Accounting and Financial Statements

LO 14-1: Describe the different uses of accounting information.
LO 14-2: Demonstrate the accounting process.
LO 14-3: Examine the various components of an income statement in order to evaluate a firm’s “bottom line.”
LO 14-4: Interpret a company’s balance sheet to determine its current financial position.
LO 14-5: Analyze financial statements, using ratio analysis, to evaluate a company’s performance.

Definition: Accounting is the recording, measurement, and interpretation of financial information.
Used by a diverse set of stakeholders—both internal (employees) and external (investors, government bodies) to evaluate organizational operations.

The Financial Accounting Standards Board (FASB) has influenced financial accounting since its inception in 1973.
- Its mission is to establish and enhance standards for guidance and education in financial accounting and reporting.
The emergence of accounting scandals led to increased federal oversight through the Securities and Exchange Commission (SEC)’s Public Company Accounting Oversight Board (PCAOB).
- PCAOB can issue disciplinary orders against firms or individuals to prohibit them from practicing accounting.

Accounting is referred to as the financial “language” organizations use for tracking funds and budgeting.
Scandals like Enron and Worldcom demonstrated significant failings in adherence to Generally Accepted Accounting Principles (GAAP), leading to legislation like the Sarbanes-Oxley Act for stricter accounting practices.

Public Accountants: Certified Public Accountants (CPAs) serve various roles including preparing financial records, tax returns, and corporate audits.
- Typically self-employed or part of the “Big Four” accounting Firms: Ernst & Young, KPMG, Deloitte, PricewaterhouseCoopers.
- Growing field includes forensic accountants who analyze financial documents for fraud.
Private Accountants: Employed by organizations to manage financial statements internally.
- May achieve Certified Management Accountant (CMA) certification, indicating deeper managerial knowledge.

Bookkeeping is limited to routine transaction recording, while accounting involves broader analysis and interpretation of financial data.

Internal Uses: Used by management for planning, directing organizational activities. Key concept is cash flow—movement of cash within the organization.
- Managerial accountants aid in budgeting (forecasts of expenses and income).
External Uses: Used for reporting financial performance to stakeholders—creditors, stockholders, regulatory bodies, etc.
- Importance of preparing annual reports which summarize financial health and growth for potential investors.

Accounting Cycle:
1. Examine Source Documents - Transactions are recorded in evidence forms like sales slips.
2. Record Transactions - In journals, detailing time-ordered account transactions.
3. Post Transactions - Transfer records from journal to ledger.
4. Prepare Financial Statements - Based on ledger accounts, once balances are confirmed.

Assets = Liabilities + Owners’ Equity
Illustrates the relationship between a firm's economic resources (assets), debts (liabilities), and residual interest owned by shareholders (equity).

Income Statement: Indicates profitability over time—revenues minus all expenses. Represents net earnings or losses.
- Components include: revenues, cost of goods sold, gross profit, operating income, net income.
- Net income formula:
  Net ext{ } income = Revenues - Expenses
Balance Sheet: Snapshot of financial position—what a company owns vs. owes at a specific point in time.
- Assets must equal liabilities plus owners’ equity.
Statement of Cash Flows: Details cash generation and usage over time, delineated into cash from operating, investing and financing activities.

Profitability Ratios: Measure operational income relative to assets and equity.
- Profit Margin: Net income divided by sales.
- Return on Assets (ROA): Net income divided by total assets.
- Return on Equity (ROE): Net income divided by stockholders’ equity.
Asset Utilization Ratios: Reflect how efficiently a company uses its assets to generate revenue.
- Receivables Turnover Ratio: Sales divided by accounts receivable.
- Inventory Turnover Ratio: Sales divided by inventory.
- Total Asset Turnover: Sales divided by total assets.
Liquidity Ratios: Indicate capability to cover short-term obligations.
- Current Ratio: Current assets divided by current liabilities.
- Quick Ratio: Current assets minus inventory divided by current liabilities.
Debt Utilization Ratios: Assess reliance on debt for financing.
- Debt to Total Assets Ratio: Total debt divided by total assets.
- Times Interest Earned Ratio: Operating income divided by interest expense.

Earnings per Share (EPS): Reflects company's net income attributable to each outstanding share.
Dividends per Share: Portion of earnings distributed to shareholders, measured against outstanding shares.

Importance of integrity and ethics in accounting processes for establishing trust and transparency among stakeholders.
Compliance with accounting principles is mandated to protect against corporate fraud and enhance financial reporting credibility.

Demand for Accountants: Expected growth of 10% with competitive salary averaging $69,350.
Positions available across various sectors, emphasizing the necessity for further education and certifications in accounting.