Wednesday morning

Accounting

Accounting

• 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

The Accounting System

Financial Accounting

• 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.– American Eagle, Disney

HOW to READ 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

Managerial Accounting

• 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

Public vs. Private 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.

Auditing

• 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.

Specialized Accountants

• Tax Accountants -- Accountants trained in tax law and are responsible for preparing tax returns or developing tax strategies.

• Forensic Accountants -- When a company is suspected of fraud or other accounting wrongdoings a court will commission a forensic accountant to search for foul play. Forensic accountants look for proof a company is “cooking the books.” Please note that this is not the role of the public accountants.

The Accounting Cycle

• Accounting Cycle -- A six-step procedure that results in the preparation and analysis of the major financial statements.

GAAP

• Generally Accepted Accounting Principles– the standard framework of guidelines for financial

accounting used in any given jurisdiction; GAAP includes the standards, conventions, and rules accountants follow in recording and summarizing transactions, and in the preparation of financial statements.

Bookkeeping

• 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.– Use of double entry bookeeping

• 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.

Cash vs. Accrual Accounting

• Revenue Recognition– An exchange of goods or services at an agreed

upon price with payment or promise of payment• Accounts receivable, unearned revenue

• Matching– Matching expenses with the revenue it helped to

generate; matching expenses to the time period when they are incurred

• inventory/cost of goods sold, accounts payable, prepaid expenses

Financial Statements

• 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

The Fundamental Accounting Equation

• Fundamental Accounting Equation -- The basis for the balance sheet.

• The equation must always be balanced and includes the formula:

o Assets = Liabilities + Owners Equity

Assets

• Assets -- Economic resources owned by a firm. Items can be tangible or intangible.

• Liquidity -- Ease with which assets can be converted into cash.

Classifying Assets

• 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.

Classifying Liabilities

• 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.

Owners’ Equity

• Owners’ Equity -- The owners’ share of the business: assets (what they own) minus liabilities (what they owe).

• Consists of:

– Paid-in Capital – amount of funds directly invested in the business by its owners

– Retained Earnings -- Accumulated earnings from the firm’s profitable operations that are reinvested in the business.

The Income Statement

• 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 or depleted.

The Multi-Step Income Statement

• The formula for the multi-step income statement:

o Revenue

o Minus Cost of Goods Sold

o Equals Gross Profit

o Minus Operating Expenses

o Equals Net Income before Taxes (Operating Income)

o Minus Taxes

o Equals Net Income or Net Loss

Income Statement Accounts

• Revenues is the monetary value a firm received for goods sold, services rendered or other payments.

– Recall revenue recognition

• Cost of Goods Sold (or Manufactured) -- Measures the cost of merchandise the firms sells or the cost of raw materials and supplies it used in producing items for resale.

– Recall matching

• Gross Profit -- How much a firm earned by buying (or making) and selling merchandise.

Income Statement Accounts, cont’d

• Operating Expenses -- Expenses a firm incurs in selling goods and services such as rent, salaries and supplies.

• Depreciation -- The systematic write-off of the cost of a tangible asset over its estimated useful life.

Statement of Cash Flows

• The purpose is to provide info about the sources and uses of cash during a particular time period

• content and organization– operating activities: generally, any activities that enter into the determination

of net income– investing activities: transactions involved in the acquisition or disposition of

non-current assets (sale or purchase of non-current assets, sales or purchases of other company’s securities, collecting or giving a loan to a third party)

– financing activities: transactions involving the company’s debt or equity (selling or acquiring company’s own stock, issuing or repaying long-term debt, payment of dividends)

– There are two different ways to prepare the operating section of the SCF, the direct and indirect method;

Understanding Cash Flow

• Cash is the lifeblood of any business• Managing cash flow is a key consideration

of a business and can be particularly challenging for small and seasonal businesses.

Example of the Accounting Cycle

• Glorian Portrait– Transaction worksheet– Income Statement

• Retained Earnings

– Balance Sheet– Statement of Cash Flows

Financial Statement Analysis

• FSA - The assessment of a firm’s financial condition using calculations and financial ratios developed from the firm’s financial statements. Sometimes referred to as ratio analysis

• The ratios do not exist in a vacuum• By themselves, they do not provide much meaning• They need to be compared to something:

– Trends over time– Key competitors– Industry averages

FSA, cont’d

• The ratios can be broken down into– Profitability– Short-term financial position (liquidity)– Long-term financial position (leverage/financial

structure)– Efficiency/effectiveness

• Yahoo Finance and WSJ as sources of ratio analysis– American Eagle (Yahoo), American Eagle (WSJ)

International Accounting Issues

• 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.

Timeline for the US move to IFRS

• 2008: SEC offers 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)