McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved ChapterEighteen Understanding Financial Information and Accounting

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved Importance of Accounting Definition Definition Audiences Audiences -Managers -Government -Investors, Suppliers & Creditors

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved The Influence of Accounting Information Managers- Financial reports pinpoint problems/opportunities Government- assists with tax collection Investors, Suppliers, & Creditors- provides a means to analyze business

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved Areas of Accounting Financial Accounting Financial Accounting -Annual Report -Private Accountant -Public Accountant -C.P.A. Auditing Tax Accounting Managerial Accounting -Inside Organization -C.M.A.

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved Different Types of Accountants Public Accountant  Auditing  Tax Consulting & Compliance  Management Consulting Private Accountant  Management Accounting  Government Accounting  Academia

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved Top Business Uses of Accountants

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved Services Growth in Acc’ting Accounting & Auditing 2.9% Taxes 13.1% Management Consulting117.7%

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved Accounting vs. Bookkeeping Bookkeeping Start of Accounting Start of Accounting Record/Journalize Record/Journalize Accounting Analyze Recommend

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved Accounting Cycle 1.Analyze/Categorize 2.Record 3.Post -General Journal -General Ledger 4.Trial Balance 5.Financial Statements -Income Statement -Balance Sheet 6.Analyze/Recommend

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved The Accounting System (Figure 18.1)

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved Steps In The Accounting Cycle (Figure 18.3)

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved Financial Statements  Balance Sheet- Statement of Financial Position  Income Statement- Statement of Revenues & Expenses  Statement of Cash Flows  Statement of Owner’s Equity

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved Accounting Equation Assets Liabilities + Owner’s Equity Owned Owed + Owner’s Claims = = $826,000 = $613,000 + $213,000 $213,000

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved Fiberrific- Balance Sheet Current Assets$600,000 Fixed Assets$206,000 Intangible Assets(Goodwill)$ 20,000 Total Assets$826,000 Current Liabilities $288,000 Current Liabilities $288,000 Long-Term Liabilities$325,000 Total Liabilities$613,000 Stockholders’ Equity$213,000 Total Liabilities & Equity$826,000 ========== ==========

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved Current Assets Cash $ 15,000 Accounts Receivable200,000 Notes Receivable 50,000 Inventory335,000 Total Current Assets $ 600,000

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved Fixed Assets Land $ 40,000 Bldg. & Impr.$200,000 Deprec. (90,000) 110,000 Equip./Veh.$120,000 Deprec. (80,000) 40,000 Furn./Fix.$ 26,000 Deprec. (10,000) 16,000 Total Fixed Assets $ 206,000

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved Current Liabilities Accounts Payable$ 40,000 Notes Payable(12/02) 8,000 Accrued Taxes 150,000 Accrued Salaries 90,000 Total Current Liabilities$288,000

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved Long-Term Liabilities Notes Payable(3/04) $ 35,000 Bonds Payable(12/14) 290,000 Total Long-Term $ 325,000

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved Stockholders’ Equity Common Stock$100,000 Retained Earnings 113,000 Total Stockholders’ Equity$213,000

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved Fiberrific- Income Statement Net Sales$ 700,000 Cost of Goods Sold (410,000) Gross Profit$ 290,000 Operating Expenses 222,000 NBIT$ 68,000 Taxes (19,000) NAT$ 49,000 =========

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved Revenues Gross Sales$ 720,000 Returns & Allowances $12,000 Returns & Allowances $12,000 Discounts 8,000 (20,000) Discounts 8,000 (20,000) Net Sales$ 700,000

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved Cost of Goods Sold Beg. Inventory$200,000 Purchases $400,000 Freight 40,000 Net Purchases 440,000 Available for Sale$640,000 End. Inventory (230,000) Cost of Goods Sold $410,000

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved Selling Expenses Sales Salaries$ 90,000 Advertising 18,000 Supplies 2,000 Total Selling Expenses$110,000

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved General Expenses Office Salaries$ 67,000 Depreciation 1,500 Insurance 1,500 Rent 28,000 Light, Heat, & Power 12,000 Miscellaneous 2,000 Total General Expenses$112,000

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved Fiberrific Statement of Cash Flow Net Cash Flow from Operations$ 52,000 Net Cash Flows from Investments ( 6,000) Net Cash Flow from Financing (19,000) Net Change in Cash & Equivalents$ 27,000 Beginning Cash Balance ( 2,000) Ending Cash Balance$ 25,000 =========

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved Using Accounting Information- Solvency Ratios Short-Term Long-Term Current Assets Current Liabilities - Quick Ratio Cash + Marketable Securities + Receivables Current Liabilities - Current Ratio - Debt to Equity Total Liabilities Equity Equity

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved Using Acc’ting Info. (cont’d)- Profitability Ratios Profitability = Operating Success - Return on Sales Net Income Net Sales - Return on Equity Net Income Owner’s Equity - Earnings Per Share Net Income # Common Shares

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved Using Acc’ting Info. (Con’td)- Activity Ratios - Inventory Turnover Cost of Goods Sold Avg. Inventory - A/R Turnover Net Acc’ts Receivable Net Daily Credit Sales

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved Current Ratio- Fiberrific $600,000$288,000 =2.08

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved Quick(Acid-Test) Ratio $265,000$288,000 =0.92

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved Debt to Equity Ratio $613,000$213,000 = 2.87

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved Profitability Ratios Earnings per Share$ 49,000 = $.049 1,000,000 Return on Sales $ 49,000 = 7% $700,000 $700,000 Return on Equity $ 49,000 = 23% $213,000 $213,000

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved Activity Ratios Inventory Turnover $410,000 = 1.9 $215,000 $215,000

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved Fiberiffic’s Balance Sheet (Assets) Fiberriffic, Inc. Period ending 3/31/02 Assets Current Assets Cash$ 15,000 Accounts Receivable 200,000 Notes Receivable 50,000 Inventory 335,000 Total Current Assets$600,000 Fixed Assets Land$ 40,000 Buildings(net) 110,000 Equipment & Vehicles(net) 56,000 Total Fixed Assets$206,000 Intangible Assets Goodwill$ 20,000 Total Intangible Assets$ 20,000 Total Assets$826,000

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved Fiberiffic’s Balance Sheet (Liabilities & Owner’s Equity) Fiberiffic, Inc. Period ending 3/31/02 Liabilities Current Liabilities Accounts Payable$ 40,000 Notes Payable 8,000 Accrued Taxes & Salaries 240,000 Total Current Liabilities$288,000 Long-term Liabilities Notes Payable$ 35,000 Bonds 290,000 Total Long-term Liabilities$325,000 Owner’s Equity Common Stock(1,000,000 shares)$100,000 Retained Earnings 113,000 Total Owner’s Equity$213,000 Total Liabilities & Owner’s Equity$826,000

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved Fiberiffic’s Income Statement Fiberiffic, Inc. Period Ending 12/31/02 Revenue Net Sales$ 700,000 Cost of Goods Sold Beginning Inventory$ 200,000 Merchandise Purchased$ 440,000 Cost of Goods Available for Sale$ 640,000 Less: Ending Inventory -$ 230,000 Cost of Goods Sold$ 410,000 Cost of Goods Sold$ 410,000 Gross Profit(Gross Margin)$ 290,000

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved Fiberiffic’s Income Statement (cont’d) Operating Expenses Selling Expenses Salaries$ 90,000 Advertising & Supplies$ 20,000 Total Selling Expenses$ 110,000 General Expenses Office Salaries$ 67,000 Depreciation$ 1,500 Insurance$ 1,500 Rent$ 28,000 Utilities$ 12,000 Miscellaneous$ 2,000 Total General Expenses$ 112,000 Total Operating Expenses$ 222,000 Net Profit (Income) Before Taxes$ 68,000 Less: Income Tax Expenses$ 19,000 Net Income (Profit) After Taxes$ 49,000

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved How to Read a Corporate Annual Report  Read management’s discussion of changes in operations. Try to identify strengths or weaknesses.  Review the firm’s consolidated balance sheet. (Its assets, liabilities, and owner’s equity.)  Analyze the Income Statement. Look beyond the year (Sales drops can spell trouble).  Review the statement of changes in cash flows.  Review auditor’s opinion.