Presentation is loading. Please wait.

Presentation is loading. Please wait.

Financial Accounting: Tools for Business Decision Making

Similar presentations

Presentation on theme: "Financial Accounting: Tools for Business Decision Making"— Presentation transcript:

1 Financial Accounting: Tools for Business Decision Making
Kimmel, Weygandt, Kieso, Trenholm KIMMEL Prepared by: Barbara Trenholm University of New Brunswick

2 Chapter 2 A Further Look at Financial Statements
After studying Chapter 2, you should be able to: Describe the basic objective of financial reporting, and explain the meaning of generally accepted accounting principles. Discuss the qualitative characteristics of accounting information. Identify two constraints in accounting. Identify the sections of a classified balance sheet. 1

3 Chapter 2 A Further Look at Financial Statements
After studying Chapter 2, you should be able to: Identify and compute ratios for analysing a company's profitability. Explain the relationship between a statement of retained earnings, a statement of earnings, and a balance sheet. Identify and compute ratios for analysing a company's liquidity and solvency. 2

4 Objective of Financial Reporting
Provide the most useful financial information for decision making 4

5 General Guide for Financial Reporting
Generally Accepted Accounting Principles

6 Characteristics of Useful Information
Understandability Relevance Reliability Comparability and consistency

7 Characteristics of Useful Information
Illustration 2-1 Characteristics of Useful Information

8 Constraints in Accounting
Modify GAAP without hurting the usefulness of information Cost-benefit Materiality 10

9 Classified Balance Sheet
Generally contains the following standard classifications: Assets Current assets Long-term investments Capital assets Liabilities Current liabilities Long-term liabilities Shareholders’ Equity Share capital Retained earnings 21

10 Current Assets Assets expected to be converted to cash or used in the business within the year Listed in order of liquidity Examples Cash Short-term investments Receivables Inventories Prepaid expenses 22

11 Long-Term Investments
Assets that can be converted into cash, but whose conversion is not expected within one year Assets not intended for use within the business Example Investments in shares and bonds of other corporations 23

12 Capital Assets Assets with relatively long useful lives
Assets used in operating the business Two categories of capital assets Tangible (with physical substance) Intangible (with no physical substance)

13 Tangible Capital Assets
Examples Property, plant, and equipment Land Buildings Machinery and equipment Furniture and fixtures Natural resources Mineral deposits Timber 24

14 Intangible Capital Assets
Examples Patents Copyrights Trademarks or trade names Franchise Intangible assets have value because of the exclusive rights or privileges they possess

15 Amortization Allocation of an asset’s full purchase price to match cost to revenues over entire estimated useful life instead of expensing full cost in year of purchase Amortization is allocated for all capital assets except land 24

16 AMORTIZATION Accumulated amortization account shows the total amount of amortization taken to date The difference between the cost of the asset and its accumulated amortization is referred to as the net book value of the asset 8

17 CSU CORPORATION Balance Sheet December 31, 2001
Capital assets should be shown at net book value (cost less accumulated amortization) Assets Cash $ 2,000 Accounts receivable 4,000 Supplies 1,800 Equipment 24,000 Less: Accumulated amortization 8, ,000 Total assets $23,800 24

18 Current Liabilities Obligations that are supposed to be paid within the coming year Accounts payable Wages payable Notes (bank loans) payable Interest payable Taxes payable Current maturities of long-term liabilities

19 Long-Term Liabilities
Debts expected to be paid after one year Bonds payable Mortgages payable Long-term notes payable Capital lease liabilities Obligations under employee pension plans 27

20 Shareholders' Equity Share capital Retained earnings
Investments in the business by the shareholders Retained earnings Earnings kept for use in the business 28

21 Current Current Assets Current assets Cash $ 272
ANY CORPORATION Balance Sheet (Sample Presentation) December 31, 2001 (in millions) Assets Current assets Cash $ Short-term investments (current) Receivables Other current assets Total current assets 1,038 Investments (long-term) Capital assets Other long-term assets Total assets $ 1,957 Liabilities and Shareholders’ Equity Liabilities Current liabilities Notes payable $ 527 Accounts payable 233 Income taxes payable Total current liabilities 816 Long-term debt 83 Total liabilities 899 Shareholders’ equity Share capital 830 Retained earnings 228 Total shareholders’ equity ,058 Total liabilities and shareholders’ equity $ 1,957 Current Current

22 Ratio Analysis Mathematical relationship
Relationship can be expressed in terms of Percentage Rate Proportion

23 Comparisons Intracompany (prior years of your company)
Intercompany (between companies) Industry averages

24 Financial Ratio Classifications
Profitability ratios Measures of the earnings or operating success of a company for a given period of time Liquidity ratios Measures of short-term ability of the company to pay its maturing obligations and to meet unexpected needs for cash Solvency ratios Measures of the ability of a company to survive over a long period of time

25 Using the Statement of Earnings
With profitability ratios Return on assets Profit margin

26 Profitability Return On Assets Ratio
Reveals the amount of net earnings generated by each dollar invested Return on assets = Net earnings Average total assets Higher value suggests favourable efficiency 18

27 Profitability Profit Margin Ratio
Measures the percentage of each dollar of sales that results in net earnings Profit margin = Net earnings Net sales Higher value suggests favourable return on each dollar of sales 19

28 Using the Statement of Retained Earnings
Describes the events that caused changes in the retained earnings account for the period Increased by earnings Decreased by losses and dividends + - 20

29 CSU CORPORATION Statement of Retained Earnings For the Year Ended December 31, 2001
Retained earnings, January 1 $ (1) Add: Net earnings 6,800 (2) 6,800 Less: Dividends Retained earnings, December 31 $ 6,800 (3) Statement interrelationships: Opening retained earnings comes from, and agrees to, ending retained earnings on prior period balance sheet Net earnings comes from, and agrees to, net earnings on statement of earnings Ending retained earnings goes to, and agrees to, ending retained earnings on current period balance sheet

30 Using the Balance Sheet
With liquidity ratios Working capital Current ratio With solvency ratios Debt to total assets

31 Liquidity Working Capital
Measures short-term ability to pay liabilities Current assets - current liabilities = Working capital 31

32 Liquidity Current Ratio
Measure of short term ability to pay obligations Current ratio = Current assets Current liabilities 32

33 Solvency Debt to Total Assets
Measures % of assets financed by creditors Debt to total assets = Total liabilities Total assets 33

34 Using the Statement of Cash Flows
To provide information about Cash receipts Cash payments Changes in cash (and cash equivalents) From changes in Operating activities Financing activities Investing activities 35

35 Operating Activities Cash inflows and cash outflows associated with the primary operations of the business 38

36 Financing Activities Cash inflows / outflows come from sources funding the business Sale of shares / payment of dividends Issuing debt / repaying debt 36

37 Investing Activities Cash inflows/ outflows result from changes in investments and capital assets Purchasing/disposing of investments and long-lived assets using cash Lending money and collecting the loans 37

38 Liquidity Cash Current Debt Coverage
Measures ability to generate sufficient cash to satisfy short-term needs Cash current debt coverage ratio = Cash provided by operating activities Average current liabilities 33

39 Solvency Cash Total Debt Coverage
Measures ability to generate sufficient cash to meet long-term needs Cash total debt coverage ratio = Cash provided by operating activities Average total liabilities

40 Decision Checkpoints Return on assets ratio
Is the company using its assets effectively? Is the company maintaining an adequate margin between sales and expenses? Can the company meet its short-term obligations? Can the company meet its long-term obligations? Return on assets ratio Profit margin ratio Working capital, current ratio, cash current debt coverage ratio Debt to total assets ratio, cash total debt coverage ratio

41 COPYRIGHT Copyright © 2001 John Wiley & Sons Canada, Ltd. All rights reserved. Reproduction or translation of this work beyond that permitted by CANCOPY (Canadian Reprography Collective) is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons Canada, Ltd. The purchaser may make back-up copies for his / her own use only and not for distribution or resale. The author and the publisher assume no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.

Download ppt "Financial Accounting: Tools for Business Decision Making"

Similar presentations

Ads by Google