PRIDE HUGHES KAPOOR INTRODUCTION TO BUSINESS ELEVENTH EDITION
PRIDE HUGHES KAPOOR INTRODUCTION TO BUSINESS ELEVENTH EDITION Chapter Seven Using Accounting Information © 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 7|
Learning Objectives 1. Explain why accurate accounting information and 2. 3. 4. 5. 6. 7. audited financial statements are important. Identify the people who use accounting information and possible careers in the accounting industry. Discuss the accounting process. Read and interpret a balance sheet. Read and interpret an income statement. Describe business activities that affect a firm’s cash flow. Summarize how managers evaluate the financial health of a business. © 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 7|2
Why Accounting Information Is Important § Recent accounting scandals • Pressure on corporate executives to look good to analysts and investors § Why audited financial statements are important • Bankers, creditors, investors, and government agencies rely on an auditor’s opinion of the validity of a firm’s financial statements. © 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 7|3
Why Accounting Information Is Important (cont’d) § What is an audit? • An examination of a company’s financial statements and accounting practices • Generally accepted accounting principles (GAAPs)— an accepted set of guidelines and practices for U. S. companies reporting financial information and the accounting profession • The FASB is developing a new set of standards combining those of GAAP and the International Financial Reporting Standards • An audit does not guarantee that a company has not “cooked” the books © 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 7|4
Why Accounting Information Is Important (cont’d) § Reform: The Sarbanes-Oxley Act of 2002 • The SEC must establish an oversight board to police the accounting industry • Top executives must certify periodic financial reports and are liable for intentional violations of reporting requirements • Accounting firms cannot provide many types of non-audit and consulting services to the companies they audit • Auditors must maintain financial documents and audit work papers for five years © 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 7|5
Why Accounting Information Is Important (cont’d) § Reform: The Sarbanes-Oxley Act of 2002 (cont’d) • Auditors and accountants can be imprisoned for up to twenty years and subject to fines for destroying documents and violating securities laws • A public corporation must change its lead auditing firm every five years • There is protection for whistle-blowers who report violations of the Sarbanes-Oxley Act © 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 7|6
Who Uses Accounting Information § Managers are the primary users • Proprietary: information that is not divulged to anyone outside the firm § Lenders, suppliers, stockholders, potential investors and government agencies are other users © 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 7|7
Users of Accounting Information Table 7. 1 © 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 7|8
Different Types of Accounting § Managerial accounting provides managers and employees within the organization with information needed to make decisions about a firm’s financing, investing, marketing, and operating activities are the primary users § Financial accounting generates financial statements and reports for interested people outside an organization © 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 7|9
Careers in Accounting § Qualities to be successful in accounting • • Be responsible, honest, ethical Have a strong background in financial management Know how to use a computer and accounting software Be able to communicate with people who need accounting information © 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 7 | 10
Careers in Accounting (cont’d) § Private Accountant • Employed by a specific organization • Services performed for the employer - Design its accounting information system - Manage its accounting department - Provide managers with accounting information, advice and assistance. § Public Accountant • Provides services to clients on a fee basis • Self-employed or employee of an accounting firm © 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 7 | 11
Careers in Accounting (cont’d) § Certified Public Accountant (CPA) • Has met state requirements for accounting education and experience and has passed a rigorous accounting examination prepared by the AICPA • Participates in continuing-education programs to maintain certification § Certified Management Accountant (CMA) • Has met requirements for education and experience, passed a rigorous exam, certified by the Institute of Management Accountants • Has demonstrated decision-making, financial planning, analysis, and critical-thinking skills © 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 7 | 12
Starting Salaries for Certified Public Accountants Source: The AICPA Web site at www. aicpa. org, April 12, 2010. © 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 7 | 13
The Accounting Process § The accounting equation § Assets = Liabilities + Owners’ equity • Assets—the resources that a business owns (e. g. , cash, inventory, equipment, and real estate) • Liabilities—the firm’s debts • Owners’ equity—the difference between assets and liabilities (what would be left for the owners if the firm’s assets were sold and the money used to pay off its liabilities) Double-entry bookkeeping system: Each financial transaction is recorded as two separate accounting entries to maintain the balance of the accounting equation © 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 7 | 14
The Accounting Process (cont’d) § The accounting cycle • Done on a regular basis - Analyzing source documents - Recording transactions as they occur in the general journal - Posting transactions to accounts in the general ledger § Done at the end of the period • Preparing the trial balance of all general ledger accounts • Preparing financial statements and closing the books © 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 7 | 15
The 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 (also called statement of financial position) § Assets • Listed in order of liquidity (ease with which an asset can be converted into cash) • Current assets—can quickly be converted into cash or that will be used in one year or less - Cash, marketable securities, accounts receivable, notes receivable, merchandise inventory, and prepaid expenses © 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 7 | 16
The Balance Sheet (cont’d) § Assets (cont’d) • Fixed assets—will be held or used for a period longer than one year - Land, buildings, and equipment - Depreciation—the process of apportioning the cost of a fixed asset over the period during which it will be used • Intangible assets—do not exist physically but have a value based on the rights or privileges they confer on the firm - Patents, copyrights, trademarks, and goodwill © 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 7 | 17
The Balance Sheet (cont’d) § Liabilities • Current liabilities—debts to be repaid in one year or less - Accounts payable—short-term obligations that arise as a result of making credit purchases - Notes payable—obligations that have been secured with promissory notes • Long-term liabilities—debts that need not be repaid for at least one year - Mortgages, bonds, and long-term loans © 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 7 | 18
The Balance Sheet (cont’d) § Owners’ or stockholders’ equity • For sole proprietorships— Assets – liabilities = owners’ equity • For partnerships—each partner’s share of ownership is reported separately in each owner’s name • For corporations—stockholders’ equity • Retained earnings—profits not distributed to stockholders © 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 7 | 19
Personal Balance Sheet Figure 7. 1 Often individuals determine their net worth, or owner’s equity, by subtracting the value of their debts from the value of their assets. © 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 7 | 20
Business Balance Sheet Figure 7. 2 A balance sheet (sometimes referred to as a statement of financial position) summarizes a firm’s accounts at the end of an accounting period, showing the various dollar amounts that enter into the accounting equation. Note that assets ($340, 000) equal liabilities plus owners’ equity ($340, 000). © 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 7 | 21
The Income Statement § A summary of a firm’s revenues and expenses during a specified accounting period • Profit (cash surplus) • Loss (cash deficit) § Revenues • The dollar amounts earned by a firm from selling goods, providing services, or performing business activities • Gross sales—the total dollar amount of all goods and services sold during the accounting period • Net sales—the actual dollar amounts received by a firm for the goods and services it has sold, after adjustment for returns, allowances, discounts © 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 7 | 22
The Income Statement (cont’d) § Cost of goods sold • The dollar amount equal to beginning inventory plus net purchases less ending inventory Cost of = goods sold Beginning Net – Ending + inventory purchases inventory Gross profit = A firm’s net sales less the cost of goods sold © 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 7 | 23
The Income Statement (cont’d) § Operating expenses • All business costs other than the cost of goods sold - Selling expenses—costs related to marketing activities - General expenses—costs of managing the business § Net income • Revenues less expenses, when the difference is positive § Net loss • Revenues less expenses, when the difference is negative © 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 7 | 24
Class Exercise § For each of the following accounts, indicate whether it belongs on a balance sheet or an income statement. • Rent • Cash • Patent • Mortgage payment • Net income • Salaries payable • Purchase • Delivery equipment • Sales • Cost of goods sold • Common stock © 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 17| 25
Personal Income Statement Figure 7. 3 By subtracting expenses from income, anyone can construct a person income statement and determine if they have a surplus or deficit at the end of each month. © 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 7 | 26
Business Income Statement Figure 7. 4 An income statement summarizes a firm’s revenues and expenses during a specified accounting period. For Northeast Art, net income after taxes is $30, 175. © 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 7 | 27
The Statement of Cash Flows § Illustrates how the operating, investing, and financing activities of a company affect cash during an accounting period • Cash flows from operating activities (providing goods and services) • Cash flows from investing activities (purchase and sale of land, equipment, and other assets and investments) • Cash flows from financing activities (changes in debt obligation and owners’ equity accounts) © 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 7 | 28
Statement of Cash Flows Figure 7. 5 A statement of cash flows summarizes how a firm’s operating, investing, and financing activities affect its cash during a specified period—one month, three months, six months, or a year. For Northeast Art, the amount of cash at the end of the year reported on the statement of cash flows is $59, 000—the same amount reported for the cash account on the firm’s balance sheet. © 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 7 | 29
Evaluating Financial Statements § Using accounting information to evaluate a potential investment • Use common sense to interpret the numbers • Financial statements should be audited by an outside source and be current • Look for use of new strategies to reduce costs • Determine the firm’s ability to pay its debts and borrow money in the future • Look at how the numbers relate to each other • Understand the financial ratios © 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 7 | 30
Evaluating Financial Statements (cont’d) § Using accounting information to evaluate a potential investment (cont’d) • Read letters from top executives • Examine the footnotes closely, look for red flags • Examine the comparative data to analyze trends © 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 7 | 31
Comparing Data for Previous Accounting Periods Figure 7. 6 Most corporations include in their annual reports comparisons of the important elements of their financial statements for recent years. Source: Adapted from the Microsoft Corporation 2009 Annual Report, www. microsoft. com, April 12, 2010. © 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 7 | 32
Comparing Data with Other Firms’ Data § Comparisons are possible because of GAAP § Managers can get a general idea of a firm’s relative effectiveness and its standing within the industry § Data are available from annual reports of public corporations § Industry averages are available from Dun & Bradstreet, Standard & Poor’s, industry trade associations © 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 7 | 33
Financial Ratios § Numbers that show the relationship between two elements of a firm’s financial statements § Can be compared with § The firm’s own past ratios § Ratios of competitors § Industry averages § Information to calculate ratios is found on a firm’s balance sheet, income statement, and statement of cash flows © 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 7 | 34
Financial Ratios (cont’d) Table 7. 2 © 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 7 | 35
Financial Ratios (cont’d) Table 7. 2 © 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 7 | 36
Financial Ratios (cont’d) Table 7. 2 © 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 7 | 37
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