Ferrell Hirt Ferrell
A CHANGING WORLD
EIGHTH EDITION
FHF
McGraw-Hill/Irwin
Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.
part
Financing the
Enterprise
6
CHAPTER 14 Accounting and Financial Statements
CHAPTER 15 Money and the Financial System
CHAPTER 16 Financial Management and Securities Markets
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Accounting
 The recording, measurement and interpretation of
financial information, often used in making business decisions
 The Financial Accounting Standards Board sets principles of
financial accounting and reporting
• Accounting can be a difficult and contentious science
…continued on next page
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Accounting
 GAAP
 Generally accepted accounting principles
 SEC
 Securities & Exchange Commission provides oversight
 Has assumed a larger oversight role in recent years
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Types of Accounting
Certified Public Accountant (CPA)
 An independent professional who provides accounting services
to the public (individuals or firms) for a fee
Private Accountant
 An accountant employed by a corporation, government agency, or other
organization
 Can be CPAs and CMAs (Certified Management Accountant)
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Forensic Accounting
 Analyzing financial data in search of fraudulent
entries or financial misconduct
 Can help uncover money laundering, terrorist activity
 Marital and family law
 A growth area for public accountants
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Accounting or Bookkeeping?
Bookkeeping
 Often (mistakenly) used interchangeably with accounting
 The routine day-to-day recording of business transactions
 Bookkeepers obtain and record the financial information that
accountants then analyze
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What Does a Job in
Accounting Involve?
 Much more than number crunching
 Requires an in-depth understanding of the
industries in which your clients are involved
 Transparency and open communication are essential
•
One of the Big Four accounting firms
•
Seeks out the best young talent to help the company grow into the future
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Uses of Accounting Information
Internal
 Managerial accounting is the internal use of
accounting statements by managers in planning and
directing organizational activities
 Cash flow, the movement of money through an organization, is
management’s greatest concern
 Accounting helps management prepare a budget, an internal
financial plan that forecasts expenses and income over a set
period of time
…continued on next page
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Uses of Accounting Information
External
 Reporting to the IRS
 The annual report, which is a summary of financial
information, products and growth plans
 Obtaining credit
 As a gauge of performance
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Deceptive Accounting Practices
Countries, states and companies have all engaged
in deceptive accounting practices
•
Hiding debt through off-balance sheet accounts
• Using derivatives to hide financial instability
•
Overleveraging with too many loans
• Regulations try to minimize the practice
• Impossible to do away with all deceptive accounting
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Uses of Accounting Information
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The Accounting Equation
Assets
=
Liabilities
+
Owners Equity
Things of
value that a
firm owns
=
A firm’s debts and
obligations
+
The difference between
a firm’s assets and its
liabilities
 The relationship between assets, liabilities and owners’ equity
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Double-Entry Bookkeeping
Assets
$ 325
=
=
Liabilities
$ -700
+
+
Owners Equity
$ 1,025
Notice that both sides of the equation balance
 A system of recording and classifying business transactions in separate
accounts in order to maintain the balance of accounting equation
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The Accounting Cycle
A four-step process through which financial data
pass
1.Examine source documents
2.Record transactions in an accounting journal
3.Post transactions to a ledger.
 If the trial balance does not balance, one must look for mistakes and try
again
4.Prepare financial statements and have them certified by an accountant
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Financial Statements
The end results of the accounting process are a
series of financial statements
 Income statement
 Balance sheet
 Statement of cash flows
Financial statements are provided to:




Stockholders and potential investors
Creditors
Government agencies
Internal Revenue Service
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The Income Statement
A financial report that shows an organization’s
overall profitability or loss over a period of time
Month
Quarter
Year
Shows a firm’s bottom line: its expenses minus revenues
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Income Statement:
Key Terms
 Revenue: The total amount of money received
or promised from the sale of goods/services and
other activities
• Cost of Goods Sold: The amount of money the firm spent to
buy and produce the products it sold
• Cost of goods sold= beginning inventory+ interim purchases – ending inventory
 Gross Income/Profit: Revenues minus the cost of goods sold
…continued on next page
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Income Statement:
Key Terms
Expenses: The costs incurred in day-to-day operations
of an organization
 Common expense accounts shown on income statements are:
 Selling, general & administrative
 R&D, engineering
 Interest
…continued on next page
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Income Statement:
Key Terms
Depreciation: A special type of expense included
in general and administrative category
 Involves spreading the costs of long-lived assets over
the total number of accounting periods in which they are
to be used
Net Income: The total profit or loss after all expenses are
deducted from revenue
 Accountants usually divide profits into subcategories (e.g.
operating income)
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John’s Pizza Income Statement
December 31, 2011
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The Balance Sheet
 A “snapshot” of an organization’s financial position
at a given moment
 Presents an accumulation of all the company’s transactions
since it began
 Shows what an organization owns and controls and sources of
income used to pay for assets
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Balance Sheet: Key Terms
Assets
Current Assets (Short-Term Assets): Used or
converted to
cash within a calendar year
Accounts Receivable: Money owed the company by clients
or customers who have promised to pay at a later date
• Accountants usually include an allowance for bad debts, which the firm
does not expect to collect
Long-Term Assets (Fixed Assets): Represent a commitment of funds
for more than one year
• Includes tangible assets (plant, equipment) and intangibles (corporate
goodwill, reputation)
…continued on next page
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Balance Sheet: Key Terms
Liabilities
 Current Liabilities: Obligations to short-term creditors
 Accounts Payable: Amounts owed to suppliers for goods and
services purchased on credit
 Accrued Expenses: All unpaid financial obligations incurred by
the company
…continued on next page
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Balance Sheet: Key Terms
Owner’s Equity
 All the owners’ contributions to the organization,
along with income earned by the organization, retained
for financing growth and development
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John’s Pizza Balance Sheet
December 31, 2009
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Statement of Cash Flows
 Explains how the company’s cash changed
from the beginning of the accounting period to
the end
 Takes the cash balance from two successive balance sheets
and compares them
 Change in cash explained in three categories:
1. Cash from (used for) operating activities
2. Cash from (used for) investing activities
3. Cash from (used for) financing activities
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Ratio Analysis
Calculations that measure an organization’s
financial health
 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
Return on Equity
=
Net Income / Equity
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Asset Utilization Ratios
Receivables Turnover
=
Sales (Total Net Revenues)
/ Receivables
Inventory Turnover
=
Sales / Inventory
Total Asset Turnover
=
Sales / Total Assets
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Liquidity Ratios
Current Ratio
=
Current Assets
/ Current Liabilities
Quick Ratio
=
Current Assets – Inventory
/ Current Liabilities
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Debt Utilization Ratios
Debt to Total Assets
=
Debts (Total liabilities)
/ Total Assets
Times Interest Earned
=
Income Before Interest & Taxes
(Operating Income)
/ Interest Expense
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Per Share Data
Earnings per Share
=
Net Income /
Number of Shares Outstanding
Dividends per share
=
Dividends Paid /
Number of Shares Outstanding
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Industry Analysis
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Accounting and the Impact of
the Financial Crisis
Even after the passage of Sarbanes-Oxley, the
financial crises and recession of 2007-2010 are an
example of failed accounting audits
• Many financial institutions manipulated their books to appear
financially healthier and downplay risky decisions
Accountants and regulators need to be more thorough
Mark-to-market accounting blamed for many problems
• Problems valuing assets/liabilities under mark-to-market rules
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