Cost Management

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14
Understanding Financial Statements
Part One Financial Accounting

• The McGraw-Hill Companies, Inc., 1999

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Who are auditor?
Slide 14-1

• Independent, outside public accountants
• Certified public accountants (CPAs) who meet
  prescribed professional standards
• Licensed to practice by the state in which they
  do business
• Their task is to examine financial statements
  (including notes) and to express an opinion

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What is the auditors opinion?
Slide 14-2

• It is a paragraph required by the AICPA
  expressing the results of the auditors
  examination of the financial statements
• Under certain circumstances, additional
  paragraphs are required

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Qualified Opinion
Slide 14-3
Qualification may occur for any of three reasons

• A lack of consistency
• Existence of a major uncertainty
• Doubt as to the entitys ability to continue as a
  going concern

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Qualified Opinion
Slide 14-4
If not justified, it is a violation of consistency
Consistency A company changed an accounting
method from the method used in the preceding year.
Uncertainty Auditors are required to call
attention to major uncertainties in an additional
paragraph following the opinion paragraph,
without making a prediction of the eventual
outcome.
Going-Concern Doubt Auditors determine if there
is substantial doubt about the companys ability
to continue as a going concern over the next year.
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Disclaimer
Slide 14-5
I cant issue an opinion... Ill have to issue
an disclaimer.
A disclaimer may result because limitations were
placed on the scope of the audit by management.
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Adverse Opinion
Slide 14-6
If the auditors conclude than the financial
statements do not present fairly the situation,
they write an adverse opinion.
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Notes to Financial Statements
Slide 14-7
Typical notes to financial statements provide

• Summaries of the accounting policies the company
  has followed in preparing the statement
• Details on long-term debt
• Description of stock option plans
• Description of postretirement benefits
• Details about the composition of inventories and
  depreciable assets
• Discussion of major contingencies
• Discussion of the companys financial condition
  and results of operations

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Segment Reporting
Slide 14-8
For each operating segment, the company reports

• Revenues from external and intercompany customers
• Operating profit or loss
• Interest expense
• Identifiable assets, including depreciation
  expense on these assets

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Basic Accounting Criteria
Slide 14-9

• Accounting information should be relevant
• Accounting information should be objective
• The reporting of accounting information should be
  feasible

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Basic Financial Accounting Concepts
Slide 14-10
Money Measurement Accounting records only those
facts that can be expressed in monetary terms.
Entity Accounts are kept for entities, as
distinguished from the persons who are associated
with those entities.
Going Concern Accounting assumes that an entity
will continue to operate indefinitely and that it
is not about to be liquidated.
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Basic Financial Accounting Concepts
Slide 14-11
Cost An asset is ordinarily entered in the
accounts at the amount paid to acquire it.
Dual Aspect The total amount of assets equals the
total amount of liabilities and owners equity.
Accounting Period Accounting measures activities
for a specified interval of time, usually one
year.
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Basic Financial Accounting Concepts
Slide 14-12
Conservatism Revenues are recognized only when
they are reasonably certain, whereas expenses are
recognized as soon as they are reasonably
possible.
Realization The amount recognized as revenue is
the amount that is reasonably certain to be
realized, that is, paid by customers.
Matching When a given event affects both revenues
and expenses, the effect on each should be
recognized in the same accounting period.
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Basic Financial Accounting Concepts
Slide 14-13
Consistency Once an entity has decided on a
certain accounting method, it should use the same
method for all subsequent events of the same
character unless it has a sound reason to change
methods.
Materiality Insignificant events may be
disregarded, but there must be full disclosure of
all important information.
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Accounting Alternatives
Slide 14-14
Differences in how certain transactions may be
recorded result from

• Requirements imposed by regulatory agencies in
  certain industries
• The latitude that exists within GAAP
• Judgments and estimates that must be made in
  applying a given principle

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Accounting Alternatives
Slide 14-15
A business is a complex organism, so there has to
been some diversity. The consistency concept
prevents diversity from becoming chaos.
Should all the diversity in accounting
be permitted?
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Inherent Limitations
Slide 14-16
Accounting has two inherent limitations that no
foreseeable accounting practice can overcome.

• Accounting reports are necessarily monetary
• They are necessarily influenced by estimates of
  future events

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Income Statement
Slide 14-17
The income statement is the dominant
financial statement.
CLOUD, INC.
Income Statement For the year ended December 31,
1998
Sales 250,000 Cost of goods sold 130,000 Gross
margin 120,000 Operating expenses Rent 20,000
Wages 35,000 Utilities 14,000 Advertising 6,000
Supplies 3,000 Depreciation 4,000
Total expenses 82,000 Income for
taxes 38,000 Income taxes 15,000 Net
income 23,000
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Effect on Income of Alternative Practices
Slide 14-18
Income Statement
Future years
Current year
Next year
Expense (period cost)
1,000
Cost item 1,000
?
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Effect on Income of Alternative Practices
Slide 14-19
Income Statement
Future years
Current year
Next year
Expense (period cost)
1,000
Cost item 1,000
Product cost
?
400 600
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Effect on Income of Alternative Practices
Slide 14-20
Income Statement
Future years
Current year
Next year
Expense (period cost)
1,000
Cost item 1,000
Product cost
?
400 600
Capital cost
0 100 100 100
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Types of Balance Sheet Items
Slide 14-21

• Monetary assets and liabilities
• Unexpired costs
• Inventories
• Investments
• Other liabilities and owners equity

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Chapter 14
The End