chapter 14 role of accountantsand accounting information © 2007 prentice hall, inc. all rights...

CHAPTER 14CHAPTER 14

ROLE OFROLE OF

ACCOUNTANTSACCOUNTANTS

ANDAND

ACCOUNTING INFORMATIONACCOUNTING INFORMATION

© 2007 Prentice Hall, Inc. All rights reserved. 14–1

B U S 1 0 0B U S 1 0 0


L E A R N I N G O B J E C T I V E SL E A R N I N G O B J E C T I V E S

After reading this chapter, you should be able to:After reading this chapter, you should be able to:

1.1. Explain the role of accountants and distinguish Explain the role of accountants and distinguish between the kinds of work done by public between the kinds of work done by public accountants, private accountants, management accountants, private accountants, management accountants, and forensic accountants.accountants, and forensic accountants.

2.2. Explain how the accounting equation is used.Explain how the accounting equation is used.

3.3. Describe the three basic financial statements and Describe the three basic financial statements and show how they reflect the activity and financial show how they reflect the activity and financial condition of a business.condition of a business.

4.4. Explain the key standards and principles for reporting Explain the key standards and principles for reporting financial statements.financial statements.


L E A R N I N G O B J E C T I V E S (cont’d)L E A R N I N G O B J E C T I V E S (cont’d)

After reading this chapter, you should be able to:After reading this chapter, you should be able to:

5.5. Describe how computing financial ratios can help Describe how computing financial ratios can help users get more information from financial statements users get more information from financial statements to determine the financial strengths of a business.to determine the financial strengths of a business.

6.6. Discuss the role of ethics in accounting.Discuss the role of ethics in accounting.


What’s in It for Me?What’s in It for Me?

By understanding this chapter’s discussion of By understanding this chapter’s discussion of accountants, their methods, and their accountants, their methods, and their responsibilities, you’ll benefit in three ways:responsibilities, you’ll benefit in three ways:1.1. if you’re thinking about starting your own business, if you’re thinking about starting your own business,

you’ll discover your obligations for reporting your you’ll discover your obligations for reporting your firm’s financial statusfirm’s financial status

2.2. As an employee or union member, you’ll see how to As an employee or union member, you’ll see how to evaluate your company’s financial condition and its evaluate your company’s financial condition and its prospects for the futureprospects for the future

3.3. As an interested citizen, you’ll learn about As an interested citizen, you’ll learn about accounting ethics and regulatory requirements for accounting ethics and regulatory requirements for maintaining public trust in the business systemmaintaining public trust in the business system


What Is Accounting?What Is Accounting?

Accounting Defined:Accounting Defined: A comprehensive system for collecting, analyzing A comprehensive system for collecting, analyzing

and communicating financial informationand communicating financial information BookkeepingBookkeeping: the recording of transactions: the recording of transactions

Users of Accounting Information:Users of Accounting Information: Business managersBusiness managers Employees and unionsEmployees and unions Investors and creditorsInvestors and creditors Tax authoritiesTax authorities Government regulatory agenciesGovernment regulatory agencies


Who Are Accountants Who Are Accountants and What Do They Do?and What Do They Do?

ControllerController Manages all of a firm’s accounting activitiesManages all of a firm’s accounting activities

Types of Accounting SystemsTypes of Accounting Systems Financial AccountingFinancial Accounting

Concerned with external information users—the firm’s Concerned with external information users—the firm’s external stakeholdersexternal stakeholders

Prepares income statements, balance sheets, and other Prepares income statements, balance sheets, and other financial reports published for shareholders and the publicfinancial reports published for shareholders and the public

Managerial (Management) AccountingManagerial (Management) Accounting Serves internal users (managers) by providing information to Serves internal users (managers) by providing information to

make departmental decisions, monitor projects, and plan make departmental decisions, monitor projects, and plan future activitiesfuture activities


Who Are Accountants and Who Are Accountants and What Do They Do? (cont’d)What Do They Do? (cont’d)

Certified Public Accountants (CPAs)Certified Public Accountants (CPAs) Licensed, offering services to the publicLicensed, offering services to the public

Auditing (GAAP)Auditing (GAAP) Tax servicesTax services Management advisory servicesManagement advisory services

Noncertified Public AccountantsNoncertified Public Accountants

Private AccountantsPrivate Accountants Work exclusively for a firm as accountantsWork exclusively for a firm as accountants

Management AccountantsManagement Accountants Certified management accountant (CMA)Certified management accountant (CMA)


Who Are Accountants and Who Are Accountants and What Do They Do? (cont’d)What Do They Do? (cont’d)

Forensic AccountantsForensic Accountants Assist in the investigation of business and financial Assist in the investigation of business and financial

issues that may have application to a court of lawissues that may have application to a court of law Investigative AccountingInvestigative Accounting

Identifying financial evidence that may be pertinentIdentifying financial evidence that may be pertinent Analyzing financial evidenceAnalyzing financial evidence Presenting accounting conclusions and their legal Presenting accounting conclusions and their legal

implicationsimplications

Litigation SupportLitigation Support Certified Fraud Examiner:Certified Fraud Examiner: A specialty area within forensic A specialty area within forensic

accountingaccounting


The CPA Vision ProjectThe CPA Vision Project

Identifying issues for the futureIdentifying issues for the future

Global forces as drivers of changeGlobal forces as drivers of change

RecommendationsRecommendations

A new directionA new direction Core servicesCore services Core competenciesCore competencies


TABLE 14.1TABLE 14.1 Core Competencies for AccountingCore Competencies for AccountingTABLE 14.1TABLE 14.1 Core Competencies for AccountingCore Competencies for Accounting

Strategic and Critical Strategic and Critical Thinking SkillsThinking Skills

The accountant can provide competent advice for The accountant can provide competent advice for strategic action by combining data, knowledge, and strategic action by combining data, knowledge, and insight.insight.

Communications and Communications and Leadership SkillsLeadership Skills

The accountant can exchange information meaningfully The accountant can exchange information meaningfully in a variety of business situations with effective delivery in a variety of business situations with effective delivery and interpersonal skills.and interpersonal skills.

Focus on the Focus on the Customer, Client, and Customer, Client, and MarketMarket

The accountant can meet the changing needs of clients, The accountant can meet the changing needs of clients, customers, and employers better than the competition customers, and employers better than the competition and can anticipate those needs better than competitors.and can anticipate those needs better than competitors.

Skills in Interpreting Skills in Interpreting Converging Converging InformationInformation

The accountant can interpret new meaning by The accountant can interpret new meaning by combining financial and nonfinancial information into a combining financial and nonfinancial information into a broader understanding that adds more business value.broader understanding that adds more business value.

Technology SkillsTechnology Skills The accountant can use technology to add value to The accountant can use technology to add value to activities performed for employers, customers, and activities performed for employers, customers, and clientsclients


Federal Restrictions on CPA Services Federal Restrictions on CPA Services and Financial Reporting: Sarboxand Financial Reporting: Sarbox

Sarbanes-Oxley Act of 2002 (Sarbox)Sarbanes-Oxley Act of 2002 (Sarbox) Enacted to restore public trust in corporate Enacted to restore public trust in corporate

accounting practices as a direct response to accounting practices as a direct response to corporate financial abusescorporate financial abuses

Restricts non-audit services that CPAs can provideRestricts non-audit services that CPAs can provide

Sarbox Compliance RequirementsSarbox Compliance Requirements CFOs and CEOs must pledge that the company’s CFOs and CEOs must pledge that the company’s

finances are correct and face severe penalties finances are correct and face severe penalties noncompliancenoncompliance

Whistleblowers must be protectedWhistleblowers must be protected


TABLE 14.2TABLE 14.2 Selected Provisions of the Sarbanes-Oxley ActSelected Provisions of the Sarbanes-Oxley ActTABLE 14.2TABLE 14.2 Selected Provisions of the Sarbanes-Oxley ActSelected Provisions of the Sarbanes-Oxley Act

• Creates a national Accounting Oversight Board that, among other activities, must establish the ethics standards used by CPA firms in preparing audits.

• Requires that auditors retain audit working papers for specified periods of time (they cannot destroy audit records).

• Requires auditor rotation by prohibiting the same person from being the lead auditor for more than five consecutive years.

• Requires that the CEO and CFO certify that the company’s financial statements are true, fair, and accurate.

• Prohibits corporations from extending personal loans to executives and directors.

• Requires that the audited company disclose whether it has adopted a code of ethics for its senior financial officers.

• Requires that the SEC regularly review each corporation’s financial statements.

• Prevents employers from retaliating against research analysts that write negative reports.

• Imposes criminal penalties on auditors and clients for falsifying, destroying, altering, or concealing records (10 years in prison).

• Imposes fine or imprisonment (up to 25 years) on any person that defrauds shareholders.

• Increases penalties for mail and wire fraud from 5 to 20 years in prison.

• Establishes criminal liability for failure of corporate officers to certify financial reports.


The Accounting EquationThe Accounting Equation

The Accounting EquationThe Accounting Equation Assets = Liabilities + Owners’ EquityAssets = Liabilities + Owners’ Equity Assets Assets –– Liabilities = Owners’ Equity (or Net Worth) Liabilities = Owners’ Equity (or Net Worth)

AssetAsset Any economic resource that is expected to benefit a Any economic resource that is expected to benefit a

firm or an individual who owns itfirm or an individual who owns it

LiabilityLiability A debt that the firm owes to an outside partyA debt that the firm owes to an outside party

Owners’ EquityOwners’ Equity Money that owners would receive if they sold all of a

company’s assets and paid all of its liabilities


Financial StatementsFinancial Statements

Balance SheetsBalance Sheets Supply detailed information about:Supply detailed information about:

AssetsAssets– Current assets: Cash/assets that can be converted into cash Current assets: Cash/assets that can be converted into cash

within a yearwithin a year

– Fixed assets: Capital that has long-term use or valueFixed assets: Capital that has long-term use or value

– Intangible assets: Patents, trademarks, copyrights, etc.Intangible assets: Patents, trademarks, copyrights, etc. LiabilitiesLiabilities

– Current liabilities: debts that must be paid within one year, Current liabilities: debts that must be paid within one year, including accounts payableincluding accounts payable

– Long-term liabilities:Long-term liabilities: debts not due for at least a year debts not due for at least a year Owners’ EquityOwners’ Equity

– Paid-in (invested) capitalPaid-in (invested) capital

– Retained earnings (net profits)Retained earnings (net profits)


FIGURE 14.1FIGURE 14.1 Google’s Balance SheetGoogle’s Balance SheetFIGURE 14.1FIGURE 14.1 Google’s Balance SheetGoogle’s Balance Sheet


Financial Statements (cont’d)Financial Statements (cont’d)

Income Statement (Profit and Loss Statement)Income Statement (Profit and Loss Statement) Its description of revenues and expenses results in a Its description of revenues and expenses results in a

figure showing the firm’s annual profit or lossfigure showing the firm’s annual profit or loss Revenues: Revenues: the funds that flow into a business from the sale the funds that flow into a business from the sale

of goods or servicesof goods or services

Cost of revenues:Cost of revenues: shows the costs of obtaining the shows the costs of obtaining the revenues from other companies during the yearrevenues from other companies during the year

Cost of goods sold:Cost of goods sold: costs of obtaining materials to make costs of obtaining materials to make products sold during the yearproducts sold during the year

Gross profit: Gross profit: considers revenues and cost of revenues considers revenues and cost of revenues from the income statementfrom the income statement

Operating expenses:Operating expenses: resources that must flow out of a resources that must flow out of a company if it is to earn revenuescompany if it is to earn revenues


FIGURE 14.2FIGURE 14.2 Google’s Income StatementGoogle’s Income StatementFIGURE 14.2FIGURE 14.2 Google’s Income StatementGoogle’s Income Statement


Financial Statements (cont’d)Financial Statements (cont’d)

Statements of Cash FlowsStatements of Cash Flows Describes yearly cash receipts and cash paymentsDescribes yearly cash receipts and cash payments

Cash Flows from Operations:Cash Flows from Operations: Concerns main operating Concerns main operating activities: cash transactions involved in buying and selling activities: cash transactions involved in buying and selling goods and servicesgoods and services

Cash Flows from Investing:Cash Flows from Investing: Net cash used in or provided Net cash used in or provided by investingby investing

Cash Flows from Financing:Cash Flows from Financing: Net cash from all financing Net cash from all financing activitiesactivities

The BudgetThe Budget A detailed report on estimated receipts and A detailed report on estimated receipts and

expenditures for a future period of timeexpenditures for a future period of time


FIGURE 14.3FIGURE 14.3 Google’s Statement of Cash FlowsGoogle’s Statement of Cash FlowsFIGURE 14.3FIGURE 14.3 Google’s Statement of Cash FlowsGoogle’s Statement of Cash Flows


FIGURE 14.4FIGURE 14.4 Perfect Posters’ Sales BudgetPerfect Posters’ Sales BudgetFIGURE 14.4FIGURE 14.4 Perfect Posters’ Sales BudgetPerfect Posters’ Sales Budget


Financial Statements ReviewFinancial Statements Review

Balance SheetBalance SheetAssets Assets – – Liabilities = Owners’ EquityLiabilities = Owners’ Equity

Balance SheetBalance SheetAssets Assets – – Liabilities = Owners’ EquityLiabilities = Owners’ Equity

Income StatementIncome StatementRevenues Revenues – Expenses = – Expenses = Profit (or Loss)Profit (or Loss)

Income StatementIncome StatementRevenues Revenues – Expenses = – Expenses = Profit (or Loss)Profit (or Loss)

Statement of Cash FlowsStatement of Cash FlowsCash In and Cash OutCash In and Cash Out

Statement of Cash FlowsStatement of Cash FlowsCash In and Cash OutCash In and Cash Out

BudgetBudgetEstimate Estimate – Actual = Variance– Actual = Variance

BudgetBudgetEstimate Estimate – Actual = Variance– Actual = Variance


Reporting Standards and PracticesReporting Standards and Practices

Generally Accepted Accounting Principles Generally Accepted Accounting Principles (GAAP)(GAAP) Revenue recognition: Formal recording and reporting Revenue recognition: Formal recording and reporting

of revenues at the appropriate timeof revenues at the appropriate time Full disclosureFull disclosure

Financial statements should not include just numbers but Financial statements should not include just numbers but should also furnish management’s interpretations and should also furnish management’s interpretations and explanations of those numbers so that users can better explanations of those numbers so that users can better understand information in the statementsunderstand information in the statements


Solvency Solvency RatiosRatios

Profitability Profitability RatiosRatios

Activity Activity RatiosRatios

Analyzing Financial StatementsAnalyzing Financial Statements


Current Current Assets Assets

Current Current LiabilitiesLiabilities

Solvency RatiosSolvency Ratios

Current Ratio:Current Ratio:

Short-TermShort-Term

Leverage:Leverage: The ability to finance an investment The ability to finance an investment through borrowed fundsthrough borrowed funds


Solvency RatiosSolvency Ratios

Debt to Owners’ Equity Ratio:Debt to Owners’ Equity Ratio:

DebtDebt

Owners’ EquityOwners’ Equity

Long-TermLong-Term


Profitability and Activity RatiosProfitability and Activity Ratios

Return on Equity:Return on Equity:

Earnings Per Share:Earnings Per Share:

Net IncomeNet Income

Total Owners' EquityTotal Owners' Equity

Inventory Turnover Ratio:Inventory Turnover Ratio:Cost of Goods SoldCost of Goods Sold

Average InventoryAverage Inventory

Net IncomeNet Income

# of Shares Outstanding# of Shares Outstanding


Bringing Ethics into the Bringing Ethics into the Accounting EquationAccounting Equation

Why Accounting Ethics?Why Accounting Ethics? To maintain public confidence in business To maintain public confidence in business

institutions, financial markets, and the products and institutions, financial markets, and the products and services of the accounting professionservices of the accounting profession

AICPA’s Code of Professional ConductAICPA’s Code of Professional Conduct Maintained and enforced by the AICPAMaintained and enforced by the AICPA The AICPA identifies six ethics-related areas with The AICPA identifies six ethics-related areas with

which accountants must comply to maintain which accountants must comply to maintain certificationcertification


TABLE 14.3TABLE 14.3 Overview of Code of Ethics for CPAs Overview of Code of Ethics for CPAsTABLE 14.3TABLE 14.3 Overview of Code of Ethics for CPAs Overview of Code of Ethics for CPAs

Membership in the American Institute of Certified Public Accountants is voluntary. By accepting membership, a certified public accountant assumes an obligation of self-discipline above and beyond the requirements of laws and regulations.

Responsibilities In carrying out their responsibilities as professionals, members should exercise sensitive professional and moral judgments in all their activities.

The Public Interest

Members should accept the obligation to act in a way that will serve the public interest, honor the public trust, and demonstrate commitment to professionalism.

Integrity To maintain and broaden public confidence, members should perform all professional responsibilities with the highest sense of integrity.

Objectivity and Independence

A member should maintain objectivity and be free of conflicts of interest in discharging professional responsibilities. A member in public practice should be independent in fact and appearance when providing auditing and other attestation services.

Due Care A member should observe the profession’s technical and ethical standards, strive continually to improve competence and the quality of services, and discharge professional responsibility to the best of the member’s ability.

Scope and Nature of Services

A member in public practice should observe the Principles of the Code of Professional Conduct in determining the scope and nature of services to be provided.


TABLE 14.4TABLE 14.4 Examples of Unethical and Illegal Accounting Examples of Unethical and Illegal Accounting ActionsActions

TABLE 14.4TABLE 14.4 Examples of Unethical and Illegal Accounting Examples of Unethical and Illegal Accounting ActionsActions

CorporationCorporation Accounting ViolationAccounting Violation

AOL Time AOL Time WarnerWarner

America Online (AOL) inflated ad revenues to keep stock prices America Online (AOL) inflated ad revenues to keep stock prices high before and after merging with Time Warner.high before and after merging with Time Warner.

CendantCendant Inflated income in financial statements by $500 million through Inflated income in financial statements by $500 million through fraud and errors.fraud and errors.

HCA, HCA, Columbia/Columbia/HCAHCA

Defrauded Medicare, Medicaid, and TRICARE through false cost Defrauded Medicare, Medicaid, and TRICARE through false cost claims and unlawful billings (must pay $1.7 billion in civil claims and unlawful billings (must pay $1.7 billion in civil penalties, damages, criminal fines, and penalties).penalties, damages, criminal fines, and penalties).

Tyco Tyco Dennis Kozlowski illegally used company funds to buy expensive Dennis Kozlowski illegally used company funds to buy expensive art for personal possession (he received an 8- to 25-year prison art for personal possession (he received an 8- to 25-year prison sentence).sentence).

Waste Waste ManagementManagement

Overstated income in financial statements (false and misleading Overstated income in financial statements (false and misleading reports) by improperly calculating depreciation and salvage value reports) by improperly calculating depreciation and salvage value for equipment.for equipment.

WorldCom WorldCom Hid $3.8 billion in expenses to show an inflated (false) profit Hid $3.8 billion in expenses to show an inflated (false) profit instead of loss in annual income statement.instead of loss in annual income statement.


K E Y T E R M SK E Y T E R M S

accountingaccounting

accounting equationaccounting equation

accounting information system accounting information system (AIS)(AIS)

accounts payable (payables)accounts payable (payables)

activity ratioactivity ratio

assetasset

auditaudit

balance sheetbalance sheet

bookkeepingbookkeeping

budgetbudget

Certified Fraud Examiner (CFE)Certified Fraud Examiner (CFE)

certified management accountant certified management accountant (CMA)(CMA)

certified public accountant (CPA)certified public accountant (CPA)

code of professional conductcode of professional conduct

controllercontroller

core competencies for core competencies for accountingaccounting

cost of goods soldcost of goods sold

cost of revenuescost of revenues

current assetcurrent asset

current liabilitycurrent liability

current ratiocurrent ratio

debtdebt

depreciationdepreciation

earnings per shareearnings per share

financial accountingfinancial accounting


K E Y T E R M S (cont’d)K E Y T E R M S (cont’d)

financial statementfinancial statement

fixed assetfixed asset

forensic accountingforensic accounting

full disclosurefull disclosure

generally accepted accounting generally accepted accounting principles (GAAP)principles (GAAP)

goodwillgoodwill

gross profitgross profit

income statement (profit-and-loss income statement (profit-and-loss statement)statement)

intangible assetintangible asset

leverageleverage

liabilityliability

liquidityliquidity

long-term liabilitylong-term liability

management accountantmanagement accountant

management advisory servicesmanagement advisory services

managerial (management) managerial (management) accountingaccounting

net income (net profit, net net income (net profit, net earnings)earnings)

operating expensesoperating expenses

operating incomeoperating income

owners’ equityowners’ equity

paid-in capitalpaid-in capital

private accountantprivate accountant

profitability ratioprofitability ratio

retained earningsretained earnings


K E Y T E R M S (cont’d)K E Y T E R M S (cont’d)

revenue recognitionrevenue recognition

revenuesrevenues

Sarbanes-Oxley Act of 2002 Sarbanes-Oxley Act of 2002 (Sarbox)(Sarbox)

short-term solvency ratioshort-term solvency ratio

solvency ratiosolvency ratio

statement of cash flowsstatement of cash flows

tax servicestax services

chapter 14 role of accountantsand accounting information © 2007 prentice hall, inc. all rights...

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