Chapter Eighteen Using Accounting Information

Key Statements Three key financial statements summarize the firm’s activities for a specific period Balance sheet (what you’re worth) Income statement (your budget) Statement of cash flows (your checkbook)

The Accounting Equation Assets - Liabilities = Owners’ equity Assets—the resources that a business owns (i.e.- cash, inventory, equipment, real estate) Liabilities—the firm’s debts (loans, a/p) Owners’ equity—difference between assets & liabilities - what would be left for the owners, if the firm’s assets were sold and the money used to pay off its liabilities

The Balance Sheet The dollar amounts of a firm’s assets, liabilities, and owners’ equity accounts at the end of a specific accounting period – also called statement of financial position –assets listed in order of liquidity ease with which an asset can be converted into cash

Assets-Listed in order of liquidity –Current assets—can quickly be converted to cash Cash, marketable securities, a/r, inventory –Fixed assets—will be held or used for a period longer than one year Land, buildings, and equipment –Intangible assets—do not exist physically -value is based on the rights they give the firm Patents, copyrights, trademarks, franchise rights, and goodwill

Liabilities –Current liabilities—debts to be repaid in one year or less Accounts payable—short-term debts from credit purchases Notes payable—debts secured with promissory notes (IOU’s) –Long-term liabilities—debts that need not be repaid for at least one year Mortgages, bonds, and long-term loans

Owners Equity –For sole proprietorships—owners’ equity –For partnerships—each partner’s share of ownership is reported separately in each owner’s name –For corporations—stockholder’s equity

Personal Balance Sheet

The Income Statement A firm’s revenues minus its expenses –Profit (cash surplus) –Loss (cash deficit) Revenues –Money earned from selling goods or providing services Gross sales—the total dollar amount of all goods and services sold during the accounting period Net sales—dollar amounts received, adjusted for returns, allowances, discounts

COGS Cost of goods sold Beginning inventory Net purchases Ending inventory =+– Gross profit –A firm’s net sales less the cost of goods sold

The Income Statement Operating expenses –All business costs other than the cost of goods sold Selling expenses—costs related to marketing activities General expenses—costs of managing the business Net income –Net sales less COGS & operating expenses, when the difference is positive Net loss –Net sales less COGS & expenses, when the difference is negative

Personal Income Statement Long term liability Current liability

The Statement of Cash Flows How the company made & spent its money –Cash flows from operating activities (providing goods and services) –Cash flows from investing activities (asset based) (purchase & sale of land, equipment, buildings) –Cash flows from financing activities (liability based) (pay off loans, sell stock, get a loan)

Statement of Cash Flows

Financial Ratios Used to show relationship between two elements of a firm’s financial statements Can be compared with –The firm’s own past ratios –Ratios of competitors –Industry averages

Who Uses Accounting Information –Managers, to plan business strategy –Lenders, to reduce their risk when lending –Stockholders, to know whether to invest or how well their investment is doing –Government agencies to enforce the law How do they know the information on the statements is accurate?

What is an audit? –An examination of a company’s financial statements and accounting practices by someone not employed by the firm –Generally accepted accounting principles (GAAP) -an accepted set of guidelines and practices for companies reporting financial information –An audit does not guarantee that a company has not “cooked” the books

The Sarbanes-Oxley Act of 2002 –Top executives are required to certify periodic financial reports and are subject to criminal penalties for violations –Auditors must maintain financial documents and audit work papers for 5 years –Auditors and accountants can be imprisoned for up to 20 years for destroying documents and violating securities laws –Public Corps must change auditing firms every 5 years –There is protection for whistle-blowers who report violations of the Sarbanes-Oxley Act