Chapter 07 using accounting information

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Chapter Seven
Using Accounting
Information
7 | 1
PRIDE HUGHES KAPOOR
INTRODUCTION TO
BUSINESS
ELEVENTH EDITION

Learning Objectives
1. Explain why accurate accounting information and
audited financial statements are important.
2. Identify the people who use accounting information
and possible careers in the accounting industry.
3. Discuss the accounting process.
4. Read and interpret a balance sheet.
5. Read and interpret an income statement.
6. Describe business activities that affect a firm’s
cash flow.
7. Summarize how managers evaluate the financial
health of a business.
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Why Accounting Information
Is Important
 Recent accounting scandals
• Pressure on corporate executives to look good to
analysts and investors
 Why audited financial statements
are important
• Bankers, creditors, investors, and government
agencies rely on an auditor’s opinion of the validity
of a firm’s financial statements.
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Why Accounting Information
Is Important (cont’d)
 What is an audit?
• An examination of a company’s financial statements
and accounting practices
• Generally accepted accounting principles (GAAPs)—
an accepted set of guidelines and practices for U.S.
companies reporting financial information and the
accounting profession
• The FASB is developing a new set of standards
combining those of GAAP and the International
Financial Reporting Standards
• An audit does not guarantee that a company has not
“cooked” the books
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Who Uses Accounting Information
 Managers are the primary users
• Proprietary: information that is not divulged to
anyone outside the firm
 Lenders, suppliers, stockholders,
potential investors and government
agencies are other users
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Users of Accounting Information
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Table 7.1

Different Types of Accounting
 Managerial accounting provides managers and
employees within the organization with
information needed to make decisions about a
firm’s financing, investing, marketing, and
operating activities are the primary users
 Financial accounting generates financial
statements and reports for interested people
outside an organization
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Careers in Accounting
 Qualities to be successful in accounting
• Be responsible, honest, ethical
• Have a strong background in financial management
• Know how to use a computer and accounting software
• Be able to communicate with people who need
accounting information
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Careers in Accounting (cont’d)
 Private Accountant
• Employed by a specific organization
• Services performed for the employer
- Design its accounting information system
- Manage its accounting department
- Provide managers with accounting information,
advice and assistance.
 Public Accountant
• Provides services to clients on a fee basis
• Self-employed or employee of an accounting firm
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Careers in Accounting (cont’d)
 Certified Public Accountant (CPA)
• Has met state requirements for accounting education
and experience and has passed a rigorous
accounting examination prepared by the AICPA
• Participates in continuing-education programs to
maintain certification
 Certified Management Accountant (CMA)
• Has met requirements for education and experience,
passed a rigorous exam, certified by the Institute of
Management Accountants
• Has demonstrated decision-making, financial
planning, analysis, and critical-thinking skills
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The Accounting Process
 The accounting equation
 Assets = Liabilities + Owners’ equity
• Assets—the resources that a business owns
(e.g., cash, inventory, equipment, and real estate)
• Liabilities—the firm’s debts
• Owners’ equity—the difference between assets and
liabilities (what would be left for the owners if the firm’s
assets were sold and the money used to pay off its
liabilities)
Double-entry bookkeeping system: Each financial
transaction is recorded as two separate accounting entries to
maintain the balance of the accounting equation
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The Accounting Process (cont’d)
 The accounting cycle
• Done on a regular basis
- Analyzing source documents
- Recording transactions as they occur in the
general journal
- Posting transactions to accounts in the
general ledger
 Done at the end of the period
• Preparing the trial balance of all general ledger
accounts
• Preparing financial statements and closing the books
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The Income Statement
 A summary of a firm’s revenues and expenses
during a specified accounting period
• Profit (cash surplus)
• Loss (cash deficit)
 Revenues
• The dollar amounts earned by a firm from selling goods,
providing services, or performing business activities
• Gross sales—the total dollar amount of all goods and
services sold during the accounting period
• Net sales—the actual dollar amounts received by a firm for
the goods and services it has sold, after adjustment for
returns, allowances, discounts
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The Income Statement (cont’d)
 Cost of goods sold
• The dollar amount equal to beginning inventory plus
net purchases less ending inventory
Cost of
goods sold
Beginning
inventory
Net
purchases
Ending
inventory
= + –
Gross profit = A firm’s net sales less the cost of goods sold
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The Income Statement (cont’d)
 Operating expenses
• All business costs other than the cost of goods sold
- Selling expenses—costs related to marketing activities
- General expenses—costs of managing the business
 Net income
• Revenues less expenses, when the difference
is positive
 Net loss
• Revenues less expenses, when the difference
is negative
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Personal Income Statement
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Figure 7.3
By subtracting expenses
from income, anyone can
construct a person
income statement and
determine if they have a
surplus or deficit at the
end of each month.

Business Income Statement
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Figure 7.4
An income statement summarizes
a firm’s revenues and expenses
during a specified accounting
period. For Northeast Art, net
income after taxes is $30,175.

The Statement of Cash Flows
 Illustrates how the operating, investing, and
financing activities of a company affect cash
during an accounting period
• Cash flows from operating activities (providing goods
and services)
• Cash flows from investing activities (purchase and
sale of land, equipment, and other assets and
investments)
• Cash flows from financing activities (changes in debt
obligation and owners’ equity accounts)
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Statement of Cash Flows
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A statement of cash flows
summarizes how a firm’s
operating, investing, and
financing activities affect
its cash during a specified
period—one month, three
months, six months, or a
year. For Northeast Art, the
amount of cash at the end
of the year reported on the
statement of cash flows is
$59,000—the same amount
reported for the cash
account on the firm’s
balance sheet.
Figure 7.5

Evaluating Financial Statements
 Using accounting information to evaluate a
potential investment
• Use common sense to interpret the numbers
• Financial statements should be audited by an outside
source and be current
• Look for use of new strategies to reduce costs
• Determine the firm’s ability to pay its debts and
borrow money in the future
• Look at how the numbers relate to each other
• Understand the financial ratios
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Evaluating Financial Statements (cont’d)
 Using accounting information to evaluate a
potential investment (cont’d)
• Read letters from top executives
• Examine the footnotes closely, look for red flags
• Examine the comparative data to analyze trends
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Comparing Data with Other Firms’ Data
 Comparisons are possible because of GAAP
 Managers can get a general idea of a firm’s relative
effectiveness and its standing within the industry
 Data are available from annual reports of public
corporations
 Industry averages are available from Dun & Bradstreet,
Standard & Poor’s, industry trade associations
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Financial Ratios
 Numbers that show the relationship between two
elements of a firm’s financial statements
 Can be compared with
 The firm’s own past ratios
 Ratios of competitors
 Industry averages
 Information to calculate ratios is found on a firm’s
balance sheet, income statement, and statement of cash
flows
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Financial Ratios (cont’d)
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Table 7.2

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Table 7.2

7 | 26
Table 7.2

Chapter 07 using accounting information

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