Transcript Slide 1

Financial Information and
Accounting Concepts
Chapter 17
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Chapter 17 Objectives
After studying this chapter, you will be able to:
• Define accounting and describe the roles of
private and public accountants.
• Explain the impact of accounting standards such
as GAAP and the Sarbanes-Oxley Act on
corporate accounting.
• Describe the accounting equation and explain
the purpose of double-entry bookkeeping and
the matching principle.
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Chapter 17 Objectives Cont.
• Identify the major financial statements and
explain how to read a balance sheet.
• Explain the purpose of the income statement
and statement of cash flows.
• Explain the purpose of ratio analysis and list the
four main categories of financial ratios.
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Understanding Accounting
Financial
Accounting
Management
Accounting
Identify
Measure
Communicate
Decision Making
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What Accountants Do
Cost Accounting
Financial
Accounting
Tax
Accounting
Forensic
Accounting
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What Accountants Do
Cost accounting: computing and analyzing production
and operating costs
Tax accounting: preparing tax returns and interpreting
tax law
Financial analysis: evaluating a company’s
performance and the financial implications of strategic
decisions such as product pricing, employee benefits, and
business acquisitions
Forensic accounting: combining accounting and
investigating skills to assist in legal and criminal matters
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Ten Most Important
Accounting Skills
• Analytical
• Leadership
• Problem solving
• Decision making
• Interpersonal
• Time management
• Listening
• Teamwork
• Communication
• Computer
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Private Accountants
Private Accountants: In-house accountants
employed by organizations and businesses other than a
public accounting firm. Also called corporate accountants.
Controller: The highest-ranking accountant in a
company, responsible for overseeing all accounting
functions.
Certified Public Accountants (CPAs):
Professionally licensed accountants who meet certain
requirements for education and experience and who pass
a comprehensive examination.
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Public Accountants
Public Accountants: Professionals who provide
accounting services to other businesses and
individuals for a fee.
Audit: Formal evaluation of the fairness and
reliability of a client’s financial statements.
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Types of Accountants
Private
CPA
CMA
Internal
Audit
Public
CPA
External
Audit
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Typical Finance Department
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The Rules of Accounting
Generally Accepted
Accounting Principles
(GAAP)
International Financial
Reporting Standards
(IFRS)
External Auditors: Independent accounting
firms that provide auditing services for public
companies
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The Rules of Accounting
The Generally Accepted Accounting Principles
(GAAP) aim to give a fair and true picture of a
company’s financial position and enable outsiders to
make confident analyses and comparisons.
During an audit, CPAs who work for an independent
accounting firm, also known as external auditors,
review a client’s financial records to determine whether
the statements that summarize these records have
been prepared in accordance with GAAP.
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The Rules of Accounting
The International Financial Reporting standards
(IFRS) overseen by the London-based International
Accounting Standards Board.
Just how complex and expensive it will be for
various companies to shift from GAAP to IFRS isn’t
clear yet either.
In general, the shift could take several years of work
and will require a comprehensive reevaluation of a
company’s finances.
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Sarbanes-Oxley
Sarbanes-Oxley: The informal name of comprehensive
legislation designed to improve integrity and accountability
of financial information.
• Outlaw most loans by corporations to their directors and executives
• Create the Public Company Accounting Oversight Board (PCAOB) to
oversee external auditors
• Require corporate lawyers to report evidence of financial wrongdoing
• Prohibit external auditors from providing certain non-audit services
• Require audit committees on the board of directors have at least one
financial expert and majority of board members be independent
• Prohibit investment bankers from influencing stock analysts
• Require CEOs and CFOs to sign statements attesting to accuracy of
financial statements
• Require companies to document and test their internal financial
controls and processes
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Fundamental Accounting Concepts
Assets: Any things of value owned or leased by
a business.
Liabilities: Claims against a firm’s assets by
creditors.
Owners’ Equity: The portion of a company’s
assets that belongs to the owners after obligations
to all creditors have been met.
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The Accounting Equation
Owner’s Equity:
Assets – Liabilities = Owner’s Equity
Accounting Equation:
Assets = Liabilities + Owner’s Equity
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Double-Entry Bookkeeping
Double-Entry Bookkeeping: A method of recording
financial transactions that requires a debit entry and credit
entry for each transaction to ensure that the accounting
equation is always kept in balance.
• Debit
• Credit
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Matching Principle
Matching Principle : The fundamental principle
requiring that expenses incurred in producing revenue
be deducted from the revenues they generate during an
accounting period.
Accrual Basis:
Cash Basis:
An accounting method
in which revenue is
recorded when a sale
is made and an
expense is recorded
when it is incurred.
An accounting method
in which revenue is
recorded when payment
is received and an
expense is recorded
when cash is paid.
Depreciation: An accounting procedure for systematically
spreading the cost of a tangible asset over its estimated useful life.
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Using Financial Statements
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Understanding Financial
Statements
• Balance Sheet
• Income Statement
• Statement of Cash
Flows
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The Balance Sheet
Assets
Current Assets
Fixed Assets
Liabilities and Shareholder’s Equity
Current
Liabilities
Long-Term
Liabilities
Shareholder’s
Equity
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Using Financial Statements: The
Balance Sheet
Balance Sheet: A statement of a firm’s financial
position on a particular date; also known as a
statement of financial position.
Fiscal Year: Any 12 consecutive months used as
an accounting period.
Current Assets: Cash and items that can be
turned into cash within one year.
Fixed Assets: Assets retained for long-term use,
such as land, buildings, machinery, and equipment.
Also referred to as property, plant, and equipment.
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Using Financial Statements: The
Balance Sheet
Current Liabilities: Obligations that must be met
within a year.
Long-Term Liabilities: Obligations that fall due
more than a year from the date of the balance
sheet.
Retained Earnings: The portion of shareholders’
equity earned by the company but not distributed to
its owners in the form of dividends.
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Income Statement
Revenues
Gross Sales – Returns and Allowances
Cost of Goods Sold
Beginning Inventory + Purchases – Cost of Goods – Ending Inventory
Operating Expenses
Selling Expenses + General Expenses
Net Operating Income
Gross Profit + Other Income – Operating Expenses
Net Income After Taxes
Net Income Before Taxes – Income Taxes
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Using Financial Statements:
Income and Cash Flow Statements
Income Statement: A financial record of a
company’s revenues, expenses, and profits over a
given period of time. Also known as a profit and loss
statement.
Expenses: Costs created in the process of
generating revenues.
Net Income: Profit earned or loss incurred by a
firm, determined by subtracting expenses from
revenues. Referred to as the bottom line.
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Using Financial Statements:
Income and Cash Flow Statements
Operating Expenses: All costs of operation that
are not included under cost of goods sold. General,
selling.
EBITDA: Earnings before interest, taxes,
depreciation, and amortization.
Statement of Cash Flows: A statement of a
firm’s cash receipts and cash payments that
presents information on its sources and uses of
cash.
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Statement of Cash Flows
• Operations
• Investments
• Financing
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Analyzing Financial Statements
Trend Analysis
Uncover
Business
Shifts
Consider
Extraordinary
Circumstances
Ratio Analysis
Consider
More Than
One Ratio
Check
Specific
Data
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Types of Financial Ratios
Profitability
Ratio
Liquidity
Ratio
Activity
Ratio
Leverage
Ratio
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Types of Financial Ratios
Profitability ratios, which show the state of the
company’s financial performance or how well it’s
generating profits.
Liquidity ratios measure a firm’s ability to pay its shortterm obligations. As you might expect, lenders and
creditors are keenly interested in liquidity measures.
Activity ratios analyze how well a company is managing
and making use of its assets.
A company’s ability to pay its long-term debts is reflected in
its leverage ratios, also known as debt ratios.
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Profitability Ratio
Return on Sales =
Net Income
Net Sales
Earnings Per Share:
A measure of a firm’s profitability
for each share of outstanding
stock, calculated by dividing net
income after taxes by the
average number of shares of
common stock outstanding.
Return on Equity =
Net Income
Total Owner’s Equity
Earnings per Share =
Net Income
Average Shares Outstanding
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Liquidity Ratio
Working Capital =
Current Assets Current Liabilities
Current Ratio =
Current Assets
Current Liabilities
Quick Ratio =
Current Assets - Liabilities
Current Liabilities
Working Capital:
Current assets minus current
liabilities.
Current Ratio:
A measure of a firm’s short-term
liquidity, calculated by dividing
current assets by current
liabilities.
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Activity Ratios
Inventory Turnover =
Cost of Goods Sold
Average Inventory
Accounts Receivable
Turnover Ratio: A measure of
Receivables Turnover =
Sales
Average Accounts Receivable
the time a company takes to turn
its accounts receivable into cash,
calculated by dividing sales by the
average value of accounts
receivable for a period.
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Leverage (Debt) Ratio
Debt-to-Equity Ratio:
A measure of the extent to
which a business is financed by
debt as opposed to invested
capital, calculated by dividing
the company’s total liabilities by
owners’ equity.
Debt-to-Assets Ratio:
A measure of a firm’s ability to
carry long-term debt, calculated
by dividing total liabilities by
total assets.
Debt to Equity =
Total Liabilities
Total Equity
Debt to Total Assets =
Total Liabilities
Total Assets
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