby Chapter 5: Financial Reporting and Analysis Financial Statement Users Managers, Creditors, Government, Directors, Investors Accounting Fraud Incentive to Commit Fraud Creating Business Opportunities ; Satisfying Personal Greed Opportunity to Commit Fraud Internal controls are the methods that a company uses to protect against theft of assets, to enhance the reliability of accounting information, to promote efficient and effective operations, and to ensure compliance with laws and regulations. Character to Rationalize and Conceal Fraud Most fraudsters have a sense of personal entitlement, which outweighs other moral principles, such as fairness, honesty, and concern for others. The Sarbanes-Oxley (SOX) Act The Financial Reporting Process Three aspects of the financial reporting process: 1. Enhance financial statement format 2. Obtain independent external audit 3. Release additional financial information
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Ch. 5 - p. 1
Ch. 5 Synchronotes for Fundamentals of Financial Accounting, 3e by Phillips/Libby/Libby
Chapter 5: Financial Reporting and Analysis
Financial Statement Users Managers, Creditors, Government, Directors, Investors
Accounting Fraud
Incentive to Commit FraudCreating Business Opportunities; Satisfying Personal Greed
Opportunity to Commit FraudInternal controls are the methods that a company uses to protect against theft of assets, to enhance the reliability of accounting information, to promote efficient and effective operations, and to ensure compliance with laws and regulations.
Character to Rationalize and Conceal FraudMost fraudsters have a sense of personal entitlement, which outweighs other moral principles, such as fairness, honesty, and concern for others.
The Sarbanes-Oxley (SOX) Act
The Financial Reporting ProcessThree aspects of the financial reporting process:
1. Enhance financial statement format2. Obtain independent external audit3. Release additional financial information
Financial reporting timeline
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Comparative Financial StatementsA comparative format reveals changes over time, such as Activision’s huge increase in Cash and decline in Short-term Investments.
Multistep Income Statements
Statement of Stockholders’ Equity
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Independent External Audit Auditors are Certified Public Accounts who are independent of the company. Unqualified Audit Opinion - Financial statements are presented in accordance with GAAPQualified Audit Opinion - Financial statements fail to follow GAAP or not able to complete needed tests
Preliminary ReleasesMost public companies announce quarterly and annual earnings through a press release that is sent to news agencies.
Financial Statement Release
Securities and Exchange Commission (SEC) Filings Public companies are required to electronically file certain reports with the SEC, including Form 10-K, Form 10-Q, and Form 8-K.
Globalization and IFRSInternational Financial Reporting Standards (IFRS) are accounting rules established by the International Accounting Standards Board for use in over 100 countries around the world.In 2008, the SEC announced a plan to allow some U.S. companies to use IFRS in 2009 and could require mandatory use of IFRS starting in 2014.
IFRS Formatting of Financial Statements
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A side-by-side comparison of a balance sheet prepared using GAAP and a statement of financial position prepared using IFRS.
Comparison to Common BenchmarksTo help interpret amounts on the financial statements, it’s useful to have points of comparison or “benchmarks.”
Prior Periods - Time series analysis compares a company’s results for one period to its own results over a series of time periods.
Competitors - Cross-sectional analysis compares the results of one company with those of others in the same section of the industry.
Time Series Analysis Chart
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Cross-Sectional Analysis
A Basic Business ModelMost businesses can be broken down into 4 elements:
(1) Obtain financing from lenders and investors, which is used to invest in assets,(2) Invest in assets, which are used to generate revenues,(3) Generate revenues, which produce net income,(4) Produce net income, which is needed to satisfy lenders and investors.
Financial Statement Ratios
In addition to making it possible to compare companies of different sizes, a benefit of ratio analysis is that it enables comparisons between companies reporting in different currencies (dollars vs. euros).
The debt-to-assets ratio provides the percentage of assets financed by debt. A higher ratio means greater financial risk.
The asset turnover ratio measures how well assets are used to generate sales. A higher ratio means greater efficiency.
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The net profit margin ratio measures the ability to generate sales while controlling expenses. A higher ratios means better performance.
How Transactions Affect RatiosThree-step process:
1. Analyze the transaction to determine its effects on the accounting equation.2. Relate the effects in step 1 to the ratio’s components, to determine whether each component
increases, decreases, or stays the same.3. Evaluate the combined impact of the effects in step 2 on the overall ratio.
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ExercisesM5-4 Preparing and Interpreting a Multistep Income StatementNutboy Theater Company reported the following single-step income statement. Prepare a multistep income statement for the local theater company. Also, calculate the net profit margin and compare it to the 8% earned in 2009. In which year did the company generate more profit from each dollar of sales?
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M5-5 Preparing a Statement of Stockholders’ EquityWER Productions began 2009 with $100,000 of contributed capital and $20,000 of retained earnings. During the year, the company had the following transactions. Prepare a statement of stockholders’ equity for the year ended December 31, 2009.
a. Issued stock for $50,000.b. Declared and paid a cash dividend of $5,000.c. Reported total revenue of $120,000 and total expenses of $87,000.d. Repurchased shares of WER stock for $10,000 (the shares had been previously issued for $10,000 and
were cancelled upon repurchase).
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M5-9 Determining the Effects of Transactions on Debt-to-Assets, Asset Turnover, and Net Profit MarginUsing the transactions in M5-8, complete the following table by indicating the sign of the effect (+ for increase, - for decrease, NE for no effect, and CD for cannot determine) of each transaction. Consider each item independently.
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M5-10 Preparing Comparative Financial StatementsComplete the blanks in the following comparative income statements, statement of stockholders’ equity, and balance sheets.
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E5-11 Analyzing and Interpreting Asset Turnover and Net Profit MarginRadioShack Corporation has populated the world with stores from Greece to Canada, and in the United States, an estimated 94 percent of all Americans live or work within five minutes of the electronics retailer—not bad for a company that originally started business as American Hide & Leather Company. The following amounts (in millions) were reported in RadioShack’s income statement and balance sheet.
1. Compute the asset turnover and net profit margin ratios for 2008 and 2007.2. Would analysts be more likely to increase or decrease their estimates of stock value on the basis of
these changes? Explain what the changes in these two ratios mean.3. Compute the debt-to-assets ratio for 2008 and 2007.4. Would analysts be more likely to increase or decrease their estimates of RadioShack’s ability to repay
lenders on the basis of this change? Explain by interpreting what the change in this ratio means.
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E5-16 Finding Financial Statement InformationIndicate whether each of the following would be reported on the balance sheet (B/S), income statement (I/S), or statement of stockholders’ equity (SSE).
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