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  1. 1. Text by Profs. Gene Boone & David Kurtz Multimedia Presentation by Prof. Milton Pressley The University of New Orleans [email_address] CHAPTER EIGHTEEN UNDERSTANDING ACCOUNTING AND FINANCIAL STATEMENTS
  2. 2. <ul><li>Explain the functions of accounting and its importance to the firm’s management, investors, creditors, and government agencies </li></ul><ul><li>Identify the three basic activities involving accounting </li></ul><ul><li>Describe the roles played by public, management, government, and not-for-profit accountants </li></ul><ul><li>Outline the steps in the accounting process </li></ul>LEARNING GOALS
  3. 3. <ul><li>Explain the functions and major components of the three principal financial statements: the income statement, the balance sheet, and statement of cash flows </li></ul><ul><li>Discuss how financial ratios are used to analyze the firm’s financial strengths and weaknesses </li></ul><ul><li>Describe the role of budgets in a business </li></ul><ul><li>Explain how exchange rates influence international accounting practices and the importance of uniform financial statements for global business </li></ul>LEARNING GOALS
  4. 4. CHAPTER OVERVIEW <ul><li>Accounting: practice of measuring, interpreting, and communicating financial information to support internal and external business decision making </li></ul>© PhotoDisc
  5. 5. CHAPTER OVERVIEW <ul><li>This chapter: </li></ul><ul><ul><li>Describes who uses accounting information </li></ul></ul><ul><ul><li>Discusses financing, investing, and operating </li></ul></ul><ul><ul><li>Explains the accounting process </li></ul></ul><ul><ul><li>Discusses the development of accounting statements from information about financial transactions </li></ul></ul><ul><ul><li>Presents the methods of interpreting these statements </li></ul></ul><ul><ul><li>Examines the role of budgets in planning and controlling for a business </li></ul></ul>© PhotoDisc
  6. 6. USERS OF ACCOUNTING INFORMATION <ul><li>People both inside and outside and organization rely on accounting information to help them make business decisions </li></ul>© PhotoDisc
  7. 7. Figure 18.1 Users of Accounting Information
  8. 8. ACCOUNTING AND THE ENVIRONMENTS OF BUSINESS <ul><li>Accountants contribute important information to help managers deal with the competitive and economic environments </li></ul><ul><li>They help others to understand, predict, and react to the technological, regulatory, and social and cultural environments </li></ul>© PhotoDisc
  9. 9. BUSINESS ACTIVITIES INVOLVING ACCOUNTING <ul><li>Accounting plays a key role in: </li></ul><ul><ul><li>Financing </li></ul></ul><ul><ul><li>Investing </li></ul></ul><ul><ul><li>Operating </li></ul></ul>© PhotoDisc
  10. 10. ACCOUNTING PROFESSIONALS <ul><li>Public accountant: provides accounting services to individuals or business firms for a fee </li></ul><ul><li>Most commonly provided services provided by accountants: </li></ul><ul><ul><li>Auditing </li></ul></ul><ul><ul><li>Tax planning and preparation </li></ul></ul><ul><ul><li>Management consulting </li></ul></ul>© PhotoDisc
  11. 11. Figure 18.2 Accounting Firms Do More Than Just Prepare Financial Statements
  12. 12. ACCOUNTING PROFESSIONALS <ul><li>Management accountant: accountant employed by a business other than a public accounting firm </li></ul><ul><ul><li>Responsible for collecting and recording financial transactions, and preparing and interpreting financial statements used by the firm’s managers </li></ul></ul>© PhotoDisc
  13. 13. ACCOUNTING PROFESSIONALS <ul><li>Government and Not-for-Profit accountants: work for federal, state, and local governments or not-for-profit organizations – perform professional services similar to those of management accountants </li></ul><ul><li>Instead of an emphasis on measuring profit or loss, they concern themselves with determining how efficiently the organizations accomplish their objectives </li></ul>© PhotoDisc
  14. 14. THE ACCOUNTING PROCESS <ul><li>Accounting process: the set of activities involved in converting data about individual transactions to financial statements </li></ul>© PhotoDisc
  15. 15. Figure 18.3 the Accounting Process
  16. 16. The Impact of Computers and the Internet on the Accounting Process <ul><li>Has simplified the process, making it faster and easier than the manual method </li></ul><ul><li>Accounting software allows: </li></ul><ul><ul><li>A do-it-once approach </li></ul></ul><ul><ul><li>Numbers can be easily converted into graphs and charts </li></ul></ul><ul><ul><li>Other automatic conversion </li></ul></ul>© PhotoDisc
  17. 17. The Impact of Computers and the Internet on the Accounting Process <ul><li>The internet has brought about: </li></ul><ul><ul><li>Web-based accounting products designed for small business </li></ul></ul><ul><ul><li>Outsourced, Web-based bookkeeping and accounting services </li></ul></ul>© PhotoDisc
  18. 18. Figure 18.4 Web-Based Accounting Services
  19. 19. THE FOUNDATION OF THE ACCOUNTING SYSTEM <ul><li>Generally Accepted Accounting Principles (GAAP): guidelines, or standards, that accountants follow to provide reliable, consistent, and unbiased information to decision makers </li></ul><ul><li>Financial Accounting Standards Board (FASB): responsible for evaluating, setting, or modifying the GAAP </li></ul>© PhotoDisc
  20. 20. The Accounting Equation <ul><li>Asset: anything of value owned or leased by a business </li></ul><ul><ul><li>Includes land, buildings, supplies, cash, accounts or notes receivable, and marketable securities </li></ul></ul>© PhotoDisc
  21. 21. The Accounting Equation <ul><li>Liability: a claim against a firm’s assets by a creditor </li></ul><ul><ul><li>Includes accounts payable, notes payable, wages payable and long-term debt </li></ul></ul>© PhotoDisc
  22. 22. The Accounting Equation <ul><li>Owners’ equity: all claims of the proprietor, partners, or stockholders against the assets of a firm, equal to the excess of assets over liabilities </li></ul>© PhotoDisc
  23. 23. The Accounting Equation <ul><li>Accounting equation: states that Assets = Liabilities + Owner’s Equity </li></ul>© PhotoDisc
  24. 24. <ul><li>Balance sheet: statement of a firm’s financial position – what it owns and the claims against its assets -- at a particular time </li></ul><ul><ul><li>Similar to a photograph of the firm’s assets together with its liabilities and owners’ equity at a specific moment in time </li></ul></ul>FINANCIAL STATEMENTS Balance sheet
  25. 25. Figure 18.5 Balance Sheet for Sierra Pasta Company
  26. 26. <ul><li>Income statement: a financial record of a company’s revenues, expenses, and profits over a period of time </li></ul><ul><ul><li>It helps decision makers to focus on the overall revenues and costs involved in generating them </li></ul></ul>FINANCIAL STATEMENTS Balance sheet Income statement
  27. 27. Figure 18.6 Income Statement for Sierra Pasta Company
  28. 28. <ul><li>Statement of cash flows: statement of a firm’s cash receipts and cash payments that present information on its sources and uses of cash </li></ul>FINANCIAL STATEMENTS Balance sheet Income statement Statement of cash flows
  29. 29. Figure 18.7 Statement of Cash Flows for Sierra Pasta Company
  30. 30. <ul><li>Accrual accounting: accounting method that records revenues and expenses when they occur, not necessarily when cash actually changes hands </li></ul>FINANCIAL STATEMENTS Balance sheet Income statement Statement of cash flows
  31. 31. FINANCIAL RATIO ANALYSIS <ul><li>Ratio analysis: one of the most commonly used tools for measuring the firm’s liquidity, profitability, and reliance on debt financing, as well as the effectiveness of management’s use of its resources </li></ul><ul><li>Allows comparisons with other firms and with the firm’s own past performance </li></ul>Liquidity ratios Profitability ratios Leverage ratios Activity ratios © PhotoDisc
  32. 33. FINANCIAL RATIO ANALYSIS <ul><li>Firm’s ability to meet its short-term obligations when they must be paid is measured by liquidity ratios </li></ul><ul><li>Current ratio and acid-test ratio are two commonly used liquidity ratios </li></ul>Liquidity ratios © PhotoDisc
  33. 34. FINANCIAL RATIO ANALYSIS <ul><li>Current ratio: compares current assets to current liabilities </li></ul><ul><ul><li>Gives managers information about the firm’s ability to pay its current debts as they mature </li></ul></ul>Liquidity ratios © PhotoDisc
  34. 35. FINANCIAL RATIO ANALYSIS <ul><li>Acid-test (or quick) ratio: compares quick assets – the most current liquid assets – against current liabilities </li></ul><ul><ul><li>Quick assets generally consist of cash and marketable securities, and accounts receivable </li></ul></ul><ul><ul><li>Measures the ability of the firm to meet its debt payments on short notice </li></ul></ul>Liquidity ratios © PhotoDisc
  35. 36. FINANCIAL RATIO ANALYSIS <ul><li>Profitability ratios: compare the firm’s earnings with total sales or investments </li></ul><ul><li>Over time, may reveal the effectiveness of management in operating the business </li></ul>Liquidity ratios Profitability ratios © PhotoDisc
  36. 37. FINANCIAL RATIO ANALYSIS <ul><li>Five important profitability ratios are: </li></ul><ul><ul><li>Gross profit margin </li></ul></ul><ul><ul><li>Net profit margin </li></ul></ul><ul><ul><li>Earnings per share </li></ul></ul><ul><ul><li>Return on assets </li></ul></ul><ul><ul><li>Return on equity </li></ul></ul>Liquidity ratios Profitability ratios © PhotoDisc
  37. 38. FINANCIAL RATIO ANALYSIS <ul><li>Leverage ratios: measures the extent to which a firm relies on debt financing </li></ul><ul><li>Provide particularly interesting information to potential investors and lenders </li></ul>Liquidity ratios Profitability ratios Leverage ratios © PhotoDisc
  38. 39. FINANCIAL RATIO ANALYSIS <ul><li>Activity ratios: measure the effectiveness of management’s use of the firm’s resources </li></ul>Liquidity ratios Profitability ratios Leverage ratios Activity ratios © PhotoDisc
  39. 40. FINANCIAL RATIO ANALYSIS <ul><li>Inventory turnover ratio: indicates the number of times merchandise moves through a business </li></ul><ul><li>Total asset turnover: measures how much in sales each dollar in assets generates </li></ul>Liquidity ratios Profitability ratios Leverage ratios Activity ratios © PhotoDisc
  40. 41. BUDGETING <ul><li>Budget: a planning and controlling tool that reflects the firm’s expected sales revenues, operating expenses, and cash receipts and outlays </li></ul><ul><li>Quantifies the firm’s plans for a specified future period </li></ul><ul><li>Serves as a financial blueprint </li></ul><ul><li>Standard for comparison against actual performance </li></ul>© PhotoDisc
  41. 42. Figure 18.8 Sample Cash Budget for Sierra Pasta Company
  42. 43. INTERNATIONAL ACCOUNTING <ul><li>Accounting procedures and practices must be adapted to accommodate an international business environment </li></ul>© PhotoDisc
  43. 44. Exchange Rates <ul><li>Exchange rate: the ratio at which a country’s currency can be exchanged for other currencies </li></ul><ul><li>Currency prices change daily according to supply and demand </li></ul><ul><ul><li>Such fluctuations complicate accounting entries and practices </li></ul></ul>© PhotoDisc
  44. 45. International Accounting Standards <ul><li>International Accounting Standards Committee (IASC), established in 1973, promotes worldwide consistency in financial reporting practices </li></ul><ul><li>Every five years, an international congress is held to: </li></ul><ul><ul><li>Judge progress in achieving consistency in standards </li></ul></ul><ul><ul><li>Work toward increasing comparability among nations’ financial data and currencies </li></ul></ul>© PhotoDisc
  45. 46. WHAT’S AHEAD <ul><li>In next chapter, the financing function of an organization will be introduced </li></ul><ul><li>Finance deals with planning, obtaining, and managing the organization funds to accomplish its objective in the most efficient and effective manner possible </li></ul>© PhotoDisc