COMMUNICATING AND INTERPRETING ACCOUNTING INFORMATION

Chapter 5 COMMUNICATING AND INTERPRETING ACCOUNTING INFORMATION McGraw-Hill/Irwin 2009 The McGraw-Hill Companies, Inc.

PLAYERS IN THE ACCOUNTING COMMUNICATION PROCESS Management Preparation CEO, CFO, Accounting Staff Guided by GAAP McGraw-Hill/Irwin Slide 2

PLAYERS IN THE ACCOUNTING COMMUNICATION PROCESS Management Preparation CEO, CFO, Accounting Staff Guided by GAAP Independent Auditors Verification Partners, Managers, Staff Guided by GAAS McGraw-Hill/Irwin Slide 3

PLAYERS IN THE ACCOUNTING COMMUNICATION PROCESS Management Preparation CEO, CFO, Accounting Staff Guided by GAAP Independent Auditors Verification Partners, Managers, Staff Guided by GAAS Gold Standard An unqualified opinion states that the financial statements are fair presentations in all material respects in conformity with GAAP.

PLAYERS IN THE ACCOUNTING COMMUNICATION PROCESS Management Preparation CEO, CFO, Accounting Staff Guided by GAAP Independent Auditors Verification Partners, Managers, Staff Guided by GAAS Information Intermediaries Analysis and Advice Financial analysis, Information services McGraw-Hill/Irwin Slide 5

PLAYERS IN THE ACCOUNTING COMMUNICATION PROCESS Management Preparation CEO, CFO, Accounting Staff Guided by GAAP Information Intermediaries Analysis and Advice Financial analysis, Information services Independent Auditors Verification Partners, Managers, Staff Guided by GAAS Financial analysts make predictions concerning companies future earnings and stock prices.

PLAYERS IN THE ACCOUNTING COMMUNICATION PROCESS Management Preparation CEO, CFO, Accounting Staff Guided by GAAP Information Intermediaries Analysis and Advice Financial analysis, Information services Independent Auditors Verification Partners, Managers, Staff Guided by GAAS Web Info Services: www.sec.gov; www.compustat.com; www.finance.yahoo.com; www.bloomberg.com; www.hoovers.com; www.factiva.com McGraw-Hill/Irwin Slide 7

Management Preparation CFO, CEO, Accounting Staff Guided by GAAP Independent Auditors Verification Partners, Managers, Staff Guided by GAAS Information Intermediaries Analysis and Advice Financial analysis, Information services Government Regulators Verification SEC Members Guided by SEC regs. Users Analysis and Decision Investors, Lenders, etc. Public companies only McGraw-Hill/Irwin Slide 8

The mission of the U.S. Securities and Exchange Commission is to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.

REGULATORS McGraw-Hill/Irwin Slide 10

ENSURING THE INTEGRITY OF FINANCIAL INFORMATION COMMUNICATION PROCESS Regulators Standard Setting and Verification SEC PCAOB Auditing Standards FASB Accounting Standards Management Primary Responsibility CFO, CEO, Accounting staff Stock Exchanges Corporate Governance Standards Auditors (CPAs) Verification Partners, Managers, Staff Directors Oversight Audit Committee (Independent directors) McGraw-Hill/Irwin Slide 11

USERS: INSTITUTIONAL AND PRIVATE INVESTORS, CREDITORS, AND OTHERS Management Primary Responsibility CFO, CEO, Accounting Staff Information Intermediaries Analysis and Advice Financial analysts, Information services Users Analysis and Decision Institutional and private investors, Lenders, Suppliers, Customers, etc. McGraw-Hill/Irwin Slide 12

As directed by the Sarbanes-Oxley Act of 2002, the SEC is adopting rules that require conformance with specific sections of the Act. These rules require officers to certify that they are responsible for establishing, maintaining and regularly evaluating the effectiveness of the issuer's internal controls; that they have made certain disclosures to the issuer's auditors and the audit committee of the board of directors about the issuer's internal controls; and that they have included information in the issuer's quarterly and annual reports about their evaluation and whether there have been significant changes in the issuer's internal controls or in other factors that could significantly affect internal controls subsequent to the evaluation.

GUIDING PRINCIPLES FOR COMMUNICATING USEFUL INFORMATION Primary Objective of External Financial Reporting To provide economic information to external users for decision making. Primary Qualitative Characteristics Relevance: Timely and Predictive Feedback Value Reliability: Accurate, Unbiased, and Verifiable Secondary Qualitative Characteristics Comparability: Across businesses Consistency: Over time McGraw-Hill/Irwin Slide 14

Primary Qualitative Characteristics Relevance: Timely and Predictive Feedback Value Reliability: Accurate, Unbiased, and Verifiable McGraw-Hill/Irwin Slide 15

Secondary Qualitative Characteristics Comparability: Across businesses Consistency: Over time

GUIDING PRINCIPLES FOR COMMUNICATING USEFUL INFORMATION Primary Objective of External Financial Reporting To provide economic information to external users for decision making. The full-disclosure principles require... Primary Qualitative Characteristics 1. Relevance: A complete Timely set and of Predictive financial and Feedback statements, Value Reliability: Accurate, and Unbiased, and Verifiable 2.Notes to the financial statements Secondary Qualitative Characteristics Comparability: Across businesses Consistency: Over time McGraw-Hill/Irwin Slide 17

INTERNATIONAL ACCOUNTING STANDARDS BOARD AND GLOBAL DIFFERENCES IN ACCOUNTING STANDARDS International Financial Reporting Standards Extraordinary items Permitted Prohibited LIFO for inventory Permitted Prohibited Reversal of inventory write-downs Prohibited Required Basis of property, plant, and equipment Historical cost Fair Value or ( Evo lving F air V alue) Historical cost McGraw-Hill/Irwin Slide 18

Refer to Note 2 to the consolidated financial statements for information pertaining to accounting changes effective in 2010, and Notes 2 and 31 to the consolidated financial statements for information on issued accounting pronouncements that will be effective in future years. Of particular note is the area of International Financial Reporting Standards (IFRSs), which will be adopted by us in 2011. The US Securities and Exchange Commission (SEC) allows foreign private issuers to use IFRSs, without reconciliation to US GAAP, provided that their foreign private issuer status is maintained. The company has established a project team that is led by finance management and includes representatives from various areas of the organization. An external resource has also been engaged to assist, under the direction of company management, with certain aspects of the project. The audit committee of the Board of Directors regularly receives progress reporting on the status of the IFRSs implementation project. The implementation project consists of three primary phases: the scoping and diagnostic phase (high-level impact assessment to identify key areas); the impact analysis, evaluation and design phase (project teams develop policy alternatives, draft financial statement content and determine changes to existing accounting policies, information systems and business processes); and the implementation and review phase (implement and approve changes to accounting policies, information systems, business processes and training programs, develop IFRSs-compliant financial statements and obtain audit committee approval). The company is now in the implementation and review phase. McGraw-Hill/Irwin Slide 19

ANNUAL REPORTS For privately held companies, annual reports are simple documents that include: 1. Four basic financial statements. 2. Related notes (footnotes). 3. Report of independent accountants (auditor s opinion) if the statements are audited. McGraw-Hill/Irwin Slide 20

ANNUAL REPORTS For public companies, annual reports are elaborate due to SEC reporting requirements: 1. A Nonfinancial Section A letter to the stockholders, a description of management s philosophy, products, successes, etc. 2. A Financial Section See next slide for a detailed listing... McGraw-Hill/Irwin Slide 21

ANNUAL REPORTS 1. Summarized financial data for 5- or 10-years. 2. Management Discussion and Analysis (MD&A). 3. The four basic financial statements. 4. Notes (footnotes). 5. Independent Accountant s Report and the Management Certification. 6. Recent stock price information. 7. Summaries of the unaudited quarterly financial data. 8. Lists of directors and officers of the company and relevant addresses. McGraw-Hill/Irwin Slide 22

McGraw-Hill/Irwin Slide 23

QUARTERLY REPORTS Usually begin with short letter to stockholders Condensed unaudited income statement and balance sheet for the quarter. Often, cash flow statement and statement of stockholders equity are omitted. Some notes to the financial statements also may be omitted. McGraw-Hill/Irwin Slide 24

SEC REPORTS 10-K, 10-Q, 8-K Form 10-K Annual Report Due within 90 days of the fiscal year-end. Contains audited financial statements. Form 10-Q Quarterly Report Due within 45 days of the end of the quarter. Financial statements can be unaudited. Form 8-K Current Report Due within 15 days of the major event date. Financial statements can be unaudited. McGraw-Hill/Irwin Slide 25

CLASSIFIED BALANCE SHEET Callaway Golf Company Consolidated Balance Sheet December 31, (in thousands, except share data and per share data) 2006 2005 ASSETS Current assets: Cash and cash equivalents $ 46,362 $ 49,481 Accounts receivable, net 118,133 98,082 Inventories, net 265,110 241,577 Other current assets 63,595 49,450 Total current assets 493,200 438,590 Property, plant and equipment, net 131,224 127,739 Intangible assets, net 175,159 175,191 Other assets 46,364 22,978 $ 845,947 $ 764,498 McGraw-Hill/Irwin Slide 26

CLASSIFIED BALANCE SHEET Callaway Golf Company Consolidated Balance Sheet December 31, (in thousands, except share data and per share data) 2006 2005 LIABILITIES & STOCKHOLDERS" EQUITY Current Liabilities: Accounts payable and accrued expenses $ 143,455 $ 140,184 Notes payable, current portion 80,000 21 Total current liabilities 223,455 140,205 Long-term liabilities: Other liabilities 43,388 28,245 Minority interest 1,987 Commitment and contingencies (Note13) McGraw-Hill/Irwin Slide 27

CLASSIFIED BALANCE SHEET (in thousands, except share data and per share data) 2006 2005 SHAREHOLDERS' EQUITY Shareholders' equity: Callaway Golf Company Consolidated Balance Sheet December 31, Common stock, $.01 par value, 85,096,782 and 84,950,694 issued and outstanding at December 31, 2006 and 2005, respectively $ 851 $ 850 Additional paid-in capital 141,192 164,202 Retained earnings 435,074 430,996 Total shareholders' equity 577,117 596,048 Total liabilities and shareholders' equity $ 845,947 $ 764,498 Contributed capital is normally shown in two accounts: 1.Common Stock 2.Additional Paid-in Capital McGraw-Hill/Irwin Slide 28

CLASSIFIED INCOME STATEMENT Income statements may contain three sections: 1. Continuing operations 2. Nonrecurring Items A. Discontinued operations B. Extraordinary items 3. Earnings per share McGraw-Hill/Irwin Slide 29

CLASSIFIED INCOME STATEMENT General Format for the Classified Income Statement S -COGS GM -OPEX OPIN +-NONOP IBT -INTAX NI Net sales Cost of goods sold Gross profit (Gross margin) Operating expenses Income from operations ± Nonoperating revenues/expenses and gains/losses Income before income taxes Income tax expense Net income McGraw-Hill/Irwin Slide 30

EARNINGS PER SHARE EPS = Net Income* Average Number of Shares of Common Stock Outstanding During the Period Basic EPS *If there are preferred dividends, the amount is subtracted from the Net Income in the numerator. McGraw-Hill/Irwin Slide 31

COMMON-SIZE INCOME STATEMENT Matrix, International Income Statement Month Ended January 31, 2009 Revenues: Sales revenue $ 66,000 94.56% Rental income 3,800 5.44% Total revenues 69,800 100.00% Costs and expenses: Cost of sales 36,000 51.58% Salaries & benefits expense 16,000 22.92% General & administrative expenses 8,100 11.60% Depreciation expense 2,500 3.58% Total costs and expenses 62,600 89.68% Operating income 7,200 10.32% Other revenues and gains (expenses and losses) Investment income 1,000 1.43% Interest expense (60) -0.09% Gain on sale of land 3,000 4.30% Income before income taxes 11,140 15.96% Income tax expense 3,899 5.59% Net income $ 7,241 10.37% Total revenue is equal to 100%. Earnings per share $ 0.40 McGraw-Hill/Irwin Slide 32

STATEMENT OF CASH FLOWS Recall that the Statement of Cash Flows is divided into three major sections. 1. Cash flows from operating activities. 2. Cash flows from investing activities. 3. Cash flows from financing activities. We will examine the indirect method of preparing the statement. This format begins with a reconciliation of accrual income to cash flows from operations. McGraw-Hill/Irwin Slide 33

CALLAWAY GOLF COMPANY Consolidated Statement of Cash Flows For the Year Ended December 31 (in thousands) 2006 Cash flows from operating activities: Net income $ 23,290 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation & amortization 32,274 Other non-cash items 14,035 Changes in assets and liabilities, net of effects from acquisitions: Accounts receivable, net (12,128) Inventories, net (16,842) Other assets (4,475) Accounts payable and accrued expenses (10,803) Income taxes payable (6,936) Other liabilities (1,128) Net cash provided by operating activities $ 17,287 McGraw-Hill/Irwin Slide 34

CALLAWAY GOLF COMPANY Consolidated Statement of Cash Flows For the Year Ended December 31 (in thousands) 2006 Cash flows from operating activities: Net income Change in Account Balance During $ 23,290 Year Adjustments to reconcile Increase net income to net cash Decrease provided by operating activities: Depreciation & amortization income. 32,274 Other non-cash items 14,035 income. Changes in assets and liabilities, net of effects from acquisitions: Accounts receivable, net (12,128) Inventories, net (16,842) Other assets (4,475) Accounts payable and accrued expenses (10,803) Income taxes payable (6,936) Other liabilities (1,128) Net cash provided by operating activities $ 17,287 Current Subtract from net Add to net income. Assets Current Add to net income. Subtract from net Liabilities McGraw-Hill/Irwin Slide 35

Consolidated Statement of Cash Flows 2006 Cash flows from investing activities Capital expenditures $ (32,453) Acquisition, net of cash acquired 374 Investment in marketable securities (10,008) Proceeds from sale of assets 469 Net cash used in investing activities $ (41,618) Cash flows from financing activities: Issuance of common stock 9,606 Acquisition of treasury stock (52,872) Proceeds from line of credit (net) 80,000 Other financing activities 2,549 Dividends paid, net (19,212) Net cash used in financing activities $ 20,071 Effect of exchange rate changes on cash 1,141 Net decrease in cash and cash equivalents (3,119) Cash and cash equivalents at beginning of year 49,481 Cash and cash equivalents at end of year $ 46,362 McGraw-Hill/Irwin Slide 36

NOTES TO FINANCIAL STATEMENTS Descriptions of the key accounting rules that apply to the company s statements. Additional detail supporting reported numbers. Relevant financial information not disclosed on the statements. McGraw-Hill/Irwin Slide 37

RETURN ON ASSETS (ROA) ANALYSIS Return on Assets = Net Income* Average Total Assets 1 ROA measures how much the firm earned for each dollar of investment. * (In complex calculations, interest expense (net of tax) and minority interest are added back to net income. 1 (beginning total assets + ending total assets) 2 McGraw-Hill/Irwin Slide 38

ROA PROFIT DRIVER ANALYSIS ROA Net Profit = Margin Asset Turnover Net Income Average Total Assets = Net Income Net Sales Net Sales Average Total Assets McGraw-Hill/Irwin Slide 39

PROFIT DRIVERS AND BUSINESS STRATEGY High-value or product-differentiation. Rely on R&D and product promotion to convince customers of the superiority of your product. Low-Cost. Rely on efficient management of accounts receivable, inventory and productive assets to produce high asset turnover. McGraw-Hill/Irwin Slide 40

CHAPTER SUPPLEMENT: NONRECURRING ITEMS General Format for the Classified Income Statement In addition, companies may have nonrecurring items. These nonrecurring items may include: Net sales Cost of goods sold Gross profit Operating expenses Income from operations ± Nonoperating revenues/expenses and gains/losses Income before income taxes Income tax expense Net income 1. Discontinued operations, 2. Extraordinary items, These items are reported separately because they are not useful in predicting future income of the company. McGraw-Hill/Irwin Slide 41

DISCONTINUED OPERATIONS Sale or abandonment of a segment of a business. Income or loss on segment s operation for the period. Gain or loss on disposal of the segment. Show net of applicable taxes. McGraw-Hill/Irwin Slide 42

EXTRAORDINARY ITEMS Unusual Infrequent Show net of applicable taxes. McGraw-Hill/Irwin Slide 43

END OF CHAPTER 5 2008 The McGraw-Hill Companies, Inc.

I think I am allergic to Accounting!!!