* * * Understanding Financial Information and Accounting * CHAPTER ** 17 Nickels * McHugh McGraw-Hill/Irwin Understanding Business, 8e * McHugh 1-1 17-1 © 2008 The McGraw-Hill Companies, Inc., All Rights * * * 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 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- Time Boost to Income Phony Transactions With Partnerships Courtesy of B Lilly- De Anza College 17-9 * * * Tips To Be Ahead of Sneaky Accountant Tricks Who’s who Pick out the bad apples Don’t fall for rapid refund Know their loyalty Watch what you sign Source: CNNMoney.com, March 17, 2006 17-10 * * * Steps In The Accounting Cycle Analyze Source Documents Take a Trial Balance Record Transactions in Journals Prepare Financial Statements Post Journal Entries to Ledger 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 Owne = Owed + Owner’s d Claims Very Vegetarian Company $826,00 = $613,00 + $213,00 0 17-20 * * * Very Vegetarian’s Balance Sheet (Assets) Period ending 12/31/07 Assets Current Assets Cash $ 15,000 Accounts Receivable 200,000 Notes Receivable 50,000 Inventory 335,000 Total Current Assets $600,000 Fixed Assets Land $ 40,000 Buildings (net) 110,000 Equipment & Vehicles (net) Furniture & Fixtures (net) Total Fixed Assets $206,000 Intangible Assets Goodwill $ 20,000 Total Intangible Assets $ Total Assets 40,000 16,000 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 $288,000 $ 35,000 290,000 $325,000 $613,000 $100,000 113,000 $213,000 $826,000 17-22 * * * Very Vegetarian Income Statement Period Ending 12/31/07 Revenue Net Sales $ 700,000 Cost of Goods Sold Beginning Inventory $ 200,000 Net Purchases $ 440,000 Cost of Goods $ 640,000 Less: Ending Inventory - $ 230,000 Less: Cost of Goods Sold - $ 410,000 Gross Profit (Gross Margin) $ 290,000 17-23 * * * Very Vegetarian’s Income Statement (cont’d) 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 $290,000 $ 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 $ 52,000 Net Cash Flows from Investments ( 6,000) Net Cash Flow from Financing (19,000) Net Change in Cash & Equivalents $ 27,000 Beginning Cash Balance ( 2,000) Ending Cash Balance $ 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 = 2.08 $288,000 Quick (Acid-Test) Ratio $265,000 = 0.92 $288,000 17-27 * * * Leverage Ratios Debt-to-Owners’ Equity Ratio Total Liabilities Owners’ Equity $613,000 = 287% $213,000 17-28 * * * Profitability Ratios Profitability = Operating Success Return on Return on Equity Sales 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 7% $ 49,000 = $700,000 Return on Equity 23% $ 49,000 = $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 1.9 $410,000 = $215,000 17-31 ... Annual Report • Private • • Accountant Public Accountant C.P.A • Auditing 17- 5 * * * Top Business Uses of Accountants 17- 6 * * * How to Read a Corporate Annual Report • Read management’s discussion... certifying accountants 17- 12 * * * Not-for-Profits’ Policies Due to Sarbanes-Oxley Source: USA Today 17- 13 * * * How can Sarbanes-Oxley be Improved? Source: USA Today 17- 14 * * * Steps to Control... Analyze Financial Statements 17- 17 * * * Computers & Accounting • Tool Not Decision Maker • Simplification • Accounting Packages • Up-To-the-Minute Information • Less Monotony 17- 18 * * * Financial