WHAT ACCOUNTANTS DO Businesses can conduct hundreds—even thousands of transactions daily. Transactions include paying staff; paying bills, such as heat and electricity; and buying and storing inventory. Most businesses use accounting software packages, such as QuickBooks and Simply Accounting, to record and track financial information. Double-entry Bookkeeping A transaction could result in one increase offset by one decrease, two increases, or two decreases. An example would be if a business pays $80 for labour, it decreases cash while increasing expenses.
ACCOUNTING AND INDIVIDUALS Personal records or transactions can be recorded in a cheque register or on a computer program. An example of a preauthorized payment would be a utility bill deducted on a monthly basis from a chequing account. Always keeping accurate records ensures that individuals do not find themselves with insufficient funds. Assets When you take ownership of something, even if you owe money on it, it becomes yours and it is an asset. Liabilities Individuals and businesses may borrow money from financial or credit companies. Personal Equity or Net Worth See equation below Owner’s Equity on the next slide.
ACCOUNTING AND BUSINESSES A balance sheet is a financial statement that shows the financial position of a business on a specific date. If the information on the balance sheet is correct, the left and right side will be equal.
Mark’s Repair Shop Accounts receivable is the money owed to the business.
ACCOUNTING AND INDIVIDUALS Accounts payable is the money that a business owes. Mortgage payable is the debt owed on a building.
PREPARING FINANCAIL STATEMENTS Outsiders interested in the business could be lenders, government employees, and other business people. See Figure 9.1, “Types of Financial Statements”, on page 281. Preparing a Balance Sheet On any given day the balance sheet should be different, that is why it is like a snapshot. Balance Sheet Equation Method If the business did not have any debts the balance sheet equation would be: Assets = Owner’s Equity .
(steps for preparing a valance sheet for Mark’s Repair Shop) Step 1 : Fill in the Statement Heading : three-line header, centred, with who, what and when Step 2 : List the Assets : Assets should be listed in order of liquidity, the ability to convert an asset or investment into cash quickly and easily. Step 3 : List the Liabilities : Liabilities are listed in order of maturity date, the date by which they must be repaid. The individuals and business under liabilities are often called creditors (a person or business that is owed money; one who lends money or sells on credit. Step 4 : Calculate Owner’s Equity : Use the balance sheet equation Assets – Liabilities = Owner’s Equity to calculate the Mark’s equity in the business. $219 600 - $128 000 = $91 200 Step 5 : Put It All Together : Using Steps 1 through 4, the balance sheet for Mark’s Repair Shop will be as shown.
Balance Sheet Report Form Method See Figure 9.2, “Who Might Need to Review a Balance Sheet?”, on page 285. PREPARTING AN INCOME STATEMENT An income statement is like a movie that shows what happened over a period of time (week, month, quarter, or year). Examples of expenses include salaries, advertising, maintenance, and utilities.
INCOME STATEMENT FOR SERVICE BUSINESSES (steps for preparing an income statement for mark’s Repair Shop for the month of September) Step 1 : Fill in the Statement Heading : It answers the questions Who? What? And When? Step 2: Organize the Revenue Section : All sources of revenue should be listed. Step 3: Organize the Expenses Section : Larger expenses tend to go first, with all of September’s expenses listed. Step 4: Calculate Net Income or Net Loss : Using the information from Steps 2 and 3 and the equation for calculating profit (Total Revenue – Total Expenses) $9 900 - $6 790 = $3 110 When expenses are shown on the income statement they should be matched with the revenue they generate. The matching principle states that accurate profit reporting can be done only if all the costs of dong business in a particular period are matched with the revenue generated during that period. Not following the matching principle might distort figures that business decisions are based on. See Table 9.1, “Matching Principle Example”, on page 289.
Income Statement for Retail Businesses Inventory is the goods and materials kept on hand by a business. Income Statement Equations Gross profit , or gross margin, is the money left over after deducting the cost of goods sold from the revenue, but before deduction the business expenses that helped generate the revenue. The cost of goods sold is calculated by starting with the opening inventory figure (goods and services purchased in previous months but not yet used), adding the new purchases made during the period, and subtracting the inventory remaining at the end of the time period.
ACCOUNTING AND INDIVIDUALS A fiscal year , or business year, is any 12-month operating period. The fiscal year often, but not always, corresponds to the calendar year,; it could be January 1 to December 31, or April 1 to March 31. At the beginning of the fiscal year (Jan. 1, 20__) the shoe store had $50 000 in inventory. The shoe store, through the year, buy $75 000 worth of additional inventory. Over the whole year the store has a total of $125 000 in inventory to sell. At the end of the twelve month period an actual physical count is done. There is $40 000 in unsold inventory. Subtract the $40 000 (ending inventory) from the $125 000 (cost of all goods available for sale) and the cost of goods sold in $85 000. Remember the cost of goods sold is not the price the customer paid. The store collected $150 000 in sales revenue (from goods sold) during the year. $85 000 (cost of goods sold) is deducted from $150 000 (sales revenue) and the gross profit is $65 000 (this is the amount before deducting the business expenses that helped to generate the revenue). Expenses ($25 000) are deducted from gross profit ($65 000) and it results in net profit ($40 000). Net profit is the amount the storeowner can declare as income for income tax purposes.
PREPARING A STATEMENT OF CASH FLOW Sources of cash moving into a business could include sales, interest on investments, accounts receivable, the sale of capital equipment, new loans, and investments. Sources of expenditures, cash moving out of the business could include rent, payroll, accounts payable, interest payable, and insurance.
Ways to Increase Cash Flow Extra investment sources are increased money from owner(s), a short-term loan from a bank, or finding new partners or investors. See Figure 9.3, “Eight Ways to Boost Your Cash Flow”, page 294. Cash-flow Implications of Credit and Debit Cards In some cases stores can make as much or more on their money-on-money investments as they do selling goods in the store.
INTERPRETING FINANCIAL STATEMENTS See Table 9.2, “Comparative Balance Sheet”, on page 297. The comparison gives an indication of where the company was and where it is now. The comparison balance sheet could demonstrate that the business needs to direct more effort to collecting accounts receivable. The balance sheet can give information concerning inventory, show that there is too much debt, or if owner’s net worth has decreased.
1. Chapter 9: AccountingBasic Accounting ConceptsBusinesses engage in activities that concentrate on financial worth,such as money, spending, expenses, mergers, and costs.What Accountants DoAccountants make meaningful and effective decisions based on up todate and accurate records of a company.Accounting is the process of recording, analyzing, and interpreting thefinancial or economic activities of a business. Financial activities inbusiness are recorded as transactions: recording something of valuefor something else of value. Bookkeeping is the recording of alltransactions for a business in a specific format.Double-Entry BookkeepingThe principle that each transaction involves two changes is known asdouble-entry bookkeeping: one increase results in one decrease, twoincreases results in two decreases, and so on. 1
2. Chapter 9: AccountingBasic Accounting ConceptsAccounting and IndividualsIndividuals need to keep accurate financial records. People often alloworganizations to take preauthorized payments resulting in moneytaken automatically and on a regular basis from their bank accounts.AssetsAssets are things of value that a business or person owns.LiabilitiesLiabilities are debts or amounts of money that are owed to others byan individual or a business.Personal Equity or Net WorthA person’s assets, after all liabilities are deducted, is known aspersonal equity or net worth. 2
3. Chapter 9: AccountingBasic Accounting ConceptsAccounting and BusinessesA businesses’ assets and liabilities are used to calculate the net worth—the owner’s equity.Owner’s EquityOwner’s equity is the owner’s investment in the business or the financialportion of the business that belongs to the owners or shareholders. Assets – Liabilities = Owner’s EquityBalance Sheet EquationsThe balance sheet equation can be expressed in two ways:1. To determine owner’s equity: Assets – Liabilities = Owner’s Equity2. To determine total assets: Assets = Liabilities + Owner’s Equity 3
4. Chapter 9: AccountingBasic Accounting ConceptsCost Principle and DepreciationThe accounting practice of always recording an asset at the actualamount it costs the business is known as the cost principle. Evenwhen an asset depreciates or loses value over time the asset value onthe books remains the same.Mark’s Repair ShopHere are the assets of Mark’s Repair Shop.• cash in the business and in a bank account ($6500)• accounts receivable ($8100)• invoicing supplies ($500)• parts inventory ($4000)• business equipment (truck) ($25 500)• building and land ($175 000) Total Assets = $219 600 4
5. Chapter 9: AccountingBasic Accounting ConceptsMark’s Repair ShopHere are Mark’s debts or liabilities.• accounts payable ($7350)• bank loan for truck ($11 050)• mortgage payable (on building) ($110 000) Total Liabilities = $128 400Equity calculation for Mark’s net worth can be calculated as follows: Assets – Liabilities = Owner’s Equity $219 600 - $128 4000 = $91 200 5
6. Chapter 9: AccountingPreparing Financial StatementsThe balance sheet, the income statement, and the statement of cash flowhelps owners and managers keep track of the financial health of thebusiness. The financial statements provide outsiders with accurateinformation about the business.Preparing a Balance SheetThe balance sheet shows the financial position on any given day of thebusiness, and provides information about its assets, liabilities, and equity.Balance Sheet Equation MethodThe balance sheet gets its name because the left side of the equation(assets) always equals the right side (liabilities plus owner’s equity).Assets are owned by one of two groups 1. owner(s) of the business (owner’s equity) 2. individuals or businesses owed money (liabilities) 6
7. Chapter 9: AccountingPreparing Financial Statements Step 1 Mark’s Repair Shop Statement Headings Step 2 Balance Sheet List Assets September 30, 20__ Step 3 List Liabilities Assets Liabilities Cash $6 500 Accounts Payable 7 350 Accounts Receivable 8 100 Bank Loan 11 050 Supplies 500 Mortgage Payable 110 000 Parts Inventory 4 000 Total Liabilities $ 128 400 Equipment 25 500 Building and Land 175 000 Owner’s Equity Mark Bianchet, Equity $ 91 200 Total Liabilities and Total Assets $ 219 600 Owner’s Equity 219 600 Step 5 Step 4 Put It All Together Calculate Owner’s Equity 7
8. Chapter 9: AccountingPreparing Financial StatementsBalance Sheet Report Form MethodComputer programs easily complete thebalance sheet using an up-and-down columnformat rather than a side-by-side format.Preparing an Income StatementThe income statement is a financial statementthat shows a business’s profit (or loss) over astated period of time.The money, or the promise of money, receivedfrom the sale of goods or services is calledrevenue.Expenses are expenditures that help abusiness generate revenue. 8
9. Chapter 9: AccountingPreparing Financial StatementsIncome Statements for Service Businesses Mark’s Repair Shop Step 1 Income Statements Statement Headings For the month ending September 30, 20__ Revenue Repairs Revenue $ 9 900 Step 2 Total Revenue $ 9 900 Organize Revenue Expenses Section Salaries $ 2 600 Rent 2 000 Step 3 Advertising 850 Organize Expenses Supplies 185 Section Utilities 235 Insurance 150 Step 4 Delivery Expense 770 Calculate Net Income/ Total Expenses $ 6 790 Loss Net Income $ 3 110 9
10. Chapter 9: AccountingPreparing Financial StatementsIncome Statements for Retail BusinessesBalance sheets for retail businesses are similar to thoseof service businesses. However, retail businesses needto take the cost of inventory (goods on hand to be sold)into account.Income Statement EquationsIncome statement equation for a service business. Revenue – Expenses = Net IncomeIncome statement equation for a retail business. Revenue – Cost of Goods Sold = Gross Profit Gross Profit – Expenses = Net Income 10
11. Chapter 9: AccountingPreparing Financial StatementsIncome Statements and Beginning Inventory, Jan.1, 20__ $50 000Inventory Inventory Purchased +75 000Tracking of inventory is critical. It Costs of All Goods for Sale 125 000 Ending Inventory, Dec. 20__ - 40 000saves the retail business money Costs of Goods Sold 85 000and increases customersatisfaction. When a physical count Sales Revenue $150 000of inventory is taken, it is compared Cost of Goods profit - 85 000to the on-going count that is Gross Profit 65 000usually maintained by computersystems.Operating expenses are deducted Gross Profit $65 000from the gross profit to determine Expenses - 25 000the net profit. Net Profit $40 000 11
12. Chapter 9: Accounting “Capital” is added to identify Basic Accounting Concepts the owner’sOwner’s Equity Account accountThe net profit is calculated first Owner’s Equitythen transferred to the balance C. Donahue, Capital, Jan. 1, 20__ $ 75sheet as part of owner’s equity. 000Creditors and owners have claims Add: Net Income $ 40on the assets of the business. 000 C. Donahue, Capital, Dec. 31, 20__ $ 115 000Preparing a Statement of CashFlowCash flow is the movement of Projected Cash Flow Statementcash-in and cash-out of a Mark’s Repair Shopbusiness. The statement of cash October 31, 20__flow is a summary of the cash-in Transaction In (+) Out (-)and cash-out transactions of a Investment Income +$ 500.00business that helps to predict the Accounts Receivables +750.00amount of cash it needs to meet Equipment to be Sold +1 250.00obligations. Payroll Not Yet Paid -$ 460.00 Loan Repayment -930.00 Insurance Due -200.00 Projected Cash Flow 12 910.00
13. Chapter 9: AccountingBasic Accounting ConceptsWays to Increase Cash FlowA business must consider several ways to meet itsobligations if cash flow is inefficient. A businessmight seek extra investments, reduce inventorypurchases, and increase efforts to collect accountsreceivables.Cash-flow Implications of Credit and Debit CardsBusiness that allow customers to use a credit and/ordebit card do not have wait for their money(accounts receivables); they receive their money(sales revenue) up front. Since these businessestake a long time to pay their own bills, they investthe customers’ cash to make more money. 13
14. Chapter 9: AccountingBasic Accounting ConceptsInterpreting Financial StatementsFinancial statement information allows accountants to makerecommendations to owners regarding future business decisions.Accountants compare data over a set period of time, usually twoor more years.A Final Measure of SuccessFor a business to be successful, the return on the owner’sinvestment should be equal to or greater than the return for asavings account, bond, or mutual fund. 14