Accounting & Financial Reporting

1. Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Communicating
and Interpreting
Accounting
Information
Chapter 5

2. 5-2
Learning Objectives
Recognize the people involved in the
accounting communication process
(regulators, managers, directors, auditors,
information intermediaries and users), their
role in the process and the guidance they
receive from legal and professional standards.

3. 5-3
Players in the
Accounting
Communication
Process
An unqualified opinion states
that the financial statements are
fair presentations in all material
respects in conformity with
GAAP.
Independent Auditors
Verification
Partners, Managers, Staff
Guided by GAAS
Management
Preparation
CEO, CFO, Accounting Staff
Guided by GAAP

4. 5-4
Information
Intermediaries
Analysis and Advice
Financial analysis,
Information services
Financial analysts
make predictions
concerning
companies’ future
earnings and stock
prices.
Independent Auditors
Verification
Partners, Managers, Staff
Guided by GAAS
Management
Preparation
CFO, CEO, Accounting Staff
Guided by GAAP
Players in the
Accounting
Communication
Process

5. 5-5
Information
Intermediaries
Analysis and Advice
Financial analysis,
Information services
Financial analysts
make predictions
concerning
companies’ future
earnings and stock
prices.
Independent Auditors
Verification
Partners, Managers, Staff
Guided by GAAS
Management
Preparation
CFO, CEO, Accounting Staff
Guided by GAAP
Web Info Services:
www/sec/gov
www.compustat.com
www.djnr.com
www.bloomberg.com
www.firstcall.com
www.hoover.com
Players in the
Accounting
Communication
Process

6. 5-6
Government
Regulators
Verification
SEC Members
Guided by SEC regs.
Users
Analysis and Decision
Investors, Lenders, etc. Public
companies only
Management
Preparation
CFO, CEO, Accounting Staff
Guided by GAAP
Information
Intermediaries
Analysis and Advice
Financial analysis,
Information services
Independent Auditors
Verification
Partners, Managers, Staff
Guided by GAAS
Players in the
Accounting
Communication
Process

7. 5-7
Ensuring the Integrity of Financial
Information Communication Process
Regulators
Standard Setting and
Verification
SEC
Management
Primary Responsibility
CFO, CEO, Accounting Staff
Auditors (CPAs)
Verification
Partners, Managers, Staff
Directors
Oversight
Audit Committee
(Independent directors)

8. 5-8
Using Financial Reports
Management
Primary Responsibility
CFO, CEO, Accounting Staff
Information
Intermediaries
Analysis and Advice
Financial analysts,
Information services
Users
Analysis and Decision
Institutional and private
investors, Lenders,
Suppliers, Customers, etc.

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 Qualitative Characteristics
Relevance: Timely and Predictive Feedback Value
Reliability: Accurate, Unbiased, and Verifiable
Secondary Qualitative Characteristics
Comparability: Across businesses
Consistency: Over time

10. 5-10
Guiding Principles for Communicating
Useful Information
Primary Objective of External Financial Reporting
To provide economic information to external users
for decision making.
Primary Qualitative Characteristics
Relevance: Timely and Predictive and Feedback Value
Reliability: Accurate, Unbiased, and Verifiable
Secondary Qualitative Characteristics
Comparability: Across businesses
Consistency: Over time
The full-disclosure principles require . . .
1.A complete set of financial statements,
and
2.Notes to the financial statements

11. 5-11
International Accounting Standards Board
and Global Differences in Accounting
Difference in Accounting Standards US GAAP IFRS
Extraordinary items Permitted Prohibited
LIFO for inventory Permitted Prohibited
Reversal of inventory write-downs Prohibited Required
Basis of property, plant, and equipment Historical cost Fair Value or
Historical cost
International Financial Reporting Standards

12. 5-12
Learning Objectives
Identify the steps in the accounting
communication process, including the
issuance of press releases, annual reports,
quarterly reports and SEC filings as well as the
role of electronic information services in this
process.

13. 5-13
The Disclosure Process
Press Releases are used to announce
quarterly and annual earnings as soon as
the verified figures are available.
Earnings Press Release Excerpt for Callaway Golf
Callaway® Golf
CARLSBAD, Calif. -- Jan. 22, 2004-- Callaway Golf
Company (NYSE:ELY) today reported record sales for the
full year ended December 31, 2003, announcing net sales of
$814 million compared with $793 million for the prior year.
Net income for the full year was $46 million versus . . . .

14. 5-14
Annual Reports
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.

15. 5-15
Annual Reports
For public companies, annual reports are
elaborate due to SEC reporting
requirements:
1. A Nonfinancial Section
 A letter to the stockholders, a description of
management’s philosophy, products,
successes, etc.
2. A Financial Section
 See next slide for a detailed listing . . .

16. 5-16
Annual Reports - Financial Section
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.

17. 5-17
Quarterly Reports
Usually begin with short letter to stockholders
 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.

18. 5-18
SEC Reports
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 8-K Current Report
•Due within 15 days of the major event date.
•Financial statements can be unaudited.

19. 5-19
Learning Objectives
Recognize and apply the different financial
statement and disclosure formats used by
companies in practice.

20. 5-20
Financial Statement Formats
Let’s take a
closer look
at the asset
section of the
balance
sheet!

21. 5-21
(in thousands, except share data and per share data) 2003 2002
ASSETS
Current assets:
Cash and cash equivalents 47,340
$ 108,452
$
Accounts receivable, net 100,664 63,867
Inventories, net 185,389 151,760
Other current assets 50,069 44,948
Total current assets 383,462 369,027
Property, plant and equipment, net 164,763 167,340
Intangible assets, net 169,851 121,317
Other assets 30,490 22,161
748,566
$ 679,845
$
Consolidated Balance Sheet
December 31,
Callaway Golf Company

22. 5-22
(in thousands, except share data and per share data) 2003 2002
ASSETS
Current assets:
Cash and cash equivalents 47,340
$ 108,452
$
Accounts receivable, net 100,664 63,867
Inventories, net 185,389 151,760
Other current assets 50,069 44,948
Total current assets 383,462 369,027
Property, plant and equipment, net 164,763 167,340
Intangible assets, net 169,851 121,317
Other assets 30,490 22,161
748,566
$ 679,845
$
Consolidated Balance Sheet
December 31,
Callaway Golf Company
Current assets
are assets that
will be turned into
cash or expire (be
used up) within
the longer of one
year or the
operating cycle.

23. 5-23
(in thousands, except share data and per share data) 2003 2002
ASSETS
Current assets:
Cash and cash equivalents 47,340
$ 108,452
$
Accounts receivable, net 100,664 63,867
Inventories, net 185,389 151,760
Other current assets 50,069 44,948
Total current assets 383,462 369,027
Property, plant and equipment, net 164,763 167,340
Intangible assets, net 169,851 121,317
Other assets 30,490 22,161
748,566
$ 679,845
$
Consolidated Balance Sheet
December 31,
Callaway Golf Company
Property, plant and
equipment includes
assets with useful
lives of more than
one year acquired
for use in the
business rather
than for resale. The
amount is reported
net of accumulated
depreciation.

24. 5-24
(in thousands, except share data and per share data) 2003 2002
ASSETS
Current assets:
Cash and cash equivalents 47,340
$ 108,452
$
Accounts receivable, net 100,664 63,867
Inventories, net 185,389 151,760
Other current assets 50,069 44,948
Total current assets 383,462 369,027
Property, plant and equipment, net 164,763 167,340
Intangible assets, net 169,851 121,317
Other assets 30,490 22,161
748,566
$ 679,845
$
Consolidated Balance Sheet
December 31,
Callaway Golf Company
Intangible assets
have no physical
existence and a
long life. They
include patents,
copyrights,
trademarks, etc.

25. 5-25
Let’s now look
at the liability
section of a
classified
balance sheet.

26. 5-26
(in thousands, except share data and per share data) 2003 2002
LIABILITIES & STOCKHOLDERS" EQUITY
Current Liabilities:
117,958
$ 98,352
$
240 3,160
Income taxes payable 11,962 7,649
Total current liabilities 130,160 109,161
Long-term liabilities:
Other liabilities 29,023 27,297
Commitment and contingencies (Note 13)
CallawayGolf Company
Consolidated Balance Sheet
December 31,
Notes payable, current portion
Accounts payable and accrued
expenses

27. 5-27
(in thousands, except share data and per share data) 2003 2002
LIABILITIES & STOCKHOLDERS' EQUITY
Current Liabilities:
117,958
$ 98,352
$
240 3,160
Income taxes payable 11,962 7,649
Total current liabilities 130,160 109,161
Long-term liabilities:
Other liabilities 29,023 27,297
Commitment and contingencies (Note 13)
CallawayGolf Company
Consolidated Balance Sheet
December 31,
Notes payable, current portion
Accounts payable and accrued
expenses
Current liabilities
are obligations
that will be paid
with current
assets, normally
within one year.

28. 5-28
(in thousands, except share data and per share data) 2003 2002
LIABILITIES & STOCKHOLDERS" EQUITY
Current Liabilities:
117,958
$ 98,352
$
240 3,160
Income taxes payable 11,962 7,649
Total current liabilities 130,160 109,161
Long-term liabilities:
Other liabilities 29,023 27,297
Commitment and contingencies (Note 13)
CallawayGolf Company
Consolidated Balance Sheet
December 31,
Notes payable, current portion
Accounts payable and accrued
expenses
Long-term liabilities are debts that have
maturity dates extending beyond one
year from the balance sheet date.

29. 5-29
Finally, we get to
the
stockholders’
equity section of
a classified
balance sheet.

30. 5-30
(in thousands, except share data and per share data) 2003 2002
LIABILITIES & STOCKHOLDERS' EQUITY
Shareholders' equity:
Common stock, $.01 par value, 83,710,094
and 83,577,427 issued and outstanding at
December 31, 2003 and 2002, respectively 837
$ 836
$
Additional paid-in capital 122,105 103,097
Retained Earnings 466,441 439,454
Total stockholders equity 589,383 543,387
Total Liabilities and stockholders' equity 748,566
$ 679,845
$
Consolidated Balance Sheet
December 31,
Callaway Golf Company
Contributed capital is often shown in
two separate accounts
1.Common stock.
2.Additional paid-in capital.

31. 5-31
(in thousands, except share data and per share data) 2003 2002
LIABILITIES & STOCKHOLDERS' EQUITY
Shareholders' equity:
Common stock, $.01 par value, 83,710,094
and 83,577,427 issued and outstanding at
December 31, 2003 and 2002, respectively 837
$ 836
$
Additional paid-in capital 122,105 103,097
Retained Earnings 466,441 439,454
Total stockholders equity 589,383 543,387
Total Liabilities and stockholders' equity 748,566
$ 679,845
$
Consolidated Balance Sheet
December 31,
Callaway Golf Company
Retained earnings is the total
earnings of the company less the
total dividends declared since
inception of operations.

32. 5-32
Balance Sheet Ratios and
Debt Contracts
When a company borrows money, it often
agrees to certain restrictions on activity.
Ratios typically part of the borrowing
agreement include:
Total Liabilities
÷ Stockholders' Equity
= Debt-to-Equity Ratio
Current Assets
÷ Current Liabilities
= Current Ratio

33. 5-33
Classified Income Statement
Income statements may contain five sections:
1. Continuing operations
2. Discontinued operations
3. Extraordinary items
4. Cumulative effect of changes in accounting
methods
5. Earnings per share

34. 5-34
Classified Income Statement
Net sales
− Cost of goods sold
Gross profit
− Operating expenses
Income from operations
± Nonoperating revenues/expenses and gains/losses
Income before income taxes
− Income tax expense
Net income
General Format for the Classified Income Statement
Gross sales minus any
discounts, returns, and
allowances during the period.

35. 5-35
Net sales
− Cost of goods sold
Gross profit
− Operating expenses
Income from operations
± Nonoperating revenues/expenses and gains/losses
Income before income taxes
− Income tax expense
Net income
General Format for the Classified Income Statement
Classified Income Statement
Cost of inventory sold.

36. 5-36
Net sales
− Cost of goods sold
Gross profit
− Operating expenses
Income from operations
± Nonoperating revenues/expenses and gains/losses
Income before income taxes
− Income tax expense
Net income
General Format for the Classified Income Statement
Classified Income Statement
Not related to the company’s primary
operations. Usually includes interest income or
expense and any gains or losses from the
retirement of equipment.

37. 5-37
Common-Size Income Statement
Revenues:
Restaurant sales 66,000
$ 94.56%
Franchise fees 3,800 5.44%
Total revenues 69,800 100.00%
Costs and expenses:
Cost of sales 36,000 51.58%
Salaries & benefits expense 16,000 22.92%
General & administrative expenses 8,100 11.60%
Depreciation expense 2,500 3.58%
Total costs and expenses 62,600 89.68%
Operating income 7,200 10.32%
Other revenues and gains (expenses and losses)
Investment income 1,000 1.43%
Interest expense (60) -0.09%
Gain on sale of land 3,000 4.30%
Income before income taxes 11,140 15.96%
Income tax expense 3,899 5.59%
Net income 7,241
$ 10.37%
Earnings per share 0.40
$
Papa John's International, Inc. and Subsidiaries
Consolidated Statement of Income
Month Ended January 31, 2004
(in thousands of dollars)
Total revenue is
equal to 100%.

38. 5-38
Earnings Per Share
EPS =
Net Income Available to Common Shareholders
Weighted Average Number of Shares
Outstanding During the Reporting Period
Basic EPS

39. 5-39
Earnings Per Share
EPS =
Net Income Available to Common Shareholders
Weighted Average Number of Shares
Outstanding During the Reporting Period
Diluted EPS
Stock options, debt securities,
equity securities are assumed to
be converted into common stock
at the beginning of the period.

40. 5-40
Statement of Cash Flows
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.

41. 5-41
Consolidated Statement of Cash Flows
(in thousands)
2003
Cash flows from operating activities:
Net income 45,523
$
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation & amortization 44,496
Other non-cash items 17,593
Changes in assets and liabilities, net of effects
from acquisitions:
Accounts receivable, net 12,698
Inventories, net 4,897
Other assets (4,743)
Accounts payable and accrued expenses (7,297)
Income taxes payable 4,004
Other liabilities 1,572
Net cash provided by operating activities 118,743
$
This is the operating activities section of Callaway using the indirect
method. Begin with accounting net income and arrive at cash
provided by operating activities.

42. 5-42
While these
items are on
the income
statement, they
have no
current cash
effect.
Consolidated Statement of Cash Flows
(in thousands)
2003
Cash flows from operating activities:
Net income 45,523
$
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation & amortization 44,496
Other non-cash items 17,593
Changes in assets and liabilities, net of effects
from acquisitions:
Accounts receivable, net 12,698
Inventories, net 4,897
Other assets (4,743)
Accounts payable and accrued expenses (7,297)
Income taxes payable 4,004
Other liabilities 1,572
Net cash provided by operating activities 118,743
$

43. 5-43
Consolidated Statement of Cash Flows
(in thousands)
2003
Cash flows from operating activities:
Net income 45,523
$
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation & amortization 44,496
Other non-cash items 17,593
Changes in assets and liabilities, net of effects
from acquisitions:
Accounts receivable, net 12,698
Inventories, net 4,897
Other assets (4,743)
Accounts payable and accrued expenses (7,297)
Income taxes payable 4,004
Other liabilities 1,572
Net cash provided by operating activities 118,743
$
This table
provides
guidance for
adjustments
related to
changes in
current assets
and current
liabilities.
Change in Account Balance During Year
Increase Decrease
Current Subtract from net Add to net income.
Assets income.
Current Add to net income. Subtract from net
Liabilities income.

44. 5-44
Consolidated Statement of Cash Flows
(in thousands)
2003
Cash flows from investing activities
Capital expenditures (7,810)
$
Acquisition, net of cash acquired (160,321)
Proceeds from sale of assets 202
Net cash used in investing activities (167,929)
$
Cash flows from financing activities:
Payments on financing arrangements (8,117)
Issuance of common stock 17,994
Acquisitiion of Common Stock (4,755)
Dividends paid, net (18,536)
Net cash used in financing activities (13,414)
$
Effect of exchange rate changes on cash 1,488
Net (decrease) increase in cash and cash
equivalents (61,112)
Cash and cash equivalents at beginning of year 108,452
Cash and cash equivalents at end of year 47,340
$
Here is the rest
of Callaway’s
Statement of
Cash Flows
showing the
cash balance
on the
company’s
balance sheet.

45. 5-45
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.

46. 5-46
Learning Objectives
Analyze a company’s performance based on
return on equity and its components.

47. 5-47
Return on Equity (ROE)
1(beginning equity + ending equity) ÷ 2
Return
on
Equity
=
Net Income
Average Stockholders’ Equity1
ROE measures how much the firm
earned for each dollar of
stockholders’ investment.

48. 5-48
ROE Profit Driver Analysis
ROE
Net Profit
Margin
Asset
Turnover
Financial
Leverage
= ×
×
Net Income
Average
Stockholders’
Equity
Net Income
Net Sales
Net Sales
Average
Total Assets
Average
Total Assets
Average
Stockholders’
Equity
× ×
=

49. 5-49
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.
Low-Cost.
Rely on efficient management of accounts receivable,
inventory and productive assets to produce
high asset turnover.

50. 5-50
Other Items Reported on the
Income Statement
Chapter Supplement A

51. 5-51
Net sales
− Cost of goods sold
Gross profit
− Operating expenses
Income from operations
± Nonoperating revenues/expenses and gains/losses
Income before income taxes
− Income tax expense
Net income
General Format for the Classified Income Statement
Classified Income Statement
In addition, companies may have nonrecurring items.
These nonrecurring items may include:
1. Discontinued operations,
2. Extraordinary items,
3. Cumulative effect of changes in accounting methods.
These items are reported separately because they are
not useful in predicting future income of the company.

52. 5-52
Discontinued Operations
Income or loss on
segment’s operation for
the period.
Gain or loss on
disposal of the
segment.
Sale or abandonment of a segment of a
business.
Show net of applicable taxes.

53. 5-53
Extraordinary Items
Unusual Infrequent
Show net of applicable taxes.

54. 5-54
Cumulative Effect of Changes in Accounting
Methods
The change must be to a preferable
method and must be disclosed in notes
to financial statements.
GAAP
Method
Change to
Alternative
GAAP
Method
Show net of applicable taxes.

55. 5-55
End of Chapter 5