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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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.
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What Bookkeepers Do
• Categorize
and
• Record the Data
in
• Books of Original
Entry
– Journals
– Ledgers
using
• Double Entry
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Bookkeeping's Role
• 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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General Journal
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Ledger T-Account
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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
17-10
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Financial Statements
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Financial Statements
Balance Sheet – Statement of
Financial Position (on a specific date)
Income Statement – Statement of
Revenues, Expenses, & Profits (specific
period of time)
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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Accounting (Balance
Sheet) Equation
Assets = Liabilities + Owner’s Equity
Owns = Owes + Owners’ Claims
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Terms
Liquidity
– How fast an asset can be
converted into cash
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Classifying Assets
• Current Assets -- Items that can or will be
converted to cash within one year.
• Fixed Assets -- Long-term assets that are
relatively permanent such as land, buildings, or
equipment.
• 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
• Liabilities -- What the business owes to others - its
debts.
• Accounts Payable -- Current liabilities a firm owes
for merchandise or services purchased on credit.
• Notes Payable -- Short or long-term liabilities a
business promises to pay by a certain date.
• Bonds Payable -- Long-term liabilities that the firm
must pay back.
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Owners’ Equity Accounts
• Retained Earnings -Accumulated earnings
from the firm’s profitable
operations that are
reinvested in the business.
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Very Vegetarian’s
Balance Sheet (Assets)
Period ending 12/31/08
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
$826,000
17-19
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Very Vegetarian’s Balance Sheet
(Liabilities & Owner’s Equity)
Period ending 12/31/08
Liabilities & Owners’ Equity
Current Liabilities
Accounts Payable
Notes Payable
Accrued Taxes & Salaries
Total Current Liabilities
Long-term Liabilities
Notes Payable
Bonds Payable
Total Long-term Liabilities
Total Liabilities
Owners’ Equity
Common Stock (1M shares)
Retained Earnings
Total Owners’ Equity
Total Liabilities & Owners’ Equity
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$ 40,000
8,000
240,000
$ 35,000
290,000
$288,000
$325,000
$613,000
$100,000
113,000
$213,000
$826,000
17-20
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Income Statement
Statement of Revenues, Expenses, & Profits
(specific period of time)
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Income Statement Equation
Profit = Revenues – Expenses
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Income Statement Formula
Revenues
– Cost of Goods Sold
=Gross Profit (Gross Margin)
– Operating Expenses
=Net Income Before Taxes
– Taxes
=Net Income (or Loss)
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Very Vegetarian Income Statement
Period Ending 12/31/10
Revenues
Net Sales
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$ 700,000
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Very Vegetarian Income Statement
Period Ending 12/31/10
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
17-27
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Statement of Cash Flows
Statement of Cash Receipts & Disbursements
(cash coming in & cash going out)
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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
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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Using Financial Ratios
• Ratio Analysis -- The assessment of a firm’s
financial condition using calculations and
financial ratios developed from the firm’s
financial statements.
• Key ratios include:
- Liquidity ratios
- Leverage ratios
- Activity ratios
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Liquidity Ratios
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Commonly Used
Liquidity Ratios
• Liquidity ratios measure a firm’s ability to turn
assets into cash to pay its short-term debts.
• Two key ratios are:
- Current ratio
- Acid-test ratio
• This information is found on the firm’s Balance
Sheet.
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Liquidity Ratios
Current Ratio
Current Assets
Current Liabilities
Quick (Acid-Test) Ratio
Cash + Marketable Securities + Receivables
Current Liabilities
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Liquidity Ratio
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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Quick (Acid-Test) Ratio
Cash + Marketable Securities + Receivables
Current Liabilities
$265,000
$288,000
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Leverage (Debt) Ratios
• Leverage ratios measure the degree to which a
firm relies on borrowed funds in its operations.
• Key ratios include:
- Debt to Owner’s Equity Ratio
• 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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