Transcript Slide 1

Communicating
and Interpreting
Accounting
Information
Chapter 5
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
5-2
Learning Objectives
Recognize the people involved in the
accounting communication process
(regulators, managers, directors, auditors,
information intermediaries and users), their
role in the process and the guidance they
receive from legal and professional standards.
5-3
Management
Players in the
Preparation
Accounting
CEO, CFO, Accounting Staff
Communication
Guided by GAAP
Process
Independent Auditors
Verification
Partners, Managers, Staff
Guided by GAAS
An unqualified opinion states
that the financial statements are
fair presentations in all material
respects in conformity with
GAAP.
5-4
Management
Players in the
Preparation
Accounting
CFO, CEO, Accounting Staff
Communication
Guided by GAAP
Process
Independent Auditors
Verification
Partners, Managers, Staff
Guided by GAAS
Information
Intermediaries
Analysis and Advice
Financial analysis,
Information services
Financial analysts
make predictions
concerning
companies’ future
earnings and stock
prices.
5-5
Management
Players in the
Preparation
Accounting
CFO, CEO, Accounting Staff
Communication
Guided by GAAP
Process
Independent Auditors
Verification
Partners, Managers, Staff
Guided by GAAS
Information
Intermediaries
Analysis and Advice
Financial analysis,
Information services
Web Info Services:
Financial
analysts
www/sec/gov
make
predictions
www.compustat.com
concerning
www.djnr.com
companies’ future
www.bloomberg.com
earnings
and stock
www.firstcall.com
prices.
www.hoover.com
5-6
Management
Players in the
Preparation
CFO, CEO, Accounting Staff
Accounting
Guided by GAAP
Communication
Process
Independent Auditors
Verification
Partners, Managers, Staff
Guided by GAAS
Information
Intermediaries
Analysis and Advice
Financial analysis,
Information services
Government
Regulators
Verification
SEC Members
Guided by SEC regs.
Users
Analysis and Decision
Investors, Lenders, etc.
Public
companies only
5-7
Ensuring the Integrity of Financial
Information Communication Process
Regulators
Standard Setting and
Verification
SEC
Management
Primary Responsibility
CFO, CEO, Accounting Staff
Auditors (CPAs)
Verification
Partners, Managers, Staff
Directors
Oversight
Audit Committee
(Independent directors)
5-8
Using Financial Reports
Management
Primary Responsibility
CFO, CEO, Accounting Staff
Information
Intermediaries
Analysis and Advice
Financial analysts,
Information services
Users
Analysis and Decision
Institutional and private
investors, Lenders,
Suppliers, Customers, etc.
5-9
Guiding Principles for Communicating
Useful Information
Primary Objective of External Financial Reporting
To provide economic information to external users
for decision making.
Primary Qualitative Characteristics
Relevance: Timely and Predictive Feedback Value
Reliability: Accurate, Unbiased, and Verifiable
Secondary Qualitative Characteristics
Comparability: Across businesses
Consistency: Over time
5-10
Guiding Principles for Communicating
Useful Information
Primary Objective of External Financial Reporting
To provide economic information to external users
for decision making.
The full-disclosure principles require . . .
Primary Qualitative Characteristics
1. Relevance:
A complete
set
financial
statements,
Timely
andof
Predictive
and Feedback
Value
and Unbiased, and Verifiable
Reliability: Accurate,
2.Notes to the financial statements
Secondary Qualitative Characteristics
Comparability: Across businesses
Consistency: Over time
5-11
International Accounting Standards Board
and Global Differences in Accounting
International Financial Reporting Standards
Difference in Accounting Standards
Extraordinary items
LIFO for inventory
Reversal of inventory write-downs
Basis of property, plant, and equipment
US GAAP
Permitted
Permitted
Prohibited
Historical cost
IFRS
Prohibited
Prohibited
Required
Fair Value or
Historical cost
5-12
Learning Objectives
Identify the steps in the accounting
communication process, including the
issuance of press releases, annual reports,
quarterly reports and SEC filings as well as the
role of electronic information services in this
process.
5-13
The Disclosure Process
Press Releases are used to announce
quarterly and annual earnings as soon as
the verified figures are available.
Earnings Press Release Excerpt for Callaway Golf
Callaway® Golf
CARLSBAD, Calif. -- Jan. 22, 2004-- Callaway Golf
Company (NYSE:ELY) today reported record sales for the
full year ended December 31, 2003, announcing net sales of
$814 million compared with $793 million for the prior year.
Net income for the full year was $46 million versus . . . .
5-14
Annual Reports
For privately held companies, annual reports
are simple documents that include:
1. Four basic financial statements.
2. Related notes (footnotes).
3. Report of independent accountants
(auditor’s opinion) if the statements are
audited.
5-15
Annual Reports
For public companies, annual reports are
elaborate due to SEC reporting
requirements:
1. A Nonfinancial Section

A letter to the stockholders, a description of
management’s philosophy, products,
successes, etc.
2. A Financial Section

See next slide for a detailed listing . . .
5-16
Annual Reports - Financial Section
1. Summarized financial
data for 5- or 10-years.
2. Management Discussion
and Analysis (MD&A).
3. The four basic financial
statements.
4. Notes (footnotes).
5. Independent Accountant’s
Report and the
Management
Certification.
6. Recent stock price
information.
7. Summaries of the
unaudited quarterly
financial data.
8. Lists of directors and
officers of the company
and relevant addresses.
5-17
Quarterly Reports
Usually begin with short letter to stockholders
 Condensed unaudited income statement and
balance sheet for the quarter.
 Often, cash flow statement and statement of
stockholders’ equity are omitted. Some notes to
the financial statements also may be omitted.
5-18
SEC Reports
Form 10-K Annual Report
•Due within 90 days of the fiscal year-end.
•Contains audited financial statements.
Form 10-Q Quarterly Report
•Due within 45 days of the end of the quarter.
•Financial statements can be unaudited.
Form 8-K Current Report
•Due within 15 days of the major event date.
•Financial statements can be unaudited.
5-19
Learning Objectives
Recognize and apply the different financial
statement and disclosure formats used by
companies in practice.
5-20
Financial Statement Formats
Let’s take a
closer look
at the asset
section of the
balance
sheet!
5-21
Callaway Golf Company
Consolidated Balance Sheet
December 31,
2003
2002
(in thousands, except share data and per share data)
ASSETS
Current assets:
Cash and cash equivalents
Accounts receivable, net
Inventories, net
Other current assets
Total current assets
$
Property, plant and equipment, net
Intangible assets, net
Other assets
$
47,340 $
100,664
185,389
50,069
383,462
108,452
63,867
151,760
44,948
369,027
164,763
169,851
30,490
748,566 $
167,340
121,317
22,161
679,845
5-22
Callaway Golf Company
Consolidated Balance Sheet
(in thousands, except share data and per share data)
ASSETS
Current assets:
Cash and cash equivalents
Accounts receivable, net
Inventories, net
Other current assets
Total current assets
Property, plant and equipment, net
Intangible assets, net
Other assets
December 31,
2003
2002
Current assets
assets
that
$ are
47,340
$ 108,452
63,867
will100,664
be
turned
into
185,389
151,760
cash50,069
or expire
(be
44,948
383,462
369,027
used
up) within
167,340
the164,763
longer of
one
169,851
121,317
year
30,490 or the
22,161
$operating
748,566 $ cycle.
679,845
5-23
Callaway Golf Company
Consolidated Balance Sheet
Property,
plant and
December 31,
equipment
includes
(in thousands, except share data and per share data)
2003
2002
ASSETS
assets with useful
Current assets:
lives
of more
than
Cash and cash equivalents
$
47,340
$ 108,452
Accounts receivable, net
63,867
one 100,664
year acquired
Inventories, net
185,389
151,760
for
use
in
the
Other current assets
50,069
44,948
Total current assets
383,462
369,027
business
rather
than 164,763
for resale.
The
Property, plant and equipment, net
167,340
Intangible assets, net
169,851
121,317
amount
is reported
Other assets
30,490
22,161
net
accumulated
$ of
748,566
$ 679,845
depreciation.
5-24
Callaway Golf Company
Consolidated Balance Sheet
(in thousands, except share data and per share data)
ASSETS
Current assets:
Cash and cash equivalents
Accounts receivable, net
Inventories, net
Other current assets
Total current assets
Property, plant and equipment, net
Intangible assets, net
Other assets
December 31,
2003
2002
Intangible
$
47,340 $ assets
108,452
100,664
63,867
have
no physical
185,389
151,760
existence
and
a
50,069
44,948
383,462
369,027
long
life. They
include
164,763 patents,
167,340
169,851
121,317
copyrights,
30,490
22,161
trademarks,
etc.
$ 748,566 $ 679,845
5-25
Let’s now look
at the liability
section of a
classified
balance sheet.
5-26
Callaway Golf Company
Consolidated Balance Sheet
December 31,
2003
2002
(in thousands, except share data and per share data)
LIABILITIES & STOCKHOLDERS" EQUITY
Current Liabilities:
Accounts payable and accrued
expenses
Notes payable, current portion
Income taxes payable
Total current liabilities
Long-term liabilities:
Other liabilities
Commitment and contingencies (Note 13)
$
117,958 $
98,352
240
11,962
130,160
3,160
7,649
109,161
29,023
27,297
5-27
Callaway Golf Company
Consolidated Balance Sheet
December 31,
2003
2002
(in thousands, except share data and per share data)
LIABILITIES & STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable and accrued
expenses
Notes payable, current portion
Income taxes payable
Total current liabilities
Long-term liabilities:
Other liabilities
Commitment and contingencies (Note 13)
Current liabilities
obligations
$ are
117,958
$
98,352
that will be paid
240 current
3,160
with
11,962
7,649
assets,
normally
130,160
109,161
within one year.
29,023
27,297
5-28
Callaway Golf Company
Consolidated Balance Sheet
December 31,
2003
2002
(in thousands, except share data and per share data)
LIABILITIES & STOCKHOLDERS" EQUITY
Current Liabilities:
Accounts payable and accrued
expenses
$
117,958 $
98,352
Long-term liabilities are debts that have
Notes payable, current portion
240
3,160
maturity
dates extending beyond
one
Income taxes payable
11,962
7,649
year Total
from
the
balance sheet
current
liabilities
130,160 date.
109,161
Long-term liabilities:
Other liabilities
Commitment and contingencies (Note 13)
29,023
27,297
5-29
Finally, we get to
the
stockholders’
equity section of
a classified
balance sheet.
5-30
Callaway Golf Company
Consolidated Balance Sheet
December 31,
2003
2002
(in thousands, except share data and per share data)
LIABILITIES & STOCKHOLDERS' EQUITY
Shareholders' equity:
Common stock, $.01 par value, 83,710,094
and 83,577,427 issued and outstanding at
December 31, 2003 and 2002, respectively
Additional paid-in capital
Retained Earnings
Total stockholders equity
Total Liabilities and stockholders' equity
$
837
122,105
466,441
589,383
748,566
$
Contributed capital is often shown in
$
$
two separate accounts
1. Common stock.
2. Additional paid-in capital.
836
103,097
439,454
543,387
679,845
5-31
Callaway Golf Company
Consolidated Balance Sheet
December 31,
2003
2002
(in thousands, except share data and per share data)
LIABILITIES & STOCKHOLDERS' EQUITY
Shareholders' equity:
Common stock, $.01 par value, 83,710,094
and 83,577,427 issued and outstanding at
December 31, 2003 and 2002, respectively
Additional paid-in capital
Retained Earnings
Total stockholders equity
Total Liabilities and stockholders' equity
$
837
122,105
466,441
589,383
748,566
$
836
103,097
439,454
543,387
679,845
$
Retained earnings is$ the total
earnings of the company less the
total dividends declared since
inception of operations.
5-32
Balance Sheet Ratios and
Debt Contracts
When a company borrows money, it often
agrees to certain restrictions on activity.
Ratios typically part of the borrowing
agreement include:
Total Liabilities
÷ Stockholders' Equity
= Debt-to-Equity Ratio
Current Assets
÷ Current Liabilities
= Current Ratio
5-33
Classified Income Statement
Income statements may contain five sections:
1.
2.
3.
4.
Continuing operations
Discontinued operations
Extraordinary items
Cumulative effect of changes in accounting
methods
5. Earnings per share
5-34
Classified Income Statement
General Format for the Classified Income Statement
−
−
±
−
Net sales
Cost of goods sold
Gross profit
Operating expenses
Income from operations
Nonoperating revenues/expenses and gains/losses
Income before income taxes
Income tax expense
Net income
Gross sales minus any
discounts, returns, and
allowances during the period.
5-35
Classified Income Statement
General Format for the Classified Income Statement
−
−
±
−
Net sales
Cost of goods sold
Gross profit
Operating expenses
Income from operations
Nonoperating revenues/expenses and gains/losses
Income before income taxes
Income tax expense
Net income
Cost of inventory sold.
5-36
Classified Income Statement
General Format for the Classified Income Statement
−
−
±
−
Net sales
Cost of goods sold
Gross profit
Operating expenses
Income from operations
Nonoperating revenues/expenses and gains/losses
Income before income taxes
Income tax expense
Net income
Not related to the company’s primary
operations. Usually includes interest income or
expense and any gains or losses from the
retirement of equipment.
5-37
Common-Size Income Statement
Papa John's International, Inc. and Subsidiaries
Consolidated Statement of Income
Month Ended January 31, 2004
(in thousands of dollars)
Revenues:
Restaurant sales
$
Franchise fees
Total revenues
Costs and expenses:
Cost of sales
Salaries & benefits expense
General & administrative expenses
Depreciation expense
Total costs and expenses
Operating income
Other revenues and gains (expenses and losses)
Investment income
Interest expense
Gain on sale of land
Income before income taxes
Income tax expense
Net income
$
Earnings per share
$
66,000
3,800
69,800
94.56%
5.44%
100.00%
36,000
16,000
8,100
2,500
62,600
7,200
51.58%
22.92%
11.60%
3.58%
89.68%
10.32%
1,000
(60)
3,000
11,140
3,899
7,241
1.43%
-0.09%
4.30%
15.96%
5.59%
10.37%
0.40
Total revenue is
equal to 100%.
5-38
Earnings Per Share
EPS =
Net Income Available to Common Shareholders
Weighted Average Number of Shares
Outstanding During the Reporting Period
Basic EPS
5-39
Earnings Per Share
EPS =
Net Income Available to Common Shareholders
Weighted Average Number of Shares
Outstanding During the Reporting Period
Diluted EPS
Stock options, debt securities,
equity securities are assumed to
be converted into common stock
at the beginning of the period.
5-40
Statement of Cash Flows
Recall that the Statement of Cash Flows is
divided into three major sections.
1. Cash flows from operating activities.
2. Cash flows from investing activities.
3. Cash flows from financing activities.
We will examine the indirect method of
preparing the statement. This format begins
with a reconciliation of accrual income to
cash flows from operations.
5-41
Consolidated Statement of Cash Flows
(in thousands)
2003
Cash flows from operating activities:
Net income
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation & amortization
Other non-cash items
Changes in assets and liabilities, net of effects
from acquisitions:
Accounts receivable, net
Inventories, net
Other assets
Accounts payable and accrued expenses
Income taxes payable
Other liabilities
Net cash provided by operating activities
$
45,523
44,496
17,593
12,698
4,897
(4,743)
(7,297)
4,004
1,572
$ 118,743
This is the operating activities section of Callaway using the indirect
method. Begin with accounting net income and arrive at cash
provided by operating activities.
5-42
Consolidated Statement of Cash Flows
(in thousands)
2003
While these
items are on
the income
statement, they
have no
current cash
effect.
Cash flows from operating activities:
Net income
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation & amortization
Other non-cash items
Changes in assets and liabilities, net of effects
from acquisitions:
Accounts receivable, net
Inventories, net
Other assets
Accounts payable and accrued expenses
Income taxes payable
Other liabilities
Net cash provided by operating activities
$ 45,523
44,496
17,593
12,698
4,897
(4,743)
(7,297)
4,004
1,572
$ 118,743
5-43
Consolidated Statement of Cash Flows
(in thousands)
Change in Account Balance During Year
2003
Increase
Decrease
Cash flows from
operating activities:
Current
Subtract from net
Add to net income.
Net income
$ 45,523
AssetsAdjustments income.
to reconcile net income to net cash
provided
by to
operating
activities:
Current
Add
net income.
Subtract from net
44,496
Liabilities Depreciation & amortization
income.
This table
provides
guidance for
adjustments
related to
changes in
current assets
and current
liabilities.
Other non-cash items
Changes in assets and liabilities, net of effects
from acquisitions:
Accounts receivable, net
Inventories, net
Other assets
Accounts payable and accrued expenses
Income taxes payable
Other liabilities
Net cash provided by operating activities
17,593
12,698
4,897
(4,743)
(7,297)
4,004
1,572
$ 118,743
5-44
Consolidated Statement of Cash Flows
(in thousands)
2003
Here is the rest
of Callaway’s
Statement of
Cash Flows
showing the
cash balance
on the
company’s
balance sheet.
Cash flows from investing activities
Capital expenditures
Acquisition, net of cash acquired
Proceeds from sale of assets
Net cash used in investing activities
Cash flows from financing activities:
Payments on financing arrangements
Issuance of common stock
Acquisitiion of Common Stock
Dividends paid, net
Net cash used in financing activities
Effect of exchange rate changes on cash
Net (decrease) increase in cash and cash
equivalents
Cash and cash equivalents at beginning of year
Cash and cash equivalents at end of year
$
$
$
$
(7,810)
(160,321)
202
(167,929)
(8,117)
17,994
(4,755)
(18,536)
(13,414)
1,488
(61,112)
108,452
47,340
5-45
Notes to Financial Statements
Descriptions of the key accounting rules
that apply to the company’s statements.
Additional detail supporting reported
numbers.
Relevant financial information not
disclosed on the statements.
5-46
Learning Objectives
Analyze a company’s performance based on
return on equity and its components.
5-47
Return on Equity (ROE)
Return
=
on
Equity
Net Income
Average Stockholders’ Equity1
ROE measures how much the firm
earned for each dollar of
stockholders’ investment.
1(beginning
equity + ending equity) ÷ 2
5-48
ROE Profit Driver Analysis
=
Net Profit
Margin
Net Income
Net Sales
×
×
Net Income
Average
Stockholders’
Equity
=
Asset
Turnover
Net Sales
Average
Total Assets
×
Financial
Leverage
×
ROE
Average
Total Assets
Average
Stockholders’
Equity
5-49
Profit Drivers and Business Strategy
High-value or product-differentiation.
Rely on R&D and product promotion to convince
customers of the superiority of your product.
Low-Cost.
Rely on efficient management of accounts receivable,
inventory and productive assets to produce
high asset turnover.
5-50
Chapter Supplement A
Other Items Reported on the
Income Statement
5-51
Classified Income Statement
General Format for the Classified Income Statement
In addition, companies may have nonrecurring items.
Net sales
These
nonrecurring items may include:
−
Cost of goods sold
1. Discontinued
operations,
Gross profit
2. Extraordinary
items,
− Operating
expenses
Income
from operations
3. Cumulative
effect
of changes in accounting methods.
± Nonoperating revenues/expenses and gains/losses
These items
are reported separately because they are
Income before income taxes
not useful
in predicting
future income of the company.
− Income
tax expense
Net income
5-52
Discontinued Operations
Sale or abandonment of a segment of a
business.
Income or loss on
segment’s operation for
the period.
Gain or loss on
disposal of the
segment.
Show net of applicable taxes.
5-53
Extraordinary Items
Unusual
Infrequent
Show net of applicable taxes.
5-54
Cumulative Effect of Changes in Accounting
Methods
GAAP
Method
Change to
Alternative
GAAP
Method
The change must be to a preferable
method and must be disclosed in notes
to financial statements.
Show net of applicable taxes.
5-55
End of Chapter 5