McGraw-Hill/Irwin
Communicating and Interpreting
Accounting Information
Chapter 5
© 2009 The McGraw-Hill Companies, Inc.

Players in the Accounting
Communication Process
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
An unqualified opinion states that the financial statements are fair presentations in all material respects in conformity with GAAP.
McGraw-Hill/Irwin
Slide 3

Players in the Accounting
Communication Process
Information
Intermediaries
Analysis and Advice
Financial analysis,
Information services
Management
Preparation
CEO, CFO, Accounting Staff
Guided by GAAP
Independent Auditors
Verification
Partners, Managers, Staff
Guided by GAAS
Financial analysts make predictions concerning companies’ future earnings and stock prices.
McGraw-Hill/Irwin
Slide 4

Players in the Accounting
Communication Process
Information
Intermediaries
Analysis and Advice
Financial analysis,
Information services
Management
Preparation
CEO, CFO, Accounting Staff
Guided by GAAP
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
McGraw-Hill/Irwin
Slide 5

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 6

Guiding Principles for Communicating
Useful Information
Primary Objective of External Financial Reporting
To provide economic information to external users
Relevance: Timely and Predictive and Feedback Value
Reliability: and
2.Notes to the financial statements
Secondary Qualitative Characteristics
Comparability: Across businesses
Consistency: Over time
McGraw-Hill/Irwin
Slide 7

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 8

Annual Reports
For privately held companies, annual reports are simple documents that include:
1.
2.
3.
Four basic financial statements.
Related notes (footnotes).
Report of independent accountants (auditor’s opinion) if the statements are audited.
McGraw-Hill/Irwin
Slide 9

Annual Reports
For public companies , annual reports are elaborate due to
SEC reporting requirements:
1.

Nonfinancial Section
Includes a letter to the stockholders, a description of management’s philosophy, products, successes, etc.
2.

Financial Section
SEC sets minimum disclosure standards for the financial section for public companies.
McGraw-Hill/Irwin
Slide 10

Annual Reports to Shareholders
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.
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.
McGraw-Hill/Irwin
Slide 11

Quarterly Reports to Shareholders
 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 12

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 4 days of the major event date.
McGraw-Hill/Irwin
Slide 13

Classified Balance Sheet
Assets used of turned into cash within one year.
Assets used of turned into cash beyond one year.
Obligations paid of settled within one year.
Obligations paid of settled after one year.
Contributed capital.
Reinvested earnings.
Slide 14
McGraw-Hill/Irwin

Classified Income Statement
Income Statements are prepared using the following basic structure.
Net sales
− Cost of goods sold
Gross profit
− Operating expenses
Income from operations
± Nonoperating revenues/expenses and gains/losses
Income before income taxes
− Income tax expense
Net income
McGraw-Hill/Irwin
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Consolidated Income Statement
Operating activities
– the focus of the business.
McGraw-Hill/Irwin
Net Income ÷ Average Number of Shares Outstanding
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Nonrecurring Items
Net sales
− Cost of goods sold
Gross profit
− Operating expenses
Income from operations
± Nonoperating revenues/expenses and gains/losses
Income before income taxes
− Income tax expense
Net income
In addition, companies may have nonrecurring items. These nonrecurring items may include:
1. Discontinued operations
2. Extraordinary items
These items are reported separately because they are not useful in predicting future income of the company.
McGraw-Hill/Irwin
Slide 17

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.
McGraw-Hill/Irwin
Slide 18

Extraordinary Items
McGraw-Hill/Irwin
Slide 19

Reporting Extraordinary Items and
Discontinued Operations
McGraw-Hill/Irwin
Slide 20

Return on Assets (ROA) Analysis
Return on
Assets
=
Net Income *
Average Total Assets 1
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 total assets + ending total assets) ÷ 2
McGraw-Hill/Irwin
Slide 21

ROA Profit Driver Analysis
ROA =
Net Profit
Margin
×
Asset
Turnover
Net Income
Average
Total Assets
=
Net Income
Net Sales
×
Net Sales
Average
Total Assets
McGraw-Hill/Irwin
Slide 22

End of Chapter 5
© 2008 The McGraw-Hill Companies, Inc.