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*ChapterSeventeen

Understanding

Accountingand FinancialInformation

Copyri ght © 2010 by the McGraw-Hil l Companies, Inc. All ri ghts reserved. McGraw-Hill/Irwin

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• A lifelong weightlifter whowanted a protein-packedcookie to take to the gym.

• Due to accountingtroubles, his Bakery Barn business was in trouble.

• Became a supplier foranother company andhired a comptroller and anew CEO.

SEAN PERICH Bakery Barn

Profile

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http://www.bakery-barn.com/index.html

http://www.bakery-barn.com/index.html

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• Accounting -- Recording, classifying, summarizing

and interpreting of financial events and transactions

in an organization to provide interested partiesneeded financial information.

• Outside parties - like employees, owners,

creditors, unions, investors and the government -make use of a firm’s accounting information.

WHAT’S ACCOUNTING? What is

Accounting?

LG1

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*The ACCOUNTING SYSTEM

What is

Accounting?

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*ACCOUNTANTS’

RESPONSIBILITIES

What is

Accounting?

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• Managerial Accounting -- Provides information

and analysis to managers inside the organization to

assist them in decision making.

• Managerial accounting is involved with:

- Costs of production

-Costs of marketing

- Preparation and control of budgets

- Minimizing tax liabilities

MANAGERIAL ACCOUNTING Managerial

Accounting

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*USERS of ACCOUNTING

INFORMATION

Managerial

Accounting

Users Type of Report

Government tax authority Tax reports

Government regulatoryagencies

Required reports

People interested in theorganization’s income

Financial statements found inannual reports

Managers of the firm Financial statements andinternally distributed financial

reports

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• Financial Accounting -- Financial information and

analyses are generated for people primarily outside

the organization. Outside users are interested in

these questions:

- Is the organization profitable?

- Is it able to pay its bills?

- How much debt does it owe?

• Annual Report -- A yearly statement of the financial

condition, progress, and expectations of the firm.

FINANCIAL ACCOUNTING Financial

Accounting

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• Key things to watch for and read:

HOW to READan ANNUAL REPORT

Financial

Accounting

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- Management’s

discussion and

analysis of operations

- Balance sheet

- Income statement

-Statement of cashflows

- Auditor’s opinion

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• Private Accountants -- Work in a single firm,

government agency, or nonprofit organization.

• Public Accountants -- Provide accountingservices to individuals or businesses.

• Certified Public Accountants (CPAs) --

Accountants who have passed a series of examinations established by the American Institute of

Certified Public Accountants (AICPA) and met a

states requirements for education and experience.

PUBLIC vs. PRIVATEACCOUNTANTS

Financial

Accounting

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http://www.aicpa.org/Becoming+a+CPA/CPA+Candidates+and+Students/




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• When a company is suspected of fraud or otheraccounting wrongdoings a court will commission

a forensic accountant to search for foul play.

• Forensic accountants look for proof a company is“cooking the books.”

• Problems within Enron, WorldCom, and ourfederal government were found by forensicaccountants.

BALANCE SHEETS SHERLOCKSLegal Briefcase

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http://www.enron.com/

http://www.enron.com/

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*STEPS to CONTROL

ACCOUNTING PRACTICES

Financial

Accounting

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• Auditing -- Reviewing and evaluating the

information used to prepare a company’s financial

statements.

• Independent Audit -- An evaluation and unbiased

opinion about the accuracy of a company’s financial

statements.

• Certified Internal Auditors (CIAs) -- Accountants

who have a bachelor’s degree and two years of

experience in internal auditing and pass an exam

administered by the Institute of Internal Auditors.

AUDITING CHECKS ACCURACY Auditing

LG2

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http://www.theiia.org/certification/certified-internal-auditor/

http://www.theiia.org/certification/certified-internal-auditor/

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• Tax Accountants -- Accountants

trained in tax law and are

responsible for preparing tax

returns or developing tax strategies.

• Government and Not-for-

Profit Accounting -- Support for organizations whose purpose is

not generating a profit, but serving

others according to a duly

approved budget.

SPECIALIZED ACCOUNTANTS Tax

Accounting

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• What’s the key difference between managerial

and financial accounting?

• How’s the job of a private accountant different

from that of a public accountant?

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What’s the job of an auditor?

PROGRESS ASSESSMENT Progress

Assessment

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• Accounting Cycle -- A six-step procedure that

results in the preparation and analysis of the major

financial statements.

The ACCOUNTING CYCLE The

Accounting

Cycle

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• Bookkeeping -- The recording of business

transactions. Bookkeepers divide a firm’s

transactions into meaningful categories and post

them into a record book or computer program called a journal.

• Double-Entry Bookkeeping -- Bookkeepers

record all transactions in two places so they cancheck one list of transactions against the other for

accuracy.

BOOKKEEPING’S ROLE The

Accounting

Cycle

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• Ledger -- A specialized

accounting book or

program where all

information is in one place.

• Trial Balance -- A

summary of all theinformation in the account

ledgers.

BOOKKEEPING’S ROLE The

Accounting

Cycle

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• Financial Statement -- A summary of all the

financial transactions that have occurred over a

particular period.

FINANCIAL STATEMENTS Understanding

Key Financial

Statements

LG3

• Key financial statements ofbusiness are:

- Balance sheet - Income statement

- Statement of cash flows

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• Fundamental Accounting Equation -- The basis

for the balance sheet.

• The equation must always be balanced andincludes the formula:

o

Assets = Liabilities + Owners Equity

The FUNDAMENTALACCOUNTING EQUATION

The

Fundamental

Accounting

Equation

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• Assets -- Economic resources owned by a firm.

Items can be tangible or intangible.

• Liquidity -- Ease with which assets can beconverted into cash.

ASSETS Classifying

Assets

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• Current Assets -- Items that can or will be

converted to cash within one year.

• Fixed Assets -- Long-term assets that are relatively

permanent such as land, buildings, or equipment.

•

Intangible Assets -- Long-term assets that have no physical form but do have value such as patents,

trademarks, and goodwill.

CLASSIFYING ASSETS Classifying

Assets

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• Liabilities -- What the business owes to others - its

debts.

• Accounts Payable -- Current liabilities a firm owesfor merchandise or services purchased on credit.

• Notes Payable -- Short or long-term liabilities a

business promises to pay by a certain date.

• Bonds Payable -- Long-term liabilities that the firm

must pay back.

CLASSIFYING LIABILITIES Liabilities and

Owners’

Equity

Accounts

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• Owners’ Equity -- The

amount of the business that

belongs to the owners minus

any liabilities of the owners.

• Retained Earnings -- Accumulated earnings from

the firm’s profitable operations

that are reinvested in the

business.

OWNERS’ EQUITY ACCOUNTS Liabilities and

Owners’

Equity

Accounts

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• What do we call the formula for the balancesheet? What three accounts does it include?

• What does it mean to list assets according toliquidity?

• What’s included in the liabilities account on the

balance sheet?

• What’s owners’ equity and how do we determine

it?


Assessment

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• Income Statement --The financial statement

that shows a firm’s bottom

line - that is, its profit after

costs, expenses, and

taxes.

• Net Income/Net Loss --The revenue left over or

depleted.

The INCOME STATEMENT The Income

Statement

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• The formula for the income statement:

o Revenue

o Minus Cost of Goods Sold

o Equals Gross Profit

o Minus Operating Expenses

o Equals Net Income before Taxeso Minus Taxes

o Equals Net Income or Net Loss

The INCOME STATEMENT The Income

Statement

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• Revenues is the monetary value a firm receivedfor goods sold, services rendered or otherpayments.

• Cost of Goods Sold (or Manufactured) --Measures the cost of merchandise the firms sells or

the cost of raw materials and supplies it used in

producing items for resale.

• Gross Profit -- How much a firm earned by buying

(or making) and selling merchandise.

ACCOUNTS of the INCOMESTATEMENT

The Income

Statement

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(Continued)

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• Operating Expenses --Expenses a firm incurs in

selling goods and servicessuch as rent, salaries and

supplies.

• Depreciation -- The

systematic write-off of the cost

of a tangible asset over its

estimated useful life.

ACCOUNTS of the INCOMESTATEMENT

(Continued )

The Income

Statement

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• Generally Accepted Accounting Principles(GAAP) sometimes permits accountants to use

different method of accounting for inventory.

• FIFO: First-In, First-Out

• LIFO: Last-In, Last-Out

• Each valuation can affect income and endinginventory valuation.

ACCOUNTING for WHAT’S COMING

and GOING in SMALL BUSINESS

Spotlight on Small Business

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• Statement of Cash Flows -- Reports cash

receipts and cash disbursements related to the three

major activities of a firm:

1. Operations

2. Investments

3. Financing

The STATEMENT of CASH FLOWS The

Statement of

Cash Flows

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• Cash Flow -- The difference between cash coming

in and cash going out of a business.

UNDERSTANDING CASH FLOW The Need for

Cash Flow

Analysis

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• Managing cash flow isa key consideration ofa business and can beparticularly challengingfor small and seasonalbusinesses.

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• You’re the only accountant employed by a small,

struggling firm.

• The firm requests a bank loan to keep operationsgoing and your boss suggests you record therevenue early.

•

This is against accounting principles, but youknow if you don’t get the loan, you may lose your

job. What do you do?

ON the ACCOUNTING HOT SEATMaking Ethical Decisions

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• Ratio Analysis -- The assessment of a firm’s

financial condition using calculations and financial

ratios developed from the firm’s financial statements.

• Key ratios include:

- Liquidity ratios

- Leverage ratios

- Performance ratios

- Activity ratios

USING FINANCIAL RATIOS Analyzing

Financial

Performance

Using Ratios

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• Liquidity ratios measure a firm’s ability to turn

assets into cash to pay its short-term debts.

• Two key ratios are:

- Current ratio

- Acid-test ratio

• This information is found on the firm’s balancesheet.

COMMONLY USEDLIQUIDITY RATIOS

Liquidity

Ratios

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• Leverage ratios measure the degree to which afirm relies on borrowed funds in its operations.


- Debt to Owner’s Equity Ratio

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This information is found on the firm’s balancesheet.

LEVERAGE RATIOS Leverage

(Debt) Ratios

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• Profitability ratios measure how effectively afirm’s managers are using the firm’s various

resources to achieve profits.


- Basic earnings per share

- Return on sales

- Return on equity

• This information is found on the firm’s balancesheet and income statement.

PROFITABILITY RATIOS Profitability

(Performance)

Ratio

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• Activity ratios measure how effectivelymanagement is turning over inventory.

•Key ratios include:- Inventory turnover ratio

ACTIVITY RATIOS Activity Ratio

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• This information is

found on the firm’sbalance sheet andincome statement.

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• Multinational companies must adapt theiraccounting reporting to the rules of multiple

countries.

• Many countries have adopted InternationalFinancial Reporting Standards (IFRS) and arepushing to make them standard.

• The U.S. Securities & Exchange Commissionbelieves there should be such a standard.

The ACCOUNTING SHOT HEARDAROUND the WORLD

Reaching Beyond Our Borders

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http://www.iasb.org/IFRSs/IFRS.htm




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• 2008: SEC offers proposed timeline

• 2009: 110 large companies have the option of using

IFRS

• 2011: SEC assesses progress of IFRS

• 2013: Final decision on the move to IFRS

• 2014: Large public companies will be required to

report in IFRS (pending SEC decision)

• 2016: All companies will be required to report in

IFRS (pending SEC decision)

TIMELINE for the MOVE to IFRSReaching

Beyond Our

Borders

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• What’s the primary purpose of performing ratio

analysis using the firm’s financial statements?

• What are the four main categories of financialratios?


Assessment

J0712 Pert12

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