Chapter 17 – Understanding Accounting and Financial Information
17-46
MAKING
ethical
decisions
PPT 17–40
Would You Cook
the Books?
WOULD YOU COOK the BOOKS?
17-40
• You are the only accountant employed by a small,
struggling dog food company.
• The company requests a bank loan to keep
operations going and your boss suggests you
record some revenue early.
• This is against accounting principles, but you
know if you don’t get the loan, you may lose your
job. What do you do?
PPT 17-39
Understanding Cash Flow
• Cash Flow — The difference between cash coming
in and cash going out of a business.
UNDERSTANDING CASH FLOW
17-39
LO 17-4
• Managing cash flow is
a key consideration of a
business and can be
particularly challenging
for small and seasonal
businesses.
test
prep
PPT 17-41
Test Prep
TEST PREP
17-41
• 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?
PPT 17-42
Using Financial Ratios
• Ratio Analysis — The assessment of a firm
’
s
financial condition using calculations and financial
ratios developed from the firm
’
s financial statements.
USING FINANCIAL RATIOS
17-42
LO 17-5
• Key ratios include:
– Liquidity ratios
– Leverage ratios
– Performance ratios
– Activity ratios
Chapter 17 – Understanding Accounting and Financial Information
17-47
pared to its financial objectives.
3. They also provide key insights into the firm’s per-
formance compared to other firms in the industry.
B. LIQUIDITY RATIOS measure the company’s ability to
turn assets into cash to pay its short-term debts.
1. Short-term debts are expected to be repaid within
one year.
2. The CURRENT RATIO is the ratio of a firm’s cur-
rent assets to its current liabilities.
a. Current ratio = Current assets
Current liabilities
b. Usually, a company with a current ratio of 2 or
better is considered a safe credit risk.
c. The ratio should be compared to that of com-
peting firms within the industry and to the
company’s current ratio in the previous year.
3. The ACID-TEST RATIO (or QUICK RATIO)
measures the cash, marketable securities, and
receivables of the firm, to its current liabilities.
a. Acid-test ratio =
Cash + Accounts receivable + Marketable securities
Current liabilities
b. This ratio is important to firms that have diffi-
culty converting inventory into quick cash.
C. LEVERAGE (DEBT) RATIOS measure the degree to
which a firm relies on borrowed funds in its operations.
Chapter 17 – Understanding Accounting and Financial Information
17-48
critical thinking
exercise 17-4
CALCULATING FINANCIAL RATIOS
(ADVANCED)
This exercise directs students to use the financial reports of a
company to calculate key financial ratios. (See the complete
exercise on page 17.92 of this manual.)
PPT 17-43
Commonly Used Liquidity Ratios
COMMONLY USED
LIQUIDITY RATIOS
17-43
LO 17-5
• 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.
critical thinking
exercise 17-5
COMPARING INDUSTRY RATIOS
(BASIC)
An investor is considering investing in a regional hotel chain.
This exercise lets students compare the financial results for
four possible investments. (See the complete exercise on page
17.97 of this manual.)
Chapter 17 – Understanding Accounting and Financial Information
17-49
1. The DEBT TO OWNERS’ EQUITY RATIO
measures the degree to which the company is fi-
nanced by borrowed funds that must be repaid.
a. Debt to owners’ equity ratio =
Total liabilities
Owners’ equity
b. A ratio above 1 (above 100%) shows that a
firm has more debt than equity.
2. It is important to COMPARE RATIOS to those of
other firms in the same industry and to the com-
pany’s ratios in previous years.
D. PROFITABILITY (PERFORMANCE) RATIOS meas-
ure how effectively a firm is using its various re-
sources to achieve profits.
1. EARNINGS PER SHARE (EPS) is an important
ratio because earnings help stimulate growth.
a. The Financial Accounting Standards Board
requires companies to report their quarterly
earning per share two ways: basic and dilut-
ed.
b. BASIC EARNINGS PER SHARE (BASIC
EPS) measures the amount of profit earned
by a company for each share of common
stock it has outstanding.
c. Basic earnings per share =
Net income after taxes
Number of shares common stock outstanding
d. DILUTED EARNINGS PER SHARE (DILUT-
ED EPS) measures the amount of profit
Chapter 17 – Understanding Accounting and Financial Information
17-50
PPT 17-44
Leverage Ratios
LEVERAGE RATIOS
17-44
LO 17-5
• 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.
PPT 17-45
Profitability Ratios
PROFITABILITY RATIOS
17-45
LO 17-5
• 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.
Chapter 17 – Understanding Accounting and Financial Information
17-51
earned by a company for each share of out-
standing common stock, but also takes into
consideration stock options, warrants, pre-
ferred stock, and convertible debt securities
that can be converted into common stock.
3. RETURN ON SALES is calculated by compar-
ing a company’s net income with its total sales.
Return on sales = Net income
Net sales
4. RETURN ON EQUITY (ROE) measures how
much was earned for each dollar invested by
owners.
a. The higher the RISK involved in an industry,
the higher the RETURN investors expect on
their investment.
b. It is calculated by comparing a company’s
net income with its total owner’s equity.
c. Return on equity = Net income after taxes
Total owners’ equity
5. These and other profitability ratios are vital
measurements of company growth and man-
agement performance.
E. ACTIVITY RATIOS measure the effectiveness of
the firm’s management in using the assets that are
available.
1. INVENTORY TURNOVER RATIO measures the
speed of inventory moving through the firm and
its conversion into sales.
Chapter 17 – Understanding Accounting and Financial Information
17-52
TEXT FIGURE 17.9
Accounts in the Balance Sheet and
Income Statement
This figure shows the major accounts included on the income
statement and the balance sheet.
PPT 17-46
Activity Ratios
ACTIVITY RATIOS
• This information is
found on the firm’s
balance sheet and
income statement.
17-46
LO 17-5
• Activity ratios measure how effectively
management is turning over inventory.
• Key ratios include:
– Inventory turnover ratio
Chapter 17 – Understanding Accounting and Financial Information
17-53
a. The more efficiently a firm manages its in-
ventory, the higher the return.
b. Inventory turnover ratio =
Cost of goods sold
Average inventory
c. A lower than average inventory turnover ra-
tio often indicates obsolete merchandise on
hand or poor buying practices.
d. Proper inventory control and expected inven-
tory turnover should be monitored.
F. Finance professionals use several other specific ra-
tios to learn more about a firm’s financial condition.
VI. SUMMARY
Chapter 17 – Understanding Accounting and Financial Information
17-54
bonus case 17-2
MANAGING BY THE NUMBERS
This case discusses how financially knowledgeable workers
helped improve one company’s finances. (See the complete
case, discussion questions, and suggested answers beginning on
page 17.102 of this manual.)
CONNECTING
ACROSS
borders
PPT 17-47
Speaking a Uni-
versal Accounting
Language
SPEAKING a UNIVERSAL
ACCOUNTING LANGUAGE
17-47
• 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.
PPT 17-48
Timeline for the Move to IFRS
TIMELINE for the MOVE to IFRS
17-48
Source: IFRS.org, accessed November 2014.
LO 17-5
• 2008: SEC offered proposed timeline
• 2009: 110 large companies had the option of using
IFRS
• 2012: SEC assessed progress of IFRS
• 2013: Final decision on the move to IFRS
• 2015: 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)
test
prep
PPT 17-49
Test Prep
TEST PREP
17-49
• What’s the primary purpose of performing ratio
analysis using the firm’s financial statements?
• What are the four main categories of financial
ratios?
Chapter 17 – Understanding Accounting and Financial Information
17-55
PowerPoint slide notes
PPT 17-1
Chapter Title
Copyright © 2015 by the McGraw-Hill Companies, Inc. All rights reserved.
McGraw-Hill/Irwin
Understanding
Accounting
and
Financial
Information
CHAPTER 17
PPT 17-2
Learning Objectives
LEARNING OBJECTIVES
17-2
1. Demonstrate the role that accounting and financial
information play for a business and 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.
PPT 17-3
Learning Objectives
LEARNING OBJECTIVES
17-3
4. Explain how the major financial statements differ.
5. Demonstrate the application of ratio analysis in
reporting financial information.
Chapter 17 – Understanding Accounting and Financial Information
17-56
PPT 17-4
John Raftery
JOHN RAFTERY
Patriot Contractors
17-4
• Served in the Marines and
used his G.I. Bill to study
accounting.
• Completed an
entrepreneurship program
for veterans and launched
Patriot Contractors.
• He credits his knowledge of
accounting with the growth of
his business.
PPT 17-5
Name That Company
NAME that COMPANY
17-5
Accounting software makes financial information
available whenever the organization needs it.
We specialize in software that addresses the
accounting needs of small businesses that are
often very different from major corporations.
Name that company!
Companies: Intuit’s QuickBooks and Sage’s
Peachtree
PPT 17-6
What’s Accounting?
WHAT’S ACCOUNTING?
17-6
LO 17-1
• 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.
Chapter 17 – Understanding Accounting and Financial Information
17-57
PPT 17-7
The Accounting System
The ACCOUNTING SYSTEM
17-7
LO 17-1
1. For students who are not taking an accounting
class, this slide can help them understand an ac-
counting system from a production perspective:
• Inputs: Sales documents, purchasing doc-
uments, payroll records travel expenses,
etc.
• Processing: Entries are made to journals;
then transferred into ledgers; and finally
summarized and reviewed to compile a tri-
al balance.
• Outputs: Development of financial state-
ments such as the balance sheet, income
statement, and statement of cash flows,
prepared for management personnel within
the company as well as interested parties
outside the company.
2. 1.It is very important for students to understand the
importance of integrity when calculating numbers.
Generally Accepted Accounting Principles
(GAAP) outlines procedures that are generally ac-
cepted in the accounting field.
3. Ask students: What role did questionable account-
ing procedures play with Enron, Fannie Mae, and
WorldCom?
Chapter 17 – Understanding Accounting and Financial Information
17-58
PPT 17-8
Accountants’ Responsibilities
ACCOUNTANTS’
RESPONSIBILITIES
17-8
LO 17-1
1. One of the biggest uses of accountants by business
is taxes and auditing. Explain to the class that the
theme of “integrity of numbers” is critical for busi-
ness.
2. In addition to the reasons listed on the slide, ac-
countants can offer businesses the following value-
added services:
• Getting complete visibility of processes
• Seeing the true cost of a process or part of
a process
• Seeing the cost of process changes, volume
changes, headcount, wastage, scrap, re-
jects, nonconformance, downtime
• Seeing costs by job and by department
• Seeing and comparing costs of outsourcing
• Mapping business processes, organization-
wide or job specific
• Using scenario analysis to see how reengi-
neering will affect resources such as costs
and headcounts
PPT 17-9
Managerial Accounting
MANAGERIAL ACCOUNTING
17-9
LO 17-2
• 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
Chapter 17 – Understanding Accounting and Financial Information
17-59
PPT 17-10
Users of Accounting Information
USERS of ACCOUNTING
INFORMATION
17-10
LO 17-2
1. This slide (Figure 17.2) gives the students an over-
view of the importance of accounting information
when managing a business. Accounting proce-
dures are the foundation for controlling mecha-
nisms that businesses put in place to measure per-
formance and plan for the future. Accounting in-
fluences decisions for managers in the following
ways:
• Understanding cost behavior and perform
cost–volume profit analysis
• Using cost allocation in planning and control
• Using job-order-costing and process–costing
to track the flow of costs to products
• Using relevant information to make market-
ing and production decisions
• Using capital budgeting techniques to make
long-term capital investment decisions
2. Accounting information can improve a company’s
ability to compete by:
• Using competitor information and sales
analysis to bring new concepts to the finan-
cial planning process
• Learning to spot financial trends to predict
strategic business decisions
• Learning how to integrate technology into
decision making
3. Explain to students the most important point of us-
ing this information to influence decision making is
to make sure you have the RIGHT information, at
the RIGHT time, and in the RIGHT format.
PPT 17-11
Financial Accounting
FINANCIAL ACCOUNTING
17-11
LO 17-2
• Financial Accounting — Financial information and
analyses are generated for people primarily outside
the organization. Outside users are interested in these
questions:
– Is the organization profitable?
– Is it able to pay its bills?
– How much debt does it owe?
• Annual Report — A yearly statement of the financial
condition, progress, and expectations of the firm.
Chapter 17 – Understanding Accounting and Financial Information
17-60
PPT 17-12
How to Read an Annual Report
• Key things to watch for and read:
HOW to READ
an ANNUAL REPORT
17-12
LO 17-2
– Management’s
discussion and
analysis of operations
– Balance sheet
– Income statement
– Statement of cash
flows
– Auditor’s opinion
1. This slide presents the key areas to read when ana-
lyzing a company’s annual report.
2. It is important that students understand that the an-
nual report is more than a balance sheet but con-
tains different areas that are just as important.
3. The auditor’s opinion is a critical area for students
to understand. Basically there are four different
types of opinion letters that can be submitted.
They are:
A. Unqualified opinion: An unqualified opin-
ion letter involves a certification made by
the independent CPA firm that the compa-
ny’s financial statements were prepared in
conformity with GAAP, and fairly repre-
sented the firm’s financial condition on the
statement date.
B. Qualified opinion: A qualified auditor’s
opinion letter is one in which the CPA has
included one or more specific qualifica-
tions to its assurance that the customer‘s fi-
nancial statements follow GAAP. This
means that one or more irregularities were
found, and that the customer could not or
would not correct these irregularities.
C. Adverse opinion: This is the most serious
of all the opinion letters that can accompa-
ny a customer‘s financial statements. When
a CPA firm discovers information during
the course of its audit that demonstrates
material noncompliance with GAAP ac-
counting rules, the CPA may choose to
submit an adverse opinion letter to accom-
pany the financial statements of the com-
pany under review.
D. Disclaimer of opinion: Due to scope limita-
tions, a CPA may be unwilling to express
any opinion about the accuracy of a cus-
tomer’s financial statements. A disclaimer
of opinion letter means the CPA does not
assume responsibility for the accuracy of
the company’s financial statements.
(Source: www.encyclopediaofcredit.com.)