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1 Financial Accounting: Tools for Business Decision Making Kimmel, Weygandt, Kieso, Trenholm KIMMEL.

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Presentation on theme: "1 Financial Accounting: Tools for Business Decision Making Kimmel, Weygandt, Kieso, Trenholm KIMMEL."— Presentation transcript:

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2 1 Financial Accounting: Tools for Business Decision Making Kimmel, Weygandt, Kieso, Trenholm KIMMEL

3 2 Chapter 2 A Further Look at Financial Statements 1.Describe the basic objective of financial reporting, and explain the meaning of generally accepted accounting principles. 2.Discuss the qualitative characteristics of accounting information. 3.Identify two constraints in accounting. 4.Identify the sections of a classified balance sheet. After studying Chapter 2, you should be able to:

4 3 5.Identify and compute ratios for analysing a company's profitability. 6.Explain the relationship between a statement of retained earnings, a statement of earnings, and a balance sheet. 7.Identify and compute ratios for analysing a company's liquidity and solvency. Chapter 2 A Further Look at Financial Statements After studying Chapter 2, you should be able to:

5 4 +Provide the most useful financial information for decision making Objective of Financial Reporting

6 5 +Generally +Accepted +Accounting +Principles General Guide for Financial Reporting

7 6 +Understandability +Relevance +Reliability +Comparability and consistency Characteristics of Useful Information

8 Illustration 2-1

9 8 Constraints in Accounting +Modify GAAP without hurting the usefulness of information +Cost-benefit +Materiality

10 9 Classified Balance Sheet Assets +Current assets +Long-term investments +Capital assets Liabilities + Current liabilities + Long-term liabilities Shareholders’ Equity + Share capital + Retained earnings Generally contains the following standard classifications:

11 10 Current Assets +Assets expected to be converted to cash or used in the business within the year +Listed in order of liquidity +Examples +Cash +Short-term investments +Receivables +Inventories +Prepaid expenses

12 11 Long-Term Investments +Assets that can be converted into cash, but whose conversion is not expected within one year +Assets not intended for use within the business +Example + Investments in shares and bonds of other corporations

13 12 Capital Assets +Assets with relatively long useful lives +Assets used in operating the business +Two categories of capital assets +Tangible (with physical substance) +Intangible (with no physical substance)

14 13 Tangible Capital Assets +Examples +Property, plant, and equipment +Land +Buildings +Machinery and equipment +Furniture and fixtures +Natural resources +Mineral deposits +Timber

15 14 Intangible assets have value because of the exclusive rights or privileges they possess Intangible Capital Assets +Examples +Patents +Copyrights +Trademarks or trade names +Franchise

16 15 Amortization +Allocation of an asset’s full purchase price to match cost to revenues over entire estimated useful life instead of expensing full cost in year of purchase +Amortization is allocated for all capital assets except land

17 16 AMORTIZATION +Accumulated amortization account shows the total amount of amortization taken to date +The difference between the cost of the asset and its accumulated amortization is referred to as the net book value of the asset

18 17 CSU CORPORATION Balance Sheet December 31, 2001 Capital assets should be shown at net book value (cost less accumulated amortization) Assets Cash$ 2,000 Accounts receivable 4,000 Supplies 1,800 Equipment24,000 Less: Accumulated amortization 8,000 16,000 Total assets $23,800

19 18 Current Liabilities +Obligations that are supposed to be paid within the coming year +Accounts payable +Wages payable +Notes (bank loans) payable +Interest payable +Taxes payable +Current maturities of long-term liabilities

20 19 Long-Term Liabilities +Debts expected to be paid after one year +Bonds payable +Mortgages payable +Long-term notes payable +Capital lease liabilities +Obligations under employee pension plans

21 20 Shareholders' Equity +Share capital +Investments in the business by the shareholders +Retained earnings +Earnings kept for use in the business

22 Current ANY CORPORATION Balance Sheet (Sample Presentation) December 31, 2001 (in millions) Assets Current assets Cash$ 272 Short-term investments (current) 609 Receivables 74 Other current assets 83 Total current assets 1,038 Investments (long-term) 317 Capital assets 322 Other long-term assets 280 Total assets$ 1,957 Liabilities and Shareholders’ Equity Liabilities Current liabilities Notes payable$527 Accounts payable233 Income taxes payable 56 Total current liabilities816 Long-term debt 83 Total liabilities899 Shareholders’ equity Share capital 830 Retained earnings228 Total shareholders’ equity 1,058 Total liabilities and shareholders’ equity$ 1,957 Current

23 22 Ratio Analysis +Mathematical relationship +Relationship can be expressed in terms of +Percentage +Rate +Proportion

24 23 Comparisons +Intracompany (prior years of your company) +Intercompany (between companies) +Industry averages

25 24 Financial Ratio Classifications +Profitability ratios +Measures of the earnings or operating success of a company for a given period of time +Liquidity ratios +Measures of short-term ability of the company to pay its maturing obligations and to meet unexpected needs for cash +Solvency ratios +Measures of the ability of a company to survive over a long period of time

26 25 Using the Statement of Earnings +With profitability ratios +Return on assets +Profit margin

27 26 Profitability Return On Assets Ratio +Reveals the amount of net earnings generated by each dollar invested Return on assets = Net earnings Average total assets Higher value suggests favourable efficiency

28 27 Profitability Profit Margin Ratio +Measures the percentage of each dollar of sales that results in net earnings Profit margin = Net earnings Net sales Higher value suggests favourable return on each dollar of sales

29 28 Using the Statement of Retained Earnings +Describes the events that caused changes in the retained earnings account for the period +Increased by earnings +Decreased by losses and dividends

30 Retained earnings, January 1$ 0 (1) Add: Net earnings6,800 (2) 6,800 Less: Dividends 0 Retained earnings, December 31$ 6,800 (3) Statement interrelationships: (1)Opening retained earnings comes from, and agrees to, ending retained earnings on prior period balance sheet (2)Net earnings comes from, and agrees to, net earnings on statement of earnings (3)Ending retained earnings goes to, and agrees to, ending retained earnings on current period balance sheet CSU CORPORATION Statement of Retained Earnings For the Year Ended December 31, 2001

31 30 Using the Balance Sheet +With liquidity ratios +Working capital +Current ratio +With solvency ratios +Debt to total assets

32 31 Liquidity Working Capital +Measures short-term ability to pay liabilities Current assets - current liabilities = Working capital

33 32 Liquidity Current Ratio +Measure of short term ability to pay obligations Current ratio = Current assets Current liabilities

34 33 Solvency Debt to Total Assets +Measures % of assets financed by creditors Debt to total assets = Total liabilities Total assets

35 34 Using the Statement of Cash Flows +To provide information about +Cash receipts +Cash payments +Changes in cash (and cash equivalents) +From changes in +Operating activities +Financing activities +Investing activities

36 35 Operating Activities +Cash inflows and cash outflows associated with the primary operations of the business

37 36 Financing Activities +Cash inflows / outflows come from sources funding the business +Sale of shares / payment of dividends +Issuing debt / repaying debt

38 37 Investing Activities +Cash inflows/ outflows result from changes in investments and capital assets +Purchasing/disposing of investments and long-lived assets using cash +Lending money and collecting the loans

39 38 Liquidity Cash Current Debt Coverage +Measures ability to generate sufficient cash to satisfy short-term needs Cash current debt coverage ratio = Cash provided by operating activities Average current liabilities

40 39 Solvency Cash Total Debt Coverage +Measures ability to generate sufficient cash to meet long-term needs Cash total debt coverage ratio = Cash provided by operating activities Average total liabilities

41 40 Decision Checkpoints +Is the company using its assets effectively? +Is the company maintaining an adequate margin between sales and expenses? +Can the company meet its short-term obligations? +Can the company meet its long-term obligations? + Return on assets ratio + Profit margin ratio + Working capital, current ratio, cash current debt coverage ratio + Debt to total assets ratio, cash total debt coverage ratio

42 41 COPYRIGHT Copyright © 2001 John Wiley & Sons Canada, Ltd. All rights reserved. Reproduction or translation of this work beyond that permitted by CANCOPY (Canadian Reprography Collective) is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons Canada, Ltd. The purchaser may make back-up copies for his / her own use only and not for distribution or resale. The author and the publisher assume no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.


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