Chapter 5
Communicating and Interpreting Accounting Information Irwin/McGraw-Hill
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Players in the Accounting Communication Process
Management Management Preparation Preparation CFO, CFO,CEO, CEO,Accounting AccountingStaff Staff Guided Guidedby byGAAP GAAP Independent IndependentAuditors Auditors Verification Verification Partners, Partners,Managers, Managers,Staff Staff Guided Guidedby byGAAS GAAS
An An unqualified unqualified opinion opinion states states that that the the financial financial statements statements are are fair fair presentations presentations in in all all material material respects respects in in conformity conformity with with GAAP. GAAP. Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2001
Players in the Accounting Communication Process
Management Management Preparation Preparation CFO, CFO,CEO, CEO,Accounting AccountingStaff Staff Guided Guidedby byGAAP GAAP Independent IndependentAuditors Auditors Verification Verification Partners, Partners,Managers, Managers,Staff Staff Guided Guidedby byGAAS GAAS
Information Information Intermediaries Intermediaries Analysisand andAdvice Advice Analysis Financialanalysis, analysis, Financial Informationservices services Information
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Financial Financial analysts analysts make make predictions predictions concerning concerning companies’ companies’ future future earnings earnings and and stock stock prices. prices. © The McGraw-Hill Companies, Inc., 2001
Players in the Accounting Communication Process
Management Management Preparation Preparation CFO, CFO,CEO, CEO,Accounting AccountingStaff Staff Guided Guidedby byGAAP GAAP Independent IndependentAuditors Auditors Verification Verification Partners, Partners,Managers, Managers,Staff Staff Guided Guidedby byGAAS GAAS
Information Information Intermediaries Intermediaries Analysisand andAdvice Advice Analysis Financialanalysis, analysis, Financial Informationservices services Information
Government Government Regulators Regulators Verification Verification SEC SEC Guided Guidedby bySEC SECregs. regs. Users Users Analysis Analysisand andDecision Decision Investors, Investors,Lenders, Lenders,etc. etc.
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Public companies only © The McGraw-Hill Companies, Inc., 2001
Guiding Principles for Communicating Useful Information Primary PrimaryObjective Objectiveof ofExternal ExternalFinancial FinancialReporting Reporting To economic information to external users for Toprovide provide economic information to external users for The principle The full-disclosure full-disclosure principle decision decisionmaking. making.
requires requires (a) aa complete set Primary Characteristics (a)Qualitative complete set of of Primary Qualitative Characteristics Relevance: and and financial statements Relevance: Timely Timely andPredictive Predictive andFeedback FeedbackValue Value financial statements Reliability: Reliability: Accurate, Accurate,Unbiased, Unbiased,and andVerifiable Verifiable and and (b) notes to the financial (b) notes to the financial Secondary Qualitative Characteristics Secondary Qualitative Characteristics statements. statements. Comparability: Comparability: Across Acrossbusinesses businesses Consistency: Consistency: Over Overtime time
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The Disclosure Process Press Press Releases Releases are are used used to to announce announce quarterly quarterly and and annual annual earnings earnings as as soon soon as as the the verified verified figures figures are are available. available. Real RealWorld WorldExcerpt Excerpt The TheSan SanDiego DiegoUnion-Tribune, Union-Tribune,January January30, 30,1998 1998 Shareholders Shareholdersdisappointed disappointedby byCallaway CallawayGolf’s Golf’slower-thanlower-thanexpected expectedearnings earningswhacked whackedthe thestock stockyesterday, yesterday,sending sendingthe the price priceabout about10 10percent percentlower lowerin inaasell-off sell-offtriggered triggeredby bythe the company’s company’sfirst firstfinancial financialbogey. bogey....... Irwin/McGraw-Hill
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Annual Reports For For privately privately held held companies, companies, annual annual reports reports are are simple simple documents documents that that include: include: Four Four basic basic financial financial statements statements !! Related Related footnotes footnotes !! Report Report of of independent independent accountants accountants (auditor’s (auditor’s opinion) opinion) !!
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Annual Reports For For public public companies, companies, annual annual reports reports are are more more elaborate elaborate with with greater greater SEC SEC requirements: requirements: !!
A A Nonfinancial Nonfinancial Section Section AAletter letterto tothe thestockholders, stockholders,aadescription descriptionof of management’s management’sphilosophy, philosophy, products, products, successes, successes,etc. etc.
!!
A A Financial Financial Section Section See Seenext nextslide slidefor foraadetailed detailedlisting listing......
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Annual Reports The Financial Section of a public company’s annual report includes: •• Summarized Summarizedfinancial financial data data •• Management ManagementDiscussion Discussion and andAnalysis Analysis •• The Thefour fourbasic basicfinancial financial statements statements •• Notes Notes •• Independent Independent Accountant’s Accountant’sReport Report Irwin/McGraw-Hill
•• Recent Recentstock stockprice price information information •• Summaries Summaries of ofthe the unaudited unauditedquarterly quarterly financial financialdata data •• Lists Listsof ofdirectors directorsand and officers officersof ofthe thecompany company and andrelevant relevantaddresses addresses © The McGraw-Hill Companies, Inc., 2001
SEC Reports Form Form10-K 10-KAnnual Annual Report Report •Due •Due within within 90 90 days daysof ofthe thefiscal fiscal year-end year-end •Must •Mustbe beaudited audited
Form Form10-Q 10-Q Quarterly QuarterlyReport Report •Due •Due within within 45 45 days daysof ofthe theend endof of the thequarter quarter •Can •Canbe beunaudited unaudited
Form Form8-K 8-KCurrent CurrentReport Report •Due •Duewithin within15 15days daysof ofthe theevent eventdate date •Can •Canbe beunaudited unaudited Irwin/McGraw-Hill
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Financial Statement Formats Let’s look at the asset section of a classified balance sheet.
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Consolidated Balance Sheet December 31, 1997 1996
(in thousands, except share data and per shate data)
ASSETS Current assets: Cash & cash equivalents Accounts receivable, net Inventories, net Deferred taxes Other current assets Total current assets
$
Property, plant and equipment, net Intangible assets, net Other assets $ Irwin/McGraw-Hill
26,204 $ 124,470 97,094 23,810 10,208 281,786
108,457 74,477 98,333 25,948 4,298 311,513
142,503 112,141 25,284 561,714 $
91,346 4,277 21,292 428,428
© The McGraw-Hill Companies, Inc., 2001
Consolidated Balance Sheet (in thousands, except share data and per shate data)
ASSETS Current assets: Cash & cash equivalents Accounts receivable, net Inventories, net Deferred taxes Other current assets Total current assets Property, plant and equipment, net Intangible assets, net Other assets
December 31, 1997 1996
Current Current assets assets are are assets assets that that $will $ 108,457 be will26,204 be turned turned 124,470 74,477 into cash or into cash or 97,094 98,333 expire (be expire (be used used 23,810 25,948 4,298 up) within up)10,208 within the the 281,786of one 311,513 longer longer of one year or year or the the91,346 142,503 operating 112,141 cycle. 4,277 operating cycle. $
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25,284 561,714 $
21,292 428,428
© The McGraw-Hill Companies, Inc., 2001
Consolidated Balance Sheet (in thousands, except share data and per shate data)
ASSETS Current assets: Cash & cash equivalents Accounts receivable, net Inventories, net Deferred taxes Other current assets Total current assets Property, plant and equipment, net Intangible assets, net Other assets
Irwin/McGraw-Hill
Property, plant Property, plant December 31, and equipment and equipment 1997 1996 includes includes assets with assets with $ 26,204 $ 108,457 useful of 124,470lives useful lives74,477 of 97,094 98,333 more than one more than one 23,810 25,948 year acquired year acquired 10,208 4,298 281,786 311,513 for use for use in in the the business business91,346 142,503 112,141than 4,277 rather rather than for for 25,284 21,292 resale. resale. $ 561,714 $ 428,428 © The McGraw-Hill Companies, Inc., 2001
Consolidated Balance Sheet December 31, 1997 1996
(in thousands, except share data and per shate data)
ASSETS Current assets: Cash & cash equivalents Accounts receivable, net Inventories, net Deferred taxes Other current assets Total current assets Property, plant and equipment, net Intangible assets, net Other assets
Other assets $Other 26,204assets $ 108,457 124,470 74,477 may include may include 97,094 98,333 intangible intangible 23,810 25,948 10,208such 4,298 assets as assets such as 281,786 311,513 patents, patents, 142,503 91,346 goodwill, goodwill, 112,141 4,277 copyrights, etc. copyrights, etc. 25,284 21,292 $
Irwin/McGraw-Hill
561,714 $
428,428
© The McGraw-Hill Companies, Inc., 2001
Let’s look at the liability section of a classified balance sheet.
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© The McGraw-Hill Companies, Inc., 2001
Consolidated Balance Sheet December 31, 1997 1996
(in thousands, except share data and per shate data
LIABILITIES & STOCKHOLDERS" EQUITY Current Liabilities: Accounts payable & accrued expenses Accrued employee compensation & benefits Accrued warranty expense Income taxes payable Total current liabilities Long-term liabilities (Note 7)
Irwin/McGraw-Hill
$
30,063 14,262 28,059 72,384 7,905
$
14,996 16,195 27,303 2,558 61,052 5,109
© The McGraw-Hill Companies, Inc., 2001
Consolidated Balance Sheet December 31, 1997 1996
(in thousands, except share data and per shate data
LIABILITIES & STOCKHOLDERS" EQUITY Current Liabilities: Accounts payable & accrued expenses Accrued employee compensation & benefits Accrued warranty expense Income taxes payable Total current liabilities Long-term liabilities (Note 7)
$
30,063 14,262 28,059 72,384 7,905
$
14,996 16,195 27,303 2,558 61,052 5,109
Current Current liabilities liabilities are are obligations obligations that that will will be be paid paid with with current current assets, assets, normally normally within within one one year. year.
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Consolidated Balance Sheet (in thousands, except share data and per shate data
December 31, 1997 1996
LIABILITIES & STOCKHOLDERS" EQUITY Current Liabilities: Accounts payable & accrued expenses
Long-term debts Long-term liabilities liabilities are are debts that $ 30,063 $ that 14,996 Accrued employee have maturity dates extending have maturity dates extending 14,262 16,195 compensation & benefits beyond one year balance Accrued warranty 28,059 27,303 beyond oneexpense year from from the the balance Income taxes payable 2,558 sheet date. sheet Total current liabilitiesdate. 72,384 61,052 Long-term liabilities (Note 7)
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7,905
5,109
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Let’s look at the stockholders’ equity section of a classified balance sheet.
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Consolidate d Balance She e t December 31, 1997 1996
Contributed Contributed capital capital is is often often shown shown in in two two LIABILITIES & STOCKHOLDERS" EQUITY separate accounts . . . Shareholders' equity: separate accounts . . . "Common stock Preferred Stock, $.01 par value, 3,000,000 "Common stock sahres authorized, none issued and #Paid-in outstandingcapital at December 31, 1997 and #Paid-in capital 1996 (in t housands, except share dat a and per shat e dat a)
Common stock, $.01 par value, 240,000,000 shares authorized, 74,251, 664 and 72,855,222 issued and outstanding at December 31, 1997 and 1996 (Note 4) Paid-in capital
$
Accumulated other comprehensive income Retained Earnings Total shareholders' equity $
Irwin/McGraw-Hill
743 182,513
$
729 123,189
(559) 298,728 481,425 561,714 $
236 238,113 362,267 428,428
© The McGraw-Hill Companies, Inc., 2001
Consolidate d Balance She e t December 31, 1997 1996
(in t housands, except share dat a and per shat e dat a)
LIABILITIES & STOCKHOLDERS" EQUITY Shareholders' equity: Preferred Stock, $.01 par value, 3,000,000 sahres authorized, none issued and outstanding at December 31, 1997 and 1996
Comprehensive Comprehensive income income includes includes gains gains and and losses losses not not included included in in the the 743 $ 729 computation computation of of net net$ income. income. 182,513 123,189
Common stock, $.01 par value, 240,000,000 shares authorized, 74,251, 664 and 72,855,222 issued and outstanding at December 31, 1997 and 1996 (Note 4) Paid-in capital
Accumulated other comprehensive income Retained Earnings Total shareholders' equity $
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(559) 298,728 481,425 561,714 $
236 238,113 362,267 428,428
© The McGraw-Hill Companies, Inc., 2001
Consolidate d Balance She e t December 31, 1997 1996
(in t housands, except share dat a and per shat e dat a)
LIABILITIES & STOCKHOLDERS" EQUITY Shareholders' equity: Preferred Stock, $.01 par value, 3,000,000 sahres authorized, none issued and outstanding at December 31, 1997 and 1996 Common stock, $.01 par value, 240,000,000 shares authorized, 74,251, 664 and 72,855,222 issued and outstanding at December 31, 1997 and 1996 (Note 4) Paid-in capital
Retained Retained earnings earnings is is the the accumulated accumulated $ 743 $the 729 earnings less earnings of of the the company company less the 182,513 123,189 accumulated dividends declared. accumulated dividends declared. Accumulated other comprehensive income (559) 236 Retained Earnings Total shareholders' equity $
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298,728 481,425 561,714
$
238,113 362,267 428,428
© The McGraw-Hill Companies, Inc., 2001
Consolidate d Balance She e t December 31, 1997 1996
(in t housands, except share dat a and per shat e dat a)
LIABILITIES & STOCKHOLDERS" EQUITY Shareholders' equity: Preferred Stock, $.01 par value, 3,000,000 sahres authorized, none issued and outstanding at December 31, 1997 and 1996 Common stock, $.01 par value, 240,000,000 shares authorized, 74,251, 664 and 72,855,222 issued and outstanding at December 31, 1997 and 1996 (Note 4) Paid-in capital
$
Accumulated other comprehensive income Retained Earnings Total shareholders' equity $
Irwin/McGraw-Hill
743 182,513
$
729 123,189
(559) 298,728 481,425 561,714 $
236 238,113 362,267 428,428
© The McGraw-Hill Companies, Inc., 2001
Liquidity Liquidity refers to a company’s ability to meet its current maturing debts. Tests of liquidity include: Current Assets - Current Liabilities Working Capital
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Current Assets ÷ Current Liabilities Current Ratio
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Debt Contracts When companies enter into a debt contract, they often agree to specific restrictions to protect the creditors. Examples include maintaining a specified cash balance or current ratio.
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Classified Income Statement Income Income statements statements have have up up to to five five major major sections: sections: " "Continuing Continuing operations operations # #Discontinued Discontinued operations operations $ $Extraordinary Extraordinary items items % %Cumulative Cumulative effect effect of of changes changes in in
accounting accounting methods methods & &Earnings Earnings per per share share Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2001
Consolidated Statement of Income (in thous ands , except per s hare data) 1997 1996 Net sales $ 842,927 100% $ 678,512 100% Cost of goods sold 400,127 47% 317,353 47% Gross profit 442,800 53% 361,159 53% Selling expenses 120,589 14% 80,701 12% General & Admin. expenses 70,724 8% 74,476 11% 4% 16,154 2% Research and development costs 30,298 Litigation settlement 12,000 1% Income from operations 209,189 25% 189,828 28% Interest and other income, net 4,576 5,767 Income before income taxes 213,765 25% 195,595 29% Provision for income taxes 81,061 73,258 Net income $ 132,704 16% $ 122,337 18% Earnings per common share Basic Diluted Common equivalent shares Basic Diluted Irwin/McGraw-Hill
$ $
1.94 1.85 68,407 71,698
$ $
1.83 1.73 66,832 70,661
© The McGraw-Hill Companies, Inc., 2001
Consolidated Statement of Income (in thous ands , except per s hare data)
Income Incomefrom from operations operationsis is computed computedby by subtracting subtracting operating operating expenses expensesfrom from gross grossprofit. profit.
1997 1996 Net sales $ 842,927 100% $ 678,512 100% Cost of goods sold 400,127 47% 317,353 47% Gross profit 442,800 53% 361,159 53% Selling expenses 120,589 14% 80,701 12% General & Admin. expenses 70,724 8% 74,476 11% 4% 16,154 2% Research and development costs 30,298 Litigation settlement 12,000 1% Income from operations 209,189 25% 189,828 28% Interest and other income, net 4,576 5,767 Income before income taxes 213,765 25% 195,595 29% Provision for income taxes 81,061 73,258 Net income $ 132,704 16% $ 122,337 18% Earnings per common share Basic Diluted Common equivalent shares Basic Diluted
Irwin/McGraw-Hill
$ $
1.94 1.85 68,407 71,698
$ $
1.83 1.73 66,832 70,661
© The McGraw-Hill Companies, Inc., 2001
Consolidated Statement of Income (in thous ands , except per s hare data)
The Thepercentages percentages are arebased basedon on Net Netsales saleseach each year yearand andare are used usedto toproduce produce Common-sized Common-sized Income Income Statements. Statements.
Irwin/McGraw-Hill
1997 1996 Net sales $ 842,927 100% $ 678,512 100% Cost of goods sold 400,127 47% 317,353 47% Gross profit 442,800 53% 361,159 53% Selling expenses 120,589 14% 80,701 12% General & Admin. expenses 70,724 8% 74,476 11% 4% 16,154 2% Research and development costs 30,298 Litigation settlement 12,000 1% Income from operations 209,189 25% 189,828 28% Interest and other income, net 4,576 5,767 Income before income taxes 213,765 25% 195,595 29% Provision for income taxes 81,061 73,258 Net income $ 132,704 16% $ 122,337 18% Earnings per common share Basic Diluted Common equivalent shares Basic Diluted
$ $
1.94 1.85 68,407 71,698
$ $
1.83 1.73 66,832 70,661
© The McGraw-Hill Companies, Inc., 2001
Continuing Operations Now, Now, let’s let’s look look at at two two common common formats formats for for presenting presenting the the continuing continuing operations operations section. section. "Single-step "Single-step #Multiple-step #Multiple-step
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Single Step (in thousands, except per share data) 1997 Net sales $ 842,927 Interest income and other income, net 4,576 Total revenues 847,503 Cost of goods sold 400,127 Selling expenses 120,589 General & Administrative expenses 70,724 Research and development costs 30,298 Litigation settlement 12,000 Total expenses 633,738 Income before income taxes 213,765 Provision for income taxes 81,061 Net income $ 132,704
Irwin/McGraw-Hill
In Inthe thesingle-step single-stepformat, format, all allrevenues, revenues,income, income, and andgains gainsare arelisted listedfirst. first. Costs, Costs,expenses, expenses,and and losses losseswere werelisted listed second secondand andthen then subtracted subtractedfrom fromTotal Total revenues revenuesto toget getto toNet Net income. income.
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Net Netsales salesare aregross grosssales salesminus minus any anydiscounts, discounts,returns, returns,and and allowances allowancesduring duringthe theperiod. period. Cost Costof ofgoods goodssold soldis isthe thecost cost of ofinventory inventorysold soldduring duringthe the period. period. Selling Sellingexpenses expensesinclude includeall all amounts amountsincurred incurredrelated relatedto to sales salesactivities. activities. General General&&admin. admin.expenses expenses include includeall allamounts amountsincurred incurredfor for the theoverall overallbusiness. business. The Theprovision provisionfor forincome incometaxes taxes represents representsthe thetax taxexpense expense related relatedto tothe thecontinuing continuing operations operationsof ofthe thecompany. company. Irwin/McGraw-Hill
Multiple Step (in thousands, except per share data) Net sales Cost of goods sold Gross Profit Selling expenses General & Administrative expenses Research and development costs Litigation settlement Income from Operations Interest income and other income, net
$
Income before income taxes Provision for income taxes Net Income $
1997 842,927 400,127 442,800 120,589 70,724 30,298 12,000 209,189 4,576 213,765 81,061 132,704
© The McGraw-Hill Companies, Inc., 2001
Classified Income Statement Now Now that that we we have have discussed discussed the the continuing continuing operations operations section, section, let’s let’s discuss discuss the the other other major major sections sections of of the the income income statement. statement.
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Discontinued Operations Sale Sale or or abandonment abandonment of of aa segment segment of of aa business. business.
Income Incomeor orloss losson on segment’s segment’soperation operationfor for the theperiod. period.
Gain Gainor orloss losson on disposal disposalof ofthe the segment. segment.
Show net of tax effect. Irwin/McGraw-Hill
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Extraordinary Items
Unusual
Infrequent
Show net of tax effect. Irwin/McGraw-Hill
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Cumulative Effect of Changes in Accounting Methods GAAP GAAP Method Method
Change to Alternative
GAAP GAAP Method Method
Changes Changes must must be be to to aa preferable preferable method method and and must must be be disclosed disclosed in in notes notes to to financial financial statements. statements.
Show net of tax effect. Irwin/McGraw-Hill
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Earnings Per Share (EPS)
EPS =
Net Income Available to Common Shareholders
Weighted Average Number of Shares ÷ Outstanding During the Reporting Period
See Example
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Consolidated Statement of Income (in thous ands , except per s hare data)
Earnings per share
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1997 1996 Net sales $ 842,927 100% $ 678,512 100% Cost of goods sold 400,127 47% 317,353 47% Gross profit 442,800 53% 361,159 53% Selling expenses 120,589 14% 80,701 12% General & Admin. expenses 70,724 8% 74,476 11% 4% 16,154 2% Research and development costs 30,298 Litigation settlement 12,000 1% Income from operations 209,189 25% 189,828 28% Interest and other income, net 4,576 5,767 Income before income taxes 213,765 25% 195,595 29% Provision for income taxes 81,061 73,258 Net income $ 132,704 16% $ 122,337 18% Earnings per common share Basic Diluted Common equivalent shares Basic Diluted
$ $
1.94 1.85 68,407 71,698
$ $
1.83 1.73 66,832 70,661
© The McGraw-Hill Companies, Inc., 2001
The End of Chapter 5 Maybe I should issue a press release to disclose my identity!
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