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* Chapter
Seventeen
Understanding
Accounting
and Financial
Information
Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin
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• A lifelong weightlifter who
wanted a protein-packed
cookie to take to the gym.
• Due to accounting
troubles, his Bakery Barn
business was in trouble.
• Became a supplier for
another company and
hired a comptroller and a
new 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 parties
needed 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
17-3
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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
17-6
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* USERS of ACCOUNTING
INFORMATION
Managerial
Accounting
Users Type of Report
Government tax authority Tax reports
Government regulatory
agencies
Required reports
People interested in the
organization’s income
Financial statements found in
annual reports
Managers of the firm Financial statements and
internally distributed financial
reports
LG2
17-7
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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
17-8
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• Key things to watch for and read:
HOW to READ
an ANNUAL REPORT
Financial
Accounting
LG2
- Management’s
discussion and
analysis of operations
- Balance sheet
- Income statement
- Statement of cash
flows
- Auditor’s opinion
17-9
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• Private Accountants -- Work in a single firm,
government agency, or nonprofit organization.
• Public Accountants -- Provide accounting
services 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. PRIVATE
ACCOUNTANTS
Financial
Accounting
LG2
17-10
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• When a company is suspected of fraud or other
accounting 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 our
federal government were found by forensic
accountants.
BALANCE SHEETS SHERLOCKS Legal Briefcase
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17-11
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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
17-13
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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
17-14
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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
17-15
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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
17-16
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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 can
check one list of transactions against the other for
accuracy.
BOOKKEEPING’S ROLE The
Accounting
Cycle
LG3
17-17
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• Ledger -- A specialized
accounting book or
program where all
information is in one
place.
• Trial Balance -- A
summary of all the
information in the account
ledgers.
BOOKKEEPING’S ROLE The
Accounting
Cycle
LG3
17-18
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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 of
business are:
- Balance sheet
- Income statement
- Statement of cash flows
17-19
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• Fundamental Accounting Equation -- The basis
for the balance sheet.
• The equation must always be balanced and
includes the formula:
o Assets = Liabilities + Owners Equity
The FUNDAMENTAL
ACCOUNTING EQUATION
The
Fundamental
Accounting
Equation
LG4
17-20
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• Assets -- Economic resources owned by a firm.
Items can be tangible or intangible.
• Liquidity -- Ease with which assets can be
converted into cash.
ASSETS Classifying
Assets
LG4
17-21
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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
17-22
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• Liabilities -- What the business owes to others - its
debts.
• Accounts Payable -- Current liabilities a firm owes
for 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
17-23
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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
LG4
17-24
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• What do we call the formula for the balance
sheet? What three accounts does it include?
• What does it mean to list assets according to
liquidity?
• 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
17-26
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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 Taxes
o Minus Taxes
o Equals Net Income or Net Loss
The INCOME STATEMENT The Income
Statement
LG4
17-27
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• Revenues is the monetary value a firm received
for goods sold, services rendered or other
payments.
• 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 INCOME
STATEMENT
The Income
Statement
LG4
(Continued) 17-28
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• Operating Expenses -- Expenses a firm incurs in
selling goods and services
such 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 INCOME
STATEMENT (Continued)
The Income
Statement
LG4
17-29
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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 ending
inventory valuation.
ACCOUNTING for WHAT’S COMING
and GOING in SMALL BUSINESS Spotlight on Small Business
17-30
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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
17-31
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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 is
a key consideration of
a business and can be
particularly challenging
for small and seasonal
businesses.
17-32
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• You’re the only accountant employed by a small,
struggling firm.
• The firm requests a bank loan to keep operations
going and your boss suggests you record the
revenue early.
• This is against accounting principles, but you
know if you don’t get the loan, you may lose your
job. What do you do?
ON the ACCOUNTING HOT SEAT Making Ethical Decisions
17-33
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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
17-34
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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 balance
sheet.
COMMONLY USED
LIQUIDITY RATIOS
Liquidity
Ratios
LG5
17-35
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• Leverage ratios measure the degree to which a
firm relies on borrowed funds in its operations.
• Key ratios include:
- Debt to Owner’s Equity Ratio
• This information is found on the firm’s balance
sheet.
LEVERAGE RATIOS Leverage
(Debt) Ratios
LG5
17-36
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• Profitability ratios measure how effectively a
firm’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 balance
sheet and income statement.
PROFITABILITY RATIOS Profitability
(Performance)
Ratio
LG5
17-37
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• Activity ratios measure how effectively
management is turning over inventory.
• Key ratios include:
- Inventory turnover ratio
ACTIVITY RATIOS Activity Ratio
LG5
• This information is
found on the firm’s
balance sheet and
income statement.
17-38
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• Multinational companies must adapt their
accounting reporting to the rules of multiple
countries.
• Many countries have adopted International
Financial Reporting Standards (IFRS) and are
pushing to make them standard.
• The U.S. Securities & Exchange Commission
believes there should be such a standard.
The ACCOUNTING SHOT HEARD
AROUND the WORLD Reaching Beyond Our Borders
17-39
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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 IFRS Reaching
Beyond Our
Borders
LG5
17-40