1. DECISION MAKING BY THE NUMBERS
CHAPTER 8: Accounting
DECISION MAKING BY THE NUMBERS

2. Market Information Goal of business: To create wealth
Competing for transactions in the market
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)

3. FINANCIAL STATEMENTS: THE MAIN OUTPUT OF FINANCIAL ACCOUNTING
Financial accounting includes three basic financial statements:
Balance Sheet
assets: value of the stuff the organization controls
liabilities: debt claims against the stuff
owners’ equity: owners’ claims against the stuff
Income Statement
revenues ($ coming in)
expenses ($ going out)
Statement of Cash Flows
Corporations with publicly held stock must publish annual reports with all three statements

4. BALANCE SHEET: WHAT WE OWN AND HOW WE GOT IT
Balance Sheet – summarizes a firm’s financial position at a specific point in time.
Liabilities –
indicates what
the firm owes to
non-owners
Assets –
things of
value that
the firm owns
Owner’s
Equity –
the claims owners
have against
their firm’s
assets
Assets =
Liabilities + Owner’s Equity

5. Stuff & claims against stuff
Car $4,000
Claims against stuff
Dave (owner) $3,000
Becky (loan) $1,000

6. Stuff & claims against stuff
House $140,000
Claims against stuff
Bank (debt) $115,000
Dave (owner) $ 25,000

7. Stuff & claims against stuff
Car $4,000
Claims against stuff
Dave (owner) $3,000
Becky (debt: 6 mo) $1,000
Stuff
House $140,000
Claims against stuff
Bank (debt) $115,000
Dave (owner) $ 25,000

8. Snap shot: The Balance Sheet
Assets (stuff)
car 4,000
house 140,000
total 144,000
Liabilities and Owners Equity
short term liabilities (becky) 1,000
long term liabilities (bank) 115,000
equity (car and house) 28,000 $ $

9. SAMPLE BALANCE SHEET

10. Foundation & Accounting Numbers
Balance Sheet
Assets Cash Accounts Receivable
Inventory Total Current Assets
Plant & Equipment Accumulated Depreciation
Total Fixed Assets
Total Assets
12/31/07
26.8%
16.1%
11.3%
54.2%
69.1%
-23.2%
45.8%
100.0%
$5,593
$3,353
$2,353
$11,299
$14,400
($4,848)
$9,552
$20,852

11. Foundation & Accounting Numbers
Liabilities & owner's equity
Accounts Payable
Current Debt
Long Term Debt
Total Liabilities
Common Stock
Retained Earnings
Total Equity
Total Liability & Owner’s Equity
$2,855 $0
$5,200
$8,055
$2,313
$10,485
$12,798
$20,852
13.7%
0.0%
24.9%
38.6%
11.1%
50.3%
61.4%
100.0%

12. THE INCOME STATEMENT: HOW DID WE DO?
Income Statement – summarizes a firm’s operations over a given period of time in terms of profit and loss.
Expenses –
the cash the firm
spends or other
assets it uses to
generate
revenue
Revenue–
the increase in
the amount of
assets the firm
earns
Net Income –
the profit or loss
the firm earns
Revenue – Expenses =
Net Income

13. SAMPLE INCOME STATEMENT

14. Foundation & Accounting Numbers
Income Statement
Total %
Sales
$40,800
100.0
Variable Costs
Direct Labor
$12,138
29.7
Direct Material
$20,240
49.6
Inventory Carry
$282
0.7
Total Variable Cost
$32,660
80.0
Contribution Margin
$8,140
20.0

15. Period Costs % Depreciation $960 2.4 SGA: R&D $0 0.0 $1,000 2.5 $637
Promotions
$1,000
2.5
Sales
Administration
$637
1.6
Total Period Costs
$3,597
8.8
Net Margin
$4,543
11.1
Other
EBIT
Short Term Interest
Long Term Interest
$641
Taxes
$1,365
3.3
Profit Sharing
$51
0.1
Net Profit
$2,485
6.1

16. STATEMENT OF CASH FLOWS: SHOW ME THE MONEY
Cash flowing into and out of the firm
Operations
Investing
Financing
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
Note the other statements that are relevant for management and audit.

17. SAMPLE STATEMENT OF CASH FLOWS

18. ADDITIONAL FINANCIAL STATEMENTS
Statement of Retained Earnings – reports how retained earnings have changed.
Stockholder’s Equity Statement – reports how net income and dividends affect retained earnings.

19. 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)
Click the link to view the notes in McDonald’s Annual report noting the independence of their auditors. Note that much of the increased demand in accounting careers are an indirect result of the scandals and the creation of new laws.

20. BEYOND THE STATEMENTS
Horizontal Analysis – compares information in a firm’s financial statement over a period of 2 years or more.
Vertical Analysis – expresses items on the balance sheet and income statement as a percentage of a key value.
Ratio Analysis – compares selected items by computing percentages, rates or proportions.

21. MANAGERIAL ACCOUNTING VS. FINANCIAL ACCOUNTING

22. MANAGERIAL ACCOUNTING: INSIDE INTELLIGENCE
Reports and analysis for informed business decisions
Product Costing
Accurate measure and analysis of costs
Activity Based Costing (ABC)

23. INCREMENTAL ANALYSIS
Evaluates the financial impact of different alternatives
in a decision-making situation.
Make parts or buy from supplier?
Repair equipment or buy new?
Perform repairs or outsource?
Eliminate or sell product line/business?

24. INCREMENTAL ANALYSIS DECISION
An electronics firm produces high definition LCD televisions at a rate of 10,000 per month. It currently makes its own speaker sets for the televisions.
A supplier offers to sell the firm similar speakers at a cost of $23 per television. The firm could lower costs by buying the speakers, $23 is less than $26. Right?

25. COST OF MAKING TELEVISION SPEAKERS: MAKE OR BUY?