Chapter 17         Understanding          Accounting         and Financial          InformationMcGraw-Hill/Irwin        Co...
ChapterSeventeen                  LEARNING GOALS    1. Demonstrate the role that accounting and financial       informatio...
ChapterSeventeen                 LEARNING GOALS    4. Explain how the major financial statements differ.    5. Demonstrate...
Profile                   SIGGI HILMARSSON                            Siggi’s Yogurt      • Hilmarsson missed an        Ic...
ChapterSeventeen               NAME that COMPANY    Until the development of accounting software       simplified the acco...
What isAccounting?     WHAT’S ACCOUNTING?    LG1    • Accounting -- Recording, classifying,        summarizing and interpr...
What isAccounting?   The ACCOUNTING SYSTEM    LG1                                      17-7
What isAccounting?    ACCOUNTANTS’    LG1       RESPONSIBILITIES                                 17-8
ManagerialAccounting     MANAGERIAL ACCOUNTING    LG2    • Managerial Accounting -- Provides information        and analys...
ManagerialAccounting         USERS of ACCOUNTING    LG2               INFORMATION                     Users               ...
FinancialAccounting    FINANCIAL ACCOUNTING    LG2    • Financial Accounting -- Financial information        and analyses ...
FinancialAccounting           HOW to READ    LG2           an ANNUAL REPORT    • Key things to watch for and read:        ...
FinancialAccounting       PUBLIC vs. PRIVATE    LG2            ACCOUNTANTS    • Private Accountants -- Work in a single fi...
FinancialAccounting      WAYS to IMPROVE    LG2      ACCOUNTING PRACTICES                                    17-14
FinancialAccounting                DODD-FRANK ACT    LG2    • Dodd-Frank Wall Street Reform and Consumer      Protection A...
Auditing              AUDITING CHECKS ACCURACY     LG2     • Auditing -- Reviewing and evaluating the           informatio...
FIGHTING ACCOUNTING FRAUD            LINE-by-LINE                       (Legal Briefcase)• Sam E. Antar, a CPA, was convic...
Tax Accountingand Not-for-ProfitAccounting           SPECIALIZED ACCOUNTANTS      LG2       • Tax Accountants -- Accountan...
ProgressAssessment   PROGRESS ASSESSMENT    • What’s the key difference between managerial      and financial accounting? ...
TheAccountingCycle        The ACCOUNTING CYCLE    LG3    • Accounting Cycle - - A six-step procedure that       results in...
TheAccountingCycle          BOOKKEEPER’S ROLE    LG3    • Bookkeeping -- The recording of business       transactions. Boo...
TheAccountingCycle         BOOKKEEPER’S TOOLS    LG3    • Ledger -- A specialized       accounting book or       program w...
AccountingTechnology   TECHNOLOGY and ACCOUNTING    LG3    • Computerized      accounting programs      post information  ...
ProgressAssessment   PROGRESS ASSESSMENT    • How is the job of the bookkeeper different from      an accountant?    • Wha...
UnderstandingKey FinancialStatements       FINANCIAL STATEMENTS     LG3     • Financial Statement -- A summary of all the ...
TheFundamentalAccounting      The FUNDAMENTALEquation    LG4       ACCOUNTING EQUATION    • Fundamental Accounting Equatio...
The BalanceSheet              The BALANCE SHEET     LG3     • Balance Sheet -- The financial statement that         report...
ClassifyingAssets                   ASSETS     LG4     • Assets -- Economic resources owned by a firm.         Items can b...
ClassifyingAssets           CLASSIFYING ASSETS     LG4     • Current Assets -- Items that can or will be         converted...
Liabilities andOwners’ EquityAccounts          CLASSIFYING LIABILITIES      LG4      • Liabilities -- What the business ow...
Liabilities andOwners’ EquityAccounts          OWNERS’ EQUITY ACCOUNTS      LG4      • Owners’ Equity -- The          amou...
ProgressAssessment   PROGRESS ASSESSMENT    • What do we call the formula for the balance      sheet? What three accounts ...
The IncomeStatement      The INCOME STATEMENT    LG4    • Income Statement --        The financial statement        that s...
The IncomeStatement      The INCOME STATEMENT    LG4    • The formula for the income statement:             Revenue       ...
Cost of GoodsSold            ACCOUNTS of the INCOME     LG4             STATEMENT     • Revenue is the monetary value a fi...
OperatingExpenses     ACCOUNTS of the INCOME     LG4          STATEMENT                               (Continued)     • Op...
WHAT’S COMING and GOING       at the COLLEGE BOOKSTORE                  (Spotlight on Small Business)• Generally Accepted ...
TheStatement ofCash Flows     The STATEMENT of CASH FLOWS     LG4     • Statement of Cash Flows -- Reports cash         re...
The Need forCash FlowAnalysis       UNDERSTANDING CASH FLOW     LG4     • Cash Flow -- The difference between cash        ...
BARKING UP the    WRONG FINANCIAL STATEMENT           (Making Ethical Decisions)•                                        1...
ProgressAssessment   PROGRESS ASSESSMENT    • What are the key steps in preparing an income      statement?    • What’s th...
AnalyzingFinancialPerformanceUsing Ratios               USING FINANCIAL RATIOS     LG5     • Ratio Analysis -- The assessm...
LiquidityRatios                 COMMONLY USED     LG5               LIQUIDITY RATIOS      • Liquidity ratios measure a fir...
Leverage(Debt) Ratios       LEVERAGE RATIOS     LG5     • Leverage ratios measure the degree to which a       firm relies ...
Profitability(Performance)Ratio                PROFITABILITY RATIOS    LG5     • Profitability ratios measure how effectiv...
Activity Ratio                       ACTIVITY RATIOS     LG5     • Activity ratios measure how effectively       managemen...
ACCOUNTANTS             of the WORLD UNITED                 (Reaching Beyond Our Borders)• Multinational companies must ad...
TIMELINE for the MOVE to IFRS• 2008: SEC offered proposed timeline• 2009: 110 large companies have the option of  using IF...
ProgressAssessment   PROGRESS ASSESSMENT    • What’s the primary purpose of performing ratio      analysis using the firm’...
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  • Companies: Intuit ’s QuickBooks and Sage’s Peachtree
  • See Learning Goal 1: Demonstrate the role financial information and accounting plays for a business and for its stakeholders.
  • See Learning Goal 1: Demonstrate the role financial information and accounting plays for a business and for its stakeholders. 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, 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. Ask students: What role did questionable accounting procedures play with Enron, Fannie Mae, and World Com?
  • See Learning Goal 1: Demonstrate the role financial information and accounting plays for a business and for its stakeholders. Accountants ’ Responsibilities One of the biggest uses of accountants by business is taxes and auditing. Explain to the class that the theme of “integrity of numbers” is critical for business. In addition to the reasons listed on the slide, 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
  • See Learning Goal 2: Identify the different disciplines within the accounting profession.
  • See Learning Goal 2: Identify the different disciplines within the accounting profession. 1. This slide (based on Figure 17.2) gives the student an overview of the importance of accounting information when managing a 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 2. 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 3. 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.
  • See Learning Goal 2: Identify the different disciplines within the accounting profession.
  • See Learning Goal 2: Identify the different disciplines within the accounting profession. How to Read an Annual Report This slide presents the key areas to read when analyzing a company ’s annual report. It is important that students understand that the annual report is more than a balance sheet but contains different areas which are just as important. The auditor ’s opinion is a critical area for students to understand. Basically there are four different types of opinion letters that can be submitted. They are: Unqualified opinion - An unqualified opinion letter involves a certification made by the independent CPA firm that the company's financial statements were prepared in conformity with Generally Accepted Accounting Principles [GAAP], and fairly represented the firm's financial condition on the statement date. Qualified opinion - A qualified auditor's opinion letter is one in which the CPA has included one or more specific qualifications to its assurance that the customer's financial statements follow GAAP. This means that one or more irregularities were found, and that the customer could not or would not correct these irregularities. Adverse opinion – This is the most serious of all the opinion letters that can accompany a customer's financial statements. When a CPA firm discovers information during the course of its audit that demonstrates material noncompliance with GAAP accounting rules, the CPA may choose to submit an adverse opinion letter to accompany the financial statements of the company under review. Disclaimer of opinion - Due to scope limitations, a CPA may be unwilling to express any opinion about the accuracy of a customer's financial statements. A disclaimer of opinion letter means the CPA does not assume responsibility for the accuracy of the company's financial statements. (Source: www.encyclopediaofcredit.com)
  • See Learning Goal 2: Identify the different disciplines within the accounting profession. This slide helps highlight the difference in public and private accounting. This may be a good time to discuss what accounting or finance careers will do for students: Develop them into a well rounded business executives 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
  • See Learning Goal 2: Identify the different disciplines within the accounting profession. Ways to Improve Accounting Practices This slide charts ways to improve the accounting practice. If the events of the last ten years have taught us anything, it is that accurate financial data is critical for creditors, investors and managers to make informed decisions. The federal government has reacted with the passage of Sarbanes-Oxley. This law which went into effect in 2002 and has five major components: Section 302 - Periodic statutory financial reports are to include certifications that: The signing officers have reviewed the report; the report does not contain any material untrue statements or material omission or be considered misleading; the financial statements and related information fairly present the financial condition and the results in all material respects; the signing officers are responsible for internal controls and have evaluated these internal controls within the previous ninety days and have reported on their findings; a list of all deficiencies in the internal controls and information on any fraud that involves employees who are involved with internal activities; and any significant changes in internal controls or related factors that could have a negative impact on the internal controls Section 401 - Financial statements published by issuers are required to be accurate and presented in a manner that does not contain incorrect statements. Section 404 - Issuers are required to publish information in their annual reports concerning the scope and adequacy of the internal control structure and procedures for financial reporting. Section 409 - Issuers are required to disclose to the public, on an urgent basis, information on material changes in their financial condition or operations. Section 802 - Imposes penalties or fines and/or up to 20 years imprisonment for altering, destroying, mutilating, concealing, falsifying records, documents or tangible objects with the intent to obstruct, impede or influence a legal investigation. (Source: www.soxlaw.com)
  • See Learning Goal 2: Identify the different disciplines within the accounting profession.
  • See Learning Goal 2: Identify the different disciplines within the accounting profession.
  • See Learning Goal 2: Identify the different disciplines within the accounting profession.
  • See Learning Goal 2: Identify the different disciplines within the accounting profession.
  • Managerial accounting provides information and analysis to the managers inside the organization and helps them make better informed decisions. Managerial accounting is concerned with measuring and reporting cost of production, marketing, and other functions such as preparing budgets; making sure business units stay within their budgets and designing strategies to minimize taxes. Financial accounting differs from managerial accounting in that financial accounting generates information for people primarily outside the organization. The private accountant works for a single firm, government agency, or nonprofit organization. While public accountants work for accounting firms that provide accounting services for a fee. Public accountants provide services to individuals or businesses that include designing an accounting system, selection of software to run the accounting system. and analyzing an organization ’s financial performance. Auditors are responsible for examining the financial health of the organization as well as looking into the operational effectiveness and efficiencies of the organization. An independent audit is an audit conducted by public accounts who provide an evaluation and unbiased opinion about the accuracy of a company’s financial statements.
  • See Learning Goal 3: List the steps in the accounting cycle, distinguish between accounting and bookkeeping, and explain how computers are used in accounting. With this slide (based on Figure 17.4) students are provided with the step-by-step progression of the accounting cycle. Place particular emphasis on the accounting cycle to give the student an overview of reporting requirements. To start a discussion with students ask the following questions before showing the next few slides: Can you explain the differences between accounting and bookkeeping? What ’s the difference between an accounting journal and a ledger? Why does a bookkeeper prepare a trial balance?
  • 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 Learning Goal 3: List the steps in the accounting cycle, distinguish between accounting and bookkeeping, and explain how computers are used in accounting.
  • See Learning Goal 3: List the steps in the accounting cycle, distinguish between accounting and bookkeeping, and explain how computers are used in accounting.
  • A bookkeeper classifies and summarizes the firm’s financial data; while accountants interpret the data, prepare financial statements, and report the information to management. The purpose of accounting journal is to divide the firm’s transactions into meaningful categories to keep information organized and manageable. A ledger transfers information from an accounting journal so managers can find information about a single account in one place. A bookkeeper prepares a trial balance to ensure the figures in the account ledgers are correct and balanced. Computer software post information from journals instantaneously even from remote locations so financial information is readily available whenever the organization needs it.
  • See Learning Goal 4: Explain how the major financial statements differ. Students often do not understand that financial statements are more than a balance sheet but incorporate the income statement and statement of cash flows.
  • See Learning Goal 4: Explain how the major financial statements differ.
  • See Learning Goal 4: Explain how the major financial statements differ. See Figure 17.5 in the text for a sample Balance Sheet for Very Vegetarian.
  • See Learning Goal 4: Explain how the major financial statements differ.
  • See Learning Goal 4: Explain how the major financial statements differ. Assets are divided into three categories according to how fast they can be converted into cash.
  • See Learning Goal 4: Explain how the major financial statements differ.
  • See Learning Goal 4: Explain how the major financial statements differ.
  • The formula for the balance sheet is referred to as the fundamental accounting equation. This equation includes the following three accounts: assets, liabilities and owners equity. Assets on the balance sheet are listed according to how quickly they can be converted to cash. Therefore, as you move down the balance sheet it becomes more difficult to convert the assets into “liquid” cash. Liabilities are what the business owes to others. The liability account is divided into current and long-term liabilities. Common liability accounts include: accounts payable, notes payable and bonds payable. Owners ’ equity is the amount of the business that belongs to the owners, minus any liabilities the business owes. The formula for owners’ equity is assets minus liabilities.
  • See Learning Goal 4: Explain how the major financial statements differ.
  • See Learning Goal 4: Explain how the major financial statements differ. See Figure 17.7 in the text for a sample Income Statement for Very Vegetarian.
  • See Learning Goal 4: Explain how the major financial statements differ.
  • See Learning Goal 4: Explain how the major financial statements differ. While depreciation is an expense, it is a non-cash expense for the company.
  • See Learning Goal 4: Explain how the major financial statements differ.
  • See Learning Goal 4: Explain how the major financial statements differ. See Figure 17.8 in the text for a sample Statement of Cash Flows for Very Vegetarian.
  • See Learning Goal 4: Explain how the major financial statements differ.
  • See Learning Goal 4: Explain how the major financial statements differ.
  • The key steps in preparing an income statement are: Revenue Cost of Goods Sold = Gross Profit Operating Expenses = Net Income before Taxes Taxes = Net Income or Net Loss 2. Revenue is the monetary value of what a firm receives for goods sold, services rendered, and other payments such as rent. Income refers to the bottom line which is the net income (or perhaps net loss) the firm incurs from revenue minus sales returns, costs, expenses, and taxes over a period of time. 3. The statement of cash flows is important because it answers such questions as: How much cash came into the business from current operations? Did the firm use cash to buy stocks, bonds, or other investments? Did it sell some investments that brought in cash?
  • See Learning Goal 5: Demonstrate the application of ratio analysis in reporting financial information. Ratio analysis provides an assessment of the firm ’s financial condition. It can be extremely useful when results of a ratio analysis are compared to industry peers.
  • See Learning Goal 5: Demonstrate the application of ratio analysis in reporting financial information. The acid-test ratio is sometimes referred to as the quick ratio.
  • See Learning Goal 5: Demonstrate the application of ratio analysis in reporting financial information.
  • See Learning Goal 5: Demonstrate the application of ratio analysis in reporting financial information.
  • See Learning Goal 5: Demonstrate the application of ratio analysis in reporting financial information.
  • See Learning Goal 5: Demonstrate the application of ratio analysis in reporting financial information.
  • See Learning Goal 5: Demonstrate the application of ratio analysis in reporting financial information. Timeline for the Move to IFRS This slide profiles the timeline for the move to International Financial Reporting Standards International Financial Reporting Standards (IFRS) are a set of accounting standards developed by the International Accounting Standards Board (IASB) that is becoming the global standard for the preparation of public company financial statements. Ask students: What are some of the benefits of international accounting standards? If time permits have students explore the IFRS website (www.ifrs.com) and review some of the accounting case studies that the website presents.
  • Ratio analysis is the assessment of a firm ’s financial condition, using calculations and financial ratios. Financial ratios are especially useful in comparing the company’s performance to its financial objectives and to the performance of others in the industry. The four main categories of financial ratios are: liquidity, leverage, profitability and activity.
  • Chap017

    1. 1. Chapter 17 Understanding Accounting and Financial InformationMcGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
    2. 2. ChapterSeventeen LEARNING GOALS 1. Demonstrate the role that accounting and financial information play for a business and for its stakeholders. 2. Identify the different disciplines within the accounting profession. 3. List the steps in the accounting cycle, distinguish between accounting and bookkeeping, and explain how computers are used in accounting. 17-2
    3. 3. ChapterSeventeen LEARNING GOALS 4. Explain how the major financial statements differ. 5. Demonstrate the application of ratio analysis in reporting financial information. 17-3
    4. 4. Profile SIGGI HILMARSSON Siggi’s Yogurt • Hilmarsson missed an Icelandic treat called skyr, a thick, strained, protein-rich yogurt. • He perfected his yogurt and contacted a former professor for help with financing. • Distribution raised cost problems that affected cash flow. 17-4
    5. 5. ChapterSeventeen NAME that COMPANY Until the development of accounting software simplified the accounting process, accountants had to enter all financial information by hand. Today accounting software makes it possible for businesses to have financial information available whenever they need it. Name two companies that provide accounting software for small businesses Name those companies! 17-5
    6. 6. What isAccounting? WHAT’S ACCOUNTING? LG1 • Accounting -- Recording, classifying, summarizing and interpreting of financial events and transactions in an organization to provide interested parties needed financial information. • Outside parties - like employees, owners, creditors, unions, investors and the government - make use of a firm’s accounting information. 17-6
    7. 7. What isAccounting? The ACCOUNTING SYSTEM LG1 17-7
    8. 8. What isAccounting? ACCOUNTANTS’ LG1 RESPONSIBILITIES 17-8
    9. 9. ManagerialAccounting MANAGERIAL ACCOUNTING LG2 • Managerial Accounting -- Provides information and analysis to managers inside the organization to assist them in decision making. • Managerial accounting is involved with: - Costs of production - Costs of marketing - Preparation and control of budgets - Minimizing tax liabilities 17-9
    10. 10. ManagerialAccounting USERS of ACCOUNTING LG2 INFORMATION Users Type of Report Government tax authority Tax reports Government regulatory Required reports agencies People interested in the Financial statements found in organization’s income annual reports Managers of the firm Financial statements and internally distributed financial reports 17-10
    11. 11. FinancialAccounting FINANCIAL ACCOUNTING LG2 • Financial Accounting -- Financial information and analyses are generated for people primarily outside the organization. Outside users are interested in these questions: - 17-11
    12. 12. FinancialAccounting HOW to READ LG2 an ANNUAL REPORT • Key things to watch for and read: - Management’s discussion and analysis of operations - Balance sheet - Income statement - Statement of cash flows - Auditor’s opinion 17-12
    13. 13. FinancialAccounting PUBLIC vs. PRIVATE LG2 ACCOUNTANTS • Private Accountants -- Work in a single firm, government agency, or nonprofit organization. • Public Accountants -- Provide accounting services to individuals or businesses. • Certified Public Accountants (CPAs) -- Accountants who have passed a series of examinations established by the American Institute of Certified Public Accountants (AICPA) and met a states requirements for education and experience. 17-13
    14. 14. FinancialAccounting WAYS to IMPROVE LG2 ACCOUNTING PRACTICES 17-14
    15. 15. FinancialAccounting DODD-FRANK ACT LG2 • Dodd-Frank Wall Street Reform and Consumer Protection Act increased financial regulation by increasing the power of the Public Company Accounting Oversight Board. • Act was brought on by the recent financial crisis. Photo Courtesy of: Nancy Pelosi 17-15
    16. 16. Auditing AUDITING CHECKS ACCURACY LG2 • Auditing -- Reviewing and evaluating the information used to prepare a company’s financial statements. • Independent Audit -- An evaluation and unbiased opinion about the accuracy of a company’s financial statements. • Certified Internal Auditors (CIAs) -- Accountants who have a bachelor’s degree and two years of experience in internal auditing and pass an exam administered by the Institute of Internal Auditors. 17-16
    17. 17. FIGHTING ACCOUNTING FRAUD LINE-by-LINE (Legal Briefcase)• Sam E. Antar, a CPA, was convicted of inflating sales figures, money laundering, and inventory fraud.• Today, he lectures companies concerning fraud, how to prevent it and training auditors in forensic accounting.• Forensic accountants are trained as crime-scene investigators. 17-17
    18. 18. Tax Accountingand Not-for-ProfitAccounting SPECIALIZED ACCOUNTANTS LG2 • Tax Accountants -- Accountants trained in tax law and are responsible for preparing tax returns or developing tax strategies. • Government and Not- for-Profit Accounting -- Support for organizations whose purpose is not generating a profit, but serving others according to a duly approved budget. 17-18
    19. 19. ProgressAssessment PROGRESS ASSESSMENT • What’s the key difference between managerial and financial accounting? • How’s the job of a private accountant different from that of a public accountant? • What’s the job of an auditor? What’s an independent audit? 17-19
    20. 20. TheAccountingCycle The ACCOUNTING CYCLE LG3 • Accounting Cycle - - A six-step procedure that results in the preparation and analysis of the major financial statements. 17-20
    21. 21. TheAccountingCycle BOOKKEEPER’S ROLE LG3 • Bookkeeping -- The recording of business transactions. Bookkeepers divide a firm’s transactions into meaningful categories and post them into a record book or computer program called a journal. • Double-Entry Bookkeeping -- Bookkeepers record all transactions in two places so they can check one list of transactions against the other for accuracy. 17-21
    22. 22. TheAccountingCycle BOOKKEEPER’S TOOLS LG3 • Ledger -- A specialized accounting book or program where all information is in one place. • Trial Balance -- A summary of all the information in the account ledgers. 17-22
    23. 23. AccountingTechnology TECHNOLOGY and ACCOUNTING LG3 • Computerized accounting programs post information instantly and from remote locations. • Intuit’s QuickBooks and Sage’s Peachtree address the specific needs of small businesses. 17-23
    24. 24. ProgressAssessment PROGRESS ASSESSMENT • How is the job of the bookkeeper different from an accountant? • What’s the purpose of accounting journals and a ledger? • Why does a bookkeeper prepare a trial balance? • How has computer software helped businesses in maintaining and compiling accounting information? 17-24
    25. 25. UnderstandingKey FinancialStatements FINANCIAL STATEMENTS LG3 • Financial Statement -- A summary of all the financial transactions that have occurred over a particular period. • Key financial statements of business are: - Balance sheet - Income statement - Statement of cash flows 17-25
    26. 26. TheFundamentalAccounting The FUNDAMENTALEquation LG4 ACCOUNTING EQUATION • Fundamental Accounting Equation -- The basis for the balance sheet. • The equation must always be balanced and includes the formula:  Assets = Liabilities + Owners Equity 17-26
    27. 27. The BalanceSheet The BALANCE SHEET LG3 • Balance Sheet -- The financial statement that reports a firm’s financial condition at a specific time. 17-27
    28. 28. ClassifyingAssets ASSETS LG4 • Assets -- Economic resources owned by a firm. Items can be tangible or intangible. • Liquidity -- Ease with which assets can be converted into cash. 17-28
    29. 29. ClassifyingAssets CLASSIFYING ASSETS LG4 • Current Assets -- Items that can or will be converted to cash within one year. • Fixed Assets -- Long-term assets that are relatively permanent such as land, buildings, or equipment. • Intangible Assets -- Long-term assets that have no physical form but do have value such as patents, trademarks, and goodwill. 17-29
    30. 30. Liabilities andOwners’ EquityAccounts CLASSIFYING LIABILITIES LG4 • Liabilities -- What the business owes to others - its debts. • Accounts Payable -- Current liabilities a firm owes for merchandise or services purchased on credit. • Notes Payable -- Short or long-term liabilities a business promises to pay by a certain date. • Bonds Payable -- Long-term liabilities that the firm must pay back. 17-30
    31. 31. Liabilities andOwners’ EquityAccounts OWNERS’ EQUITY ACCOUNTS LG4 • Owners’ Equity -- The amount of the business that belongs to the owners minus any liabilities of the owners. • Retained Earnings -- Accumulated earnings from the firm’s profitable operations that are reinvested in the business. 17-31
    32. 32. ProgressAssessment PROGRESS ASSESSMENT • What do we call the formula for the balance sheet? What three accounts does it include? • What does it mean to list assets according to liquidity? • What’s the difference between long-term and short-term liabilities on the balance sheet? • What’s owners’ equity and how do we determine it? 17-32
    33. 33. The IncomeStatement The INCOME STATEMENT LG4 • Income Statement -- The financial statement that shows a firm’s bottom line - that is, its profit after costs, expenses, and taxes. • Net Income/Net Loss -- The revenue left over after costs and expenses. 17-33
    34. 34. The IncomeStatement The INCOME STATEMENT LG4 • The formula for the income statement: Revenue -Cost of Goods Sold = Gross Profit -Operating Expenses = Net Income before Taxes -Taxes = Net Income or Net Loss 17-34
    35. 35. Cost of GoodsSold ACCOUNTS of the INCOME LG4 STATEMENT • Revenue is the monetary value a firm received for goods sold, services rendered or other payments. • Cost of Goods Sold (or Manufactured) -- Measures the cost of merchandise the firm sells or the cost of raw materials and supplies it used in producing items for resale. • Gross Profit (or Gross Margin) -- How much a firm earned by buying (or making) and selling merchandise. (Continued) 17-35
    36. 36. OperatingExpenses ACCOUNTS of the INCOME LG4 STATEMENT (Continued) • Operating Expenses – Cost involved in operating a business, such as rent, salaries and supplies. • Depreciation -- The systematic write-off of the cost of a tangible asset over its estimated useful life. 17-36
    37. 37. WHAT’S COMING and GOING at the COLLEGE BOOKSTORE (Spotlight on Small Business)• Generally Accepted Accounting Principles (GAAP) sometimes permits accountants to use different method of accounting for inventory.• FIFO: First-In, First-Out• LIFO: Last-In, First-Out• Each valuation can affect income and ending inventory valuation. 17-37
    38. 38. TheStatement ofCash Flows The STATEMENT of CASH FLOWS LG4 • Statement of Cash Flows -- Reports cash receipts and cash disbursements related to the three major activities of a firm: 1. Operations 2. Investments 3. Financing 17-38
    39. 39. The Need forCash FlowAnalysis UNDERSTANDING CASH FLOW LG4 • Cash Flow -- The difference between cash coming in and cash going out of a business. • Managing cash flow is a key consideration of a business and can be particularly challenging for small and seasonal businesses. 17-39
    40. 40. BARKING UP the WRONG FINANCIAL STATEMENT (Making Ethical Decisions)• 17-40
    41. 41. ProgressAssessment PROGRESS ASSESSMENT • What are the key steps in preparing an income statement? • What’s the difference between revenue and income on the income statement? • Why is the statement of cash flows important in evaluating a firm’s operations? 17-41
    42. 42. AnalyzingFinancialPerformanceUsing Ratios USING FINANCIAL RATIOS LG5 • Ratio Analysis -- The assessment of a firm’s financial condition using calculations and financial ratios developed from the firm’s financial statements. • Key ratios include: - Liquidity ratios - Leverage ratios - Performance ratios - Activity ratios 17-42
    43. 43. LiquidityRatios COMMONLY USED LG5 LIQUIDITY RATIOS • Liquidity ratios measure a firm’s ability to turn assets into cash to pay its short-term debts. • Two key ratios are: - Current ratio - Acid-test ratio • This information is found on the firm’s balance sheet. 17-43
    44. 44. Leverage(Debt) Ratios LEVERAGE RATIOS LG5 • Leverage ratios measure the degree to which a firm relies on borrowed funds in its operations. • Key ratios include: - Debt to Owner’s Equity Ratio • This information is found on the firm’s balance sheet. 17-44
    45. 45. Profitability(Performance)Ratio PROFITABILITY RATIOS LG5 • Profitability ratios measure how effectively a firm’s managers are using the firm’s various resources to achieve profits. • Key ratios include: - Basic earnings per share - Return on sales - Return on equity • This information is found on the firm’s balance sheet and income statement. 17-45
    46. 46. Activity Ratio ACTIVITY RATIOS LG5 • Activity ratios measure how effectively management is turning over inventory. • Key ratios include: - Inventory turnover ratio • This information is found on the firm’s balance sheet and income statement. 17-46
    47. 47. ACCOUNTANTS of the WORLD UNITED (Reaching Beyond Our Borders)• Multinational companies must adapt their accounting reporting to the rules of multiple countries.• Many countries have adopted International Financial Reporting Standards (IFRS) and are pushing to make them standard.• The U.S. Securities & Exchange Commission believes there should be such a standard. 17-47
    48. 48. TIMELINE for the MOVE to IFRS• 2008: SEC offered proposed timeline• 2009: 110 large companies have the option of using IFRS• 2011: SEC assesses progress of IFRS• 2013: Final decision on the move to IFRS• 2014: Large public companies will be required to report in IFRS (pending SEC decision)• 2016: All companies will be required to report in IFRS (pending SEC decision) Source: IFRS.org, accessed July 2011. 17-48
    49. 49. ProgressAssessment PROGRESS ASSESSMENT • What’s the primary purpose of performing ratio analysis using the firm’s financial statements? • What are the four main categories of financial ratios? 17-49

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