> > > > > > > > Chapter 16

Understanding Accounting and Financial Statements

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Explain the functions and importance of accounting, and identify the three basic activities involving accounting.
Describe the roles played by public, management, government and not-forprofit accountants. Identify the foundations of the accounting system, including GAAP and the role of the Financial Accounting Standards Board (FASB). Outline the steps in the accounting cycle, and define double-entry bookkeeping and the accounting equation.


Explain the functions and major components of the four principal financial statements: the balance sheet, the income statement, the statement of owner’s equity, and the statement of cash flows.



Discuss how financial ratios are used to analyze a company’s financial strengths and weaknesses.
Describe the role of budgets in a business. Outline accounting issues facing global business and the move toward one set of worldwide accounting rules.

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interpreting. and communicating financial information to support internal and external business decision making. .Accounting is the process of measuring.

. • Outsiders use financial data to evaluate investment opportunities.• Open book management .sharing sensitive financial information with employees and teaching them how to understand and use financial statements. • Viewing financial information may help them better understand how their work contributes to the company’s success.

• Financing activities provide necessary funds to start a business and expand it after it begins operating. but they also consider expenses as important elements of sound financial management. • Investing activities provide valuable assets required to run a business. . • Operating activities focus on selling goods and services.

• Public Accountants – Provide accounting services to individuals or business firms for a fee • Management Accountants – Provide timely. and concise information that executives can use to operate their firms • Government and Not-for-Profit Accountants . relevant. accurate.

– Created the Public Accounting Oversight Board.S. or modifying GAAP in the U. – Senior executives must personally certify that the financial information reported by the company is correct. rules. • Sarbanes-Oxley Act responded to cases of accounting fraud. . setting. and procedures for determining acceptable accounting practices at a particular time. – Resulted in increase in demand for accountants.• Generally accepted accounting principles (GAAP) encompass the conventions. which sets audit standards and investigates and sanctions accounting firms that certify the books of publicly traded firms. • Financial Accounting Standards Board (FASB) is primarily responsible for evaluating.

.Accounting process .set of activities involved in converting information about transactions into financial statements.

• Assets . . • Liability . • Owner’s equity .all claims of the proprietor.claim against a firm’s assets by a creditor. partners.relationship that states that assets equal liabilities plus owners’ equity.process by which accounting transactions are entered. • Basic accounting equation .anything of value owned or leased by a business. • Double-entry bookkeeping . equal to the excess of assets over liabilities. each individual transaction always has an offsetting transaction. or stockholders against the assets of a firm.

• Simplifies the accounting process by automating data entry and calculations. • Some systems offer web-based packages for small medium businesses. Offers different country information/language. and BusinessWorks. Peachtree. • Available products are customized for businesses of different sizes. • Software that handles accounting information for international businesses is another option. – Larger firms use larger scale software packages like: Computer Associates. Oracle. – Entrepreneurs and small businesses use: QuickBooks. and . and SAP.

statement of a firm’s financial position—what it owns and the claims against its assets—at a particular point in time.  Photograph of firm’s assets together with its liabilities and owner’s equity  Follows the accounting equation . Balance sheet .


 Focus on revenues and costs associated with revenues. expenses. and profits over a given time period.  Reports profit or loss. Income Statement . .  Firm’s financial performance in terms of revenues.financial record of a company’s revenues and expenses. and profits over a period of time.


. Statement of Owner’s Equity .is designed to show the components of the change in equity from the end of one fiscal year to the end of the next.  Net income is added.  Begins with the amount of equity shown on the balance sheet. and cash dividends paid to owners are subtracted.


 Accrual accounting . not necessarily when cash actually changes hands. .method that records revenue and expenses when they occur. Statement of cash flows .a firm’s cash receipts and cash payments that presents information on its sources and uses of cash.


as well as the effectiveness of management’s resource utilization.tool for measuring a firm’s liquidity.Ratio analysis . . profitability. and reliance on debt financing.

Cash and equivalents + short-term investments + accounts receivable Total current liabilities . Total current liabilities Acid-test (or quick) ratio measures the ability of a firm to meet its debt payments on short notice.Total current assets Current ratio compares current assets to current liabilities.

Average of total assets . Average of inventory Net sales Total asset turnover ratio indicates how much in sales each dollar invested in assets generates.Net sales Inventory turnover ratio indicates the number of times merchandise moves through a business.

Profitability ratios measure the organization’s overall financial performance by evaluating its ability to generate revenues in excess of operating costs and other expenses. .

• Leverage ratios measure the extent to which a firm relies on debt financing. • Total liabilities to total assets ratio > 50 percent indicates that a firm is relying more on borrowed money than owners’ equity. .

and cash receipts and outlays. and costs. .• Budget . • Management estimates of expected sales. cash inflows and outflows. • Cash budget .tracks the firm’s cash inflows and outflows.planning and control tool that reflects a firm’s expected sales revenues. operating expenses. • Budgets are a financial blueprint that serves as a financial plan.


International Financial Reporting Standards (IFRS) are the standards. • Consolidated financial statements must reflect gains and losses due to changes in exchange rates.ratio at which a country’s currency can be exchanged for other currencies.• International Accounting Standards Committee (IASC) promotes worldwide consistency in financial reporting practices. • Can have significant impact on financial statement. In 2001. • Exchange Rates . became the International Accounting Standards Board (IASB). .

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