Chapter 14 Using Financial Information and Accounting n

Accounting Principles Accounting – the process of collecting, recording, classifying, summarizing, reporting, and analyzing financial activities Managerial Accounting- financial information for managers inside the company Allows for decision making Allows for decision making Financial Accounting – financial information for people outside the company Allows others to see how well a company is working Allows others to see how well a company is working Eases decisions for investments Eases decisions for investments Generally Accepted Accounting Principles (GAAP) Set-up by Financial Accounting Standards Board (FASB) Set-up by Financial Accounting Standards Board (FASB) Is the U.S. standard for accounting Principles Is the U.S. standard for accounting Principles No set international accounting principles Each country has its own standards Each country has its own standards

Accounting Profession Public Accountants (CPA) Does work for individuals or companies on a free-basis Does work for individuals or companies on a free-basis Responsible for Audits Responsible for Audits Gives “Auditor’s Opinion” on whether all financial records were done by the standards CPA’s must go through several levels CPA’s must go through several levels Obtain approved Bachelor’s Degree Pass test Obtain experience Private Accountants Private Accountants Sever one company Certified Management Accountant (CMA) Must pass examination Must pass examination

Recent Accounting Problems AICPA report on bad accounting procedures Commit fraudulent accounting reporting Commit fraudulent accounting reporting Unreasonable stretch accounting rules to enhance financial records Unreasonable stretch accounting rules to enhance financial records Use loopholes to manage financial results Use loopholes to manage financial results Why do companies bend rules? Larger profit margin Larger profit margin Show profit when loss Show profit when loss Look good in short term Look good in short term

Changing in Accounting Standards Sarbanes-Oxley Act Clarified rules for auditors and services Clarified rules for auditors and services Set up the Public Company Accounting Oversight Board (PCAOB) Set up the Public Company Accounting Oversight Board (PCAOB) Has authority to amend auditing, quality control, and ethics standards Changed audit standards Changed audit standards Must keep seven years of audit documents Financial Disclosure Financial Disclosure Companies must disclose all transactions All significant changes must be made public on a current basis Financial Statement Certification Financial Statement Certification Company and Financial Officers must certify records Severe penalties for false certification Internal Controls Internal Controls Must have internal control for financial procedures Consulting Work Consulting Work Restrict non-auditing work done by auditors

The Accounting Equation Assets = Liabilties + Owner’s Equity Must Always Balance !!!!

The Accounting Cycle Six step process Analyze data recorded Analyze data recorded Record each transaction in Journal Record each transaction in Journal Journal entries recorded in Ledger Journal entries recorded in Ledger Ledger accounts totaled in Trial Balance Ledger accounts totaled in Trial Balance These Values used to prepare Financial Statements These Values used to prepare Financial Statements Analyze reports and make decisions Analyze reports and make decisions Computer in Accounting Accounting and Tax programs offers many tools Accounting and Tax programs offers many tools Typically represents a large portion of the software budget Typically represents a large portion of the software budget

The Balance Sheet Summarizes financial position for specific point in time Assets Listed in order of Liquidity Listed in order of Liquidity Current Assets Current AssetsCash Marketable Securities Accounts Receivable Notes Receivable Inventory Fixed Assets Fixed Assets Long term Accumulate depreciation over time Intangible Assets Intangible Assets Long term with no physical existence Copyrights, patents, etc. Copyrights, patents, etc.

The Balance Sheet Con’t Liabilities Current Liabilities Current Liabilities Accounts Payable Notes Payable Accrued Expenses Income Tax Payable Current portion of long-term debt Long-term Liabilities Long-term Liabilities Bank Loans, Mortgages, etc. Owner’s Equity Owner’s total investment in the company Owner’s total investment in the company

Income Statement Summarizes revenues and expenses Revenues Total income for the entity Total income for the entityExpenses Total costs for running business Total costs for running business Gross Profit – Operating Expenses = Net Profit/Loss

The Statement of Cash Flows Statement of cash flows – A financial statement that provides a summary of the money flowing into and out of a firm. the financial statement used to assess the sources and uses of cash during a period the financial statement used to assess the sources and uses of cash during a period It tracks the firm’s cash receipts and cash payments It tracks the firm’s cash receipts and cash payments It gives financial managers and analysts a way to identify cash flow problems and assess the firm’s financial ability It gives financial managers and analysts a way to identify cash flow problems and assess the firm’s financial ability All publicly traded firms must include a statement of cash flows in their financial reports to stockholders. All publicly traded firms must include a statement of cash flows in their financial reports to stockholders.

The Statement of Cash Flows Con’t The statement of cash flows divides the firm’s cash flows into three groups; Cash flow from operating activities: Cash flow from operating activities: Those related to the production of the firm’s goods and/or services. Cash flows from investment activities: Cash flows from investment activities: Those related to the purchase and sake of fixed assets. Cash flows from operating activities: Cash flows from operating activities: Those related to debt and equity financing.

Analyzing Financial Statement and Ratio Analysis Purpose of analyzing financial statements By studying the relationship among the financial statements, someone can gain more insight into a firm’s financial condition and performance. In order to do so, business people make use of ration analysis By studying the relationship among the financial statements, someone can gain more insight into a firm’s financial condition and performance. In order to do so, business people make use of ration analysis Ratio analysis The calculation and interpretation of financial ratios taken from the firm's financial statements in order to assess its condition and performance The calculation and interpretation of financial ratios taken from the firm's financial statements in order to assess its condition and performance Ratio analysis simply highlights potential problems; it does not prove that they exist. However, ratios can help managers understand operations better and identify trouble spots. Ratio analysis simply highlights potential problems; it does not prove that they exist. However, ratios can help managers understand operations better and identify trouble spots.

Classification of Ratios Ratios can be classified by what they measure; liquidity, profitability, activity, and debt. Liquidity ratios measure the firm’s ability to pay it’s short term debts as they come due Liquidity ratios measure the firm’s ability to pay it’s short term debts as they come due Current Ratio Acid-Test (quick) Ratio Net Working Capital Profitability Ratios are ratios which measure how well a firm is using its resources to generate profit, and how efficiently it is being managed. Profitability Ratios are ratios which measure how well a firm is using its resources to generate profit, and how efficiently it is being managed. Net Profit Margin Return On Equity Earnings Per Share Activity Ratios Activity Ratios Inventory Turnover Ratio Debt Ratio Debt Ratio Debt-To-Equity Ratio

Ratio Analysis 1.Current Ratio - Total Current Assets Total Current Liabilities 2. 2.Acid-Test Ratio - Total Current Assets – Inventory Total Current Liabilities 3. 3.Net Working Capital - Total Current Assets – Total Current Liabilities 4.Net Profit Margin - Net Profit Net Sales 5. Return On Equity - Net Profit Total Owner’s Equity 6.Earning Per Share - Net Profit Number of shares of common stock outstanding

Ratio Analysis Con’t 7.Inventory Turnover - Cost of Goods Sold Average Inventory Average Inventory Cost of Goods Sold (Beg. Inventory + Ending Inventory)/2 8.Debt Ratio - Total Liabilities Owner’s Equity

Trends in Business Accountants Expand their Role Accountants now take an active role advising their clients on systems and procedures, accounting software, and changes in accounting regulations. Accountants now take an active role advising their clients on systems and procedures, accounting software, and changes in accounting regulations. They also look into the risks and weaknesses of a company to prevent future complications. They also look into the risks and weaknesses of a company to prevent future complications. Valuing Knowledge Assets The world’s economy is becoming more knowledge-based rather than industrial-based The world’s economy is becoming more knowledge-based rather than industrial-based A company’s value may come from internally generated intangible assets such as brands, trademarks, and employee talent. A company’s value may come from internally generated intangible assets such as brands, trademarks, and employee talent. Tightening the GAAP Companies have been taking advantage of loopholes in GAAP to manipulate numbers. Companies have been taking advantage of loopholes in GAAP to manipulate numbers. For example, Cendant was accused of fraudulently inflating income by booking $500 million in factious revenues Many companies are pushing the accounting edge to keep earning rising to meet expectations of investment analysts and investors

Discussion/Study Questions Why are financial reports important? Financial reports give managers, employees, investors, customers, suppliers, creditors, and government agencies a way to analyze a company’s past, current, and future performance. What are the differences between public and private accountants? Public accountants work for independent firms that provide accounting services such as; financial report preparation and auditing, tax return preparation, and management consulting. Private accountants are employed to serve one particular organization and may prepare financial statements, tax returns, and management reports.

Discussion/Study Questions What is the accounting equation? Assets = Liability + Owner’s Equity What are the six steps in the accounting cycle? Analyze collected data, record transactions to the journal, record journal entries in the ledger, total ledger in trial balance, prepare financial statements, analyze reports, and make decisions. Why was the Sarbanes-Oxley Act important? It closed loopholes and clarified accounting procedures.

Discussion/Study Questions True or False;Things of value such as; cash, account receivable, and inventory, are called liabilities? False, these are called assets What does the balance sheet do? It summarizes the financial condition of the company for a point in time Why is the cash flow statement an important source of information? It summarizes the firms sources and uses of cash during a financial- reporting period.

Discussion/Study Questions What is the purpose of an income statement? It summarizes revenues and expenses, showing the net profit or loss Why is ratio analysis used? It allows someone to gain insight into a firm’s operations, profitability, and overall financial condition. What are the four types of ratios? Liquidity, profitability, activity, and debt ratios