Accounting & Financial Reporting
BUSG 503
Michael Dimond
Financial Accounting for MBAs
• Course Overview
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Introductions
Schedule
Resources
How do I get an A in this class?
Michael Dimond
School of Business Administration
Financial Accounting for MBAs
• Accounting Information
• Who uses it?
• What does it contain?
• How is it presented?
Michael Dimond
School of Business Administration
Organizations and Social Responsibility
• U.S. business entities recognize the societal aspects of their
overall mission and have established programs to meet these
responsibilities
Michael Dimond
School of Business Administration
Nature of Business Activity
• Businesses engage in three types of activities:
Financing
Investing
Operating
Activities
Activities
Activities
• Borrowing
• Sale of stock
• Purchase and
sale of assets
• Sale of products
& services
• Costs incurred
to operate
business
Michael Dimond
School of Business Administration
Exhibit 1.3—A Model of Business Activities
Michael Dimond
School of Business Administration
What is Accounting?
Identifying
Measuring
Economic
Information
Various Users

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Communicating

Management
Stockholders
Creditors
Financial analysts
Government
Michael Dimond
School of Business Administration
Users of Accounting Info and Their Needs
• Internal Users:
• Primarily the managers of a company
• Involved in the daily affairs of the business
• External Users:
• Not directly involved in the operations of a business
• Need information that differs from that needed by internal users
• Outsiders must rely on information presented by management
Michael Dimond
School of Business Administration
Financial Statements
Michael Dimond
School of Business Administration
Qualitative Characteristics of Accounting Information
• Understandability: the quality of accounting information that makes it
comprehensible to those willing to spend the necessary time
• Relevance: the capacity of information to make a difference in a decision
• Faithful representation: the quality of information that makes it
complete, neutral, and free from error
• Comparability: for accounting information, the quality that allows a user
to analyze two or more companies and look for similarities and
differences
• Consistency: for accounting information, the quality that allows a user to
compare two or more accounting periods for a single company
• Materiality: the magnitude of an accounting information omission or
misstatement that will affect the judgment of someone relying on the
information
• Conservatism: the practice of using the least optimistic estimate when
two estimates of amounts are about equally likely
Michael Dimond
School of Business Administration
Relationships Among the Financial Statements
Michael Dimond
School of Business Administration
The Balance Sheet
• Financial statement that summarizes the assets, liabilities,
and owners’ equity at a specific point in time
• At any point in time, assets must equal liabilities and owners’
equity
Michael Dimond
School of Business Administration
The Accounting Equation
• Assets = Liabilities + Shareholders’ Equity
• Left side: valuable economic resources and that will provide
future benefit to the company
• Right side: indicates who provided, or has a claim to, the
assets
• Stockholders’ equity or shareholders’ equity: used to
refer to the owners’ equity of a corporation
• Equity is created when a company issues stock to an investor
• Equity is increased by retained earnings
• Earnings accumulated or retained by the company
• Part of owners’ equity that represents the income earned less
dividends paid over the life of an entity
Michael Dimond
School of Business Administration
Preparing a Balance Sheet
Michael Dimond
School of Business Administration
The Income Statement
• Summarizes the revenues and expenses of a company for a
period of time
Michael Dimond
School of Business Administration
Single-Step Income Statement
Michael Dimond
School of Business Administration
Multiple-Step Income Statement
Michael Dimond
School of Business Administration
The Statement of Retained Earnings
• Summarizes the income earned and dividends paid over the
life of a business
• Dividends: Distribution of the net income of a business to its
owners
Michael Dimond
School of Business Administration
The Statement of Cash Flows
• Summarizes a
company’s cash
receipts and cash
payments during the
period from operating,
investing, and
financing activities
Michael Dimond
School of Business Administration
Financial Statement Assumptions
Economic
Entity
Concept
Cost
Principle
Time
Period
Assumption
Going
Concern
Monetary
Unit
Michael Dimond
LO 6
School of Business Administration
Setting Accounting Standards
• Generally accepted accounting principles (GAAP)
• Various methods, rules, practices, and other procedures
• Securities and Exchange Commission (SEC)
• Federal agency with ultimate authority to determine the rules for preparing
statements
• Financial Accounting Standards Board (FASB)
• Authority to set accounting standards
• American Institute of Certified Public Accountants
(AICPA)
• Professional organization of Certified Public Accountants (CPA)
• Public Company Accounting Oversight Board (PCAOB)
• Five-member body to set auditing standards (since 2002)
• International Accounting Standards Board (IASB)
• Develop worldwide accounting standards
Michael Dimond
School of Business Administration
Audit of Financial Statements
• Most stockholders are not actively involved in the daily affairs
of the business
• Auditing: examining whether financial statements are fairly
presented
• External auditor performs various tests and procedures and render his opinion
• Auditors’ report is an opinion, not a statement of fact
Michael Dimond
School of Business Administration
Ethics in Accounting
• Ethics plays a critical role in
providing useful financial
information
• Investors and other users
must have confidence in a
company, its accountants,
and its outside auditors that
the information presented in
financial statements is
relevant, complete, neutral,
and free from error
• Moral and social ethical
behavior must be considered
while making decisions
Michael Dimond
School of Business Administration
Sarbanes-Oxley Act
• An attempt to bring about major reforms in corporate
accountability and stewardship
• Most important provisions in the act:
• Establishment of the Public Company Accounting
Oversight Board
• Requirement that the external auditors report
directly to the company’s audit committee
• Clause to prohibit public accounting firms from
providing any other services that could impair their
ability to act independently in the course of their
audit
Michael Dimond
School of Business Administration
Financial Statements
Michael Dimond
School of Business Administration
Basic Financial Analysis
• Financial figures are related, and they can reveal many
details about a company, its performance, and its value
• Accounting figures are prepared according to specific rules
and certain distortions exist.
• There are so many numbers… where shall we begin?
Michael Dimond
School of Business Administration
Meaningful Ratio Analysis
• Analysis means to break something down to understand it.
• Ratio analysis should be used to answer a specific question
or set of questions.
• If you were examining the financial statements for a
company, you might start with this basic question:
“Is this a good use of investors’ money?”
• What financial ratio would answer this question?
How about Return on Equity?
• How do you compute Return on Equity (ROE)?
Michael Dimond
School of Business Administration
Analyzing ROE
• ROE = NI ÷ Equity and answers the question, “is this a good
use of investors’ money?”
• If you were to break this down, there are three basic
questions to answer:
How profitable is this business?
How efficiently are assets being used?
How much does financial leverage help the investors?
• What financial ratios would answer these questions?
Profit Margin (PM)
Total Asset Turnover (TAT)
Equity Multiplier (EM)
Michael Dimond
School of Business Administration
Drivers of ROE
• Profit Margin (PM) = NI ÷ Sales and answers the question,
“How profitable is this business?”
• Total Asset Turnover (TAT) = Sales ÷ Total Assets and
answers the question, “How efficiently are assets being
used?”
• Equity Multiplier (EM) = Total Assets ÷ Equity and answers
the question, “How much does financial leverage help the
investors?”
Michael Dimond
School of Business Administration
The DuPont Identity
• ROE is directly driven by profitability, efficiency and leverage.
• ROE = PM x TAT x EM
How does that work?
ROE =
PM x
TAT
x
EM
NI
NI
Sales
Total Assets
=
x
x
Equity
Sales
Total Assets
Equity
NI
NI
Sales
Total Assets
=
x
x
Equity
Sales
Total Assets
Equity
• The numerators and denominators cancel to reduce the
equation to NI ÷ Equity
Michael Dimond
School of Business Administration
A word about ROA
• ROA = Return on Assets
• What’s the difference between Equity & Assets?
• Leverage
• What’s the difference between ROE & ROA?
• Leverage
• ROE = PM x TAT x EM
• EM represents leverage
• ROA = PM x TAT
• No leverage
Michael Dimond
School of Business Administration
Digging Deeper with Financial Ratios
• How would you analyze profitability, efficiency and leverage?
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•
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How do profitability, efficiency and leverage relate?
What affects profitability?
What drives sales?
What is the composition of assets?
How were assets paid for?
How are liabilities managed?
• Where shall we begin?
Michael Dimond
School of Business Administration
Common-Size Financial Statements
• Shows each line item as a percent of an appropriate total.
• Common-size balance sheet
•
•
•
•
% of Total Assets
Shows the composition of assets
Liabilities & equity items are also shown as % of total assets
Debt Ratio = Total Liabilities ÷ Total Assets
• Common-size income statement
• % of Sales
• PM = Net Income as % of Sales
Michael Dimond
School of Business Administration
Common-Size Income Statement
100%
60.8%
11.4%
Michael Dimond
School of Business Administration
Common-Size Balance Sheet
100%
100%
Michael Dimond
School of Business Administration
We don’t make a common-size CF Statement
There are other
ways to examine
relevant information
which would be
more helpful
Michael Dimond
School of Business Administration
Vertical & Horizontal Analysis
• Vertical Analysis compares figures as a percent of a relevant
total (“common size” financial statements)
• Horizontal Analysis compares the same figure over a series
of periods (showing % change or % growth)
Michael Dimond
School of Business Administration
Measuring growth
• Financial figures change from year to year
• To find the % change (“% growth”) over a 1-year period,
divide the difference of the two figures by the first year’s
value:
• [ending – beginning] / [beginning]
OR
• [ending] / [beginning] - 1
• Measuring growth over more than one period means we
need to find the average growth during that time.
Michael Dimond
School of Business Administration
Operating Cycle
• Period of time between the purchase of inventory and the
collection of any receivable from the sale of the inventory
Michael Dimond
School of Business Administration
Using the SEC website for information
Michael Dimond
School of Business Administration