1. Chapter 17
Understanding
Accounting
and Financial
Information
McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

2. Chapter
Seventeen
LEARNING GOALS
1. Demonstrate the role that accounting and financial
information play for a business and for its
stakeholders.
2. Identify the different disciplines within the
accounting profession.
3. List the steps in the accounting cycle, distinguish
between accounting and bookkeeping, and explain
how computers are used in accounting.
17-2

3. Chapter
Seventeen
LEARNING GOALS
4. Explain how the major financial statements differ.
5. Demonstrate the application of ratio analysis in
reporting financial information.
17-3

4. Profile
SIGGI HILMARSSON
Siggi’s Yogurt
• Hilmarsson missed an
Icelandic treat called skyr, a
thick, strained, protein-rich
yogurt.
• He perfected his yogurt and
contacted a former
professor for help with
financing.
• Distribution raised cost
problems that affected cash
flow.
17-4

5. Chapter
Seventeen
NAME that COMPANY
Until the development of accounting software
simplified the accounting process, accountants
had to enter all financial information by hand.
Today accounting software makes it possible
for businesses to have financial information
available whenever they need it. Name two
companies that provide accounting software for
small businesses
Name those companies!
17-5

6. What is
Accounting? WHAT’S ACCOUNTING?
LG1
• Accounting -- Recording, classifying,
summarizing and interpreting of financial events and
transactions in an organization to provide interested
parties needed financial information.
• Outside parties - like employees, owners,
creditors, unions, investors and the government -
make use of a firm’s accounting information.
17-6

7. What is
Accounting? The ACCOUNTING SYSTEM
LG1
17-7

8. What is
Accounting? ACCOUNTANTS’
LG1 RESPONSIBILITIES
17-8

9. Managerial
Accounting MANAGERIAL ACCOUNTING
LG2
• Managerial Accounting -- Provides information
and analysis to managers inside the organization to
assist them in decision making.
• Managerial accounting is involved with:
- Costs of production
- Costs of marketing
- Preparation and control of budgets
- Minimizing tax liabilities
17-9

10. Managerial
Accounting USERS of ACCOUNTING
LG2 INFORMATION
Users Type of Report
Government tax authority Tax reports
Government regulatory Required reports
agencies
People interested in the Financial statements found in
organization’s income annual reports
Managers of the firm Financial statements and
internally distributed financial
reports
17-10

11. Financial
Accounting FINANCIAL ACCOUNTING
LG2
• Financial Accounting -- Financial information
and analyses are generated for people primarily
outside the organization. Outside users are interested
in these questions:
-
17-11

12. Financial
Accounting HOW to READ
LG2 an ANNUAL REPORT
• Key things to watch for and read:
- Management’s
discussion and
analysis of operations
- Balance sheet
- Income statement
- Statement of cash
flows
- Auditor’s opinion
17-12

13. Financial
Accounting PUBLIC vs. PRIVATE
LG2 ACCOUNTANTS
• Private Accountants -- Work in a single firm,
government agency, or nonprofit organization.
• Public Accountants -- Provide accounting
services to individuals or businesses.
• Certified Public Accountants (CPAs) --
Accountants who have passed a series of
examinations established by the
American Institute of Certified Public Accountants (AICPA)
and met a states requirements for education and
experience.
17-13

14. Financial
Accounting WAYS to IMPROVE
LG2 ACCOUNTING PRACTICES
17-14

15. Financial
Accounting
DODD-FRANK ACT
LG2
• Dodd-Frank Wall Street Reform and Consumer
Protection Act increased financial regulation by
increasing the power of the Public Company
Accounting Oversight Board.
• Act was brought on by the recent financial crisis.
Photo Courtesy of: Nancy Pelosi
17-15

16. Auditing
AUDITING CHECKS ACCURACY
LG2
• Auditing -- Reviewing and evaluating the
information used to prepare a company’s financial
statements.
• Independent Audit -- An evaluation and
unbiased opinion about the accuracy of a company’s
financial statements.
• Certified Internal Auditors (CIAs) --
Accountants who have a bachelor’s degree and two
years of experience in internal auditing and pass an
exam administered by the
Institute of Internal Auditors. 17-16

17. FIGHTING ACCOUNTING FRAUD
LINE-by-LINE
(Legal Briefcase)
• Sam E. Antar, a CPA, was convicted of inflating
sales figures, money laundering, and inventory
fraud.
• Today, he lectures companies concerning fraud,
how to prevent it and training auditors in forensic
accounting.
• Forensic accountants are trained as crime-scene
investigators.
17-17

18. Tax Accounting
and Not-for-Profit
Accounting SPECIALIZED ACCOUNTANTS
LG2
• Tax Accountants -- Accountants trained in tax
law and are responsible for preparing tax returns or
developing tax strategies.
• Government and Not-
for-Profit Accounting --
Support for organizations
whose purpose is not
generating a profit, but
serving others according to a
duly approved budget.
17-18

19. Progress
Assessment PROGRESS ASSESSMENT
• What’s the key difference between managerial
and financial accounting?
• How’s the job of a private accountant different
from that of a public accountant?
• What’s the job of an auditor? What’s an
independent audit?
17-19

20. The
Accounting
Cycle The ACCOUNTING CYCLE
LG3
• Accounting Cycle - - A six-step procedure that
results in the preparation and analysis of the major
financial statements.
17-20

21. The
Accounting
Cycle BOOKKEEPER’S ROLE
LG3
• Bookkeeping -- The recording of business
transactions. Bookkeepers divide a firm’s
transactions into meaningful categories and post
them into a record book or computer program called
a journal.
• Double-Entry Bookkeeping -- Bookkeepers
record all transactions in two places so they can
check one list of transactions against the other for
accuracy.
17-21

22. The
Accounting
Cycle BOOKKEEPER’S TOOLS
LG3
• Ledger -- A specialized
accounting book or
program where all
information is in one
place.
• Trial Balance -- A
summary of all the
information in the account
ledgers.
17-22

23. Accounting
Technology TECHNOLOGY and ACCOUNTING
LG3
• Computerized
accounting programs
post information
instantly and from
remote locations.
• Intuit’s QuickBooks
and Sage’s Peachtree
address the specific
needs of small
businesses.
17-23

24. Progress
Assessment PROGRESS ASSESSMENT
• How is the job of the bookkeeper different from
an accountant?
• What’s the purpose of accounting journals and a
ledger?
• Why does a bookkeeper prepare a trial balance?
• How has computer software helped businesses in
maintaining and compiling accounting
information?
17-24

25. Understanding
Key Financial
Statements FINANCIAL STATEMENTS
LG3
• Financial Statement -- A summary of all the
financial transactions that have occurred over a
particular period.
• Key financial statements of
business are:
- Balance sheet
- Income statement
- Statement of cash flows
17-25

26. The
Fundamental
Accounting The FUNDAMENTAL
Equation
LG4 ACCOUNTING EQUATION
• Fundamental Accounting Equation -- The
basis for the balance sheet.
• The equation must always be balanced and
includes the formula:
 Assets = Liabilities + Owners Equity
17-26

27. The Balance
Sheet The BALANCE SHEET
LG3
• Balance Sheet -- The financial statement that
reports a firm’s financial condition at a specific
time.
17-27

28. Classifying
Assets ASSETS
LG4
• Assets -- Economic resources owned by a firm.
Items can be tangible or intangible.
• Liquidity -- Ease with which assets can be
converted into cash.
17-28

29. Classifying
Assets CLASSIFYING ASSETS
LG4
• Current Assets -- Items that can or will be
converted to cash within one year.
• Fixed Assets -- Long-term assets that are
relatively permanent such as land, buildings, or
equipment.
• Intangible Assets -- Long-term assets that have
no physical form but do have value such as patents,
trademarks, and goodwill.
17-29

30. Liabilities and
Owners’ Equity
Accounts CLASSIFYING LIABILITIES
LG4
• Liabilities -- What the business owes to others -
its debts.
• Accounts Payable -- Current liabilities a firm
owes for merchandise or services purchased on
credit.
• Notes Payable -- Short or long-term liabilities a
business promises to pay by a certain date.
• Bonds Payable -- Long-term liabilities that the
firm must pay back. 17-30

31. Liabilities and
Owners’ Equity
Accounts OWNERS’ EQUITY ACCOUNTS
LG4
• Owners’ Equity -- The
amount of the business that
belongs to the owners minus
any liabilities of the owners.
• Retained Earnings --
Accumulated earnings from
the firm’s profitable operations
that are reinvested in the
business.
17-31

32. Progress
Assessment PROGRESS ASSESSMENT
• What do we call the formula for the balance
sheet? What three accounts does it include?
• What does it mean to list assets according to
liquidity?
• What’s the difference between long-term and
short-term liabilities on the balance sheet?
• What’s owners’ equity and how do we determine
it?
17-32

33. The Income
Statement The INCOME STATEMENT
LG4
• Income Statement --
The financial statement
that shows a firm’s bottom
line - that is, its profit after
costs, expenses, and
taxes.
• Net Income/Net
Loss -- The revenue left
over after costs and
expenses.
17-33

34. The Income
Statement The INCOME STATEMENT
LG4
• The formula for the income statement:
Revenue
-Cost of Goods Sold
= Gross Profit
-Operating Expenses
= Net Income before Taxes
-Taxes
= Net Income or Net Loss
17-34

35. Cost of Goods
Sold ACCOUNTS of the INCOME
LG4 STATEMENT
• Revenue is the monetary value a firm received
for goods sold, services rendered or other
payments.
• Cost of Goods Sold (or Manufactured) --
Measures the cost of merchandise the firm sells or
the cost of raw materials and supplies it used in
producing items for resale.
• Gross Profit (or Gross Margin) -- How much
a firm earned by buying (or making) and selling
merchandise. (Continued)
17-35

36. Operating
Expenses ACCOUNTS of the INCOME
LG4 STATEMENT
(Continued)
• Operating Expenses –
Cost involved in operating a
business, such as rent,
salaries and supplies.
• Depreciation -- The
systematic write-off of the cost
of a tangible asset over its
estimated useful life.
17-36

37. WHAT’S COMING and GOING
at the COLLEGE BOOKSTORE
(Spotlight on Small Business)
• Generally Accepted Accounting Principles
(GAAP) sometimes permits accountants to use
different method of accounting for inventory.
• FIFO: First-In, First-Out
• LIFO: Last-In, First-Out
• Each valuation can affect income and ending
inventory valuation.
17-37

38. The
Statement of
Cash Flows The STATEMENT of CASH FLOWS
LG4
• Statement of Cash Flows -- Reports cash
receipts and cash disbursements related to the three
major activities of a firm:
1. Operations
2. Investments
3. Financing
17-38

39. The Need for
Cash Flow
Analysis UNDERSTANDING CASH FLOW
LG4
• Cash Flow -- The difference between cash
coming in and cash going out of a business.
• Managing cash flow is
a key consideration of
a business and can be
particularly challenging
for small and seasonal
businesses.
17-39

40. BARKING UP the
WRONG FINANCIAL STATEMENT
(Making Ethical Decisions)
•
17-40

41. Progress
Assessment PROGRESS ASSESSMENT
• What are the key steps in preparing an income
statement?
• What’s the difference between revenue and
income on the income statement?
• Why is the statement of cash flows important in
evaluating a firm’s operations?
17-41

42. Analyzing
Financial
Performance
Using Ratios
USING FINANCIAL RATIOS
LG5
• Ratio Analysis -- The assessment of a firm’s
financial condition using calculations and financial
ratios developed from the firm’s financial statements.
• Key ratios include:
- Liquidity ratios
- Leverage ratios
- Performance ratios
- Activity ratios
17-42

43. Liquidity
Ratios COMMONLY USED
LG5 LIQUIDITY RATIOS
• Liquidity ratios measure a firm’s ability to turn
assets into cash to pay its short-term debts.
• Two key ratios are:
- Current ratio
- Acid-test ratio
• This information is found on the firm’s balance
sheet.
17-43

44. Leverage
(Debt) Ratios LEVERAGE RATIOS
LG5
• Leverage ratios measure the degree to which a
firm relies on borrowed funds in its operations.
• Key ratios include:
- Debt to Owner’s Equity Ratio
• This information is found on the firm’s balance
sheet.
17-44

45. Profitability
(Performance)
Ratio
PROFITABILITY RATIOS
LG5
• Profitability ratios measure how effectively a
firm’s managers are using the firm’s various
resources to achieve profits.
• Key ratios include:
- Basic earnings per share
- Return on sales
- Return on equity
• This information is found on the firm’s balance
sheet and income statement.
17-45

46. Activity Ratio
ACTIVITY RATIOS
LG5
• Activity ratios measure how effectively
management is turning over inventory.
• Key ratios include:
- Inventory turnover ratio
• This information is
found on the firm’s
balance sheet and
income statement.
17-46

47. ACCOUNTANTS
of the WORLD UNITED
(Reaching Beyond Our Borders)
• Multinational companies must adapt their
accounting reporting to the rules of multiple
countries.
• Many countries have adopted
International Financial Reporting Standards (IFRS)
and are pushing to make them standard.
• The U.S. Securities & Exchange Commission
believes there should be such a standard.
17-47

48. TIMELINE for the MOVE to IFRS
• 2008: SEC offered proposed timeline
• 2009: 110 large companies have the option of
using IFRS
• 2011: SEC assesses progress of IFRS
• 2013: Final decision on the move to IFRS
• 2014: Large public companies will be required to
report in IFRS (pending SEC decision)
• 2016: All companies will be required to report in
IFRS (pending SEC decision)
Source: IFRS.org, accessed July 2011.
17-48

49. Progress
Assessment PROGRESS ASSESSMENT
• What’s the primary purpose of performing ratio
analysis using the firm’s financial statements?
• What are the four main categories of financial
ratios?
17-49