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Communicating and 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.

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
Primary Responsibility Along with state governments, set overall corporate governance standards.

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Managers
Management
Primary Responsibility Responsible for the information in the financial statements and disclosures. Chief Executive Officer (CEO): highest officer of the company Chief Financial Officer (CFO): highest officer associated with the financial and accounting side of the business Accounting Staff: prepare the details of the reports and bear professional responsibility for the accuracy of the information.

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Board of Directors (Audit Committee)


Board of Directors
Primary Responsibility Responsible for ensuring that processes are in place for maintaining the integrity of the companys accounting, financial statement preparation, and financial reporting.

Board of Directors (Audit Committee)


Primary Responsibility Is composed of non-management (independent) directors with financial knowledge and is responsible for hiring the companys independent auditors. They also meet separately with the auditors to discuss managements compliance with their financial reporting responsibilities.
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Auditors
Independent Auditors
Primary Responsibility Follow established auditing standards to assess the fairness of the financial statements and related presentations

An unqualified, or clean, opinion states that the financial statements are fair presentations in all material respects in conformity with GAAP.
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Unqualified Opinion

Information Intermediaries: Financial Analysts and Information Services


Information Intermediaries
Analysis and Advice 1. Receive accounting reports and other information about the company from electronic information services
2. Gather information through conversations with company executives and visits to company facilities and competitors 3. Results of their analyses are combined into analysts reports.

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Users: Institutional and Private Investors, Creditors, and Other


Institutional Investors
Includes pension, mutual, endowment and other funds that invest on the behalf of others

Private Investors
Individuals who purchase shares in companies

Lenders or Creditors
Suppliers, banks, commercial credit companies, and other financial institutions that lend money to companies

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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
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Differences in Accounting Methods

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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 (auditors opinion) if the statements are audited.

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Annual Reports
For public companies, annual reports are elaborate due to SEC reporting requirements: 1. Nonfinancial Section
Includes a letter to the stockholders, a description of managements philosophy, products, successes, etc. SEC sets minimum disclosure standards for the financial section for public companies.

2. Financial Section

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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 Accountants 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.

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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.

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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


Income Statements are prepared using the following basic structure.
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

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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:
1. Continuing operations 2. Nonrecurring Items
a) Discontinued operations b) Extraordinary items

3. Earnings per share

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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.
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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.

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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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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.
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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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Return on Assets (ROA) Analysis


Return = on Assets Net Income* Average Total Assets1

*(In

complex calculations, interest expense (net of tax) and minority interest are added back to net income. total assets + ending total assets) 2

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1(beginning

ROA Profit Driver Analysis


ROA

Net Profit Margin

Asset Turnover

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Net Income Average Total Assets

Net Income Net Sales

Net Sales Average Total Assets

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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Discontinued Operations
Sale or abandonment of a segment of a business.

Income or loss on segments operation for the period.

Gain or loss on disposal of the 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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