1. 5-1 PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Cynthia J. Rooney, Ph.D., CPA Communicating and Interpreting Accounting Information Chapter 05 McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

2. 5-2 Players in the Accounting Communication Process

3. 5-3 Regulators Securities and Exchange Commission Primary Responsibility Protect investors and maintain the integrity of the securities market. Primary Responsibility Stock Exchanges Primary Responsibility Along with state governments, set overall corporate governance standards. Financial Accounting Standards Board Primary Responsibility Primary Responsibility Set Generally Accepted Accounting Standards (GAAP). Primary Responsibility Public Company Accounting Oversight Board Primary Responsibility Sets auditing standards for independent auditors (CPAs) of public companies.

4. 5-4 Managers Management Primary Responsibility Responsible for the information in the financial statements and disclosures.  Chief Executive Officer (CEO): highest officer of the company  Chief Financial Officer (CFO): highest officer associated with the financial and accounting side of the business  Accounting Staff: prepare the details of the reports and bear professional responsibility for the accuracy of the information. Management Primary Responsibility Responsible for the information in the financial statements and disclosures.  Chief Executive Officer (CEO): highest officer of the company  Chief Financial Officer (CFO): highest officer associated with the financial and accounting side of the business  Accounting Staff: prepare the details of the reports and bear professional responsibility for the accuracy of the information.

5. 5-5 Board of Directors (Audit Committee) Board of Directors Primary Responsibility Responsible for ensuring that processes are in place for maintaining the integrity of the company’s accounting, financial statement preparation, and financial reporting. Board of Directors Primary Responsibility Responsible for ensuring that processes are in place for maintaining the integrity of the company’s accounting, financial statement preparation, and financial reporting. Board of Directors (Audit Committee) Primary Responsibility Is composed of non-management (independent) directors with financial knowledge and is responsible for hiring the company’s independent auditors. They also meet separately with the auditors to discuss management’s compliance with their financial reporting responsibilities. Board of Directors (Audit Committee) Primary Responsibility Is composed of non-management (independent) directors with financial knowledge and is responsible for hiring the company’s independent auditors. They also meet separately with the auditors to discuss management’s compliance with their financial reporting responsibilities.

6. 5-6 Independent Auditors Primary Responsibility Follow established auditing standards to assess the fairness of the financial statements and related presentations Independent Auditors Primary Responsibility Follow established auditing standards to assess the fairness of the financial statements and related presentations Auditors An unqualified, or clean, opinion states that the financial statements are fair presentations in all material respects in conformity with GAAP. Unqualified Opinion

7. 5-7 Information Intermediaries: Financial Analysts and Information Services Information Intermediaries Analysis and Advice 1.Receive accounting reports and other information about the company from electronic information services 2.Gather information through conversations with company executives and visits to company facilities and competitors 3.Results of their analyses are combined into analysts’ reports. Information Intermediaries Analysis and Advice 1.Receive accounting reports and other information about the company from electronic information services 2.Gather information through conversations with company executives and visits to company facilities and competitors 3.Results of their analyses are combined into analysts’ reports.

8. 5-8 Users: Institutional and Private Investors, Creditors, and Other Institutional Investors Includes pension, mutual, endowment and other funds that invest on the behalf of others Institutional Investors Includes pension, mutual, endowment and other funds that invest on the behalf of others Private Investors Individuals who purchase shares in companies Private Investors Individuals who purchase shares in companies Lenders or Creditors Suppliers, banks, commercial credit companies, and other financial institutions that lend money to companies Lenders or Creditors Suppliers, banks, commercial credit companies, and other financial institutions that lend money to companies

9. 5-9 Guiding Principles for Communicating Useful Information Primary Objective of External Financial Reporting To provide economic information to external users for decision making. 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 Primary Qualitative Characteristics Relevance: Timely and Predictive Feedback Value Reliability: Accurate, Unbiased, and Verifiable Secondary Qualitative Characteristics Comparability: Across businesses Consistency: Over time Secondary Qualitative Characteristics Comparability: Across businesses Consistency: Over time

10. 5-10 Differences in Accounting Methods

11. 5-11 Annual Reports For privately held companies, annual reports are simple documents that include: For privately held companies, annual reports are simple documents that include: 1. Four basic financial statements. 2. Related notes (footnotes). 3. Report of independent accountants (auditor’s opinion) if the statements are audited.

12. 5-12 Annual Reports For public companies, annual reports are elaborate due to SEC reporting requirements: 1.Nonfinancial Section Includes a letter to the stockholders, a description of management’s philosophy, products, successes, etc. 2.Financial Section SEC sets minimum disclosure standards for the financial section for public companies. For public companies, annual reports are elaborate due to SEC reporting requirements: 1.Nonfinancial Section Includes a letter to the stockholders, a description of management’s philosophy, products, successes, etc. 2.Financial Section SEC sets minimum disclosure standards for the financial section for public companies.

13. 5-13 Annual Reports 1.Summarized financial data for 5- or 10-years. 2.Management Discussion and Analysis (MD&A). 3.The four basic financial statements. 4.Notes (footnotes). 5.Independent Accountant’s Report and the Management Certification. 1.Summarized financial data for 5- or 10-years. 2.Management Discussion and Analysis (MD&A). 3.The four basic financial statements. 4.Notes (footnotes). 5.Independent Accountant’s Report and the Management Certification. 6.Recent stock price information. 7.Summaries of the unaudited quarterly financial data. 8.Lists of directors and officers of the company and relevant addresses. 6.Recent stock price information. 7.Summaries of the unaudited quarterly financial data. 8.Lists of directors and officers of the company and relevant addresses.

14. 5-14 Quarterly Reports Usually begin with short letter to stockholders Usually begin with short letter to stockholders Condensed unaudited income statement and balance sheet for the quarter. Condensed unaudited income statement and balance sheet for the quarter. Often, cash flow statement and statement of stockholders’ equity are omitted. Some notes to the financial statements also may be omitted. Often, cash flow statement and statement of stockholders’ equity are omitted. Some notes to the financial statements also may be omitted. Usually begin with short letter to stockholders Usually begin with short letter to stockholders Condensed unaudited income statement and balance sheet for the quarter. Condensed unaudited income statement and balance sheet for the quarter. Often, cash flow statement and statement of stockholders’ equity are omitted. Some notes to the financial statements also may be omitted. Often, cash flow statement and statement of stockholders’ equity are omitted. Some notes to the financial statements also may be omitted.

15. 5-15 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-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. Form 10-Q Quarterly Report Due within 45 days of the end of the quarter. Financial statements can be unaudited. Form 8-K Current Report Due within 15 days of the major event date. Financial statements can be unaudited. Form 8-K Current Report Due within 15 days of the major event date. Financial statements can be unaudited.

16. 5-16 Classified Balance Sheet Assets used of turned into cash within one year. Assets used of turned into cash beyond one year. Obligations paid of settled within one year. Obligations paid of settled after one year. Contributed capital.. Reinvested earnings.

17. 5-17 Classified Income Statement Income Statements are prepared using the following basic structure.

18. 5-18 Consolidated Income Statement Operating activities – the focus of the business. Net Income ÷ Average Number of Shares Outstanding

19. 5-19 Nonrecurring Items Income statements may contain three sections: 1.Continuing operations 2.Nonrecurring Items a)Discontinued operations b)Extraordinary items 3.Earnings per share Income statements may contain three sections: 1.Continuing operations 2.Nonrecurring Items a)Discontinued operations b)Extraordinary items 3.Earnings per share

20. 5-20 Earnings Per Share EPS = Net Income* Average Number of Shares of Common Stock Outstanding During the Period Basic EPS * If there are preferred dividends, the amount is subtracted from the Net Income in the numerator.

21. 5-21 Statement of Cash Flows Recall that the Statement of Cash Flows is divided into three major sections. Recall that the Statement of Cash Flows is divided into three major sections. 1.Cash flows from operating activities. 2.Cash flows from investing activities. 3.Cash flows from financing activities. Recall that the Statement of Cash Flows is divided into three major sections. Recall that the Statement of Cash Flows is divided into three major sections. 1.Cash flows from operating activities. 2.Cash flows from investing activities. 3.Cash flows from financing activities. We will examine the indirect method of preparing the statement. This format begins with a reconciliation of accrual income to cash flows from operations.

22. 5-22 Cash flows associated with earning income. Cash flows related to purchase and sale of productive assets and investments. Cash flows related to borrowing and repaying loans and issue and repurchase of stock. Change in the cash account.

23. 5-23

24. 5-24 Notes to Financial Statements Descriptions of the key accounting rules that apply to the company’s statements. Additional detail supporting reported numbers. Relevant financial information not disclosed on the statements.

25. 5-25 Accounting Rules Applied in the Company’s Statements One of the first notes to the financial statements is usually the statement of significant account policies. This particular note relates to the Callaway Golf’s policies regarding depreciation of Property, Plant, and Equipment.

26. 5-26 Additional Detail Supporting Reported Numbers The second category of notes provides supplemental information concerning the data shown on the financial statements.

27. 5-27 Relevant Financial Information Not Disclosed on the Statements The final category includes information that impacts the company financially but is not shown on the statements.

28. 5-28 Return on Assets (ROA) Analysis 1 (beginning total assets + ending total assets) ÷ 2 Return on Assets = Net Income* Average Total Assets 1 ROA measures how much the firm earned for each dollar of investment. * (In complex calculations, interest expense (net of tax) and minority interest are added back to net income.

29. 5-29 ROA Profit Driver Analysis ROA Net Profit Margin Asset Turnover =× Net Income Average Total Assets Net Income Average Total Assets Net Income Net Sales Net Income Net Sales Average Total Assets Net Sales Average Total Assets × =

30. 5-30 Profit Drivers and Business Strategy High-Value or Product-Differentiation Rely on R&D and product promotion to convince customers of the superiority of your product. High-Value or Product-Differentiation Rely on R&D and product promotion to convince customers of the superiority of your product. Low-Cost Strategy Rely on efficient management of accounts receivable, inventory and productive assets to produce high asset turnover. Low-Cost Strategy Rely on efficient management of accounts receivable, inventory and productive assets to produce high asset turnover.

31. 5-31 Chapter Supplement: Nonrecurring Items In addition, companies may have nonrecurring items. These nonrecurring items may include: 1. Discontinued operations 2. Extraordinary items These items are reported separately because they are not useful in predicting future income of the company. In addition, companies may have nonrecurring items. These nonrecurring items may include: 1. Discontinued operations 2. Extraordinary items These items are reported separately because they are not useful in predicting future income of the company.

32. 5-32 Discontinued Operations Income or loss on segment’s operation for the period. Gain or loss on disposal of the segment. Gain or loss on disposal of the segment. Sale or abandonment of a segment of a business. Show net of applicable taxes.

33. 5-33 Extraordinary Items UnusualInfrequent Show net of applicable taxes.

34. 5-34 Reporting Extraordinary Items and Discontinued Operations

35. 5-35 End of Chapter 05