1 Instructor’s Manual – Chapter 14 | Ferrell / Hirt / Ferrell: Business © 2016 by McGraw-Hill Education.
Ferrell / Hirt / Ferrell:
Business
Instructor’s Manual – Chapter 14
Chapter 14: Accounting and Financial
Statements
Use this Instructor’s Manual to facilitate class discussion and incorporate the unique features of the text’s
highlights. Follow-up via the Connect exercises is then encouraged to provide a holistic understanding of the
chapter.
C H A P T E R F O R E C A S T
Accounting, the financial “language” that organizations use to record, measure, and interpret all of their
financial transactions and records, is very important in business. This chapter explores the role of accounting in
business and its importance in making business decisions. First, we discuss the uses of accounting information
and the accounting process. Then, we briefly look at some simple financial statements and accounting tools
that are useful in analyzing organizations worldwide.
L E A R N I N G O B J E C T I V E S
LO 14-2 Demonstrate the accounting process.
LO 14-4 Interpret a company’s balance sheet to determine its current financial position.
LO 14-6 Assess a company’s financial position using its accounting statements and ratio analysis.
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L E A R N T H E T E R M S
accounting 422
accounting cycle 429
asset utilization ratios 445
assets 428
balance sheet 437
budget 426
cash flow 425
certified management
accountants (CMAs) 424
current ratio 446
debt to total assets ratio 447
debt utilization ratios 446
depreciation 435
dividends per share 447
double-entry bookkeeping
429
journal 430
ledger 430
liabilities 428
liquidity ratios 446
managerial accounting 425
net income 435
quick ratio (acid test) 446
statement of cash flows 441
K E Y T E R M S A N D D E F I N I T I O N S
accounting
The recording, measurement, and interpretation of financial
information.
accounting cycle
The four-step procedure of an accounting system: examining source
documents, recording transactions in an accounting journal, posting
recorded transactions, and preparing financial statements.
accounting equation
Assets = liabilities + owners’ equity.
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accounts payable
The amount a company owes to suppliers for goods and services
purchased with credit.
accounts receivable
Money owed the company by customers or clients who have promised
to pay for products at a later date.
accrued expenses
Is an account representing all unpaid financial obligations incurred by
the organization.
annual report
A summary of a firm’s financial information, products, and growth plans
for owners and potential investors.
asset utilization ratios
Ratios that measure how well a firm uses its assets to generate each $1
of sales.
assets
A firm’s economic resources, or items of value that it owns, such as cash,
inventory, land, equipment, buildings, and other tangible and intangible
things.
balance sheet
A “snapshot” of a company’s financial position at a given moment.
budget
An internal financial plan that forecasts expenses and income over a set
period of time.
cash flow
The movement of money through a business on a daily, weekly,
monthly, or yearly basis.
certified management
accountants (CMA)
Private accountants who, after rigorous examination, are certified by the
Institute of Management Accountants and who have some managerial
responsibility.
certified public accountant
(CPA)
An individual who has been certified by the state in which he or she
practices to provide accounting services ranging from the preparation of
financial records and the filing of tax returns to the complex audits of
corporate financial records.
cost of goods sold
The amount of money a firm spent to buy or produce the products it
sold during the period to which the income statement applies.
current assets
Assets that are used or converted into cash within the course of a
calendar year; also called short-term assets.
current liabilities
A firm’s financial obligations to short-term creditors, which must be
repaid within one year; also called short-term liabilities.
current ratio
Current assets divided by current liabilities.
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Instructor’s Manual – Chapter 14
debt to total assets ratio
A ratio indicating how much of the firm is financed by debt and how
much by owners’ equity.
debt utilization ratios
Ratios that measure how much debt an organization is using relative to
other sources of capital, such as owners’ equity.
depreciation
The process of spreading the costs of long-lived assets such as buildings
and equipment over the total number of accounting periods in which
they are expected to be used.
dividends per share
The actual cash received for each share owned.
double-entry bookkeeping
A system of recording and classifying business transactions that
maintains the balance of the accounting equation.
earnings per share
Net income or profit divided by the number of stock shares outstanding.
expenses
The costs incurred in the day-to-day operations of an organization.
gross income (profit)
Revenues minus the cost of goods sold required to generate the
revenues.
income statement
A financial report showing the profitability of a firm over a period of
time—month, quarter, or year.
inventory turnover
Sales divided by total inventory.
journal
A time-ordered list of account transactions.
ledger
A book or computer file with separate files for each account.
liabilities
Debts a firm owes to others.
liquidity ratios
Ratios that measure the speed with which a company can turn assets
into cash to pay off short-term debt.
managerial accounting
The internal use of accounting statements by managers in planning and
directing the organization’s activities.
net income
The total profit (or loss) after all expenses, including taxes, have been
deducted from revenue; also called net earnings.
owners’ equity
Equals assets minus liabilities and reflects historical value.
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per share data
Data used by investors to compare the performance of one company
with another on an equal, per share basis.
private accountants
Accountants employed by large corporations, government agencies, and
other organizations to prepare and analyze its financial statements.
profit margin
Net income divided by sales.
profitability ratios
Ratios that measure the amount of operating income or net income a
firm is able to generate relative to its assets, owners’ equity, and sales.
quick ratio (acid test)
A stringent measure of liquidity that eliminates inventory.
ratio analysis
Calculations that measure an organization’s financial health.
receivables turnover
Sales divided by accounts receivable.
return on assets
Net income divided by assets.
return on equity
Net income divided by owners’ equity; also called return on investment
(ROI).
revenue
The total amount of money received from the sale of goods or services,
as well as from related business activities.
statement of cash flows
Explains how the company’s cash changed from the beginning of the
accounting period to the end.
times interest earned ratio
Operating income divided by interest expense.
total asset turnover
Sales divided by total assets.
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C O N T E N T O U T L I N E
The following section provides the flow of information using the LEARNING OBJECTIVES as a guide, KEY TERMS
learners will need to take away from the course and a notation of when to use POWERPOINT SLIDES with
LECTURE NOTES to drive home teaching points. There is also a reminder on when CONNECT activities can be
used. This is created so that you can facilitate in–class or online discussion effectively.
LO 14-1
Key Terms:
• Accounting
• Certified public
accountant (CPA)
• Private accountants
• Certified management
accountants (CMAs)
• Managerial accounting
• Cash flow
• Budget
• Annual report
PowerPoint Slides
PPT 14.4
Lecture Outline and Notes:
I. The Nature of Accounting
A. Accounting is the recording, measurement, and interpretation of
financial information.
1. Large numbers of people, both within and outside businesses, use
accounting tools to evaluate organizational operations.
2. The Financial Accounting Standards Board has been establishing
3. Scandals happen when accounting firms fail to follow generally
accepted accounting principles, or GAAP.
4. Today, the Public Company Accounting Oversight Board establishes
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PPT 14.8
B. Accountants are the people who prepare accounting information.
1. Public Accountants
a. Certified public accountants (CPAs) are individuals who have
been certified by the state in which they practice to provide
accounting services ranging from the preparation of financial
records and the filing of tax returns to complex audits of
1) Sarbanes-Oxley made accounting firms separate their
consulting and auditing businesses and punished corporate
partially due to questionable lending practices and
investments based on risky financial instruments.
banks can buy; the amount of capital they must maintain;
e. A growing area for public accounts is forensic accounting, which
involves analyzing financial documents in search of fraudulent
are now being rapidly added by many auditing firms.
2) The Association of Certified Fraud Examiners, which certifies
agencies, and other organizations to prepare their financial
statements.
accountants by passing a rigorous examination; they have some
degree of managerial responsibility.
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PPT 14.10
PPT 14.11
C. Accounting or Bookkeeping?
1. Although the terms accounting and bookkeeping are often used
interchangeably, they should not be confused.
2. Bookkeeping is more narrow and mechanical than accounting and is
typically limited to the routine, day-to-day recording of business
transactions.
3. Bookkeepers require less training than accountants.
beyond their four- and five-year accounting degrees so they can not
only record financial information, but understand, interpret, and
analyze complex financial information.
D. The Uses of Accounting Information (Figure 14.1)
managers who understand the consequences of their decisions.
2. Managers and owners use financial statements for internal and
external purposes.
statements by managers in planning and directing the course of
the organization.
b. Cash flow is the movement of money through a business on a
daily, weekly, monthly, or yearly basis.
1) It is not uncommon for even successful companies to
planning.
c. A budget is an internal financial plan that forecasts expenditures
and revenues over a set period of time.
1) While most companies prepare master budgets for the
department or project level and are combined at the CEO’s
office.
inflows and outflows.
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Instructor’s Manual – Chapter 14
PPT 14.13
4. External Uses
a. Managers also use accounting statements to report the financial
performance of a business to outside organizations.
1) Such statements are used for filing income taxes, obtaining
credit from lenders, and reporting results to a firm’s
and potential investors.
1) The single most important component of an annual report is the
signature of a certified public accountant attesting that the
required financial statements are an accurate reflection of the
underlying financial conditions of the firm; those that meet
these conditions are called audited.
2) The primary users of audited financial information are
government agencies, stockholders and potential investors, and
the return on their investment and the overall quality of the firm’s
loan or credit is granted.
LO 14-2
Demonstrate the accounting process.
o The Accounting Equation
Key Terms:
• Liabilities
• Owners’ equity
• Accounting cycle
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PPT 14.16
PPT 14.17
PPT 14.18
PPT 14.19
connect
understanding the
Accounting Cycle?
brief animated
explanation.
II. The Accounting Process
A. Accounting Equation
1. Assets are a firm’s economic resources or items of value that it
owns.
2. Liabilities are debts the firm owes to others.
3. Owners’ equity is assets minus liabilities and includes all of the funds
that have ever been contributed to the company that never have to
be paid back.
Barbecue in Memphis includes the money the owners have put
into the firm
4. Accounting equation: Assets = Liabilities + Owners’ equity.
B. Double-entry bookkeeping is the system of recording and classifying
must be recorded in two separate accounts.
2. Most organizations not only classify transactions as assets, liabilities,
C. The accounting cycle is the process of collecting, recording, and
analyzing raw data, and it occurs constantly through the business’s life
(see Figure 14.3).
transactions.
is assigned to a particular account.
3. Step Three: Post Transactions
a. Transactions are then posted to a general ledger, a book or
sometimes quarterly or monthly), a summary of the balances of
all the accounts in the general ledger, called a trial balance, must
be prepared.
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4. Step Four: Prepare Financial Statements. The information from the
trial balance is used to prepare financial statements, such as the
balance sheet, income statement, and other documents.
a. In the case of public corporations and certain other
LO 14-3
Examine the various components of an income statement in
order to evaluate a firm’s “bottom line.”
• Financial Statements
o The Income Statement
Key Terms:
• Income statement
• Revenue
• Cost of goods sold
PPT 14.21
III. Financial Statements
A. The physical results of the accounting process are financial statements—
the income statement, the balance sheet, and the statement of cash
flow.
1. Manufacturing firms, service providers, and nonprofit organizations
each use a different set of accounting principles or rules upon which
the accounting profession has agreed; these are sometimes referred
to as generally accepted accounting principles (GAAP).
2. Many accounting concepts go by more than one name. Each country
has a different set of rules the businesses within that country must
3. Moreover, certain concepts have more than one name. For
examples, sales and revenues are used interchangeably, as are
profits, income and earnings. (Table 14.2)
size does not fill all.
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PPT 14.20
PPT 14.22
PPT 14.23
B. The income statement is a financial statement showing the profitability
of a firm over a period of time. (Table 14.3)
1. Other names for the income statement include profit and loss (P&L)
statement or an operating statement.
2. The income statement indicates the firm’s profitability or income,
which is derived by subtracting the firm’s expenses from its
revenues.
3. Revenue
a. Revenue is the total amount of money received (or promised)
from the sale of goods or services, as well as from other business
1) Nonbusiness entities typically obtain revenues through
donations and/or grants.
the income statement applies. (CGS = Beginning inventory +
Interim purchases – Ending inventory.)
c. Gross income or profit is equal to revenues minus the cost of
goods sold.
a. There are three common expense accounts shown on income
statements.
1) Selling, general, and administrative expenses include
advertising and sales salaries, salaries of executives and
staff, and the costs of owning and maintaining the general
known as depreciation, the process of spreading the costs of
long-lived assets over the total number of accounting
periods in which they are expected to be used.
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2) Research, development, and engineering expenses include
scientific, engineering, and marketing personnel and the
equipment and information used to design and build
prototypes and samples.
3) Interest expenses include the direct costs of borrowing
money.
comparison of performance from one period to another.
6. Temporary Nature of Income Statement Accounts
b. Gross profit, earnings before interest and taxes, and net income
result from information from the revenue and expense accounts
c. At the end of each accounting period, the dollar amounts in all
the revenue and expense accounts are moved into a “Retained
Earnings” account, one of the owners’ equity accounts.
d. This shifting of dollar values from the revenue and expense
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LO 14-4
Interpret a company’s balance sheet to determine its current
financial position.
• The Balance Sheet
Key Terms:
• Balance sheet
• Current assets
• Accrued expenses
PPT 14.25
C. The balance sheet presents a “snapshot” of a company’s financial
position at a given moment. (Table 14.5)
1. The balance sheet takes its name from its reliance on the accounting
equation: it assets must equal liabilities plus owners’ equity.
2. The balance sheet presents an accumulation of all the company’s
transactions since it began.
3. Assets
a. Asset accounts are listed in descending order of liquidity—how
easily they can be converted into cash.
temporary investments, accounts receivable (money owed the
company by its customers who have promised to pay at a later
c. Long-term (fixed) assets represent a commitment of
as “goodwill.”
1) Following long-established traditions, items on the balance
sheet are listed on the basis of their original cost less
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PPT 14.27
PPT 14.28
4. Liabilities
a. Current (short-term) liabilities include a firm’s financial obligations
to short-term creditors, which must be repaid within a year;
long-term liabilities have longer repayment terms.
b. Accounts payable are amounts owed to a company’s suppliers for
goods and services purchased with credit.
c. Other liabilities include wages earned by employees but not yet paid
and taxes owed to the government.
d. These accounts may be consolidated into an accrued expense
account representing all unpaid financial obligations incurred by the
firm.
5. Owners’ equity represents the owners’ contributions to their business
along with income retained to finance continued growth and product
development.
a. Owners’ equity accounts vary according to type and class of stock
issued.
b. Each type of stock is represented by a separate owners’ equity
account, called contributed capital.
LO 14-5
Analyze the statement of cash flows to evaluate the
increase and decrease in a company’s cash balance.
o The Statement of Cash Flows
• Ratio Analysis: Analyzing Financial Statements
o Profitability Ratios
o Asset Utilization Ratios
o Liquidity Ratios
o Debt Utilization Ratios
Key Terms:
• Statement of cash flows
• Ratio analysis
• Profitability ratios
• Profit margin
• return on assets
• Return on equity
• Asset utilization ratios
• Receivables turnover
• Inventory turnover
• Dividends per share
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PPT 14.30
PPT 14.31
PPT 14.33
PPT 14.34
D. The statement of cash flows explains how the company’s cash changed
from the beginning of the accounting period to the end.
1. Many investors and other users of financial statements want more
information about a firm’s cash flow to better understand its
financial health.
2. The change in cash is explained through details in three categories.
a. Cash from operating activities is calculated by combining the
changes in the revenue accounts, expense accounts, current
b. Cash from investing activities is calculated from changes in the
long-term of fixed asset accounts.
c. Cash from financing activities is calculated from changes in the
long-term liability accounts and the contributed capital accounts
in owners’ equity.
relationship between the two numbers.
2. Financial ratios are used to weigh and evaluate a firm’s operating
performance.
3. The results of the ratio computation should be compared to other
companies in the same industry and to the company’s own past
record.
4. It answers two questions: 1) How much did the firm gain/loss? and 2)
How much is the firm currently worth on historical values found on
the balance sheet?
1. Profit margin = Net income/Sales; it shows the overall percentage
profits earned by the company
a. The higher the profit margin, the better the cost controls within
the company and the higher the return on every dollar of
revenue.
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PPT 14.36
PPT 14.37
PPT 14.38
PPT 14.39
PPT 14.40
PPT 14.42
PPT 14.43
3. Return on equity = Net income/Owners’ Equity; it shows how much
income is generated by each $1 the owners have invested in the
firm.
a. Stockholders are always concerned with how much money they
will make on their investment, and they frequently use the
return on equity ratio as one of their key performance
yardsticks.
C. Asset utilization ratios measure how efficiently a firm uses its assets to
a. It also demonstrates how quickly a firm is able to collect
2. Inventory turnover = Sales/Total Inventory; it indicates how many
times a firm sells and replaces its inventory over the course of a
year.
stock levels.
3. Total asset turnover = Sales/Total assets; it measures how well an
1. High liquidity ratios may satisfy a creditor’s need for safety, but
2. Current ratio = Current assets/Current liabilities.
3. Quick ratio (acid test) = Current assets – Inventory/Current liabilities.
a. By eliminating inventory, the least liquid current asset, the quick