1. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. Part 5 Managing Technology and information

2. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. Chapter 16 Understanding Accounting and Financial Statements

3. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 16-3 Chapter Objectives 1.Explain the functions of accounting and its importance to the firm’s management, investors, creditors, and government agencies. 2.Identify the three basic activities involving accounting. 3.Describe the roles played by public, management, government, and not-for-profit accountants. 4.Outline the steps in the accounting process. 5.Describe the impact of recent ethical scandals and the Sarbanes-Oxley Act on the accounting profession. 6.Explain the functions and major components of the three principal financial statements: the balance sheet, the income statement, and the statement of cash flows. 7.Discuss hw financial ratios are used to analyze a firm’s financial strengths and weaknesses.

4. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 16-4 Chapter Objectives 8.Describe the role of budgets in a business. 9.Explain how exchange rates influence international accounting practices and the importance of uniform financial statements for global business.

5. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 16-5 Users of Accounting Information People both inside and outside and organization rely on accounting information to help them make business decisions Accounting—practice of measuring, interpreting, and communicating financial information to support internal and external business decision making.

6. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 16-6 Users of Accounting Information

7. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 16-7 Business Activities That Involve Accounting Accountants contribute important information to help managers deal with the competitive and economic environments They help others to understand, predict, and react to the technological, regulatory, and social and cultural environments Accounting plays a key role in: Financing Investing Operating

8. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 16-8 Business Activities That Involve Accounting Public accountant: provides accounting services to individuals or business firms for a fee Management accountant: accountant employed by a business other than a public accounting firm Responsible for collecting and recording financial transactions, and preparing and interpreting financial statements used by the firm’s managers

9. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 16-9 Business Activities That Involve Accounting Certified Public Accountants—accountants who met specified educational and experiential requirements and passed a comprehensive examination on accounting theory and practice. Other Certifications— Certified Management Accountants Certified Internal Auditor

10. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 16-10 Business Activities That Involve Accounting Government and Not-for-Profit accountants—work for federal, state, and local governments or not-for-profit organizations—perform professional services similar to those of management accountants Instead of an emphasis on measuring profit or loss, they concern themselves with determining how efficiently the organizations accomplish their objectives

11. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 16-11 The Accounting Process Accounting Process—set of activities involved in converting information about individual transactions into financial statements.

12. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 16-12 The Accounting Process

13. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 16-13 The Accounting Process The Impact of Computers and the Internet on the Accounting Process Has simplified the process, making it faster and easier than the manual method Web-based products and services growing Accounting software allows:  A do-it-once approach  Numbers can be easily converted into graphs and charts  Other automatic conversion

14. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 16-14 The Accounting Process The Foundation of the Accounting System Generally Accepted Accounting Principles (GAAP)—guidelines, or standards, that accountants follow to provide reliable, consistent, and unbiased information to decision makers Financial Accounting Standards Board (FASB)—responsible for evaluating, setting, or modifying the GAAP

15. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 16-15 The Accounting Process The Foundation of the Accounting System Sarbanes-Oxley Act of 2002 Public Company Accounting Oversight Board—five member board created by the Sarbanes-Oxley Act of 2002 to set audit standards and to investigate and sanction accounting firms that certify the books of publicly traded firms; members of the board are appointed by the SEC to serve staggered five-year terms.

16. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 16-16 The Accounting Process The Accounting Equation Asset—anything of value owned or leased by a business. Liability—claim against a firms assets by a creditor. Owner’s equity—all claims of the proprietor, partners, or stockholders, against the assets of a firm, equal to the excess of assets over liabilities.

17. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 16-17 The Accounting Process The Accounting Equation Relationship that states that assets equal liabilities plus owner’s equity. Assets = Liabilities + Owner’s Equity

18. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 16-18 Financial Statements The Balance Sheet Balance sheet—statement of a firm’s financial position - what it owns and the claims against its assets - at a particular point in time.  Similar to a photograph of the firm’s assets together with its liabilities and owners’ equity at a specific moment in time

19. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 16-19

20. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 16-20

21. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 16-21 Financial Statements The Income Statement Financial record of a company’s revenues, expenses, and profits over a period of time.

22. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 16-22

23. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 16-23 Financial Statements The Statement of Cash Flows Statement of a firm’s cash receipt and cash payments that presents information on its sources and uses of cash.  Accrual accounting—accounting method that records revenue and expenses when they occur, not necessarily, when cash actually changes hands.

24. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 16-24

25. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 16-25 Financial Ratio Analysis Ratio analysis—one of the most commonly used tools for measuring the firm’s liquidity, profitability, and reliance on debt financing, as well as the effectiveness of management’s use of its resources Allows comparisons with other firms and with the firm’s own past performance

26. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 16-26 Financial Ratio Analysis Financial Ratios and What They Measure

27. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 16-27 Financial Ratio Analysis Liquidity Ratios Firm’s ability to meet its short-term obligations when they must be paid is measured by liquidity ratios Current ratio—compares current assets to current liabilities Acid-test (or quick) ratio—compares quick assets – the most current liquid assets – against current liabilities

28. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 16-28 Financial Ratio Analysis Profitability Ratios Profitability ratios—compare the firm’s earnings with total sales or investments Five important profitability ratios are:  Gross profit margin  Net profit margin  Earnings per share  Return on assets  Return on equity

29. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 16-29 Financial Ratio Analysis Leverage ratios—measures the extent to which a firm relies on debt financing Activity ratios—measure the effectiveness of management’s use of the firm’s resources Inventory turnover ratio—indicates the number of times merchandise moves through a business Total asset turnover—measures how much in sales each dollar in assets generates

30. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 16-30 Budgeting Budget—a planning and controlling tool that reflects the firm’s expected sales revenues, operating expenses, and cash receipts and outlays Quantifies the firm’s plans for a specified future period Serves as a financial blueprint Standard for comparison against actual performance Cash Budget

31. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 16-31 Three-Month Cash Budget for Golden Harvest

32. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 16-32 International Accounting Accounting procedures and practices must be adapted to accommodate an international business environment

33. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 16-33 International Accounting Exchange rate—the ratio at which a country’s currency can be exchanged for other currencies Currency prices change daily according to supply and demand Such fluctuations complicate accounting entries and practices

34. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 16-34 International Accounting International Accounting Standards International Accounting Standards Committee (IASC), established in 1973, promotes worldwide consistency in financial reporting practices