and Communicating Interpreting
Accounting Information
Chapter 05
PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA
McGraw-Hill/Irwin
5-1
Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.
Players in the Accounting
Communication Process
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Regulators
Securities and Exchange Commission
Primary Responsibility
Protect investors and maintain the integrity of the securities market.
Financial Accounting Standards Board
Primary Responsibility
Set Generally Accepted Accounting Standards (GAAP).
Public Company Accounting Oversight Board
Primary Responsibility
Sets auditing standards for independent auditors (CPAs)
of public companies.
Stock Exchanges
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Primary Responsibility
Along with state governments, set overall corporate governance
Along
standards.
standards.
Managers
Management
Primary Responsibility
Primary Responsibility
Responsible for the information in the financial statements
Responsible for the information in the financial statements
and disclosures.
and disclosures.
Chief Executive Officer (CEO):: highest officer of the
Chief Executive Officer (CEO) highest officer of the
company
company
Chief Financial Officer (CFO):: highest officer associated
Chief Financial Officer (CFO) highest officer associated
with the financial and accounting side of the business
with the financial and accounting side of the business
Accounting Staff:: prepare the details of the reports and
Accounting Staff prepare the details of the reports and
bear professional responsibility for the accuracy of the
bear professional responsibility for the accuracy of the
iinformation.
nformation.
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Board of Directors (Audit Committee)
Board of Directors
Board of Directors
Board
Primary Responsibility
Primary Responsibility
Responsible for ensuring that processes are in place for
Responsible for ensuring that processes are in place for
maintaining the integrity of the companys accounting, financial
maintaining the integrity of the companys accounting, financial
statement preparation, and financial reporting.
statement preparation, and financial reporting.
Board of Directors (Audit Committee)
Board of Directors (Audit Committee)
Primary Responsibility
Primary Responsibility
Is composed of non-management (independent) directors with
Is composed of non-management (independent) directors with
ffinancial knowledge and is responsible for hiring the companys
inancial knowledge and is responsible for hiring the companys
iindependent auditors. They also meet separately with the
ndependent auditors. They also meet separately with the
auditors to discuss managements compliance with their
auditors to discuss managements compliance with their
ffinancial reporting responsibilities.
inancial reporting responsibilities.
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Auditors
Independent Auditors
Independent Auditors
Primary Responsibility
Primary Responsibility
Follow established auditing standards to assess the fairness of
Follow established auditing standards to assess the fairness of
Follow
Follow
the financial statements and related presentations
tthe financial statements and related presentations
the
he
An unqualified, or clean,
An unqualified, or clean,
opinion states that the
opinion states that the
ffinancial statements are
inancial statements are
ffair presentations in all
air presentations in all
material respects in
material respects in
conformity with GAAP.
conformity with GAAP.
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Unqualified
Opinion
Information Intermediaries: Financial
Analysts and Information Services
Information Intermediaries
Information Intermediaries
Analysis and Advice
Analysis and Advice
1.Receive accounting reports and other information about the
1.Receive accounting reports and other information about the
Receive
Receive
company from electronic information services
company from electronic information services
company
company
2.Gather information through conversations with company
2.Gather information through conversations with company
Gather
Gather
executives and visits to company facilities and competitors
executives and visits to company facilities and competitors
executives
executives
3.Results of their analyses are combined into analysts reports.
3.Results of their analyses are combined into analysts reports.
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Users: Institutional and Private
Investors, Creditors, and Other
Institutional Investors
Institutional Investors
Includes pension, mutual, endowment and other funds that invest on the
Includes pension, mutual, endowment and other funds that invest on the
behalf of others
behalf of others
Private Investors
Private Investors
Individuals who purchase shares in companies
Individuals who purchase shares in companies
Lenders or Creditors
Lenders or Creditors
Suppliers, banks, commercial credit companies, and other financial
Suppliers, banks, commercial credit companies, and other financial
iinstitutions that lend money to companies
nstitutions that lend money to companies
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Guiding Principles for Communicating
Useful Information
Primary Objective of External Financial Reporting
Primary Objective of External Financial Reporting
Primary
To provide economic information to external users for
To provide economic information to external users for
decision making.
decision making.
Primary Qualitative Characteristics
Primary Qualitative Characteristics
Primary
Relevance: Timely and Predictive Feedback Value
Relevance: Timely and Predictive Feedback Value
Timely
Timely
Reliability: Accurate, Unbiased, and Verifiable
Reliability: Accurate, Unbiased, and Verifiable
Accurate,
Accurate,
Secondary Qualitative Characteristics
Secondary Qualitative Characteristics
Comparability: Across businesses
Comparability: Across businesses
Across
Across
Consistency: Over time
Consistency: Over time
Consistency: Over
Consistency: Over
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Differences in Accounting Methods
5-10
Annual Reports
For privately held companies, annual
privately
reports are simple documents that include:
reports
1. Four basic financial statements.
2. Related notes (footnotes).
3. Report of independent accountants (auditors
Report
opinion) if the statements are audited.
opinion)
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Annual Reports
For public companies,, annual reports are elaborate
For public companies annual reports are elaborate
due to SEC reporting requirements:
due to SEC reporting requirements:
1. Nonfinancial Section
1. Nonfinancial Section
Includes a letter to the stockholders, a description of
Includes a letter to the stockholders, a description of
managements philosophy, products, successes, etc.
managements philosophy, products, successes, etc.
1. Financial Section
1. Financial Section
SEC sets minimum disclosure standards for the
SEC sets minimum disclosure standards for the
ffinancial section for public companies.
inancial section for public companies.
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Annual Reports
1. Summarized financial
1. Summarized financial
1. Summarized
Summarized
data for 5- or 10-years.
data for 5- or 10-years.
data
data
2. Management Discussion
2. Management Discussion
Management
Management
and (MD&A).
and Analysis Analysis (MD&A).
and
and
3. The four basic financial
3. The four basic financial
The
The
statements.
statements.
statements.
statements.
4. Notes (footnotes).
4. Notes (footnotes).
5. IIndependent Accountants
5. Independent Accountants
ndependent
Independent
Report and the
Report and the
Management
Management
Certification.
Certification.
Certification.
Certification.
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6.. Recent stock price
6. Recent stock price
6 Recent
Recent
information.
iinformation.
information.
nformation.
7. Summaries of the
7. Summaries of the
Summaries
Summaries
unaudited quarterly
unaudited quarterly
financial data.
ffinancial data.
financial
inancial
8. Lists of directors and
8. Lists of directors and
Lists
Lists
officers of the company
officers of the company
and relevant addresses.
and relevant addresses.
and
and
Quarterly Reports
Usually begin with short letter to stockholders
Usually begin with short letter to stockholders
Condensed unaudited iincome statement and
Condensed unaudited ncome statement and
balance sheet for the quarter.
balance sheet for the quarter.
Often, cash flow statement and statement of
Often, cash flow statement and statement of
stockholders equity are omitted.. Some notes to
stockholders equity are omitted Some notes to
the financial statements also may be omitted.
the financial statements also may be omitted.
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SEC Reports 10-K, 10-Q, 8-K
Form 10-K Annual Report
Form 10-K Annual Report
Due within 90 days of the fiscal year-end.
Due within 90 days of the fiscal year-end.
Contains audited financial statements.
Contains audited financial statements.
Form 10-Q Quarterly Report
Form 10-Q Quarterly Report
Due within 45 days of the end of the quarter.
Due within 45 days of the end of the quarter.
Financial statements can be unaudited.
Financial statements can be unaudited.
Form 8-K Current Report
Form 8-K Current Report
Due within 15 days of the major event date.
Due within 15 days of the major event date.
Financial statements can be unaudited.
Financial statements can be unaudited.
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Classified Balance Sheet
Assets used of turned into
cash within one year.
Assets used of turned into
cash beyond one year.
Obligations paid of
settled within one year.
Obligations paid of
settled after one year.
Contributed capital..
Reinvested earnings.
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Classified Income Statement
IncomeStatementsarepreparedusingthe
followingbasicstructure.
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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
Consolidated Income Statement
Operating
activities the
focus of the
business.
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Net Income Average Number of Shares Outstanding
Nonrecurring Items
Income statements may contain three sections:
Income statements may contain three sections:
1.
1.
2.
2.
Continuing operations
Continuing operations
Nonrecurring Items
Nonrecurring Items
a)
a)
b)
b)
Discontinued operations
Discontinued operations
Extraordinary items
Extraordinary items
3. Earnings per share
3. Earnings per share
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Earnings Per Share
EPS=
EPS=
NetIncome*
AverageNumberofSharesofCommonStock
OutstandingDuringthePeriod
BasicEPS
*If there are preferred dividends, the
If there are preferred dividends, the
amount is subtracted from the Net
amount is subtracted from the Net
IIncome in the numerator.
ncome in the numerator.
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Common-Size Income Statement
Total revenue is
equal to 100%.
DELETE THIS SLIDE`
5-21
Statement of Cash Flows
1.
1.
2.
2.
3.
3.
Recall that the Statement of Cash Flows is
Recall that the Statement of Cash Flows is
divided into three major sections.
divided into tthree major sections.
three
hree
Cash flows from operating activities.
Cash flows from operating activities.
Cash flows from investing activities.
Cash flows from investing activities.
Cash flows from financing activities.
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.
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Cash flows
associated with
earning income.
Cash flows related to
purchase and sale of
productive assets
and investments.
Cash flows related to
borrowing and
repaying loans and
issue and repurchase
of stock.
Change in the cash
account.
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Notes to Financial Statements
Descriptions of the key accounting rules
that apply to the companys statements.
Additional detail supporting reported
numbers.
Relevant financial information not
disclosed on the statements.
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Accounting Rules Applied in the
Companys Statements
One of the first notes to the financial statements is usually
the statement of significant account policies.
This particular note relates to the Callaway Golfs policies
regarding depreciation of Property, Plant, and Equipment.
regarding
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Additional Detail Supporting
Reported Numbers
The second category of notes provides supplemental
information concerning the data shown on the financial
statements.
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Relevant Financial Information Not
Disclosed on the Statements
The final category includes information that impacts the
company financially but is not shown on the statements.
5-28
Return on Assets (ROA) Analysis
ROA measures how much the firm earned for each
dollar of investment.
(Incomplexcalculations,interestexpense(netoftax)andminorityinterest
areaddedbacktonetincome.
*
1
(beginningtotalassets+endingtotalassets)2
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ROA Profit Driver Analysis
NetIncome
Average
TotalAssets
5-30
=
NetIncome
NetSales
=
NetSales
Average
TotalAssets
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 Strategy
Rely on efficient management of accounts
receivable, inventory and productive assets
to produce high asset turnover.
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Chapter Supplement: Nonrecurring
Items
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
In addition, companies may have nonrecurring items.
In
These nonrecurring items may include:
These
1. Discontinued operations
1. Discontinued
2. Extraordinary items
2. Extraordinary
These items are reported separately because they are not
These
useful in predicting future income of the company.
useful
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Discontinued Operations
Sale or abandonment of a segment off a
Sale or abandonment of a segment o a
business.
business.
IIncome or loss on
Income or loss on
ncome
Income
segments operation for
segments operation for
the period.
tthe period.
the
he
Gain or loss on
Gain or loss on
Gain
Gain
disposal of the
disposal of the
segment.
segment.
segment.
segment.
Show net of applicable taxes.
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Extraordinary Items
Unusual
Infrequent
Show net of applicable taxes.
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Reporting Extraordinary Items and
Discontinued Operations
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End of Chapter 05
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