Lecture No.

8
SS-406

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 Understanding
Financial
Information
and
Accounting

McGraw-Hill/Irwin
17-2
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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
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– Ledgers
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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
Record
Analyze Source Transactions Post Journal
Documents in Journals Entries to Ledger

Prepare Analyze
Take a
Financial Financial
Trial Balance
Statements Statements

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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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 ABC CO. Ltd
Balance 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
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 ABC CO’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

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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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 ABC CO. 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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 ABC CO.’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

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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
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 Depreciation

Depreciation -- The systematic write-

off 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 Ratio

Current Ratio

Current Assets
Current Liabilities

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 Current Ratio- ABC CO

Current Assets
Current Liabilities

$600,000 = 2.08
$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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 Thank You

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