* * *

* *

McGraw-Hill/Irwin Understanding Business, 8e

Understanding Financial Information and Accounting

* 17 1-1

* * * Importance of Accounting Information

• •

Definition Accounting Audiences

•

Managers

•

Government

•

Investors, Suppliers & Creditors

17-2

* * *

The Accounting System

17-3

* * *

• •

The Influence of Accounting Information

• Managers- Financial reports pinpoint

problems/opportunities Government- assists with tax collection Investors, Suppliers, & Creditors- provides a means to analyze business

17-4

* * *

Areas of Accounting

• • •

Managerial Accounting

•

Inside Organization

•

C.M.A. Tax Accounting Government & Not-for-profit Accounting

•

Financial Accounting

• •

Annual Report Private Accountant

•

Public Accountant

•

C.P.A.

•

Auditing

17-5

* * * Top Business Uses of Accountants Valuation, Merger, Acquistion Personal Financial Planning Market Strategy & Planning Cash Mgmt. & Forecasting Tax/Auditing 0% 20% 40% 60% 80% 100% 120%

17-6

* * * How to Read a Corporate Annual Report

• • • • •

Read management’s discussion of changes in operations. Try to identify strengths or weaknesses.

Review the firm’s consolidated balance sheet. (Its assets, liabilities, and owners’ equity.) Analyze the Income Statement. Look beyond the year. (Sales drops can spell trouble.) Review the statement of changes in cash flows.

Review auditor’s opinion.

17-7

* * *

Types of Accountants

Public

•

Auditing

•

Tax Consulting & Compliance

•

Management Consulting Private

•

Management Accounting

•

Government Accounting

•

Academia

17-8

* * *

“Cooking the Books”

• • •

Early Recognition of Revenue Late Recognition of Expense

•

Inadequate Reserves for Bad Debts, Returns, & Liabilities

•

Changing Inventory Valuation Methods- 1 Time Boost to Income Phony Transactions With Partnerships

Courtesy of B. Lilly- De Anza College 17-9

* * * 5 Tips To Be Ahead of Sneaky Accountant Tricks 1.

Who’s who 2.

Pick out the bad apples 3.

Don’t fall for rapid refund 4.

Know their loyalty 5.

Watch what you sign

Source: CNNMoney.com, March 17, 2006 17-10

* * * 5 Ways to Avoid More Enrons 1.

2.

3.

4.

5.

Bring hidden liabilities back onto the balance sheet Highlight the things that matter List the risks and assumptions built into the numbers Standardize operating income Provide aid in figuring free-cash flow

Source: Business Week, February 18, 2002 17-11

* * *

Sarbanes-Oxley Timeline

Effective July 30, 2002 August 29, 2002 January 26, 2003 April 26, 2003 Requirements Prohibit personal loans to officers/directors.

CEOs/CFOs return incentive-based compensation after erroneous financial report.

CEOs/CFOs must certify annual/quarterly reports. Officers must make certifications regarding company’s internal controls.

Responsibilities for attorneys/audit firms increased. Disclosure requirements for off balance sheets transactions tightened. Audit committees must: be independent directors, be responsible for compensation & oversight of certifying accountants.

17-12

* * *

Source: USA Today

Not-for-Profits’ Policies Due to Sarbanes-Oxley 70% 60% 50% 40% 30% 20% 10% 0% Conflict-of Interest Policy Audit Committee Charter Records Retention Policy Code-of-Ethics Statement Whistle-blower Policy

17-13

* * * How can Sarbanes-Oxley be Improved? 80% 70% 60% 50% 40% 30% 20% 10% 0% No changes Exempt smaller companies Scale it back or remove it completely Separate pervasive control matters Provide better guidance

Source: USA Today 17-14

* * * Steps to Control Accounting Practices 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% Review Change Current Create/Expand Internal Audits Procedures

Source: USA Today , “Snapshots”, Section B, pg. 1, March 26, 2003

Hire Independent Firm for Consulting Restructure Executive Compensation Plans

17-15

* * * Bookkeeping vs. Accounting Bookkeeping

•

Start of Accounting

•

Record/Journalize Accounting

•

Analyze

•

Recommend

17-16

* * * Steps In The Accounting Cycle Analyze Source Documents Take a Trial Balance Record Transactions in Journals Post Journal Entries to Ledger Prepare Financial Statements Analyze Financial Statements

17-17

* * *

Computers & Accounting

•

Tool Not Decision Maker

•

Simplification

•

Accounting Packages

•

Up-To-the-Minute Information

•

Less Monotony

17-18

* * *

Financial Statements

•

Balance Sheet- Statement of Financial Position

•

Income Statement- Statement of Revenues & Expenses

•

Statement of Cash Flows – Statement of Cash Receipts & Disbursements

17-19

* * *

Accounting Equation

Assets = Liabilities + Owner’s Equity Owned = Owed + Owner’s Claims Very Vegetarian Company $826,000 = $613,000 + $213,000

17-20

* * * Very Vegetarian’s Balance Sheet (Assets) Period ending 12/31/07 Assets Current Assets Cash Accounts Receivable Notes Receivable Inventory Total Current Assets Fixed Assets Land Buildings (net) Equipment & Vehicles (net) Furniture & Fixtures (net) Total Fixed Assets Intangible Assets Goodwill Total Intangible Assets Total Assets $ 15,000 200,000 50,000 335,000 $600,000 $ 40,000 110,000 40,000 16,000 $206,000 $ 20,000 $ 20,000 $826,000

17-21

* * * Very Vegetarian’s Balance Sheet (Liabilities & Owner’s Equity) Period ending 12/31/07 Liabilities & Owners’ Equity Current Liabilities Accounts Payable Notes Payable Accrued Taxes & Salaries Total Current Liabilities Long-term Liabilities Notes Payable Bonds Payable Total Long-term Liabilities Total Liabilities Owners’ Equity Common Stock (1M shares) Retained Earnings Total Owners’ Equity Total Liabilities & Owners’ Equity $ 40,000 8,000 240,000 $ 35,000 290,000 $100,000 113,000 $288,000 $325,000 $613,000 $213,000 $826,000

17-22

* * * Very Vegetarian Income Statement Period Ending 12/31/07 Revenue Net Sales Cost of Goods Sold Beginning Inventory $ 700,000 Net Purchases Cost of Goods Gross Profit (Gross Margin) $ 200,000 $ 440,000 $ 640,000 Less: Ending Inventory - $ 230,000 Less: Cost of Goods Sold - $ 410,000 $ 290,000

17-23

* * * Very Vegetarian’s Income Statement (cont’d) $290,000 Gross Profit Operating Expenses Selling Expenses Salaries Advertising & Supplies Total Selling Expenses General Expenses Office Salaries Depreciation Insurance Rent Utilities Miscellaneous Total General Expenses Less: Total Operating Expenses Net Income (Profit) Before Taxes Less: Income Tax Expenses Net Income (Profit) After Taxes $ 90,000 $ 20,000 $ 110,000 $ 67,000 $ 1,500 $ 1,500 $ 28,000 $ 12,000 $ 2,000 $ 112,000 - $ 222,000 $ 68,000 - $ 19,000 $ 49,000

17-24

* * * Very Vegetarian’s Statement of Cash Flow Net Cash Flow from Operations Net Cash Flows from Investments $ 52,000 ( 6,000) Net Cash Flow from Financing (19,000) Net Change in Cash & Equivalents $ 27,000 Beginning Cash Balance Ending Cash Balance ( 2,000) $ 25,000 =========

17-25

* * *

Liquidity Ratios

Current Ratio Current Assets Current Liabilities Quick (Acid-Test) Ratio Cash + Marketable Securities + Receivables Current Liabilities

17-26

* * * Very Vegetarian Current Ratio

$600,000 $288,000

= 2.08

Quick (Acid-Test) Ratio

$265,000 $288,000 = 0.92

17-27

* * *

Leverage Ratios

Debt-to-Owners’ Equity Ratio Total Liabilities Owners’ Equity

$613,000 $213,000

=

287%

17-28

* * *

Profitability Ratios

Profitability = Operating Success Return on Sales Return on Equity Net Income Net Sales Net Income After Tax Total Owners’ Equity Basic Earnings Per Share Net Income After Taxes Number of Common Stock Shares Outstanding

17-29

* * *

Profitability Ratios

Return on Sales $ 49,000 = 7% $700,000 Return on Equity $ 49,000 = 23% $213,000 Earnings per Share $ 49,000 = $.049

$1,000,000

17-30

* * *

Activity Ratios

Inventory Turnover Cost of Goods Sold Average Inventory Inventory Turnover $410,000 = 1.9

$215,000

17-31