Communicating and Interpreting Accounting Information Chapter 5 Mc

Communicating and Interpreting Accounting Information Chapter 5 Mc. Graw-Hill/Irwin © 2009 The Mc. Graw-Hill Companies, Inc.

Players in the Accounting Communication Process Management Preparation CEO, CFO, Accounting Staff Guided by GAAP Independent Auditors Verification Partners, Managers, Staff Guided by GAAS An unqualified opinion states that the financial statements are fair presentations in all material respects in conformity with GAAP. 5 -2

Players in the Accounting Communication Process Management Preparation CEO, CFO, Accounting Staff Guided by GAAP Information Intermediaries Analysis and Advice Financial analysis, Information services Independent Auditors Verification Partners, Managers, Staff Guided by GAAS Financial analysts make predictions concerning companies’ future earnings and stock prices. 5 -3

Players in the Accounting Communication Process Management Preparation CEO, CFO, Accounting Staff Guided by GAAP Information Intermediaries Analysis and Advice Financial analysis, Information services Independent Auditors Verification Partners, Managers, Staff Guided by GAAS Web Info Services: www. sec. gov; www. compustat. com; www. finance. yahoo. com; www. bloomberg. com; www. hoovers. com; www. factiva. com 5 -4

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

Ensuring the Integrity of Financial Information Communication Process Regulators Standard Setting and Verification SEC Stock Exchanges FASB PCAOB Corporate Governance Standards Accounting Standards Auditing Standards Management Primary Responsibility CFO, CEO, Accounting staff Auditors (CPAs) Verification Partners, Managers, Staff Directors Oversight Audit Committee (Independent directors) 5 -6

Users: Institutional and Private Investors, Creditors, and Others 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. 5 -7

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 5 -8

Guiding Principles for Communicating Useful Information Primary Objective of External Financial Reporting To provide economic information to external users for decision making. The full-disclosure principles require. . . Primary Qualitative Characteristics 1. Relevance: A complete set financial statements, Timely andof Predictive and Feedback Value and Unbiased, and Verifiable Reliability: Accurate, 2. Notes to the financial statements Secondary Qualitative Characteristics Comparability: Across businesses Consistency: Over time 5 -9

International Accounting Standards Board and Global Differences in Accounting Standards International Financial Reporting Standards 5 -10

Annual Reports For privately held companies, annual reports are simple documents that include: 1. 2. 3. Four basic financial statements. Related notes (footnotes). Report of independent accountants (auditor’s opinion) if the statements are audited. 5 -11

Annual Reports For public companies, annual reports are elaborate due to SEC reporting requirements: 1. A Nonfinancial Section 2. A letter to the stockholders, a description of management’s philosophy, products, successes, etc. A Financial Section See next slide for a detailed listing. . . 5 -12

Annual Reports 1. 2. 3. 4. 5. Summarized financial data for 5 - or 10 -years. Management Discussion and Analysis (MD&A). The four basic financial statements. Notes (footnotes). Independent Accountant’s Report and the Management Certification. 6. 7. 8. Recent stock price information. Summaries of the unaudited quarterly financial data. Lists of directors and officers of the company and relevant addresses. 5 -13

Quarterly Reports ü Usually begin with short letter to stockholders ü Condensed unaudited income statement and balance sheet for the quarter. ü Often, cash flow statement and statement of stockholders’ equity are omitted. Some notes to the financial statements also may be omitted. 5 -14

SEC Reports – 10 -K, 10 -Q, 8 -K 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. 5 -15

Classified Balance Sheet 5 -16

Classified Balance Sheet 5 -17

Classified Balance Sheet Contributed capital is normally shown in two accounts: 1. Common Stock 2. Additional Paid-in Capital 5 -18

Classified Income Statement Income statements may contain three sections: Continuing operations Nonrecurring Items 1. 2. A. B. 3. Discontinued operations Extraordinary items Earnings per share 5 -19

Classified Income Statement General Format for the Classified Income Statement 5 -20

Earnings Per Share EPS = Net Income* Average Number of Shares of Common Stock Outstanding During the Period Basic EPS *If there are preferred dividends, the amount is subtracted from the Net Income in the numerator. 5 -21

Common-Size Income Statement Total revenue is equal to 100%. 5 -22

Statement of Cash Flows 1. 2. 3. Recall that the Statement of Cash Flows is divided into three major sections. Cash flows from operating activities. Cash flows from investing activities. 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. 5 -23

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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. 5 -27

Return on Equity (ROE) Analysis Return = on Equity Net Income Average Stockholders’ Equity 1 ROE measures how much the firm earned for each dollar of stockholders’ investment. 1(beginning equity + ending equity) ÷ 2 5 -28

ROE Profit Driver Analysis = Net Profit Margin Net Income Net Sales × × Net Income Average Stockholders’ Equity = Asset Turnover Net Sales Average Total Assets × Financial Leverage × ROE Average Total Assets Average Stockholders’ Equity 5 -29

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. 5 -30

Chapter Supplement: Nonrecurring Items General Format for the Classified Income Statement In addition, companies may have nonrecurring items. These nonrecurring items may include: 1. Discontinued operations, 2. Extraordinary items, These items are reported separately because they are not useful in predicting future income of the company. 5 -31

Discontinued Operations Sale or abandonment of a segment of a business. Income or loss on segment’s operation for the period. Gain or loss on disposal of the segment. Show net of applicable taxes. 5 -32

Extraordinary Items Unusual Infrequent Show net of applicable taxes. 5 -33

End of Chapter 5 Mc. Graw-Hill/Irwin © 2009 The Mc. Graw-Hill Companies, Inc.