Communicating and Interpreting Accounting Information Chapter 5 McGraw-Hill/Irwin © 2009 The McGraw-Hill Companies, Inc.

McGraw-Hill/Irwin Slide 2 Understanding the business Corporate Governance: Procedures to ensure that the company is managed in the interest of the shareholders Sarbanes-Oxley Act: A law which strengthens financial reporting and corporate governance for public companies. 5-2

McGraw-Hill/Irwin Slide 3 Players in the Accounting Communication Process 5-3

McGraw-Hill/Irwin Slide 4 Regulators Securities and Exchange Commission Protects investors and maintain the integrity of the securities market. Financial Accounting Standards Board Sets Generally Accepted Accounting Standards (GAAP). Public Company Accounting Oversight Board Sets auditing standards for independent auditors (CPAs) of public companies. 5-4

McGraw-Hill/Irwin Slide 5 Managers 5-5 Managers are responsible for the information in the financial statements and disclosures. Chief Executive Officer (CEO): highest officer of the company Chief Financial Officer (CFO): highest officer associated with the financial and accounting side of the business Accounting staff prepare the details of the reports and also bear professional responsibility for the accuracy of the information. Managers are responsible for the information in the financial statements and disclosures. Chief Executive Officer (CEO): highest officer of the company Chief Financial Officer (CFO): highest officer associated with the financial and accounting side of the business Accounting staff prepare the details of the reports and also bear professional responsibility for the accuracy of the information.

McGraw-Hill/Irwin Slide 6 Independent Auditors Follow established auditing standards to assess the fairness of the financial statements and related presentations Independent Auditors Follow established auditing standards to assess the fairness of the financial statements and related presentations Auditors An unqualified, or clean, opinion states that the financial statements are fair presentations in all material respects in conformity with GAAP. Unqualified Opinion 5-6

McGraw-Hill/Irwin Slide 7 Board of Directors (Audit Committee) Board of Directors The board of directors is elected by the stockholders to represent their interests. Board of Directors The board of directors is elected by the stockholders to represent their interests. Board of Directors (Audit Committee) The audit committee of the board of directors is responsible for maintaining the integrity of the company’s financial reports. Board of Directors (Audit Committee) The audit committee of the board of directors is responsible for maintaining the integrity of the company’s financial reports. 5-7

McGraw-Hill/Irwin Slide 8 Annual Reports For privately held companies, annual reports are simple documents that include: For privately held companies, annual reports are simple documents that include: 1. Four basic financial statements. 2. Related notes (footnotes). 3. Report of independent accountants (auditor’s opinion) if the statements are audited.

McGraw-Hill/Irwin Slide 9 Annual Reports For public companies, annual reports are elaborate due to SEC reporting requirements: 1. Nonfinancial Section  Includes a letter to the stockholders, a description of management’s philosophy, products, successes, etc. 2. Financial Section  SEC sets minimum disclosure standards for the financial section for public companies. For public companies, annual reports are elaborate due to SEC reporting requirements: 1. Nonfinancial Section  Includes a letter to the stockholders, a description of management’s philosophy, products, successes, etc. 2. Financial Section  SEC sets minimum disclosure standards for the financial section for public companies.

McGraw-Hill/Irwin Slide 10 Annual Reports to Shareholders 1.Summarized financial data for 5- or 10-years. 2.Management Discussion and Analysis (MD&A). 3.The four basic financial statements. 4.Notes (footnotes). 5.Independent Accountant’s Report and the Management Certification. 1.Summarized financial data for 5- or 10-years. 2.Management Discussion and Analysis (MD&A). 3.The four basic financial statements. 4.Notes (footnotes). 5.Independent Accountant’s Report and the Management Certification. 6.Recent stock price information. 7.Summaries of the unaudited quarterly financial data. 8.Lists of directors and officers of the company and relevant addresses. 6.Recent stock price information. 7.Summaries of the unaudited quarterly financial data. 8.Lists of directors and officers of the company and relevant addresses.

McGraw-Hill/Irwin Slide 11 Quarterly Reports to Shareholders Usually begin with short letter to stockholders Usually begin with short letter to stockholders Condensed unaudited income statement and balance sheet for the quarter. Condensed unaudited income statement and balance sheet for the quarter. Often, cash flow statement and statement of stockholders’ equity are omitted. Some notes to the financial statements also may be omitted. Often, cash flow statement and statement of stockholders’ equity are omitted. Some notes to the financial statements also may be omitted. Usually begin with short letter to stockholders Usually begin with short letter to stockholders Condensed unaudited income statement and balance sheet for the quarter. Condensed unaudited income statement and balance sheet for the quarter. Often, cash flow statement and statement of stockholders’ equity are omitted. Some notes to the financial statements also may be omitted. Often, cash flow statement and statement of stockholders’ equity are omitted. Some notes to the financial statements also may be omitted.

McGraw-Hill/Irwin Slide 12 SEC Reports – 10-K, 10-Q, 8-K Form 10-K Annual Report Due within 90 days of the fiscal year-end. Contains audited financial statements. Form 10-K Annual Report Due within 90 days of the fiscal year-end. Contains audited financial statements. Form 10-Q Quarterly Report Due within 45 days of the end of the quarter. Financial statements can be unaudited. Form 10-Q Quarterly Report Due within 45 days of the end of the quarter. Financial statements can be unaudited. Form 8-K Current Report Due within 4 days of the major event date. Form 8-K Current Report Due within 4 days of the major event date.

McGraw-Hill/Irwin Slide 13 Statement of Comprehensive income 5-13

McGraw-Hill/Irwin Slide 14 Gross Profit Percentage 5-14

McGraw-Hill/Irwin Slide 15 Return on Assets (ROA) Analysis 1 (beginning total assets + ending total assets) ÷ 2 Return on Assets = Net Income* Average Total Assets 1 ROA measures how much the firm earned for each dollar of investment. * (In complex calculations, interest expense (net of tax) and minority interest are added back to net income.

McGraw-Hill/Irwin Slide 16 ROA Profit Driver Analysis ROA Net Profit Margin Asset Turnover =× Net Income Average Total Assets Net Income Average Total Assets Net Income Net Sales Net Income Net Sales Average Total Assets Net Sales Average Total Assets × =

McGraw-Hill/Irwin Slide 17 Differences in Accounting Methods acceptable under ifrs and u.s. gaap Many countries have adopted international financial reporting standards (IFRS) issued by the International Accounting Standards Board (IASB). IFRS are similar to U.S. GAAP, but there are several important differences. The FASB and IASB are working together to eliminate these and other differences. 5-17

© 2008 The McGraw-Hill Companies, Inc. End of Chapter 5