Chapter
Understanding
Financial
Information
and
Accounting
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What is Accounting?
Recording, classifying,
summarizing, &
interpreting financial
events & transactions
to provide management
& other parties
information to allow
them to make good
decisions.
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Financial Transactions
Include buying &
selling goods &
services, acquiring
insurance, using
supplies, & paying
taxes.
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The Accounting Process
DATA
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PROCESSING
INFORMATION
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What Bookkeepers Do
o Categorize
and
o Record the Data
in
o Books of Original
Entry
o Journals
o Ledgers
using
o Double Entry
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Bookkeeping's Role
• Bookkeeping -- The recording of business
transactions. Bookkeepers divide a firm’s
transactions into meaningful categories and post
them into a record book or computer program called
a journal.
• Double-Entry Bookkeeping -- Bookkeepers
record all transactions in two places so they can
check one list of transactions against the other for
accuracy.
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Bookkeeping's Role
• Ledger -- A
specialized accounting
book or program
where all information is
in one place.
• Trial Balance -- A
summary of all the
information in the
account ledgers.
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Accounting Guidelines
Financial Accounting Standards
Board (FASB) defines what are
Generally Accepted Accounting
Principles (GAAP) that
accountants must follow
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Bookkeeping vs. Accounting
Bookkeeping
Accounting
– Start of Accounting Process
– Recording of Business
Transactions
–
–
–
–
–
Classify
Summarize
Analyze
Interpret
Recommend
– Record/Journalize
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General Journal
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General Ledger
Cash
Date
Accounts Receivable
Date
Office Supplies
Date
Prepaid Insurance
Date
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Explanation
PR
PR
PR
PR
Debit
Debit
Debit
Debit
Credit
No. 101
Balance
Credit
No. 106
Balance
Credit
No. 124
Balance
Credit
No. 128
Balance
17-11
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The Accounting Cycle
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Steps In The
Accounting Cycle
Analyze Source
Documents
Record
Transactions
in Journals
Take a
Trial Balance
Prepare
Financial
Statements
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Post Journal
Entries to Ledger
Analyze
Financial
Statements
17-13
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Financial Statements
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Financial Statements
o Balance Sheet – Statement of
Financial Position (on a specific date)
o Income Statement – Statement of
Revenues, Expenses, & Profits (specific
period of time)
o Statement of Cash Flows – Statement
of Cash Receipts & Disbursements (cash
coming in & cash going out)
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Balance Sheet
Statement of Financial Position
(on a specific date)
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Terms
Assets
– What the Company owns
• Liabilities
– What the Company owes
• Equity
– Owners’ Claims
• Liquidity
– How fast an asset can be
converted into cash
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Accounting (Balance
Sheet) Equation
Assets = Liabilities + Owner’s Equity
Owns = Owes + Owners’ Claims
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Classifying Assets
o Current Assets -- Items that can or will be
converted to cash within one year.
o Fixed Assets -- Long-term assets that are
relatively permanent such as land, buildings, or
equipment.
o Intangible Assets -- Long-term assets that
have no physical form but do have value such
as patents, trademarks, and goodwill.
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Classifying Liabilities
o Liabilities -- What the business owes to others - its
debts.
o Accounts Payable -- Current liabilities a firm owes
for merchandise or services purchased on credit.
o Notes Payable -- Short or long-term liabilities a
business promises to pay by a certain date.
o Bonds Payable -- Long-term liabilities that the firm
must pay back.
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Owners’ Equity Accounts
• Owners’ Equity -- The
amount of the business
that belongs to the owners
minus any liabilities of the
owners.
• Retained Earnings -Accumulated earnings
from the firm’s profitable
operations that are
reinvested in the business.
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Balance Sheet Equation
Assets = Liabilities + Owner’s Equity
Very Vegetarian Company
$826,000 = $613,000
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+ $213,000
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Very Vegetarian’s
Balance Sheet (Assets)
Period ending 12/31/14
Assets
Current Assets
Cash
Accounts Receivable
Notes Receivable
Inventory
Total Current Assets
Fixed Assets
Land
Buildings (net)
Equipment & Vehicles (net)
Furniture & Fixtures (net)
Total Fixed Assets
Intangible Assets
Goodwill
Total Intangible Assets
Total Assets
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$ 15,000
200,000
50,000
335,000
$600,000
$ 40,000
110,000
40,000
16,000
$206,000
$ 20,000
$ 20,000
$826,000
17-23
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Very Vegetarian’s Balance Sheet
(Liabilities & Owner’s Equity)
Period ending 12/31/14
Liabilities & Owners’ Equity
Current Liabilities
Accounts Payable
Notes Payable
Accrued Taxes & Salaries
Total Current Liabilities
Long-term Liabilities
Notes Payable
Bonds Payable
Total Long-term Liabilities
Total Liabilities
Owners’ Equity
Common Stock (1M shares)
Retained Earnings
Total Owners’ Equity
Total Liabilities & Owners’ Equity
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$ 40,000
8,000
240,000
$ 35,000
290,000
$288,000
$325,000
$613,000
$100,000
113,000
$213,000
$826,000
17-24
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Income Statement
Statement of Revenues, Expenses, & Profits
(specific period of time)
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Income Statement
• Income Statement -The financial statement
that shows a firm’s
bottom line - that is, its
profit after costs,
expenses, and taxes.
• Net Income/Net Loss
-- The revenue left over
or depleted.
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Accounts of the Income Statement
• Revenues is the monetary value a firm received
for goods sold, services rendered or other
payments.
• Cost of Goods Sold (or Manufactured) -Measures the cost of merchandise the firms sells or
the cost of raw materials and supplies it used in
producing items for resale.
• Gross Profit -- How much a firm earned by buying
(or making) and selling merchandise.
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Accounts of the Income Statement
• Operating Expenses -Expenses a firm incurs in
selling goods and services
such as rent, salaries and
supplies.
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Income Statement Equation
Profit = Revenues – Expenses
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Income Statement Formula
Revenues
– Cost of Goods Sold
=Gross Profit (Gross Margin)
– Operating Expenses
=Net Income Before Taxes
– Taxes
=Net Income (or Loss)
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Very Vegetarian Income Statement
Period Ending 12/31/14
Revenues
Net Sales
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$ 700,000
17-31
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Very Vegetarian Income Statement
Period Ending 12/31/14
Revenue
Net Sales
$ 700,000
Cost of Goods Sold
Beginning Inventory
$ 200,000
Purchases During the
Year
$ 440,000
Cost of Goods Available
for Sale During the Year $ 640,000
Less: Ending Inventory $ 230,000
Less: Cost of Goods Sold
$ 410,000
Gross
Profit (Gross Margin)
$ 290,000
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Income Statement Formula
Revenues
– Cost of Goods Sold
=Gross Profit (Gross Margin)
– Operating Expenses
=Net Income Before Taxes
– Taxes
=Net Income (or Loss)
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Very Vegetarian’s
Income Statement (cont’d)
Gross Profit
Operating Expenses
Selling Expenses
Salaries
Advertising & Supplies
Total Selling Expenses
General Expenses
Office Salaries
Depreciation
Insurance
Rent
Utilities
Miscellaneous
Total General Expenses
Less: Total Operating Expenses
Net Income (Profit) Before Taxes
Less: Income Tax Expenses
Net Income (Profit) After Taxes
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$290,000
$ 90,000
$ 20,000
$ 110,000
$ 67,000
$ 1,500
$ 1,500
$ 28,000
$ 12,000
$ 2,000
$ 112,000
- $ 222,000
$ 68,000
- $ 19,000
$ 49,000
17-34
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Statement of Cash Flows
Statement of Cash Receipts & Disbursements
(cash coming in & cash going out)
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Understanding Cash Flow
• Cash Flow -- The difference between cash
coming in and cash going out of a business.
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Statement of Cash Flows
Reports cash receipts and disbursements
related to the firm’s major activities:
Operations – cash transactions
associated with running the business
Investments – cash used in or provided
by firm’s investment activities
Financing – cash raised from the
issuance of new debt or equity capital
or cash used to pay business
expenses, past debts, or company
dividends
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Depreciation
o Depreciation -- The systematic writeoff of the cost of a tangible asset over
its estimated useful life.
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Ratio Analysis
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Ratio Analysis
Assessment of firm’s financial
condition and performance
through calculations and
interpretations of financial
ratios developed from the
firm’s financial statements
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Using Financial Ratios
o Ratio Analysis -- The assessment of a firm’s
financial condition using calculations and
financial ratios developed from the firm’s
financial statements.
o Key ratios include:
- Liquidity ratios
- Leverage ratios
- Activity ratios
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Liquidity Ratios
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Commonly Used
Liquidity Ratios
o Liquidity ratios measure a firm’s ability to turn
assets into cash to pay its short-term debts.
o Two key ratios are:
o Current ratio
o Acid-test ratio
o This information is found on the firm’s Balance
Sheet.
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Liquidity Ratios
Current Ratio
Current Assets
Current Liabilities
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Current Ratio- Very Vegetarian
Current Assets
Current Liabilities
$600,000 = 2.08
$288,000
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Leverage (Debt) Ratios
o Leverage ratios measure the degree to which
a firm relies on borrowed funds in its
operations.
o Key ratios include:
o Debt to Owner’s Equity Ratio
o This information is found on the firm’s Balance
Sheet.
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Debt to Equity Ratio
Total Liabilities
Owners’ Equity
$613,000
= 287%
$213,000
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Activity Ratios
Inventory Turnover
Cost of Goods Sold
Average Inventory
Inventory Turnover = $410,000 = 1.9
$215,000
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