UndersStanding accounting and financial statements

Accounting Process of measuring, interpreting, and communicating financial information to support internal and external business decision making.USERS OF ACCOUNTING INFORMATION... ACCOU

Describe the roles played by

public, management, government

and not-for-profit accountants

Explain the three principal financial statements

Discuss how financial ratios are used to analyze a firm’s financial strengths and weaknesses

Describe the role of budgets in a business

Explain uniform financial statements and how

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Accounting Process of measuring, interpreting, and communicating financial information to support internal and external business decision making.

USERS OF ACCOUNTING

INFORMATION

• Open book management Sharing sensitive financial information with

employees and teaching them how to understand and use financial statements

• Viewing financial information may help them better understand how their work contributes to the company’s success

• Outsiders use financial data to evaluate investment opportunities

• Accountants serve public good

• Example: Volunteer programs that provide free help for low- and income senior citizens file their taxes

middle-BUSINESS ACTIVITIES INVOLVING

ACCOUNTING

• Accounting plays a key role in each of a businesses three key areas:

• Financing activities Provide necessary funds to start and expand a business.

• Investing activities Provide valuable assets required to run a business

• Operating activities Focus on selling goods and services, but they also

consider expenses as important elements of sound financial management

ACCOUNTING PROFESSIONALS

Public Accountants

Public accountant Accountant who works for an independent accounting firm

• Provide three basic services to clients:

• Auditing, or examining, financial records

• Tax preparation, planning, and related services

• Management consulting for an independent accounting firm

• Four largest firms dominate the industry: Deloitte & Touche, Ernst & Young, KPMG, and PricewaterhouseCoopers

• Legislation limits the types of consulting services auditors can provide

Certified public accountant (CPA) Accountant who meets specified

educational and experiential requirements and has passed a

Management Accountants

• Manage ment accountant Accountant employed by a

business other than a public accounting firm.

• Collects and records financial transactions and prepares

financial statements used by the firm’s managers in

decision making

• Answers questions such as:

• Where is the company going?

• What opportunities await it?

• Do certain situations expose the company to excessive risk?

• Does the firm’s information system provide detailed and timely information to all levels of management?

• Often specialize (e.g., internal auditor, tax accountant).

Government and Not-for-Profit Accountants

• Perform professional services similar to those of management accountants.

THE ACCOUNTING PROCESS

Accounting process Set of activities involved in converting information about transactions into financial statements.

The Impact of Computers and the Internet on the

Accounting Process

• Simplifies the accounting process by automating data entry and calculations

• Available products are customized for businesses of different sizes

• Entrepreneurs and small businesses: QuickBooks, Peachtree, and

BusinessWorks

• Larger firms: Computer Associates, Oracle, and SAP

• Software that handles accounting information for international businesses is also available

• Some systems are Web-based

The Foundation of the Accounting System

• Generally accepted accounting principles (GAAP) Principles that

encompass the conventions, rules, and procedures for determining acceptable accounting practices at a particular time

• Financ ial Accounting Standards Board (FAS B) Organization primarily

responsible for evaluating, setting, or modifying GAAP in the U.S

• Monitors changing business conditions

• Enacts new rules

• Modifies existing rules when necessary

Sarbane s-Oxley Act A response to cases of accounting fraud.

• Created the Public Accounting Ove rs ight Board, which sets audit

standards and investigates and sanctions accounting firms that certify the books

of publicly traded firms

• Added to the reporting requirements for publicly traded companies

• Senior executives must personally certify that the financial information reported by the company is correct

• Resulted in increase in demand for accountants

The Accounting Equation

Assets Anything of value owned or leased by a business

• Tangible: Equipment, buildings, inventory

• Intangible: Patents, trademarks

Liability Claim against a firm’s assets by a creditor

Owner’s equity All claims of the proprietor, partners, or stockholders against the assets of a firm, equal to the excess of assets over liabilities

Basic accounting equation Relationship that states that assets equal liabilities plus owners’ equity

Double-entry bookkeeping Process by which accounting transactions are

entered; each individual transaction always has an offsetting

transaction

FINANCIAL STATEMENTS

• Provide managers with information for evaluating organization’s ability to meet current obligations and needs, its profitability, and its overall financial health

The Balance Sheet

Balance sheet Statement of a firm’s financial position—what it owns and the claims against its assets—at a particular point in time

The Income Statement

Income statement Financial record of a company’s revenues, expenses, and profits over a period of time

• Helps decision makers focus on overall revenues and the costs involved in generating these revenues

• Sometimes called a profit-and-loss, or P&L, statement

This gentleman has clearly encountered more loss than profit…

The Statement of Cash Flows

Statement of cash flows Statement of a firm’s cash receipts and cash payments that presents information on its sources and uses of cash

Accrual accounting Accounting method that records revenue and expenses when they occur, not necessarily when cash actually changes hands

• Inadequate cash flow is a reason for many business failures

FINANCIAL RATIO ANALYSIS

• Ratio analysis Tool for measuring a firm’s liquidity, profitability, and reliance

on debt financing, as well as the effectiveness of management’s resource

utilization

• Ratio of 2 to 1 is generally considered to indicate

Total current assets

Total current liabilities

• Acid-test (or quick) ratio measures the ability of a firm to meet its debt payments on short notice

• Example: Shasta Cash and equivalents

+ short-term investments + accounts receivable

Total current liabilities

• Example: Shasta Net sales

Average of inventory 1/31/07 and 1/31/06

• Total asset turnover ratio indicates how much in sales each dollar invested

Profitability Ratios

• Profitability ratios Measure the organization’s overall financial performance

by evaluating its ability to generate revenues in excess of operating costs and other expenses

Budget Planning and control tool that reflects a firm’s

expected sales revenues, operating expenses, and cash receipts and outlays

• Preparation is generally time-consuming, involving people throughout the organization

• Cash budget Tracks the firm’s cash inflows and outflows.

INTERNATIONAL ACCOUNTING

• Global firms must translate financial statements of the firm’s international affiliates, branches, and subsidiaries and convert data about foreign currency transactions to dollars

Exchange Rates

• Ratio at which a country’s currency can be exchanged for other currencies

• Consolidated financial statements must reflect gains and losses due to changes

in exchange rates

• Can have significant impact on financial statement

• Over a recent three-year period, foreign currency adjustments effectively added more than $1.5 billion to Procter & Gamble’s earnings

International Accounting Standards

• International Accounting Standards Committee (IASC) promotes worldwide consistency in financial reporting practices

• Working to create one worldwide set of accounting rules