Regulatory agencies intervene in this process with various disclosure requirements that establish a minimum supply of information. Managers and employees also demand financial accounting information for use in compensation and bonus contracts that are tied to such numbers.
The popularity of employee profit sharing and stock ownership plans has further increased demand for financial information. Other sources of demand include union contracts that link wage negotiations to accounting numbers and pension and benefit plans whose solvency depends on company performance. Financial reports reflect information about past performance and current resources available to companies. These reports also provide information about claims on those resources, including claims by suppliers, creditors, lenders, and stockholders.
This information allows analysts to make informed assessments about future financial performance and condition so they can provide stock recommendations or write commentaries. Creditors and Suppliers Banks and other lenders demand financial accounting information to help determine loan terms, loan amounts, interest rates, and required collateral.
For example, loan covenants might require the loan recipient to maintain minimum levels of working capital, retained earnings, interest coverage, and so forth to safeguard lenders.
Covenant violations can yield technical default, enabling the creditor to demand early payment or other compensation. Suppliers demand financial information to establish credit terms and to determine their long-term commitment to supplychain relations. Both creditors and suppliers use financial information to monitor and adjust their contracts and commitments with a company. Stockholders and Directors Stockholders and directors demand financial accounting information to assess the profitability and risks of companies.
Stockholders and others such as investment analysts, brokers, and potential investors search for information useful in their investment decisions. Fundamental analysis uses financial information to estimate company value and to form buy-sell stock strategies. Both directors and stockholders use accounting information to evaluate managerial performance.
Managers similarly use such information to request an increase in compensation and managerial power from directors. Outside directors are crucial to determining who runs the company, and these directors use accounting information to help make leadership decisions. Regulators and Tax Agencies Regulators such as the SEC, the Federal Trade Commission, and the Federal Reserve Bank and tax agencies demand accounting information for antitrust assessments, public protection, price setting, import-export analyses, and setting tax policies.
For example, governments often grant monopoly rights to electric and gas companies serving specific areas in exchange for regulation over prices charged to consumers. These prices are mainly determined from accounting measures. Voters and Their Representatives Voters and their representatives to national, state, and local governments demand accounting information for policy decisions.
The decisions can involve economic, social, taxation, and other initiatives. Voters and their representatives also use accounting information to monitor government spending.
Contributors to nonprofit organizations also demand accounting information to assess the impact of their donations. Managers release information provided the benefits of disclosing that information outweigh the costs of doing so. Both regulation and bargaining power affect disclosure costs and benefits and thus play roles in determining the supply of accounting information.
Most areas of the world regulate the minimum levels of accounting disclosures. Forms K which must be filed within 60 [90] days of the year-end for larger [smaller] companies and Q which must be filed within 40 [45] days of the quarter-end for larger [smaller] companies, except for the fourth quarter when it is part of the K are available electronically from the SEC Website see Appendix 1A.
The minimum, regulated level of information is not the standard. Both the quantity and quality of information differ across companies and over time. We need only look at several annual reports to see considerable variance in the amount and type of accounting information supplied. For example, differences abound on disclosures for segment operations, product performance reports, and financing activities. Further, some stakeholders possess ample bargaining power to obtain accounting information for themselves.
These typically include private lenders and major suppliers and customers. Companies must compete in these markets. Companies reap the benefits of disclosure with good news about their products, processes, management, and so forth. That is, there are real economic incentives for companies to disclose reliable audited accounting information enabling them to better compete in capital, labor, input, and output markets.
What inhibits companies from providing false or misleading good news? There are several constraints. An important constraint imposed by stakeholders is that of audit requirements and legal repercussions associated with inaccurate accounting information.
Another relates to reputation effects from disclosures as subsequent events either support or refute earlier news. Costs of Disclosure The costs of supplying accounting information include its preparation and dissemination, competitive disadvantages, litigation potential, and political costs.
Preparation and dissemination costs can be substantial, but companies have often already incurred those costs because managers need similar information for their own business decisions. The potential for information to yield competitive disadvantages is high. Companies are concerned that disclosures of their activities such as product or segment successes, strategic alliances or pursuits, technological or system innovations, and product or process quality improvements will harm their competitive advantages.
Also, companies are frequently sued when disclosures create expectations that are not met. For example, government defense contractors, large software conglomerates, and oil companies are favorite targets of public scrutiny. Disclosure costs are higher for companies facing political costs. In the past, many companies disclosed important information in meetings and conference calls that excluded individual stockholders.
The goal of this rule is to even the playing field for all investors. In the early s, pressure mounted for these two standard-setting organizations to collaborate and create one set of internationally acceptable standards.
At a joint meeting in , the FASB and the IASB each acknowledged their commitment to the development of high-quality, compatible accounting standards that could be used for both domestic and cross-border financial reporting. The original intent of the two boards was to create one set of standards that companies across the globe would adopt. However, resistance from U. Instead, a new approach has emerged and has the support of the SEC staff.
At present, the two boards have the following projects on their agendas: loan impairment, insurance contracts, and investment entities.
The report did not include a final policy decision, or even a recommendation, as to whether or how IFRS should be incorporated into the U.
Thus, as of early , there is no formal plan for U. Interestingly, foreign companies that are listed on U. At a broad level, the answer is no. Both are prepared using accrual accounting and utilize similar conceptual frameworks. That does not mean that no differences exist.
However, the differences are typically technical in nature, and do not differ on broad principles discussed in this book. At the end of each module, we summarize key differences between U. Also, there are a variety of sources that provide more detailed and technical analysis of similarities and differences between U. The two standard-setting bodies also provide useful information, see: FASB www. SOX sought to rectify perceived problems in accounting, including weak audit committees and deficient internal controls.
Increased scrutiny of financial reporting and internal controls has had some success. A report by Glass, Lewis and Co. The Glass, Lewis and Co. Bottom line: we must be critical readers of financial reports. Companies use four financial statements to periodically report on business activities. The three statements in the middle of Exhibit 1. Of course, firms prepare financial statements more frequently; semiannual, quarterly, and monthly financial statements are common.
Berkshire Hathaway is a calendar-year company. Some companies choose a fiscal year ending on a date other than December 31, such as when sales and inventory are low. The balance sheet also reports the sources of asset financing. There are two ways a company can finance its assets. It can raise money from stockholders; this is owner financing. It can also raise money from banks or other creditors and suppliers; this is nonowner financing. This means that both owners and nonowners hold claims on company assets.
Owner claims on assets are referred to as equity and nonowner claims are referred to as liabilities or debt. Since all financing must be invested in something, we obtain the following basic relation: investing equals financing. The balance sheet for Berkshire Hathaway is in Exhibit 1. Assets equal liabilities plus equity, which reflects the accounting equation: investing equals financing.
Investing Activities Balance sheets are organized like the accounting equation. These assets are financed by a combination of nonowner financing liabilities and owner financing equity. This means that the financial statement includes a parent company and one or more subsidiaries, companies that the parent company controls. For Berkshire Hathaway, other equity includes accumulated other comprehensive income and treasury stock.
Noncash assets consist of several asset categories Module 2 explains the composition of noncash assets. These categories are listed in order of their nearness to cash. For example, companies own a category of assets called inventories. These are goods that the company intends to sell to its customers. Inventories are converted into cash when they are sold, which typically occurs within a short period of time. Hence, they are classified as short-term assets. Companies also report a category of assets called property, plant and equipment.
Although managers can influence the relative amounts and proportion of assets, their flexibility is somewhat limited by the nature of their industries. Owner or equity financing includes resources contributed to the company by its owners along with any profit retained by the company. Nonowner creditor or debt financing is borrowed money.
We distinguish Relative Proportion of Liabilities and Equity between these two financing sources for a reason: borrowed Equity money entails a legal obligation to repay amounts owed, and failure to do so can result in severe consequences for the Liabilities borrower. Equity financing entails no such legal obligation for repayment. This is evident in the graph to the side, again citing many of the companies we feature as focus companies in this book.
They can operate with more nonowner financing. Our discussion of investing and financing activities uses many terms and concepts that we explain later in the book. Our desire here is to provide a sneak preview into the interplay among financial statements, manager behavior, and economics. Many investment-type companies such as Berkshire Hathaway and high-tech companies such as Cisco Systems carry high levels of cash.
Why is that? Is there a cost to holding too much cash? Is it costly to carry too little cash? Why is this the case? Why is the composition of assets on balance sheets for companies in the same industry similar?
How can long-term creditors influence strategic direction? Would reporting assets and liabilities at fair values be more informative?
What problems might fair-value reporting cause? Review the Berkshire Hathaway balance sheet summarized in Exhibit 1. We provide answers for each of these questions as we progress through the book. For example, intangible assets are typically listed first and cash is listed last among assets.
Also, equity is often listed before liabilities, where liabilities are again listed in order of decreasing liquidity. These choices reflect convention and not IFRS requirements. Revenues less expenses yield the bottom-line net income amount.
Net income reflects the profit also called earnings to owners for that specific period. When you buy stock in Berkshire Hathaway, you are a stockholder of that company. Berkshire Hathaway owns stock in other companies, and the companies that Berkshire Hathaway the parent owns are called subsidiaries. In this case, Berkshire Hathaway includes all of the revenues and all of the expenses of such a subsidiary in its own consolidated income statement.
Then, Berkshire Hathaway separates the total consolidated net income into the portion that it owns income attributable to Berkshire Hathaway stockholders and the portion owned by outside stockholders income attributable to noncontrolling interest.
So, which income number should we use in an analysis of Berkshire Hathaway? Because analysis is usually performed from the standpoint of a stockholder of Berkshire Hathaway, we focus on the net income attributable to Berkshire Hathaway stockholders.
It is also common to report a subtotal called gross profit or gross margin , which is revenues less cost of goods sold. Input Net Income as a Percent of Sales markets generate most expenses or costs such as inventory, salaries, materials, and logistics. Output markets generate revenues or sales to customers. Output markets also generate some expenses such as marketing and distributing products and services to customers. Net income arises when revenues exceed expenses.
A loss occurs when expenses exceed revenues. Differences exist in the relative profitability of companies across industries. Although effective management can increase the profitability of a company, business models play a large part in determining company profitability. These differences are illustrated in the graph to the side of net income as a percentage of sales for several companies.
Target operates in a mature industry with little ability to differentiate its merchandise from competitors. Hence, its income as a percent of sales is low. Southwest Airlines faces a different kind of problem: having competitors that are desperate and trying to survive.
Profitability will not return to the transportation industry until weaker competitors are no longer protected by bankruptcy courts. At the other end of the spectrum are Apple, Google, and Intel. All three are dominant in their industries with products protected by patent laws. Their profitability levels are more akin to that of monopolists.
Should the seller recognize the sale when it is made or when cash is collected? Should a company, instead, record the cost of that building as an expense when it is acquired? If not, how should a company report the cost of that asset over the course of its useful life?
Manufacturers and merchandisers report the cost of a product as an expense when the product sale is recorded. How might we measure the costs of a product that is sold by a merchandiser? By a manufacturer? If an asset, such as a building, increases in value, that increase in value is not reported as income until the building is sold, if ever.
What concerns arise if we record increases in asset values as part of income, when measurement of that increase is based on appraised values? Employees commonly earn wages that are yet to be paid at the end of a particular period. Should their wages be recognized as an expense in the period that the work is performed, or when the wages are paid? Companies are not allowed to report profit on transactions relating to their own stock.
Review the Berkshire Hathaway income statement summarized in Exhibit 1. For each type of equity, the statement reports the beginning balance, a summary of the activity in the account during the year, and the ending balance.
During the recent period, its equity changed due to share issuances and income reinvestment. Stock issuance repurchase. Net income. We briefly discuss each of these accounts here and explain the accounts in depth in Module 8.
The change in retained earnings links consecutive balance sheets via the income statement: Ending retained earnings 5 Beginning retained earnings 1 Net income for the period 2 Dividends for the period. Treasury stock is the cost of the shares that Berkshire Hathaway has repurchased and not reissued. It can be seen as the opposite of contributed capital. Treasury stock decreases equity when shares are repurchased hence, the negative sign. We defer discussion of this account to Modules 8 and 9.
Research Insight Are Earnings Important? A study asked top finance executives of publicly traded companies to rank the three most important measures to report to outsiders. Alternatively, it could reflect myopic managerial concern about earnings. The emphasis on earnings is noteworthy because cash flows continue to be the measure emphasized in the academic finance literature.
The study provides the following insights. Several executives mention that comparison to seasonally lagged earnings numbers provides a measure of earnings momentum and growth, and therefore is a useful gauge of corporate performance. To the majority of finance chiefs surveyed, the answer is a resounding yes. Source: Graham, et al. The statement reports cash inflows and outflows from operating, investing, and financing activities over a period of time.
Investing cash flows. Financing cash flows. Cash, December 31, This is due to timing differences between when revenue and expense items are recognized on the income statement and when cash is received and paid. We discuss this concept further in subsequent modules. Both cash flow and net income numbers are important for business decisions. Do the balance sheet and income statement provide sufficient cash flow information? How is this information useful? What are the implications if operating cash flows are negative for an extended period of time?
What kind of information might we look for? Are positive investing cash flows favorable? What questions might that information help us answer? Why or why not? Review the Berkshire Hathaway statement of cash flows summarized in Exhibit 1. Berkshire Hathaway did not pay dividends in The statement of cash flows is also linked to the balance sheet as the change in the balance sheet cash account reflects the net cash inflows and outflows for the period. Items that impact one financial statement ripple through the others.
Linkages among the four financial statements are an important feature of the accounting system. After I got Financial Accounting for MBAs 8e pdf book download I learned that We are all in sales and regularly read all sorts of books, from self-improvement to habit training, to sales.
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This book is the product of extensive market research including focus groups, market surveys, class tests, manuscript reviews, and interviews with faculty from across the country. We are grateful to students and faculty who used the previous editions and whose feedback greatly benefited this new edition. Download or Buy eBook Here. Leave a Comment Cancel reply. Easton, John J. Wild, Robert F. Halsey, and Mary Lea McAnally.
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If you are a new instructor to Cambridge Business Publishers, please use the button below to register. Click here to preview. It focuses on core introductory financial accounting topics that match pre-requisite requirements for students advancing to intermediate financial accounting. A corporate approach is utilized versus beginning with a sole proprietor Intermediate Financial Accounting Volume 2. Intermediate Financial Accounting Volume 2 developed in collaboration by Athabasca University and Lyryx, is intended for the second of two in Intermediate Financial Accounting courses.
It presumes that students have already completed the Introductory Financial Accounting, and the first Intermediate Financing Accounting course.
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