Chapter 14 The Role of Accountants and Accounting

Chapter 14 The Role of Accountants and Accounting Information © 2007 Prentice Hall, Inc. All rights reserved. 1

LEARNING OUTCOMES After reading this chapter, you should be able to: Explain the role of accountants and distinguish between the kinds of work done by public accountants, private accountants, management accountants, and forensic accountants. Explain how the accounting equation is used. Describe three basic financial statements and show they reflect the activity and financial condition of a business. Explain the key standards and principles for reporting financial statements. Describe how computing financial ratios can help users get more information from financial statements to determine the financial strengths of a business. Discuss the role of ethics in accounting. © 2007 Prentice Hall, Inc. All rights reserved. 2

What’s in It for Me? By understanding this chapter’s discussion of accountants, their methods, and their responsibilities, you’ll benefit in three ways: 1. if you’re thinking about starting your own 2. 3. business, you’ll discover your obligations for reporting your firm’s financial status As an employee or union member, you’ll see how to evaluate your company’s financial condition and its prospects for the future As an interested citizen, you’ll learn about accounting ethics and regulatory requirements for maintaining public trust in the business system © 2007 Prentice Hall, Inc. All rights reserved. 3

What Is Accounting? Accounting Defined: Ø A comprehensive system for collecting, analyzing and communicating financial information Ø Bookkeeping: the recording of transactions Users of Accounting Information: Ø Business managers Ø Employees and unions Ø Investors and creditors Ø Tax authorities Ø Government regulatory agencies © 2007 Prentice Hall, Inc. All rights reserved. 4

Who Are Accountants and What Do They Do? Controller Ø Manages all of a firm’s accounting activities Types of Accounting Systems Ø Financial Accounting v Concerned with external information users—the firm’s external stakeholders v Prepares income statements, balance sheets, and other financial reports published for shareholders and the public Ø Managerial (Management) Accounting v Serves internal users (managers) by providing information to make departmental decisions, monitor projects, and plan future activities © 2007 Prentice Hall, Inc. All rights reserved. 5

Who Are Accountants and What Do They Do? (cont’d) Certified Public Accountants (CPAs) Ø Licensed, offering services to the public v Auditing (GAAP) v Tax services v Management advisory services Noncertified Public Accountants Private Accountants Ø Work exclusively for a firm as accountants Management Accountants Ø Certified management accountant (CMA) © 2007 Prentice Hall, Inc. All rights reserved. 6

Who Are Accountants and What Do They Do? (cont’d) Forensic Accountants Ø Assist in the investigation of business and financial issues that may have application to a court of law Ø Investigative Accounting v Identifying financial evidence that may be pertinent v Analyzing financial evidence v Presenting accounting conclusions and their legal implications Ø Litigation Support v Certified Fraud Examiner: A specialty area within forensic accounting © 2007 Prentice Hall, Inc. All rights reserved. 7

The CPA Vision Project Identifying issues for the future Global forces as drivers of change Recommendations A new direction Ø Core services Ø Core competencies © 2007 Prentice Hall, Inc. All rights reserved. 8

Federal Restrictions on CPA Services and Financial Reporting: Sarbox Sarbanes-Oxley Act of 2002 (Sarbox) Ø Enacted to restore public trust in corporate accounting practices as a direct response to corporate financial abuses Ø Restricts non-audit services that CPAs can provide Sarbox Compliance Requirements Ø CFOs and CEOs must pledge that the company’s finances are correct and face severe penalties noncompliance Ø Whistleblowers must be protected © 2007 Prentice Hall, Inc. All rights reserved. 9

The Accounting Equation Ø Assets = Liabilities + Owners’ Equity Ø Assets – Liabilities = Owners’ Equity (or Net Worth) Asset Ø Any economic resource that is expected to benefit a firm or an individual who owns it Liability Ø A debt that the firm owes to an outside party Owners’ Equity Ø Money that owners would receive if they sold all of a company’s assets and paid all of its liabilities © 2007 Prentice Hall, Inc. All rights reserved. 10

Financial Statements Balance Sheets Ø Supply detailed information about: v Assets – Current assets: Cash/assets that can be converted into cash within a year – Fixed assets: Capital that has long-term use or value – Intangible assets: Patents, trademarks, copyrights, etc. v Liabilities – Current liabilities: debts that must be paid within one year, including accounts payable – Long-term liabilities: debts not due for at least a year v Owners’ Equity – Paid-in (invested) capital – Retained earnings (net profits) © 2007 Prentice Hall, Inc. All rights reserved. 11

Financial Statements (cont’d) Income Statement (Profit and Loss Statement) Ø Its description of revenues and expenses results in a figure showing the firm’s annual profit or loss v Revenues: the funds that flow into a business from the sale of goods or services v Cost of revenues: shows the costs of obtaining the revenues from other companies during the year v Cost of goods sold: costs of obtaining materials to make products sold during the year v Gross profit: considers revenues and cost of revenues from the income statement v Operating expenses: resources that must flow out of a company if it is to earn revenues © 2007 Prentice Hall, Inc. All rights reserved. 12

Financial Statements (cont’d) Statements of Cash Flows Ø Describes yearly cash receipts and cash payments v Cash Flows from Operations: Concerns main operating activities: cash transactions involved in buying and selling goods and services v Cash Flows from Investing: Net cash used in or provided by investing v Cash Flows from Financing: Net cash from all financing activities The Budget Ø A detailed report on estimated receipts and expenditures for a future period of time © 2007 Prentice Hall, Inc. All rights reserved. 13

Financial Statements Review Balance Sheet Assets – Liabilities = Owners’ Equity Income Statement Revenues – Expenses = Profit (or Loss) Statement of Cash Flows Cash In and Cash Out Budget Estimate – Actual = Variance © 2007 Prentice Hall, Inc. All rights reserved. 14

Reporting Standards and Practices Generally Accepted Accounting Principles (GAAP) Ø Revenue recognition: Formal recording and reporting of revenues at the appropriate time Ø Full disclosure v Financial statements should not include just numbers but should also furnish management’s interpretations and explanations of those numbers so that users can better understand information in the statements © 2007 Prentice Hall, Inc. All rights reserved. 15

Solvency Ratios Short-Term Current Ratio: Current Assets Current Liabilities Leverage: The ability to finance an investment through borrowed funds © 2007 Prentice Hall, Inc. All rights reserved. 16

Solvency Ratios Long-Term Debt to Owners’ Equity Ratio: Debt Owners’ Equity © 2007 Prentice Hall, Inc. All rights reserved. 17

Profitability and Activity Ratios Return on Equity: Earnings Per Share: Inventory Turnover Ratio: © 2007 Prentice Hall, Inc. All rights reserved. Net Income Total Owners' Equity Net Income # of Shares Outstanding Cost of Goods Sold Average Inventory 18

Bringing Ethics into the Accounting Equation Why Accounting Ethics? Ø To maintain public confidence in business institutions, financial markets, and the products and services of the accounting profession AICPA’s Code of Professional Conduct Ø Maintained and enforced by the AICPA Ø The AICPA identifies six ethics-related areas with which accountants must comply to maintain certification © 2007 Prentice Hall, Inc. All rights reserved. 19

Overview of the Code of Ethics for CPAs Membership in the American Institute of Certified Public Accountants is voluntary. By accepting membership, a certified public accountant assumes an obligation of selfdiscipline above and beyond the requirements of laws and regulations. • Responsibilities • The Public Interest • Integrity • Objectivity and Independence • Due Care • Scope and Nature of Services © 2007 Prentice Hall, Inc. All rights reserved. 20