Chapter 5
COMMUNICATING
AND
INTERPRETING
ACCOUNTING
INFORMATION
McGraw-Hill/Irwin
© 2009 The McGraw-Hill Companies, Inc.
PLAYERS IN THE ACCOUNTING
COMMUNICATION PROCESS
Management
Preparation
CEO, CFO, Accounting Staff
Guided by GAAP
McGraw-Hill/Irwin
Slide 2
PLAYERS IN THE ACCOUNTING
COMMUNICATION PROCESS
Management
Preparation
CEO, CFO, Accounting Staff
Guided by GAAP
Independent Auditors
Verification
Partners, Managers, Staff
Guided by GAAS
McGraw-Hill/Irwin
Slide 3
PLAYERS IN THE ACCOUNTING
COMMUNICATION PROCESS
Management
Preparation
CEO, CFO, Accounting Staff
Guided by GAAP
Independent Auditors
Verification
Partners, Managers, Staff
Guided by GAAS
Gold
Standard
An unqualified opinion states that the
financial statements are fair
presentations in all material respects in
conformity with GAAP.
PLAYERS IN THE ACCOUNTING
COMMUNICATION PROCESS
Management
Preparation
CEO, CFO, Accounting Staff
Guided by GAAP
Independent Auditors
Verification
Partners, Managers, Staff
Guided by GAAS
Information
Intermediaries
Analysis and Advice
Financial analysis,
Information services
McGraw-Hill/Irwin
Slide 5
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.
PLAYERS IN THE ACCOUNTING
COMMUNICATION PROCESS
Management
Preparation
CEO, CFO, Accounting Staff
Guided by GAAP
Information
Intermediaries
Analysis and Advice
Financial analysis,
Information services
McGraw-Hill/Irwin
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
Slide 7
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.
McGraw-Hill/Irwin
Public
companies only
Slide 8
The mission of the U.S. Securities and Exchange
Commission is to protect investors, maintain fair, orderly,
and efficient markets, and facilitate capital formation.
REGULATORS
McGraw-Hill/Irwin
Slide 10
ENSURING THE INTEGRITY OF FINANCIAL
INFORMATION COMMUNICATION PROCESS
Regulators
Standard Setting and
Verification SEC
PCAOB
Auditing Standards
FASB
Accounting Standards
Stock Exchanges
Corporate
Governance
Standards
Management
Primary Responsibility
CFO, CEO, Accounting staff
Auditors (CPAs)
Verification
Partners, Managers, Staff
McGraw-Hill/Irwin
Directors
Oversight
Audit Committee
(Independent directors)
Slide 11
USERS: INSTITUTIONAL AND PRIVATE
INVESTORS, CREDITORS, AND OTHERS
Management
Primary Responsibility
CFO, CEO, Accounting Staff
Information
Intermediaries
Analysis and Advice
Financial analysts,
Information services
McGraw-Hill/Irwin
Users
Analysis and Decision
Institutional and private
investors, Lenders,
Suppliers, Customers, etc.
Slide 12
As directed by the Sarbanes-Oxley Act of 2002, the SEC is adopting rules that require conformance
with specific sections of the Act. These rules require officers to certify that they are responsible for
establishing, maintaining and regularly evaluating the effectiveness of the issuer's internal controls;
that they have made certain disclosures to the issuer's auditors and the audit committee of the board
of directors about the issuer's internal controls; and that they have included information in the
issuer's quarterly and annual reports about their evaluation and whether there have been significant
changes in the issuer's internal controls or in other factors that could significantly affect internal
controls subsequent to the evaluation.
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
McGraw-Hill/Irwin
Slide 14
Primary Qualitative Characteristics
Relevance: Timely and Predictive Feedback Value
McGraw-Hill/Irwin
Reliability: Accurate, Unbiased, and Verifiable
Slide 15
Secondary Qualitative Characteristics
Comparability: Across businesses
Consistency: Over time
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
McGraw-Hill/Irwin
Slide 17
INTERNATIONAL ACCOUNTING STANDARDS
BOARD AND GLOBAL DIFFERENCES IN
ACCOUNTING STANDARDS
International Financial Reporting Standards
Extraordinary items
LIFO for inventory
Reversal of inventory write-downs
Basis of property, plant, and equipment
Permitted
Permitted
Prohibited
Historical cost
( Evo lving F air V alue)
McGraw-Hill/Irwin
Prohibited
Prohibited
Required
Fair Value or
Historical cost
Slide 18
Refer to Note 2 to the consolidated financial statements for
information pertaining to accounting changes effective in 2010,
and Notes 2 and 31 to the consolidated financial statements for
information on issued accounting pronouncements that will be
effective in future years.
Of particular note is the area of International Financial Reporting
Standards (IFRSs), which will be adopted by us in 2011. The US
Securities and Exchange Commission (SEC) allows foreign private
issuers to use IFRSs, without reconciliation to US GAAP, provided
that their foreign private issuer status is maintained.
The company has established a project team that is led by finance
management and includes representatives from various areas of the
organization. An external resource has also been engaged to assist,
under the direction of company management, with certain aspects
of the project. The audit committee of the Board of Directors
regularly receives progress reporting on the status of the IFRSs
implementation project.
The implementation project consists of three primary phases:
the scoping and diagnostic phase (high-level impact assessment
to identify key areas); the impact analysis, evaluation and design
phase (project teams develop policy alternatives, draft financial
statement content and determine changes to existing accounting
policies, information systems and business processes); and the
implementation and review phase (implement and approve changes
to accounting policies, information systems, business processes and
training programs, develop IFRSs-compliant financial statements
and obtain audit committee approval). The company is now in the
implementation and review phase.
McGraw-Hill/Irwin
Slide 19
ANNUAL REPORTS
For privately held companies, annual reports are
simple documents that include:
1. Four basic financial statements.
2. Related notes (footnotes).
3. Report of independent accountants (auditor’s
opinion) if the statements are audited.
McGraw-Hill/Irwin
Slide 20
ANNUAL REPORTS
For public companies, annual reports
are elaborate due to SEC reporting
requirements:
1. A Nonfinancial Section

A letter to the stockholders, a description
of management’s philosophy, products,
successes, etc.
2. A Financial Section

McGraw-Hill/Irwin
See next slide for a detailed listing . . .
Slide 21
ANNUAL REPORTS
1. Summarized financial data
for 5- or 10-years.
2. Management Discussion
and Analysis (MD&A).
3. The four basic financial
statements.
4. Notes (footnotes).
5. Independent Accountant’s
Report and the
Management Certification.
McGraw-Hill/Irwin
6. Recent stock price
information.
7. Summaries of the
unaudited quarterly
financial data.
8. Lists of directors and
officers of the company
and relevant addresses.
Slide 22
QUARTERLY REPORTS
 Usually begin with short letter to stockholders
 Condensed unaudited income statement and
balance sheet for the quarter.
 Often, cash flow statement and statement of
stockholders’ equity are omitted. Some notes to
the financial statements also may be omitted.
McGraw-Hill/Irwin
Slide 23
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.
McGraw-Hill/Irwin
Slide 24
CLASSIFIED BALANCE SHEET
Callaway Golf Company
Consolidated Balance Sheet
December 31,
2006
2005
(in thousands, except share data and per share data)
ASSETS
Current assets:
Cash and cash equivalents
Accounts receivable, net
Inventories, net
Other current assets
Total current assets
Property, plant and equipment, net
Intangible assets, net
Other assets
McGraw-Hill/Irwin
$
$
46,362 $
118,133
265,110
63,595
493,200
49,481
98,082
241,577
49,450
438,590
131,224
175,159
46,364
845,947 $
127,739
175,191
22,978
764,498
Slide 25
CLASSIFIED BALANCE SHEET
Callaway Golf Company
Consolidated Balance Sheet
(in thousands, except share data and per share data)
December 31,
2006
2005
LIABILITIES & STOCKHOLDERS" EQUITY
Current Liabilities:
Accounts payable and accrued
expenses
$
Notes payable, current portion
Total current liabilities
Long-term liabilities:
Other liabilities
Minority interest
Commitment and contingencies (Note13)
McGraw-Hill/Irwin
143,455 $
80,000
223,455
43,388
1,987
140,184
21
140,205
28,245
Slide 26
CLASSIFIED BALANCE SHEET
Callaway Golf Company
Consolidated Balance Sheet
December 31,
2006
(in thousands, except share data and per share data)
2005
SHAREHOLDERS' EQUITY
Shareholders' equity:
Common stock, $.01 par value,
85,096,782 and 84,950,694 issued
and outstanding at December 31,
2006 and 2005, respectively
$
851 $
850
Additional paid-in capital
141,192
164,202
Retained earnings
435,074
430,996
577,117
596,048
Total shareholders' equity
Total liabilities and shareholders' equity
McGraw-Hill/Irwin
Contributed
capital is
normally shown
in two
accounts:
1.Common
Stock
2.Additional
Paid-in Capital
$ 845,947 $ 764,498
Slide 27
CLASSIFIED INCOME STATEMENT
Income statements may contain three sections:
1. Continuing operations
2. Nonrecurring Items
A. Discontinued operations
B. Extraordinary items
3. Earnings per share
McGraw-Hill/Irwin
Slide 28
CLASSIFIED INCOME STATEMENT
General Format for the Classified Income Statement
S
-COGS
GM
-OPEX
OPIN
+-NONOP
IBT
-INTAX
NI
McGraw-Hill/Irwin
−
−
±
−
Net sales
Cost of goods sold
Gross profit (Gross margin)
Operating expenses
Income from operations
Nonoperating revenues/expenses and gains/losses
Income before income taxes
Income tax expense
Net income
Slide 29
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.
McGraw-Hill/Irwin
Slide 30
COMMON-SIZE INCOME STATEMENT
Matrix, International
Income Statement
Month Ended January 31, 2009
Revenues:
Sales revenue
$
Rental income
Total revenues
Costs and expenses:
Cost of sales
Salaries & benefits expense
General & administrative expenses
Depreciation expense
Total costs and expenses
Operating income
Other revenues and gains (expenses and losses)
Investment income
Interest expense
Gain on sale of land
Income before income taxes
Income tax expense
Net income
$
Earnings per share
McGraw-Hill/Irwin
$
66,000
3,800
69,800
94.56%
5.44%
100.00%
36,000
16,000
8,100
2,500
62,600
7,200
51.58%
22.92%
11.60%
3.58%
89.68%
10.32%
1,000
(60)
3,000
11,140
3,899
7,241
1.43%
-0.09%
4.30%
15.96%
5.59%
10.37%
Total revenue is
equal to 100%.
0.40
Slide 31
STATEMENT OF CASH FLOWS
Recall that the Statement of Cash Flows is
divided into three major sections.
1. Cash flows from operating activities.
2. Cash flows from investing activities.
3. 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.
McGraw-Hill/Irwin
Slide 32
CALLAWAY GOLF COMPANY
Consolidated Statement of Cash Flows
For the Year Ended December 31
(in thousands)
McGraw-Hill/Irwin
Cash flows from operating activities:
Net income
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation & amortization
Other non-cash items
Changes in assets and liabilities, net of effects
from acquisitions:
Accounts receivable, net
Inventories, net
Other assets
Accounts payable and accrued expenses
Income taxes payable
Other liabilities
Net cash provided by operating activities
2006
$
23,290
32,274
14,035
$
(12,128)
(16,842)
(4,475)
(10,803)
(6,936)
(1,128)
17,287
Slide 33
CALLAWAY GOLF COMPANY
Consolidated Statement of Cash Flows
For the Year Ended December 31
(in thousands)
2006
McGraw-Hill/Irwin
Cash flows from operating activities:
Net income Change in Account Balance During
$ 23,290
Year
Adjustments to reconcile
net income to net cashDecrease
Increase
Current
Subtract
from net
Add to net income.
provided by operating
activities:
Assets
income.
Depreciation & amortization
32,274
Current
Add toitems
net income.
Subtract from
net
Other non-cash
14,035
Liabilities
income.
Changes in assets and liabilities, net of effects
from acquisitions:
Accounts receivable, net
(12,128)
Inventories, net
(16,842)
Other assets
(4,475)
Accounts payable and accrued expenses
(10,803)
Income taxes payable
(6,936)
Other liabilities
(1,128)
Net cash provided by operating activities
$ 17,287
Slide 34
Consolidated Statement of Cash Flows
Cash flows from investing activities
Capital expenditures
Acquisition, net of cash acquired
Investment in marketable securities
Proceeds from sale of assets
Net cash used in investing activities
Cash flows from financing activities:
Issuance of common stock
Acquisition of treasury stock
Proceeds from line of credit (net)
Other financing activities
Dividends paid, net
Net cash used in financing activities
Effect of exchange rate changes on cash
Net decrease in cash and cash equivalents
Cash and cash equivalents at beginning of year
Cash and cash equivalents at end of year
McGraw-Hill/Irwin
2006
$
$
$
$
(32,453)
374
(10,008)
469
(41,618)
9,606
(52,872)
80,000
2,549
(19,212)
20,071
1,141
(3,119)
49,481
46,362
Slide 35
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.
McGraw-Hill/Irwin
Slide 36
RETURN ON ASSETS (ROA) ANALYSIS
Return
=
on
Assets
Net Income*
Average Total Assets1
ROA measures how much the firm earned for each
dollar of investment.
*(In
complex calculations, interest expense (net of tax) and minority interest
are added back to net income.
1(beginning
McGraw-Hill/Irwin
total assets + ending total assets) ÷ 2
Slide 37
ROA PROFIT DRIVER ANALYSIS
Net Income
Average
Total Assets
McGraw-Hill/Irwin
=
Net Profit
Margin
=
Net Income
Net Sales
×
Asset
Turnover
×
ROA
Net Sales
Average
Total Assets
Slide 38
RETURN ON EQUITY (ROE) ANALYSIS
Return
=
on
Equity
Net Income
Average Stockholders’ Equity1
ROE measures how much the firm
earned for each dollar of
stockholders’ investment.
1(beginning
McGraw-Hill/Irwin
equity + ending equity) ÷ 2
Slide 39
ROE PROFIT DRIVER ANALYSIS
McGraw-Hill/Irwin
=
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
Slide 40
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.
McGraw-Hill/Irwin
Slide 41
CHAPTER SUPPLEMENT: NONRECURRING
ITEMS
General Format for the Classified Income Statement
In addition, companies may have nonrecurring
Net salesnonrecurring items may include:
items. These
−
Cost of goods sold
1. Discontinued
operations,
Gross profit
− Operating expenses
2. Extraordinary
items,
Income from operations
These±items
are reported
separately
Nonoperating
revenues/expenses
andbecause
gains/losses
before income
taxes
they areIncome
not useful
in predicting
future income
Income tax expense
of the−company.
Net income
McGraw-Hill/Irwin
Slide 42
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.
McGraw-Hill/Irwin
Slide 43
EXTRAORDINARY ITEMS
Unusual
Infrequent
Show net of applicable taxes.
McGraw-Hill/Irwin
Slide 44
END OF CHAPTER 5
© 2008 The McGraw-Hill Companies, Inc.
I think I am allergic to Accounting !!!