Accounting Principles


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Information on why accounting principles are important to credit. Also includes basic accounting principles and financial statements.

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  • An important skill that an effective credit professional should have is the ability to understand and analyze financial statements. The standard financial statements, as well as related supporting records, can provide valuable information for making informed credit decisions. In understanding and analyzing financial statements, it is also important to be familiar with standard accounting terms and conventions and the roles of external financial auditors.
  • Assets Assets are all the resources owned by a company or a person. Assets are subdivided and listed on the balance sheet in order of liquidity (the ability to be converted into cash): Current assets are expected to be converted into cash within one year or one operating cycle, whichever is longer. The five categories of current assets are: cash, marketable securities, accounts receivable, inventory, and prepayments. Cash is the most liquid. Fixed or long-term assets are permanent investments in tangible properties required for the conduct of the business and not subject to periodic purchase or sale. Liabilities Liabilities are claims against the assets of a company. Current liabilities are obligations maturing within one year. Long-term liabilities are those that are due in a term longer than one year. Equity The stockholders’ equity of a business firm may be called net worth, proprietary interest, partners’ capital, or capital. Corporate net worth or stockholders’ equity is divided into various classes of preferred and common outstanding stock and retained earnings.
  • Overview It is also called the Income Statement, the Statement of Earnings, and the Statement of Operations. The income statement is considered to be perhaps the most important financial statement. It provides a summary of income and expenses, and gains and losses for a specific period of time. An income statement should contain information on sales, cost of goods sold, expenses, net operating profit, information on other income and expenses, and profit before and after taxes. Income statements are presented in one of two ways: The single-step method totals all revenues and all expenses, and then subtracts the latter from the former to get net income. The multiple-step method matches revenues and expenses from the earliest calculation of gross profit until it derives net income. Components A detailed list of components is found in Pages 456-459 in the text book.
  • The Role of the Auditor The terms of an auditor’s engagement determine the extent of the audit, the number and detail of the schedules produced, and the amount of verification work done. Types of Audits The audit may range from detailed audit with verification of all items and transactions, to a simple book audit concerned only with arithmetic accuracy in transferring ledger figures into the balance sheet and statement of income and retained earnings. Responsibility for Financial Reporting While the auditing firm is liable for its opinion of the financial statement, company management is responsible for the statement’s integrity and objectivity. Change in Auditors When a firm changes auditors, it is required to file a form 8-K with the SEC. When the regular auditor quits an engagement, it is important to determine the underlying reason. Auditor-Client Relationships Auditors prepare financial statement and supporting schedules for clients and not to meet the special needs of creditors. Their work is governed by their intensive training, strict regulation of auditing procedures and conventions, and their accountability to professional societies. They do, however, have a responsibility to clarify items in their audits when questions are raised, and usually give such explanations readily.
  • Overview The Auditor’s Report: The letter of transmittal in which the auditor reports the results of the audit to the client is termed the certificate. It is a formal, written statement of the auditor’s opinion concerning the financial statements after a financial audit has been completed. Customary Schedules in Audit Reports Primary exhibits or schedules are the balance sheet, statement of income, statement of retained earnings, and statement of cash flow. The report may also include various supporting and analytical schedules. Compilation Often, the auditor will have done a compilation, which means that the auditor has helped prepare the financial records to produce the financial statements or has helped in preparing the financial statements. Reliability The audit and certification is generally accepted as adequate endorsement of the correctness of a financial statement.
  • Accounting Principles

    1. 1. Why Accounting Principles are Important to Credit © Basic Accounting Principles Financial Statements by: Jim Menard, CCE email:
    2. 2. Learning Objectives <ul><li>Types of financial statements </li></ul><ul><li>Major components of the Balance Sheet, Statement of Income, Statement of retained earnings and statement of cash flows </li></ul><ul><li>Key aspects of other financial reports </li></ul><ul><li>Differences in audit reports </li></ul>
    3. 3. Financial Statements <ul><li>Types of Financial Statements </li></ul><ul><li>There are four basic financial statements </li></ul><ul><ul><li>The Balance Sheet </li></ul></ul><ul><ul><li>Statement of Income </li></ul></ul><ul><ul><li>Statement of Retained Earnings </li></ul></ul><ul><ul><li>Statement of Cash Flows </li></ul></ul>
    4. 4. Types of Financial Statements <ul><li>Reporting Periods </li></ul><ul><li>Role of Financial Statements </li></ul><ul><li>Annual Reports </li></ul><ul><li>Basic Financial Statements </li></ul>
    5. 5. Reporting Periods <ul><li>Reporting periods are usually monthly, quarterly, or yearly, which presupposes that a company’s business can be divided into regular, consistent time periods. </li></ul><ul><li>Two types of accounting methods may be used: cash or accrual . Using cash accounting, revenues and expenses are reported in the income statement for the time period in which the revenues and expenses occur. Using accrual accounting , revenues are reported when they are earned, rather than actually received, and the costs incurred in generating these revenues are recognized as expenses in the same time period as the revenues . </li></ul>
    6. 6. Role of the Financial Statements <ul><li>Although the financial status of a business changes from day-to-day, the financial statements present pictures of the firm at two different time intervals. The balance sheet gives a snapshot of the firm’s finances at one point in time. The income statement and the statement of cash flows show the firm’s finances over the course of the reporting period . </li></ul>
    7. 7. Annual Reports <ul><li>Publicly owned corporations issue annual reports to their shareholders. These reports contain a great deal of information about the corporation, its executives, its product lines, and its performance for the past year and previous years. Publicly held corporations are required by Securities and Exchange Commission (SEC) regulations to file forms 10-K (annual) and 10-Q (quarterly), which presents detailed information regarding the business and its operations. </li></ul>
    8. 8. Why use financial statements? <ul><li>Savvy use of financial statements allows the user to assess: </li></ul><ul><li>Financial position of the company </li></ul><ul><li>Success of its operations </li></ul><ul><li>Policies & strategies of management </li></ul><ul><li>Insight into future performance </li></ul>
    9. 9. Accounting Issues <ul><li>Generally Accepted Accounting Principles (GAAP) </li></ul><ul><li>Accounting Assumptions </li></ul><ul><li>Financial Accounting Standards Board (FASB) </li></ul><ul><li>Notes to Financial Statements </li></ul>
    10. 10. GAAP / FASB / SEC <ul><li>GAAP Accounting principles must have public and professional support. </li></ul><ul><li>Generally Accepted Accounting Principles (GAAP), as established by the Financial Accounting Standard Board (FASB) and the Security and Exchange Commission (SEC), represents the body of knowledge of accounting. As such, they provide a common format for preparing financial statements </li></ul>
    11. 11. Notes to Financial Statements <ul><li>FASB was formed to oversee financial accounting standards and to research new standards. </li></ul><ul><li>Notes to Financial Statements The notes are an important part of the financial statements and must be read to understand thoroughly the presentation of specific items in the actual statements. </li></ul><ul><li>As a first step in analyzing the figures, the credit manager should adjust all balance sheet and income accounts for the transactions reflected in the footnotes. </li></ul>
    12. 12. The Balance Sheet <ul><li>Assets </li></ul><ul><li>Liabilities </li></ul><ul><li>Stockholders’ Equity </li></ul><ul><li>Assets = Liabilities + Equity </li></ul><ul><li>Overview </li></ul>
    13. 13. Overview <ul><li>A balance sheet is a statement of a company’s financial position and contains specific details concerning the major financial items of a company at a specific point in time. It is also called the statement of condition or statement of financial position. The balance sheet shows, as of a particular date, what a business or person owns (expressed as assets), owes (expressed as liabilities), and its capitalization (expressed as stockholders equity), which is also the difference between assets and liabilities. </li></ul>
    14. 14.
    15. 15. Statement of Income <ul><li>Overview </li></ul><ul><li>Components </li></ul><ul><li>The income statement is considered to be perhaps the most important financial statement. It provides a summary of income and expenses, and gains and losses for a specific period of time. </li></ul>
    16. 16. Check the Percentage Changes From period To period…
    17. 17. Statement of Retained Earnings <ul><li>Overview - The statement of retained earnings reconciles the increases and decreases in retained earnings for the period stated </li></ul><ul><li>Components </li></ul><ul><li>Retained Earnings, Net Income, and Dividends </li></ul>
    18. 18. The Statement of Stockholder’s Equity In a nutshell, it simply explains how each account in the Statement of Stockholder’s Equity got from the balance at the beginning of the period to the balance at the end of the period and describes “events” that caused the balances to change
    19. 19. Statement of Cash Flows <ul><li>Overview </li></ul><ul><li>Cash Flows from Operating Activities </li></ul><ul><li>Cash Flows from Investing Activities </li></ul><ul><li>Cash Flows from Financing Activities </li></ul>
    20. 20. Statement of Cash Flow… <ul><li>Overview The statement of cash flows (SCF) details cash inflows and cash outflows during the same period as the income statement. It is important for understanding the true cash flows of the business. The statement of cash flows separates the cash flows into three activities: operating, investing, and financing </li></ul>
    21. 21. Statement of Cash Flow… <ul><li>Cash Flows from Operating Activities Operating activities include manufacturing, or delivering goods for sale or resale, or providing services, that is, the core business of the firm. Cash inflows are the receipts from the sale of goods or services, the receipt of interest on loans, or dividends received from equity ownership. Cash outflows are payments for inventory items, salaries and wages, taxes, interest expense, and other expense payments to suppliers. </li></ul>
    22. 22. Statement of Cash Flow… <ul><li>Cash Flows from Investing Activities Investing activities include buying and selling investments and productive long-term assets and lending money and collecting interest on the loans. Cash inflows come from the sale of property, plant and equipment; from the sale of debt or equity securities of other firms held as investments; and from interest or other payments received from loans to others. Cash outflows come from buying property, plant, and equipment; buying debt or equity securities of other firms as investments; or making loans to other entities. </li></ul>
    23. 23. Statement of Cash Flow… <ul><li>Cash Flows from Financing Activities Financing activities are those related to liability and owners’ equity. Cash inflows come from selling equity securities of the firm and from selling bonds, mortgages, notes, and any other short-or long-term debt instruments. Cash outflows are dividend payments, repayments of debt, and repurchasing the company’s own stock. </li></ul>
    24. 24. Have they made money from their operations?
    25. 25. Audit Issues <ul><li>The Role of the Auditor </li></ul><ul><li>Types of Audits </li></ul><ul><li>Responsibility for Financial Reporting </li></ul><ul><li>Change in Auditors </li></ul><ul><li>Auditor-Client Relationships </li></ul>
    26. 26. Audit Reports <ul><li>Overview </li></ul><ul><li>Customary Schedules in Audit Reports </li></ul><ul><li>Unqualified Opinions </li></ul><ul><li>Qualified Opinions </li></ul><ul><li>Compilation </li></ul><ul><li>Reliability </li></ul>
    27. 27. Unqualified Opinions <ul><li>Is one that states that the schedules are prepared accurately, fairly present the results of operations for the period reported. </li></ul><ul><li>… in our opinion, the financial statements referred to above present fairly , in all material respects, the financial position of XYZ Company… </li></ul>
    28. 28. Qualified Opinions <ul><li>Is one that explains the qualifications detailed in the footnotes, usually referenced by the footnote number, which may have a material effect on the company’s operating results and financial condition </li></ul><ul><li>… in our opinion, except for the effects on the 2007 financial statements… </li></ul><ul><li>or referred to above do not present fairly , in conformity with GAAP… </li></ul>
    29. 29. To Review <ul><li>Four types of financial statements and </li></ul><ul><li>the major components of the Balance Sheet, Statement of Income, Statement of Retained Earnings and Statement of Cash Flows (and the Notes) </li></ul><ul><li>Key aspects of other financial reports </li></ul><ul><li>Auditor reports (Qualified vs. Unqualified) </li></ul>
    30. 30. For Further Consideration <ul><li>NACM Classes – now On Line, too </li></ul><ul><li>NACM designations – CBA / CBF / CCE </li></ul><ul><li>NACM Conferences–Regional / National </li></ul><ul><ul><li>WRCC October 2010 in Las Vegas </li></ul></ul><ul><li>Future webinars from CMA – always looking for suggestions… </li></ul>
    31. 31. Any Questions??? <ul><li>Thank you for attending this webinar </li></ul><ul><li>Jim </li></ul>