Chapter 17 Understanding Accounting and Financial Information McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc All rights reserved Chapter Seventeen LEARNING GOALS Demonstrate the role that accounting and financial information play for a business and for its stakeholders Identify the different disciplines within the accounting profession List the steps in the accounting cycle, distinguish between accounting and bookkeeping, and explain how computers are used in accounting 17-2 Chapter Seventeen LEARNING GOALS Explain how the major financial statements differ Demonstrate the application of ratio analysis in reporting financial information 17-3 Profile SIGGI HILMARSSON Siggi’s Yogurt • Hilmarsson missed an Icelandic treat called skyr, a thick, strained, protein-rich yogurt • He perfected his yogurt and contacted a former professor for help with financing • Distribution raised cost problems that affected cash flow 17-4 Chapter Seventeen NAME that COMPANY Until the development of accounting software simplified the accounting process, accountants had to enter all financial information by hand Today accounting software makes it possible for businesses to have financial information available whenever they need it Name two companies that provide accounting software for small businesses Name those companies! 17-5 What is Accounting? WHAT’S ACCOUNTING? LG1 • Accounting Recording, classifying, summarizing and interpreting of financial events and transactions in an organization to provide interested parties needed financial information • Outside parties - like employees, owners, creditors, unions, investors and the government make use of a firm’s accounting information 17-6 What is Accounting? The ACCOUNTING SYSTEM LG1 17-7 What is Accounting? LG1 ACCOUNTANTS’ RESPONSIBILITIES 17-8 Managerial Accounting MANAGERIAL ACCOUNTING LG2 • Managerial Accounting Provides information and analysis to managers inside the organization to assist them in decision making • Managerial accounting is involved with: - Costs of production - Costs of marketing - Preparation and control of budgets - Minimizing tax liabilities 17-9 Managerial Accounting LG2 USERS of ACCOUNTING INFORMATION Users Type of Report Government tax authority Tax reports Government regulatory agencies Required reports People interested in the organization’s income Financial statements found in annual reports Managers of the firm Financial statements and internally distributed financial reports 17-10 Cost of Goods Sold LG4 ACCOUNTS of the INCOME STATEMENT • Revenue is the monetary value a firm received for goods sold, services rendered or other payments • Cost of Goods Sold (or Manufactured) -Measures the cost of merchandise the firm sells or the cost of raw materials and supplies it used in producing items for resale • Gross Profit (or Gross Margin) How much a firm earned by buying (or making) and selling merchandise (Continued) 17-35 Operating Expenses LG4 ACCOUNTS of the INCOME STATEMENT (Continued) • Operating Expenses – Cost involved in operating a business, such as rent, salaries and supplies • Depreciation The systematic write-off of the cost of a tangible asset over its estimated useful life 17-36 WHAT’S COMING and GOING at the COLLEGE BOOKSTORE (Spotlight on Small Business) • Generally Accepted Accounting Principles (GAAP) sometimes permits accountants to use different method of accounting for inventory • FIFO: First-In, First-Out • LIFO: Last-In, First-Out • Each valuation can affect income and ending inventory valuation 17-37 The Statement of Cash Flows The STATEMENT of CASH FLOWS LG4 • Statement of Cash Flows Reports cash receipts and cash disbursements related to the three major activities of a firm: Operations Investments Financing 17-38 The Need for Cash Flow Analysis UNDERSTANDING CASH FLOW LG4 • Cash Flow The difference between cash coming in and cash going out of a business • Managing cash flow is a key consideration of a business and can be particularly challenging for small and seasonal businesses 17-39 BARKING UP the WRONG FINANCIAL STATEMENT (Making Ethical Decisions) • You’re the only accountant employed by a small, struggling dog food company • The company requests a bank loan to keep operations going and your boss suggests you record some revenue early • This is against accounting principles, but you know if you don’t get the loan, you may lose your job What you do? 17-40 Progress Assessment PROGRESS ASSESSMENT • What are the key steps in preparing an income statement? • What’s the difference between revenue and income on the income statement? • Why is the statement of cash flows important in evaluating a firm’s operations? 17-41 Analyzing Financial Performance Using Ratios USING FINANCIAL RATIOS LG5 • Ratio Analysis The assessment of a firm’s financial condition using calculations and financial ratios developed from the firm’s financial statements • Key ratios include: - Liquidity ratios - Leverage ratios - Performance ratios - Activity ratios 17-42 Liquidity Ratios LG5 COMMONLY USED LIQUIDITY RATIOS • Liquidity ratios measure a firm’s ability to turn assets into cash to pay its short-term debts • Two key ratios are: - Current ratio - Acid-test ratio • This information is found on the firm’s balance sheet 17-43 Leverage (Debt) Ratios LEVERAGE RATIOS LG5 • Leverage ratios measure the degree to which a firm relies on borrowed funds in its operations • Key ratios include: - Debt to Owner’s Equity Ratio • This information is found on the firm’s balance sheet 17-44 Profitability (Performance) Ratio PROFITABILITY RATIOS LG5 • Profitability ratios measure how effectively a firm’s managers are using the firm’s various resources to achieve profits • Key ratios include: - Basic earnings per share - Return on sales - Return on equity • This information is found on the firm’s balance sheet and income statement 17-45 Activity Ratio ACTIVITY RATIOS LG5 • Activity ratios measure how effectively management is turning over inventory • Key ratios include: - Inventory turnover ratio • This information is found on the firm’s balance sheet and income statement 17-46 ACCOUNTANTS of the WORLD UNITED (Reaching Beyond Our Borders) • Multinational companies must adapt their accounting reporting to the rules of multiple countries • Many countries have adopted International Financial Reporting Standards (IFRS ) and are pushing to make them standard • The U.S Securities & Exchange Commission believes there should be such a standard 17-47 TIMELINE for the MOVE to IFRS • 2008: SEC offered proposed timeline • 2009: 110 large companies have the option of using IFRS • 2011: SEC assesses progress of IFRS • 2013: Final decision on the move to IFRS • 2014: Large public companies will be required to report in IFRS (pending SEC decision) • 2016: All companies will be required to report in IFRS (pending SEC decision) Source: IFRS.org, accessed July 2011 17-48 Progress Assessment PROGRESS ASSESSMENT • What’s the primary purpose of performing ratio analysis using the firm’s financial statements? • What are the four main categories of financial ratios? 17-49 ... of a firm’s accounting information 17- 6 What is Accounting? The ACCOUNTING SYSTEM LG1 17- 7 What is Accounting? LG1 ACCOUNTANTS’ RESPONSIBILITIES 17- 8 Managerial Accounting MANAGERIAL ACCOUNTING. .. income Financial statements found in annual reports Managers of the firm Financial statements and internally distributed financial reports 17- 10 Financial Accounting FINANCIAL ACCOUNTING LG2 • Financial. .. helped businesses in maintaining and compiling accounting information? 17- 24 Understanding Key Financial Statements FINANCIAL STATEMENTS LG3 • Financial Statement A summary of all the financial