chapter 15 and chapter 16

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Chapter 15

Using Management and Accounting Information

Pride/Hughes/Kapoor, Foundations of Business, 6th Edition. © 2019 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Learning Objectives

15-1 Examine how information can reduce risk when making a decision.

15-2 Discuss management’s information requirements.

15-3 Outline the five functions of an information system.

15-4 Explain why accurate accounting information and audited financial statements are important.

15-5 Read and interpret a balance sheet.

15-6 Read and interpret an income statement.

15-7 Describe business activities that affect a firm’s cash flow.

15-8 Summarize how managers evaluate the financial health of a business.

Information and Risk

To improve the decision-making process, the information used by individuals and business firms must be relevant.

Using relevant information results in better decisions.

Relevant information → Better intelligence and knowledge → Better decisions

For businesses, better intelligence and knowledge that lead to better decisions are especially important because they can provide a competitive edge over competitors and improve a firm’s profits.

FIGURE 15-1 The Relationship Between Information and Risk

The Difference Between Data and Information

Data – numerical or verbal descriptions that usually result from some sort of measurement

Information – data presented in a form that is useful for a specific purpose

Knowledge Management (1 of 2)

Database – a single collection of data and information stored in one place that can be used by people throughout an organization to make decisions

Knowledge management (K M) – a firm’s procedures for generating, using, and sharing important data and information

Knowledge Management (2 of 2)

Making Smart Decisions

Decision-support system (D S S) – a type of software program that provides relevant data and information to help a firm’s employees make decisions

Expert system – a type of computer program that uses artificial intelligence to imitate a human’s ability to think

Business Application Software

A number of business software applications can improve both employee decision making and productivity.

TABLE 15-1 Current Business Application Software Used to Improve Productivity

Word processing	Users can prepare and edit written documents and store them in the computer or on a memory device.
Desktop publishing	Users can combine text and graphics in professional reports, newsletters, and pamphlets.
Accounting	Users can record routine financial transactions and prepare financial reports at the end of the accounting period.
Database management	Users can electronically store large amounts of data and transform the data into information.
Graphics	Users can display and print pictures, drawings, charts, and diagrams.
Spreadsheets	Users can organize numerical data into a grid of rows and columns.

What Is a Management Information System?

Management information system (M I S) – a system that provides managers and employees with the information they need to perform their jobs as effectively as possible

The purpose of an MIS is to distribute timely and useful information from both internal and external sources to the managers and employees who need it.

FIGURE 15-2 Management Information System (M I3S)

A Firm’s Information Requirements (1 of 2)

Many firms are organized into five areas of management:

A Firm’s Information Requirements (2 of 2)

Managers in each of these areas need specific information in order to make decisions.

Financial managers must ensure that the firm’s managers and employees, lenders and suppliers, stockholders and potential investors, and government agencies have the information they need to measure the financial health of the firm.

Operations managers are concerned with present and future sales levels, current inventory levels of work in process and finished goods, and the availability and cost of the resources required to produce goods and services.

Marketing managers need to have detailed information about a firm’s products and services and those offered by competitors.

Human resources managers must be aware of anything that pertains to a firm’s employees.

Administrative managers are responsible for the overall management of the organization.

FIGURE 15-3 Five Management Information System Functions

Why Accounting Information Is Important

Accounting – the process of systematically collecting, analyzing, and reporting financial information

Not only can accounting information be used to answer questions about what has happened in the past, it can also be used to help make decisions about the future.

To improve the accuracy of a firm’s accounting information and its financial statements, businesses rely on audits conducted by accountants employed by public accounting firms.

Why Audited Financial Statements Are Important

Audit – an examination of a company’s financial statements and the accounting practices that produced them

The purpose of an audit is to make sure that a firm’s financial statements have been prepared in accordance with generally accepted accounting principles.

Generally accepted accounting principles (G A A P s) – an accepted set of guidelines and practices for U.S. companies reporting financial information and for the accounting profession

Accounting Fraud, Ethical Behavior, and Reform

Accounting problems at many companies have forced many investors, lenders and suppliers, and government regulators to question the motives behind fraudulent and unethical accounting practices.

Unfortunately, the ones hurt when companies report inaccurate or misleading accounting information often are not the high-paid corporate executives; rather, it’s the employees, who lose their jobs and the money they invested in the company’s retirement program if the company files for bankruptcy, and the investors, lenders, and suppliers, who experience a loss due to their investments in the company based on fraudulent accounting information.

To help ensure that corporate financial information is accurate and to prevent accounting scandals, Congress enacted the Sarbanes-Oxley Act.

Different Types of Accounting

Accounting is usually broken down into two broad categories:

Additional special areas of accounting include:

Careers in Accounting

Accountants generally are classified as either:

Certified public accountant (C P A) – an individual who has met state requirements and experience and has passed a rigorous accounting examination

The Accounting Equation (1 of 2)

Accounting equation – the basis for the accounting process:

= +

The Accounting Equation (2 of 2)

To use the accounting equation, a firm’s accountants record the firm’s day-to-day financial transactions using the double-entry bookkeeping system.

Double-entry bookkeeping system – a system in which each financial transaction is recorded as two separate accounting entries to maintain the balance shown in the accounting equation

At the end of a specific accounting period, all of the financial transactions are summarized in the firm’s financial statements and included in the firm’s annual report.

Annual report – a report distributed to stockholders and other interested parties that describes the firm’s operating activities and its financial condition

The Balance Sheet

Balance sheet (or statement of financial position) – a summary of the dollar amounts of a firm’s assets, liabilities, and owners’ equity accounts at the end of a specific accounting period

The balance sheet must demonstrate that assets are equal to liabilities plus owners’ equity, and the accounting equation is still in balance.

FIGURE 15-5 Personal Balance Sheet

FIGURE 15-6 Business Balance Sheet

Assets (1 of 3)

On a balance sheet, assets are listed in order from the most liquid to the least liquid.

Liquidity – the ease with which an asset can be converted into cash

Current Assets

Current assets – assets that can be converted quickly into cash or that will be used in one year or less

Assets (2 of 3)

Current Assets (continued)

Order of current assets from most liquid to least liquid:

Assets (3 of 3)

Fixed Assets

Fixed assets – assets that will be held or used for a period longer than one year

Examples:

Depreciation – the process of apportioning the cost of a fixed asset over the period during which it will be used

Intangible Assets

Intangible assets – assets that do not exist physically but that have a value based on the rights or privileges they confer on a firm

Examples:

Liabilities and Owners’ Equity (1 of 2)

Current Liabilities

Current liabilities – debts that will be repaid in one year or less

Balance sheet Includes:

Organizing e-Business Resources

Long-Term Liabilities

Long-term liabilities – debts that need not be repaid for at least one year

Owners’ or Stockholders’ Equity

For a sole proprietorship or partnership, the owners’ equity is shown as the difference between assets and liabilities.

For a corporation, the owners’ equity usually is referred to as stockholders’ equity.

The dollar amount reported on the balance sheet is the total value of stock plus retained earnings that have accumulated to date.

Retained earnings – the portion of a business’s profits not distributed to stockholders

The Income Statement

Income statement – a summary of a firm’s revenues and expenses during a specified accounting period

The difference between income and expenses is referred to as:

Profit or loss (for a business)

Cash surplus or cash deficit (for an individual)

For a business:

– – = Net income

FIGURE 15-7 Personal Income Statement

FIGURE 15-8 Business Income Statement

Revenues

Revenues – the dollar amounts earned by a firm from selling goods, providing services, or performing business activities

Gross sales − Sales deductions = Net sales

Gross sales – the total dollar amount of all goods and services sold during the accounting period

Deductions:

Net sales – the actual dollar amounts received by a firm for the goods and services it has sold after adjustment for returns, allowances, and discounts

Cost of Goods Sold

Cost of goods sold – the dollar amount equal to beginning inventory plus net purchases less ending inventory

Cost of goods sold = Beginning inventory + Net purchases – Ending inventory

Gross profit – a firm’s net sales less the cost of goods sold

Gross profit = Net sales – Cost of goods sold

Operating Expenses

Operating expenses – all business costs other than the cost of goods sold

Total operating expenses generally are divided into two categories:

Net Income

Net income – occurs when revenues exceed expenses

Net loss – occurs when expenses exceed revenues

The Statement of Cash Flows (1 of 2)

Statement of cash flows – a statement that illustrates how the company’s operating, investing, and financing activities affect cash during an accounting period

FIGURE 15-9 Statement of Cash Flows

The Statement of Cash Flows (2 of 2)

Three different activities of a statement of cash flows; Explain briefly:

The totals of all three activities are added to the beginning cash balance to determine the ending cash balance.

Financial Ratios (1 of 3)

Financial ratio – a number that shows the relationship between two elements of a firm’s financial statements

Measuring a Firm’s Ability to Earn Profits

Return on sales (or profit margin) – a financial ratio calculated by dividing net income after taxes by net sales

Example for Northeast Art Supply:

The return on sales indicates how effectively the firm is transforming sales into profits.

A higher return is better than a low one.

A low return on sales can be increased by reducing expenses and increasing sales.

Financial Ratios (2 of 3)

Measuring a Firm’s Ability to Pay Its Debts

Current ratio – a financial ratio computed by dividing current assets by current liabilities

Example for Northeast Art Supply:

A high current ratio indicates that a firm can pay its current liabilities.

A low current ratio can be improved by repaying current liabilities, by reducing dividend payments to stockholders to increase the firm’s cash balance, or by obtaining additional cash from investors.

Financial Ratios (3 of 3)

Measuring How Well a Firm Manages Its Inventory

Inventory turnover – a financial ratio calculated by dividing the cost of goods sold in one year by the average value of the inventory

Average value of the inventory:

(Beginning inventory + Ending inventory) ÷ 2

Example for Northeast Art Supply:

The average inventory turnover for all firms is about 9 times per year, but turnover rates vary widely from industry to industry.

The quickest way to improve inventory turnover is to order merchandise in smaller quantities at more frequent intervals.