1. principles of accounting

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ITB Accounting and Finance

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1. principles of accounting

  1. 1. CHAPTER 17 Understanding Principles of Accounting 1
  2. 2. 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 2
  3. 3. 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 3
  4. 4. 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 4
  5. 5. Users of Accounting Information  Business Managers  Employees and Unions  Investors and Creditors  Tax Authorities  Government Regulatory Agencies 5
  6. 6. What is a Controller? Person who manages all of a firm’s accounting activities (chief accounting officer 6
  7. 7. 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 7
  8. 8. What is an Audit? Systematic examination of a company’s accounting system to determine whether its financial reports fairly represent its operations 8
  9. 9. What is GAAP (or Generally Accepted Accounting Principles)? Accepted rules and procedures governing the content and form of financial reports 9
  10. 10. The Accounting Equation Assets = Liabilities + Owners’ Equity 10
  11. 11. 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 11
  12. 12. What is Double-Entry Accounting? Bookkeeping system that balances the accounting equation by recording the dual effects of every financial transaction 12
  13. 13. Financial Statements  Balance sheets supply detailed information about the accounting equation factors:  Assets  Current Assets  Fixed Assets  Intangible Assets 13
  14. 14. 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 14
  15. 15. Perfect Posters’ Balance Sheet 15
  16. 16. 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 16
  17. 17. Perfect Posters’ Income Statement 17
  18. 18. 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 18
  19. 19. An Internal Financial Statement: What is the Budget? Detailed statement of estimated receipts and expenditures for a future period of time 19
  20. 20. Perfect Posters’ Sales Budget 20
  21. 21. Analyzing Financial Statements Solvency Ratio Financial ratio, either short- or long-term, for estimating the risk in investing in a firm Profitability Ratio Financial ratio for measuring a firm’s potential earnings Activity Ratio Financial ratio for evaluating management’s use of a firm’s assets 21
  22. 22. 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 22
  23. 23. 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 Current assets $57,210 2.61 Current liabilities $21,935 23
  24. 24. Short-Term Solvency Ratios Working Capital Difference between a firm’s current assets and current liabilities Quick (or Acid-Test) Ratio Solvency ratio for determining a firm’s ability to meet emergency demands for cash Quick Asset Cash plus assets one step removed from cash (marketable securities and accounts receivable) Quick assets $7,050 2,300 26,210 650 1.59 Current liabilities $21,935 24
  25. 25. Long-Term Solvency Ratios Debt Ratio Solvency ratio measuring a firm’s ability to meet its long-term debts Debt-to-Owners’ Equity Ratio (or Debt-to-Equity Ratio) Solvency ratio describing the extent to which a firm is financed through borrowing Debt A firm’s total liabilities Debt $61,935 0.56 Owners'equity $111155 , 25
  26. 26. Profitability Ratios Net Profit Margin (or Return on Sales) Profitability ratio indicating the percentage of its income that is a firm’s profit Net income $12,585 0.049 4.9% Sales $256,425 Return on Equity Profitability ratio measuring income earned for each dollar invested Net income $12,585 11.3% T otalowners'equity $111155 , 26
  27. 27. Profitability Ratios Earnings Per Share Profitability ratio measuring the size of the dividend that a firm can pay shareholders Net income $12,585 $1.57per share Number of commonsharesoutstandin g 8,000 27
  28. 28. Activity Ratios Inventory Turnover Ratio Activity ratio measuring the average number of times that inventory is sold and restocked during the year Cost of goods sold Cost of goods sold Averageinventory (Beginninginventory Endinginventory) /2 $104,765 4.8 times ($22,380 $21,250)/2 28

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