McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved Chapter Sixteen Understanding Accounting & Financial Statements

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved Importance of Accounting Definition Definition Audiences Audiences -Managers -Government -Investors, Suppliers & Creditors

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved Areas of Accounting Financial Accounting Financial Accounting -Annual Report -Private Accountant -Public Accountant -C.P.A. Auditing Tax Accounting Managerial Accounting -Inside Organization -C.M.A.

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved Different Types of Accountants Public Accountant  Auditing  Tax Consulting & Compliance  Management Consulting Private Accountant  Management Accounting  Government Accounting  Academia

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved Foundation of the Accounting System Generally Accepted Accounting Principles (GAAP) Generally Accepted Accounting Principles (GAAP) Guidelines to provide reliable, consistent, unbiased information Guidelines to provide reliable, consistent, unbiased information Regulated by FASB Regulated by FASB

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved Accounting vs. Bookkeeping Bookkeeping Start of Accounting Start of Accounting Record/Journalize Record/Journalize Accounting Analyze Recommend

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved Accounting Cycle 1.Analyze/Categorize 2.Record 3.Post -General Journal -General Ledger 4.Trial Balance 5.Financial Statements -Income Statement -Balance Sheet 6.Analyze/Recommend

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved Steps In The Accounting Cycle

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved Financial Statements  Balance Sheet- Statement of Financial Position  Income Statement- Statement of Revenues & Expenses

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved Accounting Equation Assets Liabilities + Owner’s Equity Owned Owed + Owner’s Claims = = $826,000 = $613,000 + $213,000 $213,000

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved Fiberrific- Balance Sheet Current Assets$600,000 Fixed Assets$206,000 Intangible Assets(Goodwill)$ 20,000 Total Assets$826,000 Current Liabilities $288,000 Current Liabilities $288,000 Long-Term Liabilities$325,000 Total Liabilities$613,000 Stockholders’ Equity$213,000 Total Liabilities & Equity$826,000 ========== ==========

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved Current Assets Cash $ 15,000 Accounts Receivable200,000 Notes Receivable 50,000 Inventory335,000 Total Current Assets $ 600,000

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved Fixed Assets Land $ 40,000 Bldg. & Impr.$200,000 Deprec. (90,000) 110,000 Equip./Veh.$120,000 Deprec. (80,000) 40,000 Furn./Fix.$ 26,000 Deprec. (10,000) 16,000 Total Fixed Assets $ 206,000

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved Current Liabilities Accounts Payable$ 40,000 Notes Payable(12/02) 8,000 Accrued Taxes 150,000 Accrued Salaries 90,000 Total Current Liabilities$288,000

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved Long-Term Liabilities Notes Payable(3/04) $ 35,000 Bonds Payable(12/14) 290,000 Total Long-Term $ 325,000

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved Stockholders’ Equity Common Stock$100,000 Retained Earnings 113,000 Total Stockholders’ Equity$213,000

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved Fiberiffic’s Balance Sheet (Assets) Fiberriffic, Inc. Period ending 3/31/02 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) 56,000 Total Fixed Assets$206,000 Intangible Assets Goodwill$ 20,000 Total Intangible Assets$ 20,000 Total Assets$826,000

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved Fiberiffic’s Balance Sheet (Liabilities & Owner’s Equity) Fiberiffic, Inc. Period ending 3/31/02 Liabilities Current Liabilities Accounts Payable$ 40,000 Notes Payable 8,000 Accrued Taxes & Salaries 240,000 Total Current Liabilities$288,000 Long-term Liabilities Notes Payable$ 35,000 Bonds 290,000 Total Long-term Liabilities$325,000 Owner’s Equity Common Stock(1,000,000 shares)$100,000 Retained Earnings 113,000 Total Owner’s Equity$213,000 Total Liabilities & Owner’s Equity$826,000

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved Fiberrific- Income Statement Net Sales$ 700,000 Cost of Goods Sold (410,000) Gross Profit$ 290,000 Operating Expenses 222,000 Profit before income tax$ 68,000 Taxes (19,000) Net income after tax$ 49,000 =========

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved Revenues Gross Sales$ 720,000 Returns & Allowances $12,000 Returns & Allowances $12,000 Discounts 8,000 (20,000) Discounts 8,000 (20,000) Net Sales$ 700,000

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved Fiberiffic’s Income Statement Fiberiffic, Inc. Period Ending 12/31/02 Revenue Net Sales$ 700,000 Cost of Goods Sold Beginning Inventory$ 200,000 Merchandise Purchased$ 440,000 Cost of Goods Available for Sale$ 640,000 Less: Ending Inventory -$ 230,000 Cost of Goods Sold$ 410,000 Cost of Goods Sold$ 410,000 Gross Profit(Gross Margin)$ 290,000

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved Fiberiffic’s Income Statement (cont’d) Operating Expenses Selling Expenses Salaries$ 90,000 Advertising & Supplies$ 20,000 Total Selling Expenses$ 110,000 General Expenses Office Salaries$ 67,000 Depreciation$ 1,500 Insurance$ 1,500 Rent$ 28,000 Utilities$ 12,000 Miscellaneous$ 2,000 Total General Expenses$ 112,000 Total Operating Expenses$ 222,000 Net Profit (Income) Before Taxes$ 68,000 Less: Income Tax Expenses$ 19,000 Net Income (Profit) After Taxes$ 49,000

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved Fiberrific 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 =========

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved Using Accounting Information- Solvency Ratios Short-Term Long-Term Current Assets Current Liabilities - Quick Ratio Cash + Marketable Securities + Receivables Current Liabilities - Current Ratio - Debt to Equity Total Liabilities Equity Equity

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved Using Acc’ting Info. (cont’d)- Profitability Ratios Profitability = Operating Success - Return on Sales Net Income Net Sales - Earnings Per Share Net Income # Common Shares

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved Profitability Ratios Earnings per Share$ 49,000 = $.049 1,000,000 Return on Sales $ 49,000 = 7% $700,000 $700,000 Return on Equity $ 49,000 = 23% $213,000 $213,000

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved Activity Ratios Inventory Turnover $410,000 = 1.9 $215,000 $215,000

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved 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 owner’s 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.