Global Institute for Leadership and Management Development Accounting for Leaders

Effective Leadership and Management in Challenging Times - The Accounting Challenge Economic Climate Cash Flow Lending Competition Regulatory Environment Sarbanes Oxley Banking Crisis Ethical Reporting

Accounting What is it? What does it tell me?

Accounting as an Information System

A business is an economic unit that aims to sell goods and services to customers at prices that will provide an adequate return to its owners. – Goals Profitability—earning a sufficient return to maintain owner interest Liquidity—having enough cash to pay debts as they come due

Business Goals and Activities

Foundations of Financial Reporting Objective of financial reporting IT IS YOUR REPORT CARD AND PLANNING TOOL – Assess cash flow prospects Ability to pay dividends, interest and returns to capital – Assess leadership effectiveness in terms of profitability Provide information about business resources, claims to those resources, and changes in them – General-purpose external financial statements consist of the balance sheet, income statement, statement of retained earnings, and statement of cash flows.

Foundations of Financial Reporting STAYING OUT OF TROUBLE! Under the Sarbanes-Oxley Act, the CEO and CFO of public companies must certify the financial statements and the system of internal control. – Know what you are signing – Does it make sense

Accounting Conventions for Preparing Financial Statements Full disclosure (transparency) HELPS YOU STAY OUT OF TROUBLE – Financial statements must present all information relevant to users’ understanding of the statements – Explanatory notes disclosing changes in account procedures, or significant events occurring after balance sheet dates

Accounting as an Information System WHAT DOES IT MEASURE? The 3 main business activities Operating—selling goods and services to customers; employing managers and workers; buying and producing goods and services; and paying taxes Investing—spending the capital a company receives in productive ways that help it achieve its objectives Financing—obtaining funds to begin operations and to continue operating

Accounting Measurement Four questions must be answered to make an accounting measurement. – What is measured? – When should the measurement be made? – What value should be placed on what is measured? – How should what is measured be classified?

Measurement Issues Three measurement issues must be resolved before a business transaction is recorded. – Recognition issue—When should the transaction be recorded? – Valuation issue—What dollar amount should be recorded? – Classification issue—Which accounts are affected?

Measurement Issues A sale is recognized when title passes to the buyer (recognition point). Transactions must classified according to the appropriate categories or accounts.

Merchandise in Transit

Measurement Issues Transactions should be recorded at their original cost (historical cost). – The fair value is the exchange price, which results from an agreement between the buyer and seller that can be verified by evidence at the time of the transaction. – Assets are valued at the initial fair value or cost unless there is evidence that the fair value has changed and an adjustment must be made.

Measurement Issues Recognition, valuation, and classification are important factors in ethical financial reporting

Financial Position and the Accounting Equation Define financial position, and state the accounting equation. Balancing the books

The Accounting Equation

Financial Position and the Accounting Equation A balance sheet discloses a business’s financial position by showing the relationship among assets, liabilities, and stockholders’ equity. The accounting equation is Assets = Liabilities + Stockholders’ Equity. Assets are a company’s economic resources, such as cash, receivables, inventory, and equipment. Liabilities are the present obligations of a business, such as amounts owed to banks, suppliers, employees, and others.

Financial Position and the Accounting Equation Stockholders’ equity represents the claims of the owner of a business to the net assets of the business. It is made up of the stockholders’ investment and all earnings not paid back to the stockholders in the form of dividends. Net income is the excess of revenues over expenses; net loss is the excess of expenses over revenues.

Financial Statements Identify the four basic financial statements.

Income Statement for Weiss Consultancy, Inc.

Statement of Retained Earnings for Weiss Consultancy, Inc.

Balance Sheet for Weiss Consultancy, Inc.

Income Statement, Statement of Retained Earnings, Balance Sheet, and Statement of Cash Flows for Weiss Consultancy

Relationships of Stockholders’ Equity Accounts

Measuring Business Income The Income Statement

Profitability Measurement: Issues and Ethics Define net income, and explain the assumptions underlying income measurement and their ethical application.

Figure 5: Assumptions and the Matching Rule

Profitability Measurement: Issues and Ethics Net income is the excess of revenues over expenses; net loss is the reverse. Revenues are increases in owner’s equity resulting from selling goods, rendering services, or performing other business activities.

Profitability Measurement: Issues and Ethics Expenses are the decreases in stockholders’ equity resulting from the cost of selling goods or rendering services in the course of earning revenue. The continuity assumption states that when measuring income, in the absence of evidence to the contrary, the accountant should assume that a business will continue to operate indefinitely.

Profitability Measurement: Issues and Ethics The periodicity issue recognizes that the measurement of net income for a given period is at best an estimate. A fiscal year is any 12-month period; it may or may not correspond to the calendar year.

Cash Basis Accounting LOOK AT THE FINE PRINT! Under the cash basis of accounting, revenues and expenses are recognized (recorded) when cash is received or paid.

Accrual Accounting Accrual accounting consists of all the techniques used to apply the matching rule. – When a revenue is recorded before cash is received, a receivable is also recorded. – When an expense is recorded before cash is paid, a payable is also recorded.

Accrual Accounting The SEC stated that all the following conditions must exist before revenue is recognized: – Persuasive evidence of an arrangement exists. – A product or service has been delivered. – The seller’s price to the buyer is fixed or determinable. – Collectibility is reasonably assured.

Accrual Accounting Adjusting entries ensure that transactions appear in the proper accounting period. Adjusting entries do not affect cash flow because they never involve the Cash account, but they are important for the accurate measure of performance.

The Four Types of Adjustments

Profitability Measurement: Issues and Ethics According to the matching rule, revenues are recorded in the accounting period in which they are earned, and expenses are recorded in the same accounting period as the revenue generated by the particular expense; the timing of cash receipts and payments is irrelevant.

Profitability Measurement: Issues and Ethics Earnings management is the manipulation of revenues and expenses to achieve a specific outcome. While not illegal within small ranges, larger variations can mislead the user and lead to fraudulent financial reporting.

Overview of the Accounting Cycle

Cash Flows from Accrual-Based Information Use accrual-based information to analyze cash flows.

Cash Flows from Accrual-Based Information Accrual-based net income indicates whether management has met its profitability goal. Cash flow measures liquidity.

Cash Flows in the Operating Cycle

Classified Balance Sheet

Liquidity Ratios Liquidity measures a company’s ability to pay its bills when they fall due. – Working capital is current assets minus current liabilities. – The current ratio is current assets divided by current liabilities.

Profitability Ratios Profitability may be measured several ways. – Profit margin—net income divided by net sales – Asset turnover—net sales divided by average total assets – Return on assets—net income divided by average total assets – Debt to equity ratio—total liabilities divided by stockholders’ equity – Return on equity—net income divided by average stockholders’ equity