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*ChapterSeventeen
Understanding
Accountingand FinancialInformation
Copyri ght © 2010 by the McGraw-Hil l Companies, Inc. All ri ghts reserved. McGraw-Hill/Irwin
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• A lifelong weightlifter whowanted a protein-packedcookie to take to the gym.
• Due to accountingtroubles, his Bakery Barn business was in trouble.
• Became a supplier foranother company andhired a comptroller and anew CEO.
SEAN PERICH Bakery Barn
Profile
17-2
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• Accounting -- Recording, classifying, summarizing
and interpreting of financial events and transactions
in an organization to provide interested partiesneeded financial information.
• Outside parties - like employees, owners,
creditors, unions, investors and the government -make use of a firm’s accounting information.
WHAT’S ACCOUNTING? What is
Accounting?
LG1
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*The ACCOUNTING SYSTEM
What is
Accounting?
LG1
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*ACCOUNTANTS’
RESPONSIBILITIES
What is
Accounting?
LG1
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• Managerial Accounting -- Provides information
and analysis to managers inside the organization to
assist them in decision making.
• Managerial accounting is involved with:
- Costs of production
-Costs of marketing
- Preparation and control of budgets
- Minimizing tax liabilities
MANAGERIAL ACCOUNTING Managerial
Accounting
LG2
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*USERS of ACCOUNTING
INFORMATION
Managerial
Accounting
Users Type of Report
Government tax authority Tax reports
Government regulatoryagencies
Required reports
People interested in theorganization’s income
Financial statements found inannual reports
Managers of the firm Financial statements andinternally distributed financial
reports
LG2
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• Financial Accounting -- Financial information and
analyses are generated for people primarily outside
the organization. Outside users are interested in
these questions:
- Is the organization profitable?
- Is it able to pay its bills?
- How much debt does it owe?
• Annual Report -- A yearly statement of the financial
condition, progress, and expectations of the firm.
FINANCIAL ACCOUNTING Financial
Accounting
LG2
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• Key things to watch for and read:
HOW to READan ANNUAL REPORT
Financial
Accounting
LG2
- Management’s
discussion and
analysis of operations
- Balance sheet
- Income statement
-Statement of cashflows
- Auditor’s opinion
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• Private Accountants -- Work in a single firm,
government agency, or nonprofit organization.
• Public Accountants -- Provide accountingservices to individuals or businesses.
• Certified Public Accountants (CPAs) --
Accountants who have passed a series of examinations established by the American Institute of
Certified Public Accountants (AICPA) and met a
states requirements for education and experience.
PUBLIC vs. PRIVATEACCOUNTANTS
Financial
Accounting
LG2
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• When a company is suspected of fraud or otheraccounting wrongdoings a court will commission
a forensic accountant to search for foul play.
• Forensic accountants look for proof a company is“cooking the books.”
• Problems within Enron, WorldCom, and ourfederal government were found by forensicaccountants.
BALANCE SHEETS SHERLOCKSLegal Briefcase
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*STEPS to CONTROL
ACCOUNTING PRACTICES
Financial
Accounting
LG2
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• Auditing -- Reviewing and evaluating the
information used to prepare a company’s financial
statements.
• Independent Audit -- An evaluation and unbiased
opinion about the accuracy of a company’s financial
statements.
• Certified Internal Auditors (CIAs) -- Accountants
who have a bachelor’s degree and two years of
experience in internal auditing and pass an exam
administered by the Institute of Internal Auditors.
AUDITING CHECKS ACCURACY Auditing
LG2
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• Tax Accountants -- Accountants
trained in tax law and are
responsible for preparing tax
returns or developing tax strategies.
• Government and Not-for-
Profit Accounting -- Support for organizations whose purpose is
not generating a profit, but serving
others according to a duly
approved budget.
SPECIALIZED ACCOUNTANTS Tax
Accounting
LG2
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• What’s the key difference between managerial
and financial accounting?
• How’s the job of a private accountant different
from that of a public accountant?
•
What’s the job of an auditor?
PROGRESS ASSESSMENT Progress
Assessment
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• Accounting Cycle -- A six-step procedure that
results in the preparation and analysis of the major
financial statements.
The ACCOUNTING CYCLE The
Accounting
Cycle
LG3
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• Bookkeeping -- The recording of business
transactions. Bookkeepers divide a firm’s
transactions into meaningful categories and post
them into a record book or computer program called a journal.
• Double-Entry Bookkeeping -- Bookkeepers
record all transactions in two places so they cancheck one list of transactions against the other for
accuracy.
BOOKKEEPING’S ROLE The
Accounting
Cycle
LG3
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• Ledger -- A specialized
accounting book or
program where all
information is in one place.
• Trial Balance -- A
summary of all theinformation in the account
ledgers.
BOOKKEEPING’S ROLE The
Accounting
Cycle
LG3
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• Financial Statement -- A summary of all the
financial transactions that have occurred over a
particular period.
FINANCIAL STATEMENTS Understanding
Key Financial
Statements
LG3
• Key financial statements ofbusiness are:
- Balance sheet - Income statement
- Statement of cash flows
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• Fundamental Accounting Equation -- The basis
for the balance sheet.
• The equation must always be balanced andincludes the formula:
o
Assets = Liabilities + Owners Equity
The FUNDAMENTALACCOUNTING EQUATION
The
Fundamental
Accounting
Equation
LG4
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• Assets -- Economic resources owned by a firm.
Items can be tangible or intangible.
• Liquidity -- Ease with which assets can beconverted into cash.
ASSETS Classifying
Assets
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• Current Assets -- Items that can or will be
converted to cash within one year.
• Fixed Assets -- Long-term assets that are relatively
permanent such as land, buildings, or equipment.
•
Intangible Assets -- Long-term assets that have no physical form but do have value such as patents,
trademarks, and goodwill.
CLASSIFYING ASSETS Classifying
Assets
LG4
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• Liabilities -- What the business owes to others - its
debts.
• Accounts Payable -- Current liabilities a firm owesfor merchandise or services purchased on credit.
• Notes Payable -- Short or long-term liabilities a
business promises to pay by a certain date.
• Bonds Payable -- Long-term liabilities that the firm
must pay back.
CLASSIFYING LIABILITIES Liabilities and
Owners’
Equity
Accounts
LG4
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• Owners’ Equity -- The
amount of the business that
belongs to the owners minus
any liabilities of the owners.
• Retained Earnings -- Accumulated earnings from
the firm’s profitable operations
that are reinvested in the
business.
OWNERS’ EQUITY ACCOUNTS Liabilities and
Owners’
Equity
Accounts
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• What do we call the formula for the balancesheet? What three accounts does it include?
• What does it mean to list assets according toliquidity?
• What’s included in the liabilities account on the
balance sheet?
• What’s owners’ equity and how do we determine
it?
PROGRESS ASSESSMENT Progress
Assessment
17-25
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• Income Statement --The financial statement
that shows a firm’s bottom
line - that is, its profit after
costs, expenses, and
taxes.
• Net Income/Net Loss --The revenue left over or
depleted.
The INCOME STATEMENT The Income
Statement
LG4
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• The formula for the income statement:
o Revenue
o Minus Cost of Goods Sold
o Equals Gross Profit
o Minus Operating Expenses
o Equals Net Income before Taxeso Minus Taxes
o Equals Net Income or Net Loss
The INCOME STATEMENT The Income
Statement
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• Revenues is the monetary value a firm receivedfor goods sold, services rendered or otherpayments.
• Cost of Goods Sold (or Manufactured) --Measures the cost of merchandise the firms sells or
the cost of raw materials and supplies it used in
producing items for resale.
• Gross Profit -- How much a firm earned by buying
(or making) and selling merchandise.
ACCOUNTS of the INCOMESTATEMENT
The Income
Statement
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• Operating Expenses --Expenses a firm incurs in
selling goods and servicessuch as rent, salaries and
supplies.
• Depreciation -- The
systematic write-off of the cost
of a tangible asset over its
estimated useful life.
ACCOUNTS of the INCOMESTATEMENT
(Continued )
The Income
Statement
LG4
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• Generally Accepted Accounting Principles(GAAP) sometimes permits accountants to use
different method of accounting for inventory.
• FIFO: First-In, First-Out
• LIFO: Last-In, Last-Out
• Each valuation can affect income and endinginventory valuation.
ACCOUNTING for WHAT’S COMING
and GOING in SMALL BUSINESS
Spotlight on Small Business
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• Statement of Cash Flows -- Reports cash
receipts and cash disbursements related to the three
major activities of a firm:
1. Operations
2. Investments
3. Financing
The STATEMENT of CASH FLOWS The
Statement of
Cash Flows
LG4
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• Cash Flow -- The difference between cash coming
in and cash going out of a business.
UNDERSTANDING CASH FLOW The Need for
Cash Flow
Analysis
LG4
• Managing cash flow isa key consideration ofa business and can beparticularly challengingfor small and seasonalbusinesses.
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• You’re the only accountant employed by a small,
struggling firm.
• The firm requests a bank loan to keep operationsgoing and your boss suggests you record therevenue early.
•
This is against accounting principles, but youknow if you don’t get the loan, you may lose your
job. What do you do?
ON the ACCOUNTING HOT SEATMaking Ethical Decisions
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• Ratio Analysis -- The assessment of a firm’s
financial condition using calculations and financial
ratios developed from the firm’s financial statements.
• Key ratios include:
- Liquidity ratios
- Leverage ratios
- Performance ratios
- Activity ratios
USING FINANCIAL RATIOS Analyzing
Financial
Performance
Using Ratios
LG5
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• Liquidity ratios measure a firm’s ability to turn
assets into cash to pay its short-term debts.
• Two key ratios are:
- Current ratio
- Acid-test ratio
• This information is found on the firm’s balancesheet.
COMMONLY USEDLIQUIDITY RATIOS
Liquidity
Ratios
LG5
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• Leverage ratios measure the degree to which afirm relies on borrowed funds in its operations.
• Key ratios include:
- Debt to Owner’s Equity Ratio
•
This information is found on the firm’s balancesheet.
LEVERAGE RATIOS Leverage
(Debt) Ratios
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• Profitability ratios measure how effectively afirm’s managers are using the firm’s various
resources to achieve profits.
• Key ratios include:
- Basic earnings per share
- Return on sales
- Return on equity
• This information is found on the firm’s balancesheet and income statement.
PROFITABILITY RATIOS Profitability
(Performance)
Ratio
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• Activity ratios measure how effectivelymanagement is turning over inventory.
•Key ratios include:- Inventory turnover ratio
ACTIVITY RATIOS Activity Ratio
LG5
• This information is
found on the firm’sbalance sheet andincome statement.
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• Multinational companies must adapt theiraccounting reporting to the rules of multiple
countries.
• Many countries have adopted InternationalFinancial Reporting Standards (IFRS) and arepushing to make them standard.
• The U.S. Securities & Exchange Commissionbelieves there should be such a standard.
The ACCOUNTING SHOT HEARDAROUND the WORLD
Reaching Beyond Our Borders
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• 2008: SEC offers proposed timeline
• 2009: 110 large companies have the option of using
IFRS
• 2011: SEC assesses progress of IFRS
• 2013: Final decision on the move to IFRS
• 2014: Large public companies will be required to
report in IFRS (pending SEC decision)
• 2016: All companies will be required to report in
IFRS (pending SEC decision)
TIMELINE for the MOVE to IFRSReaching
Beyond Our
Borders
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• What’s the primary purpose of performing ratio
analysis using the firm’s financial statements?
• What are the four main categories of financialratios?
PROGRESS ASSESSMENT Progress
Assessment
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