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Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Communicatingand Interpreting
AccountingInformation
Chapter 5
5-2
Learning Objectives
Recognize the people involved in the accounting communication process
(regulators, managers, directors, auditors, information intermediaries and users), their role in the process and the guidance they
receive from legal and professional standards.
Recognize the people involved in the accounting communication process
(regulators, managers, directors, auditors, information intermediaries and users), their role in the process and the guidance they
receive from legal and professional standards.
5-3
Players in the Accounting
Communication Process
An An unqualifiedunqualified opinion states opinion states that the financial statements are that the financial statements are fair presentations in all material fair presentations in all material
respects in conformity with respects in conformity with GAAP.GAAP.
An An unqualifiedunqualified opinion states opinion states that the financial statements are that the financial statements are fair presentations in all material fair presentations in all material
respects in conformity with respects in conformity with GAAP.GAAP.
Independent AuditorsIndependent AuditorsVerificationVerification
Partners, Managers, StaffPartners, Managers, StaffGuided by GAASGuided by GAAS
Independent AuditorsIndependent AuditorsVerificationVerification
Partners, Managers, StaffPartners, Managers, StaffGuided by GAASGuided by GAAS
ManagementManagementPreparationPreparation
CEO, CFO, Accounting StaffCEO, CFO, Accounting StaffGuided by GAAPGuided by GAAP
ManagementManagementPreparationPreparation
CEO, CFO, Accounting StaffCEO, CFO, Accounting StaffGuided by GAAPGuided by GAAP
5-4
Information Information IntermediariesIntermediaries
Analysis and AdviceAnalysis and AdviceFinancial analysis, Financial analysis,
Information servicesInformation services
Information Information IntermediariesIntermediaries
Analysis and AdviceAnalysis and AdviceFinancial analysis, Financial analysis,
Information servicesInformation services
Financial analysts Financial analysts make predictions make predictions
concerning concerning companies’ future companies’ future earnings and stock earnings and stock
prices.prices.
Financial analysts Financial analysts make predictions make predictions
concerning concerning companies’ future companies’ future earnings and stock earnings and stock
prices.prices.
Independent AuditorsIndependent AuditorsVerificationVerification
Partners, Managers, StaffPartners, Managers, StaffGuided by GAASGuided by GAAS
Independent AuditorsIndependent AuditorsVerificationVerification
Partners, Managers, StaffPartners, Managers, StaffGuided by GAASGuided by GAAS
ManagementManagementPreparationPreparation
CFO, CEO, Accounting StaffCFO, CEO, Accounting StaffGuided by GAAPGuided by GAAP
ManagementManagementPreparationPreparation
CFO, CEO, Accounting StaffCFO, CEO, Accounting StaffGuided by GAAPGuided by GAAP
Players in the Accounting
Communication Process
5-5
Information Information IntermediariesIntermediaries
Analysis and AdviceAnalysis and AdviceFinancial analysis, Financial analysis,
Information servicesInformation services
Information Information IntermediariesIntermediaries
Analysis and AdviceAnalysis and AdviceFinancial analysis, Financial analysis,
Information servicesInformation services
Financial analysts Financial analysts make predictions make predictions
concerning concerning companies’ future companies’ future earnings and stock earnings and stock
prices.prices.
Financial analysts Financial analysts make predictions make predictions
concerning concerning companies’ future companies’ future earnings and stock earnings and stock
prices.prices.
Independent AuditorsIndependent AuditorsVerificationVerification
Partners, Managers, StaffPartners, Managers, StaffGuided by GAASGuided by GAAS
Independent AuditorsIndependent AuditorsVerificationVerification
Partners, Managers, StaffPartners, Managers, StaffGuided by GAASGuided by GAAS
ManagementManagementPreparationPreparation
CFO, CEO, Accounting StaffCFO, CEO, Accounting StaffGuided by GAAPGuided by GAAP
ManagementManagementPreparationPreparation
CFO, CEO, Accounting StaffCFO, CEO, Accounting StaffGuided by GAAPGuided by GAAP
Web Info Services:Web Info Services:www/sec/govwww/sec/gov
www.compustat.comwww.compustat.comwww.djnr.comwww.djnr.com
www.bloomberg.comwww.bloomberg.comwww.firstcall.comwww.firstcall.comwww.hoover.comwww.hoover.com
Web Info Services:Web Info Services:www/sec/govwww/sec/gov
www.compustat.comwww.compustat.comwww.djnr.comwww.djnr.com
www.bloomberg.comwww.bloomberg.comwww.firstcall.comwww.firstcall.comwww.hoover.comwww.hoover.com
Players in the Accounting
Communication Process
5-6
Government Government RegulatorsRegulatorsVerificationVerification
SEC MembersSEC MembersGuided by SEC regs.Guided by SEC regs.
Government Government RegulatorsRegulatorsVerificationVerification
SEC MembersSEC MembersGuided by SEC regs.Guided by SEC regs.
UsersUsersAnalysis and DecisionAnalysis and Decision
Investors, Lenders, etc.Investors, Lenders, etc.
UsersUsersAnalysis and DecisionAnalysis and Decision
Investors, Lenders, etc.Investors, Lenders, etc. Public companies only
ManagementManagementPreparationPreparation
CFO, CEO, Accounting StaffCFO, CEO, Accounting StaffGuided by GAAPGuided by GAAP
ManagementManagementPreparationPreparation
CFO, CEO, Accounting StaffCFO, CEO, Accounting StaffGuided by GAAPGuided by GAAP
Information Information IntermediariesIntermediaries
Analysis and AdviceAnalysis and AdviceFinancial analysis, Financial analysis,
Information servicesInformation services
Information Information IntermediariesIntermediaries
Analysis and AdviceAnalysis and AdviceFinancial analysis, Financial analysis,
Information servicesInformation services
Independent AuditorsIndependent AuditorsVerificationVerification
Partners, Managers, StaffPartners, Managers, StaffGuided by GAASGuided by GAAS
Independent AuditorsIndependent AuditorsVerificationVerification
Partners, Managers, StaffPartners, Managers, StaffGuided by GAASGuided by GAAS
Players in the Accounting
Communication Process
5-7
Ensuring the Integrity of Financial Information Communication Process
RegulatorsRegulatorsStandard Setting and Standard Setting and
VerificationVerificationSECSEC
RegulatorsRegulatorsStandard Setting and Standard Setting and
VerificationVerificationSECSEC
ManagementManagementPrimary ResponsibilityPrimary Responsibility
CFO, CEO, Accounting StaffCFO, CEO, Accounting Staff
ManagementManagementPrimary ResponsibilityPrimary Responsibility
CFO, CEO, Accounting StaffCFO, CEO, Accounting Staff
Auditors (CPAs)Auditors (CPAs)VerificationVerification
Partners, Managers, StaffPartners, Managers, Staff
Auditors (CPAs)Auditors (CPAs)VerificationVerification
Partners, Managers, StaffPartners, Managers, Staff
DirectorsDirectorsOversightOversight
Audit Committee Audit Committee (Independent directors)(Independent directors)
DirectorsDirectorsOversightOversight
Audit Committee Audit Committee (Independent directors)(Independent directors)
5-8
Using Financial Reports
ManagementManagementPrimary ResponsibilityPrimary Responsibility
CFO, CEO, Accounting StaffCFO, CEO, Accounting Staff
ManagementManagementPrimary ResponsibilityPrimary Responsibility
CFO, CEO, Accounting StaffCFO, CEO, Accounting Staff
Information Information IntermediariesIntermediaries
Analysis and AdviceAnalysis and AdviceFinancial analysts, Financial analysts,
Information servicesInformation services
Information Information IntermediariesIntermediaries
Analysis and AdviceAnalysis and AdviceFinancial analysts, Financial analysts,
Information servicesInformation services
UsersUsersAnalysis and DecisionAnalysis and DecisionInstitutional and private Institutional and private
investors, Lenders, investors, Lenders, Suppliers, Customers, etc.Suppliers, Customers, etc.
UsersUsersAnalysis and DecisionAnalysis and DecisionInstitutional and private Institutional and private
investors, Lenders, investors, Lenders, Suppliers, Customers, etc.Suppliers, Customers, etc.
5-9
Guiding Principles for Communicating Useful Information
Primary Objective of External Financial ReportingPrimary Objective of External Financial Reporting To provide economic information to external users To provide economic information to external users
for decision making. for decision making.
Primary Objective of External Financial ReportingPrimary Objective of External Financial Reporting To provide economic information to external users To provide economic information to external users
for decision making. for 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
5-10
Guiding Principles for Communicating Useful Information
Primary Objective of External Financial ReportingPrimary Objective of External Financial Reporting To provide economic information to external users To provide economic information to external users
for decision making.for decision making.
Primary Objective of External Financial ReportingPrimary Objective of External Financial Reporting To provide economic information to external users To provide economic information to external users
for decision making.for decision making.
Primary Qualitative CharacteristicsPrimary Qualitative Characteristics
Relevance:Relevance: Timely and Predictive and Feedback ValueTimely and Predictive and Feedback Value
Reliability:Reliability: Accurate, Unbiased, and VerifiableAccurate, Unbiased, and Verifiable
Primary Qualitative CharacteristicsPrimary Qualitative Characteristics
Relevance:Relevance: Timely and Predictive and Feedback ValueTimely and Predictive and 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
The full-disclosure principles require . . .The full-disclosure principles require . . .
1.1.A complete set of financial statements,A complete set of financial statements,andand
2.2.Notes to the financial statementsNotes to the financial statements
The full-disclosure principles require . . .The full-disclosure principles require . . .
1.1.A complete set of financial statements,A complete set of financial statements,andand
2.2.Notes to the financial statementsNotes to the financial statements
5-11
International Accounting Standards Board and Global Differences in Accounting
Difference in Accounting Standards US GAAP IFRSExtraordinary items Permitted ProhibitedLIFO for inventory Permitted ProhibitedReversal of inventory write-downs Prohibited RequiredBasis of property, plant, and equipment Historical cost Fair Value or
Historical cost
IInternational nternational FFinancial inancial RReporting eporting SStandardstandardsIInternational nternational FFinancial inancial RReporting eporting SStandardstandards
5-12
Learning Objectives
Identify the steps in the accounting communication process, including the issuance
of press releases, annual reports, quarterly reports and SEC filings as well as the role of
electronic information services in this process.
Identify the steps in the accounting communication process, including the issuance
of press releases, annual reports, quarterly reports and SEC filings as well as the role of
electronic information services in this process.
5-13
The Disclosure Process
Press ReleasesPress Releases are used to announce are used to announce quarterly and annual earnings as soon as quarterly and annual earnings as soon as
the verified figures are available.the verified figures are available.
Press ReleasesPress Releases are used to announce are used to announce quarterly and annual earnings as soon as quarterly and annual earnings as soon as
the verified figures are available.the verified figures are available.
Earnings Press Release Excerpt for Callaway GolfEarnings Press Release Excerpt for Callaway Golf
Callaway® Golf
CARLSBAD, Calif. -- Jan. 22, 2004-- Callaway Golf Company (NYSE:ELY) today reported record sales for the full year ended December 31, 2003, announcing net sales of $814 million compared with $793 million for the prior year. Net income for the full year was $46 million versus . . . .
Earnings Press Release Excerpt for Callaway GolfEarnings Press Release Excerpt for Callaway Golf
Callaway® Golf
CARLSBAD, Calif. -- Jan. 22, 2004-- Callaway Golf Company (NYSE:ELY) today reported record sales for the full year ended December 31, 2003, announcing net sales of $814 million compared with $793 million for the prior year. Net income for the full year was $46 million versus . . . .
5-14
Annual Reports
For For privatelyprivately held companies, annual reports held companies, annual reports are simple documents that include: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 Report of independent accountants (auditor’s opinion) if the statements are (auditor’s opinion) if the statements are audited.audited.
For For privatelyprivately held companies, annual reports held companies, annual reports are simple documents that include: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 Report of independent accountants (auditor’s opinion) if the statements are (auditor’s opinion) if the statements are audited.audited.
5-15
Annual Reports
For For publicpublic companiescompanies, annual reports are , annual reports are elaborate due to SEC reporting elaborate due to SEC reporting
requirements:requirements:
1.1. A Nonfinancial SectionA Nonfinancial Section A letter to the stockholders, a description of A letter to the stockholders, a description of
management’s philosophy, products, management’s philosophy, products, successes, etc.successes, etc.
2.2. A Financial SectionA Financial Section See next slide for a detailed listing . . . See next slide for a detailed listing . . .
For For publicpublic companiescompanies, annual reports are , annual reports are elaborate due to SEC reporting elaborate due to SEC reporting
requirements:requirements:
1.1. A Nonfinancial SectionA Nonfinancial Section A letter to the stockholders, a description of A letter to the stockholders, a description of
management’s philosophy, products, management’s philosophy, products, successes, etc.successes, etc.
2.2. A Financial SectionA Financial Section See next slide for a detailed listing . . . See next slide for a detailed listing . . .
5-16
Annual Reports - Financial Section
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 Independent Accountant’s Report and Accountant’s Report and the Management the 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 Independent Accountant’s Report and Accountant’s Report and the Management the 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.
5-17
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.
5-18
SEC Reports
Form 10-K Annual ReportForm 10-K Annual Report•Due within 90 days of the fiscal year-end.Due within 90 days of the fiscal year-end.•Contains audited financial statements.Contains audited financial statements.
Form 10-K Annual ReportForm 10-K Annual Report•Due within 90 days of the fiscal year-end.Due within 90 days of the fiscal year-end.•Contains audited financial statements.Contains audited financial statements.
Form 10-Q Quarterly ReportForm 10-Q Quarterly Report•Due within 45 days of the end of the quarter.Due within 45 days of the end of the quarter.•Financial statements can be unaudited.Financial statements can be unaudited.
Form 10-Q Quarterly ReportForm 10-Q Quarterly Report•Due within 45 days of the end of the quarter.Due within 45 days of the end of the quarter.•Financial statements can be unaudited.Financial statements can be unaudited.
Form 8-K Current ReportForm 8-K Current Report•Due within 15 days of the major event date.Due within 15 days of the major event date.•Financial statements can be unaudited.Financial statements can be unaudited.
Form 8-K Current ReportForm 8-K Current Report•Due within 15 days of the major event date.Due within 15 days of the major event date.•Financial statements can be unaudited.Financial statements can be unaudited.
5-19
Learning Objectives
Recognize and apply the different financial statement and disclosure formats used by
companies in practice.
Recognize and apply the different financial statement and disclosure formats used by
companies in practice.
5-20
Financial Statement Formats
Let’s take aLet’s take acloser lookcloser lookat the assetat the asset
section of thesection of thebalance balance sheet!sheet!
5-21
5-22
Current assets Current assets are assets that are assets that
will be turned into will be turned into cash or expire cash or expire (be used up) (be used up)
within the longer within the longer of one year or the of one year or the operating cycle.operating cycle.
Current assets Current assets are assets that are assets that
will be turned into will be turned into cash or expire cash or expire (be used up) (be used up)
within the longer within the longer of one year or the of one year or the operating cycle.operating cycle.
5-23
Property, plant and Property, plant and equipment includes equipment includes assets with useful assets with useful lives of more than lives of more than one year acquired one year acquired
for use in the for use in the business rather business rather
than for resale. The than for resale. The amount is reported amount is reported net of net of accumulated accumulated
depreciationdepreciation..
Property, plant and Property, plant and equipment includes equipment includes assets with useful assets with useful lives of more than lives of more than one year acquired one year acquired
for use in the for use in the business rather business rather
than for resale. The than for resale. The amount is reported amount is reported net of net of accumulated accumulated
depreciationdepreciation..
5-24
Intangible assets Intangible assets have no physical have no physical existence and a existence and a long life. They long life. They
include patents, include patents, copyrights, copyrights,
trademarks, etc.trademarks, etc.
Intangible assets Intangible assets have no physical have no physical existence and a existence and a long life. They long life. They
include patents, include patents, copyrights, copyrights,
trademarks, etc.trademarks, etc.
5-25
Let’s now look Let’s now look at the liability at the liability section of a section of a classified classified
balance sheet.balance sheet.
5-26
5-27
Current liabilities Current liabilities are obligations are obligations that will be paid that will be paid
with current with current assets, normally assets, normally within one year.within one year.
Current liabilities Current liabilities are obligations are obligations that will be paid that will be paid
with current with current assets, normally assets, normally within one year.within one year.
5-28
Long-term liabilities are debts that have Long-term liabilities are debts that have maturity dates extending beyond one maturity dates extending beyond one
year from the balance sheet date.year from the balance sheet date.
Long-term liabilities are debts that have Long-term liabilities are debts that have maturity dates extending beyond one maturity dates extending beyond one
year from the balance sheet date.year from the balance sheet date.
5-29
Finally, we get to the
stockholders’ equity section of
a classified balance sheet.
5-30
Contributed capital is often shown in Contributed capital is often shown in two separate accountstwo separate accounts
1.1. Common stock.Common stock.
2.2. Additional paid-in capital.Additional paid-in capital.
Contributed capital is often shown in Contributed capital is often shown in two separate accountstwo separate accounts
1.1. Common stock.Common stock.
2.2. Additional paid-in capital.Additional paid-in capital.
5-31
Retained earnings is the total Retained earnings is the total earnings of the company less the earnings of the company less the
total dividends declared since total dividends declared since inception of operations.inception of operations.
Retained earnings is the total Retained earnings is the total earnings of the company less the earnings of the company less the
total dividends declared since total dividends declared since inception of operations.inception of operations.
5-32
Balance Sheet Ratios andDebt Contracts
When a company borrows money, it often agrees to certain restrictions on activity.
Ratios typically part of the borrowing agreement include:
Total Liabilities÷ Stockholders' Equity= Debt-to-Equity Ratio
Total Liabilities÷ Stockholders' Equity= Debt-to-Equity Ratio
Current Assets÷ Current Liabilities= Current Ratio
Current Assets÷ Current Liabilities= Current Ratio
5-33
Classified Income Statement
Income statements may contain five sections:Income statements may contain five sections:1.1. Continuing operationsContinuing operations
2.2. Discontinued operationsDiscontinued operations
3.3. Extraordinary itemsExtraordinary items
4.4. Cumulative effect of changes in accounting Cumulative effect of changes in accounting methodsmethods
5.5. Earnings per shareEarnings per share
Income statements may contain five sections:Income statements may contain five sections:1.1. Continuing operationsContinuing operations
2.2. Discontinued operationsDiscontinued operations
3.3. Extraordinary itemsExtraordinary items
4.4. Cumulative effect of changes in accounting Cumulative effect of changes in accounting methodsmethods
5.5. Earnings per shareEarnings per share
5-34
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
General Format for the Classified Income StatementGeneral Format for the Classified Income Statement
Gross sales minus any Gross sales minus any discounts, returns, and discounts, returns, and
allowances during the period.allowances during the period.
Gross sales minus any Gross sales minus any discounts, returns, and discounts, returns, and
allowances during the period.allowances during the period.
5-35
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
General Format for the Classified Income StatementGeneral Format for the Classified Income Statement
Classified Income Statement
Cost of inventory sold.Cost of inventory sold.Cost of inventory sold.Cost of inventory sold.
5-36
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
General Format for the Classified Income StatementGeneral Format for the Classified Income Statement
Classified Income Statement
Not related to the company’s primary Not related to the company’s primary operations. Usually includes interest income or operations. Usually includes interest income or
expense and any gains or losses from the expense and any gains or losses from the retirement of equipment.retirement of equipment.
Not related to the company’s primary Not related to the company’s primary operations. Usually includes interest income or operations. Usually includes interest income or
expense and any gains or losses from the expense and any gains or losses from the retirement of equipment.retirement of equipment.
5-37
Common-Size Income Statement
Total revenue isequal to 100%.
5-38
Earnings Per Share
EPS =EPS =Net Income Available to Common ShareholdersNet Income Available to Common Shareholders
Weighted Average Number of Shares Outstanding During the Reporting Period
Weighted Average Number of Shares Outstanding During the Reporting Period
Basic EPSBasic EPSBasic EPSBasic EPS
5-39
Earnings Per Share
EPS =EPS =Net Income Available to Common ShareholdersNet Income Available to Common Shareholders
Weighted Average Number of Shares Outstanding During the Reporting Period
Weighted Average Number of Shares Outstanding During the Reporting Period
Diluted EPSDiluted EPSStock options, debt securities, Stock options, debt securities,
equity securities are assumed to equity securities are assumed to be converted into common stock be converted into common stock at the beginning of the period.at the beginning of the period.
Diluted EPSDiluted EPSStock options, debt securities, Stock options, debt securities,
equity securities are assumed to equity securities are assumed to be converted into common stock be converted into common stock at the beginning of the period.at the beginning of the period.
5-40
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.
We will examine the indirect method of We will examine the indirect method of preparing the statement. This format begins preparing the statement. This format begins
with a with a reconciliationreconciliation of accrual income to of accrual income to cash flows from operations.cash flows from operations.
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 We will examine the indirect method of preparing the statement. This format begins preparing the statement. This format begins
with a with a reconciliationreconciliation of accrual income to of accrual income to cash flows from operations.cash flows from operations.
5-41
This is the operating activities section of Callaway using theThis is the operating activities section of Callaway using the indirect indirect methodmethod. Begin with accounting net income and arrive at cash . Begin with accounting net income and arrive at cash
provided by operating activities.provided by operating activities.
This is the operating activities section of Callaway using theThis is the operating activities section of Callaway using the indirect indirect methodmethod. Begin with accounting net income and arrive at cash . Begin with accounting net income and arrive at cash
provided by operating activities.provided by operating activities.
5-42
While these While these items are on items are on the income the income
statement, they statement, they have no have no
current cash current cash effect.effect.
While these While these items are on items are on the income the income
statement, they statement, they have no have no
current cash current cash effect.effect.
5-43
This table This table provides provides
guidance for guidance for adjustments adjustments
related to related to changes in changes in
current assets current assets and current and current liabilities.liabilities.
This table This table provides provides
guidance for guidance for adjustments adjustments
related to related to changes in changes in
current assets current assets and current and current liabilities.liabilities.
5-44
Here is the rest Here is the rest of Callaway’s of Callaway’s Statement of Statement of Cash Flows Cash Flows showing the showing the
cash balance cash balance on the on the
company’s company’s balance sheet.balance sheet.
Here is the rest Here is the rest of Callaway’s of Callaway’s Statement of Statement of Cash Flows Cash Flows showing the showing the
cash balance cash balance on the on the
company’s company’s balance sheet.balance sheet.
5-45
Notes to Financial Statements
Descriptions of the key accounting rules Descriptions of the key accounting rules that apply to the company’s statements.that apply to the company’s statements.Descriptions of the key accounting rules Descriptions of the key accounting rules that apply to the company’s statements.that apply to the company’s statements.
Additional detail supporting reported Additional detail supporting reported numbers.numbers.
Additional detail supporting reported Additional detail supporting reported numbers.numbers.
Relevant financial information not Relevant financial information not disclosed on the statements.disclosed on the statements.
Relevant financial information not Relevant financial information not disclosed on the statements.disclosed on the statements.
5-46
Learning Objectives
Analyze a company’s performance based on return on equity and its components.
Analyze a company’s performance based on return on equity and its components.
5-47
Return on Equity (ROE)
1(beginning equity + ending equity) ÷ 2
Return Return onon
EquityEquity==
Net IncomeNet IncomeAverage Stockholders’ EquityAverage Stockholders’ Equity11
ROE measures how much the firm earned for each dollar of stockholders’ investment.
5-48
ROE Profit Driver Analysis
ROEROE Net ProfitMargin
Net ProfitMargin
AssetTurnover
AssetTurnover
FinancialLeverageFinancialLeverage= ××
Net IncomeAverage
Stockholders’Equity
Net IncomeAverage
Stockholders’Equity
Net IncomeNet Sales
Net IncomeNet Sales
Net SalesAverage
Total Assets
Net SalesAverage
Total Assets
AverageTotal Assets
AverageStockholders’
Equity
AverageTotal Assets
AverageStockholders’
Equity
× ×=
5-49
Profit Drivers and Business Strategy
High-value or product-differentiation.High-value or product-differentiation.Rely on R&D and product promotion to convinceRely on R&D and product promotion to convince
customers of the superiority of your product.customers of the superiority of your product.
High-value or product-differentiation.High-value or product-differentiation.Rely on R&D and product promotion to convinceRely on R&D and product promotion to convince
customers of the superiority of your product.customers of the superiority of your product.
Low-Cost.Low-Cost.Rely on efficient management of accounts receivable,Rely on efficient management of accounts receivable,
inventory and productive assets to produceinventory and productive assets to producehigh asset turnover.high asset turnover.
Low-Cost.Low-Cost.Rely on efficient management of accounts receivable,Rely on efficient management of accounts receivable,
inventory and productive assets to produceinventory and productive assets to producehigh asset turnover.high asset turnover.
5-50
Other Items Reported on the Income Statement
Other Items Reported on the Income Statement
Chapter Supplement A
5-51
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
General Format for the Classified Income StatementGeneral Format for the Classified Income Statement
Classified Income Statement
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 operations,Discontinued operations,2. 2. Extraordinary items,Extraordinary items,3. 3. Cumulative effect of changes in accounting methods.Cumulative effect of changes in accounting methods.
These items are reported separately because they are These items are reported separately because they are not useful in predicting future income of the company.not 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 operations,Discontinued operations,2. 2. Extraordinary items,Extraordinary items,3. 3. Cumulative effect of changes in accounting methods.Cumulative effect of changes in accounting methods.
These items are reported separately because they are These items are reported separately because they are not useful in predicting future income of the company.not useful in predicting future income of the company.
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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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Cumulative Effect of Changes in Accounting Methods
The change must be to a The change must be to a preferable preferable methodmethod and must be disclosed in notes and must be disclosed in notes
to financial statements.to financial statements.
The change must be to a The change must be to a preferable preferable methodmethod and must be disclosed in notes and must be disclosed in notes
to financial statements.to financial statements.
GAAP GAAP MethodMethodGAAP GAAP
MethodMethodChange to
AlternativeGAAP GAAP
MethodMethodGAAP GAAP
MethodMethod
Show net of applicable taxes.Show net of applicable taxes.
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End of Chapter 5