Chapter Seventeen Using Accounting Information Learning Objectives 1. Explain why accounting information and audited financial statements are important. 2. Identify the people who use accounting information and possible careers in the accounting industry. 3. Discuss the accounting process. 4. Read and interpret a balance sheet. 5. Read and interpret an income statement. 6. Describe business activities that affect a firm s cash flow. 7. Summarize how managers evaluate the financial health of a business. 17 2
Chapter 17 Outline Why Accounting Information Is Important Recent Accounting Problems for Corporations and Their Auditors Why Audited Financial Statements Are Important Reform: The Sarbanes Oxley Act of 2002 Who Uses Accounting Information? The People Who Use Accounting Information Different Types of Accounting Careers in Accounting The Accounting Process The Accounting Equation The Accounting Cycle 17 3 Chapter 17 Outline (cont d) The Balance Sheet Assets Liabilities and Owners Equity The Income Statement Revenues Cost of Goods Sold Operating Expenses Net Income The Statement of Cash Flows 17 4
Chapter 17 Outline (cont d) Evaluating Financial Statements Ui Using Annual lreports to Compare Dt Data for Different Accounting Periods Comparing Data with Other Firms Data Profitability Ratios Short Term Financial Ratios Activity Ratios Debt to Owners Equity Ratio Northeast s Financial Ratios: A Summary 17 5 Why Accounting Information Is Important Recent accounting problems for corporations and their auditors Pressure on corporate executives to look good to analysts and investors Why audited financial statements are important Bankers, creditors, investors, and government agencies rely on an auditor s opinion 17 6
Why Accounting Information Is Important (cont d) What is an audit? Reform: The Sarbanes Oxley Act of 2002 17 7 Who Uses Accounting Information The people who use accounting information Managers are primary users Lenders require financial information before lending Stockholders want to know whether to invest or how well their investment is doing Government agencies require a variety of information 17 8
Careers in Accounting Qualities to be successful in accounting Be responsible, honest, ethical Have a strong background in financial management Know how to use a computer and accounting software Be able to communicate with people who need accounting information 17 9 Careers in Accounting (cont d) Private Accountant Employed by a specific organization Services performed for the employer General accounting (recording transactions and preparing statements) Budgeting (for sales and operating expenses) Cost accounting (determining costs of producing products and services) Tax accounting (planning strategy and preparing returns) Internal auditing (reviewing finances and operations against goals) 17 10
Careers in Accounting (cont d) Public Accountant Provides services to clients on a fee basis Self employed or employee of an accounting firm Certified Public Accountant (CPA) Has met state requirements for accounting education and experience and has passed a rigorous two day accounting examination prepared by the AICPA Participates in continuing education programs to maintain certification 17 11 The Accounting Process The accounting equation Assets = Liabilities + Owners equity Assets the resources that a business owns (e.g., cash, inventory, equipment, and real estate) Liabilities the firm s debts Owners equity the difference between assets and liabilities (what would be left for the owners if the firm s assets were sold and the money used to pay off its liabilities) Double-entry bookkeeping system: Each financial transaction is recorded as two separate accounting entries to maintain the balance of the accounting equation 17 12
The Accounting Process (cont d) The accounting cycle Done on a regular basis Done at the end of the period Preparing the trial balance of all general ledger accounts Preparing financial statements and closing the books 17 13 The Accounting Cycle 5. Preparing financial statements 1. Analyzing source documents 4. Preparing the trial balance 2. Recording transactions 3. Posting transactions 17 14
The Balance Sheet A summary of the dollar amounts of a firm s assets, liabilities, and owners equity accounts at the end of a specific accounting period (also called statement of financial position) Assets Liabilities Owners or stockholders equity 17 15 The Income Statement A summary of a firm s revenues and expenses during a specified accounting period Profit (cash surplus) Loss (cash deficit) Revenues 17 16
The Income Statement (cont.) Cost of goods sold The dollar amount equal to beginning g inventory plus net purchases less ending inventory Cost of goods sold = Beginning + Net inventory purchases Ending inventory Gross profit A firm s net sales less the cost of goods sold 17 17 The Income Statement (cont.) Operating expenses Net income Net loss 17 18
The Statement of Cash Flows Illustrates how the operating, investing, and financing activities of a company affect cash during an accounting period 17 19 Evaluating Financial Statements Identify trends in sales, profits, borrowing, and other business variables Determine whether the firm is on track to meet long term goals 17 20
Comparing Data with Other Firms Data Comparisons are possible because of GAAP Managers can get a general idea of a firm s relative effectiveness and its standing within the industry Data are available from annual reports of public corporations Industry averages are available from Dun & Bradstreet, Standard & Poor s, industry trade associations 17 21 Financial Ratios Numbers that show the relationship between two elements of a firm s financial statements Can be compared with The firm s own past ratios Ratios of competitors Industry averages Information to calculate ratios is found on a firm s balance sheet and income statement 17 22
Table 17.1 Users of Accounting Information 234 Users of Accounting Information The primary users of accounting information are a company s managers, but individuals and organizations outside the company also require information on its finances. Management Lenders and Suppliers Stockholders and Potential Investors Government Agencies Plan and set goals Organize Lead and motivate Control Evaluate credit risks before committing to short- or longterm financing Evaluate the financial health of the firm before purchasing stocks or bonds Confirm tax liabilities Confirm payroll deductions Approve new issues of stocks and bonds 3768X_17_ch17_p234-247.indd 234 3/6/09 9:12:23 PM
Figure 17.1 Personal Balance Sheet 235 Personal Balance Sheet Marty Campbell Personal Balance Sheet December 31, 20XX ASSETS Cash Savings account Automobile Stereo Television Furniture TOTAL ASSETS LIABILITIES Automobile loan Credit card balance TOTAL LIABILITIES NET WORTH (Owner s Equity) TOTAL LIABILITIES AND NET WORTH $ 2,500 5,000 15,000 1,000 500 2,500 $ 9,500 500 $26,500 $10,000 16,500 $26,500 3768X_17_ch17_p234-247.indd 235 3/6/09 9:12:25 PM
Figure 17.2 Business Balance Sheet Business Balance Sheet 236 Balance Sheet December 31, 20XX ASSETS Current assets Cash Marketable securities Accounts receivable Less allowance for doubtful accounts $ 40,000 2,000 $ 59,000 10,000 38,000 Notes receivable Merchandise inventory Prepaid expenses Total current assets 32,000 41,000 2,000 $182,000 Fixed assets Delivery equipment Less accumulated depreciation Furniture and store equipment Less accumulated depreciation Total fixed assets $110,000 20,000 $62,000 15,000 $ 90,000 47,000 137,000 Intangible assets Patents Goodwill Total intangible assets $ 6,000 15,000 21,000 TOTAL ASSETS $340,000 LIABILITIES AND STOCKHOLDERS EQUITY Current liabilities Accounts payable Notes payable Salaries payable Taxes payable Total current liabilities $ 35,000 25,675 4,000 5,325 $ 70,000 Long-term liabilities Mortgage payable on store equipment Total long-term liabilities $ 40,000 $ 40,000 TOTAL LIABILITIES $110,000 Stockholders equity Common stock Retained earnings $150,000 80,000 TOTAL OWNERS EQUITY 230,000 TOTAL LIABILITIES AND OWNERS EQUITY $340,000 3768X_17_ch17_p234-247.indd 236 3/6/09 9:12:25 PM
Figure 17.3 Personal Income Statement 237 Personal Income Statement Marty Campbell Personal Income Statement For the month ended December 31, 20XX INCOME (Take-home pay) $1,900 LESS MONTHLY EXPENSES Automobile loan Credit card payment Apartment rent Utilities Food Clothing Recreation & entertainment $ 250 100 500 200 250 100 250 TOTAL MONTHLY EXPENSES 1,650 CASH SURPLUS (or profit) $ 250 3768X_17_ch17_p234-247.indd 237 3/6/09 9:12:26 PM
Figure 17.4 Business Income Statement 238 Business Income Statement Income Statement For the Year Ended December 31, 20XX Revenues Gross sales Less sales returns and allowances Less sales discounts Net sales $ 9,500 4,500 $465,000 14,000 $451,000 Cost of goods sold Beginning inventory, January 1, 20XX Purchases Less purchase discounts Net purchases Cost of goods available for sale Less ending inventory December 31, 20XX Cost of goods sold $346,000 11,000 $ 40,000 335,000 $375,000 41,000 334,000 Gross profit $117,000 Operating expenses Selling expenses Sales salaries Advertising Sales promotion Depreciation store equipment Depreciation delivery equipment Miscellaneous selling expenses Total selling expenses $ 22,000 4,000 2,500 3,000 4,000 1,500 $ 37,000 General expenses Office salaries Rent Depreciation office furniture Utilities expense Insurance expense Miscellaneous expense Total general expense Total operating expenses $ 28,500 8,500 1,500 2,500 1,000 500 42,500 79,500 Net income from operations Less interest expense $ 37,500 2,000 NET INCOME BEFORE TAXES Less federal income taxes $ 35,500 5,325 NET INCOME AFTER TAXES $ 30,175 3768X_17_ch17_p234-247.indd 238 3/6/09 9:12:26 PM
Figure 17.5 Statement of Cash Flows 239 Statement of Cash Flows Statement of Cash Flows For the Year Ended December 31, 20XX Cash flows from operating activities Cash received from customers Cash paid to suppliers and employees Interest paid Income taxes paid $ 451,000 (385,500) (2,000) (5,325) Net cash provided by operating activities $ 58,175 Cash flows from investing activities Purchase of equipment Purchase of investments Sale of investments $ (2,000) (10,000) 10,000 Net cash provided by investing activities (2,000) Cash flows from financing activities Payment of short-term debt Payment of long-term debt Payment of dividends $ (9,000) (17,000) (15,000) Net cash provided by financing activities (41,000) NET INCREASE (DECREASE) IN CASH Cash at beginning of year CASH AT END OF YEAR $ 15,175 43,825 $ 59,000 3768X_17_ch17_p234-247.indd 239 3/6/09 9:12:26 PM
Table 17.2 Financial Ratios of Northeast Art Supply Compared with Average Ratios for All Businesses 240 Financial Ratios of Northeast Art Supply Compared with Average Ratios for all Businesses Ratio Formula Northeast Ratio Average Business Ratio Direction for Improvement Profitability Ratios Return on sales net income after taxes net sales 6.7% 4% 5% Higher Return on owners equity net income after taxes owners equity 13% 12% 15% Higher Earnings per share net income after taxes common stock shares outstanding $1.21 per share Higher Short-Term Financial Ratios Working capital current assets current liabilities $112,000 Higher Current ratio current assets current liabilities 2.6 2.0 Higher Acid-test ratio cash + marketable securites + receivables current liabilities 1.99 1.0 Higher Activity Ratios Accounts receivable turnover net sales accounts receivable 11.9 Higher Inventory turnover cost of goods sold average inventory 8.2 9 Higher Debt-to-owners -equity ratio total liabilities owners equity 48 percent Lower 3768X_17_ch17_p234-247.indd 240 3/6/09 9:12:27 PM
Figure 17.A Chapter Outline Chapter 17 Outline Using Accounting Information Why Accounting Information Is Important Recent Accounting Problems for Corporations and Their Auditors Why Audited Financial Statements Are Important Reform: The Sarbanes-Oxley Act of 2002 Who Uses Accounting Information? The People Who Use Accounting Information Different Types of Accounting Careers in Accounting The Accounting Process The Accounting Equation The Accounting Cycle The Balance Sheet Assets Liabilities and Owners Equity The Income Statement Revenues Cost of Goods Sold Operating Expenses Net Income The Statement of Cash Flows Evaluating Financial Statements Using Annual Reports to Compare Data for Different Accounting Periods Comparing Data with Other Firms Data Profitability Ratios Short-Term Financial Ratios Activity Ratios Debt-to-Owners Equity Ratio Northeast s Financial Ratios: A Summary 241 3768X_17_ch17_p234-247.indd 241 3/6/09 9:12:27 PM
Figure 17.B Class Exercise Class Exercise 242 For each account listed below, indicate with a check mark ( ) if it belongs on a balance sheet or an income statement. Individual Account Balance Sheet Income Statement Rent Cash Patent Mortgage payable Net income Salaries payable Purchase Delivery equipment Sales Cost of goods sold Common stock 3768X_17_ch17_p234-247.indd 242 3/6/09 9:12:27 PM
Figure 17.C Debate Issue Debate Issue Do computerized systems help smallbusiness owners maintain accurate accounting records? YES Day-to-day accounting work can be completed much faster with the aid of a computer. Computerized accounting systems generate more useful management information than oldfashioned systems. Computer hardware and the accompanying software packages are bargains at today s low prices. NO 243 In order to really understand an accounting system, the small-business owner needs to record accounting information the old-fashioned way by hand. Usually small-business owners do not understand accounting, much less a computerized accounting system. Computer hardware and software packages are only bargains if the small-business owner is going to use them. 3768X_17_ch17_p234-247.indd 243 3/6/09 9:12:27 PM
Figure 17.D Chapter Quiz Chapter Quiz 244 1. The is designed to improve accounting standards. a. Ethics in Accounting Act b. Graham-Rudman Reform Act c. Sarbanes-Oxley Act d. Securities and Exchange Accounting Act e. Accounting Standards Establishment Act 2. An accountant who is employed by a specific business or organization is referred to as a(n) a. public accountant. b. private accountant. c. proprietary accountant. d. AICPA accountant. e. asset accountant. 3. The first step in the accounting cycle is to a. analyze source documents. b. record individual transactions. c. post individual transactions. d. construct a beginning financial statement. e. prepare a list of employees. 4. Assets, liabilities, and owners equity would be listed on a firm s a. balance sheet. b. income statement. c. statement of earnings. d. statement of retained earnings. e. statement of capital. 5. Current assets minus current liabilities equals a. return on owners equity. b. current ratio. c. acid-test ratio. d. working capital. e. current cash statement. 3768X_17_ch17_p234-247.indd 244 3/6/09 9:12:27 PM
Figure 17.E Classification of Accountants 245 Classification of Accountants PRIVATE ACCOUNTANTS Accountants employed by a specific organization PUBLIC ACCOUNTANTS Accountants who provide services to clients on a fee basis CERTIFIED PUBLIC ACCOUNTANTS (CPAs) Individuals who have met state requirements for accounting education and experience and have passed a rigorous accounting examination 3768X_17_ch17_p234-247.indd 245 3/6/09 9:12:27 PM
Figure 17.F The Accounting Equation 246 The Accounting Equation 3768X_17_ch17_p234-247.indd 246 3/6/09 9:12:28 PM
Figure 17.G The Accounting Cycle 247 The Accounting Cycle 3768X_17_ch17_p234-247.indd 247 3/6/09 9:12:30 PM