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© 2009 South-Western, a division of Cengage Learning
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CHAPTER 8: Accounting
DECISION MAKING BY THE NUMBERS
© 2009 South-Western, a division of Cengage Learning
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LOOKING AHEAD
• What is accounting? How is accounting information used?
• What are career opportunities in accounting?
• What are the goals of generally accepted accounting principles?
• What are the key elements of the major financial statements?
• How can horizontal, vertical and ratio analysis provide insight into financial statements?
• How can managerial accounting help managers with product costing, incremental analysis, and budgeting?
© 2009 South-Western, a division of Cengage Learning
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ACCOUNTING: WHO NEEDS IT?
Managers Stockholders
Employees Creditors
What other groups would be interested in accounting information?
© 2009 South-Western, a division of Cengage Learning
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THE ACCOUNTING PROFESSION:MORE THAN
• What Accountants Do– Private Accountants
– Internal Auditors
– Public Accountants
– Government Accountants
• Qualifications for Accounting Positions– Bachelor’s Degree
– Spreadsheet/Software Experience
– Certified Public Accountant (CPA)
– Certified Management Accountant (CMA)
– Master’s Degree – Preferred
© 2009 South-Western, a division of Cengage Learning
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GAAP: PLAYING BY THE RULES OF FINANCIAL ACCOUNTING
Generally Accepted Accounting Principles (GAAP) –
accounting standards that are used in the preparation
of financial statements.
Financial Accounting Standards Board (FASB) –
private self regulated board that establishes and enforces GAAP.
Through GAAP, the FASB aims to ensure that financial statements are:
• Relevant• Reliable• Consistent• Comparable
© 2009 South-Western, a division of Cengage Learning
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ETHICS IN ACCOUNTING
• Accounting scandals have shocked American business since the late 1990s– Overstating earnings
– Hidden money and debt
• The scandals have served as a wake-up call– State and federal laws have been
changed
– Auditor independence
© 2009 South-Western, a division of Cengage Learning
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FINANCIAL STATEMENTS: THE MAIN OUTPUT OF FINANCIAL
• Financial accounting includes three basic financial statements:– Balance Sheet
– Income Statement
– Statement of Cash Flows
• Corporations with publicly held stock must publish annual reports with all three statements
© 2009 South-Western, a division of Cengage Learning
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BALANCE SHEET: WHAT WE OWN AND HOW WE GOT IT
Assets =
Liabilities + Owner’s Equity
Owner’s Equity –
the claims owners have against their firm’s
assets
Balance Sheet – summarizes a firm’s financial position at a specific point in time.
Assets – things of
value that the firm owns
Liabilities – indicates what
the firm owes to non-owners
© 2009 South-Western, a division of Cengage Learning
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SAMPLE BALANCE SHEET
© 2009 South-Western, a division of Cengage Learning
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THE INCOME STATEMENT: HOW DID WE DO?
Revenue – Expenses =
Net Income
Net Income – the profit or lossthe firm earns
Income Statement – summarizes a firm’s operations over a given period of time in terms of profit and loss.
Revenue– the increase in the amount of assets the firm
earns
Expenses – the cash the firmspends or other assets it uses to
generate revenue
© 2009 South-Western, a division of Cengage Learning
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ACCRUAL BASIS ACCOUNTING
• Revenue is not the same as cash received during the same time period
• Accrual basis accounting records revenues as they are earned
• Expenses are matched to the revenues they generated
© 2009 South-Western, a division of Cengage Learning
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SAMPLE INCOME STATEMENT
© 2009 South-Western, a division of Cengage Learning
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STATEMENT OF CASH FLOWS: SHOW ME THE MONEY
• Cash flowing into and out of the firm
– Operations
– Investing
– Financing
• Increase and decrease from all three sources
• Total amount of cash on hand
• Stakeholders want to know if there is adequate cash to pay workers, creditors, suppliers and IRS
© 2009 South-Western, a division of Cengage Learning
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SAMPLE STATEMENT OF CASH FLOWS
© 2009 South-Western, a division of Cengage Learning
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ADDITIONAL FINANCIAL STATEMENTS
Statement of Retained Earnings – reports how retained earnings have changed.
Stockholder’s Equity Statement – reports how net income and dividends affect retained earnings.
© 2009 South-Western, a division of Cengage Learning
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INTERPRETING FINANCIAL STATEMENTS: DIGGING
• It’s important to view financial statements and:– Auditor’s Report
– Notes from Statements
– Analytical Techniques
© 2009 South-Western, a division of Cengage Learning
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INDEPENDENT AUDITOR’S REPORT: A NECESSARY STAMP
• Publicly traded corporations are required to have a CPA firm perform an external audit
– Is the information in the financial statements accurate?
• The auditor will issue an unqualified, qualified or adverse opinion
• Auditors must be independent
© 2009 South-Western, a division of Cengage Learning
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SARBANES-OXLEY ACT OF 2002
• Commonly referred to as SOX
• Banned relationships between CPA firms that might create conflict of interest
• Created Public Company Accounting Oversight Board (PCOAB)
© 2009 South-Western, a division of Cengage Learning
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ANDERSEN’S REPUTATION LEFT IN SHREDS
• Arthur Andersen was a highly respected accounting firm until several thousand pages of documents related to the Enron case were shredded
• Although Andersen’s conviction was overturned, the company’s reputation had been shredded
© 2009 South-Western, a division of Cengage Learning
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NOTES TO FINANCIAL STATEMENTS: READING THE
• Additional information may be required to explain the numbers– Lawsuits
– Employment Facts
– Mergers or acquisitions
– Health Insurance/Pension Funding
© 2009 South-Western, a division of Cengage Learning
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BEYOND THE STATEMENTS
Horizontal Analysis – compares information in a firm’s financial statement over a period of 2 years or more.
Vertical Analysis – expresses items on the balance sheet and income statement as a percentage of a key value.
Ratio Analysis – compares selected items by computing percentages, rates or proportions.
© 2009 South-Western, a division of Cengage Learning
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MANAGERIAL ACCOUNTING VS. FINANCIAL ACCOUNTING
© 2009 South-Western, a division of Cengage Learning
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MANAGERIAL ACCOUNTING: INSIDE INTELLIGENCE
• Reports and analysis for informed business decisions– Product Costing
• Accurate measure and analysis of costs
• Activity Based Costing (ABC)
© 2009 South-Western, a division of Cengage Learning
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• Make parts or buy from supplier?
• Repair equipment or buy new?
• Perform repairs or outsource?
• Eliminate or sell product line/business?
INCREMENTAL ANALYSIS
Evaluates the financial impact of different alternatives in a decision-making situation.
© 2009 South-Western, a division of Cengage Learning
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INCREMENTAL ANALYSIS DECISION
An electronics firm produces high definition LCD televisions at a rate of 10,000 per month. It currently makes its own speaker sets for the televisions.
A supplier offers to sell the firm similar speakers at a cost of $23 per television. The firm could lower costs by buying the speakers, $23 is less than $26. Right?
© 2009 South-Western, a division of Cengage Learning
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COST OF MAKING TELEVISION SPEAKERS: MAKE OR BUY?
© 2009 South-Western, a division of Cengage Learning
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BUDGETS
• Outline how resources will be used to meet goals
• Communication and coordination among managers and employees
• Motivate achievement of goals
• Monitor progress
© 2009 South-Western, a division of Cengage Learning
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DIFFERENT TYPES OF BUDGETS
• Operating Budgets identify sales and production goals.– Sales Budget– Production Budget– Direct Labor Budget
• Financial Budgets focus on the firm’s financial objectives.– Cash Budget– Capital Budget
Master Budget – brings together all of the budgets to
represent the overall plan.
© 2009 South-Western, a division of Cengage Learning
29
LOOKING BACK
• What is accounting? How is accounting information used by stakeholders?
• What are career opportunities in accounting?
• What are the goals of generally accepted accounting principles?
• What are the key elements of the major financial statements?
• How can horizontal, vertical and ratio analysis provide insight into financial statements?
• How can managerial accounting help managers with product costing, incremental analysis, and budgeting?
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