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PowerPoint Authors:Susan Coomer Galbreath, Ph.D., CPACharles W. Caldwell, D.B.A., CMAJon A. Booker, Ph.D., CPA, CIACynthia J. Rooney, Ph.D., CPA

Communicating and Interpreting Accounting Information

Chapter 05

McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

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Players in the AccountingCommunication Process

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RegulatorsSecurities and Exchange Commission

Primary ResponsibilityPrimary ResponsibilityProtect investors and maintain the integrity of the securities market.

Stock ExchangesPrimary ResponsibilityPrimary Responsibility

Along with state governments, set overall corporate governance Along with state governments, set overall corporate governance standards.standards.

Financial Accounting Standards BoardPrimary ResponsibilityPrimary Responsibility

Set Generally Accepted Accounting Standards (GAAP).

Public Company Accounting Oversight BoardPrimary ResponsibilityPrimary Responsibility

Sets auditing standards for independent auditors (CPAs)of public companies.

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Managers

ManagementPrimary Responsibility

Responsible for the information in the financial statements and disclosures.

Chief Executive Officer (CEO): highest officer of the company

Chief Financial Officer (CFO): highest officer associated with the financial and accounting side of the business

Accounting Staff: prepare the details of the reports and bear professional responsibility for the accuracy of the information.

ManagementPrimary Responsibility

Responsible for the information in the financial statements and disclosures.

Chief Executive Officer (CEO): highest officer of the company

Chief Financial Officer (CFO): highest officer associated with the financial and accounting side of the business

Accounting Staff: prepare the details of the reports and bear professional responsibility for the accuracy of the information.

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Board of Directors (Audit Committee)

Board of DirectorsBoard of DirectorsPrimary ResponsibilityPrimary Responsibility

Responsible for ensuring that processes are in place for maintaining the integrity of the company’s accounting, financial

statement preparation, and financial reporting.

Board of DirectorsBoard of DirectorsPrimary ResponsibilityPrimary Responsibility

Responsible for ensuring that processes are in place for maintaining the integrity of the company’s accounting, financial

statement preparation, and financial reporting.

Board of Directors (Audit Committee)Board of Directors (Audit Committee)Primary ResponsibilityPrimary Responsibility

Is composed of non-management (independent) directors with financial knowledge and is responsible for hiring the company’s

independent auditors. They also meet separately with the auditors to discuss management’s compliance with their

financial reporting responsibilities.

Board of Directors (Audit Committee)Board of Directors (Audit Committee)Primary ResponsibilityPrimary Responsibility

Is composed of non-management (independent) directors with financial knowledge and is responsible for hiring the company’s

independent auditors. They also meet separately with the auditors to discuss management’s compliance with their

financial reporting responsibilities.

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Independent AuditorsIndependent AuditorsPrimary ResponsibilityPrimary Responsibility

Follow established auditing standards to assess the fairness of Follow established auditing standards to assess the fairness of the financial statements and related presentationsthe financial statements and related presentations

Independent AuditorsIndependent AuditorsPrimary ResponsibilityPrimary Responsibility

Follow established auditing standards to assess the fairness of Follow established auditing standards to assess the fairness of the financial statements and related presentationsthe financial statements and related presentations

Auditors

An unqualified, or clean, opinion states that the

financial statements are fair presentations in all

material respects in conformity with GAAP.

An unqualified, or clean, opinion states that the

financial statements are fair presentations in all

material respects in conformity with GAAP.

Unqualified Opinion

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Information Intermediaries: Financial Analysts and Information Services

Information IntermediariesInformation IntermediariesAnalysis and AdviceAnalysis and Advice

1.1.Receive accounting reports and other information about the Receive accounting reports and other information about the company from electronic information servicescompany from electronic information services

2.2.Gather information through conversations with company Gather information through conversations with company executives and visits to company facilities and competitorsexecutives and visits to company facilities and competitors

3.3.Results of their analyses are combined into analysts’ reports.Results of their analyses are combined into analysts’ reports.

Information IntermediariesInformation IntermediariesAnalysis and AdviceAnalysis and Advice

1.1.Receive accounting reports and other information about the Receive accounting reports and other information about the company from electronic information servicescompany from electronic information services

2.2.Gather information through conversations with company Gather information through conversations with company executives and visits to company facilities and competitorsexecutives and visits to company facilities and competitors

3.3.Results of their analyses are combined into analysts’ reports.Results of their analyses are combined into analysts’ reports.

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Users: Institutional and Private Investors, Creditors, and Other

Institutional InvestorsInstitutional InvestorsIncludes pension, mutual, endowment and other funds that invest on the

behalf of others

Institutional InvestorsInstitutional InvestorsIncludes pension, mutual, endowment and other funds that invest on the

behalf of others

Private InvestorsPrivate InvestorsIndividuals who purchase shares in companies

Private InvestorsPrivate InvestorsIndividuals who purchase shares in companies

Lenders or CreditorsLenders or CreditorsSuppliers, banks, commercial credit companies, and other financial

institutions that lend money to companies

Lenders or CreditorsLenders or CreditorsSuppliers, banks, commercial credit companies, and other financial

institutions that lend money to companies

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Guiding Principles for CommunicatingUseful Information

Primary Objective of External Financial ReportingPrimary Objective of External Financial Reporting To provide economic information to external users for To provide economic information to external users for

decision making. decision making.

Primary Objective of External Financial ReportingPrimary Objective of External Financial Reporting To provide economic information to external users for To provide economic information to external users for

decision making. decision making.

Primary Qualitative CharacteristicsPrimary Qualitative Characteristics

Relevance:Relevance: Timely and Predictive Feedback ValueTimely and Predictive Feedback Value

Reliability:Reliability: Accurate, Unbiased, and VerifiableAccurate, Unbiased, and Verifiable

Primary Qualitative CharacteristicsPrimary Qualitative Characteristics

Relevance:Relevance: Timely and Predictive Feedback ValueTimely and Predictive Feedback Value

Reliability:Reliability: Accurate, Unbiased, and VerifiableAccurate, Unbiased, and Verifiable

Secondary Qualitative CharacteristicsSecondary Qualitative Characteristics

Comparability:Comparability: Across businessesAcross businesses

Consistency:Consistency: Over timeOver time

Secondary Qualitative CharacteristicsSecondary Qualitative Characteristics

Comparability:Comparability: Across businessesAcross businesses

Consistency:Consistency: Over timeOver time

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Differences in Accounting Methods

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Annual Reports

For For privatelyprivately held companies, annual held companies, annual reports are simple documents that include:reports are simple documents that include:

1.1. Four basic financial statements.Four basic financial statements.

2.2. Related notes (footnotes).Related notes (footnotes).

3.3. Report of independent accountants (auditor’s Report of independent accountants (auditor’s opinion) if the statements are audited.opinion) if the statements are audited.

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Annual Reports

For public companies, annual reports are elaborate due to SEC reporting requirements:

1. Nonfinancial Section• Includes a letter to the stockholders, a description of

management’s philosophy, products, successes, etc.

2. Financial Section• SEC sets minimum disclosure standards for the

financial section for public companies.

For public companies, annual reports are elaborate due to SEC reporting requirements:

1. Nonfinancial Section• Includes a letter to the stockholders, a description of

management’s philosophy, products, successes, etc.

2. Financial Section• SEC sets minimum disclosure standards for the

financial section for public companies.

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Annual Reports

1.1. Summarized financial Summarized financial data for 5- or 10-years.data for 5- or 10-years.

2.2. Management Discussion Management Discussion and Analysis (MD&A).and Analysis (MD&A).

3.3. The four basic financial The four basic financial statements.statements.

4.4. Notes (footnotes).Notes (footnotes).5.5. Independent Accountant’s Independent Accountant’s

Report and the Report and the Management Management Certification.Certification.

1.1. Summarized financial Summarized financial data for 5- or 10-years.data for 5- or 10-years.

2.2. Management Discussion Management Discussion and Analysis (MD&A).and Analysis (MD&A).

3.3. The four basic financial The four basic financial statements.statements.

4.4. Notes (footnotes).Notes (footnotes).5.5. Independent Accountant’s Independent Accountant’s

Report and the Report and the Management Management Certification.Certification.

6.6. Recent stock price Recent stock price information.information.

7.7. Summaries of the Summaries of the unaudited quarterly unaudited quarterly financial data.financial data.

8.8. Lists of directors and Lists of directors and officers of the company officers of the company and relevant addresses.and relevant addresses.

6.6. Recent stock price Recent stock price information.information.

7.7. Summaries of the Summaries of the unaudited quarterly unaudited quarterly financial data.financial data.

8.8. Lists of directors and Lists of directors and officers of the company officers of the company and relevant addresses.and relevant addresses.

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Quarterly Reports

Usually begin with short letter to stockholdersUsually begin with short letter to stockholders Condensed Condensed unauditedunaudited income statement and income statement and

balance sheet for the quarter.balance sheet for the quarter. Often, cash flow statement and statement of Often, cash flow statement and statement of

stockholders’ equity are stockholders’ equity are omittedomitted. Some notes to . Some notes to the financial statements also may be omitted.the financial statements also may be omitted.

Usually begin with short letter to stockholdersUsually begin with short letter to stockholders Condensed Condensed unauditedunaudited income statement and income statement and

balance sheet for the quarter.balance sheet for the quarter. Often, cash flow statement and statement of Often, cash flow statement and statement of

stockholders’ equity are stockholders’ equity are omittedomitted. Some notes to . Some notes to the financial statements also may be omitted.the financial statements also may be omitted.

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SEC Reports – 10-K, 10-Q, 8-K

Form 10-K Annual Report•Due within 90 days of the fiscal year-end.•Contains audited financial statements.

Form 10-K Annual Report•Due within 90 days of the fiscal year-end.•Contains audited financial statements.

Form 10-Q Quarterly Report•Due within 45 days of the end of the quarter.•Financial statements can be unaudited.

Form 10-Q Quarterly Report•Due within 45 days of the end of the quarter.•Financial statements can be unaudited.

Form 8-K Current Report•Due within 15 days of the major event date.•Financial statements can be unaudited.

Form 8-K Current Report•Due within 15 days of the major event date.•Financial statements can be unaudited.

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Classified Balance Sheet

Assets used of turned intocash within one year.

Assets used of turned intocash beyond one year.

Obligations paid ofsettled within one year.

Obligations paid ofsettled after one year.

Contributed capital..Reinvested earnings.

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Classified Income Statement

Net sales− Cost of goods sold

Gross profit− Operating expenses

Income from operations± Nonoperating revenues/expenses and gains/losses

Income before income taxes− Income tax expense

Net income

Income Statements are prepared using the Income Statements are prepared using the following basic structure.following basic structure.

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Consolidated Income Statement

Operating activities – the focus of the business.

Net Income ÷ Average Number of Shares Outstanding

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Nonrecurring Items

Income statements may contain three sections:1. Continuing operations

2. Nonrecurring Itemsa) Discontinued operations

b) Extraordinary items

3. Earnings per share

Income statements may contain three sections:1. Continuing operations

2. Nonrecurring Itemsa) Discontinued operations

b) Extraordinary items

3. Earnings per share

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Earnings Per Share

EPS =EPS =Net Income*Net Income*

Average Number of Shares of Common Stock Outstanding During the Period

Average Number of Shares of Common Stock Outstanding During the Period

Basic EPSBasic EPSBasic EPSBasic EPS

*If there are preferred dividends, the amount is subtracted from the Net Income in the numerator.

*If there are preferred dividends, the amount is subtracted from the Net Income in the numerator.

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Common-Size Income Statement

Total revenue isequal to 100%.

DELETE THIS SLIDE`

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Statement of Cash Flows

Recall that the Statement of Cash Flows is Recall that the Statement of Cash Flows is divided into divided into threethree major sections. major sections.

1.1. Cash flows from operating activities.Cash flows from operating activities.

2.2. Cash flows from investing activities.Cash flows from investing activities.

3.3. Cash flows from financing activities.Cash flows from financing activities.

Recall that the Statement of Cash Flows is Recall that the Statement of Cash Flows is divided into divided into threethree major sections. major sections.

1.1. Cash flows from operating activities.Cash flows from operating activities.

2.2. Cash flows from investing activities.Cash flows from investing activities.

3.3. Cash flows from financing activities.Cash flows from financing activities.

We will examine the indirect method of preparing the statement. This format begins with a reconciliation of accrual income to cash

flows from operations.

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Cash flows associated with earning income.

Cash flows related to purchase and sale of productive assets and investments.

Cash flows related to borrowing and repaying loans and issue and repurchase of stock.

Change in the cash account.

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Notes to Financial Statements

Descriptions of the key accounting rules that apply to the company’s statements.Descriptions of the key accounting rules that apply to the company’s statements.

Additional detail supporting reported numbers.

Additional detail supporting reported numbers.

Relevant financial information not disclosed on the statements.

Relevant financial information not disclosed on the statements.

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Accounting Rules Applied in the Company’s Statements

One of the first notes to the financial statements is usually the statement of significant account policies.

This particular note relates to the Callaway Golf’s policies This particular note relates to the Callaway Golf’s policies regarding depreciation of Property, Plant, and Equipment.regarding depreciation of Property, Plant, and Equipment.

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Additional Detail SupportingReported Numbers

The second category of notes provides supplemental information concerning the data shown on the financial

statements.

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Relevant Financial Information Not Disclosed on the Statements

The final category includes information that impacts the company financially but is not shown on the statements.

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Return on Assets (ROA) Analysis

1(beginning total assets + ending total assets) ÷ 2

ROA measures how much the firm earned for each dollar of investment.

*(In complex calculations, interest expense (net of tax) and minority interest are added back to net income.

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ROA Profit Driver Analysis

= ×

Net IncomeAverage

Total Assets

Net IncomeAverage

Total AssetsNet IncomeNet Sales

Net IncomeNet Sales

Net SalesAverage

Total Assets

Net SalesAverage

Total Assets

×

=

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Profit Drivers and Business Strategy

High-Value or Product-DifferentiationRely on R&D and product promotion toconvince customers of the superiority of

your product.

High-Value or Product-DifferentiationRely on R&D and product promotion toconvince customers of the superiority of

your product.

Low-Cost StrategyRely on efficient management of accounts

receivable, inventory and productive assets to produce high asset turnover.

Low-Cost StrategyRely on efficient management of accounts

receivable, inventory and productive assets to produce high asset turnover.

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Chapter Supplement: Nonrecurring Items

In addition, companies may have nonrecurring items. In addition, companies may have nonrecurring items. These nonrecurring items may include:These nonrecurring items may include:

1. 1. Discontinued operationsDiscontinued operations2. 2. Extraordinary itemsExtraordinary items

These items are reported separately because they are not These items are reported separately because they are not useful in predicting future income of the company.useful in predicting future income of the company.

In addition, companies may have nonrecurring items. In addition, companies may have nonrecurring items. These nonrecurring items may include:These nonrecurring items may include:

1. 1. Discontinued operationsDiscontinued operations2. 2. Extraordinary itemsExtraordinary items

These items are reported separately because they are not These items are reported separately because they are not useful in predicting future income of the company.useful in predicting future income of the company.

Net sales− Cost of goods sold

Gross profit− Operating expenses

Income from operations± Nonoperating revenues/expenses and gains/losses

Income before income taxes− Income tax expense

Net income

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Discontinued Operations

Income or loss on Income or loss on segment’s operation for segment’s operation for

the period.the period.

Income or loss on Income or loss on segment’s operation for segment’s operation for

the period.the period.

Gain or loss on Gain or loss on disposal of the disposal of the

segment.segment.

Gain or loss on Gain or loss on disposal of the disposal of the

segment.segment.

Sale or abandonment of a Sale or abandonment of a segmentsegment of a of a business.business.

Sale or abandonment of a Sale or abandonment of a segmentsegment of a of a business.business.

Show net of applicable taxes.Show net of applicable taxes.

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Extraordinary Items

UnusualUnusual InfrequentInfrequent

Show net of applicable taxes.Show net of applicable taxes.

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Reporting Extraordinary Items and Discontinued Operations

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End of Chapter 05