Management Chapter 14 Although Annual Reports Seem Good Examples Printing And Graphic Work The Publishing

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PPT 14.44

PPT 14.45

PPT 14.48

E. Debt utilization ratios indicate how much debt the company is using

relative to other sources of capital.

1. Debt financing is riskier than equity as it demands a monthly

payment regardless of profitability. In addition, recessions affect

heavily indebted firms far more than those financed through equity.

a. Most companies tend to keep debt-to-asset levels below 50

percent.

2. Debt to total assets ratio = Total debt/Total assets; it indicates how

much of the firm is financed by debt and how much by owners’

interest payments it must make to its creditors.

F. Per share data is used by investors to compare the performance of one

company with another on an equal basis.

number of shares outstanding but diluted. Diluted shares include

potential shares that could be issued due to the exercise of stock

options or the conversion of certain types of debt into common

stock.

2. Dividends per share = Dividends paid/Number of shares

outstanding. Dividends result in double taxation.

3. Ratios of other firms in a specific industry provide data for

comparative purposes so that performance can be evaluated.

a. Example 1: Many of Netflix’s financial ratios were higher than

the industry average. However, after the company raised the

stock price fell significantly. This could impact Netflix’s future

financial ratios.

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PPT 14.49

PPT 14.50

b. Example 2: Since 2009, McDonald’s increased its after-tax profits

by 21% while Starbucks profits increased by 300%. Both

ratios and its stock price.

V. Importance of Integrity in Accounting

the books

1. Assets/Liabilities are transferred to another entity with the promise

of buying them back later

C. On the other hand, strong compliance to accounting principles creates

trust among stakeholders.

D. It is most important to remember that integrity in accounting processes

requires ethical principles and compliance with both the spirit of the law

and professional standards in the accounting profession.

LO 14-6

Assess a company’s financial position using its accounting

statements and ratio analysis.

Key Terms:

PPT 14.51

VI. Solve the Dilemma—Exploring the Secrets of Accounting

A. You have been promoted from vice president of marketing of BrainDrain

Co. to president and CEO

B. You know marketing like the back of your hand, but know next to

nothing about finance

C. BrainDrain is in danger of failure if steps to correct large and continuing

financial losses are not taken at once

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PPT 14.52

D. Searching for answers:

1. With the firm’s trusted senior financial analyst by your side, you

delve into the accounting statements

2. Resolved to “get to the bottom” of the firm’s financial problems

3. Set new course that will take the firm from insolvency and failure to

financial recovery and perpetual prosperity

E. Discussion questions:

1. Describe the three basic accounting statements. What types of

information does each provide that can help you evaluate the

situation?

The three basic accounting statements are the income statement,

the balance sheet, and the statement of cash flow. The income

statement shows the profitability of a firm over a period of time—its

overall revenues and the costs incurred in generating those

revenues. The balance sheet is a snapshot of a company’s financial

position at a given moment and indicates what the organization

For example, profitability ratios (profit margin, return on assets, and

return on equity) are likely to be of great value (at least initially)

because they measure how much operating or net income an

organization is able to generate relative to its assets, owners’ equity,

and sales. Simply, is the firm making or losing money? Because the

firm is in trouble, debt, asset utilization, and liquidity ratios may be

poor.

provides only part of the financial story. Other information is needed

to evaluate clearly a firm’s performance. For example, strategic

objectives and environmental (business environment, social/political

environment, etc.) factors may impede or facilitate the firm’s ability

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B O X E D T E X T D I S C U S S I O N Q U E S T I O N S

ENTER THE WORLD OF BUSINESS—Former Enron CFO Talks about Accounting Fraud

Andrew Fastow was the CFO of Enron responsible for hiding debt using financial structures he designed,

including off-balance sheet partnerships. These structures misled investors about Enron’s true financial

1. Even if Fastow did not believe what he was doing was illegal, how did his activities qualify as

accounting fraud?

2. If Fastow’s claim that he received approval from accountants, lawyers, and directors for his financial

structures is true, does this make him less liable for the fraud? Why or why not?

3. Why do you think Fastow believes companies today are engaging in accounting and financial

manipulation that is worse than Enron’s?

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GOING GREEN—Companies Investigate Ways to Integrate Financial Information and Sustainability Costs

It has been estimated that about 80 percent of a firm’s value is not found on the balance sheet. One of the

least understood areas involves sustainability. Some socially responsible businesses have adopted a triple

1. Why might it be important to include sustainability and other factors in a firm’s financial reports?

2. What is the purpose of the Integrated Reporting Council?

3. Why do you think NASDAQ is beginning to require more information on a firm’s corporate governance

and environmental activities?

CONSIDER ETHICS AND SOCIAL RESPONSIBILITY—Deloitte Partners with New Profit to Drive Social

Innovation

Deloitte LLP is one of the largest consulting firms in the world, specializing in financial advisory, risk

management, and audit and tax services. It has established a multimillion- dollar partnership with New Profit

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1. Do you believe Deloitte should be investing so many resources in philanthropy? Why or why not?

2. How is Deloitte contributing to New Profit Inc.’s mission?

3. What benefits do both organizations receive through this partnership?

This collaboration between a large public financial firm and a small private organization is a profound

S U P P L E M E N T A L L E C T U R E

The Annual Report

The textbook indicates that one of the disadvantages of the corporate form of ownership is the need for

disclosure of information. The text further points out that most of this information is disseminated through

the annual report. Here are some observations on that document.

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Financial Statements

Even the most modest annual report contains a balance sheet and income statement. A statement of

changes in financial position and a statement of retained earnings will be included. More elaborate reports

may contain a number of additional financial documents that the board of directors feels will enhance the

To learn the most from a set of accounting documents in an annual report, it is important to read the

footnotes. Financial analysts say that the footnotes reveal more about a company’s health than the rest of

the annual report combined.

The So-Called Factual Narrative

Even in a bad year, the factual narrative leaves the reader confident that the firm will surmount all of its

problems and remain a viable economic force for many years to come.

The Chairman’s Message

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This desire for credibility does not mean that a top corporate executive will refrain from strongly emphasizing

the bright spots in an otherwise gloomy picture. Net sales are down over the previous period, but perhaps

1. What are the three key aspects of a typical annual report from a large corporation?

2. How does the chairperson of the board use the annual report as a sales message to stockholders or

potential stockholders?

3. What is the physical layout of the annual report? What type of printing and typography is used?

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C O N T R O V E R S I A L I S S U E

Can You Really Play Games with Ratios?

Ratio analysis can be a very important ingredient in financial analysis. And the textbook explains how various

ratios can provide fresh, new insights.

Speaking of long-term debt, let’s see how a deterioration of debt and retained earnings pictures can improve

return on equity. First, here is a greatly simplified version of the liabilities and equities side of a balance sheet

for a company experiencing some financial difficulties.

Total debt

$

2,700,000

Common stock

2,000,000

Retained earnings

2,000,000

$

6,700,000

For this first year, the firm made a net profit of $80,000. Since total equity is $4,000,000, that income is a

return on equity of .02 or 2 percent. The firm wants to pay a 15 percent return to its common stockholders.

Total debt

$

3,000,000

Common stock

2,000,000

Retained earnings

1,700,000

$

6,700,000

Although the loan of $300,000 provided the cash with which to make the dividend payments, the payment of

dividends comes out of retained earnings. If the next year the firm has a net income of $80,000, the return

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1. As these examples have indicated, games can be played with figures and ratios. What are some other

quirks in the system?

S O Y O U W A N T T O B E A N A C C O U N T A N T

Do you like numbers and finances? Are you detail oriented, a perfectionist, and highly accountable for your

decisions?

C H E C K Y O U R P R O G R E S S

1. Why are accountants so important to a corporation? What function do they perform?

2. Discuss the internal uses of accounting statements.

3. What is a budget?

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4. Discuss the external uses of financial statements.

5. Describe the accounting process and cycle.

6. The income statements of all corporations are in the same format. True or false? Discuss.

7. Which accounts appear under “current liabilities”?

8. Together, the income statement and balance sheet answer two basic questions. What are they?

9. What are the five basic ratio classifications? What ratios are found in each category?

The five basic ratio classifications and the ratios they contain are:

a. Profitability ratios—profit margin, return on assets, return on equity.

10. Why are debt ratios important in assessing the risk of the firm?

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G E T I N V O L V E D

1. Go to the library or the Internet and get the annual report of a company with which you are familiar.

Read through the financial statements, then write up an analysis of the firm’s performance using ratio

analysis. Look at data over several years and analyze whether the firm’s performance is changing

through time.

Sample student answer (not exhaustive): IBM

2011

2010

2009

2008

Return on Assets

13.79

13.33

12.29

10.7

Return on Equity

73.43

64.94

74.37

58.66

Quick Ratio

.98

1.13

.95

Current Ratio

1.21

1.19

1.36

1.15

Total Asset

Turnover

.93

.9

.88

.9

Receivables

Turnover

3.7

3.63

3.52

3.67

Inventory

Turnover

22.51

21.79

20.01

21.61

Times Interest

Earned

73.77

65.76

55.23

48.3

Source: Mergent Online Database,

We can see that IBM’s return on assets, return on equity, and times interest earned generally increased in

the past four years. The other ratios seemed to fluctuate a bit more during certain years, but all the ratios

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While students might want to say that IBM is doing well because its ratios have improved, they must also

realize that these ratios—although showing some improvement—means little without comparing them

to similar companies in the industry. If the ratios of all the other companies are higher, than they might

2. Form a group of three or four students to perform an industry analysis. Each student should analyze a

company in the same industry, and then all of you should compare your results. The following

companies would make good group projects:

Automobiles:

DaimlerChrysler, Ford, General Motors

Computers:

Apple, IBM, Dell

Brewing:

MillerCoors, Molson Coors, G. Heileman

Chemicals:

Du Pont, Dow Chemical, Monsanto

Petroleum:

Chevron, ExxonMobil, BP

Pharmaceuticals:

Merck, Lilly, UpJohn

Retail:

Sears, JCPenney, Macy’s, The Limited

Students’ answers will vary depending on which industry they choose. Yahoo! Finance is a good resource

to compare the financial ratios of companies to competitors, including the market leaders for that

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B U I L D Y O U R S K I L L S

Comparison of Western Grain Ratios with the Industry

Western Grain

Industry

Difference

profit margin

10.81%

12%

-1.19%

return on assets

16.07%

18%

-1.93%

return on equity

39.73%

25%

14.73%

B U I L D Y O U R B U S I N E S S P L A N

For this chapter, perhaps by using the Thai Restaurant example, ask the students what the expenses will be

to start this new business. As they provide answers, write them on the board so students can visualize the

scope of expenditures. A key discussion should revolve around whether they should buy or lease the

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S E E F O R Y O U R S E L F V I D E O C A S E:

T H E A C C O U N T I N G F U N C T I O N A T G O O D W I L L I N D U S T R I E S

I N T E R N A T I O N A L I N C.

Case Overview

The mission of Goodwill is to enhance the lives of individuals, families, and communities “through learning

and the power of work.” Despite its nonprofit status, Goodwill establishments are similar to for-profit

businesses regarding the accounting function. Like for-profit firms, nonprofit organizations like Goodwill

1. What are some similarities between the type of accounting performed at Goodwill and accounting at

for-profit companies?

Similarities include the fact that Goodwill must generate the equivalent of a balance sheet and income

statement; determine costs and expenses, such as cost of goods sold and general and administrative

2. What are some differences between the type of accounting performed at Goodwill and accounting at

for-profit companies?

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3. How can Goodwill use ratio analysis to improve its operations?

Ratio analysis can be used to determine the financial health of a company. In so doing, the company can

measure how it is doing compared to past results and toward similar organizations and determine where it

T E A M E X E R C I S E

T E R M P A P E R O R P R O J E C T T O P I C S

These topics may be assigned as individual or collaborative projects:

1. Accounting as a Profession

3. Effects of Computers in Accounting

5. The Certification and Functions of Certified Management Accountants (CMAs)

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G U E S T S P E A K E R S U G G E S T I O N S

2. A private accountant to address aspects of the job.

4. A representative of a firm with responsibility for the physical layout of the annual report.

5. A professor to speak about ethical concerns and issues in accounting.

T E A C H I N G S U G G E S T I O N S

1. This chapter is not intended to cover all accounting principles but to give students an insight into

2. Present the lecture using “Lecture Outline and Notes” and slides planned for the chapter.

3. Get copies of different annual reports for the class to look over. Sometimes companies will give

4. To help students understand the objectives of the chapter, go over “Check Your Progress” at the end of