Chapter 15 Understanding Accounting and Financial Statements
Learning Goals1 Explain the functions and identify the 5 Explain the functions and major three basic activities involving accounting. components of the four principal financial statements: the balance2 Describe the roles played by public, sheet, the income statement, the management, government, and not-for- statement of owner’s equity, and the profit accountants. statement of cash flows.3 Identify the foundations of the accounting 6 Discuss how financial ratios are system, including GAAP and the role of used to analyze a company’s the Financial Accounting Standards financial strengths and weaknesses. Board (FASB). 7 Describe the role of budgets in a4 Outline the steps in the accounting cycle, business. and define double-entry bookkeeping and 8 the accounting equation. Outline accounting issues facing global business and the move toward one set of worldwide accounting rules.
Accountings Accounting is the process of measuring, interpreting, and communicating financial information to enable people inside and outside the firm to make informed decisions.
Open Book Managements Open book management- sharing sensitive financial information with employees and teaching them how to understand and use financial statements.s Viewing financial information may help them better understand how their work contributes to the company’s success.s Outsiders use financial data to evaluate investment opportunities.
Business Activities Involving Accountings Financing activities provide necessary funds to start a business and expand it after it begins operating.s Investing activities provide valuable assets required to run a business.s Operating activities focus on selling goods and services, but they also consider expenses as important elements of sound financial management.
Accounting Professionalss Public Accountants s Provide accounting services (auditing, tax preparation, consulting) to individuals or business firms for a fee s CPAs Management Accountants s Provide timely, relevant, accurate, and concise information that executives can use to operate their firms s CMAs Government and Not-for- Profit Accountants
Foundation of Accounting Systemss Generally accepted accounting principles (GAAP) encompass the conventions, rules, and procedures for determining acceptable accounting practices at a particular time.s Financial Accounting Standards Board (FASB) is primarily responsible for evaluating, setting, or modifying GAAP in the U.S.s Sarbanes-Oxley Act (SOX) responded to cases of accounting fraud.s Created the Public Accounting Oversight Board, which sets audit standards and investigates and sanctions accounting firms that certify the books of publicly traded firms.s Senior executives must personally certify that the financial information reported by the company is correct.s Resulted in increase in demand for accountants.
The Accounting Cycles Accounting cycle- set of activities involved in converting information about transactions into financial statements.
The Accounting Equations Assets- anything of value owned or leased by a business.s Liability- claim against a firm’s assets by a creditor.s Owner’s equity- all claims of the proprietor, partners, or stockholders against the assets of a firm, equal to the excess of assets over liabilities.s Basic accounting equation- relationship that states assets equal liabilities plus owners’ equity.s Double-entry bookkeeping- process by which accounting transactions are entered; each individual transaction always has an offsetting transaction.
Impact of Technology on Accountings Simplifies the accounting process by automating data entry and calculations.s Available products are customized for businesses of different sizes. s Entrepreneurs and small businesses use: QuickBooks, Peachtree, and BusinessWorks. s Larger firms use larger scale software packages like: Computer Associates, Oracle, and SAP.s Software that handles accounting information for international businesses is another option. Offers different country information/language.s Some systems offer web-based packages for small and medium businesses.
Balance Sheets Balance sheet— statement of a firm’s financial position—what it owns and the claims against its assets—at a particular point in times Photograph of firm’s assets together with its liabilities and owner’s equitys Follows the accounting equation
Income Statements Income Statement— financial record of a company’s revenues and expenses and profits over a period of times Firm’s financial performance in terms of revenues, expenses, and profits over a given time periods Reports profit or losss Focus on revenues and costs associated with revenues
Statement of Owners’ Equitys Statement of Owners’ Equity— is designed to show the components of the change in equity from the end of one fiscal year to the end of the nexts Begins with the amount of equity shown on the balance sheets Net income is added, and cash dividends paid to owners are subtracted
Statement of Cash Flowss Statement of cash flows— a firm’s cash receipts and cash payments that presents information on its sources and uses of cashs Accrual accounting— method that records revenue and expenses when they occur, not necessarily when cash actually changes hands
Financial Ratios Analysiss Ratio analysis— tool for measuring a firm’s liquidity, profitability, and reliance on debt financing as well as the effectiveness of management’s resource utilization
Liquidity Ratios Total current assetss Current ratio compares current assets to current liabilities. Total current liabilitiess Cash and equivalents Acid-test (or quick) ratio + short-term investments measures the ability of a firm + accounts receivable to meet its debt payments on short notice. Total current liabilities
Activity Ratios Net saless Inventory turnover ratio indicates the number of times merchandise moves Average of inventory through a business. Net saless Total asset turnover ratio indicates how much in sales each dollar invested in assets generates. Average of total assets
Profitability Ratioss Profitability ratios measure the organization’s overall financial performance by evaluating its ability to generate revenues in excess of operating costs and other expenses.
Leverage Ratioss Leverage ratios measure the extent to which a firm relies on debt financing.s Total liabilities to total assets ratio > 50 percent indicates that a firm is relying more on borrowed money than owners’ equity.
Budgetss Budget- planning and control tool that reflects a firm’s expected sales revenues, operating expenses, and cash receipts and outlayss Management estimates of expected sales, cash inflows and outflows, and costss Budgets are a financial blueprint that serves as a financial plans Cash budget- tracks the firm’s cash inflows and outflows.
International Accountings Accounting procedures and practices must be adapted to accommodate an international business environment.s The International Accounting Standards Committee (IASC) was established in 1973 to promote worldwide consistency in financial reporting practices. The IASC soon developed its first set of accounting standards and interpretations and, in 2001, became the International Accounting Standards Board (IASB). International Financial Reporting Standards (IFRS) are the standards and interpretations adopted by the IASB.s Exchange rates- ratio at which a country’s currency can be exchanged for other currenciess Consolidated financial statements must reflect gains and losses due to changes in exchange ratess Can have significant impact on financial statement