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

2. 1. Demonstrate the role that accounting and financial information play for a business and for its stakeholders. 2. Identify the different disciplines within the accounting profession. 3. List the steps in the accounting cycle, distinguish between accounting and bookkeeping, and explain how computers are used in accounting. 4. Explain how the major financial statements differ. 5. Demonstrate the application of ratio analysis in reporting financial information. LEARNING GOALS Chapter Seventeen 17-2

3. 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. WHAT’S ACCOUNTING? What is Accounting? LG1 17-3

4. The ACCOUNTING SYSTEM LG1 What is Accounting? 17-4

5. Accounting Cycle -- A six-step procedure that results in the preparation and analysis of the major financial statements. The ACCOUNTING CYCLE The Accounting Cycle LG3 17-5

6. Fundamental Accounting Equation -- The basis for the balance sheet. The equation must always be balanced and includes the formula:  Assets = Liabilities + Owners Equity The FUNDAMENTAL ACCOUNTING EQUATION The Fundamental Accounting Equation LG4 17-6

7. Financial Statement -- A summary of all the financial transactions that have occurred over a particular period. Key things to watch for and read: HOW to READ an ANNUAL REPORT  Management’s discussion and analysis of operations  Balance sheet  Income statement  Statement of cash flows  Auditor’s opinion LG2 Financial Accounting 17-7

8. Balance Sheet -- The financial statement that reports a firm’s financial condition at a specific time. The BALANCE SHEET The Balance Sheet LG3 17-8

9. Assets -- Economic resources owned by a firm. Items can be tangible or intangible. Liquidity -- Ease with which assets can be converted into cash. 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. ASSETS Classifying Assets LG4 17-9

10. 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. CLASSIFYING LIABILITIES Liabilities and Owners’ Equity Accounts LG4 17-10

11. 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 LG4 Liabilities and Owners’ Equity Accounts 17-11

12. 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. The INCOME STATEMENT The Income Statement LG4 17-12

13. 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. 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. ACCOUNTS of the INCOME STATEMENT LG4 Cost of Goods Sold 17-13

14. 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 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. The STATEMENT of CASH FLOWS The Statement of Cash Flows LG4 17-14

15. USERS of ACCOUNTING INFORMATION UsersType of Report Government tax authorityTax reports Government regulatory agencies Required reports People interested in the organization’s income Financial statements found in annual reports Managers of the firmFinancial statements and internally distributed financial reports LG2 Managerial Accounting 17-15

16. 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.American Institute of Certified Public Accountants (AICPA) PUBLIC vs. PRIVATE ACCOUNTANTS LG2 Financial Accounting 17-16

17. 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.Institute of Internal Auditors AUDITING CHECKS ACCURACY Auditing LG2 17-17

18. 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 LG2 17-18

19. 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 LG2 17-19

20. Tax Accountants -- Accountants trained in tax law and are responsible for preparing tax returns or developing tax strategies. SPECIALIZED ACCOUNTING Tax Accounting and Not-for-Profit Accounting LG2 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. 17-20

21. 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. BOOKKEEPER’S ROLE LG3 The Accounting Cycle 17-21

22. 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. BOOKKEEPER’S TOOLS LG3 The Accounting Cycle 17-22

23. Computerized accounting programs post information instantly and from remote locations. Intuit’s QuickBooks and Sage’s Peachtree address the specific needs of small businesses.QuickBooksPeachtree TECHNOLOGY and ACCOUNTING LG3 Accounting Technology 17-23

24. Ratio Analysis -- The assessment of a firm’s financial condition using calculations and financial ratios developed from the firm’s financial statements. USING FINANCIAL RATIOS Analyzing Financial Performance Using Ratios LG5 Key ratios include:  Liquidity ratios  Leverage ratios  Performance ratios  Activity ratios 17-24

25. Activity ratios measure how effectively management is turning over inventory. Key ratios include:  Inventory turnover ratio ACTIVITY RATIOS Activity Ratio This information is found on the firm’s balance sheet and income statement. LG5 17-25

26. 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 The INCOME STATEMENT LG4 The Income Statement 17-26

27. 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. COMMONLY USED LIQUIDITY RATIOS Liquidity Ratios LG5 17-27

28. 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. LEVERAGE RATIOS Leverage (Debt) Ratios LG5 17-28

29. 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. PROFITABILITY RATIOS Profitability (Performance) Ratio LG5 17-29

30. 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? BARKING UP the WRONG FINANCIAL STATEMENT (Making Ethical Decisions) 17-30