Chapter Fourteen
Accounting and Financial
Statements
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The Nature of Accounting
• The recording, measurement, and
interpretation of financial
information, often used in making
business decisions.
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Types of Accountants
Public Accountant
An independent professional who provides accounting services to the
public (individuals or firms) for a fee. A Certified Public Account
(CPA) is an individual who has been certified in the state in which he or
she resides by meeting state requirements for accounting, education, and
experience and by passing a 2 1/2 -day accounting examination.
Private Accountant
An accountant employed by a corporation, government agency, or other
organization. Can be either a CPA or a CMA (Certified Management
Accountant).
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Is it Accounting or
Bookkeeping?
• Bookkeeping is much narrower and
more mechanical than accounting.
• Bookkeeping is typically limited to
routine day-to-day business
transactions and obtaining and
recording information that accountants
use in financial analysis.
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Corporate America’s Demand
for Accounting Specialties
•
•
•
•
•
•
•
Accounts Receivable – 21%
Accounts Payable – 15%
Payroll – 15%
Cost Accounting – 9%
General Ledger – 8%
Tax – 5%
Credit – 2%
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Uses for Accounting
Information
• Internal Uses:
– Managerial
Accounting
– Cash Flow
– Budget
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• External Uses:
– Reporting financial
performance to
outsiders
– Filing Income
Taxes
– Obtaining Credit
– Reporting to
Stockholders
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Internal Accounting
Information
Management
Plan and set goals
Organize
Lead and motivate
Control
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• Lenders &
Suppliers
Evaluate Credit Risks
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External Accounting
Information
• Stockholders and
Potential Investors
Evaluate soundness
of investments
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• Government
Agencies
Confirm tax liabilities
Confirm payroll
Deductions
Approve new issues of
stocks and bonds
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Who Uses Accounting Information?
Business Activities
Accounting
Management
Owners, partners
Boards of
directors
Officers of the
company
Managers
Department
heads
Supervisors
Those with
Direct
Financial
Interest
Present or
potential
investors
Present or
potential
creditors
Those with Indirect Financial Interest
Tax
authorities
Federal (IRS)
State
Regulatory
Agencies
Economic
Planners
Other
groups
SEC
Council of
Economic
Advisors
Employees
and labor
unions
Financial
advisors
Customers
and the
general
public
Stock
exchanges
Municipal
ICC, FAA,
etc.
Federal
Reserve
Board
Other
Other
agencies
Government
planners
Actions That Affect Business Activities
Source: Needles, Belverd E., Henry R. Anderson, and James C. Caldwell. Principles of Accounting,
Fourth Edition. Copyright © 1990 by Houghton-Mifflin. Used with permission.
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The Accounting Process:
The Accounting Equation
Assets
=
Things
of value
that a
firm owns
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Liabilities
A firm’s
debts and
obligations
+
Owners’ Equity
The difference
between a firm’s
assets and its
liabilities
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The Accounting Process:
Double-Entry Bookkeeping
Assets
=
$325
=
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Liabilities +
Owners’ Equity
$325
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The Accounting Cycle
1. Examining Source Documents
2. Recording Transactions
3. Posting Transactions
4. Preparing Financial Statements
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Preparing Accounting
Statements with GAAP
• Generally Accepted Accounting
Principles (GAAP)
• The Best-known Financial Statements:
– Income Statement
– Balance Sheet
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Equivalent Accounting Terms
Term:
• Revenues
• Gross Profit
• Operating Income
• Income Before Taxes
• Net Income
• Income Available to
Stockholders
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Equivalent Term:
Sales
Gross Income / Gross Earnings
Operating Profit / Earnings Before
Income & Taxes / Income Before
Interest & Taxes
Earnings Before Taxes / Profit Before
Taxes
Earnings After Taxes / Profit After
Taxes
Earnings Available to Common
Stockholders
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The Income Statement
• A financial report
that shows an
organization’s
profitability over a
period of time –
month, quarter or
year.
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Key Income Statement Terms
•
•
•
•
Revenue
Cost of Goods Sold
Gross Income
Expenses
– Selling, general & administrative
– R&D, engineering
– Interest
• Depreciation
• Net Income
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Anna’s Flowers
Income Statement
December 31, 2002
Revenues:
Net Sales
Consulting:
Total Revenues
Expenses:
Cost of Goods Sold
Selling Expenses
General & Admin.
Other expenses
Total Expenses
Net Income
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$123,850
73,850
$197,700
$ 72,600
37,700
18,400
5,600
$134,300
$ 63,400
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The Balance Sheet
• A “snapshot” of an
organization’s
financial position
at a given moment.
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Key Balance Sheet Terms
• Assets
– Accounts Receivable
• Liabilities
– Accounts Payable
– Accrued Expenses
• Owner’s Equity
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Anna’s Flowers
Balance Sheet
December 31, 2002
Assets:
Current Assets:
Cash:
Accounts Receivable
Merchandise Inventory
Total Assets:
Property & Equipment
Equipment
Office Building
Total Prop. & Equip.
Total Assets:
$17,850
10,200
8,750
11,050
73,850
Liabilities & Owner’s Equity
Current Liabilities
Acct’s Payable
$12,600
Total Current Liabilities
Long-term Liabilities
Mortgage Payable
Total Liabilities
Owner’s Equity:
Anna Rodriguez, Capital
Total Liabilities & Owner’s Equity
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$36,800
84,900
$121,700
12,600
23,600
36,200
85,500
$121,700
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Anna’s Flowers
Annual Budget
for 2002
January
February
March
April
May
June
July
August
September
October
November
December
Annual
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Sales
6,500
6,000
5,800
6,100
7,000
8,100
8,600
6,900
6,700
5,900
5,000
4,500
$123,850
Consulting
5,000
6,000
6,200
6,500
6,800
7,600
7,800
8,000
8,700
9,000
8,500
8,000
$73,850
Total
11,500
12,000
12,000
12,600
13,800
15,700
16,400
14,900
15,400
14,900
13,500
12,500
$197,700
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Analyzing Financial Statements
with Ratio Analysis
•
•
•
•
•
Profitability ratios
Asset utilization ratios
Liquidity ratios
Debt utilization ratios
Per share data
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Profitability Ratios
Profit Margin
=
Net income
Sales
Return on Assets
=
Net income
Assets
=
Net income
Equity
Return on equity
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Asset Utilization Ratios
Receivables turnover =
Inventory turnover
Return on equity
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Sales
Receivable s
=
Sales
Inventory
=
Sales
Total Assets
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Liquidity Ratios
Current ratio =
Quick ratio
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Current assets
Current liabilitie s
Current assets - Inventory
=
Current liabilitie s
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Debt Utilization Ratios
Debt to total assets
Times interest =
earned
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=
Total debt
Total assets
Income before interest & taxes
Interest expense
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Per Share Data
Earnings per share =
Dividends per
share
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=
Net income
Number of shares outstandin g
Total dividends paid
Number of shares outstandin g
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Solve the Dilemma
1. Describe the two basic accounting
statements. What type of information does
each provide that can help you evaluate
the situation?
2. Which of the financial ratios are likely to
prove to be of greatest value in identifying
problem areas in the company? Why?
Which of your company’s financial ratios
might you expect to be especially poor?
3. Discuss the limitations of ratio analysis.
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Explore Your Career Options
What contributions do accountants
make to organizations?
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Additional Discussion Questions
and Exercises
1. What is the accounting equation? Which
financial statement (income statement or
balance sheet) is most similar to the
accounting equation?
2. What is meant by the liquidity of assets?
3. In measuring a firm’s performance, many
investors and managers prefer industry
analysis or industry ratios. What is the
advantage in using industry ratios?
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Additional Discussion Questions
and Exercises
4. How do public accounts, private
accountants, and certified public
accountants differ?
5. What are some different types of
liabilities?
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Chapter 14 Quiz
1. Which generally appears on an income statement?
a. Assets = Liability + Owners’ equity
b. Revenue - Expenses = Profit or loss
c. Assets - Expenses = revenue
d. Current assets/Current liabilities
2. An accountant who provides accounting services
to individuals and/or businesses for a fee is
considered a
a. certified public accountant (CPA).
b. public accountant.
c. private accountant.
d. local accountant.
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Chapter 14 Quiz
3. Assume a firm’s inventory turnover was 25. That means
a. the firm made a 25 percent profit on its sales.
b. the firm has sold and replaced its inventory 25 times in a
year.
c. the firm has 25 items in inventory.
d. the firm needs to sell 25 items in inventory to make a profit.
4. The internal financial statement that forecasts expenditures
and revenues for a period is known as
a. a balance sheet.
b. an income statement.
c. a budget.
d. an annual report.
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Multiple Choice Questions
about the Video
1. The financial position of a company at a given time is reflected
on its
a. balance sheet.
b. income statement.
c. owners’ equity statement.
d. statement of cash flows.
e. checkbook.
2. The most important of the firm’s financial statements is its
a. balance sheet.
b. income statement.
c. owners’ equity statement.
d. statement of cash flows.
e. collateral loan.
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