CHAPTER 8: Accounting DECISION MAKING BY THE NUMBERS 1
LOOKING AHEAD What is accounting? How is accounting information used? What are career opportunities in accounting? What are the goals of generally accepted accounting principles? What are the key elements of the major financial statements? How can horizontal, vertical and ratio analysis provide insight into financial statements? How can managerial accounting help managers with product costing, incremental analysis, and budgeting? 2
ACCOUNTING: WHO NEEDS IT? Managers Stockholders Employees Creditors What other groups would be interested in accounting information? 3
THE ACCOUNTING PROFESSION:MORE THAN What Accountants Do Private Accountants Internal Auditors Public Accountants Government Accountants Qualifications for Accounting Positions Bachelor s Degree Spreadsheet/Software Experience Certified Public Accountant (CPA) Certified Management Accountant (CMA) Master s Degree Preferred 4
GAAP: PLAYING BY THE RULES OF FINANCIAL ACCOUNTING Generally Accepted Accounting Principles (GAAP) accounting standards that are used in the preparation of financial statements. Financial Accounting Standards Board (FASB) private self regulated board that establishes and enforces GAAP. Through GAAP, the FASB aims to ensure that financial statements are: Relevant Reliable Consistent Comparable 5
ETHICS IN ACCOUNTING Accounting scandals have shocked American business since the late 1990s Overstating earnings Hidden money and debt The scandals have served as a wake-up call State and federal laws have been changed Auditor independence 6
FINANCIAL STATEMENTS: THE MAIN OUTPUT OF FINANCIAL Financial accounting includes three basic financial statements: Balance Sheet Income Statement Statement of Cash Flows Corporations with publicly held stock must publish annual reports with all three statements 7
BALANCE SHEET: WHAT WE OWN AND HOW WE GOT IT Balance Sheet summarizes a firm s financial position at a specific point in time. Assets things of value that the firm owns Liabilities indicates what the firm owes to non-owners Assets = Liabilities + Owner s Equity Owner s Equity the claims owners have against their firm s assets 8
SAMPLE BALANCE SHEET 9
THE INCOME STATEMENT: HOW DID WE DO? Income Statement summarizes a firm s operations over a given period of time in terms of profit and loss. Revenue the increase in the amount of assets the firm earns Expenses the cash the firm spends or other assets it uses to generate revenue Net Income the profit or loss the firm earns Revenue Expenses = Net Income 10
ACCRUAL BASIS ACCOUNTING Revenue is not the same as cash received during the same time period Accrual basis accounting records revenues as they are earned Expenses are matched to the revenues they generated 11
SAMPLE INCOME STATEMENT 12
STATEMENT OF CASH FLOWS: SHOW ME THE MONEY Cash flowing into and out of the firm Operations Investing Financing Increase and decrease from all three sources Total amount of cash on hand Stakeholders want to know if there is adequate cash to pay workers, creditors, suppliers and IRS 13
SAMPLE STATEMENT OF CASH FLOWS 14
ADDITIONAL FINANCIAL STATEMENTS Statement of Retained Earnings reports how retained earnings have changed. Stockholder s Equity Statement reports how net income and dividends affect retained earnings. 15
INTERPRETING FINANCIAL STATEMENTS: DIGGING It s important to view financial statements and: Auditor s Report Notes from Statements Analytical Techniques 16
INDEPENDENT AUDITOR S REPORT: A NECESSARY STAMP Publicly traded corporations are required to have a CPA firm perform an external audit Is the information in the financial statements accurate? The auditor will issue an unqualified, qualified or adverse opinion Auditors must be independent 17
SARBANES-OXLEY ACT OF 2002 Commonly referred to as SOX Banned relationships between CPA firms that might create conflict of interest Created Public Company Accounting Oversight Board (PCOAB) 18
ANDERSEN S REPUTATION LEFT IN SHREDS Arthur Andersen was a highly respected accounting firm until several thousand pages of documents related to the Enron case were shredded Although Andersen s conviction was overturned, the company s reputation had been shredded 19
NOTES TO FINANCIAL STATEMENTS: READING THE Additional information may be required to explain the numbers Lawsuits Employment Facts Mergers or acquisitions Health Insurance/Pension Funding 20
BEYOND THE STATEMENTS Horizontal Analysis compares information in a firm s financial statement over a period of 2 years or more. Vertical Analysis expresses items on the balance sheet and income statement as a percentage of a key value. Ratio Analysis compares selected items by computing percentages, rates or proportions. 21
MANAGERIAL ACCOUNTING VS. FINANCIAL ACCOUNTING 22
MANAGERIAL ACCOUNTING: INSIDE INTELLIGENCE Reports and analysis for informed business decisions Product Costing Accurate measure and analysis of costs Activity Based Costing (ABC) 23
INCREMENTAL ANALYSIS Evaluates the financial impact of different alternatives in a decision-making situation. Make parts or buy from supplier? Repair equipment or buy new? Perform repairs or outsource? Eliminate or sell product line/business? 24
INCREMENTAL ANALYSIS DECISION An electronics firm produces high definition LCD televisions at a rate of 10,000 per month. It currently makes its own speaker sets for the televisions. A supplier offers to sell the firm similar speakers at a cost of $23 per television. The firm could lower costs by buying the speakers, $23 is less than $26. Right? 25
COST OF MAKING TELEVISION SPEAKERS: MAKE OR BUY? 26
BUDGETS Outline how resources will be used to meet goals Communication and coordination among managers and employees Motivate achievement of goals Monitor progress 27
DIFFERENT TYPES OF BUDGETS Operating Budgets identify sales and production goals. Sales Budget Production Budget Direct Labor Budget Financial Budgets focus on the firm s financial objectives. Cash Budget Capital Budget Master Budget brings together all of the budgets to represent the overall plan. 28
LOOKING BACK What is accounting? How is accounting information used by stakeholders? What are career opportunities in accounting? What are the goals of generally accepted accounting principles? What are the key elements of the major financial statements? How can horizontal, vertical and ratio analysis provide insight into financial statements? How can managerial accounting help managers with product costing, incremental analysis, and budgeting? 29