Communicating and Interpreting Accounting Information

1. Communicating and Interpreting Accounting Information Chapter 5 McGraw-Hill/Irwin © 2009 The McGraw-Hill Companies, Inc.

2. Players in the AccountingCommunication Process Management Preparation CEO, CFO, Accounting Staff Guided by GAAP Independent Auditors Verification Partners, Managers, Staff Guided by GAAS An unqualified opinion states that the financial statements are fair presentations in all material respects in conformity with GAAP.

3. Players in the AccountingCommunication Process Management Preparation CEO, CFO, Accounting Staff Guided by GAAP Independent Auditors Verification Partners, Managers, Staff Guided by GAAS Information Intermediaries Analysis and Advice Financial analysis, Information services Financial analysts make predictions concerning companies’ future earnings and stock prices.

4. Players in the AccountingCommunication Process Management Preparation CEO, CFO, Accounting Staff Guided by GAAP Independent Auditors Verification Partners, Managers, Staff Guided by GAAS Information Intermediaries Analysis and Advice Financial analysis, Information services Web Info Services:www.sec.gov; www.compustat.com;www.finance.yahoo.com;www.bloomberg.com;www.hoovers.com; www.factiva.com

5. Management Preparation CFO, CEO, Accounting Staff Guided by GAAP Independent Auditors Verification Partners, Managers, Staff Guided by GAAS Information Intermediaries Analysis and Advice Financial analysis, Information services Government Regulators Verification SEC Members Guided by SEC regs. Users Analysis and Decision Investors, Lenders, etc. Public companies only

6. Ensuring the Integrity of Financial Information Communication Process Regulators Standard Setting and Verification SEC Stock ExchangesCorporateGovernance Standards FASBAccounting Standards PCAOBAuditing Standards Management Primary Responsibility CFO, CEO, Accounting staff Directors Oversight Audit Committee (Independent directors) Auditors (CPAs) Verification Partners, Managers, Staff

7. Users: Institutional and Private Investors, Creditors, and Others Management Primary Responsibility CFO, CEO, Accounting Staff Information Intermediaries Analysis and Advice Financial analysts, Information services Users Analysis and Decision Institutional and private investors, Lenders, Suppliers, Customers, etc.

8. Guiding Principles for CommunicatingUseful Information Primary Objective of External Financial Reporting To provide economic information to external users for decision making. Primary Qualitative Characteristics Relevance:Timely and Predictive Feedback Value Reliability:Accurate, Unbiased, and Verifiable Secondary Qualitative Characteristics Comparability:Across businesses Consistency:Over time

9. Guiding Principles for Communicating Useful Information Primary Objective of External Financial Reporting To provide economic information to external users for decision making. • The full-disclosure principles require . . . • A complete set of financial statements, • and • Notes to the financial statements Primary Qualitative Characteristics Relevance:Timely and Predictive and Feedback Value Reliability:Accurate, Unbiased, and Verifiable Secondary Qualitative Characteristics Comparability:Across businesses Consistency:Over time

10. International Accounting Standards Board and Global Differences in Accounting Standards InternationalFinancialReporting Standards

11. For privately held companies, annual reports are simple documents that include: Four basic financial statements. Related notes (footnotes). Report of independent accountants (auditor’s opinion) if the statements are audited. Annual Reports

12. For publiccompanies, annual reports are elaborate due to SEC reporting requirements: A Nonfinancial Section A letter to the stockholders, a description of management’s philosophy, products, successes, etc. A Financial Section See next slide for a detailed listing . . . Annual Reports

13. Summarized financial data for 5- or 10-years. Management Discussion and Analysis (MD&A). The four basic financial statements. Notes (footnotes). Independent Accountant’s Report and the Management Certification. Recent stock price information. Summaries of the unaudited quarterly financial data. Lists of directors and officers of the company and relevant addresses. Annual Reports

14. Usually begin with short letter to stockholders Condensed unaudited income statement and balance sheet for the quarter. Often, cash flow statement and statement of stockholders’ equity are omitted. Some notes to the financial statements also may be omitted. Quarterly Reports

15. 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-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.

16. Classified Balance Sheet

17. Classified Balance Sheet

18. Classified Balance Sheet Contributed capital is normally shown in two accounts: Common Stock Additional Paid-in Capital

19. Income statements may contain three sections: Continuing operations Nonrecurring Items Discontinued operations Extraordinary items Earnings per share Classified Income Statement

20. Classified Income Statement General Format for the Classified Income Statement

21. Net Income* EPS = Average Number of Shares of Common Stock Outstanding During the Period Earnings Per Share Basic EPS *If there are preferred dividends, the amount is subtracted from the Net Income in the numerator.

22. Common-Size Income Statement Total revenue isequal to 100%.

23. Recall that the Statement of Cash Flows is divided into three major sections. Cash flows from operating activities. Cash flows from investing 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. Statement of Cash Flows

27. Notes to Financial Statements Descriptions of the key accounting rules that apply to the company’s statements. Additional detail supporting reported numbers. Relevant financial information not disclosed on the statements.

28. Return onEquity Net Income = Average Stockholders’ Equity1 Return on Equity (ROE) Analysis ROE measures how much the firm earned for each dollar of stockholders’ investment. 1(beginning equity + ending equity) ÷ 2

29. Net ProfitMargin AssetTurnover FinancialLeverage ROE AverageTotal Assets AverageStockholders’Equity Net Income AverageStockholders’Equity Net Sales AverageTotal Assets Net Income Net Sales = × × ROE Profit Driver Analysis = × ×

30. Profit Drivers and Business Strategy High-value or product-differentiation.Rely on R&D and product promotion to convincecustomers of the superiority of your product. Low-Cost.Rely on efficient management of accounts receivable,inventory and productive assets to producehigh asset turnover.

31. Chapter Supplement: Nonrecurring Items General Format for the Classified Income Statement In addition, companies may have nonrecurring items. These nonrecurring items may include: 1. Discontinued operations,2. Extraordinary items, These items are reported separately because they are not useful in predicting future income of the company.

32. Discontinued Operations Sale or abandonment of a segment of a business. Income or loss on segment’s operation for the period. Gain or loss on disposal of the segment. Show net of applicable taxes.

33. Extraordinary Items Unusual Infrequent Show net of applicable taxes.

34. End of Chapter 5