THE ROLE AND FUNCTIONS OF ACCOUNTING
Nasrin, Ritvik, and Melika (Ch.8)
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Accounting: The process of recording, analyzing, and interoperating, the economic activities
of a business
o CALCULATION FOR ACCOUNTING, “THE ACCOUNTING EQUATION”
 Assets = Liabilities + Owner’s Equity
o Kinds of activities that business is involved in help determine the accounting method
that the business uses
Transaction: The process of exchanging something of value for something else that has
value
o Accurate transaction records give a business information that it can use for budgeting
 To budget accurately, businesses should estimate sales and expenses
 Can be done by analyzing previous years during the same period
 Over or underestimating sales could affect a business
Accountability: The principle that employees with access to cash are responsible for the
money they handle and must explain any losses or discrepancies
o All businesses guarantee accountability through bookkeeping
Bookkeeping: The method of recording all transactions for a business in a specific format
o Bookkeepers use invoices
Invoice: A bill for goods and services either bought by or sold to the business
Capital Gain: Money made when an asset is sold for more than it cost to purchase it
Financial Statements: Reports that summarize the financial performance of a business
 Three Types
o Balance Sheet
o Income Statement
o Cash Flow statement
 Corporation also prepares a statement of shareholder’s equity
o Financial statements are presented to shareholders and potential investors in the
form of an annual report
Annual Report: A publication that presents a company’s financial statements for the year to
shareholders and potential investors
Credit: The borrowing capacity of an individual or company; also, a situation in which
someone receives something of value now and agrees to pay it for later
Fiscal Year: Business year; the 12 month period used for financial calculations and
comparisons by a business
Costs of Goods Sold: The cost of inventory that was sold to generate business revenue for
a specific period of time
o CALCULATION FOR COGS:
 Beginning Inventory + Inventory Purchased - Ending Inventory = COGS
Gross Profit: All the money left after deducting the cost of good sold from revenue, but
before deducting the business expenses that helped generate the revenue
o CALCULATION FOR GROSS PROFIT:
 Sales Revenue - COGS = Gross Profit
Net Profit (also known as Net Income): The money left over once operating expenses have
been deducted from the gross profit
o CALCULATION FOR NET PROFIT/INCOME:
 Gross Profit - Expenses = Net Profit/Income
Balance Sheet: A financial statements that shows the financial position of a business on a
specific date
Accounts Receivable: Money owed to a business
o Falls under assets on a balance sheet
Current Assets: Assets that are held for a short period of time and that can quickly be
converted into cash. A company funds its day-to-day operations from current assets
o Examples Include…
 Cash, Accounts Receivable, Supplies (pens/pencils)
Capital Assets: Assets that businesses keep for a long time that last longer than a year.
Commonly referred to as “long term assets”
THE ROLE AND FUNCTIONS OF ACCOUNTING
Nasrin, Ritvik, and Melika (Ch.8)
Examples Include…
 Building, Land, Trucks
Liquidity: The ability to convert an asset or investment into cash quickly and easily
Liability: A debt of the business
Accounts Payable: Money that a business owes
o Falls under liabilities on a balance sheet
Loans Payable: Debt acquired by borrowing money from investors, banks, or other financial
institutions, also called notes payable
Current Liability: A debt that should be paid quickly, usually within a year
Mortgage Loan: A long-term credit plan for purchasing real estate
Long-Term Liability: A debt that takes longer than a year to pay in full
Owner’s Equity: The owner’s investment in the business or the financial portion of the
business that actually belongs to the owner
Shareholder’s Equity: The shareholder’s investment in a corporation or the financial portion
of the corporation that actually belongs to the shareholders
Working Capital: The fund a business uses to pay its short-term debts
o CALCULATION FOR WORKING CAPITAL:
 Working Capital = Current Assets – Current Liabilities
Current Ratio: The number of dollars of liquid assets (cash or near cash) a business has for
every dollar of its short-term debt
o CALCULATION FOR CURRENT RATIO:
 Current Ratio = Total Current Assets / Total Current Liabilities
o Current ratio allows creditors and investors to tell very quickly whether a business
can meet its short-term obligations
Income Statement: A financial statement that shows a business’s profit (or loss) over a
stated period if time
o 5 parts: Revenue, Costs of Goods Sold (COGS), Gross Profit, Operating Expenses,
& Net Profit
o A business earns revenue or income from the sale of goods or services
Purchases: The total goods bought by the business in a year
o Calculated by examining invoices for the year, as recorder in the books of the
business
Operating Expenses: The cost of doing business for a particular period
Matching Principle: The principle that accurate profit reporting can be done only if all the
costs of doing business in a particular period are matched with the revenue generated during
that period
Margin: The difference between the cost of the product and the selling price of the product
Cash Flow: The movement of cash in and out of a business, or cash that is available to the
owner for the purpose of running the business on a daily basis and is used to pay for costs
and expenses
Cash-Flow Statement: A summary of the cash0in and cash0out transactions of a business
in order to predict whether the business will have enough cash to meet its obligations
o By examining the cash-in and cash-out section of a statement of cash flow, a
business must predict whether it will have enough cash to meet obligations
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Rate of return on Average Owner’s Equity: A figure calculated in order to determine the
success of a business.
o CALCULATION FOR RATE OF RETURN ON AVERAGE OWNER’S EQUITY:
 Rate of Return on Average Owner’s Equity = (Net Profit / Average Owner’s
Equity) x 100%
o Businesses use the rate of return on average owner’s equity to determine their
success
o To consider a business successful the rate of return should be EQUAL to or
GREATER than the return if the owner had put the money in a savings account or
invested the money in a bond or mutual fund
THE ROLE AND FUNCTIONS OF ACCOUNTING
Nasrin, Ritvik, and Melika (Ch.8)
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Budgeting: To budget accurately a business has to be able to estimate sales and expenses
o The best way a company can predict sales figures is to analyze all the records of
transactions for the same period in previous years
Service businesses
o Require the simplest type of accounting
o Sell intangibles
o Pure service business have no product inventory to record
o Absence of inventory  main difference between a pure service business and any
other type
Retail and Product Sales Businesses
o Sell products therefore use some accounts in their accounting systems that service
businesses don’t use
o Must keep track of inventory
o Every retailers starts the fiscal year with inventory on hand
o Companies physically count the inventory to check that records are accurate at least
once a year
Any business activity involving money is recorded as a transaction
All businesses operating in Canada have to pay taxes on their profit/earnings
The Government requires every business to keep a set of books including
o Accurate accounting records of transactions
o Yearly income statement (should show the company’s profit or loss)
 Must be included with the necessary tax forms and taxes must be paid
SAMPLE BALANCE SHEET & INCOME STATEMENT
THE ROLE AND FUNCTIONS OF ACCOUNTING
Nasrin, Ritvik, and Melika (Ch.8)
A) Fill in the blanks with the appropriate words.
1. Net profit is determined by subtracting ___________ from the gross profit.
2. Things that have value in a business, including accounts receivable, are called
_____.
3. _________ is the movement of money in and out of a business.
4. _________ is the exchange of something that has value for something else
that has value.
B) True or false.
___ 1. Accounting is the process of recording, analyzing and interpreting the
economic activities of a business.
___ 2. Cost of goods sold is calculated by adding the ending inventory to the
inventory purchased and then adjusting it with the beginning inventory figure.
___ 3. The rate of return on sales is the difference between the cost of the
product and its selling price.
___ 4. A balance sheet, unlike an income statement, provides a snapshot of the
business’s financial position.
C) Thinking questions.
1. What does it mean if a current ratio for a business is 2:1?
2. Why is accounting so important? How does it benefit the business?
3. If a business has an increase in their revenue, does this indicate that the
business is successful? Explain why or why not.
4. Why is accounting for a service business easier than a manufacturing
business?