Chapter 1 Uses of Accounting Information and the Financial Statements Skyline College.

Chapter 1

Uses of Accounting Information and the Financial Statements

Skyline College

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CVS: How Is Success Measured?

Learn more about the company at CVS.com

More than 5,400 stores Quality products

Holds #1 or #2 market share in 73% of the top 100 markets in which it serves

Large selection

Good service

Strong management

© Royalty Free Digital Vision/ Getty Images


What Is Accounting?

Accounting is an information system that measures, processes, and communicates financial information about an economic entity

Supplies information for reasoned choices among alternative uses of scarce resources in business and economic activities

© Royalty-Free/Corbis


Economic Entity: Business

Economic unit that aims to sell goods and services to customers

Provides adequate return to owners

Examples: Wal-Mart, Best Buy, Wendy’s



Meeting Business Goals

Profitability

Is the business earning enough

income to attract and hold

investment capital?

Liquidity

Does the business have enough cash to

pay debts when they are

due? © Royalty Free C Squared Studios/ Getty Images


Conducting Business Activities

Operating Activities

Investing Activities

Financing Activities

Purchasing resources to operate the business

Selling these resources when no longer needed

Obtaining capital from •creditors•owners

Repaying •creditors•Paying dividends

Selling to customers

Wages

Buying goods and services

Paying taxes


Performance Measures managers

achieve business goals

business activities are well managed

Must motivate managers to act in the best interests of the owners of the business!

© Royalty Free PhotoDisc Collection/ Getty Images


Performance Measures: Ratios

Used to compare a company’s financial performance from one year to the next

Helpful when making comparisons among companies

Return on Assets = how much is earned on each dollar invested in assets

CVS 2004 2003

Net Income $918.8 $847.3Average Total Assets ($14,546.8 + $10,543.1) / 2 ($10,543.1 + $9,645.3) / 2

Return on Assets 7.3% 8.4%

(in millions)

=

=


Who Needs Accounting Information?

Internal Users External Users

Management Accounting

Information about past performance and what can be expected in the future

Financial Accounting

Financial statements report on profitability and liquidity to evaluate the success of a business

Employees

Managers

Stockholders

Creditors

Government regulators


Components of Accounting

AccountingRecord Transactions: Bookkeeping

System Design

Analyze & Interpret Information

CommunicateInformation

Processing can be done: • Manually,• By computer, or • Using a management information system

© Royalty Free C Squared Studios/ Getty Images


Importance of Ethics in Financial Reporting

Users of reports depend on the good faith of those who prepared the reports, rely on the accuracy of the reports, and the disclosure of all relevant facts

we make decisions based on the reports



Sarbanes-Oxley Act Chief executives (CEO) and chief financial officers

(CFO) of all publicly traded U.S. companies must attest to the accuracy and completeness of their quarterly and annual reports filed with the SEC

On the Web

Violations can result in criminal penalties

Want to learn more about the legislation?

Sarbanes-Oxley.com


Management Responsibility What assurance does management give that a company’s

reports are not false or misleading?

Research: Find the current year’s annual report for CVS on the company’s website and locate the “Management’s Report.” What language is used?

CVS’s SEC Filings

We are responsible for establishing and maintaining effective internal control over financial reporting. . . . the unauthorized acquisition, use or disposition of assets are prevented or timely detected and that transactions are authorized, recorded and reported properly to permit the preparation of financial statements in accordance with GAAP and receipt and expenditures are duly authorized.

On the Web


Who Uses Accounting Information?

Direct Financial Interests

Management Those With Indirect Financial Interests Finance

Investment

Operations & Production

Marketing

Human Relations

Accounting

Tax Authorities

Regulators

Labor Unions

Customers

Economic Planners

Investors Creditors Banks



If You Were a Manager…Making good financial decisions requires

reliable accounting information.

Does my company have enough cash?

Which products are most profitable?

Is the rate of return to owners adequate?

What is the cost of manufacturing each product or service?



Users with Direct Financial Interests

Investors

analyze the past success and potential earnings of a business

Creditors

assess whether a company will have the cash to repay debt



Users with Indirect Financial Interests

Labor Unions, Consumer Groups, Customers, etc

Regulatory Agencies

Tax Authorities



Making an Accounting Measurement

• What is measured?

Business transactions

Economic events that affect the financial position of a business

Sale of goods

Purchases

Collection of loan

Borrow money


Concept of Money MeasureAll business transactions

are recorded in money.

The monetary unit is the US Dollar

An exchange rate is used to translate into US Dollars for international transactions.


Concept of Separate EntityA business is considered distinct from its creditors and customers as well as its owners

Business reports & accounts

Personal reports & accounts


Forms of BusinessSole Proprietorship Partnership Corporation

One owner

Owner takes all profits and losses

Owner is liable for all business obligations

Two or more owners

Partners share in profits and losses

One partner can obligate the business to another party

Must be dissolved if ownership changes

Business unit chartered by the state with articles of incorporation; legally separate from owners (stockholders)

Stockholders enjoy limited liability

Life of corporation is unlimited



Organization of a Corporation

Stockholders

Elect a board of directors

and own shares of

stock

Board of Directors

Determines corporate

policy, declares dividends, and

appoints corporate officers

Management

Carries out corporate

policies and manages the

business


Corporate Governance

In the News:In a recent survey,

78% of boards of directors established

ethical standards for their

companies

Oversight of a corporation’s management and ethics by the board of directors

Companies with codes of ethics tend to have higher stock prices than those without codes

Use of audit committees helps ensure that adequate systems are in place to safeguard resources


Financial Position

Economic resources (cash, inventory, buildings) and the claims against those resources at a particular point in time

Economic Resources = Creditors + Stockholders’ Equity



Building the Accounting Equation

Economic Resources = Creditors’ Equities + Stockholders’ Equity

In accounting terms…

Assets = Liabilities + Stockholders’ Equity

The two sides of the equation must always be in balance.


Assets Economic resources

expected to benefit the company’s future operations

Patents, trademarks, copyrights (nonphysical)

Inventory, land, equipment, buildings (physical items)

Cash, accounts receivable (monetary items)



Liabilities Obligations to pay cash, transfer assets, or

provide services to other entities in the future

Examples:

accounts payable, taxes payable, loans, or wages owed to employees

Liabilities are claims recognized by law



Stockholders’ EquityClaims of the owners of a corporation to

the assets of the business

Stockholders’ Equity

Contributed Capital Retained Earnings (RE)

Amount that stockholders invested in the business

Profits generated by business that haven’t been paid out to stockholders

Add’l paid-in capital

Revenues increase RE

Expenses and dividends decrease

RE

Capital Stock


Income Statement

Ramirez Agency, Inc. Income Statement

For the Month Ended December 31, 20xx Revenues Commissions earned $7,000 Expenses Equipment rental expense $1,400 Wages expense 800 Utilities expense 600

Total expenses 2,800 Income before income taxes $4,200 Income taxes expense 600 Net Income $3,600

Summarizes revenues and expenses over an accounting period

Shows whether the goal of profitability was achieved


Statement of Retained Earnings

Ramirez Agency, Inc.

Statement of Retained Earnings For the Month Ended December 31, 20xx

Retained earnings, December 1, 20xx $ 0 Net income for the month 3,600 Subtotal $3,600 Less dividends 1,200 Retained earnings, December 31, 20xx $2,400

Shows changes in retained earnings over an accounting period

Net income figure from income

statement

Use this figure to prepare the balance

sheet


Balance Sheet

Ramirez Agency, Inc. Balance Sheet

December 31, 20xx

Assets Liabilities Cash $30,600 Accounts payable $ 1,200 Accounts receivable 2,000 Supplies 1,000 Stockholders’ Equity Land 20,000 Building 50,000 Common stock $100,000 Retained earnings 2,400 Total stockholders’ equity 102,400 Total assets $103,600 Total liabilities and stockholders’ equity $ 103,600

Shows financial position on a certain date

Ending balance of retained earnings from statement of retained earnings


Statement of Cash Flows

Ramirez Agency, Inc. Statement of Cash Flows

For the Month Ended December 31, 20xx Cash flows from operating activities Net income $ 3,600 Adjustments to reconcile net income to net cash

flows from operating activities

Increase in accounts receivable ($2,000) Increase in supplies (1,000) Increase in accounts payable 1,200 (1,800) Net cash flows from operating activities $ 1,800 Cash flows from investing activities Purchase of land ($20,000) Purchase of building (50,000) Net cash flows from investing activities (70,000) Cash flows from financing activities Investments by stockholders $100,000 Dividends (1,200) Net cash flows from financing activities 98,800 Net increase (decrease) in cash $30,600 Cash at beginning of month 0 Cash at end of month $30,600

Shows cash inflows and outflows for an accounting period

Net income from income

statement

Matches cash account on

balance sheet


What Are GAAP?

Generally accepted accounting principles (GAAP) encompass the conventions, rules, and procedures for accepted accounting practices

GAAP are constantly growing, changing, and improving



GAAP and the Audit

by independent CPAs

The CPA renders an opinion about whether the statements present fairly or conform in all material respects to GAAP

Audits are performed to determine that financial statements have been prepared in accordance with GAAP


Organizations That Influence GAAP

GAAP

Public Company Accounting Oversight Board (PCAOB)

Financial Accounting Standards Board (FASB)

American Institute of Certified Public Accountants (AICPA)

Securities and Exchange Commission (SEC)

Governmental Accounting Standards Board (GASB)

International Accounting Standards Board (IASB)

Primary source of GAAP


Professional Ethics Key to the accountant’s

reputation for independence and competence

The AICPA’s code of professional ethics governs conduct of CPAs

Is the accountant honest and candid? Does he or she put aside personal gain in service of the public trust?

Is the accountant impartial and intellectually honest?

Does the accountant avoid all relationships that impair or appear to impair his or her objectivity?

Integrity

Objectivity

Independence

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Chapter 1 Uses of Accounting Information and the Financial Statements Skyline College.

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