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Chapter 6Financial Reporting and Analysis
By Kong Ratanak-MBA
Course facilitator
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OBJECTIVES
1. Define objectives of financial reporting
2. Qualitative Characteristics of accountinginformation and its interrelationship
3. Accounting convention ofcomparability andconsistency, materiality, conservatism, full
disclosure and cost-benefit.4. Explain management responsibility forethical
financial reporting and define fraudulencefinancial reporting
5. Basic components ofclassified balance sheet6. Multiple step Vssingle step income statement7. Use classified financial statements forevaluation
ofliquidity and profitability.
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Objectives of Financial reporting
Investment and credit decision
Assessing Cash flow prospect
Business resources, claim andchanges in those resources.
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Qualitative characteristics
FINANCIAL STATEMENTS
QUALITATIVE CHARACTERISTICSQUALITATIVE CHARACTERISTICS
UnderstandabilityDecisionmakers must be ableto interpret accountinginformation.
UsefulnessAccountant must provide information that isuseful in making decision
CONVENTION THAT
HELP ININTERPRETATIONComparability &Consistency Materiality Conservatism Full Disclosure Cost-benefit
RelevanceFeed back valuePredictive ValueTimeliness
ReliabilityFaithful representationVerifiabilityNeutrality
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Conventions that help in interpretation ofFinancial Statement
Comparability and Consistency:
similarity, differences, trend over different timeperiod and companies to companies
Procedures of accounting are kept unless it isinformed of the change.
Materiality
Relative important of an Item or event
Conservatism
When facing the uncertainty, accountant will choosethe procedures that is least likely overstated assetsand income.
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Conventions..cont.
Full Disclosure
Financial statements and their notes present allinformation that is relevant to the users.
Cost benefit Benefit to be gained from providing new
accounting information should be greater thanthe Cost of providing it.
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Managements responsibility for EthicalReporting
Preparation of Financial statements comply toGAAP
Internal Control (the assurance that the
objective is achieved)
Fraudulent financial reporting is the intentionalpreparation of misleading financial
statements.
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Tools for Analysis of Financial Statements
LIQUIDITY AND DEBT SERVICES RATIOCurrent Ratio Current Assets /
Current LiabilityA measure of Liquidity; theability to meet near-termobligation
Quick Ratio (Cash + Short-terminvestment + A/R)/Current Liabilities
A narrow measure of liquidity;the ability to meet near-termobligation
Debt to TotalAssets Ratio
Total Debt / TotalAssets
Percentage of Assets finance bylong-term and short term debt
Debt to Total
Equity ratio
Total Debt / Total
Equity
Proportion of financing that is
debt relatedTime interest earnratio
Income before incometaxes and interest /Interest Charged
Ability to meet interest obligation
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Tools for Analysis of Financial Statements
TURNOVER RATIOAccount Receivableturnover ratio
Net Credit Sales / AverageNet Account Receivable
Frequency of collection cycle tomonitor credit policy
Inventory turnoverratio
Cost of Goods Sold /Average inventory
Frequency of inventory rotation;to monitor inventorymanagement
PROFITABILITY RATIONet profit on Sales ratio Net income / Net Sales Profitability on sales for
comparison and trend analysisGross profit marginratio
Gross Profit / Net Sales Gross profit rate; for comparisonand trend analysis.
Return on Assets Ratio (Net income+ Interestexpenses) / AverageAssets
Assets utilization in producingreturns
Return on Equity Ratio (Net income - PreferredDividend)/ Averagecommon Equity
Effectiveness of equityinvestment in producing returns
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Classified Financial Statements
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Ratio for Emerson CorporationDecember 31, 19x5
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Review Problem19x2 19x1
Current Assets 200,000.00 170,000.00
Total Assets 880,000.00 710,000.00
Current Liabilities 90,000.00 50,000.00
Long-term Liabilities 150,000.00 50,000.00
Stockholders Equity 640,000.00 610,000.00
Sales 1,200,000.00 1,050,000.00
Net Income 60,000.00 80,000.00
Beginning Total Asset 19x1= $690,000 & Equity = $590,000
Liquidity Analysis? & Profitability Analysis ?
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Answer to Review problemsLiquidity Analysis Current Asset Current
Liabilities
Working Capital Current Ratio
19x1 170,000 50,000 120,000 3.40
19x2 200,000 90,000 110,000 2.22
Increase (Decrease) in working capital (10,000)
Decrease in current ratio 1.18
Profitability Analysis NetIncome
Sales ProfitMargin
Average totalAssets
AssetsTurnover
ReturnonAssets
AverageStockHolders'Equity
ReturnonEquity
19x1
80,000 1,050,000
7.6% 700,000 1.50 11.4%
600,000
13.3%
19x260,000 1,200,000
5.0% 795,000 1.51 7.5%625,000
9.6%
Increase(Decrease)(20,000)
150,000
-2.6% 95,000.000 0.01 -3.9%25,000
-3.7%
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Welcome to
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Total Liability StockholdersEquity
Debt to EquityRatio
19x1 100,000.00 610,000.00 16.4%
19x2 240,000.00 640,000.00 37.5%Increase 140,000.00 30,000.00 21.1%