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CHAPTER 17

Understanding Principles of Accounting

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Chapter Outline

What Is Accounting and Who Uses Accounting Information?

Who Are Accountants and What Do They Do?

Tools of the Accounting Trade Financial Statements Analyzing Financial Statements International Accounting

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What Is Accounting and Who Uses Accounting Information?

Accounting is a comprehensive system for collecting, analyzing and communicating financial information

Bookkeeping is the recording of transactions

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What Is Accounting and Who Uses Accounting Information?

Accounting information system (AIS) is an organized means by which financial information is identified, measured, recorded and retained for use in accounting statements and management reports

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Users of Accounting Information

Business Managers Employees and Unions Investors and Creditors Tax Authorities Government Regulatory Agencies

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What is a Controller?

Person who manages all of a firm’s

accounting activities (chief accounting

officer

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Who Are Accountants and What Do They Do?

Financial Versus Managerial Accounting Financial accounting system is

concerned with external information users

Managerial (or Management) accounting system serves internal users

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What is an Audit?

Systematic examination of a

company’s accounting system to determine whether its financial

reports fairly represent its operations

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What is GAAP (or Generally Accepted Accounting Principles)?

Accepted rules and procedures governing the content and form of financial reports

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The Accounting Equation

Assets = Liabilities + Owners’ Equity

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The Accounting Equation

Asset is any economic resource expected to benefit a firm or an individual who owns it

Liability is a debt owned by a firm to an outside organization or individual

Owners’ equity is the amount of money that owners would receive if they sold all of a firm’s assets and paid all of its liabilities

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What is Double-Entry Accounting?

Bookkeeping system that balances the accounting equation by recording the dual effects of every financial transaction

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Financial Statements

Balance sheets supply detailed information about the accounting equation factors: Assets

Current Assets Fixed Assets Intangible Assets

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Financial Statements

Balance sheets supply detailed information about the accounting equation factors: Liabilities

Current Liabilities Long-Term Liabilities

Owners’ Equity Common Stock Paid-in Capital Retained Earnings

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Perfect Posters’ Balance Sheet

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Financial Statements

Income statement (or Profit-and-loss statement) lists a firm’s annual revenues and expenses so that a bottom line shows annual profit or loss. Three major categories: Revenues Cost of Goods Sold

Gross Profit (or Gross Margin) Operating Expenses

Operating and Net Income

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Perfect Posters’ Income Statement

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Financial Statements

Statement of cash flows describes a firm’s yearly cash receipts and cash payments. Three activities: Cash Flows from Operations Cash Flows from Investing Cash Flows from Financing

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An Internal Financial Statement: What is the Budget?

Detailed statement of estimated receipts and expenditures for a future period of time

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Perfect Posters’ Sales Budget

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Analyzing Financial Statements

Solvency RatioFinancial ratio, either short- or long-term, for estimating the risk in investing in a firm

Profitability RatioFinancial ratio for measuring a firm’s potential earnings

Activity RatioFinancial ratio for evaluating management’s use of a firm’s assets

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Analyzing Financial Statements

Solvency ratios, both short- and long-term, estimate risk. They include:

Short-Term Solvency Ratios Liquidity ratio measures a firm’s

ability to pay its immediate debts Current Ratio

Working Capital

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Short-Term Solvency Ratios

Liquidity Ratio

Solvency ratio measuring a firm’s ability to pay its immediate debts

Current Ratio

Solvency ratio that determines a firm’s credit worthiness by measuring its ability to pay current liabilities

61.2935,21$

210,57$

sliabilitieCurrent

assetsCurrent

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Short-Term Solvency RatiosWorking Capital

Difference between a firm’s current assets and current liabilities

Quick (or Acid-Test) RatioSolvency ratio for determining a firm’s ability to meet emergency demands for cash

Quick AssetCash plus assets one step removed from cash (marketable securities and accounts receivable)

59.1935,21$

650210,26300,2050,7$

sliabilitieCurrent

assetsQuick

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Long-Term Solvency Ratios

Debt Ratio  Solvency ratio measuring a firm’s ability to meet its long-term debtsDebt-to-Owners’ Equity Ratio (or Debt-to-Equity Ratio)  Solvency ratio describing the extent to which a firm is financed through borrowingDebt  A firm’s total liabilities

56.0155,111$

935,61$

equity Owners'

Debt

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Profitability RatiosNet Profit Margin (or Return on Sales)

Profitability ratio indicating the percentage of its income that is a firm’s profit

%9.4049.0425,256$

585,12$

Sales

incomeNet

Return on EquityProfitability ratio measuring income earned for each dollar invested

%3.11155,111$

585,12$

equity owners' Total

incomeNet

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Profitability Ratios

Earnings Per Share

Profitability ratio measuring the size of the dividend that a firm can pay shareholders

shareper $1.578,000

$12,585

goutstandin sharescommon ofNumber

incomeNet

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Activity Ratios

Inventory Turnover Ratio

Activity ratio measuring the average number of times that inventory is sold and restocked during the year

/2inventory) Endinginventory (Beginning

sold goods ofCost

inventory Average

sold goods ofCost

times4.8$21,250)/2($22,380

$104,765