Chapter 15 Using Accounting Information Learning Objectives 1

Chapter 15 Using Accounting Information

Learning Objectives 1. Explain why accurate accounting information and audited financial statements are important. 2. Identify the people who use accounting information and possible careers in the accounting industry. 3. Discuss the accounting process. 4. Read and interpret a balance sheet. 5. Read and interpret an income statement. 6. Describe business activities that affect a firm’s cash flow. 7. Summarize how managers evaluate the financial health of a business. Copyright © Cengage Learning. All rights reserved. Chapter 15 | Slide 2

Accounting …the process of systematically collecting, analyzing, and reporting financial information. Copyright © Cengage

Accounting Provides Answers 1. How much profit did a business earn last year? 2. How much tax does a business owe the Internal Revenue Service? 3. How much cash does a business have on hand? Copyright © Cengage Learning. All rights reserved. Chapter 15 | Slide 4

Accounting As an Information System Source: Needles, Powers, Crosson, Principles of Accounting (Boston: Houghton

Recent Accounting Problems § Pressure to “cook” the books § Greed: compensation tied to stock value § Inaccurate/misleading reporting § Increased SEC and IRS scrutiny Copyright © Cengage Learning. All rights reserved. Chapter 15 | Slide 6

Audited Financial Statements Audit: Examination of a company’s financial statements and accounting practices that produced them Generally Accepted Accounting Principles (GAAPs): Accepted set of guidelines and practices for companies reporting financial information and for the accounting profession Copyright © Cengage Learning. All rights reserved. Chapter 15 | Slide 7

Organizations Influencing Accounting Profession § Financial Accounting Standards Board (FASB) § American Institute of Certified Public Accountants (AICPA) § International Accounting Standards Board (IASB) Copyright © Cengage Learning. All rights reserved. Chapter 15 | Slide 8

Sarbanes-Oxley Act (2002) § SEC established oversight board § CEO/CFO required to certify reports § Accounting firms cannot provide non-auditing/consulting services § Auditors keep documents/work papers for 5 years § Prison sentences up to 20 years for document destruction § Change auditing firm every 5 years § Protection of whistle-blowers Copyright © Cengage Learning. All rights reserved. Chapter 15 | Slide 9

Table 15. 1: Users of Accounting Information Managers + outside individuals + other organizations

Types of Accounting § Managerial: provides information to make decisions about financing, investing, and operations § Financial: generates statements/reports § Cost: determines cost of production § Government: ensures tax revenues collected § Not-for-Profit: accounts for donations and expenditures § Tax: plans tax strategy and prepares returns Copyright © Cengage Learning. All rights reserved. Chapter 15 | Slide 11

To Be Successful in Accounting § Be responsible, honest, ethical § Have strong background in financial management § Know computer/software to process data § Be able to communicate about accounting information Copyright © Cengage Learning. All rights reserved. Chapter 15 | Slide 12

Spotlight Income for Accountants and Auditors Source: The Bureau of Labor Statistics web site

Accountant Classifications § Private: employed by specific organization § Public: works on fee basis for clients and may be self-employed § Certified Public Accountant (CPA): individual has met state requirements for accounting education and experience and has passed AICPA exam § Certified Management Accountant (CMA): certified by Institute for Management Accountants Copyright © Cengage Learning. All rights reserved. Chapter 15 | Slide 14

Requirements for Becoming a CPA 1. Education = 150 undergraduate and/or graduate semester hours 2. Most areas a) At least a bachelor’s degree b) Two+ years of public accounting (some areas accept non-public accounting) c) Certificate and license: pass exam and fulfill experience 3. Age = 18+ Source: Smart. Pros, “Basic Information on the CPA Exam”, 2000, http: //www. pro 2 net. com/x 14341. xml Copyright © Cengage Learning. All rights reserved. Chapter 15 | Slide 15

Accounting Equation Assets = Liabilities + Owners’ Equity Assets = Resources Business Owns Liabilities = Firm’s Debts Owners’ Equity = Total Assets - Total Liabilities Copyright © Cengage Learning. All rights reserved. Chapter 15 | Slide 16

Double-Entry Bookkeeping …a system in which each financial transaction is recorded as two separate accounting entries to maintain the balance shown in the accounting equation. Copyright © Cengage Learning. All rights reserved. Chapter 15 | Slide 17

Accounting Cycle Analyze Close Prepare Record Post Copyright © Cengage Learning. All rights reserved.

Balance Sheet …a summary of the dollar amounts of a firm’s assets, liabilities, and owners’ equity accounts at the end of a specific accounting period. Copyright © Cengage Learning. All rights reserved. Chapter 15 | Slide 19

Figure 15. 1: Personal Balance Sheet Individuals determine their net worth, or owner’s equity, by subtracting the value of their debts from the value of their assets. Copyright © Cengage Learning. All rights reserved. Chapter 15 | Slide 20

Balance Sheet Assets Listed Most Liquid Least Liquid Copyright © Cengage Learning. All rights

Figure 15. 2: Business Balance Sheet Summarizes firm’s accounts at the end of an accounting period. Note that assets ($340, 000) equal liabilities plus owners’ equity ($340, 000). Copyright © Cengage Learning. All rights reserved. Chapter 15 | Slide 22

Income Statement …a summary of a firm’s revenues and expenses during a specified accounting

Figure 15. 3: Personal Income Statement By subtracting expenses from income, anyone can construct a personal income statement and determine if they have a surplus or deficit at the end of each month. Copyright © Cengage Learning. All rights reserved. Chapter 15 | Slide 24

Income Statement Expense Accounts Cost of Goods Sold = Beginning Inventory + Net Purchases

Figure 15. 4: Business Income Statement Summarizes firm’s revenues and expenses during a specified accounting period. For Northeast Art, net income after taxes is $30, 175. Copyright © Cengage Learning. All rights reserved. Chapter 15 | Slide 26

Statement of Cash Flows A statement that illustrates how the operating, investing, and financing activities of a company affect cash during an accounting period. Copyright © Cengage Learning. All rights reserved. Chapter 15 | Slide 27

Figure 15. 5: Statement of Cash Flows For Northeast Art, the amount of cash at the end of the year is $59, 000—the same amount reported for the cash account on the firm’s balance sheet. Copyright © Cengage Learning. All rights reserved. Chapter 15 | Slide 28

Cash Flows Activities § Operating : cash flow from primary revenue source § Investing: cash flow from investments such as purchase/sale of land, equipment, etc. § Financing: cash flow from financing such as changes in debt obligation and owners’ equity Added to beginning cash balance to get ending cash balance Copyright © Cengage Learning. All rights reserved. Chapter 15 | Slide 29

Using Annual Reports to Compare Data § Determine profitability § Read the letters § Compare current statements with prior period statements § Examine footnotes § Learn to calculate financial ratios § Compare with other firms’ Copyright © Cengage Learning. All rights reserved. Chapter 15 | Slide 30

Comparison of Financial Statements Statement Timeframe Main Accounts Income Up to 1 year Income Expense Profit Balance Sheet Since the beginning of the company Assets Liabilities Equity Up to 1 year Operating Investment Financing Cash Flow Copyright © Cengage Learning. All rights reserved. Chapter 15 | Slide 31

Financial Ratio …a number that shows the relationship between two elements of a firm’s

Ratio Classification § Profitability: effectiveness in use of resources § Short-Term: ability to pay current liabilities § Activity: how many times per year accounts receivable collected or inventory sold § Debt to Owners’ Equity: degree operations financed through borrowing Copyright © Cengage Learning. All rights reserved. Chapter 15 | Slide 33

Profitability Ratios Return on Sales = net income after tax net sales $30, 175 = $451, 000 = 6. 7% Return on net income after tax $30, 175 = = $230, 000 = 13. 0% owners’ equity Owners’ Equity Earnings per Share = net income after tax common stock shares outstanding Copyright © Cengage Learning. All rights reserved. $30, 175 = $25, 000 = $1. 21 Chapter 15 | Slide 34

Short-Term Financial Ratios Working Capital = Current Ratio = Acid-Test Ratio = current assets - current liabilities working capital current assets current liabilities = $182, 000 -$ 70, 000 $112, 000 = $182, 000 $70, 000 cash + marketable $139, 000 = securities + receivables $70, 000 current liabilities Copyright © Cengage Learning. All rights reserved. = 2. 6 = 1. 99 Chapter 15 | Slide 35

Activity Ratios A/R Turnover = = Inventory Turnover net sales accounts receivable $451, 000 $38, 000 = 11. 9 times per year cost of goods sold = average inventory = $334, 000 $40, 500 Copyright © Cengage Learning. All rights reserved. = 8. 2 times per year Chapter 15 | Slide 36

Debt-to-Owners’ Equity Ratio Debt-to-Owners’ Equity = total liabilities owners’ equity = Copyright © Cengage

Table 15. 2: Financial Ratios Compared Copyright © Cengage Learning. All rights reserved. Chapter

Chapter Quiz 1. The _____ is designed to improve accounting standards. a) b) c) d) e) Ethics in Accounting Act Graham-Rudman Reform Act Sarbanes-Oxley Act Securities and Exchange Accounting Act Accounting Standards Establishment Act Copyright © Cengage Learning. All rights reserved. Chapter 15 | Slide 39

Chapter Quiz 2. An accountant who is employed by a specific business or organization is referred to as a(n) a) b) c) d) e) public accountant. private accountant. proprietary accountant. AICPA accountant. asset accountant. Copyright © Cengage Learning. All rights reserved. Chapter 15 | Slide 40

Chapter Quiz 3. The first step in the accounting cycle is to a) b) c) d) e) analyze source documents. record individual transactions. post individual transactions. construct a beginning financial statement. prepare a list of employees. Copyright © Cengage Learning. All rights reserved. Chapter 15 | Slide 41

Chapter Quiz 4. Assets, liabilities, and owners’ equity would be listed on a firm’s a) b) c) d) e) balance sheet. income statement of earnings. statement of retained earnings. statement of capital. Copyright © Cengage Learning. All rights reserved. Chapter 15 | Slide 42

Chapter Quiz 5. Current assets minus current liabilities equals a) b) c) d) e) return on owners’ equity. current ratio. acid-test ratio. working capital. current cash statement. Copyright © Cengage Learning. All rights reserved. Chapter 15 | Slide 43