Financial Accounting

Belverd E. Needles, Jr. Marian Powers

----------Multimedia Slides by: Dr. Howard A. Kanter, CPA
DePaul University

Milton M. Pressley
University of New Orleans
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LEARNING OBJECTIVES
1. State the objectives of financial reporting. 2. State the qualitative characteristics of accounting information and describe their interrelationships. 3. Define and describe the use of the conventions of comparability and consistency, materiality, conservatism, full disclosure, and cost-benefit. 4. Explain managements responsibility for ethical financial reporting and define fraudulent financial reporting.
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LEARNING OBJECTIVES
(continued)

5. Identify and describe the basic components of a classified balance sheet. 6. Prepare multi-step and single-step classified income statements. 7. Evaluate liquidity and profitability using classified financial statements.

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Objectives of Financial Information

OBJECTIVE 1
State the objectives of financial reporting.

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Objectives of Financial Reporting

The needs of users and the general business environment are the basis for the FASBs three objectives of financial reporting:
1. To furnish information useful in making investment and credit decisions. 2. To provide information useful in assessing cash flow prospects. 3. To provide information about business resources, claims to those resources, and changes in them.
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Qualitative Characteristics of Accounting Information

OBJECTIVE 2
State the qualitative characteristics of accounting information and describe their interrelationships.

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Qualitative Characteristics of Accounting Information

Qualitative

characteristics of accounting information are standards for judging that information. The two qualitative characteristics are understandability and usefulness.

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Understandability
The

accountant prepares financial statements according to accepted practices that are believed to be understandable. Decision makers must interpret accounting information and use it in making decisions.

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Usefulness

To

be useful, accounting information must be relevant and reliable. Relevance means the information can affect the outcome of a decision.
Provide feedback. Help predict future conditions. Be timely.

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Reliability means the user must be able to depend on the information.

Must represent what it is meant to represent. Must be credible. Must be verifiable by independent parties using the same methods of measuring. Must be neutral.

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Conventions That Help in the Interpretation of Financial Information

OBJECTIVE 3
Define and describe the use of the conventions of comparability and consistency, materiality, conservatism, full disclosure, and cost-benefit.
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Comparability
Information

is presented in such a way that a decision maker can recognize similarities, differences, and trends over different time periods or between different companies. Accounting information about a company is more useful if it can be compared with similar facts about the same company over several time periods or about another company for the same time period.
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Consistency
An

accounting procedure, once adopted by a company, remains in use from one period to the next unless users are informed of the change. GAAP requires that the change and its dollar effect be described in the notes to the financial statements.

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Materiality
Materiality

refers to the relative importance of an item or event. An item is material if users would have done something differently if they had not known about the item. Materiality is normally determined by relating its dollar value to an element of the financial statements, such as net income or total assets. Some accountants follow the 5% or more of net income rule to judge materiality.
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Conservatism
When

accountants face major uncertainties about which accounting procedure to use, they generally choose the one that is least likely to overstate assets and income. Abuse of the conservatism principle may lead to financial statements that are misleading.

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Full Disclosure
Full disclosure requires that financial statements and their notes present all information that is relevant to the users understanding of the statements. Beyond required disclosures, application of full disclosure is based on the judgment of management and the accountants who prepare the financial statements. The demands for full disclosure have increased in recent years.

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Cost-Benefit
Benefits

to be gained from providing accounting information should be greater than the costs of providing it. Beyond providing minimum levels of relevance and reliability, costbenefit is based on professional judgment.

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Managements Responsibility for Ethical Reporting

OBJECTIVE 4
Explain managements responsibility for ethical financial reporting and define fraudulent financial reporting.

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Fraudulent Financial Reporting

The

intentional preparation of misleading financial statements. The distortion of records (manipulation of inventory records). Falsified transactions (fictitious sales or orders). The misapplication of accounting principles (treating as an asset an item that should be expensed).
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Possible Motives for Fraudulent Financial Reporting

To

obtain a higher price when a company is sold. To meet the expectations of stockholders. To obtain a loan. For personal gain.

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Classified Balance Sheet

OBJECTIVE 5
Identify and describe the basic components of a classified balance sheet.

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Assets

Assets are divided into four categories. 1. Current assets. 2. Investments. 3. Property, plant, and equipment. 4. Intangible assets.

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Current Assets
Cash and other assets that are reasonably expected to be realized in cash, sold, or consumed over the next year or the normal operating cycle of the business, whichever is longer. Cash to cash cycle. Listed in order of decreasing liquidity.

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Investments

Investments

are assets, usually long term, that are not used in the normal operations of the business and that management does not plan to convert to cash within the next year.

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Property, Plant, and Equipment

Long-term

assets used in the continuing operation of the business. Also called fixed, operating, long-lived, or tangible assets. Often abbreviated PP&E.

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Intangible Assets

Intangible assets are long-term assets that have no physical substance but have a value based on the rights or privileges that belong to their owner.

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Other Assets

Other

assets are sometimes used for all owned assets other than current assets and PP&E.

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Liabilities

Liabilities

are divided into two categories. 1. Current liabilities. 2. Long-term liabilities.

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Current Liabilities

Current

liabilities are obligations due to be paid or performed within a year or within the normal operating cycle of the business, whichever is longer.

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Long-Term Liabilities
Long-term

liabilities are the debts of a business that fall due more than one year in the future or beyond the normal operating cycle, or that are paid out of non-current assets.

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Stockholders Equity
Stockholders

equity is divided into two categories. 1. Contributed or paid-in capital. 2. Retained earnings.

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Multi-step Income Statement

OBJECTIVE 6
Prepare multi-step and single-step classified income statements.

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Multi-step Income Statement

Multi-step

income statement derives net income in a step-bystep manner; however, it shows only the totals of major categories.

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Multi-step Income Statement: A Merchandising Company

Net

sales Cost of goods sold Gross margin Operating expenses Income from operations Other revenues and expenses Income before income taxes Income taxes Net income Earnings per share
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Single-Step Income Statement

Single-step

income statement derives income before income taxes in a single step by putting the major revenue categories in the first part of the statement and by putting the major cost and expense categories in the second part of the statement. Income taxes shown as a separate item. Simple presentation.
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Using Classified Financial Statements

OBJECTIVE 7
Evaluate liquidity and profitability using classified financial statements.

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Evaluation of Liquidity: Working Capital

The

amount by which total current assets exceed total current liabilities. Current assets $124,356 Current liabilities $42,683 Working capital $81,673

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Evaluation of Liquidity: Current Ratio

The

ratio of current assets to current liabilities. Compare to last year and industry.
Current assets $123,356 = = 2.9 Current liabilities $ 42,683
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Evaluation of Profitability: Profit Margin

The

percentage of each sales dollar that results in net income. Net income Net sales = $ 14,500 $289,656 = .05

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Evaluation of Profitability: Asset Turnover

Measure

of how efficiently assets are used. =

Net sales Average total assets

$289,656 = 1.9 times $153,768

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Evaluation of Profitability: Return on Assets

Measure

of how efficiently assets are used. Considers assets and income. Net income $ 14,500 = = .094 Average total assets $153,768

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Evaluation of Profitability: Debt to Equity

Proportion of company financed by creditors compared to the amount financed by investors.

Total liabilities Stockholders equity $60,483 = .614 = $98,433

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Evaluation of Profitability: Return on Equity

Measure

of how much shareholders have earned on their investment. $14,500 = $99,492 = .146

Net income Average stockholders equity

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