Getting to the
Bottom Line:
Basic Accounting Concepts
© Prentice Hall, 2007
Excellence in Business, 3e
Chapter 16 - 1
What is Accounting?
• Financial
• Management
© Prentice Hall, 2007
Excellence in Business, 3e
Chapter 16 - 2
What Accountants Do
•
•
•
•
Bookkeeping
Cost accounting
Tax accounting
Financial analysis
© Prentice Hall, 2007
Excellence in Business, 3e
Chapter 16 - 3
Ten Most Important
Accounting Skills
• Analytical
• Leadership
• Problem solving
• Decision making
• Interpersonal
• Time management
• Listening
• Teamwork
• Communication
• Computer
© Prentice Hall, 2007
Excellence in Business, 3e
Chapter 16 - 4
Types of Accountants
• Private
– CMA or CPA
– Internal audit
• Public
– CPA
– External audit
© Prentice Hall, 2007
Excellence in Business, 3e
Chapter 16 - 5
Typical Finance Department
Board of
Directors
President
Vice President
Sales
Vice President
Finance
Treasurer
Credit
Manager
Inventory
Manager
© Prentice Hall, 2007
Vice President
Manufacturing
Controller
Director
of Capital
Budgeting
Cost
Accounting
Excellence in Business, 3e
Financial
Accounting
Tax
Department
Chapter 16 - 6
Accounting Rules
• Generally Accepted Accounting Principles
(GAAP)
• Financial Accounting Standards Board
(FASB)
• International Accounting Standards (IAS)
• Securities and Exchange Commission
(SEC)
© Prentice Hall, 2007
Excellence in Business, 3e
Chapter 16 - 7
Sarbanes-Oxley Act
• Advantages
– Authority of auditors, conflict of
interest, investor protection,
corporate accountability
• Disadvantages
– Implementation, cost of compliance,
enforcement, reporting requirements
© Prentice Hall, 2007
Excellence in Business, 3e
Chapter 16 - 8
Fundamental
Accounting Concepts
• The accounting equation
• Double-entry bookkeeping
• The matching principle
© Prentice Hall, 2007
Excellence in Business, 3e
Chapter 16 - 9
The Accounting Equation
Owner’s Equity:
Assets – Liabilities = Owner’s Equity
Accounting Equation:
Assets = Liabilities + Owner’s Equity
© Prentice Hall, 2007
Excellence in Business, 3e
Chapter 16 - 10
Maintaining Balance
• Double-entry bookkeeping
– Credit purchase
– Cash purchase
• Matching principle
– Accrual basis
– Cash basis
© Prentice Hall, 2007
Excellence in Business, 3e
Chapter 16 - 11
How Are Financial
Statements Used?
• A transaction takes place
• The transaction is measured and recorded
• Journal entries are analyzed and posted to
a ledger
• Account data are summarized and used to
prepare budgets, reports, and financial
statements
© Prentice Hall, 2007
Excellence in Business, 3e
Chapter 16 - 12
Understanding Financial
Statements
• Balance sheet
• Income statement
• Cash-flow statement
© Prentice Hall, 2007
Excellence in Business, 3e
Chapter 16 - 13
The Balance Sheet
• Assets
– Current
– Fixed
• Liabilities and shareholder’s equity
– Current liabilities
– Long-term liabilities
– Shareholder’s equity
© Prentice Hall, 2007
Excellence in Business, 3e
Chapter 16 - 14
The Income Statement
Revenues
Gross Sales
Less Sales Returns and Allowances
Cost of Goods Sold
Beginning Inventory + Net Purchases – Ending Inventory
Operating Expenses
Selling Expenses
General Expenses
Income Taxes
Net Income After Taxes
Net Income Before Taxes – Income Taxes
© Prentice Hall, 2007
Excellence in Business, 3e
Chapter 16 - 15
The Cash-Flow Statement
• Operations
• Investments
• Financing
© Prentice Hall, 2007
Excellence in Business, 3e
Chapter 16 - 16
Analyzing Financial
Statements
Trend Analysis
Ratio Analysis
Uncover Business Shifts
Consider More
Than One Ratio
Consider Extraordinary
Circumstances
Check Specific Data
© Prentice Hall, 2007
Excellence in Business, 3e
Chapter 16 - 17
Types of Financial Ratios
•
•
•
•
Profitability
Liquidity
Activity
Leverage
© Prentice Hall, 2007
Excellence in Business, 3e
Chapter 16 - 18
Profitability Ratios
Return on Sales
Net Income/Net Sales
Return on Equity
Net Income/Total Owner’s Equity
Earnings per Share
Net Income/Average Shares Outstanding
© Prentice Hall, 2007
Excellence in Business, 3e
Chapter 16 - 19
Liquidity Ratios
Current Ratio
Current Assets/Current Liabilities
Quick Ratio
Current Assets – Inventory/Current Liabilities
© Prentice Hall, 2007
Excellence in Business, 3e
Chapter 16 - 20
Activity Ratios
Inventory Turnover
Cost of Goods Sold/Average Inventory
Accounts Receivable Turnover
Sales/Average Accounts Receivable
© Prentice Hall, 2007
Excellence in Business, 3e
Chapter 16 - 21
Leverage Ratios
Debt to Equity
Total Liabilities/Total Equity
Debt to Total Assets
Total Liabilities/Total Assets
© Prentice Hall, 2007
Excellence in Business, 3e
Chapter 16 - 22