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Understanding Accounting and Financial Information

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1 Understanding Accounting and Financial Information
Chapter 17 Understanding Accounting and Financial Information McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

2 LEARNING GOALS Chapter Seventeen Demonstrate the role that accounting and financial information play for a business and for its stakeholders. Identify the different disciplines within the accounting profession. List the steps in the accounting cycle, distinguish between accounting and bookkeeping, and explain how computers are used in accounting. Explain how the major financial statements differ. Demonstrate the application of ratio analysis in reporting financial information. 17-2

Profile Hilmarsson missed an Icelandic treat called skyr, a thick, strained, protein-rich yogurt. He perfected his yogurt and contacted a former professor for help with financing. Distribution raised cost problems that affected cash flow. 17-3

4 WHAT’S ACCOUNTING? What is Accounting? LG1 Accounting -- Recording, classifying, summarizing and interpreting of financial events and transactions in an organization to provide interested parties needed financial information. Outside parties - like employees, owners, creditors, unions, investors and the government - make use of a firm’s accounting information. 17-4

5 The ACCOUNTING SYSTEM What is Accounting? LG1 17-5

LG2 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 17-6

Managerial Accounting LG2 Users Type of Report Government tax authority Tax reports Government regulatory agencies Required reports People interested in the organization’s income Financial statements found in annual reports Managers of the firm Financial statements and internally distributed financial reports 17-7

8 FINANCIAL ACCOUNTING Financial Accounting LG2 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. 17-8

Financial Accounting LG2 Key things to watch for and read: Management’s discussion and analysis of operations Balance sheet Income statement Statement of cash flows Auditor’s opinion 17-9

Financial Accounting LG2 Private Accountants -- Work in a single firm, government agency, or nonprofit organization. Public Accountants -- Provide accounting services 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. 17-10

11 Photo Courtesy of: Nancy Pelosi
DODD-FRANK ACT Financial Accounting LG2 Dodd-Frank Wall Street Reform and Consumer Protection Act increased financial regulation by increasing the power of the Public Company Accounting Oversight Board. Act was brought on by the recent financial crisis. Photo Courtesy of: Nancy Pelosi 17-11

LG2 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. 17-12

Tax Accounting and Not-for-Profit Accounting LG2 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. . 17-13

14 The ACCOUNTING CYCLE The Accounting Cycle LG3 Accounting Cycle -- A six-step procedure that results in the preparation and analysis of the major financial statements. 17-14

15 BOOKKEEPER’S ROLE The Accounting Cycle LG3 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 can check one list of transactions against the other for accuracy. 17-15

16 BOOKKEEPER’S TOOLS The Accounting Cycle LG3 Ledger -- A specialized accounting book or program where all information is in one place. Trial Balance -- A summary of all the information in the account ledgers. 17-16

Accounting Technology LG3 Computerized accounting programs post information instantly and from remote locations. Intuit’s QuickBooks and Sage’s Peachtree address the specific needs of small businesses. 17-17

18 FINANCIAL STATEMENTS Understanding Key Financial Statements LG3 Financial Statement -- A summary of all the financial transactions that have occurred over a particular period. Key financial statements of business are: Balance sheet Income statement Statement of cash flows 17-18

The Fundamental Accounting Equation The FUNDAMENTALS ACCOUNTING EQUATION LG4 Fundamental Accounting Equation -- The basis for the balance sheet. The equation must always be balanced and includes the formula: Assets = Liabilities + Owners Equity Balance Sheet -- The financial statement that reports a firm’s financial condition at a specific time. Assets -- Economic resources owned by a firm. Items can be tangible or intangible. Liquidity -- Ease with which assets can be converted into cash. 17-19

20 CLASSIFYING ASSETS Classifying Assets LG4 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. 17-20

Liabilities and Owners’ Equity Accounts LG4 Liabilities -- What the business owes to others - its debts. Accounts Payable -- Current liabilities a firm owes for 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. 17-21

Liabilities and Owners’ Equity Accounts LG4 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. 17-22

23 The INCOME STATEMENT The Income Statement LG4 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 after costs and expenses. 17-23

24 The INCOME STATEMENT The formula for the income statement: Revenue
LG4 The formula for the income statement: Revenue Cost of Goods Sold = Gross Profit Operating Expenses = Net Income before Taxes Taxes = Net Income or Net Loss 17-24

Cost of Goods Sold LG4 Revenue is the monetary value a firm received for goods sold, services rendered or other payments. Cost of Goods Sold (or Manufactured) -- Measures the cost of merchandise the firm sells or the cost of raw materials and supplies it used in producing items for resale. Gross Profit (or Gross Margin) -- How much a firm earned by buying (or making) and selling merchandise. (Continued) 17-25

Operating Expenses ACCOUNTS of the INCOME STATEMENT (Continued) LG4 Operating Expenses – Cost involved in operating a business, such as rent, salaries and supplies. Depreciation -- The systematic write-off of the cost of a tangible asset over its estimated useful life. 17-26

27 WHAT’S COMING and GOING at the COLLEGE BOOKSTORE (Spotlight on Small Business)
Generally Accepted Accounting Principles (GAAP) sometimes permits accountants to use different method of accounting for inventory. FIFO: First-In, First-Out LIFO: Last-In, First-Out Each valuation can affect income and ending inventory valuation. 17-27

LG4 Statement of Cash Flows -- Reports cash receipts and cash disbursements related to the three major activities of a firm: Operations Investments Financing . 17-28

The Need for Cash Flow Analysis LG4 Cash Flow -- The difference between cash coming in and cash going out of a business. Managing cash flow is a key consideration of a business and can be particularly challenging for small and seasonal businesses. 17-29

30 BARKING UP the WRONG FINANCIAL STATEMENT (Making Ethical Decisions)
You’re the only accountant employed by a small, struggling dog food company. The company requests a bank loan to keep operations going and your boss suggests you record some revenue early. This is against accounting principles, but you know if you don’t get the loan, you may lose your job. What do you do? 17-30

Analyzing Financial Performance Using Ratios LG5 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 17-31

LG5 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 balance sheet. 17-32

33 LEVERAGE RATIOS Leverage (Debt) Ratios LG5 Leverage ratios measure the degree to which a firm relies on borrowed funds in its operations. Key ratios include: Debt to Owner’s Equity Ratio This information is found on the firm’s balance sheet. 17-33

34 PROFITABILITY RATIOS Profitability (Performance) Ratio LG5 Profitability ratios measure how effectively a firm’s managers are using the firm’s various resources to achieve profits. Key ratios include: Basic earnings per share Return on sales Return on equity This information is found on the firm’s balance sheet and income statement. 17-34

35 ACTIVITY RATIOS Activity Ratio LG5 Activity ratios measure how effectively management is turning over inventory. Key ratios include: Inventory turnover ratio This information is found on the firm’s balance sheet and income statement. 17-35

36 ACCOUNTANTS of the WORLD UNITED (Reaching Beyond Our Borders)
Multinational companies must adapt their accounting reporting to the rules of multiple countries. Many countries have adopted International Financial Reporting Standards (IFRS) and are pushing to make them standard. The U.S. Securities & Exchange Commission believes there should be such a standard. . 17-36

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