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Chapter 15

Chapter 15. Using Accounting Information. Learning Objectives. Explain why accurate accounting information and audited financial statements are important. Identify the people who use accounting information and possible careers in the accounting industry.

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Chapter 15

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  1. Chapter 15 Using Accounting Information

  2. Learning Objectives • Explain why accurate accounting information and audited financial statements are important. • Identify the people who use accounting information and possible careers in the accounting industry. • Discuss the accounting process. • Read and interpret a balance sheet. • Read and interpret an income statement. • Describe business activities that affect a firm’s cash flow. • Summarize how managers evaluate the financial health of a business.

  3. Accounting …the process of systematically collecting, analyzing, and reporting financial information.

  4. AccountingProvides Answers • How much profit did a business earn last year? • How much tax does a business owe the Internal Revenue Service? • How much cash does a business have on hand?

  5. Accounting As an Information System Source: Needles, Powers, Crosson, Principles of Accounting (Boston: Houghton Mifflin, 2005).

  6. Recent Accounting Problems • Pressure to “cook” the books • Greed: compensation tied to stock value • Inaccurate/misleading reporting • Increased SEC and IRS scrutiny

  7. Audited Financial Statements Audit: Examination of a company’s financial statements and accounting practices that produced them Generally Accepted Accounting Principles(GAAPs): Accepted set of guidelines and practices for companies reporting financial information and for the accounting profession

  8. Organizations Influencing Accounting Profession • Financial Accounting Standards Board (FASB) • American Institute of Certified Public Accountants (AICPA) • International Accounting Standards Board (IASB)

  9. Sarbanes-Oxley Act (2002) • SEC established oversight board • CEO/CFO required to certify reports • Accounting firms cannot provide non-auditing/consulting services • Auditors keep documents/work papers for 5 years • Prison sentences up to 20 years for document destruction • Change auditing firm every 5 years • Protection of whistle-blowers

  10. Table 15.1: Users of Accounting Information Managers + outside individuals + other organizations

  11. Types of Accounting • Managerial: provides information to make decisions about financing, investing, and operations • Financial: generates statements/reports • Cost: determines cost of production • Government: ensures tax revenues collected • Not-for-Profit: accounts for donations and expenditures • Tax: plans tax strategy and prepares returns

  12. To Be Successful in Accounting • Be responsible, honest, ethical • Have strong background in financial management • Know computer/software to process data • Be able to communicate about accounting information

  13. Spotlight Income for Accountants and Auditors Source: The Bureau of Labor Statistics web site at www.bls.gov, May 18, 2009.

  14. Accountant Classifications • Private: employed by specific organization • Public: works on fee basis for clients and may be self-employed • Certified Public Accountant (CPA): individual has met state requirements for accounting education and experience and has passed AICPA exam • Certified Management Accountant (CMA): certified by Institute for Management Accountants

  15. Requirements for Becoming a CPA • Education = 150 undergraduate and/or graduate semester hours • Most areas • At least a bachelor’s degree • Two+ years of public accounting (some areas accept non-public accounting) • Certificate and license: pass exam and fulfill experience • Age = 18+ Source: SmartPros, “Basic Information on the CPA Exam”, 2000, http://www.pro2net.com/x14341.xml

  16. Accounting Equation Assets + Owners’ Equity = Liabilities Assets = Resources Business Owns Liabilities = Firm’s Debts Owners’ Equity = Total Assets - Total Liabilities

  17. Double-Entry Bookkeeping …a system in which each financial transaction is recorded as two separate accounting entries to maintain the balance shown in the accounting equation.

  18. Accounting Cycle

  19. Balance Sheet …a summary of the dollar amountsof a firm’s assets, liabilities, and owners’ equity accounts at the end of a specific accounting period.

  20. Figure 15.1: Personal Balance Sheet Individuals determine their net worth, or owner’s equity, by subtracting the value of their debts from the value of their assets.

  21. Balance Sheet Assets Listed Most Liquid Least Liquid

  22. Figure 15.2: Business Balance Sheet Summarizes firm’s accounts at the end of an accounting period. Note that assets ($340,000) equal liabilities plus owners’ equity ($340,000).

  23. Income Statement …a summary of a firm’s revenuesand expenses during a specifiedaccounting period.

  24. Figure 15.3: Personal Income Statement By subtracting expenses from income, anyone can construct a personal income statement and determine if they have a surplus or deficit at the end of each month.

  25. Income StatementExpense Accounts Cost of Goods Sold = Beginning Inventory Net Purchases Ending Inventory + -

  26. Figure 15.4: Business Income Statement Summarizes firm’s revenues and expenses during a specified accounting period. For Northeast Art, net income after taxes is $30,175.

  27. Statement of Cash Flows A statement that illustrates how the operating, investing, and financing activities of a company affect cash during an accounting period.

  28. Figure 15.5: Statement of Cash Flows For Northeast Art, the amount of cash at the end of the year is $59,000—the same amount reported for the cash account on the firm’s balance sheet.

  29. Cash Flows Activities • Operating : cash flow from primary revenue source • Investing: cash flow from investments such as purchase/sale of land, equipment, etc. • Financing: cash flow from financing such as changes in debt obligation and owners’ equity Added to beginning cash balance to get ending cash balance

  30. Using Annual Reports to Compare Data • Determine profitability • Read the letters • Compare current statements with prior period statements • Examine footnotes • Learn to calculate financial ratios • Compare with other firms’

  31. Comparison of Financial Statements

  32. Financial Ratio …a number that shows therelationship between two elements of a firm’s financial statements.

  33. Ratio Classification • Profitability: effectiveness in use of resources • Short-Term: ability to pay current liabilities • Activity: how many times per year accounts receivable collected or inventory sold • Debt to Owners’ Equity: degree operations financed through borrowing

  34. Profitability Ratios net income after tax net sales $30,175 $451,000 6.7% Return on Sales = = = Return on Owners’ Equity net income after tax owners’ equity $30,175 $230,000 13.0% = = = net income after tax common stock shares outstanding Earnings per Share $30,175 $25,000 = = = $1.21

  35. Short-Term Financial Ratios current assets - current liabilities working capital $182,000 -$ 70,000 $112,000 Working Capital = = current assets current liabilities $182,000 $70,000 2.6 Current Ratio = = = cash + marketable securities + receivables current liabilities $139,000 $70,000 1.99 Acid-Test Ratio = = =

  36. Activity Ratios net sales accounts receivable A/R Turnover = $451,000 $38,000 11.9 times per year = = Inventory Turnover cost of goods sold average inventory = $334,000 $40,500 = = 8.2 times per year

  37. Debt-to-Owners’ Equity Ratio Debt-to-Owners’ Equity total liabilities owners’ equity = $110,000 $230,000 48 percent = =

  38. Table 15.2: Financial Ratios Compared

  39. Chapter Quiz • The __________ is designed to improve accounting standards. • Ethics in Accounting Act • Graham-Rudman Reform Act • Sarbanes-Oxley Act • Securities and Exchange Accounting Act • Accounting Standards Establishment Act

  40. Chapter Quiz • An accountant who is employed by a specific business or organization is referred to as a(n) • public accountant. • private accountant. • proprietary accountant. • AICPA accountant. • asset accountant.

  41. Chapter Quiz • The first step in the accounting cycle is to • analyze source documents. • record individual transactions. • post individual transactions. • construct a beginning financial statement. • prepare a list of employees.

  42. Chapter Quiz • Assets, liabilities, and owners’ equity would be listed on a firm’s • balance sheet. • income statement. • statement of earnings. • statement of retained earnings. • statement of capital.

  43. Chapter Quiz • Current assets minus current liabilities equals • return on owners’ equity. • current ratio. • acid-test ratio. • working capital. • current cash statement.

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