14.1 Accounting: More than Numbers
- Why are financial reports and accounting information important, and who uses them?
Accounting involves collecting, recording, classifying, summarizing, reporting, and analyzing a firm’s financial activities according to a standard set of procedures. The financial reports resulting from the accounting process give managers, employees, investors, customers, suppliers, creditors, and government agencies a way to analyze a company’s past, current, and future performance. Financial accounting is concerned with the preparation of financial reports using generally accepted accounting principles. Managerial accounting provides financial information that management can use to make decisions about the firm’s operations.
14.2 The Accounting Profession
- What are the differences between public and private accountants, and how has federal legislation affected their work?
Public accountants work for independent firms that provide accounting services—such as financial report preparation and auditing, tax return preparation, and management consulting—to other organizations on a fee basis. Private accountants are employed to serve one particular organization and may prepare financial statements, tax returns, and management reports.
The bankruptcies of companies such as Enron and WorldCom, plus widespread abuses of accounting practices, raised critical issues of auditor independence and the integrity and reliability of financial reports. To set better standards for accounting, auditing, and financial reporting and prevent future accounting irregularities, Congress passed the Sarbanes-Oxley Act in 2002. This Act created an independent board to oversee the accounting profession, set stricter auditing and financial disclosure standards, and placed increased accountability on a company’s senior executives and management. In addition, the law restricts auditors from providing certain types of consulting services to clients. Other organizations such as the SEC, the New York Stock Exchange, and accounting industry professional associations issued new regulations and guidelines related to compliance with the Act.
14.3 Basic Accounting Procedures
- What are the six steps in the accounting cycle?
The accounting cycle refers to the process of generating financial statements. It begins with analyzing business transactions, recording them in journals, and posting them to ledgers. Ledger totals are then summarized in a trial balance that confirms the accuracy of the figures. Next the accountant prepares the financial statements and reports. The final step involves analyzing these reports and making decisions. Computers have simplified many of these labor-intensive tasks.
14.4 The Balance Sheet
- In what terms does the balance sheet describe the financial condition of an organization?
The balance sheet represents the financial condition of a firm at one moment in time, in terms of assets, liabilities, and owners’ equity. The key categories of assets are current assets, fixed assets, and intangible assets. Liabilities are divided into current and long-term liabilities. Owners’ equity, the amount of the owners’ investment in the firm after all liabilities have been paid, is the third major category.
14.5 The Income Statement
- How does the income statement report a firm’s profitability?
The income statement is a summary of the firm’s operations over a stated period of time. The main parts of the statement are revenues (gross and net sales), cost of goods sold, operating expenses (selling and general and administrative expenses), taxes, and net profit or loss.
14.6 The Statement of Cash Flows
- Why is the statement of cash flows an important source of information?
The statement of cash flows summarizes the firm’s sources and uses of cash during a financial-reporting period. It breaks the firm’s cash flows into those from operating, investment, and financing activities. It shows the net change during the period in the firm’s cash and marketable securities.
14.7 Analyzing Financial Statements
- How can ratio analysis be used to identify a firm’s financial strengths and weaknesses?
Ratio analysis is a way to use financial statements to gain insight into a firm’s operations, profitability, and overall financial condition. The four main types of ratios are liquidity ratios, profitability ratios, activity ratios, and debt ratios. Comparing a firm’s ratios over several years and comparing them to ratios of other firms in the same industry or to industry averages can indicate trends and highlight financial strengths and weaknesses.
14.8 Trends in Accounting
- What major trends affect the accounting industry today?
The post-SOX business environment has brought many changes to the accounting profession, including higher standards for audit procedures. In addition, the FASB has made slow but steady progress in making changes related to GAAP; however, the implementation of global accounting standards may not occur anytime soon. Several important trends will continue to impact the accounting industry going forward, including cloud-based services, automation, and staffing challenges, as accountants shift the focus of their practice to one incorporating technological advances and a more comprehensive approach to their companies’ and clients’ overall business environment.