McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved Chapter 1818 Understanding Financial Information and Accounting 18-1

McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved Importance of Financial Information Definition- AccountingDefinition- Accounting AudiencesAudiences -Managers -Government -Investors, Suppliers & Creditors

McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved The Accounting System

McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved Government- assists with tax collection The Influence of Accounting Information Managers- Financial reports pinpoint problems/opportunities Investors, Suppliers, & Creditors- provides a means to analyze business

McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved Areas of Accounting Managerial AccountingManagerial Accounting -Inside Organization -C.M.A. Financial AccountingFinancial Accounting -Annual Report -Private Accountant -Public Accountant -C.P.A. AuditingAuditing Tax AccountingTax Accounting Government & Not- for-profit AccountingGovernment & Not- for-profit Accounting

McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved Top Business Uses of Accountants

McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved Public  Auditing  Tax Consulting & Compliance  Management Consulting Private  Management Accounting  Government Accounting  Academia Types of Accountants

McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved “Cooking the Books” Early Recognition of Revenue Late Recognition of Expense Inadequate Reserves for Bad Debts, Returns, & Liabilities Changing Inventory Valuation Methods- 1 Time Boost to Income Phony Transactions With Partnerships Courtesy of B. Lilly- De Anza College

McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved Steps to Control Accounting Practices Source: USA Today, “Snapshots”, Section B, pg. 1, March 26, 2003

McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved Bookkeeping vs. Accounting Bookkeeping –Start of Accounting –Record/Journalize Accounting –Analyze –Recommend

McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved Steps In The Accounting Cycle Analyze Source Documents Record Transactions in Journals Post Journal Entries to Ledger Take a Trial Balance Prepare Financial Statements Analyze Financial Statements

McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved Computers & Accounting Tool Not Decision MakerTool Not Decision Maker SimplificationSimplification Accounting PackagesAccounting Packages Up-To-the-Minute InformationUp-To-the-Minute Information Less MonotonyLess Monotony

McGraw-Hill/Irwin Understanding Business, 7/e © 2005 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 Cash Receipts & Disbursements

McGraw-Hill/Irwin Understanding Business, 7/e © 2005 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 Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved Fiberrific’s Balance Sheet (Assets) Fiberriffic, Inc. Period ending 12/31/04 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) 40,000 Furniture & Fixtures (net) 16,000 Total Fixed Assets$206,000 Intangible Assets Goodwill$ 20,000 Total Intangible Assets$ 20,000 Total Assets$826,000

McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved Fiberrific’s Balance Sheet (Liabilities & Owner’s Equity) Fiberiffic, Inc. Period ending 12/31/04 Liabilities & Owners’ Equity 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 Payable 290,000 Total Long-term Liabilities$325,000 Total Liabilities$613,000 Owners’ Equity Common Stock (1M shares) $100,000 Retained Earnings 113,000 Total Owners’ Equity$213,000 Total Owners’ Equity$213,000 Total Liabilities & Owners’ Equity$826,000

McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved Fiberrific’s Income Statement Fiberiffic, Inc. Period Ending 12/31/04 Revenue Net Sales$ 700,000 Cost of Goods Sold Beginning Inventory $ 200,000 Net Purchases $ 440,000 Cost of Goods $ 640,000 Less: Ending Inventory - $ 230,000 Less: Cost of Goods Sold - $ 410,000 Less: Cost of Goods Sold - $ 410,000 Gross Profit (Gross Margin)$ 290,000

McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved Fiberrific’s Income Statement (cont’d) Gross Profit $290,000 Operating Expenses Selling Expenses Salaries$ 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 Less: Total Operating Expenses - $ 222,000 Net Income (Profit) Before Taxes$ 68,000 Less: Income Tax Expenses -$ 19,000 Net Income (Profit) After Taxes$ 49,000

McGraw-Hill/Irwin Understanding Business, 7/e © 2005 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 Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved Applying Accounting Knowledge in Business  Depreciation  Inventory Valuation  FIFO- First In First Out  LIFO- Last In First Out

McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved Liquidity Ratios Current Assets Current Liabilities Quick (Acid-Test) Ratio Cash + Marketable Securities + Receivables Current Liabilities Current Ratio

McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved Current Ratio- Fiberrific $600,000$288,000 =2.08

McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved Quick (Acid-Test) Ratio $265,000$288,000 =0.92

McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved Debt to Equity Ratio $613,000$213,000 = 287% Total Liabilities Owners’ Equity

McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved Profitability Ratios Profitability = Operating Success Return on Sales Net Income Net Sales Net Income Owners’ Equity Earnings Per Share Net Income # Common Shares Return on Equity

McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved Profitability Ratios Earnings per Share$ 49,000 = $.049 1,000,000 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 Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved Activity Ratios Inventory Turnover $410,000 = 1.9 $215,000 $215,000 Inventory Turnover Cost of Goods Sold Avg. Inventory

McGraw-Hill/Irwin Understanding Business, 7/e © 2005 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 owners’ 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.