1. FHF McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

2. part CHAPTER 15 Money and the Financial System 6 FHF 14-2 CHAPTER 14 Accounting and Financial Statements CHAPTER 16 Financial Management and Securities Markets

3. FHF AccountingAccounting  The recording, measurement and interpretation of financial information, often used in making business decisions  The Financial Accounting Standards Board sets principles of financial accounting and reporting Accounting can be a difficult and contentious science 14-3 …continued on next page

4. FHF AccountingAccounting  GAAP  Generally accepted accounting principles  SEC  Securities & Exchange Commission provides oversight  Has assumed a larger oversight role in recent years 14-4

5. FHF Types of Accounting Certified Public Accountant (CPA)  An independent professional who provides accounting services to the public (individuals or firms) for a fee Private Accountant  An accountant employed by a corporation, government agency, or other organization  Can be CPAs and CMAs (Certified Management Accountant) 14-5

6. FHF Forensic Accounting  Analyzing financial data in search of fraudulent entries or financial misconduct  Can help uncover money laundering, terrorist activity  Marital and family law  A growth area for public accountants 14-6

7. FHF Accounting or Bookkeeping? Bookkeeping  Often (mistakenly) used interchangeably with accounting  The routine day-to-day recording of business transactions  Bookkeepers obtain and record the financial information that accountants then analyze 14-7

8. FHF What Does a Job in Accounting Involve? 14-8  Much more than number crunching  Requires an in-depth understanding of the industries in which your clients are involved  Transparency and open communication are essential One of the Big Four accounting firms Seeks out the best young talent to help the company grow into the future

9. FHF Uses of Accounting Information Internal  Managerial accounting is the internal use of accounting statements by managers in planning and directing organizational activities  Cash flow, the movement of money through an organization, is management’s greatest concern  Accounting helps management prepare a budget, an internal financial plan that forecasts expenses and income over a set period of time 14-9 …continued on next page

10. FHF Uses of Accounting Information External  Reporting to the IRS  The annual report, which is a summary of financial information, products and growth plans  Obtaining credit  As a gauge of performance 14-10

11. FHF Deceptive Accounting Practices Countries, states and companies have all engaged in deceptive accounting practices Hiding debt through off-balance sheet accounts Using derivatives to hide financial instability Overleveraging with too many loans Regulations try to minimize the practice Impossible to do away with all deceptive accounting 14-11

12. FHF Uses of Accounting Information 14-12

13. FHF The Accounting Equation 14-13  The relationship between assets, liabilities and owners’ equity Assets=Liabilities+Owners Equity Things of value that a firm owns = A firm’s debts and obligations + The difference between a firm’s assets and its liabilities

14. FHF Double-Entry Bookkeeping 14-14 Assets=Liabilities+Owners Equity $ 325=$ -700+$ 1,025 Notice that both sides of the equation balance  A system of recording and classifying business transactions in separate accounts in order to maintain the balance of accounting equation

15. FHF The Accounting Cycle A four-step process through which financial data pass 1. Examine source documents 2. Record transactions in an accounting journal 3. Post transactions to a ledger.  If the trial balance does not balance, one must look for mistakes and try again 4. Prepare financial statements and have them certified by an accountant 14-15

16. FHF Financial Statements The end results of the accounting process are a series of financial statements  Income statement  Balance sheet  Statement of cash flows Financial statements are provided to: Stockholders and potential investors Creditors Government agencies Internal Revenue Service 14-16

17. FHF The Income Statement A financial report that shows an organization’s overall profitability or loss over a period of time  Month  Quarter  Year  Shows a firm’s bottom line: its expenses minus revenues 14-17

18. FHF Income Statement: Key Terms  Revenue : The total amount of money received or promised from the sale of goods/services and other activities Cost of Goods Sold : The amount of money the firm spent to buy and produce the products it sold Cost of goods sold= beginning inventory+ interim purchases – ending inventory  Gross Income/Profit : Revenues minus the cost of goods sold 14-18 …continued on next page

19. FHF Income Statement: Key Terms Expenses : The costs incurred in day-to-day operations of an organization  Common expense accounts shown on income statements are: Selling, general & administrative R&D, engineering Interest 14-19 …continued on next page

20. FHF Income Statement: Key Terms Depreciation : A special type of expense included in general and administrative category  Involves spreading the costs of long-lived assets over the total number of accounting periods in which they are to be used Net Income : The total profit or loss after all expenses are deducted from revenue  Accountants usually divide profits into subcategories (e.g. operating income) 14-20

21. FHF John’s Pizza Income Statement December 31, 2011 14-21

22. FHF The Balance Sheet  A “snapshot” of an organization’s financial position at a given moment  Presents an accumulation of all the company’s transactions since it began  Shows what an organization owns and controls and sources of income used to pay for assets 14-22

23. FHF Balance Sheet: Key Terms Assets  Current Assets (Short-Term Assets): Used or converted to cash within a calendar year  Accounts Receivable : Money owed the company by clients or customers who have promised to pay at a later date Accountants usually include an allowance for bad debts, which the firm does not expect to collect  Long-Term Assets (Fixed Assets): Represent a commitment of funds for more than one year Includes tangible assets (plant, equipment) and intangibles (corporate goodwill, reputation) 14-23 …continued on next page

24. FHF Balance Sheet: Key Terms Liabilities  Current Liabilities: Obligations to short-term creditors  Accounts Payable : Amounts owed to suppliers for goods and services purchased on credit  Accrued Expenses: All unpaid financial obligations incurred by the company 14-24 …continued on next page

25. FHF Balance Sheet: Key Terms Owner’s Equity  All the owners’ contributions to the organization, along with income earned by the organization, retained for financing growth and development 14-25

26. FHF John’s Pizza Balance Sheet December 31, 2009 14-26

27. FHF Statement of Cash Flows  Explains how the company’s cash changed from the beginning of the accounting period to the end  Takes the cash balance from two successive balance sheets and compares them  Change in cash explained in three categories: 1. Cash from (used for) operating activities 2. Cash from (used for) investing activities 3. Cash from (used for) financing activities 14-27

28. FHF Ratio Analysis Calculations that measure an organization’s financial health  Profitability ratios  Asset utilization ratios  Liquidity ratios  Debt utilization ratios  Per share data 14-28

29. FHF Profitability Ratios 14-29 Profit Margin=Net Income / Sales Return on Assets=Net Income / Assets Return on Equity=Net Income / Equity

30. FHF Asset Utilization Ratios 14-30 Receivables Turnover=Sales (Total Net Revenues) / Receivables Inventory Turnover=Sales / Inventory Total Asset Turnover=Sales / Total Assets

31. FHF Liquidity Ratios 14-31 Current Ratio=Current Assets / Current Liabilities Quick Ratio=Current Assets – Inventory / Current Liabilities

32. FHF Debt Utilization Ratios 14-32 Debt to Total Assets=Debts (Total liabilities) / Total Assets Times Interest Earned=Income Before Interest & Taxes (Operating Income) / Interest Expense

33. FHF Per Share Data 14-33 Earnings per Share=Net Income / Number of Shares Outstanding Dividends per share=Dividends Paid / Number of Shares Outstanding

34. FHF Industry Analysis 14-34

35. FHF Accounting and the Impact of the Financial Crisis Even after the passage of Sarbanes-Oxley, the financial crises and recession of 2007-2010 are an example of failed accounting audits Many financial institutions manipulated their books to appear financially healthier and downplay risky decisions  Accountants and regulators need to be more thorough  Mark-to-market accounting blamed for many problems Problems valuing assets/liabilities under mark-to-market rules 14-35