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Understanding
Financial
Information
and
Accounting
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CHAPTER
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17
Nickels
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McGraw-Hill/Irwin
Understanding Business, 8e
McHugh
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McHugh
1-1
17-1
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
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Importance of
Accounting Information
• DefinitionAccounting
• Audiences
• Managers
• Government
• Investors,
Suppliers &
Creditors
17-2
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The Accounting System
17-3
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The Influence of
Accounting Information
• Managers- Financial reports pinpoint
problems/opportunities
• Government- assists with tax collection
• Investors, Suppliers, & Creditors- provides a
means to analyze business
17-4
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Areas of Accounting
• Managerial
Accounting
• Inside
Organization
• C.M.A.
• Tax Accounting
• Government &
Not-for-profit
Accounting
• Financial
Accounting
• Annual Report
• Private
Accountant
• Public
Accountant
• C.P.A.
• Auditing
17-5
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Top Business
Uses of Accountants
Valuation, Merger,
Acquistion
Personal Financial
Planning
Market Strategy &
Planning
Cash Mgmt. &
Forecasting
Tax/Auditing
0%
20%
40%
60%
80%
100%
120%
17-6
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How to Read a
Corporate Annual Report
• Read management’s discussion of changes
in operations. Try to identify strengths or
weaknesses.
• Review the firm’s consolidated balance sheet.
(Its assets, liabilities, and owners’ equity.)
• Analyze the Income Statement. Look beyond
the year. (Sales drops can spell trouble.)
• Review the statement of changes in cash
flows.
• Review auditor’s opinion.
17-7
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Types of Accountants
Public
• Auditing
• Tax Consulting
& Compliance
• Management
Consulting
Private
• Management
Accounting
• Government
Accounting
• Academia
17-8
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“Cooking the Books”
• Early Recognition of Revenue
• Late Recognition of Expense
• Inadequate Reserves for Bad
Debts, Returns, & Liabilities
• Changing Inventory Valuation
Methods- 1 Time Boost to Income
• Phony Transactions With
Partnerships
Courtesy of B. Lilly- De Anza College
17-9
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5 Tips To Be Ahead of
Sneaky Accountant Tricks
1. Who’s who
2. Pick out the bad apples
3. Don’t fall for rapid refund
4. Know their loyalty
5. Watch what you sign
Source: CNNMoney.com, March 17, 2006
17-10
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5 Ways to Avoid
More Enrons
1. Bring hidden liabilities back onto the
balance sheet
2. Highlight the things that matter
3. List the risks and assumptions built
into the numbers
4. Standardize operating income
5. Provide aid in figuring free-cash flow
Source: Business Week, February 18, 2002
17-11
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Sarbanes-Oxley Timeline
Effective
Requirements
July 30, 2002
Prohibit personal loans to officers/directors.
CEOs/CFOs return incentive-based
compensation after erroneous financial report.
August 29, 2002
CEOs/CFOs must certify annual/quarterly
reports. Officers must make certifications
regarding company’s internal controls.
January 26, 2003
Responsibilities for attorneys/audit firms
increased. Disclosure requirements for offbalance sheets transactions tightened.
April 26, 2003
Audit committees must: be independent
directors, be responsible for compensation &
oversight of certifying accountants.
17-12
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Not-for-Profits’ Policies
Due to Sarbanes-Oxley
70%
60%
50%
40%
30%
20%
10%
0%
Conflict-ofAudit Committee
RecordsCode-of-Ethics
Interest Policy
Charter
Retention Policy
Statement
Whistle-blower
Policy
Source: USA Today
17-13
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How can Sarbanes-Oxley
be Improved?
80%
70%
60%
50%
40%
30%
20%
10%
0%
No changes
Exempt smaller Scale it back or
Separate
Provide better
companies
remove it
pervasive
guidance
completely
control matters
Source: USA Today
17-14
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Steps to Control
Accounting Practices
45%
40%
35%
30%
25%
20%
15%
10%
5%
0%
Review Change Create/Expand Hire Independent Restructure
Current
Internal Audits
Firm for
Executive
Procedures
Consulting
Compensation
Source: USA Today, “Snapshots”, Section B, pg. 1, March 26, 2003
Plans
17-15
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Bookkeeping vs. Accounting
Bookkeeping
Accounting
• Start of Accounting
• Analyze
• Record/Journalize
• Recommend
17-16
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Steps In The
Accounting Cycle
Analyze Source
Documents
Take a
Trial Balance
Record
Transactions
in Journals
Prepare
Financial
Statements
Post Journal
Entries to Ledger
Analyze
Financial
Statements
17-17
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Computers & Accounting
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Tool Not Decision Maker
Simplification
Accounting Packages
Up-To-the-Minute Information
Less Monotony
17-18
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Financial Statements
• Balance Sheet- Statement of Financial
Position
• Income Statement- Statement of
Revenues & Expenses
• Statement of Cash Flows – Statement
of Cash Receipts & Disbursements
17-19
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Accounting Equation
Assets
= Liabilities + Owner’s Equity
Owned = Owed + Owner’s Claims
Very Vegetarian Company
$826,000 = $613,000 + $213,000
17-20
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Very Vegetarian’s
Balance Sheet (Assets)
Period ending 12/31/07
Assets
Current Assets
Cash
Accounts Receivable
Notes Receivable
Inventory
Total Current Assets
Fixed Assets
Land
Buildings (net)
Equipment & Vehicles (net)
Furniture & Fixtures (net)
Total Fixed Assets
Intangible Assets
Goodwill
Total Intangible Assets
Total Assets
$ 15,000
200,000
50,000
335,000
$600,000
$ 40,000
110,000
40,000
16,000
$206,000
$ 20,000
$ 20,000
$826,000
17-21
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* Very Vegetarian’s Balance Sheet
(Liabilities & Owner’s Equity)
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Period ending 12/31/07
Liabilities & Owners’ Equity
Current Liabilities
Accounts Payable
Notes Payable
Accrued Taxes & Salaries
Total Current Liabilities
Long-term Liabilities
Notes Payable
Bonds Payable
Total Long-term Liabilities
Total Liabilities
Owners’ Equity
Common Stock (1M shares)
Retained Earnings
Total Owners’ Equity
Total Liabilities & Owners’ Equity
$ 40,000
8,000
240,000
$ 35,000
290,000
$288,000
$325,000
$613,000
$100,000
113,000
$213,000
$826,000
17-22
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Very Vegetarian
Income Statement
Period Ending 12/31/07
Revenue
Net Sales
$ 700,000
Cost of Goods Sold
Beginning Inventory
$ 200,000
Net Purchases
$ 440,000
Cost of Goods
$ 640,000
Less: Ending Inventory - $ 230,000
Less: Cost of Goods Sold
- $ 410,000
Gross Profit (Gross Margin)
$ 290,000
17-23
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Very Vegetarian’s
Income Statement (cont’d)
Gross Profit
Operating Expenses
Selling Expenses
Salaries
Advertising & Supplies
Total Selling Expenses
General Expenses
Office Salaries
Depreciation
Insurance
Rent
Utilities
Miscellaneous
Total General Expenses
Less: Total Operating Expenses
Net Income (Profit) Before Taxes
Less: Income Tax Expenses
Net Income (Profit) After Taxes
$290,000
$ 90,000
$ 20,000
$ 110,000
$ 67,000
$ 1,500
$ 1,500
$ 28,000
$ 12,000
$ 2,000
$ 112,000
- $ 222,000
$ 68,000
- $ 19,000
$ 49,000
17-24
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Very Vegetarian’s
Statement of Cash Flow
Net Cash Flow from Operations
$ 52,000
Net Cash Flows from Investments
( 6,000)
Net Cash Flow from Financing
(19,000)
Net Change in Cash & Equivalents
Beginning Cash Balance
Ending Cash Balance
$ 27,000
( 2,000)
$ 25,000
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17-25
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Liquidity Ratios
Current Ratio
Current Assets
Current Liabilities
Quick (Acid-Test) Ratio
Cash + Marketable Securities + Receivables
Current Liabilities
17-26
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Very Vegetarian
Current Ratio
$600,000 = 2.08
$288,000
Quick (Acid-Test) Ratio
$265,000
$288,000
= 0.92
17-27
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Leverage Ratios
Debt-to-Owners’ Equity Ratio
Total Liabilities
Owners’ Equity
$613,000
= 287%
$213,000
17-28
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Profitability Ratios
Profitability = Operating Success
Return on Sales
Return on Equity
Net Income
Net Sales
Net Income After Tax
Total Owners’ Equity
Basic Earnings Per Share
Net Income After Taxes
Number of Common Stock Shares Outstanding
17-29
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Profitability Ratios
Return on Sales
$ 49,000 = 7%
$700,000
Return on Equity $ 49,000 = 23%
$213,000
Earnings per Share
$ 49,000 = $.049
$1,000,000
17-30
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Activity Ratios
Inventory Turnover
Cost of Goods Sold
Average Inventory
Inventory Turnover $410,000 = 1.9
$215,000
17-31