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Chapter. Understanding Financial Information and Accounting. 17. 17- 1. What is Accounting?. Recording, classifying, summarizing, & interpreting financial events & transactions to provide management & other parties information to allow them to make good decisions. Financial Transactions.
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Chapter Understanding Financial Information and Accounting 17 17-1
What is Accounting? Recording, classifying, summarizing, & interpretingfinancial events & transactions to provide management & other parties information to allow them to make good decisions.
Financial Transactions Include buying & selling goods & services, acquiring insurance, using supplies, & paying taxes.
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.
What Bookkeepers Do • Categorize and • Record the Data in • Books of Original Entry • Journals • Ledgers using • Double Entry
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.
Steps In The Accounting Cycle Record Transactions in Journals Analyze Source Documents Post Journal Entries to Ledger Prepare Financial Statements Analyze Financial Statements Take a Trial Balance
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)
Balance Sheet Statement of Financial Position (on a specific date)
Accounting (Balance Sheet) Equation Assets = Liabilities + Owner’s Equity = Owes + Owners’ Claims Owns
Terms Liquidity • How fast an asset can be converted into cash
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.
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.
Owners’ Equity Accounts • Retained Earnings -- Accumulated earnings from the firm’s profitable operations that are reinvested in the business.
Very Vegetarian’sBalance Sheet (Assets) Period ending 12/31/08 Assets Current Assets Cash $ 15,000 Accounts Receivable 200,000 Notes Receivable 50,000 Inventory 335,000 Total Current Assets $600,000 Fixed Assets Land $ 40,000 Buildings (net) 110,000 Equipment & Vehicles (net) 40,000 Furniture & Fixtures (net) 16,000 Total Fixed Assets $206,000 Intangible Assets Goodwill $ 20,000 Total Intangible Assets $ 20,000 Total Assets $826,000
Very Vegetarian’s Balance Sheet(Liabilities & Owner’s Equity) Period ending 12/31/08 Liabilities & Owners’ Equity Current Liabilities Accounts Payable $ 40,000 Notes Payable 8,000 Accrued Taxes & Salaries 240,000 Total Current Liabilities $288,000 Long-term Liabilities Notes Payable $ 35,000 Bonds Payable 290,000 Total Long-term Liabilities $325,000 Total Liabilities $613,000 Owners’ Equity Common Stock (1M shares) $100,000 Retained Earnings 113,000 Total Owners’ Equity $213,000 Total Liabilities & Owners’ Equity $826,000
Income Statement Statement of Revenues, Expenses, & Profits (specific period of time)
Income Statement Equation Profit = Revenues – Expenses
Income Statement Formula Revenues • Cost of Goods Sold =Gross Profit (Gross Margin) • Operating Expenses = Net Income Before Taxes • Taxes =Net Income (or Loss)
Very Vegetarian Income Statement Period Ending 12/31/10 Revenues Net Sales $ 700,000
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
Income Statement Formula Revenues • Cost of Goods Sold =Gross Profit (Gross Margin) • Operating Expenses = Net Income Before Taxes • Taxes =Net Income (or Loss)
Very Vegetarian’s Income Statement (cont’d) Gross Profit $290,000 Operating Expenses Selling Expenses Salaries $ 90,000 Advertising & Supplies $ 20,000 Total Selling Expenses $ 110,000 General Expenses Office Salaries $ 67,000 Depreciation $ 1,500 Insurance $ 1,500 Rent $ 28,000 Utilities $ 12,000 Miscellaneous $ 2,000 Total General Expenses $ 112,000 Less: Total Operating Expenses - $ 222,000 Net Income (Profit) Before Taxes $ 68,000 Less: Income Tax Expenses - $ 19,000 Net Income (Profit) After Taxes $ 49,000
Statement of Cash Flows Statement of Cash Receipts & Disbursements (cash coming in & cash going out)
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 Statement of Cash Flows
Depreciation • Depreciation -- The systematic write-off of the cost of a tangible asset over its estimated useful life.
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
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.
Liquidity Ratios Current Ratio Current Assets Current Liabilities Quick (Acid-Test) Ratio Cash + Marketable Securities + Receivables Current Liabilities
Liquidity Ratio Current Ratio Current Assets Current Liabilities
Current Ratio- Very Vegetarian Current Assets Current Liabilities $600,000 $288,000 = 2.08
Quick (Acid-Test) Ratio Cash + Marketable Securities + Receivables Current Liabilities $265,000 $288,000 = 0.92
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.
Debt to Equity Ratio Total Liabilities Owners’ Equity $613,000 $213,000 = 287%
Activity Ratios Inventory Turnover Cost of Goods Sold Average Inventory Inventory Turnover=$410,000= 1.9 $215,000