chapter14
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Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 1999
Understanding Financial Statements
© The McGraw-Hill Companies, Inc., 1999
14Part One: Financial Accounting
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 1999
• 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
• 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
Who are auditor? Slide 14-1
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• 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
What is the auditors’ opinion? Slide 14-2
In our opinion, such financial statements present fairly, in all material respects, the financial position of X Company as of
December 31, 1998, and 1997, and the results of its operations for each of the three years in the period ended December 31, 1998, in
conformity with generally accepted accounting principles.
Standard Opinion ParagraphStandard Opinion Paragraph
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A lack of consistencyExistence of a major
uncertaintyDoubt as to the entity’s ability
to continue as a going concern
A lack of consistencyExistence of a major
uncertaintyDoubt as to the entity’s ability
to continue as a going concern
Qualified Opinion Slide 14-3
Qualification may occur for any of three reasons:
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© The McGraw-Hill Companies, Inc., 1999
Qualified Opinion Slide 14-4
Consistency
A company changed an accounting method from the method used in the
preceding year.
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.
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
company’s ability to continue as a going concern over the next year.
Going-Concern Doubt
Auditors determine if there is substantial doubt about the
company’s ability to continue as a going concern over the next year.
If not If not justified, it is justified, it is a violation of a violation of consistencyconsistency
If not If not justified, it is justified, it is a violation of a violation of consistencyconsistency
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 1999
Disclaimer Slide 14-5
I can’t issue an opinion... I’ll
have to issue an disclaimer.
A disclaimer may result because
limitations were placed on the scope
of the audit by management.
Irwin/McGraw-Hill
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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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• 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 company’s financial condition and
results of operations
Notes to Financial Statements Slide 14-7
Typical notes to financial statements provide:
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Revenues from external and intercompany customers
Operating profit or loss Interest expense Identifiable assets, including depreciation expense
on these assets
Revenues from external and intercompany customers
Operating profit or loss Interest expense Identifiable assets, including depreciation expense
on these assets
Segment Reporting Slide 14-8
For each operating segment, the company reports:
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Accounting information should be relevant Accounting information should be
objective The reporting of accounting information
should be feasible
Basic Accounting Criteria Slide 14-9
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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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
Materiality
Insignificant events may be disregarded, but there must
be full disclosure of all important information.
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• 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
• 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
Accounting Alternatives Slide 14-14
Differences in how certain transactions may be recorded result from:
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Accounting Alternatives Slide 14-15
Should allthe diversity in accounting be
permitted?
Should allthe diversity in accounting be
permitted?
A business is a complexorganism, so there has to been some diversity. The
consistency concept preventsdiversity from becoming chaos.
A business is a complexorganism, so there has to been some diversity. The
consistency concept preventsdiversity from becoming chaos.
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 1999
• Accounting reports are necessarily monetary
• They are necessarily influenced by estimates of future events
Inherent Limitations Slide 14-16
Accounting has two inherent limitations that
no foreseeable accountingpractice can overcome.
Accounting has two inherent limitations that
no foreseeable accountingpractice can overcome.
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Income Statement Slide 14-17
CLOUD, INC. Income StatementFor the year ended December 31, 1998
Sales $250,000Cost of goods sold 130,000Gross margin 120,000Operating expenses:
Rent $20,000Wages 35,000Utilities 14,000Advertising 6,000Supplies 3,000Depreciation 4,000 Total expenses 82,000
Income for taxes 38,000Income taxes 15,000Net income $23,000
The income statementis the dominant financial
statement.
The income statementis the dominant financial
statement.
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 1999
Effect on Income of Alternative Practices Slide 14-18
Cost itemCost item$1,000$1,000
Cost itemCost item$1,000$1,000 ?
Expense (period cost)
Income Statement
Current year
Next year
Future years
$1,000
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 1999
Effect on Income of Alternative Practices Slide 14-19
Cost itemCost item$1,000$1,000
Cost itemCost item$1,000$1,000 ?
Product cost
Income Statement
Current year
Next year
Future years
$1,000
$400 $600
Expense (period cost)
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 1999
Effect on Income of Alternative Practices Slide 14-20
Cost itemCost item$1,000$1,000
Cost itemCost item$1,000$1,000 ?
Product cost
Capital cost
Income Statement
Current year
Next year
Future years
$1,000
$400 $600
$0 $100 $100 $100
Expense (period cost)
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© The McGraw-Hill Companies, Inc., 1999
Monetary assets and liabilities
Unexpired costs Inventories Investments Other liabilities and
owners’ equity
Monetary assets and liabilities
Unexpired costs Inventories Investments Other liabilities and
owners’ equity
Types of Balance Sheet Items Slide 14-21
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 1999
Chapter 14
The End
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