Accounting Chapter 5

The Fraud Triangle conditions

(1)An incentive to commit fraud (2)An opportunity to commit fraud (3)The ability to rationalize the misdeed

Gross Profit

(Gross Margin) Net sales less cost of goods sold

Operating Income

(Income from Operations) Net sales less cost of goods sold and other operating expenses

What does the Gross Profit Percentage measure?

A company's ability to charge premium prices and produce goods and services at a low cost

Goodwill

A general intangible asset representing the excess of the price paid for another company over the value of its identifiable assets

Board of Directors

A group of individuals elected by stockholders to represent their interests

XBRL

A language that tags each fact to identify its source and meaning

Sarbanes-Oxley Act

A law which strengthens US financial reporting and corporate governance regulations

Press Release

A written public news announcement normally distributed to major news services

Conference Call

After a press release, in which senior managers answer analysts' questions about the results

Information Services

Allow investors to gather their own information about the company and monitor the recommendations of a variety of analysts

Immaterial Amounts

Amounts that are NOT large enough to influence a user's decision

Material Amounts

Amounts that are large enough to influence a user's decision

If one or both of the Nonrecurring Items occur, how are they presented?

An additional subtotal is presented for Income from Continuing Operations (or Income before Nonrecurring Items), after which non recurring items are presented

How does an auditor affect lenders/investors?

An auditor reduces the risk of inaccuracy in financial statements which lowers the interest that investors/lenders charge

Unqualified (clean) audit opinion

An auditor's statement that the financial statements are fair presentations in all material respects in conformity with GAAP

CEO

Chief Executive Officer; the highest officer in the company

CFO

Chief Financial Officer; the highest officer associated with the financial and accounting side of the business

Additional subtotals and classifications in financial statements

Companies use slightly different statement formats.

Another word for Lenders

Creditors

What do institutional and private investors become when they buy a company's publicly traded bonds

Creditors

Item 1: Business

Description of business operations and company strategy.

What is the Form 8-K used by publicly traded companies to do?

Disclose any material event not previously reported that might be important to investors

Earnings per Share

Earnings per Share = Net Income / Average Number of Shares of Common Stock Outstanding during the Period

Low-Cost strategy

Efficient management of production reduces costs and increases the gross profit percentage

EDGAR

Electronic Data Gathering and Retrieval; an SEC sponsored site through which companies file their SEC forms

FD

Fair Disclosure; Requires that companies provide all investors equal access to all important company news

What do many companies do after a press release?

Follow with a public conference call

Extraordinary items

Gains or losses incurred that are both unusual and infrequent in occurrence

Gross Profit Percentage

Gross Profit*/Net Sales *Gross Profit = Net Sales - Cost of Sales

Intangible Assets

Have no physical existence and a long life

How is Net Income obtained from Pretax Earnings?

Income Tax Expense is subtracted from Pretax Earnings

Who controls the majority of publicly traded shares of U.S. companies?

Institutional investors

Private Investors

Large individual investors (such as venture capitalists) and small retail investors who purchase shares in companies

What is the Audit Committee responsible for?

Maintaining the integrity of a company's financial reports

Item 7: Management's Discussion and Analysis of Financial Condition and Results of Operations

Management's views on the causes of its successes and failures during the reporting periods and the risks it faces in the future.

Institutional investors

Managers of pension, mutual, endowment, and other funds that invest on the behalf of others.

What happens to Intangible Assets?

Most (except goodwill, trademarks and other intangibles) are amortized (reduced)

What must the Audit Committee be composed of?

Nonmanagement [independent] directors with financial knowledge

Where are Nonrecurring Items reported?

On the Income Statement

Intangible Assets EX

Patents, trademarks, copyrights, and franchises

Earnings forecasts

Predictions of earnings for future accounting periods, prepared by financial analysts

What does the SEC require in terms of auditors?

Publicly traded companies must have their statements and their control systems over the financial reporting process audited by an independent auditor following auditing standards established by the PCAOB

How does the stock market react to earnings announcements?

QUICKLY

Financial Analysts

Receive accounting reports and other information about the company from electronic information services; they also gather information by way of company executives and visits to facilities

How are Intangible Assets reported?

Reported net of accumulated amortization on the balance sheet

Cost effectiveness

Requires that the benefits of accounting for and reporting information outweigh the costs

Product-Differentiation strategy

Research and development and product promotion activities are used to charge premium prices, producing a higher gross profit percentage

Income before Income Taxes (Pretax Earnings)

Revenues minus all expenses except income tax expense

Non Operating (other) Items

Revenues, expenses, gains, and losses that do not relate to the company's primary operations

What is the additional statement required by the FASB and IASB that can be presented separately or in combination with the income statement?

Statement of Comprehensive Income

Item 6: Selected Financial Data

Summarized financial data for a 5-year period.

Lenders include

Suppliers, banks, commercial credit companies, and other financial institutions that lend money to companies

What is the annual report that publicly traded companies must file with the SEC?

The Form 10-K

What is the quarterly report that publicly traded companies must file with the SEC?

The Form 10-Q

What are the other reports that publicly traded companies must file with the SEC?

The Form 8-K

Securities and Exchange Commision (SEC)

The U.S. government agency that determines the financial statements that public companies must provide to stockholders and the measurement rules that they must use in producing those statement

What do Private Investors rely on?

The advice of information intermediaries or turning over their money to those with expertise

Form 10-K

The annual report that publicly traded companies must file with the SEC

The primary responsibility for the information in a company's financial statements and related disclosures lies with...

The chief executive officer (CEO) and the chief financial officer (CFO)

Unexpected earnings

The difference between expected earnings and actual earnings

Item 8: Financial Statements and Supplemental Data

The four basic financial statements and related notes, the report of management, and the auditor's report

Public Company Accounting Oversight Board (PCAOB)

The private sector body given the primary responsibility to issue detailed auditing standards for independent auditors (CPAs) of public companies

Financial Accounting Standards Board (FASB)

The private sector body given the primary responsibility to work out the detailed rules that become generally accepted accounting principles

Corporate Governance

The procedures designed to ensure that the company is managed in the interests of the shareholders

Form 10-Q

The quarterly report that publicly traded companies must file with the SEC

The Fraud Triangle

The three conditions necessary for financial statement fraud to occur

Comparative financial statements

Values from multiple periods allow users to compare performance from period to period.

Additional disclosures

Voluminous notes that are necessary for comprehension of performance, financial condition, and certain complex transactions.

Discontinued Operations

When a major component of a business is sold or abandoned

What are three additional characteristics of financial statements?

~Comparative financial statements ~Additional subtotals and classifications in financial statements ~Additional disclosures

Nonrecurring Items

~Discontinued operations ~Extraordinary items

Non Operating (other) Items examples

~Interest income ~Interest expense ~Gains/losses on the sale of fixed assets and investments

What are principal components of the Form 10-K?

~Item 1. Business ~Item 6. Selected Financial Data ~Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations ~Item 8. Financial Statements and Supplemental Data

What are the roles of the SEC?

~Oversees the work of the FASB ~Reviews the reports filed with it for compliance with its standards ~Investigates irregularities ~Punishes violators

Annual reports include...

~The four basic financial statements ~Related notes (footnotes) ~Report of Independent Accountants (Auditor's Opinion) ; Only if the statements are audited

What is the difference between quarterly reports and annual reports?

~Unaudited ~Often the cash flow statement, statement of stockholders' equity, and notes are omitted