1. 17 * * * * * Understanding Financial Information and Accounting
CHAPTER 17
Nickels McHugh McHugh * *
1-1
McGraw-Hill/Irwin
Understanding Business, 8e
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

2. Importance of Accounting Information
Definition- Accounting
Audiences
Managers
Government
Investors, Suppliers & Creditors
See Learning Goal 1: Describe the importance of financial information and accounting.
See text pages:

3. The Accounting System Also available on a Transparency Acetate
See Learning Goal 1: Describe the importance of financial information and accounting.
See text pages: 456
The Accounting System
For students who are not taking an accounting class this slide can help them understand an accounting system from a production perspective:
Inputs - Sales documents, purchasing documents, payroll records travel expenses, etc.
Processing – Entries are made to journals; then transferred into ledgers; and finally summarized and reviewed to compile a trial balance.
Outputs – Development of financial statements such as the balance sheet, income statement, and statement of cash flows, that are prepared for management personnel within the company as well as interested parties outside the company.
It is very important for students to understand the importance of integrity when calculating numbers. Generally Accepted Accounting Principles (GAAP) outlines procedures that are generally accepted in the accounting field. This would be a good time to ask the students what role questionable accounting procedures played with Enron, Adelphia, and World Com.

4. The Influence of Accounting Information
Managers- Financial reports pinpoint problems/opportunities
Government- assists with tax collection
Investors, Suppliers, & Creditors- provides a means to analyze business
Also available on a Transparency Acetate
See Learning Goal 1: Describe the importance of financial information and accounting.
See text pages: 457
The Influence of Accounting Information
This slide gives the student an overview of the importance of accounting information when managing their business. Accounting procedures are the foundation for controlling mechanisms that businesses put in place to measure performance and plan for the future.
Accounting influences decisions for managers in the following ways:
Understanding cost behavior and perform cost-volume profit analysis
Using cost allocation in planning and control
Using job-order-costing and process-costing to track the flow of costs to products
Using relevant information to make marketing and production decisions
Using capital budgeting techniques to make long-term capital investment decisions
Accounting information can improve a company’s ability to compete by:
Using competitor information and sales analysis to bring new concepts to the financial planning process
Learning to spot financial trends to predict strategic business decisions
Learning how to integrate technology into decision-making
Explain to the students the most important point of using accounting information to influence decision-making is to make sure you have the RIGHT information, at the RIGHT time and in the RIGHT format.

5. Areas of Accounting Managerial Accounting Tax Accounting
Inside Organization
C.M.A.
Tax Accounting
Government & Not-for-profit Accounting
Financial Accounting
Annual Report
Private Accountant
Public Accountant
C.P.A.
Auditing
See Learning Goal 2: Define and explain the different areas of the accounting profession.
See text pages:

6. Top Business Uses of Accountants
Also available on a Transparency Acetate
See Learning Goal 2: Define and explain the different areas of the accounting profession.
Top Business Uses of Accountants
One of the biggest uses of accountants by business is the tax and auditing business. Explain to the class that the theme of “integrity of numbers” is critical for business.
In addition to the reasons listed on the acetate, accountants can offer businesses the following value-added services:
Getting complete visibility of processes
Seeing the true cost of a process or part of a process
Seeing the cost of process changes, volume changes, headcount, wastage, scrap, rejects, non-conformance, downtime
Seeing costs by job and by department
Seeing and comparing costs of outsourcing
Mapping business processes, organization-wide or job specific
Using scenario analysis to see how re-engineering will affect resources such as costs and headcounts
(Source: Activemodeler.com)

7. 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 owners’ 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.
See Learning Goal 2: Define and explain the different areas of the accounting profession.
See Learning Goal 5: Explain the importance of ratio analysis in reporting financial information.

8. Types of Accountants Public Private Auditing
Tax Consulting & Compliance
Management Consulting
Private
Management Accounting
Government Accounting
Academia
Also available on a Transparency Acetate
See Learning Goal 2: Define and explain the different areas of the accounting profession.
See text pages: 458
Types of Accountants
This slide helps highlight the difference in public and private accounting. The topics of Certified Public Accountant (CPA) and Certified Management Accountant (CMA) can also be discussed from this information.
This may be a good time to discuss what accounting or finance careers will do for students:
Develop them into a well rounded Business Executive
Help them learn how to analyze and forecast financial goals through utilization of historical data, competitor information and financial data/information
Make an impression at a multi-billion dollar corporation
See the company increase its financial vitality by being a part of the financial planning and reporting process
(Source: Retailology.com)

9. “Cooking the Books” Early Recognition of Revenue
Late Recognition of Expense
Inadequate Reserves for Bad Debts, Returns, & Liabilities
Changing Inventory Valuation Methods- 1 Time Boost to Income
Phony Transactions With Partnerships
Also available on a Transparency Acetate
See Learning Goal 2: Define and explain the different areas of the accounting profession.
Cooking the Books
This slide describes some questionable strategies companies have used when presenting company financial information. Have the students go through each item on the slide and discuss what they mean.
The Security and Exchange Commission (SEC) has issued an account bulletin referred to as SAB 101- Revenue Recognition. This issue deals with company’s improperly recording revenue when received on a contract rather than recognizing the revenue over the life of the agreement.
According to the SEC, this is the single largest issue involving companies restating their earnings. According to SmartPros.com, “Companies try to boost revenue by manipulating the recognition of revenue. Think about a bottle of wine. You wouldn’t pop the cork on the bottle before it was ready. But some companies are doing this with their revenue – recognizing it before a sale is complete, before the product is delivered to a customer, or at a time when the customer still has options to terminate, void, or delay the sale.”
Revenue recognition issues are among the most serious financial reporting problems. When revenue is inappropriately recognized, serious cash flow problems can result. This situation causes stock prices to plummet indefinitely.
The SEC recently issued SAB 101 which provides a good framework for companies to follow. The two requirements that must exist for revenue recognition are:
Revenue must be realized or realizable and earned. This does not occur until all of the following criteria are met:
There is persuasive evidence of an arrangement.
Delivery has occurred or services have been rendered.
Price is defined or determinable.
Collectibles are reasonably assured.
Courtesy of B. Lilly- De Anza College

10. 5 Tips To Be Ahead of Sneaky Accountant Tricks
Who’s who
Pick out the bad apples
Don’t fall for rapid refund
Know their loyalty
Watch what you sign
Also available on a Transparency Acetate
See Learning Goal 2: Define and explain the different areas of the accounting profession.
5 Tips To Be Ahead of Sneaky Accountant Tricks
This slide presents the five tips to recognize the red flags about accountants.
Ensure that the accountant is either a CPA or an enrolled agent. Enrolled agents have either passed an IRS exam or has worked at least five years with IRS. According to the Bureau of Labor Statistics, there are over a million accountants, tax preparers, and auditors. However, only 640,000 are Certified (CPAs).
Find out from the Better Business Bureau if there are any complaints filed against the tax preparer. Watch out for big promises.
Many tax preparers advertise Refund Anticipation Loan. People think they are getting their own refund money, but these are actually short term loans charging anywhere from 40 to 700 percent interest in addition to fees.
Does your accountant’s loyalty lie with you or their own business? You are responsible for making sure that you get the most out of your tax return.
The personal information with your accountant may become available to banks and mortgage brokers if you sign a consent form. So be aware of what you sign.
(Source: CNNMoney.com, March 17, 2006)
Source: CNNMoney.com, March 17, 2006

11. 5 Ways to Avoid More Enrons
Bring hidden liabilities back onto the balance sheet
Highlight the things that matter
List the risks and assumptions built into the numbers
Standardize operating income
Provide aid in figuring free-cash flow
Also available on a Transparency Acetate
See Learning Goal 2: Define and explain the different areas of the accounting profession.
5 Ways to Avoid More Enrons
This slide presents five improvements that could help avoid more Enron like situations.
Currently, a company can have Special Purpose Entities (SPEs) where billions of off-balance sheet debt can be hidden. If a company can find an investor who puts in 3% of the SPE, it can be removed from the company’s balance sheet.
Anything less than 5 or 10% of earnings or assets was considered “immaterial” to overall performance and could be left out of the statements. For example, Tyco acquired hundreds of companies in three years prior to 2002 totaling over $8 billion but did not identify the specifics because each individual acquisition fell below the threshold.
Transparency of risks and assumptions in numbers should be present.
Pro forma operating earnings are not standardized and they are left up to companies as to what to include or exclude.
How much free cash flow a company would earn is a guessing game and left up to different interpretations.
(Source: Business Week, February 18, 2002)
Source: Business Week, February 18, 2002

12. Sarbanes-Oxley Timeline
Effective
Requirements
July 30, 2002
Prohibit personal loans to officers/directors.
CEOs/CFOs return incentive-based compensation after erroneous financial report.
August 29, 2002
CEOs/CFOs must certify annual/quarterly reports. Officers must make certifications regarding company’s internal controls.
January 26, 2003
Responsibilities for attorneys/audit firms increased. Disclosure requirements for off-balance sheets transactions tightened.
April 26, 2003
Audit committees must: be independent directors, be responsible for compensation & oversight of certifying accountants.
See Learning Goal 2: Define and explain the different areas of the accounting profession.
Sarbanes-Oxley Timeline
This slide identifies the Sarbanes-Oxley Act of 2002, whereby the Congress and the SEC imposed a variety of obligations and restrictions on public companies. The statutory and regulatory pronouncements include dates on which companies must act or refrain from doing certain actions.
The SEC adopted regulations and a timeline to help companies prepare for corporate governance and disclosure.
Explain to the students that Sarbanes-Oxley legislation is a direct result of the improper accounting and reporting of financial information by companies like Enron. The purpose of this legislation is to prevent such corruption from occurring again.

13. Not-for-Profits’ Policies Due to Sarbanes-Oxley
See Learning Goal 2: Define and explain the different areas of the accounting profession.
Source: USA Today

14. How can Sarbanes-Oxley be Improved?
See Learning Goal 2: Define and explain the different areas of the accounting profession.
Source: USA Today

15. Steps to Control Accounting Practices
See Learning Goal 2: Define and explain the different areas of the accounting profession.
Steps Companies Take to Control Accounting Practices
Listed on this slide are items companies can practice to ensure they are in compliance with GAAP guidelines and SEC policies.
Companies must realize the importance of controlling accounting practices. This all starts with top management and must be communicated throughout the organization. Establishing proper accounting practices can have the following positive impact on your organization:
Improved cost reporting by sector, department or item
Automatic allocation of direct and indirect costs to cost/profit centers
Provide managers with the data they need to control costs
Create a new environment of cost responsibility in middle management
Source: USA Today, “Snapshots”, Section B, pg. 1, March 26, 2003

16. Bookkeeping vs. Accounting
Start of Accounting
Record/Journalize
Accounting
Analyze
Recommend
See Learning Goal 3: List the steps in the accounting cycle, distinguish between accounting and bookkeeping, and explain how computers are used in accounting.
See text pages: 461

17. Steps In The Accounting Cycle
Analyze Source
Documents
Take a
Trial Balance
Record
Transactions
in Journals
Prepare
Financial
Statements
Also available on a Transparency Acetate
See Learning Goal 3: List the steps in the accounting cycle, distinguish between accounting and bookkeeping, and explain how computers are used in accounting.
See text pages: 461
Steps in The Accounting Cycle
With this acetate students are provided with the step-by-step progression of the accounting cycle. I would place particular emphasis on the accounting cycle to give the student an overview of reporting requirements.
The students should be able to explain the following questions:
Can you explain the difference between accounting and bookkeeping
What’s the difference between an accounting journal and a ledger?
Why does a bookkeeper prepare a trial balance?
Post Journal
Entries to Ledger
Analyze
Financial
Statements

18. Computers & Accounting
Tool Not Decision Maker
Simplification
Accounting Packages
Up-To-the-Minute Information
Less Monotony
See Learning Goal 3: List the steps in the accounting cycle, distinguish between accounting and bookkeeping, and explain how computers are used in accounting.
See text pages:

19. Financial Statements Balance Sheet- Statement of Financial Position
Income Statement- Statement of Revenues & Expenses
Statement of Cash Flows – Statement of Cash Receipts & Disbursements
See Learning Goal 4: Explain how the major financial statements differ.
See text pages: 463

20. Very Vegetarian Company
Accounting Equation =
Assets
Liabilities + Owner’s Equity
Owned =
Owed + Owner’s Claims
See Learning Goal 4: Explain how the major financial statements differ.
See text pages: 464
Very Vegetarian Company
$213,000 +
$826,000 =
$613,000

21. Very Vegetarian’s Balance Sheet (Assets)
Period ending 12/31/07
Assets
Current Assets
Cash $ 15,000
Accounts Receivable ,000
Notes Receivable ,000
Inventory ,000
Total Current Assets $600,000
Fixed Assets
Land $ 40,000
Buildings (net) ,000
Equipment & Vehicles (net) ,000
Furniture & Fixtures (net) ,000
Total Fixed Assets $206,000
Intangible Assets
Goodwill $ 20,000
Total Intangible Assets $ 20,000
Total Assets $826,000
Also available on a Transparency Acetate
See Learning Goal 4: Explain how the major financial statements differ.
See text pages:
Very Vegetarian’s Balance Sheet (Assets)
This slide shows the assets section of Very Vegetarian’s Balance Sheet.
Walk the students through each classification of assets separately to insure their understanding. Listed below are a couple items you may want to address with the class:
What are current assets? Assets that are easily converted into cash within one year.
What are fixed assets? Long-term (12 months are more) tangible assets held for business use and not expected to be converted in the current or upcoming fiscal year to cash.
What are Goodwill assets? Assets that carry a positive image like a brand name Coca-Cola. The public places a significant value on the name and its image. Goodwill assets can be expensed over 40 years of expected economic life of the goodwill.

22. Very Vegetarian’s Balance Sheet (Liabilities & Owner’s Equity)
Period ending 12/31/07
Liabilities & Owners’ Equity
Current Liabilities
Accounts Payable $ 40,000
Notes Payable ,000
Accrued Taxes & Salaries 240,000
Total Current Liabilities $288,000
Long-term Liabilities
Notes Payable $ 35,000
Bonds Payable ,000
Total Long-term Liabilities $325,000
Total Liabilities $613,000
Owners’ Equity
Common Stock (1M shares) $100,000
Retained Earnings ,000
Total Owners’ Equity $213,000
Total Liabilities & Owners’ Equity $826,000
Also available on a Transparency Acetate
See Learning Goal 4: Explain how the major financial statements differ.
See text pages:
Very Vegetarian’s Balance Sheet (Liabilities & Owner’s Equity)
This slide contains the liabilities and owner’s equity for Very Vegetarian.
It helps once again to walk students through the acetate step-by-step and make certain students understand the accounts of the balance sheet.
You may want to define the following line items with the class:
Accrued Salaries – Salaries where payment is owed for employees work already done
Notes Payable – Business debts payable within one year or beyond the current fiscal year
Retained Earnings – Profits not paid out as dividends, but instead reinvested in the core business or used to pay off debt

23. Very Vegetarian Income Statement
Period Ending 12/31/07
Revenue
Net Sales $ 700,000
Cost of Goods Sold
Beginning Inventory $ 200,000
Net Purchases $ 440,000
Cost of Goods $ 640,000
Less: Ending Inventory - $ 230,000
Less: Cost of Goods Sold $ 410,000
Gross Profit (Gross Margin) $ 290,000
Also available on a Transparency Acetate
See Learning Goal 4: Explain how the major financial statements differ.
See text pages: 468
Very Vegetarian Income Statement
It’s important for students to understand the structure , objective, and relevance of the income statement to the organization as well as outside users of this information.
Share with the class the following information regarding income statements and their use in business:
Income statements are the major device for measuring the profitability of a firm.
Income statements cover a defined period of time.
The statement is presented in a stair-step or progressive fashion so we can examine the profit or loss after each type of expense item.

24. Very Vegetarian’s Income Statement (cont’d)
Gross Profit $290,000
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
Less: Total Operating Expenses $ 222,000
Net Income (Profit) Before Taxes $ 68,000
Less: Income Tax Expenses $ 19,000
Net Income (Profit) After Taxes $ 49,000
Also available on a Transparency Acetate
See Learning Goal 4: Explain how the major financial statements differ.
See text pages: 468
Very Vegetarian’s Income Statement (cont’d)
Although this slide does not address the term Pro Forma Income Statements, you may want to address the definition and its use in business practice.
Pro Forma Statements will provide a projection of how much profit the firm anticipates making over the ensuing time period. In developing the pro forma income statement, it is suggested that you follow four important steps:
Establish a sales projection
Determine a production schedule and the costs associated
Compute other expenses
Determine profit by completing the actual pro forma statement
Explain to the class the difference in the slide and a pro forma income statement is: Very Vegetarian’s Income Statement illustrates actual expenses and income, while a pro forma statement would be a forecast.

25. Very Vegetarian’s 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
See Learning Goal 4: Explain how the major financial statements differ.
See text pages: 471
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26. Quick (Acid-Test) Ratio Cash + Marketable Securities + Receivables
Liquidity Ratios
Current Ratio
Current Assets
Current Liabilities
Quick (Acid-Test) Ratio
See Learning Goal 5: Explain the importance of ratio analysis in reporting financial information.
See text pages: 474
Cash + Marketable Securities + Receivables
Current Liabilities

27. Very Vegetarian Current Ratio
$600,000
$288,000 =
2.08
Quick (Acid-Test) Ratio
See Learning Goal 5: Explain the importance of ratio analysis in reporting financial information.
See text pages: 474
$265,000
$288,000 =
0.92

28. Debt-to-Owners’ Equity Ratio
Leverage Ratios
Debt-to-Owners’ Equity Ratio
Total Liabilities
Owners’ Equity
See Learning Goal 5: Explain the importance of ratio analysis in reporting financial information.
See text pages: 474
$613,000
$213,000 =
287%

29. Profitability Ratios Profitability = Operating Success
Return on Sales
Return on Equity
Net Income
Net Sales
Net Income After Tax
Total Owners’ Equity
Basic Earnings Per Share
See Learning Goal 5: Explain the importance of ratio analysis in reporting financial information.
See text pages: 475
Net Income After Taxes
Number of Common Stock Shares Outstanding

30. Profitability Ratios Return on Sales $ 49,000 = 7% $700,000
Return on Equity $ 49,000 = 23%
$213,000
See Learning Goal 5: Explain the importance of ratio analysis in reporting financial information.
See text pages: 475
Earnings per Share $ 49,000 = $.049
$1,000,000

31. Activity Ratios Inventory Turnover $410,000 = 1.9 $215,000
Cost of Goods Sold
Average Inventory
Inventory Turnover $410,000 = 1.9
$215,000
See Learning Goal 5: Explain the importance of ratio analysis in reporting financial information.
See text pages: 476