ACCOUNTING INFORMATION FINANCIAL ACTIVITIES

1. 15/2/2006 1 ACCOUNTING INFORMATION & FINANCIAL ACTIVITIES Accountants help managers and owners avoid problems and how to extricate themselves from existing problems. Accounting is a key component of business management. It is almost impossible to run a business effectively without being able to read, understand and analyze accounting reports and financial statements. These are as revealing of the health of a business as pulse rate and blood pressure reports are in revealing the health of a person. Accountants help managers and owners avoid problems and how to extricate themselves from existing problems. Accounting is a key component of business management. It is almost impossible to run a business effectively without being able to read, understand and analyze accounting reports and financial statements. These are as revealing of the health of a business as pulse rate and blood pressure reports are in revealing the health of a person.

2. 15/2/2006 2 TECHNOLOGY, GADGETRY& ACCOUNTING & AUDITING Accountants & auditors also affected by global competition, rapid technological advances, environmental & ethical questions. Computer revolutionized accounting profession Accountants have important role to play in evaluating specific software systems Two special problems of desktop workstations: confidentiality & computer fraud In the course we have emphasized the tremendous changes that have incurred in society – specifically globalization and rapid technological advances. In addition, ethical questions, such as sustainable economic development, have also increasingly affected business. Accountants & auditors are certainly not exempt from the impact of these sweeping changes; technological changes especially have changed how these professionals operate.     In the course we have emphasized the tremendous changes that have incurred in society – specifically globalization and rapid technological advances. In addition, ethical questions, such as sustainable economic development, have also increasingly affected business. Accountants & auditors are certainly not exempt from the impact of these sweeping changes; technological changes especially have changed how these professionals operate.    

3. 15/2/2006 3 CHAPTER DIVISIONS The Nature of Accounting The Accounting Process Financial Statements Ratio Analysis: Analyzing Financial Statements

4. 15/2/2006 4 The Role of Accounting “How are we doing?” “What problems do we have?” Accounting Reports and the Financial Statements are used to answer these questions! To run a business you must be able to understand accounting!

5. 15/2/2006 5 What is Accounting? Accounting is the recording, classifying, summarizing and interpreting of financial transactions and events! The purpose of accounting is to provide relevant information for decision making on a timely basis to users and their advisors! Hence, accounting is user oriented. Hence, accounting is user oriented.

6. 15/2/2006 6 Users of Accounting Information

7. 15/2/2006 7 The Language of Business Two major branches of accounting Managerial Accounting - this is accounting information used by company insiders to run the company, i.e., a production cost report, payroll records, etc. Financial Accounting - the preparation of financial statements for people inside and outside of the firm Managerial accounting is used to provide information & analyses to managers within the organization to assist them in decision making. Managerial accounting is concerned with measuring and reporting costs of production, marketing, and other functions; preparing budgets; checking whether or not departments are staying within their budgets or meeting sales and other targets; and designing strategies to minimize taxes. Financial accounting – differs from managerial accounting in that the information and analyses it provides are also needed by people outside of the organization. This information goes to owners & prospective owners, creditors & lenders, employee unions, customers, government units, and the general public. The external users are interested in the organization’s profits, its ability to pay its bills, and other financial information. Managerial accounting is used to provide information & analyses to managers within the organization to assist them in decision making. Managerial accounting is concerned with measuring and reporting costs of production, marketing, and other functions; preparing budgets; checking whether or not departments are staying within their budgets or meeting sales and other targets; and designing strategies to minimize taxes. Financial accounting – differs from managerial accounting in that the information and analyses it provides are also needed by people outside of the organization. This information goes to owners & prospective owners, creditors & lenders, employee unions, customers, government units, and the general public. The external users are interested in the organization’s profits, its ability to pay its bills, and other financial information.

8. 15/2/2006 8 Different Types of Accountants Private accountants are employees who carry out managerial & financial accounting functions for their employer. Many have degrees in accounting and are qualified professionals. Very small companies often cannot afford or do not require accounting employees, so they hire independent public accounting firms.Private accountants are employees who carry out managerial & financial accounting functions for their employer. Many have degrees in accounting and are qualified professionals. Very small companies often cannot afford or do not require accounting employees, so they hire independent public accounting firms.

9. 15/2/2006 9 Public and Private Accountants In Canada, Chartered Accountants (CA’s) are Public Accountants - they audit company accounting records Certified Management Accountants (CMA’s) are private accountants who work in government and industry Certified General Accountants (CGA’s) perform audits and work as private accountants About half of all CA’s work as private accountants

10. 15/2/2006 10 THE PROCESS OF ACCOUNTING

11. 15/2/2006 11 The Accounting Cycle

12. 15/2/2006 12 The Accounts of Accounting Asset Accounts - assets are things of value from which the company expects some future benefit Liability Accounts - these are the debts or obligations of the company Owner’s Equity - this is the owner’s share of the company Revenue Accounts - sales and other sources of income Expense Accounts - costs incurred to generate Revenue Assets: Assets are divided into current, fixed and other. Fixed are assets used to run the business and are not usually sold (machinery, trucks, buildings). Most other assets are current – cash or will become cash in the normal course of events. Other assets include special items like goodwill, patent rights and copyrights. Liability accounts – divided into two categories: current – normal debts due within one year & long-term – debts due more than one year from the balance sheet date. Owner’s equity – cconsists of the owner’s initial investment plus profits to date less any withdrawals to date. In a corporation owners’ equity is called shareholders’ equity. Revenue accounts – all sources of income such as sales, commissions, royalties or rentals are revenue accounts. Cost of goods sold – Companies selling products record all the different costs involved with making the product. This category includes materials, labor, and factory expenses. Expense accounts – all expenses of running the business – selling, administration, etc. – come under this category.Assets: Assets are divided into current, fixed and other. Fixed are assets used to run the business and are not usually sold (machinery, trucks, buildings). Most other assets are current – cash or will become cash in the normal course of events. Other assets include special items like goodwill, patent rights and copyrights. Liability accounts – divided into two categories: current – normal debts due within one year & long-term – debts due more than one year from the balance sheet date. Owner’s equity – cconsists of the owner’s initial investment plus profits to date less any withdrawals to date. In a corporation owners’ equity is called shareholders’ equity. Revenue accounts – all sources of income such as sales, commissions, royalties or rentals are revenue accounts. Cost of goods sold – Companies selling products record all the different costs involved with making the product. This category includes materials, labor, and factory expenses. Expense accounts – all expenses of running the business – selling, administration, etc. – come under this category.

13. 15/2/2006 13 Accounting Records Transactions are recorded in the following sequence Journals Ledgers Financial Statements [are prepared from the Ledgers]

14. 15/2/2006 14 Double-entry Accounting This method is used all over the world Every transaction requires an equal entry in two different accounts A sale on credit of $1,000 means the following: An entry of $1,000 in the Sales Account An entry of $1,000 in the Accounts Receivable Account

15. 15/2/2006 15 FINANCIAL STATEMENTS

16. 15/2/2006 16 Financial Statements Balance Sheet Assets = Liabilities + Owner’s Equity Income Statement Revenue - Expenses = Net Income The Balance Sheet is a “snap shot” of the business, i.e., a point in time The Income Statement covers a period of time, i.e., one year The accounting process consists of two major functions: recording data and preparing financial statements. Two of the most important financial statements are the income statement and the balance sheet. Together they provide a picture of the firm’s operations and position. Income statement – This statement is a summary of all transactions affecting profits for a certain period of time. Here we find all revenues, costs, and expenses and net income. The Balance sheet – This statement shows all the assets, liabilities and net worth of the company at the end of the period shown on the income statement. A balance sheet should be thought of as a snapshot of a business at a given business at a given moment. It was different the day before and will be different the day after. Because of the double-entry system, the balance sheet must balance.The accounting process consists of two major functions: recording data and preparing financial statements. Two of the most important financial statements are the income statement and the balance sheet. Together they provide a picture of the firm’s operations and position. Income statement – This statement is a summary of all transactions affecting profits for a certain period of time. Here we find all revenues, costs, and expenses and net income. The Balance sheet – This statement shows all the assets, liabilities and net worth of the company at the end of the period shown on the income statement. A balance sheet should be thought of as a snapshot of a business at a given business at a given moment. It was different the day before and will be different the day after. Because of the double-entry system, the balance sheet must balance.

17. 15/2/2006 17 The Accounting Equation This is the fundamental accounting equation. This is the fundamental accounting equation.

18. 15/2/2006 18 Classic Cereals (Assets)

19. 15/2/2006 19 Liabilities & Owner’s Equity

20. 15/2/2006 20 Income Statement

21. 15/2/2006 21 How to Read an Annual Report 1. Read management’s discussion of changes in operations. Try to identify strengths or weaknesses. 2. Review the firm’s consolidated balance sheet. (Its assets, liabilities, and owner’s equity.) 3. Analyze the Income Statement. Try to look beyond the year. (Sales drops can spell trouble.) 4. Review the statement of changes in cash flows. 5. Carefully review the auditor’s opinion.

22. 15/2/2006 22 What to Look for in Reading Financial Reports

23. 15/2/2006 23 RATIO ANALYSIS

24. 15/2/2006 24 Ratio Analysis Profitability ratios Asset utilization ratios Liquidity ratios Debt utilization ratios Per share data

25. 15/2/2006 25 Profitability Ratios Profit Margin = Net Earnings Gross operating Revenue Return on Assets = Net earnings Assets Return on equity = Net earnings Total shareholders’ equity

26. 15/2/2006 26 Asset Utilization Ratios Return on Sales = Net income Sales Receivables turnover = Gross operating revenue Accounts Receivable Inventory turnover = Gross operating revenue Inventory Total Asset turnover = Gross operating revenue Total Assets

27. 15/2/2006 27 Liquidity Ratios Current ratio = Quick ratio = 

28. 15/2/2006 28 CASH FLOW: AVERAGE COLLECTION PERIOD OF RECEIVABLES First step: get the average collection period in days Total annual credit sales 365 days Second step: Figure out the ratio collection period in days: Accounts receivable Average daily credit sales

29. 15/2/2006 29 Debt Utilization Ratios Debt to total assets = Debt to equity = Total liabilities Owners equity Times interest =earned 

30. 15/2/2006 30 Per Share Data Earnings per share = Dividends per =share

31. 15/2/2006 31 SOLVE THE DILEMMA: EXPLORING THE SECRETS OF ACCOUNTING Describe the 2 basic accounting statements. What types of information does each provide that can help you evaluate the situation? Which of the financial ratios are likely to prove to be of greatest value in identifying problem areas in the company? Why? Which of the company’s financial ratios might you expect to be especially poor? Discuss the limitations of ratio analysis. 1) The two basic accounting statements are the income statement and the balance sheet. The income statement shows the profitability of a firm over a period of time--its overall revenues and the costs incurred in generating those revenues. The balance sheet is a snapshot of a company’s financial position at a given moment and indicates what the organization owns or controls and the various sources of funds used to pay for these assets (debt or equity). In other words, it shows what is owned (and who owns it) and owed. 2) Students’ answers may vary, but should include logical justification. For example, profitability ratios (profit margin, return on assets, and return on equity) are likely to be of great value (at least initially) because they measure how much operating or net income an organization is able to generate relative to its assets, owners’ equity, and sales. Simply, is the firm making or losing money? Because the firm is in trouble, debt and asset utilization, and liquidity ratios may be poor. 3) The main limitation of ratio analysis is that accounting practices of different organizations are never quite the same. Hence, making comparisons with ratios is never quite comparing apples to apples. Another limitation is that a single or even a set of ratios provides only part of the financial story. Other information is needed to evaluate clearly a firm’s performance. For example, strategic objectives and environmental (business environment, social/political environment, etc.) factors may impede or facilitate the firm’s ability to perform, thus biasing conclusions drawn merely from ratio analysis.1) The two basic accounting statements are the income statement and the balance sheet. The income statement shows the profitability of a firm over a period of time--its overall revenues and the costs incurred in generating those revenues. The balance sheet is a snapshot of a company’s financial position at a given moment and indicates what the organization owns or controls and the various sources of funds used to pay for these assets (debt or equity). In other words, it shows what is owned (and who owns it) and owed. 2) Students’ answers may vary, but should include logical justification. For example, profitability ratios (profit margin, return on assets, and return on equity) are likely to be of great value (at least initially) because they measure how much operating or net income an organization is able to generate relative to its assets, owners’ equity, and sales. Simply, is the firm making or losing money? Because the firm is in trouble, debt and asset utilization, and liquidity ratios may be poor. 3) The main limitation of ratio analysis is that accounting practices of different organizations are never quite the same. Hence, making comparisons with ratios is never quite comparing apples to apples. Another limitation is that a single or even a set of ratios provides only part of the financial story. Other information is needed to evaluate clearly a firm’s performance. For example, strategic objectives and environmental (business environment, social/political environment, etc.) factors may impede or facilitate the firm’s ability to perform, thus biasing conclusions drawn merely from ratio analysis.

32. 15/2/2006 32 VIDEO: THE MANY PURPOSES OF ACCOUNTING STATEMENTS If a business has assets of $20,00 and liabilities of $15,000, what is the owner’s equity? Using the Statement of Changes in Owners’ Equity, what events increase owners’ equity, & what events decrease owners’ equity? Why do you think the income statement is considered the most important statement used by business? What are the three main parts of the Statement of Cash Flows? 1) In this case, owners’ equity would be $5,000 following the equation: A = L + OE. 2) This statement helps to monitor the financial events that affect owners’ equity in the firm. This statement reflects both increases, from events like investments and net income earned, and decreases, from events like the owners’ withdrawal of assets or a net loss for the company. 3) Students should recognize the importance of the income statement in showing whether the firm has actually earned a profit or net income during a given time period. 4) Cash flow statements provide a summary of how cash moves into and out of the business. These flows are reported in three categories: (1) cash flows from operations; (2) investing activities; and (3) cash flows from financing. 1) In this case, owners’ equity would be $5,000 following the equation: A = L + OE. 2) This statement helps to monitor the financial events that affect owners’ equity in the firm. This statement reflects both increases, from events like investments and net income earned, and decreases, from events like the owners’ withdrawal of assets or a net loss for the company. 3) Students should recognize the importance of the income statement in showing whether the firm has actually earned a profit or net income during a given time period. 4) Cash flow statements provide a summary of how cash moves into and out of the business. These flows are reported in three categories: (1) cash flows from operations; (2) investing activities; and (3) cash flows from financing.

33. 15/2/2006 33 ASSIGNMENT FOR 15/2/2006 Accounting & Financial Statements, part 2 Prepare exercise prior to class Guest Speaker: Susan Gardiner, Faculty of Business Administration

34. 15/2/2006 34 ASSIGNMENT FOR 27/2/2006 SECTION: Managing for Quality & Competitiveness TOPIC: Managerial Decision Making Solve the Dilemma: Infinity Computers, p. 159 Activity: Leadership Styles (group work) Video: She-EO, p. 165