Kế toán tài chính 2 - Chapter 6: Financial reporting and analysis

Financial Reporting and AnalysisMultimedia Slides by: Gail A. Mestas, MAcc, New Mexico State UniversityChapter 6Learning ObjectivesState the objectives of financial reporting.State the qualitative characteristics of accounting information and describe their interrelationships.Define and describe the conventions of comparability and consistency, materiality, conservatism, full disclosure, and cost-benefit.2Copyright © Houghton Mifflin Company. All rights reserved.Learning Objectives (cont’d)Explain management’s responsibility for ethical financial reporting and define fraudulent financial reporting.Identify and describe the basic components of a classified balance sheet.Prepare multistep and single-step classified income statements.Evaluate liquidity and profitability using classified financial statements.3Copyright © Houghton Mifflin Company. All rights reserved.Objectives of Financial AccountingObjective 1State the objectives of financial reporting4Copyright © Houghton Mifflin Company. All rights reserved.Purpose of Financial AccountingTo provide financial information about a company, particularly its ability to generate adequate cash flowsInterested parties includeInvestorsInterested in returns from dividends and the market price of their investmentCreditorsInterested in a company’s ability to repay debt5Copyright © Houghton Mifflin Company. All rights reserved.Objectives of Financial InformationThe Financial Accounting Standards Board (FASB) has developed three objectives of financial reportingThese objectives are based on the information needs of users and the general business environment6Copyright © Houghton Mifflin Company. All rights reserved.Objectives of Financial InformationTo furnish information that is useful in making investment and credit decisionsInformation that can help present and potential investors and creditors make rational investment and credit decisions To provide information useful in assessing cash flow prospectsInformation to help users judge the amounts, timing, and risk of expected cash receipts from dividends or interest and the proceeds from the sale, redemption, or maturity of stocks and loansTo provide information about business resources, claims to those resources, and changes in themInformation about, and the effects of transactions on, the company’s assets, liabilities, and owner's equity7Copyright © Houghton Mifflin Company. All rights reserved.Financial StatementsBalance sheetIncome statementStatement of owner’s equityStatement of cash flowsFinancial statements are the most important outcome of the accounting systemThey communicate financial information gathered and processed in the accounting system to parties outside the business8Copyright © Houghton Mifflin Company. All rights reserved.Financial Statements (cont’d)Are general purpose because of their wide audienceAre external because their users are outside the businessAre often audited by outside accountants to increase confidence in their reliabilityManagers, who prepare the statements, potentially have a conflict of interest with investors and creditors, who invest in or lend money to the business9Copyright © Houghton Mifflin Company. All rights reserved.DiscussionWhat are the three objectives of financial reporting? According to the Financial Accounting Standards Board, the three objectives of financial reporting are: To furnish information useful in making investment and credit decisionsTo provide information useful in assessing cash flow prospectsTo provide information about business resources, claims to those resources, and changes in them10Copyright © Houghton Mifflin Company. All rights reserved.Qualitative Characteristics of Accounting InformationObjective 2State the qualitative characteristics of accounting information and describe their interrelationships11Copyright © Houghton Mifflin Company. All rights reserved.The Goal of Accounting InformationTo provide the basic data that different users need to make informed decisionsThe goal is an idealIn practice, accounting informationIs neither simple nor preciseRarely satisfies all criteriaOften results from approximate measuresBased on rules and conventions rather than exact amounts12Copyright © Houghton Mifflin Company. All rights reserved.Concepts to Facilitate Interpretation of Accounting InformationQualitative characteristics of accounting informationStandards for judging accounting information Generally accepted conventions for recording and reporting Simplify interpretation of accounting information13Copyright © Houghton Mifflin Company. All rights reserved.Qualitative Characteristics and the Conventions of Accounting Information14Copyright © Houghton Mifflin Company. All rights reserved.Qualitative Characteristics of Accounting Information are standards for judging accounting informationDeveloped to facilitate interpretation of accounting informationNecessary because approximate measures are used to produce the informationEstimatesClassificationsSummarizationsJudgmentsAllocations15Copyright © Houghton Mifflin Company. All rights reserved.Qualitative CharacteristicsUnderstandabilityPreparing financial statements in accordance with accepted practices is believed to generate information that is understandableThe decision maker (user) must judge what information to use, how to use it, and what it meansUsefulnessTo be useful, information must be relevant and reliable16Copyright © Houghton Mifflin Company. All rights reserved.RelevanceMeans that the information applies to the outcome of a decisionTo be relevant, information mustProvide feedbackHelp predict future conditionsBe timely17Copyright © Houghton Mifflin Company. All rights reserved.ReliabilityMeans that the user must be able to depend on the informationTo be reliable, information must beA faithful representationCredible and verifiable by independent partiesNeutral18Copyright © Houghton Mifflin Company. All rights reserved.DiscussionWhat are qualitative characteristics of accounting information, and why are they important? Qualitative characteristics are standards for judging the information that accountants give to decision makersAccountants try to provide information that is understandable and useful19Copyright © Houghton Mifflin Company. All rights reserved.Discussion (cont’d)Understandable means that the user is able to interpret the information Usefulness depends on the characteristics of relevance and reliability Relevance requires that the information give feedback, help make predictions, and be timelyReliability requires that the information represent what it is supposed to represent, and be credible, verifiable, and neutral20Copyright © Houghton Mifflin Company. All rights reserved.Conventions That Help in the Interpretation of Financial InformationObjective 3Define and describe the conventions of comparability and consistency, materiality, conservatism, full disclosure, and cost-benefit21Copyright © Houghton Mifflin Company. All rights reserved.ConventionsRules of thumbUsed by accountants when recording transactions and preparing financial statementsAid in the interpretation of financial statementsNecessary because of difficulties associated with financial statementsDifficulties result fromThe fact financial statements are based on estimatesThe application of accounting rules for recognition and allocation22Copyright © Houghton Mifflin Company. All rights reserved.Conventions (cont’d)Five conventions help in the interpretation of financial statementsComparability and consistencyMaterialityConservatismFull disclosureCost-benefit23Copyright © Houghton Mifflin Company. All rights reserved.ComparabilityMeans information is presented so that decision makers can recognize SimilaritiesDifferencesTrends Over different time periodsBetween companies24Copyright © Houghton Mifflin Company. All rights reserved.ConsistencyMeans constantly applying policies or principlesOnce an accounting procedure is adopted by a company, it must remain in use from one period to another, unless users are informed of a changeUsers can assume that no arbitrary changes in accounting measures and procedures have taken place when interpreting financial statements25Copyright © Houghton Mifflin Company. All rights reserved.Consistency (cont’d)Changes in accounting measures and procedures may become necessaryExample:A method of accounting for inventory may be changed because it is believed that the new method improves the matching of revenues and costsGenerally accepted accounting principles require that changes and their dollar effects be described in the notes to the financial statements26Copyright © Houghton Mifflin Company. All rights reserved.MaterialityRefers to the importance of an item or eventIf an item is relevant to the decisions a user of financial statements makes, it is materialIs normally determined by relating an item’s dollar value to an element of the financial statementsSome accountants believe an item that is 5% or more of net income is relevantDepends on the nature of the itemThe discovery of a bribe or theft, no matter what the amount involved, is considered material27Copyright © Houghton Mifflin Company. All rights reserved.ConservatismMeans that when there is uncertainty about which accounting procedure to use, the one that is least likely to overstate assets and income should be usedShould be used only when uncertainty existsIf used incorrectly, leads to incorrect and misleading financial statementsA common application is use of the lower-of-cost-or-market method of accounting for inventoriesIf market value > cost, use costIf market value < cost, use market value28Copyright © Houghton Mifflin Company. All rights reserved.Full DisclosureRequires that financial statements and their notes present all information relevant to usersFinancial statements should offer explanations needed to keep them from being misleadingMany disclosures are required by the SEC and other official bodiesOther disclosures are based on the judgment of management and the company accountantsIf too much information is disclosed, the notes impede rather than help understanding29Copyright © Houghton Mifflin Company. All rights reserved.Examples of Required DisclosuresChanges of accounting practicesAmount of depreciation expense on income statementAmount of accumulated depreciation on the balance sheetAccounting procedures used in preparing financial statementsImportant terms of the company’s debtCommitments and contingenciesImportant events taking place after the date of the statements30Copyright © Houghton Mifflin Company. All rights reserved.Cost-BenefitHolds that the benefits of providing accounting information should exceed the costs of providing itInformation must meet minimum levels of reliance and reliability to be usefulBeyond that, the FASB and SEC, who require information, and the accountant, who provides information, must judge the costs and benefits in each case31Copyright © Houghton Mifflin Company. All rights reserved.Costs and BenefitsCostsFall at first on the preparers of financial statementsUltimately are passed on to society in the form of pricesBenefitsReaped by both the preparers and users of financial statementsUltimately are passed on to society in the form of social benefits from more efficient allocation of resources32Copyright © Houghton Mifflin Company. All rights reserved.DiscussionWhat are the accounting conventions? The five conventions that help users interpret financial statements areComparability and consistencyMaterialityConservatismFull disclosureCost-benefit33Copyright © Houghton Mifflin Company. All rights reserved.Management’s Responsibility for Ethical ReportingObjective 4Explain management’s responsibility for ethical financial reporting and define fraudulent financial reporting34Copyright © Houghton Mifflin Company. All rights reserved.Fraudulent Financial Reporting is the intentional preparation of misleading financial statementsCan result fromThe distortion of recordsThe manipulation of inventory recordsFalsified transactionsFictitious sales or ordersThe misapplication of accounting principlesExpensing an item that should be treated as an asset35Copyright © Houghton Mifflin Company. All rights reserved.Incentives for Fraudulent Financial ReportingTo obtain a higher price when a company is soldTo meet the expectations of stockholdersTo obtain a loanPersonal gainAdditional compensationPromotionAvoidance of penalties for poor performance36Copyright © Houghton Mifflin Company. All rights reserved.Costs of Fraudulent Financial AccountingPersonal costs to those authorizing or preparing fraudulent financial statementsCriminal penaltiesFinancial lossOther parties affectedInvestorsLendersEmployeesCustomers37Copyright © Houghton Mifflin Company. All rights reserved.Responsibility for Ethical ReportingManagementUltimately, responsibility for ethical reporting falls on managementManagement must insist on honest and accurate financial reportingAchieved by maintaining a system of internal controls AccountantsMust maintain high ethical standardsAchieved by applying financial accounting concepts38Copyright © Houghton Mifflin Company. All rights reserved.Sarbanes-Oxley ActPassed by Congress in 2002In response to abuses in financial reporting by companies such as WorldCom and EnronOrders the SEC to draw up rules requiring chief executives and chief financial officers of publicly traded companies to file statements swearing that their company’s quarterly and annual statements are accurate and complete, based on their knowledge39Copyright © Houghton Mifflin Company. All rights reserved.DiscussionWho is responsible for preparing reliable financial statements, and what is a principal way of fulfilling the responsibility?Management is responsible for the preparation of reliable financial statements. Management fulfills its responsibility by maintaining a system of internal controls40Copyright © Houghton Mifflin Company. All rights reserved.Classified Balance SheetObjective 5Identify and describe the basic components of a classified balance sheet41Copyright © Houghton Mifflin Company. All rights reserved.Classified Financial Statements... are general purpose financial statements divided into useful subcategoriesClassifying often makes financial statements more usefulInvestors and creditors study the relationships among the subcategories42Copyright © Houghton Mifflin Company. All rights reserved.Classified Balance SheetAssets, liabilities, and owner's equity sections are subdivided into useful categoriesMost companies use similar subdivisions, but subdivisions usually depend upon the type of business43Copyright © Houghton Mifflin Company. All rights reserved.AssetsOften divided into four categoriesCurrent assetsInvestmentsProperty, plant, and equipmentIntangible assetsThe categories are listed according to how easily they are assumed to be converted into cash Some companies may group investments, intangible assets, and other miscellaneous assets as “other assets”44Copyright © Houghton Mifflin Company. All rights reserved.Current Assets cash and other assets that are reasonably expected to be converted to cash, sold, or consumedwithin one yearor within the normal operating cycle of the business,whichever is longer45Copyright © Houghton Mifflin Company. All rights reserved.Reasonable ExpectationCurrent assets include assets other than cash that are reasonably expected to be converted to cash, sold, or consumed within one yearThis means that it is probable and likely that, under normal circumstances, these assets will be converted to cash, sold, or consumed within one year46Copyright © Houghton Mifflin Company. All rights reserved.Normal Operating CycleThe average time needed to go from cash to cashSpend cash to buy merchandise inventorySell inventory on accountCollect cash The normal operating cycle is usually less than one yearExceptionsProducts requiring more than one year to produceTobaccoCompanies selling on the installment basisAppliances47Copyright © Houghton Mifflin Company. All rights reserved.Current AssetsIncludeCashTemporary investmentsAccounts receivableInventoryPrepaid expenses48Copyright © Houghton Mifflin Company. All rights reserved.Investments are assets,usually long-term,that are not used in the normal operation of the businessand that management does not plan to convert to cash within the next year49Copyright © Houghton Mifflin Company. All rights reserved.Types of InvestmentsSecurities held for investmentLong-term notes receivableLand held for future usePlant or equipment not used in the businessSpecial funds established toPay off debtPurchase a buildingLarge permanent investments in another companyFor the purpose of controlling that company50Copyright © Houghton Mifflin Company. All rights reserved.Property, Plant, and Equipment includes long-term assetsused in the continuing operation of the businessThese assets represent a place to operate (land and buildings)and equipment to produce, sell, deliver, and service the company’s goods51Copyright © Houghton Mifflin Company. All rights reserved.Classifying Natural ResourcesNatural resources used in the regular course of business are listed in the property, plant, and equipment categoryForest landsOil and gas propertiesCoal minesIf the natural resources are not used in the course of running the business, they are listed in the investments category52Copyright © Houghton Mifflin Company. All rights reserved.Property, Plant, and EquipmentAlso calledOperating assetsFixed assetsTangible assetsLong-lived assetsPlant assetsThe costs of these assets are depreciatedSpread over the periods they benefitPast depreciation is recorded in the Accumulated Depreciation accounts53Copyright © Houghton Mifflin Company. All rights reserved.Balance Sheet Presentation for Property, Plant, and EquipmentThe order in which property, plant, and equipment items are listed on the balance sheet is not the same for every company Accounts are often combined to make the financial statements less clutteredMany companies simply report a total for property, plant, and equipmentDetails are provided in a note to the financial statements54Copyright © Houghton Mifflin Company. All rights reserved.Intangible Assets are long-term assetsthat have no physical substancebut have a value based on rights or privileges that belong to their ownerThese assets are recorded at costThe cost is spread over the expected life of the right or privilege55Copyright © Houghton Mifflin Company. All rights reserved.Intangible Assets (cont’d)ExamplesPatentsCopyrightsGoodwillFranchisesTrademarks56Copyright © Houghton Mifflin Company. All rights reserved.Liabilities are divided into two categoriesbased on when they fall due:Current liabilitiesandLong-term liabilities57Copyright © Houghton Mifflin Company. All rights reserved.Current Liabilities are obligations due to be paid or performed within one year or within the normal operating cycle, whichever is longerAre typically paid from current assets or by incurring new short-term liabilities58Copyright © Houghton Mifflin Company. All rights reserved.Current Liabilities (cont’d)ExamplesNotes payableAccounts payableCurrent portion of long-term debtSalaries and wages payableTaxes payableCustomer advances (unearned revenues)59Copyright © Houghton Mifflin Company. All rights reserved.Long-Term Liabilities are debts of the businessthat fall due more than one year in the future or beyond the normal operating cycle,or that are to be paid out of noncurrent assets60Copyright © Houghton Mifflin Company. All rights reserved.Long-Term Liabilities (cont’d)ExamplesMortgages payableLong-term notesBonds payableEmployee pension obligationsLong-term lease liabilities61Copyright © Houghton Mifflin Company. All rights reserved.Owner’s EquityAlso calledProprietorshipCapitalNet worthAll represent the owner’s interest in the companyFor accounting purposes, net worth is not a preferable term, becauseMost assets are recorded at original cost, not current valueTherefore, the ownership section does not represent “worth”It is actually a claim against the assets of the company62Copyright © Houghton Mifflin Company. All rights reserved.Form of Business Organization and the Balance SheetThe form of business organization affects the equity section of the balance sheetSole proprietorshipPartnershipCorporationAsset and liability sections are usually not affected by the form of business organization63Copyright © Houghton Mifflin Company. All rights reserved. Sole ProprietorThe equity section simply shows the amount of capital in the owner’s nameCalled Owner’s Equity64Copyright © Houghton Mifflin Company. All rights reserved. PartnershipThe equity section for a partnership is much like that for a sole proprietorshipCalled Partners’ EquityEach partners’ capital amount is listed separately65Copyright © Houghton Mifflin Company. All rights reserved.CorporationIs a separate legal entity from its owners, who are called stockholdersThe equity section of the balance sheet for a corporation is called stockholders’ equityHas two partsContributed, or paid-in, capitalRetained earnings66Copyright © Houghton Mifflin Company. All rights reserved. CorporationContributed capital also called paid-in capitalReflects the amounts of assets contributed by stockholdersGenerally, contributed capital is shown by two amountsPar value of the issued stockAmounts paid in, or contributed, in excess of the par value per share 67Copyright © Houghton Mifflin Company. All rights reserved. CorporationRetained earnings are also called earned capital Represent stockholders' claims to assets that are earned from operations and reinvested in corporate operationsDividends reduce the Retained Earnings account balance Similar to owner’s withdrawals reducing the Capital account balance in a sole proprietorship68Copyright © Houghton Mifflin Company. All rights reserved.Dell Computer Corporation Consolidated Statement of Financial Position69Copyright © Houghton Mifflin Company. All rights reserved.Dell Computer Corporation Consolidated Statement of Financial Position (cont’d)70Copyright © Houghton Mifflin Company. All rights reserved.Graphical Presentation of Dell Computer Corporation’s Balance Sheet71Copyright © Houghton Mifflin Company. All rights reserved.DiscussionHow would a mortgage that is paid monthly for 120 months be classified? Current liabilityThe portion due during the next year or the current operating cycle Long-term liabilityThe portion due after next year or the current operating cycle72Copyright © Houghton Mifflin Company. All rights reserved.Forms of the Income StatementObjective 6Prepare multistep and single-step classified income statements73Copyright © Houghton Mifflin Company. All rights reserved.Forms of the Income StatementCondensed financial statementsPresent only the major categories of the detailed financial statementsTwo common forms of condensed income statementMultistep formSingle-step form74Copyright © Houghton Mifflin Company. All rights reserved.Multistep Income Statements go through a series of steps, or subtotals, to arrive at net incomeSame as the step-by-step, detailed income statement except only total amounts of significant categories are givenTwo sectionsIncome from operations Gross margin less operating expensesOther revenues and expenses75Copyright © Houghton Mifflin Company. All rights reserved.Condensed Multistep Income StatementBy separating income from operations and other revenues and expenses, the multistep income statement facilitates analysis of a company’s normal business operations76Copyright © Houghton Mifflin Company. All rights reserved.Single-Step Income Statement is a condensed income statement that arrives at net income in a single stepFirst section includes major categories of revenuesSecond section includes major categories of expensesTotal Revenues – Total Expenses = Income Before Income Taxes77Copyright © Houghton Mifflin Company. All rights reserved.Condensed Single-Step Income Statement78Copyright © Houghton Mifflin Company. All rights reserved.Advantages of Single-Step and Multistep Income StatementsSingle-step formSimplicityMultistep formShows the components used in deriving net income79Copyright © Houghton Mifflin Company. All rights reserved.Reading and Graphing Real Company Income StatementsAs with balance sheet presentations, rarely will two companies have income statements that are exactly alikeGraphical presentations of the income statement help visualize Relative amountsComponents of the statements in relation to other componentsChanges in the financial statementsIncreases and decreases in each component80Copyright © Houghton Mifflin Company. All rights reserved.Income Statement for Dell Computer CorporationGraphical Presentation of Dell Computer Corp.’s Income Statement82Copyright © Houghton Mifflin Company. All rights reserved.DiscussionWhy are other revenues and expenses separated from operating revenues and expenses in the multistep income statement?So that income from operations (the actual business of the company) can be isolated from the financing and non-operating aspects83Copyright © Houghton Mifflin Company. All rights reserved.Using Classified Financial StatementsObjective 7Evaluate liquidity and profitability using classified financial statements84Copyright © Houghton Mifflin Company. All rights reserved.Using Classified Financial StatementsInformation in financial statements may be used to evaluate two important goals of managementMaintaining adequate liquidityAchieving satisfactory profitabilityA series of ratios are used to evaluate these two goals85Copyright © Houghton Mifflin Company. All rights reserved.Evaluating LiquidityLiquidity means having enough cash on hand to pay bills when they become due and to cover unexpected needs for cashTwo measures of liquidityWorking capitalCurrent ratio86Copyright © Houghton Mifflin Company. All rights reserved.Working Capital is the amount by which total current assets exceed total current liabilities87Copyright © Houghton Mifflin Company. All rights reserved.Working Capital (cont’d)Current assetsAssets that will be converted to cash or used up within one year or one operating cycle, whichever is longerCurrent liabilitiesDebts that must be paid or obligations that must be performed within one year or one operating cycle, whichever is longer88Copyright © Houghton Mifflin Company. All rights reserved.Working Capital (cont.)By definition, current liabilities are paid out of current assetsThe excess of current assets over current liabilities is the net current assets on hand to continue operationsTotal Current Assets – Total Current Liabilities = Net Current Assets Available to Continue Business OperationsTotal Current Assets – Total Current Liabilities = Working CapitalIfthenWorking Capital = Net Current Assets Available to Continue Business Operations89Copyright © Houghton Mifflin Company. All rights reserved.Working Capital (cont’d)Working capital is used to buy inventory, obtain credit, and finance expanded salesLack of working capital can lead to a company's failureCompute working capital for Shafer Auto Parts Company90Copyright © Houghton Mifflin Company. All rights reserved. is the ratio of current assets to current liabilitiesCurrent RatioIs closely related to working capitalBelieved by many to be a good indicator of a company’s ability toPay its billsRepay outstanding debt91Copyright © Houghton Mifflin Company. All rights reserved.Evaluating ProfitabilityProfitability means the ability to earn a satisfactory incomeCommon profitability measuresProfit marginAsset turnoverReturn on assetsDebt to equityReturn on equity92Copyright © Houghton Mifflin Company. All rights reserved. Compute the profit margin for Shafer Auto Parts This means that on each dollar of net sales, Shafer Auto Parts made 6.2 centsProfit Margin shows the percentage of each sales dollar that results in net income93Copyright © Houghton Mifflin Company. All rights reserved.Asset Turnover measures how efficiently assets are used to produce sales It shows how many dollars of sales were generated by each dollar of assetsA high asset turnover means a company uses its assets productivelyThis ratio shows a meaningful relationship between an income statement figure and a balance sheet figure94Copyright © Houghton Mifflin Company. All rights reserved.Asset Turnover (cont’d)Compute asset turnover for Shafer Auto Parts CompanyAverage total assets is computed by adding total assets at the beginning of the year to total assets at the end of the year and dividing by 2This means that Shafer produces $1.90 in sales for each $1.00 invested in average total assets95Copyright © Houghton Mifflin Company. All rights reserved.Return on Assets measures how efficiently a companyuses its assets to produce income 96Copyright © Houghton Mifflin Company. All rights reserved.Indicates how efficiently the company is using all its assetsIndicates income-generating strength of the company’s resourcesReturn on Assets (cont’d)Combines profit margin and asset turnoverReturn on assets overcomes the limitations of profit margin and asset turnover ratiosProfit margin does not consider the assets necessary to produce incomeAsset turnover ratio does not take into account the amount of net income produced97Copyright © Houghton Mifflin Company. All rights reserved.Return on Assets (cont’d)Compute return on assets for Shafer Auto Parts CompanyAverage total assets is computed by adding total assets at the beginning of the year to total assets at the end of the year and dividing by 2This means that for each dollar invested by the owner, Shafer’s assets generate 11.6 cents of net incomeOr,Difference due to rounding98Copyright © Houghton Mifflin Company. All rights reserved.Debt to Equity shows the portion of the company financed by creditors in comparison to that financed by the owner A company with a high debt to equity ratio is riskier in poor economic times because it must continue to repay creditorsA company with a low debt to equity ratio is safer because the owner does not have to be repaid99Copyright © Houghton Mifflin Company. All rights reserved.Represents assets financed by the ownerRepresents assets financed by creditorsDebt to Equity (cont’d)The assets of a company are financed by Creditors (creating liabilities) OwnersA debt to equity ratio of 1.0 means that half the company’s assets are financed by creditors and half are financed by the owner 100Copyright © Houghton Mifflin Company. All rights reserved.Debt to Equity (cont.)Compute debt to equity for Shafer Auto Parts CompanyA ratio less than 1.0 (or 100%) means that less than half of the company’s assets are financed by creditors and more than half are financed by the ownerFor every 61.4 cents of financing from creditors, $1.00 of financing came from the owner101Copyright © Houghton Mifflin Company. All rights reserved. Acceptability of a company’s return on equity ratio depends on how muchthe company earned in prior yearsother companies in the same industry earnedReturn on Equity measures how much income was earned on each dollar invested by the owner102Copyright © Houghton Mifflin Company. All rights reserved.Average owner's equity is computed by adding total owner's equity at the beginning of the year to total owner's equity at the end of the year and dividing by 2This means that Shafer earned 18.0 cents on every dollar invested by the ownerReturn on Equity (cont’d)Compute return on equity for Shafer Auto Parts Company103Copyright © Houghton Mifflin Company. All rights reserved.Graphical Presentation of Dell Computer Corp.’s Profitability RatiosDiscussionWhich is the more important goal, liquidity or profitability? Explain your answerThe goals of liquidity and profitability are equally important. Both must be met if a business is to survive105Copyright © Houghton Mifflin Company. All rights reserved.Time for ReviewState the objectives of financial reportingState the qualitative characteristics of accounting information and describe their interrelationshipsDefine and describe the conventions of comparability and consistency, materiality, conservatism, full disclosure, and cost-benefit106Copyright © Houghton Mifflin Company. All rights reserved.And FinallyExplain management’s responsibility for ethical financial reporting and define fraudulent financial reportingIdentify and describe the basic components of a classified balance sheetPrepare multistep and single-step classified income statementsEvaluate liquidity and profitability using classified financial statements107Copyright © Houghton Mifflin Company. All rights reserved.