CHAPTER 8: ACCOUNTING DECISION MAKING BY THE NUMBERS

Market Information  How can you tell how well you are doing?  Measure individual transactions  Put them all together – How much “stuff” (acquired wealth) do you have Where did it come from? (assets = liabilities + owners equity) How much new wealth are you creating with it? (revenue - expense = profit)  Goal of business: To create wealth  Competing for transactions in the market  What are Your Personal Goals?

Financial statements: the main output of financial accounting  Financial accounting includes three basic financial statements:  Balance Sheet assets: value of the stuff the you or the organization controls liabilities: debt claims against the stuff owners’ equity: owners’ claims against the stuff  Income Statement revenues ($ coming in) revenues ($ coming in) expenses ($ going out) expenses ($ going out)  Statement of Cash Flows  Companies with more than $10 million in assets and a class of equity securities that is held by more than 500 owners must file annual and other periodic reports, regardless of whether the securities are publicly or privately traded.  The 10-K includes information such as company history, organizational structure, executive compensation, equity, subsidiaries, and audited financial statements, among other information.

Let’s Look At It From a Personal Perspective  Do you use a personal budget?  How do you monitor your budget?  What software/tools do you use?  What type of costs do you categorize?  What short and long-term goals are you aiming for?  Is it evident in your budget?  How do you manage your finances for the future? 4

Personal Financial Planning  Financial planning starts with outlined goals for companies and individuals.  If you want to have a million dollars by age 65.  If you save $286 per month at age 25, you will have a million dollars by age 65.  But, you would need to save $488 or $1,689 at ages 35 and 45 to reach that amount.  With an 8% return, planning to be a millionaire is very possible!

Balance sheet: what we own and how we got it Owner’s Equity – the claims owners have against their firm’s assets Balance Sheet – summarizes a firm’s financial position at a specific point in time. Assets – things of value that the firm owns Liabilities – indicates what the firm owes to non-owners =+

Stuff & claims against stuff Stuff Checking $ 1,500 Savings $ 2,000

Stuff & claims against stuff Stuff Checking $ 1,500 Savings $ 2,000 Tires$ 450 Claims against stuff Credit Card$ 450

Stuff & claims against stuff Stuff Checking $ 1,500 Savings $ 2,000 Tires$ 450 Car $23,000 Claims against stuff Credit Card$ 450 Dave (owner) $ 3,000 Credit Union (loan)$20,000

Stuff & claims against stuff Stuff House $150,000 Claims against stuff Bank (debt) $115,000 Dave (owner) $ 35,000

Stuff & claims against stuff Stuff Checking $ 1,500 Savings $ 2,000 New Tires$ 450 Car $23,000 Claims against stuff Credit Card $ 450 Dave (owner) $ 3,000 Credit Union (loan )$20,000 Stuff House $150,000 Claims against stuff Bank (debt) $115,000 Dave (owner) $ 35,000

Snap shot: Personal Balance Sheet Assets Checking $1,500 Savings 2,000 Tires 450 Car 23,000 House 150,000 Total Assets$176,950 Liabilities Credit Card $450 Car 20,000 Bank - mortgage 115,000 Equity (car and house and money) 41,000 Total Liabilities$176,950

The income statement: how did we do? Net Income – the profit or loss the firm earns Income Statement – summarizes a firm’s operations over a given period of time in terms of profit and loss. Revenue– the increase in the amount of assets the firm earns Expenses – the cash the firm spends or other assets it uses to generate revenue -=

OK… You Have a Paycheck Name Address City, State Zip Employee ID: Department: Location: Marital Status: Allowances: Addl %: Addl Amt: Hours and Earnings ---Current YTD----- Description Rate Hours Earnings Hours Earnings Total Taxes: Current YTD Fed Withholding Fed MED/EE Fed OASD/EE Before Tax Deduction Parking Permit Retirement / 401K After Tax Deduction United Way Campaign Employer Paid Benefits Life Basic Retirement / 401K Total Gross FED Taxable Gross Total Taxes Total Deduction Current: YTD: YTD Hours VAC SICK FICA Taxable Gross Net Pay Distribution Medicare Taxable Gross

w4 Fill Out Your W-4

OK… You Have a Paycheck – Taxes and Deductions Name Address City, State Zip Employee ID: Department: Location: Marital Status: Allowances: Addl %: Addl Amt: Hours and Earnings ---Current YTD Description Rate Hours Earnings Hours Earnings Total Taxes: Current YTD Fed Withholding 2013 Tax Tables Fed MED/EE 1.45% Fed OASD/EE 6.20% Before Tax Deduction Parking Permit Retirement / 401K After Tax Deduction United Way Campaign Employer Paid Benefits Life Basic Retirement / 401K Total Gross FED Taxable Gross Total Taxes Total Deduction Current: YTD: YTD Hours VAC SICK FICA Taxable Gross Net Pay Distribution Medicare Taxable Gross

OK… You Have a Paycheck – Net Pay Calculation Pay Begin Date: 6/01/2013 Pay End Date: 6/30/2013 Name Address City, State Zip Employee ID: Department: Location: Marital Status: Single Allowances: 1 Addl %: 0 Addl Amt: 0 Hours and Earnings ---Current YTD Description Rate Hours Earnings Hours Earnings Regular 3, , Holiday Total Taxes: Current YTD Fed Withholding Fed MED/EE Fed OASD/EE Before-Tax-Deduction Parking Permit Retirement / 401K After-Tax-Deduction United Way Campaign Employer Paid Benefits Life Basic Retirement / 401K Total Gross FED Taxable Gross Total Taxes Total Deduction Net Pay Current: 3, , , YTD: 22, , , , , YTD Hours VAC SICK FICA Taxable Gross Net Pay Distribution , , Medicare Taxable Gross 22, Assumptions: Salary - $45,000 Paid Monthly - $3,750 Single 401K deduction - 5% Employer match United Way - $120/yr tools/payroll-calculators/salary-paycheck-calculator.aspx

Monthly Income Statement Income Wages $ 2,794 Expenditures for Donations $ Church 100 Expenditures for Living Expenses $ Food 500 Mortgage – principal, interest, taxes, insurance 778 Utilities – gas, electric, water 150 Credit Card 100 Car loan 439 Insurance – car 150 Gas 200 Medical 125 Clothing 50 Entertainment 200 Total Expenditures $2,792 Total Income Less Expenditures $2 Assumptions: Salary - $45, Yr Mortgage 3.835% Principal & Interest - $562 Property Taxes - $150 Homeowners Insurance - $67 Auto Loan 4 years 1.9% interest

Personal investing  What are your short-term and long-term goals?  Given your budget, how much are you able to invest?  How long can you leave your money invested?  How concerned are you about the tax implications of your investments?  How much tolerance do you have for risk?  DIVERSIFICATION

Direct stock purchase plans  Many Corporations offer Direct Stock Purchase Plans  Purchase stock direct from company  Dividend Reinvestment Plans (DRIPS) allow current stockholders to reinvest dividends to purchase additional stock

Strategies for investing in securities  Investing for Income  Market Timing  Value Investing  Investing for Growth  Buying and Holding

From a Business Perspective  How can you tell how well you are doing?  Measure individual transactions  Put them all together – How much “stuff” (acquired wealth) do you have Where did it come from? (assets = liabilities + owners equity) How much new wealth are you creating with it? (revenue - expense = profit)  Goal of business: To create wealth  Competing for transactions in the market

Financial statements: the main output of financial accounting  Financial accounting includes three basic financial statements:  Balance Sheet assets: value of the stuff that you or the organization controls liabilities: debt claims against the stuff owners’ equity: owners’ claims against the stuff  Income Statement revenues ($ coming in) revenues ($ coming in) expenses ($ going out) expenses ($ going out)  Statement of Cash Flows  Companies with more than $10 million in assets and a class of equity securities that is held by more than 500 owners must file annual and other periodic reports, regardless of whether the securities are publicly or privately traded.  The 10-K includes information such as company history, organizational structure, executive compensation, equity, subsidiaries, and audited financial statements, among other information.

The Independent Auditor’s Report: A Necessary Stamp of Approval Publicly traded corporations are required to have a CPA firm perform an external audit Rigorous Process Check figures and methods Physical Counts The auditor will issue an unqualified, qualified or adverse opinion Auditors must be independent No problem here! Slight concern, but probably OK! Seriously flawed, probably misleading and unreliable

Checking Out the Notes to Financial Statements: What’s in the Fine Print? Additional information may be required to explain the numbers, and notes can be very revealing: Can be many pages… Additional information about operations Clarify and supplement numbers Explain accounting methods or changes Detail status of lawsuits Another important section: Management’s Discussion and Analysis

Managerial Accounting vs. Financial Accounting Financial AccountingManagerial Accounting Purpose Primarily intended to provide information to external stakeholders; stockholders, creditors, and government regulators. Information is generally available to the general public. Primarily intended to provide information to internal stakeholders; managers of specific departments or divisions. Information is proprietary and is not available to the general public. Type of Information Presented Focuses almost exclusively on financial information. Provides both financial and nonfinancial information. Nature of Reports Prepares a standard set of financial statements. Prepares customized reports to deal with specific problems or issues. Timing of Reports Presents financial statements on a predetermined schedule – usually quarterly and annual. Creates repots upon request rather than on a predetermined schedule. Adherence to Accounting Standards Governed by a set of Generally Accepted Accounting Principles - GAAP Uses procedures developed internally that are not required to follow GAAP Time period Focus Summarizes past performance and its impact on the form’s present condition. Provided reports dealing with past performance, but also involves making projections about the future when dealing with planning issues.

Looking for Trends in Comparative Statements  The SEC requires publicly traded companies to provide comparative financial statements 2-3 years of figures side-by-side View changes over a period of time Trace what has happened to key assets and liabilities  Comparative analysis is a form of horizontal analysis

So What’s New or Different? Products Office Factories People

What Do You Need To Do To Make Your Business Successful?                

Types of Costs Out-of-pocket costs – also called explicit costs; actual expenditures. Payments made to suppliers, workers and rent for office space Implicit costs– opportunity costs; not monetary but what is given up Fixed costs– do not changes with levels of production Variable costs– rise and vary when the firm produces goods and services

Developing the Key Budget Components: One Step at a Time Operating Budgets identify sales and production goals. Sales Budget Production Budget Direct Labor Budget Financial Budgets focus on the firm’s financial objectives. Cash Budget Capital Budget Master Budget – brings together all of the budgets to represent the overall plan

Balance sheet: what we own and how we got it Owner’s Equity – the claims owners have against their firm’s assets Assets – things of value that the firm owns Liabilities – indicates what the firm owes to non-owners =+

Sample balance sheet

Foundation & Accounting Numbers Balance Sheet (in 000’s) Total% Assets 12/31/08 Cash$5, % Accounts Receivable$3, % Inventory$2, % Total Current Assets$11, % Plant & Equipment$14, % Accumulated Depreciation($4,848)-23.2% Total Fixed Assets $9, % Total Assets$20, %

Foundation & Accounting Numbers Liabilities & Owner's EquityTotal% Accounts Payable$2, % Current Debt$00.0% Long Term Debt$5, % Total Liabilities$8, % Common Stock$2, % Retained Earnings$10, % Total Equity$12, % Total Liability & Owner’s Equity$20, %

The income statement: how did we do? Net Income – the profit or loss the firm earns Income Statement – summarizes a firm’s operations over a given period of time in terms of profit and loss. Revenue– the increase in the amount of assets the firm earns Expenses – the cash the firm spends or other assets it uses to generate revenue -=

Sample income statement Depreciation is a loss in value of an asset, and so is treated as an expense here. However, no cash exchanges hands. Capsim calls this Contribution Margin New Cash infused into the company

Foundation & Accounting Numbers Income Statement (in 000’s) Total% Sales$40, Variable Costs Direct Labor$12, Direct Material$20, Inventory Carry$ Total Variable Cost$32, Contribution Margin$8,

Period Costs% Depreciation$ SGA: R&D $00.0 Promotions $1, Sales $1, Administration $ Total Period Costs$3, Net Margin$4, Other$00.0 EBIT$4, Short Term Interest$00.0 Long Term Interest$ Taxes$1, Profit Sharing$510.1 Net Profit$2,4856.1

Statement of cash flows: show me the money  Increase and decrease from all three sources  Total amount of cash on hand  Stakeholders want to know if there is adequate cash to pay workers, creditors, suppliers and IRS Operations Investing Financing

Sample statement of cash flows Remember that we treated this as an expense in the income statement and so subtracted it from our incoming revenue. However, no cash exchanged hands, so we add this back in to show that. New cash from the income statement

Foundation & Accounting Numbers Cash Flows from Operating Activities: (in 000’S)2011 Net Income (Loss)$2,485 Depreciation$960 Extraordinary gains/losses/writeoffs$0 Accounts Payable$855 Inventory($2,353) Accounts Receivable$3,647 Net cash from operations$5,593 Cash Flows from Investing Activities: Plant Improvements$0 Cash Flows from Financing Activities: Dividends Paid($1,000) Sales of Common Stock$0 Purchase of Common Stock$0 Cash from long term debt$0 Retirement of long term debt$0 Change in current debt (net)$0 Net cash from financing activities($1,000) Net change in cash position$4,593 Closing cash position$5,593

Sarbanes-Oxley act of 2002  Commonly referred to as SOX  Banned relationships between CPA firms that might create conflict of interest  Created Public Company Accounting Oversight Board (PCOAB)

Balance Sheet Horizontal Analysis – compares information in a firm’s financial statement over a period of 2 years or more. ASSETS Cash$2,8265.3%$4, % Accounts Receivable$11, %$9, % Inventory$4,1537.8%$00.0% Total Current Assets $18, %$13, % Plant & Equipment$44, %$30, % Accumulated Depreciation($10,536)-19.9%($7,787)-21.8% Total Fixed Assets $34, %$22, % Total Assets $52, %$35, % LIABILITIES & OWNERS' EQUITY Accounts Payable$5, %$4, % Current Debt$00.0%$8672.4% Long Term Debt$4,3338.2%$4, % Total Liabilities $9, %$9, % Common Stock$18, %$8, % Retained Earnings$25, %$17, % Total Equity$43, %$26, % Total Liab. & O. Equity$52, %$35, %

Income Statement Vertical Analysis – expresses items on the balance sheet and income statement as a percentage of a key value. AbleAsableAbeAmableAleNA 2019 Total Sales$56,852$56,826$66,285$26,942$0 $206, % Variable Costs: Direct Labor$6,894$7,401$9,968$4,950$0 $29, % Direct Material$19,086$23,446$25,368$10,824$0 $78, % Inventory Carry$162$0 $320$0 $4820.2% Total Variable$26,142$30,846$35,336$16,094$0 $108, % Contribution Margin$30,710$25,980$30,949$10,848$0 $98, % Period Costs: Depreciation$3,467$2,153$2,880$693$0 $9,1934.4% SG&A: R&D$622$541$588$410$1,000$0 $3,1621.5% Promotions$1,740$2,500 $2,000$0 $8,7404.2% Sales$3,000 $1,500$0 $10,5005.1% Admin$673 $785$319$0 $2,4491.2% Total Period$9,502$8,867$9,753$4,922$1,000$0 $34, % Net Margin$21,208$17,113$21,196$5,925($1,000)$0 $64, % Other$1,3010.6% EBIT$63, % Short Term Interest$00.0% LongTerm Interest$1,2580.6% Taxes$21, % Profit Sharing$8040.4% Net Profit$39, %