1. McGraw-Hill/IrwinCopyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

2. Chapter 5 Financial Reporting and Analysis PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Fred Phillips, Ph.D., CA

3. Learning Objective 1 Explain the needs of financial statement users. 5-3

4. The Needs of Financial Statement Users Managers DirectorsCreditorsInvestors Government 5-4

5. Learning Objective 2 Describe the environment for financial reporting, including the Sarbanes-Oxley Act. 5-5

6. Accounting Fraud Opportunity (How?) Incentive (Why?) Character (Who?) The Fraud Triangle 5-6

7. Incentive to Commit Fraud Creating Business Opportunities Satisfying Personal Greed 5-7

8. Opportunity to Commit Fraud Internal controls are the methods that a company uses to protect against theft of assets, to enhance the reliability of accounting information, to promote efficient and effective operations, and to ensure compliance with laws and regulations. 5-8

9. Character to Rationalize and Conceal Fraud Most fraudsters have a sense of personal entitlement, which outweighs other moral principles, such as fairness, honesty, and concern for others. 5-9

10. The Sarbanes-Oxley (SOX) Act SOX Counteract Incentives Reduce Opportunities Encourage Good Character 5-10

11. Learning Objective 3 Prepare a comparative balance sheet, multistep income statement, and statement of stockholders’ equity. 5-11

12. Financial Reporting in the U.S. March 31, 2008 May 8, 2008 May 30, 2008 Fiscal Year End Preliminary Release of Key Results Final Release of Annual Report Financial Statement Preparation Independent External Audit Enhance financial statement format Obtain independent external audit Release additional financial information 5-12

13. Comparative Financial Statements A comparative format reveals changes over time, such as Activision’s huge increase in Cash and decline in Short-term Investments. 5-13

14. Multistep Income Statements 5-14

15. Statement of Stockholders’ Equity 5-15

16. Learning Objective 4 Describe other significant aspects of the financial reporting process, including external audits and the distribution of financial information. 5-16

17. Independent External Audit Auditors are Certified Public Accounts who are independent of the company. Unqualified Audit Opinion Financial statements are presented in accordance with GAAP Qualified Audit Opinion Financial statements fail to follow GAAP or not able to complete needed tests 5-17

18. Preliminary Releases Most public companies announce quarterly and annual earnings through a press release that is sent to news agencies. 5-18

19. Financial Statement Release 5-19

20. Securities and Exchange Commission (SEC) Filings Public companies are required to electronically file certain reports with the SEC, including Form 10-K, Form 10-Q, and Form 8-K. 5-20

21. Learning Objective 5 Explain the reasons for, and financial statement presentation effects of, adopting IFRS. 5-21

22. Globalization and IFRS International Financial Reporting Standards (IFRS) are accounting rules established by the International Accounting Standards Board for use in over 100 countries around the world. In 2008, the SEC announced a plan to allow some U.S. companies to use IFRS in 2009 and could require mandatory use of IFRS starting in 2014. 5-22

23. IFRS Formatting of Financial Statements 5-23

24. A side-by-side comparison of a balance sheet prepared using GAAP and a statement of financial position prepared using IFRS. 5-24

25. Learning Objective 6 Compare results to common benchmarks. 5-25

26. Comparison to Common Benchmarks Prior Periods Time series analysis compares a company’s results for one period to its own results over a series of time periods. Competitors Cross-sectional analysis compares the results of one company with those of others in the same section of the industry. To help interpret amounts on the financial statements, it’s useful to have points of comparison or “benchmarks.” 5-26

27. Time Series Analysis Chart 5-27

28. Cross-Sectional Analysis 5-28

29. Learning Objective 7 Calculate and interpret the debt-to-assets, asset turnover, and net profit margin ratios. 5-29

30. A Basic Business Model Most businesses can be broken down into 4 elements: (1)Obtain financing from lenders and investors, which is used to invest in assets, (2)Invest in assets, which are used to generate revenues, (3)Generate revenues, which produce net income, (4)Produce net income, which is needed to satisfy lenders and investors. (2) Assets(3) Revenues Operating Investing Financing Invested in generate produce (1) Debt & Equity Financing (4) Net Income 5-30

31. Financial Statement Ratios In addition to making it possible to compare companies of different sizes, a benefit of ratio analysis is that it enables comparisons between companies reporting in different currencies (dollars vs. euros). 5-31

32. Financial Statement Ratios The debt-to-assets ratio provides the percentage of assets financed by debt. A higher ratio means greater financial risk. 5-32

33. Financial Statement Ratios The asset turnover ratio measures how well assets are used to generate sales. A higher ratio means greater efficiency. 5-33

34. Financial Statement Ratios The net profit margin ratio measures the ability to generate sales while controlling expenses. A higher ratio means better performance. 5-34

35. How Transactions Affect Ratios Three-step process: 1.Analyze the transaction to determine its effects on the accounting equation. 2.Relate the effects in step 1 to the ratio’s components, to determine whether each component increases, decreases, or stays the same. 3.Evaluate the combined impact of the effects in step 2 on the overall ratio. 5-35

36. Chapter 5 Solved Exercises M5-4, M5-5, M5-9, M5-10, E5-11, E5-16

37. M5-4 Preparing and Interpreting a Multistep Income Statement Nutboy Theater Company reported the following single-step income statement. Prepare a multistep income statement for the local theater company. Also, calculate the net profit margin and compare it to the 8% earned in 2009. In which year did the company generate more profit from each dollar of sales? 5-37

38. M5-4 Preparing and Interpreting a Multistep Income Statement 5-38

39. M5-5 Preparing a Statement of Stockholders’ Equity On December 31, 2008, WER Productions reported $100,000 of contributed capital and $20,000 of retained earnings. During 2009, the company had the following transactions. Prepare a statement of stockholders’ equity for the year ended December 31, 2009. a.Issued stock for $50,000. b.Declared and paid a cash dividend of $5,000. c.Reported total revenue of $120,000 and total expenses of $87,000. 5-39

40. M5-5 Preparing a Statement of Stockholders’ Equity 5-40

41. M5-9 Determining the Effects of Transactions on Debt-to- Assets, Asset Turnover, and Net Profit Margin Using the transactions in M5-8, complete the following table by indicating the sign of the effect (+ for increase, - for decrease, NE for no effect, and CD for cannot determine) of each transaction. Consider each item independently. 5-41

42. M5-10 Preparing Comparative Financial Statements Complete the blanks in the following comparative income statements, statement of stockholders’ equity, and balance sheets. (a)Income from Operations (b)Income before Income Tax Expense (c)100 5-42

43. M5-10 Preparing Comparative Financial Statements (d)480 (e)80 (from December 31, 2009, Balance Sheet) (f)120 5-43

44. M5-10 Preparing Comparative Financial Statements (g)480 (h)180 5-44

45. E5-11 Analyzing and Interpreting Asset Turnover and Net Profit Margin RadioShack Corporation has populated the world with stores from Greece to Canada, and in the United States, an estimated 94 percent of all Americans live or work within five minutes of the electronics retailer—not bad for a company that originally started business as American Hide & Leather Company. The following amounts (in millions) were reported in RadioShack’s income statement and balance sheet. Requirements are listed on the next slide. 5-45

46. E5-11 Analyzing and Interpreting Asset Turnover and Net Profit Margin Required: 1.Compute the asset turnover and net profit margin ratios for 2008 and 2007. 5-46

47. E5-11 Analyzing and Interpreting Asset Turnover and Net Profit Margin Required: 2.Would analysts be more likely to increase or decrease their estimates of stock value on the basis of these changes? Explain what the changes in these two ratios mean. The asset turnover ratio determines how well assets are used to generate sales. This analysis indicates that the company has decreased its efficiency in using assets to generate sales from 2.09 in 2007 to 1.98 in 2008. Net profit margin measures a company’s ability to control expenses while generating sales. This analysis indicates that the company’s performance is this regard has declined from 5.6% in 2007 to 4.5% in 2008. 5-47

48. E5-11 Analyzing and Interpreting Asset Turnover and Net Profit Margin Required: 3.Compute the debt-to-assets ratio for 2008 and 2007. 5-48

49. E5-11 Analyzing and Interpreting Asset Turnover and Net Profit Margin Required: 4.Would analysts be more likely to increase or decrease their estimates of RadioShack’s ability to repay lenders on the basis of this change? Explain by interpreting what the change in this ratio means. The debt-to-assets ratio indicates the percentage of assets financed by debt as a sign of the company’s financing risk. This analysis indicates that the company has increased its debt financing from 61.3% in 2007 to 64.2% in 2008. Analysts would likely decrease their estimates of RadioShack’s ability to repay lenders because the company increased its relative reliance on debt financing, making the company more risky. 5-49

50. E5-16 Finding Financial Statement Information Indicate whether each of the following would be reported on the balance sheet (B/S), income statement (I/S), or statement of stockholders’ equity (SSE). 5-50

51. E5-16 Finding Financial Statement Information Indicate whether each of the following would be reported on the balance sheet (B/S), income statement (I/S), or statement of stockholders’ equity (SSE). 5-51

52. End of Chapter 5