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One Day of Notes
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CSCI A110: Intro to Computers and Computing
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This 15 page One Day of Notes was uploaded by Jordan Wawrzyniak on Monday February 2, 2015. The One Day of Notes belongs to H352 at Indiana University taught by Terry Renner in Winter2015. Since its upload, it has received 35 views.
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Date Created: 02/02/15
Chapter 3 09042014 Introduction 0 Involves identifying measuring recording and communicating in dollar terms the economic events and status of an organization 0 quotThe language of businessquot communicates important info about organization 0 Financial statements nancials 0 Where the information from nancial accounting summarized o The best way to summarize a business s nancial status and performance Thousands of years ago people were selfcontained they gathered their own food made their own clothes etc Specialization began some people became good at hunting others at shing others at making clothes etc With specialization came trade initially by bartering one type of good for another People set up shops 0 employed workers simple forms of money were used 0 trade expanded beyond their local area As simple economies grew 0 more formal forms of money developed 0 a primitive form of banking began with merchants leading pro ts from past dealings to enterprising shop owners and traders who needed money to expand their operations 0 First loans lenders could physically inspect borrowers assets and judge likelihood of repayment Arise of nancial statements 0 As industrial borrowers were developing large factories and merchants were acquiring eets of ships and wagons etc lenders could no longer easily inspect the assets that backed their loans so they needed a practical way to summarize the value of those assets 0 Certain loans were made on the basis of a share of the pro ts of a business D so a uniform widely accepted method for expressing income was required 0 Although economic systems have grown the original reasons for accounting statements still apply 0 Bankers and other investors need accounting information to make intelligent investment decisions 0 Managers need it to operate their organizations ef ciently o Taxing authorities need it to assess taxes in an equitable way but that is what accountants have to do when they construct nancial statements costs reported on an income statement may be overstated or understated o The numbers shown on the balance sheet to re ect a bussiness s assets and liabilities generally re ect historical costs and prices but inventories may be spoiledobsoletemissing or land and buildings may have current values much higher than their historical costs money owed to the business may be uncollectible some liabilities may not even show up in the numbers etc The Users of Financial Accounting Information 0 Investors and Managers 0 Those parties who have a nancial interest in the organization and hence are concerned with its economic status Outside stakeholders n Investors who supply the capital funds needed by businesses I Investors the primary outside users of nancial accounting info because the use the info to make judgments about whether to make a certain investment as well as to set the return required on the investment 0 Two types of investors 0 Owners who supply equity capital to investor owned businesses 0 Creditors or lenders who supply debt capital to both investorowned and notforpro t businesses A diverse group of investors banks suppliers granting trade credit bondholders I often create nancial targets based on the numbers reported in nancial statements that managers must attain or suffer some sort ofconsequence 0 Ex many debt agreements require borrowers to maintain stated nancial standards such as a min earnings level to keep the debt in force If isn t met lender demands business to ipay back full amount of loan amp if cant bankrupt Internal stakeholders n Managers including its board of directorstrustees of an organization both create and use the nancial statements to assess the current nancial condition of the organization ad formulate plans to ensure that its future nancial condition will support its goals Regulations and Standards of Financial Accounting Great Depression caused many businesses to fail and brought down the entire securities industry Consequence Federal government started regulating the form and disclosure of info related to publicly traded securities Regulation based on theory that nancial info constructed and presented according to standardized rules allows investors to make the bestinformed decisions SEC Securities and Exchange Commission 0 Independent regulatory agency of the US government that regulates the sale of securities and the operations of securities exchanges Also has overall responsibility for the format and content of nancial statements 0 End result businesses except for the smallest create SECconforming nancial statements 0 SEC does not directly manage the process but designates other organizations to create and implement the standard system mostly delegates this responsibility to the Financial Accounting Standards Board FASB FASB Financial Accounting Standards Board 0 Private organization 0 Mission is to establish and improve standards of nancial accounting and reporting for private businesses 0 Applies across a wide range of industries general in nature 0 Combined all of the previously issued standards into a single set called the FASB Accounting Standards Codi cation in Sept 2009 because of the large of statements and pronouncements that had been issued by the FASB amp other standardsetting organizations Purpose to simplify access to accounting standards by placing them into a single source AICPA American Institute of Certi ed Public Accountants 0 The professional association of the public accountants who established industry committees Industry committees provide more speci c implementation guidance especially when industryunique circumstances must be addressed Principles and Practices Board 0 Established by the Healthcare Financial Management Association 0 Develops position statements and analyses on issues that require furthermore speci c guidance than the standards provide 0 All the guidance contained in codi cation o The set of guidelines that has evolved to guide the preparation and presentation of nancial statements 0 Purpose to set the rules for the nancial statement preparation game to ensure the best possible development amp presentation of nancial statements 0 Note only applies to the area of nancial accounting not managerial or tax accounting favors accrual based accounting 0 Entitiesorganizations involved in establishing SEC FASB private AICPA public Field of nancial accounting is typically classi ed as a social science rather than a physical science 0 The end result represents negotiation compromise and interpretation 0 Organizations involved in setting standards are continuously reviewing amp revising the GAAP to ensure the best possible development amp presentation of nancial data this task is motivated by the fact that the US economy is constantly evolving w new business arrangement amp securities being created almost daily 0 External audit 0 The nal link in the nancial statement quality assurance process for large organizations 0 Performed by an independent outside auditor usually from one of the major accounting rms 0 Results are re orted in the auditors opinion a letter attached to the nancial statements stating whether or not the statements are a fair presentation of the business s operations cash ows and nancial position as speci ed by GAAP purpose to veri and validate the organization s nancial statements 0 1 Clean Bill of HealthUnquali ed Opinion 0 Most favorable in agreement with statements 0 2 Quali ed Opinion 0 Auditor has some reservations about the statements 0 3 Adverse Opinion 0 Auditor believes statements don t present a fair picture of the nancial status of the organization F Transparency means timely meaningful and reliable disclosure of a business s nancial information Needed because the US nancial s stem is so dependent on the reliability of nancial statements Conceptual Framework of Financial Reporting IG To achieve the goal GAAP speci es 4 assumptions 4 principles and 4 constraints 0 Assaptions 1 The entity business for which a set of accounting statements applies It s important to de ne this entity for two reasons I 1 For investorowned businesses nancial accounting data must be pertinent to the business activity as opposed to the personal affairs of owners I 2 Within any business the accounting entity de nes the speci c areas of the business to be included in the nancial statements It s assumed that the accounting entity will operate as a going concern and hence have an inde nite life I This means that assets should be valued on the basis of their contribution to an ongoing business as opposed to their current fair market value The going concern assumption coupled with the fact that nancial statements should be prepared for relatively short terms means that nancial accounting data are not exact but represent logical and s stematic a roaches applied to complex measurement problems 3 Because accounting entities are assumed to have an inde nite life but users of n Statements require timely info its common to report nancial results on a relatively short periodic basis The accounting period period covered can be any length of time an organizations managers or outside parties want to evaluate operational and nancial results Most health services organizations use calendar periods monthsquartersyears but occasionally will use a scal year nancial year that doesn t coincide with the calendar year such as from October 1 to Sept 30 Provides the common basis by which all economic events are measured 0 Principles In US dollar 0 1 o 2 o 3 o 4 o Constraints This principle requires organizations to report the values of most assets based on acquisition costs rather than fair market value which implies that the dollar has constant purchasing power over time Ex land that cost 1 million 20 years ago might cost 2 million today but still reported as initial cost of 1 milion Ensures reliable information removing subjectivity even if not the most current information bc of in ation This principle requires that revenues be recognized in the period in which they are realizable and earned n Generally the period in which the service is rendered because at that point the price is known realized amp service has been provided earned Sometimes dif culties with this primarily when there are uncertainties surrounding the revenue amount or the completion of the service This principle requires that an organization s expenses be matched to the extent possible with the revenues to which they are related After the revenues have been allocated to a particular accounting period all expenses associated with producing those revenues should be matched to the same period This can create many problems I Ex an MRI machine provides revenue for several years and the cost matching principle dictates that its acquisition cost should be spread over the same of years however there are many ways to do this and not one single way is best Financial statements must contain a complete picture of the economic events of the business Financial statements must be RELEVANT to a diversity of users Pushes preparers to include more info in statements 1 One of the measurement constraints The information reported in n statements must be based on objective veri able supporting data Preparers should base the data on supporting documentation such as invoices and contracts To keep statements manageable only entries that are important to the operation and nancial status of the organization need to be separately iden ed Affects the presentation of the nancial statements rather than their a re ate nancial content the s involves the application of like guidelines to a single accounting entity overtime When a business s statements are compared over extended periods annual statements for the past 10 yrs users must feel con dent that the are comparing apples to apples not apples to oranges lf uncertainty in the data or GAAP permits alternative interpretations of the nancial data this constraint says to choose the approach that is lease likely to overstate the business s nancial condition Should not deliberately understate the nancial condition however but when in doubt its best to choose the pat that will not overstate the situation Accounting Methods Cash Versus Accrual 0 Cash Accounting 0 O O Often called cash basis accounting Economic events are recognized put into the nancial statements when the nancial transaction occurs when money is RECEIVED Core argument in favor of cash accounting is that the most important event to record on the nancial statements is the receipt of cash not the provision of the service ie The obligation to pay Records the actual ow of money into and out of a business Advantages 1 Simple and easy to understand 2 Closely aligned to accounting for tax purposes so its easy to translate cash accounting statements into income tax ling data About 80 if all medical practices typically smaller ones use 0 Most businesses that use this don t use the quotpurequot method but only some features of it usually to report revenuesexpenses Accrual Accounting 0 Often called accrual basis accounting 0 The recording of economic events when a transaction takes place that leads to a cash exchange 0 When applied to revenues the accrual concept implies that revenue earned does not necessarily correspond to the receipt of cash because earned revenue is recognized in nancial statements when a service has been provided that creates a payment obligation on the part of the payer rather than when the payment is actually received 0 ln healthcare the payment obligation usually falls on the patient thirdparty payer or both 0 Not all reported revenues represent cash receipts same goes for expenses 0 GAAP favors accrual over cash accounting because the cash method presents an incomplete picture of the nancial status of a business Recording and Compiling Financial Accounting Data Ultimate goal of business s nancial accounting system to produce nancial statements the starting point for the identi cation and recording of nancial accounting information de ned as an exchange of goods or services from one individual or enterprise to another 0 Once a transaction is identi ed it must be recorded or posted to an which is a record of transactions for one uniquely identi ed activity the master listing of an organizations primary accounts a Subsidiary accounts support primary accounts Pertain to speci c assets or liabilities or to individual patients or vendors are aggregated to create data for a primary general ledger account a document that assigns a unique numerical identi ercode to every account of an organization 0 Because everyone who deals with the accounts is familiar with the business s chart of accounts transactions can be easily sorted by account code to ensure that transactions are posted to the correct amount Permanent accounts include items that must be carried from one accounting period to another remain active until the items in the account are no longer quoton the booksquot of the business Temporary accounts for those items that will automatically be closed at the end of each accounting period 0 Ex a business s revenue and expenses accounts are typically closed at the end of the accounting period and opened with a zero balance at start of next period Contra accounts special accounts that convert the gross value of some other account into a net value associated with depreciation expense journal entry each transaction recorded the system used to make accounting journal entries each transaction must be entered in at least two different accounts once as a debit and once as a credit debits entered on the left side of the vertical line and credits entered on the right side 0 Whether an entry is a debit or credit depends on the nature of the entry revenue or expense and the type of account Afterjournal entries are veri ed consolidated and reconciled they re formatted into the business s nancial statements Annual reports a report issued annually by an organization to its stakeholders that contains descriptive information and historical nancial statements verbal section and then nancial statements 0 Additional info in quotnotesquot section what s not covered in statement For health service orgs notes contain info on inventory accounting practices composition of long term debt pension plan status amount of charity care provided etc o GAAP also requires organizations to provide certain supplementary information bc may be essential to a good understanding of the nancial statements Income Statements Basics Most important question about a business Is the business making money Income statement 0 also called the statement of operations or statement of activities 0 core components revenues expenses and pro tability o basically summarizes the ability of an organization to generate pro ts lists the organization s revenue and income the expenses that must be incurred to produce the revenues and the differences between the two 0 more latitude in the construction of income statement than on the balance sheet Balance sheet 0 reports a business s nancial position at a single point in time o Revenues represent both the cash received and the unpaid obligations of payers for the services provided during each year of presented for healthcare providers the revenues result mostly from the provision of patient services a Expenses classi ed as operating or capital consist of salaries supplies insurance and other costs directly related to providing services Capital costs the costs associated with the buildings and equipment used by the organization such as depreciation lease and interest expenses Operating expenses consist of salaries supplies insurance and other costs directly related to providing services Revenues Can be shown on income statement in many different formats The rst line of the revenue section reports net patient service revenue 0 Revenues that stem solely from patient services as opposed to revenues that stem from related sources such as parking fees or food services net signi es that the amount shown is less than the clinic s gross charges for the services provided Charge master contains the charge codes and gross price for each service 0 Rarely represents the amount the clinic expects to be paid for a service EX Govt payers medicareaid reimburse providers a set amount that is often well below the charge master price Contractual allowances Differences bt charge master prices and actual reimbursement amts are incorporated before revenue is recorded on the net patient service revenue line reported after contractual allowances have been considered so it represents the actual reimb amount Charity care services not re ected in the net patient service revenue line 0 Indigent patients those who presumably are willing to pay for services but do not have the ability to do so l charity care is often provided to these patients Bad debt losses payments for services that are owed and hence reported as revenues that will never be collected listed as an expense as a provision for this lost revenue Difference bt charity care amp bad debt losses a Charity care represents services that are provided to patients who DO NOT HAVE the capacity to pay often identi ed before the service is rendered a Bad debt losses result from the failure to collect revenues from patients or third party payers who DO HAVE the ability to pay A description of policies regarding discounts and charity care often appears in the notes to the nancial statements Premium revenue reported separately on the income statement a signi cant amount of revenue stemming from capitation contracts Difference bt patient service re venue and premium revenue 0 Patient service revenue is reported when services are provided but premium revenue is reported at the start of each contract payment period typically the start of each month a Premium revenue implies an obligation on the part of the reporting organization to provide future services but patient service rev represents an obligation on the part of payers to pay the reporting organization for services already done Note Different types of providers may use different terminology for revenuesnursing lunnesrepo 39TeQdentsen cerevenuequot Other revenue Most health service orgs have revenue related to but not arising directly 39 onipa entsen ces 0 Ex parking fees nonpatient food service staff etc 0 Operating revenue when all the revenue associated with patient services is totaled the amount reported although its not listed as such on the income statement stems from the providers core operations the provision of patient services 0 Income that results from noncore activities primarily contributions and securities investments will be reported at the bottom of income statement Expenses Expenses the cost of doing business Natural or Functional Classi cation 0 Natural classi cation Classi es expenses by the nature of the expense 0 Functional classi cation Classi es expenses by purpose inpatient services etc 0 Salaries and Bene ts reported as expense paid to employees input cost a The detail of how these are broken down by department or contract or the relationship of these expenses to volume is not part of the nancial acct info system but this info IS very important to managers and is available in the managerial acct system Supplies represents the cost of supplies used in providing services 0 Some organizations order as needed some keep an inventory 0 The amount on hand is reported on the balance sheet 0 The income statement expense reports the supplies ACTUALLY CONSUMED in providing services 0 Insurance expense 0 Expense to protect business from many risks 0 Lease expense Depreciation o Businesses require property and equipment xed assets to provide goods and services 0 Although some of these assets are leased businesses often own many xed assets necessary to support its mission 0 When xed assets are initially purchased business does NOT report their cost as an expense on the income statement because the cost matching principle Cost matching principle dictates that such costs be matched to the accounting periods during which the asset produced revenues To match the costs of xed assets to the revenues produced by such long lived assets accountants use the concept of quotdepreciation expensequot which spreads cost of xed assets over many years 0 Cost v quotExpense In terms of depreciation quotcostquot is applied to the actual cash outlay for a xed asset and expense is used to describe the allocation of that cost over time o Depreciation expense is calculated in accordance with GAAP Uses straight line method historical cost of the asset minus its estimated salvage value the number of years of its estimated useful life annual dep exp I Annual depreciation expense is re ected in each year s income statement over the est life of asset o Depreciation is a noncash expense there is no actual payment associated with the expense 0 Provision for bad debts o Businesses often will not collect every dollar that it expects to even though the payers are assumed to have the ability to pay 0 Divide estimated bad debt losses by expected revenue to get percentage of net patient service revenue that the clinicbusiness could expect from their revenue 13 0 Interest expense 0 For debt capital supplied during that scal year 0 The amount reported by a business is in uenced primarily by its capital structure which re ects the amount of debt it uses 0 Affected by the borrower s creditworthiness its mix of long term versus short term debt and the general level of interest rates o Other expense category 0 Often includes general and administrative expenses that are individually too small to list separately usually a note with more detail regarding those expenses Operating Income 0 Most important info on income statement Pro tability 0 Can be measured in 2 different ways operating income nonoperating income and net income 0 Operating income total revenues total expenses 0 O O 0 General idea is to focus on revenuesexpenses related to operations Many healthcare providers have signi cant revenues that stem from nonpatient service related activities so it s useful to report the inherent pro tability of the core business separately from the overall pro tability of the enterprise Important because it focuses on the core activity of the business Positive net income operating at a pro t Negative operating income an operating loss worrisome because means that business s core operations are losing money Represents an est of the longrun operating pro tability of buz Shortcomings It doesn t represent cash ow Nonoperating Income Nonoperating income Income generated from activities unrelated to the provision of healthcare services 0 O 0 First category contributions Many notforpro t organizations especially those with large wellendowed foundations rely heavily on charitable contributions that can be usedspent immediately and reported as nonoperating income 2nOI category investment income stems from 2 primary sources I 1 Businesses usually have funds available that exceed the minimum necessary to meet current cash expenses to meet unexpected needs so these excess cash funds are often invested in shortterm interest earning securities such as treasury bills or money market mutual funds The INTEREST earned on these is reported as investment income I 2 Notfor pro t businesses often have large amounts of endowment fund contributions that are not reported as income because although received are not available to be spent however the income from securities purchased w endowment funds is available to the organization and is reported as nonop Income Note The income statements of some providers do not contain a separate section titled quotnonoperating incomequot it is included in the revenue section that heads the income statement total rev includes both nonop and op income Net Income 0 Second pro tability measure referred to as the quotbottom linequot 0 Even notforpro ts still must make a pro t to produce funds in the future 0 Most of a business s net income is reinvested in the business Notfor pro ts MUST reinvest ALL earnings into the business An investorowned corporation may return a portion or all of its net income to owners in the form of dividend payments that s the difference 0 Amount reinvested in an investor owned business net income dividends paid to owners 0 quotbecomes an expense that reduces net income rather than a distribution of net income reporting mechanism is much different Note Both operating income and net income measure pro tability as de ned by GAAP attempt to measure economic income of a business which is hard because economic gains and losses often aren t tied to easily identi able events Net Income v Cash Flow Although net income is an important measure of pro tability an organization s nancial condition depends more on the actual cash ow into and out of the business at least in the short run gt o A business will occasionally go bankrupt even if its net income has been historically reported positive 0 Commonly businesses have reported negative net incomes but have survived with little or no nancial damage Problem the income statement is like a mixture of apples and oranges 0 Some revenues reported for the previous year were actually collected this year but these do not appear on this years income statement because of accrual accounting l thus reported revenue is not the same as cash revenue same logic for expenses 0 Also not one cent of depreciation expense was paid out as cashdep expense is an accounting relfection of the cost of xed assets but a business does not actually pay it out in cash to a quotdistribution collectorquot Can net income be converted to cash ow actual amount of cash generated during the year 0 Because of accrual accounting net income doesn t represent an estimate of the organization s cash ow for the reporting period 0 The equation used to convert net income to a rough estimate of cash ow Cash ow net income noncash expensesdepreciation The idea behind the income statement treatement is that a business would be able to set aside the deprecation amount which is above and beyond its cash expenses this year and in future years Eventually the total of DEPRECIATION CASH FLOW would be used by business to replace its xed assets as they wear out or become obsolete l the incorporation of the depreciation expense into the cost and ultimately the price structure of services provided is designed to ensure the ability of an organization to replace its xed assets as needed assuming that the assets could be purchased at their historical cost 0 Essentially businesses must plan to generate net income in addition of the accumulated depreciation funds suf cient to replace existing xed assets in the future at in ated costs or even to expand the asset base Note cash ow is only an estimate of actual cash ow for scal year because almost every item of revenues and expenses listed on the income statement does not equal its cash ow counterpart o The bigger the difference between the reported values and the cash values the less reliable is the rough estimate of cash ow Income Statements of InvestorOwned Businesses Difference between notfor pro ts amp investorowned organization s nancial statements transactions that are applicable to only one form of ownership 0 In reality more differences exist in nancial statements because of lines of business rather than because of ownership Forpro t organizations has a percent tax rate which reduces net income by a like amount 0 Example 20 tax rate on income of 7860000 1572000 which reduces net income by that amountso net income is 78600001572000 6288000 The impact of taxes on net income addition of taxes reduces net income and the greater the tax rate the greater the reduction The impact of taxes on cash ow net income depreciation o Depreciation expense lowers taxable income by a like amount and hence lowers taxes by T Depreciation expense where T is the tax rate 0 Depreciation shield the amount taxes saved the dollar amount of taxes that will not have to be paid because of the business s depreciation expense l Bc depreciation expense reduces taxes it is said to shield forpro t businesses from taxes and the amount of taxes saved is called the depreciation shield Example Depreciation shied T Depreciation expense 150000 030 500000 Statement of Changes in Equity Also called the statement of changes in net assets A nancial statement that indicates how much of an organization s net income will be retained in the business and hence increase the amount of equity shown on the balance sheet Example if the entire amount of a business s net income was retained in the business the equity net assets of the business increases Ex Forpro t entity some portion of the earnings net income of the business is paid out as dividents In 2011 the business had net income of 7860000 but 2000000 of this amount was paid to owners So only 5860000 is available to increase the balance sheet equity account A Look Ahead Using Income Statement Data in Financial Statement Analysis Financial Ratio Analysis one of the techniques used in nancial condition analysis values found on the nancial statements are combined to form ratios that have economic meaning and help managers and investors interpret the numbers Total pro t margin net income divided by total revenues including investment income 0 Example total margin for a clinic in 2011 was 78600001719790004113000 7860000 176092000 0045 45SO each dollar of revenues and income generated by the clinic produced 45 cents of pro t and 955 cents of expenses The total margin is a measure of expense control The higher the net income and hence total margin the lower the expenses Operating margin operating income divided by total revenues 0 Ex if op income 3747000 and total rev 171979000op income divided by total rev 0022 or 22 each dollar of operating revenues generated by the clinic produced 22 cents of pro t operating income 0 Because operating margin doesn t include noncore revenues contributions amp investment income it s lower than the total margin which does include such Income
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