Chapter Eighteen
Using Accounting
Information
Key Statements
Three key financial statements summarize the
firm’s activities for a specific period
• Balance sheet (what you’re worth)
• Income statement (your budget)
• Statement of cash flows (your checkbook)
The Accounting Equation
Assets - Liabilities = Owners’ equity
Assets—the resources that a business owns
(i.e.- cash, inventory, equipment, real estate)
Liabilities—the firm’s debts (loans, a/p)
Owners’ equity—difference between assets & liabilities
- what would be left for the owners, if the
firm’s assets were sold and the money
used to pay off its liabilities
The Balance Sheet
• The dollar amounts of a firm’s assets,
liabilities, and owners’ equity accounts at
the end of a specific accounting period
– also called statement of financial position
– assets listed in order of liquidity
ease with which an asset can be converted into cash
Assets-Listed in order of liquidity
– Current assets—can quickly be
converted to cash
• Cash, marketable securities, a/r, inventory
– Fixed assets—will be held or used for a period
longer than one year
• Land, buildings, and equipment
– Intangible assets—do not exist physically
-value is based on the rights they give the firm
• Patents, copyrights, trademarks, franchise rights,
and goodwill
Liabilities
– Current liabilities—debts to be repaid in one
year or less
• Accounts payable—short-term debts from credit
purchases
• Notes payable—debts secured with promissory
notes (IOU’s)
– Long-term liabilities—debts that need not be
repaid for at least one year
• Mortgages, bonds, and long-term loans
Owners Equity
– For sole proprietorships—owners’ equity
– For partnerships—each partner’s share of
ownership is reported separately in each
owner’s name
– For corporations—stockholder’s equity
Personal Balance Sheet
The Income Statement
• A firm’s revenues minus its expenses
– Profit (cash surplus)
– Loss (cash deficit)
• Revenues
– Money earned from selling goods or providing services
• Gross sales—the total dollar amount of all goods and services
sold during the accounting period
• Net sales—dollar amounts received, adjusted for returns,
allowances, discounts
COGS
Cost of
Net
= Beginning +
– Ending
goods sold
inventory purchases inventory
• Gross profit
– A firm’s net sales less the cost of goods
sold
The Income Statement
• Operating expenses
– All business costs other than the cost of goods
sold
• Selling expenses—costs related to marketing activities
• General expenses—costs of managing the business
• Net income
– Net sales less COGS & operating expenses,
when the difference is positive
• Net loss
– Net sales less COGS & expenses, when the
difference is negative
Personal Income Statement
Long term liability
Current liability
The Statement of Cash Flows
• How the company made & spent its money
– Cash flows from operating activities
(providing goods and services)
– Cash flows from investing activities (asset based)
(purchase & sale of land, equipment, buildings)
– Cash flows from financing activities (liability based)
(pay off loans, sell stock, get a loan)
Statement
of
Cash
Flows
Financial Ratios
• Used to show relationship between two
elements of a firm’s financial statements
• Can be compared with
– The firm’s own past ratios
– Ratios of competitors
– Industry averages
Who Uses Accounting Information
– Managers, to plan business strategy
– Lenders, to reduce their risk when lending
– Stockholders, to know whether to invest or how
well their investment is doing
– Government agencies to enforce the law
How do they know the information on the statements is accurate?
What is an audit?
– An examination of a company’s financial statements
and accounting practices by someone not
employed by the firm
– Generally accepted accounting principles (GAAP)
-an accepted set of guidelines and practices for
companies reporting financial information
– An audit does not guarantee that a company has
not “cooked” the books
The Sarbanes-Oxley Act of 2002
– Top executives are required to certify periodic financial
reports and are subject to criminal penalties for
violations
– Auditors must maintain financial documents and audit
work papers for 5 years
– Auditors and accountants can be imprisoned for up to
20 years for destroying documents and violating
securities laws
– Public Corps must change auditing firms every 5 years
– There is protection for whistle-blowers who report
violations of the Sarbanes-Oxley Act