1. Communicating and Interpreting Accounting Information
Chapter 5: Communicating and interpreting accounting information.
Chapter 5
McGraw-Hill/Irwin
© 2009 The McGraw-Hill Companies, Inc.

2. Players in the Accounting Communication Process
Management
Preparation
CEO, CFO, Accounting Staff
Guided by GAAP
Independent Auditors
Verification
Partners, Managers, Staff
Guided by GAAS
An unqualified opinion states that the financial statements are fair presentations in all material respects in conformity with GAAP.
We will begin this chapter by looking at the players in the accounting communication process.
Management is responsible for the preparation of financial statements. The chief executive officer and chief financial officer bear ultimate responsibility for the content of the financial statements. They are guided by members of the accounting staff who followed generally accepted accounting principles. Independent auditors verify the fairness of presentation of the financial statements in accordance with generally accepted accounting standards. Independent auditors are guided by generally accepted auditing standards.

3. Players in the Accounting Communication Process
Management
Preparation
CEO, CFO, Accounting Staff
Guided by GAAP
Independent Auditors
Verification
Partners, Managers, Staff
Guided by GAAS
Information Intermediaries
Analysis and Advice
Financial analysis, Information services
Information intermediaries such as financial analysts make predictions concerning the company’s future earnings and stock prices as a result of past financial information.
Financial analysts make predictions concerning companies’ future earnings and stock prices.

4. CFO, CEO, Accounting Staff Guided by GAAP
Management
Preparation
CFO, CEO, Accounting Staff
Guided by GAAP
Independent Auditors
Verification
Partners, Managers, Staff
Guided by GAAS
Government Regulators
Verification
SEC Members
Guided by SEC regs.
Information Intermediaries
Analysis and Advice
Financial analysis, Information services
Government regulators, primarily the Securities and Exchange Commission, also verify the financial information presented by management. The staff of the Securities and Exchange Commission is guided by regulations developed by the commission. Only publicly traded companies need to follow the regulations specified by the Securities and Exchange Commission. Users of financial information such as investors and lenders incorporate information from all of these sources when making their final decision about the credit worthiness or long-term investment potential of the company.
Users
Analysis and Decision
Investors, Lenders, etc.
Public
companies only

5. Guiding Principles for Communicating Useful Information
Primary Objective of External Financial Reporting
To provide economic information to external users for decision making.
Primary Qualitative Characteristics
Relevance: Timely and Predictive Feedback Value
Reliability: Accurate, Unbiased, and Verifiable
The primary objective of external financial reporting is to provide economic information to external users that will assist them in the decision-making process. The primary qualitative characteristics of useful information include relevance and reliability. The secondary qualitative characteristics of useful information include comparability and consistency.
Secondary Qualitative Characteristics
Comparability: Across businesses
Consistency: Over time

6. Annual Reports
For privately held companies, annual reports are simple documents that include:
Four basic financial statements.
Related notes (footnotes).
Report of independent accountants (auditor’s opinion) if the statements are audited.
Privately held companies whose reports are not distributed to the general public are required to issue the four basic financial statements, related notes to financial statements, and if the statements are audited, the auditor’s report.

7. Annual Reports
For public companies, annual reports are elaborate due to SEC reporting requirements:
A Nonfinancial Section
A letter to the stockholders, a description of management’s philosophy, products, successes, etc.
A Financial Section
See next slide for a detailed listing . . .
Due to elaborate reporting requirements of the Securities and Exchange Commission, publicly held companies issue an annual report that can be divided into two major sections. The first section deals with nonfinancial matters and the second section deals with the financials. The nonfinancial section contains a letter to the stockholders, usually from the CEO, a description of management’s philosophy, products produced and sold, and any major successes or failures the company has experienced in the past year.

8. Annual Reports Summarized financial data for 5- or 10-years.
Management Discussion and Analysis (MD&A).
The four basic financial statements.
Notes (footnotes).
Independent Accountant’s Report and the Management Certification.
Recent stock price information.
Summaries of the unaudited quarterly financial data.
Lists of directors and officers of the company and relevant addresses.
Here is a list of the major categories of information that you will find in the typical annual report of a publicly held company. Towards the end of the report there is a summary of financial data for five or ten years. Management is required to communicate to the reader certain financial and nonfinancial information. This is referred to as management discussion and analysis. All annual reports contain the four basic financial statements and related notes to those financial statements, and the report of the independent accountant and the management certification. In addition, many annual reports contain information about the recent stock price for each quarter of the year. Also, we may find summaries of unaudited quarterly financial information, a listing of the company’s directors and officers, and relevant addresses and telephone numbers for contacting the company.

9. SEC Reports – 10-K, 10-Q, 8-K Form 10-K Annual Report
Due within 90 days of the fiscal year-end.
Contains audited financial statements.
Form 10-Q Quarterly Report
Due within 45 days of the end of the quarter.
Financial statements can be unaudited.
Companies are required to prepare reports for the Securities and Exchange Commission.
One of the most common reports is known as form 10-K, or the annual report. The form is due within 90 days of the end of the company’s fiscal year and it must contain audited financial statements.
The form 10-Q is a quarterly report. It is due within 45 days of the end of each quarter and contains financial statements that are usually unaudited.
Form 8-K is a current events report. It is due within 15 days of the occurrence of a major reportable event. Any financial statements that are included in the form can be unaudited.
Form 8-K Current Report
Due within 15 days of the major event date.
Financial statements can be unaudited.

10. Classified Income Statement
General Format for the Classified Income Statement
This table shows the general format for the classified income statement. Net sales is equal to gross sales less any sales discounts, less any sales returns, and less any sales allowances for the period.
Cost of goods sold is subtracted from net sales to arrive at gross profit. Cost of goods sold represents the inventory items that have been sold to customers.
One of the most important income measures that we will encounter is the income from operations. Financial analysts and others who exam our financial statements closely examine income from operations. It is a measure of how much profit or loss we incurred as a result of the normal operations of our business. Nonoperating revenues and expenses or gains and losses are not integral parts of the operations of our business, and are therefore separated out from income from operations.

11. Average Number of Shares of Common Stock Outstanding During the Period
Earnings Per Share
EPS =
Net Income*
Average Number of Shares of Common Stock Outstanding During the Period
Basic earnings per share is calculated by dividing net income available to common shareholders by the weighted average number of shares outstanding during the reporting period. Net income available to common shareholders is equal to net income less dividends on preferred stock.
Basic EPS
*If there are preferred dividends, the amount is subtracted from the Net Income in the numerator.

12. Notes to Financial Statements
Descriptions of the key accounting rules that apply to the company’s statements.
Additional detail supporting reported numbers.
The notes to financial statements provide the reader with descriptions of key accounting rules applied to the company’s financial statements. Detailed supporting schedules are used to report additional information to the reader, and information that is relevant to the reader but is not included in the financial statements may be disclosed in the notes to the financial statements.
Relevant financial information not disclosed on the statements.

13. Discontinued Operations
Sale or abandonment of a segment of a business.
Income or loss on segment’s operation for the period.
Gain or loss on
disposal of the
segment.
Discontinued operations result from the sale or abandonment of a segment of our business operations. We divide discontinued operations into two categories. The first is the income or loss of the segment reported during the period. The second category is the gain or loss on disposal of the segment’s assets and liabilities. Each of these two categories are reported net of applicable taxes.
Show net of applicable taxes.

14. Show net of applicable taxes.
Extraordinary Items
Unusual
Infrequent
An extraordinary item is a material amount that is both unusual in nature and infrequent in occurrence. Extraordinary items also are reported net of applicable taxes.
Show net of applicable taxes.

15. End of Chapter 5
End of chapter 5.