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Chapter Eight
Accounting: Decision Making by the Numbers

Review Questions

1. How do public accountants differ from management accountants? Who are the key users of the
accounting information? What type of information does each stakeholder group need?

2. Financial statements are prepared using generally accepted accounting principles (GAAP). What
group is responsible for establishing these principles, and what goals guide their formulation?
Why are many generally accepted accounting principles likely to change in the near future?

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3. State the “accounting equation” and define each of its terms. What is the logic behind this
equation? How is the structure of the balance sheet related to this equation?

4. You have a company's balance sheet, its income statement, and its statement of cash flows. Which
would you refer to if you wanted to know if a company made a profit last year? If you wanted to
find out whether the firm had any intangible assets? If you wanted to know why its cash balance
had changed over the past year? If you wanted to know how much debt the firm had used to
finance its assets? If you wanted to know what the firm’s operating expenses were for the past
year?

5. Describe the three basic categories of cash flows reported by a statement of cash flows and give
examples of specific cash flows included in each category.

6. Identify and describe the basic elements of an income statement. Explain how the accrual basis of
accounting guides the way the information on the income statement is reported.

7. What is the purpose of an external audit by an independent CPA firm? How does an auditor go
about conducting an audit? How does a qualified opinion by an auditor differ from an unqualified
opinion or an adverse opinion?

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8. What is the purpose of budgeting? What is the master budget, and what are its major components?
How does a top down budgeting process differ from a bottom up approach, and what are the
advantages and disadvantages of each?

9. Describe the key differences between financial accounting and managerial accounting.

10. How do management accountants view cost? How do implicit costs differ from explicit costs?
Give some examples to illustrate the difference.

Application Questions

1. You have recently graduated with an accounting degree. Use the Internet to investigate what exactly
is involved in becoming a Certified Public Accountant (CPA). Good places to start are Wikipedia's
"Certified Public Accountant" entry and the Department of Labor's Occupational Outlook Handbook
entry on accountants and auditors. What advantages and disadvantages do you see? Would you
decide to take this step? Why or why not?

2. The past several years have seen a number of significant accounting scandals have been
uncovered across the business world in companies ranging from tech companies like Hewlett
Packard and Groupon, to snack companies like Diamond Foods, and camera and medical
equipment maker Olympus. Research online news sites to find a recent accounting scandal, and
using concepts and terms from this chapter, describe the violations committed by the company.

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3. The generally accepted accounting principles (GAAPs) developed by the Financial Accounting
Standards Board (FASB) try to make interpreting and comparing a firm's financial performance
easier for a variety of stakeholders. Those stakeholders include suppliers, stockholders, creditors,
and the government. Go to the FASB website and find out more this board. Provide a brief
overview of the board’s mission. Who are the current members of the FASB and what are their
qualifications? Given these backgrounds, do you believe that the members of the FASB will
adequately represent the interest of this diverse set of stakeholders?

4. Check out the most recent financial statements for a major U.S. corporation. Go to the company’s
website and find the link to investor relations. (This may take a bit of searching. Not all corporate
websites are laid out the same way, but almost all of them contain a link to investor relations or
investor information. It is often at the top of the home page.) From the investor relations page,
look for a link to the company’s annual report. The financial statements will be presented in this
report, along with a lot of other information. Use information from these financial statements to
answer the following questions:
a. What amount of revenue did the firm earn in the most recent year?
b. What was its net income? Did it earn a profit or a loss?
c. How much cash did the company have?
d. What was the value of its accounts receivable—and what does this number represent?
e. What was the total amount of current liabilities? What does this value represent?
f. What was the company’s net cash flow from investing activities?

5. A new startup company will be producing environmentally friendly diapers and baby products,
and you have been named as the chair of its budgeting committee. Thanks to generous investors,
and the personal fortune of the company’s founder, you have been given $50 million for five
years. Using this resource, create a basic budget for the company that shows the operating budget
and the financial budget, and also deals with the various costs that a company has to deal with.

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Team Project

Pick out several publicly traded corporations, including some that you know are doing very well
financially and others that are struggling. Print out the most recent comparative financial statements for
each company. (Links to these statements are available on most financial websites as well as the
investor relationship pages of the firm’s websites.)
Break the class into small groups and give each group the financial statements for one of the
corporations. Tell the group to work together to find out what has happened over the past two years to
the firm’s total liabilities and stockholder’s equity, revenues, major costs and expenses, net income and
cash position and discuss what these figures tell them about the company’s financial recent performance
and current financial condition. Have each team report its findings to the class and have the class
discuss the results and compare the performance of the various companies.

Case Connections

A Wild Frontier

In 2001, U.S. airlines spent about 10 percent of their budget on fuel. In 2011, they had to spend 35
percent of their budget on fuel. Airlines, of course, can’t do one bit of business without jet fuel. So
when the most important line item in a company’s budget more than triples, the consequence is a
tremendous amount of financial pressure. And with nearly all experts agreeing that the price of fuel will
only increase, airlines have the unenviable task of buying the fuel they need while not breaking their
budget.
Industry-wide, there seem to be two main approaches to mitigating the effects of rising fuel prices—
reducing overall expenses and increasing revenue.
Companies focusing on reducing overall expenses related to fuel have been taking innovative
approaches:
• Some have tried to reduce their dependence on traditional jet fuels by looking for alternatives.
Virgin Atlantic was the first airline in the world to operate a commercial jet with a biofuel, which
was made from coconut oil and babassu nuts. Recently, United Continental announced a major
agreement to purchase algae-derived fuel from Solazyme.
• Delta Airlines, meanwhile, hopes that vertical integration can provide some budget relief. When it
learned that an oil refinery in Pennsylvania was going to be shut down, it purchased the facility so

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that it could make some of its own fuel. Delta executives estimate that it will provide a savings of
$300 million over five years.
• Some airlines are turning to high-tech solutions to reduce fuel use and reduce fuel-related
expenses. A number of airlines are using GPS navigation, rather than radar, to reduce the flight
times of an airplane. Some are adding small winglets, vertical facing tips to the ends of wings,
which reduce fuel use by 5%. And many are looking to new or remodeled aircraft, such as the
Boeing 787 or the Airbus A320neo, which use 15 to 20 percent less fuel than older models do.

Reducing expenses, however, will not balance out the sharp uptick in fuel costs. Companies, therefore,
have also focused on generating revenue from all aspects of their organization. Nearly all airlines have
taken steps to increase revenue through fees that cover almost everything. There are fees for checked
bags, fees for booking a ticket over the phone, fees for picking a certain seat, fees for a wider seat, fees
for pillows and blankets, fees for carry-on bags, fees for drinks and snacks, and more. Overall, the focus
on fees has been successful:
• In 2011, U.S. airlines collected over $3 billion in fees exclusively just by charging for checked
baggage.
• From January 2012 to January 2013, 28 new baggage-related fees were levied on air travelers.
Overall, 50 new fees were introduced by U.S. airlines in 2012.
• In the first six months of 2012, the airlines collected $1.3 billion in cancellation and reservation
change fees.

Yet, while airlines may have many options for responding to rising fuel costs, not all have done so
successfully. Take for example, Frontier Airlines, a low-cost carried based in Denver. Due to rising
costs and $1 billion in debt, it was forced to declare bankruptcy in 2009. The first two years after
emerging from bankruptcy, it lost another $148 million. Even adding extra fees, as nearly all other
airlines, hasn’t helped., and Frontier had to eliminate service to cities like Colorado Springs, Dayton,
and Philadelphia, while looking for less competitive places to operate.

You Decide:

• In your opinion, should Frontier Airlines focus on managerial accounting or financial

accounting as it works to get its finances back on firm footing?

• In this environment, would you recommend that Frontier Airlines use a bottom-up or top-down
approach to budgeting? Why?

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• Many U.S. airlines have solved their financial woes by merging with complementary
competitors or by making cuts and becoming much smaller airlines. Do you believe that these
are the only two options open to Frontier Airlines? What else could you propose?

Sources: “Clean, Green Options Lacking as Airline Seek Alternative to Petroleum,” by Amanda Peterka, E&E
Publishing:http://www.eenews.net/public/Greenwire/2013/01/14/2; “Airlines seek to slash fuel costs,” by Steve Hargreaves,
CNN.com: http://money.cnn.com/2012/06/01/news/economy/airlines-fuel/index.htm “How Different Airlines Are Managing
Fuel Costs Part Two,” by Alexander MacLennan, The Motley Fool: http://beta.fool.com/tulipspeculator1/2012/12/17/how-
sifferent-airlines-are-managing-fuel-costs-par/18907/: “U.S. Airlines ‘Only’ Collected $3.36 Billion in Baggage Fees Last
Year,” by Brad Tuttle, Time.com: http://business.time.com/2012/05/21/u-s-airlines-only-collected-3-36-billion-in-baggage-
fees-last-year/; “Frontier Struggles to Find a Route Map That Works,” by Ben Mutzabaugh, USAToday:
http://www.usatoday.com/story/todayinthesky/2013/02/19/frontier-airlines-struggle-to-find-a-route-map-that-
works/1928881/: “Investment Firms in Talks to Buy Frontier Airlines,” by Mike Spector and Jack Nicas, Wall Street
Journal: http://online.wsj.com/article/SB10001424127887324504704578412631654366830.html; “Airlines Collect a
Record Amount of Bag Fees,” by S. Mayerowitz, Associated Press, Sept 25, 2012, retrieved from Daily Finance:
http://www.dailyfinance.com/2012/09/25/airlines-collect-a-record-amount-of-bag-fees/;
“TravelNerd Study Finds over 50 U.S. Airline Fee Changes Since Last Year,” January 31, 2013, retrieved from
http://www.travelnerd.com/blog/2013/travelnerd-study-finds-50-airline-fee-changes/.

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