Foundations of Business 3e Pride, Hughes, & Kapoor

© 2013 South-Western, a part of Cengage Learning. All rights reserved. Chapter 15 | Slide 2 Using Accounting Information Chapter15

© 2013 South-Western, a part of Cengage Learning. All rights reserved. Chapter 15 | Slide 3 1.Explain why accurate accounting information and audited financial statements are important. 2.Identify the people who use accounting information and possible careers in the accounting industry. 3.Discuss the accounting process. 4.Read and interpret a balance sheet. 5.Read and interpret an income statement. 6.Describe business activities that affect a firm’s cash flow. 7.Summarize how managers evaluate the financial health of a business. Learning Objectives

© 2013 South-Western, a part of Cengage Learning. All rights reserved. Chapter 15 | Slide 4  Recent accounting scandals Pressure on corporate executives to look good to analysts and investors  Why audited financial statements are important Bankers, creditors, investors, and government agencies rely on an auditor’s opinion of the validity of a firm’s financial statements. Why Accounting Information Is Important

© 2013 South-Western, a part of Cengage Learning. All rights reserved. Chapter 15 | Slide 5  What is an audit? An examination of a company’s financial statements and accounting practices Generally accepted accounting principles (GAAPs)— an accepted set of guidelines and practices for U.S. companies reporting financial information and the accounting profession The FASB is developing a new set of standards combining those of GAAP and the International Financial Reporting Standards An audit does not guarantee that a company has not “cooked” the books Why Accounting Information Is Important (cont.)

© 2013 South-Western, a part of Cengage Learning. All rights reserved. Chapter 15 | Slide 6  Reform: The Sarbanes-Oxley Act of 2002 The SEC must establish an oversight board to police the accounting industry. Top executives must certify periodic financial reports and are liable for intentional violations of reporting requirements. Accounting firms cannot provide many types of non-audit and consulting services to the companies they audit. Auditors must maintain financial documents and audit work papers for five years. Why Accounting Information Is Important (cont.)

© 2013 South-Western, a part of Cengage Learning. All rights reserved. Chapter 15 | Slide 7  Reform: The Sarbanes-Oxley Act of 2002 (cont.) Auditors and accountants can be imprisoned for up to twenty years and subject to fines for destroying documents and violating securities laws. A public corporation must change its lead auditing firm every five years. There is protection for whistle-blowers who report violations of the Sarbanes-Oxley Act. Why Accounting Information Is Important (cont.)

© 2013 South-Western, a part of Cengage Learning. All rights reserved. Chapter 15 | Slide 8  Managers are the primary users Proprietary: information that is not divulged to anyone outside the firm  Lenders, suppliers, stockholders, potential investors, and government agencies are other users Who Uses Accounting Information

© 2013 South-Western, a part of Cengage Learning. All rights reserved. Chapter 15 | Slide 9 Users of Accounting Information

© 2013 South-Western, a part of Cengage Learning. All rights reserved. Chapter 15 | Slide 10  Managerial accounting provides managers and employees within the organization with information needed to make decisions about a firm’s financing, investing, marketing, and operating activities.  Financial accounting generates financial statements and reports for interested people outside an organization. Different Types of Accounting

© 2013 South-Western, a part of Cengage Learning. All rights reserved. Chapter 15 | Slide 11  Qualities to be successful in accounting Be responsible, honest, ethical Have a strong background in financial management Know how to use a computer and accounting software Be able to communicate with people who need accounting information Careers in Accounting

© 2013 South-Western, a part of Cengage Learning. All rights reserved. Chapter 15 | Slide 12  Private accountant Employed by a specific organization Services performed for the employer – Designs organization’s accounting information system – Manages its accounting department – Provides managers with accounting information, advice, and assistance.  Public accountant Provides services to clients on a fee basis Self-employed or employee of an accounting firm Careers in Accounting (cont.)

© 2013 South-Western, a part of Cengage Learning. All rights reserved. Chapter 15 | Slide 13  Certified public accountant (CPA) Has met state requirements for accounting education and experience and has passed a rigorous accounting examination prepared by the AICPA Participates in continuing-education programs to maintain certification  Certified management accountant (CMA) Has met requirements for education and experience, passed a rigorous exam, certified by the Institute of Management Accountants Has demonstrated decision-making, financial-planning, analysis, and critical-thinking skills Careers in Accounting (cont.)

© 2013 South-Western, a part of Cengage Learning. All rights reserved. Chapter 15 | Slide 14  The accounting equation: assets = liabilities + owners’ equity Assets—the resources that a business owns (e.g., cash, inventory, equipment, and real estate) Liabilities—the firm’s debts Owners’ equity—the difference between assets and liabilities (what would be left for the owners if the firm’s assets were sold and the money used to pay off its liabilities) The Accounting Process Double-entry bookkeeping system : each financial transaction is recorded as two separate accounting entries to maintain the balance of the accounting equation

© 2013 South-Western, a part of Cengage Learning. All rights reserved. Chapter 15 | Slide 15  The accounting cycle Done on a regular basis – Analyze source documents – Record transactions as they occur in the general journal – Post transactions to accounts in the general ledger  Done at the end of the period Prepare the trial balance of all general ledger accounts Prepare financial statements and close the books The Accounting Process (cont.)

© 2013 South-Western, a part of Cengage Learning. All rights reserved. Chapter 15 | Slide 16  A summary of the dollar amounts of a firm’s assets, liabilities, and owners’ equity accounts at the end of a specific accounting period (also called statement of financial position)  Assets Listed in order of liquidity (ease with which an asset can be converted into cash) Current assets—can quickly be converted into cash or that will be used in one year or less – Cash, marketable securities, accounts receivable, notes receivable, merchandise inventory, and prepaid expenses The Balance Sheet

© 2013 South-Western, a part of Cengage Learning. All rights reserved. Chapter 15 | Slide 17  Assets (cont.) Fixed assets—will be held or used for a period longer than one year – Land, buildings, and equipment – Depreciation—the process of apportioning the cost of a fixed asset over the period during which it will be used Intangible assets—do not exist physically but have a value based on the rights or privileges they confer on the firm – Patents, copyrights, trademarks, and goodwill The Balance Sheet (cont.)

© 2013 South-Western, a part of Cengage Learning. All rights reserved. Chapter 15 | Slide 18  Liabilities Current liabilities—debts to be repaid in one year or less – Accounts payable—short-term obligations that arise as a result of making credit purchases – Notes payable—obligations that have been secured with promissory notes Long-term liabilities—debts that need not be repaid for at least one year – Mortgages, bonds, and long-term loans The Balance Sheet (cont.)

© 2013 South-Western, a part of Cengage Learning. All rights reserved. Chapter 15 | Slide 19  Owners’ or stockholders’ equity For sole proprietorships— Assets – liabilities = owners’ equity For partnerships—each partner’s share of ownership is reported separately in each owner’s name For corporations—stockholders’ equity Retained earnings—profits not distributed to stockholders The Balance Sheet (cont.)

© 2013 South-Western, a part of Cengage Learning. All rights reserved. Chapter 15 | Slide 20 Personal Balance Sheet

© 2013 South-Western, a part of Cengage Learning. All rights reserved. Chapter 15 | Slide 21 Business Balance Sheet

© 2013 South-Western, a part of Cengage Learning. All rights reserved. Chapter 15 | Slide 22  A summary of a firm’s revenues and expenses during a specified accounting period Profit (cash surplus) Loss (cash deficit)  Revenues The dollar amounts earned by a firm from selling goods, providing services, or performing business activities Gross sales—the total dollar amount of all goods and services sold during the accounting period Net sales—the actual dollar amounts received by a firm for the goods and services it has sold, after adjustment for returns, allowances, discounts The Income Statement

© 2013 South-Western, a part of Cengage Learning. All rights reserved. Chapter 15 | Slide 23  Cost of goods sold The dollar amount equal to beginning inventory plus net purchases less ending inventory The Income Statement (cont.) Cost of goods sold Beginning inventory Net purchases Ending inventory =+ – Gross profit = a firm’s net sales less the cost of goods sold

© 2013 South-Western, a part of Cengage Learning. All rights reserved. Chapter 15 | Slide 24  Operating expenses All business costs other than the cost of goods sold – Selling expenses—costs related to marketing activities – General expenses—costs of managing the business  Net income Revenues less expenses, when the difference is positive  Net loss Revenues less expenses, when the difference is negative The Income Statement (cont.)

© 2013 South-Western, a part of Cengage Learning. All rights reserved. Chapter 15 | Slide 25 Personal Income Statement

© 2013 South-Western, a part of Cengage Learning. All rights reserved. Chapter 15 | Slide 26  Business Income Statement

© 2013 South-Western, a part of Cengage Learning. All rights reserved. Chapter 15 | Slide 27  Illustrates how the operating, investing, and financing activities of a company affect cash during an accounting period Cash flows from operating activities (providing goods and services) Cash flows from investing activities (purchase and sale of land, equipment, and other assets and investments) Cash flows from financing activities (changes in debt obligation and owners’ equity accounts) The Statement of Cash Flows

© 2013 South-Western, a part of Cengage Learning. All rights reserved. Chapter 15 | Slide 28 Statement of Cash Flows

© 2013 South-Western, a part of Cengage Learning. All rights reserved. Chapter 15 | Slide 29  Using accounting information to evaluate a potential investment Use common sense to interpret the numbers. Financial statements should be audited by an outside source and be current. Look for use of new strategies to reduce costs. Determine the firm’s ability to pay its debts and borrow money in the future. Look at how the numbers relate to each other. Understand the financial ratios. Evaluating Financial Statements

© 2013 South-Western, a part of Cengage Learning. All rights reserved. Chapter 15 | Slide 30  Using accounting information to evaluate a potential investment (cont.) Read letters from top executives. Examine the footnotes closely, look for red flags. Examine the comparative data to analyze trends. Evaluating Financial Statements (cont.)

© 2013 South-Western, a part of Cengage Learning. All rights reserved. Chapter 15 | Slide 31  Comparing Data for Previous Accounting Periods

© 2013 South-Western, a part of Cengage Learning. All rights reserved. Chapter 15 | Slide 32  Comparisons are possible because of GAAP.  Managers can get a general idea of a firm’s relative effectiveness and its standing within the industry.  Data are available from annual reports of public corporations.  Industry averages are available from Dun & Bradstreet, Standard & Poor’s, and industry trade associations. Comparing Data with Other Firms’ Data

© 2013 South-Western, a part of Cengage Learning. All rights reserved. Chapter 15 | Slide 33  Numbers that show the relationship between two elements of a firm’s financial statements  Can be compared with: The firm’s own past ratios Ratios of competitors Industry averages  Information to calculate ratios is found on a firm’s balance sheet, income statement, and statement of cash flows Financial Ratios

© 2013 South-Western, a part of Cengage Learning. All rights reserved. Chapter 15 | Slide 34 Financial Ratios (cont.)