Finanacial Accounting Ch5

8/3/2019 Finanacial Accounting Ch5

1/43

Copyright2001 by HoughtonMifflin Company. All rights reserved.

1

Financial AccountingFinancial Accounting

Belverd E. Needles, Jr.Belverd E. Needles, Jr.

Marian PowersMarian Powers

- - - - - - - - - - -

Multimedia Slides by:

Dr. Howard A. Kanter, CPA

DePaul University

Milton M. Pressley

University of New Orleans


2/43


2

LEARNING OBJECTIVESLEARNING OBJECTIVES

1. State the objectives of financialreporting.

2. State the qualitative characteristics of

accounting information and describe

their interrelationships.3. Define and describe the use of the

conventions ofcomparabilitycomparability and

consistencyconsistency,, materiality, conservatism, fullmateriality, conservatism, full

disclosuredisclosure,, and costcost--benefit.benefit.

4. Explain managements responsibility for

ethical financial reporting and define

fraudulent financial reporting.fraudulent financial reporting.


3/43


4/43


4

Objectives of FinancialObjectives of Financial

InformationInformation

OBJECTIVE 1OBJECTIVE 1State the objectives of

financial reporting.


5/43


5

Objectives of FinancialObjectives of Financial

ReportingReporting

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.

The needs of users and the general business

environment are the basis for the FASBs

three objectives of financial reporting:


6/43


6

Qualitative Characteristics ofQualitative Characteristics of

Accounting InformationAccounting Information

OBJECTIVE 2OBJECTIVE 2

State the qualitative characteristics

of accounting information and

describe their interrelationships.


7/43


7

Qualitative Characteristics ofQualitative Characteristics of

Accounting InformationAccounting Information

Qualitative characteristics of

accounting information arestandards for judging that

information.

The two qualitative characteristics

are understandabilityunderstandability andusefulnessusefulness.


8/43


8

UnderstandabilityUnderstandability

The accountant prepares financial

statements according to accepted

practices that are believed to beunderstandable.

Decision makers must interpret

accounting information and use it in

making decisions.


9/43


9

UsefulnessUsefulness

To be useful, accounting information

must be relevantrelevant and reliablereliable.

RelevanceRelevance means the information canaffect the outcome of a decision.

Provide feedback.

Help predict future conditions.

Be timely.


10/43


10

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.

ReliabilityReliability means the user must be able

to depend on the information.


11/43


11

Conventions That Help inConventions That Help in

the Interpretation ofthe Interpretation of

Financial InformationFinancial Information

OBJECTIVE 3OBJECTIVE 3Define and describe the use of the

conventions of comparabilitycomparability and

consistency, materiality,consistency, materiality,conservatism, full disclosure,conservatism, full disclosure, and

costcost--benefit.benefit.


12/43


12

ComparabilityComparability

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 overseveral time periods or about another

company for the same time period.


13/43

Copyright2001 by HoughtonMifflin Company. All rights reserved. 13

ConsistencyConsistency

An accounting procedure, once adopted

by a company, remains in use from one

period to the next unless users areinformed of the change.

GAAP requires that the change and its

dollar effect be described in the notes to

the financial statements.


14/43


aterialityMateriality

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 knownabout 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.


15/43


ConservatismConservatism

When accountants face major uncertainties

about which accounting procedure to use,

they generally choose the one that is leastlikely to overstate assets and income.

Abuse of the conservatism principle may

lead to financial statements that are

misleading.


16/43


Full DisclosureFull 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.


17/43


CostCost--BenefitBenefit

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, cost-

benefit is based on professionaljudgment.


18/43


Managements ResponsibilityManagements Responsibility

forEthical ReportingforEthical Reporting


Explain managements responsibilityfor ethical financial reporting and

define fraudulent financial reporting.fraudulent financial reporting.


19/43


Fraudulent FinancialFraudulent Financial

ReportingReporting

The intentional preparation of misleading

financial statements.

The distortion of records (manipulation of

inventory records).

Falsified transactions (fictitious sales or

orders).

The misapplication of accountingprinciples (treating as an asset an item

that should be expensed).


20/43


Possible Motives forPossible Motives for

Fraudulent Financial ReportingFraudulent 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.


21/43


Classified Balance SheetClassified Balance Sheet


Identify and describe the basic

components of a classified balance

sheet.


22/43


AssetsAssets

1. Current assets.

2. Investments.

3. Property, plant, and

equipment.

4. Intangible assets.

Assets are divided into four categories.


23/43


Current AssetsCurrent 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 ofdecreasing liquidity.


24/43


InvestmentsInvestments

Investments are assets, usually long term,

that are not used in the normal operationsof the business and that management does

not plan to convert to cash within the next

year.


25/43

Copyright2001 by Houghton

Mifflin Company. All rights reserved.

25

Property, Plant, and EquipmentProperty, Plant, and Equipment

Long-term assets used in the continuing

operation of the business.

Also called fixed, operating, long-lived, ortangible assets.

Often abbreviated PP&E.


26/43



26

Intangible AssetsIntangible Assets

Intangible assets are long-term

assets that have no physicalsubstance but have a value

based on the rights or privileges

that belong to

their owner.


27/43



27

Other AssetsOther Assets

Other assets are sometimes used

for all owned assets other thancurrent assets and PP&E.


28/43



28

LiabilitiesLiabilities

Liabilities are divided into two

categories.

1. Current liabilities.

2. Long-term liabilities.


29/43



29

Current LiabilitiesCurrent Liabilities

Current liabilities are obligations

due to be paid or performedwithin a year or within the

normal operating cycle of the

business, whichever is longer.


30/43



30

LongLong--Term LiabilitiesTerm 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.


31/43



31

Stockholders EquityStockholders Equity

Stockholders equity is divided

into two categories.

1. Contributed or paid-incapital.

2. Retained earnings.


32/43



32

MultiMulti--step Income Statementstep Income Statement


Prepare multi-step and single-stepclassified income statements.


33/43



33

MultiMulti--step Income Statementstep Income Statement

Multi-step income statement

derives net income in a step-by-

step manner; however, it shows

only the totals of major

categories.


34/43



34

MultiMulti--step Income Statement:step Income Statement:

A Merchandising CompanyA Merchandising Company

Net sales

Cost of goods sold

Gross marginGross margin

Operating expenses Income from operationsIncome from operations

Other revenues andexpenses

Income before income taxesIncome before income taxes Income taxes

Net incomeNet income

Earnings per share


35/43



35

SingleSingle--Step IncomeStep Income

StatementStatement

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 statementand by putting the major cost and expense

categories in the second part of the

statement.

Income taxes shown as a separate item.

Simple presentation.


36/43



36

Using Classified FinancialUsing Classified Financial

StatementsStatements


Evaluate liquidity and profitability

using classified financial statements.


37/43



37

Evaluation ofLiquidity:Evaluation ofLiquidity:

Working CapitalWorking Capital

The amount by which total current

assets exceed total current liabilities.

Current assetsCurrent assets $124,356

Current liabilitiesCurrent liabilities $42,683

Working capitalWorking capital $81,673


38/43



38

Evaluation ofLiquidity:Evaluation ofLiquidity:

Current RatioCurrent Ratio

The ratio of current assets to

current liabilities.

Compare to last year and industry.

Current assets $123,356

Current liabilities $ 42,683= = 2.9


39/43



39

Evaluation ofProfitability:Evaluation ofProfitability:

Profit MarginProfit Margin

The percentage of each sales

dollar that results in net income.

Net income $ 14,500

Net sales $289,656= = .05


40/43



40


Asset TurnoverAsset Turnover

Measure of how efficiently assets are used.

Net sales $289,656

Average total assets $153,768

= = 1.9 times

f ff f


41/43



41


Return on AssetsReturn on Assets

Measure of how efficiently assets are used.

Considers assets and income.

Net income $ 14,500

Average total assets $153,768= = .094

E l i f P fi biliE l i f P fi bili


42/43



42


Debt to EquityDebt to Equity

Proportion of company financed by

creditors compared to the amount

financed by investors.

Total liabilities $60,483

Stockholders equity $98,433

= = .614


43/43



43


Return on EquityReturn on Equity

Measure of how much shareholders have

earned on their investment.

Net income $14,500

Average stockholders equity $99,492

= = .146

Finanacial Accounting Ch5

Documents

Transcript of Finanacial Accounting Ch5