Basic Accounting
Principles
The Financial Statements
Accounting Terms
Account
• A group of items having common
characteristics
Types of Accounts
• Asset Liability
• Income E...
Chart of Accounts
Listing of all of the accounts
used by a business
Asset Accounts
Items of Value
Characterized as current
and non-current
Liability Accounts
Claims that others have against
the assets
Have a known:
• Amount
• Date to be paid
• Person to whom ...
Equity Accounts
Claims that the owner has
against the assets
Sometimes called net worth
Difference between value of
ass...
Income and Expense
Accounts
Types of equity accounts
Simple accounting systems
often only contain these
accounts
Double vs Single Entry
Accounting
 Single – One account entry for each
transaction
 Double – Two account entries for eac...
Basic Accounting
Equation
Always maintained in double
entry accounting
Assets will always equal
liabilities plus equity
Transactions
Will be equal and offsetting
Two types:
• Income & Expenses
• Transfers between accounts
Cash and Accrual
Accounting
Refers to the timing of entries
into the accounting system
Cash Based Records
Transactions are recorded when
cash is received or paid out
Accrual Based Records
Transactions are recorded when
they take place
Regardless of whether cash is
involved
Accrual Adjusted
Statements
Cash based records are kept
throughout the year
Non-Cash adjustments are
made to the cash ba...
Account Valuation
Income Accounts
• Value received is recorded
Expense Accounts
• Value paid is recorded
Liability Acco...
Account Valuation
Asset Accounts
• More difficult because they may
not be traded routinely
Asset Valuation
Cost Basis
Market Value Basis
Cost Basis Asset
Valuation
Original cost minus depreciation
Must establish a depreciation
method
Market Basis Asset
Valuation
Recorded as the price they
could bring if sold, less selling
expenses
Based on recent aucti...
Depreciation
Section II page 29, (FFSTF
Guidelines)
Allocation of the expense that
reflects the “using up” of capital
as...
Depreciation
Allocation applied to original cost
minus salvage value
Accelerated versus straight line
methods
• Example ...
Financial Reports
Balance Sheet
Income Statement
Statement of Cash Flows
Statement of Owner Equity
Balance Sheet
Represents a financial situation
at a single point in time
Has a date on it
Broken down by:
• Type of Ass...
Balance Sheet
Current Assets
• Cash and other assets that will
be converted into cash during one
operating cycle
Non-Cur...
Balance Sheet
Current Liabilities
• Debts that will come due within
one year from the balance sheet
date
Non-Current Lia...
Balance Sheet
Intermediate Assets and Liabilities
Long term Assets and Liabilities
Can use cost or market valuations
or...
Income Statement
Summary of income and expenses
Represents a period of time
between two balance sheets
Explains the cha...
Assets Liabilities
Equity
Assets Liabilities
Equity
+/- Net Income
+/- Valuation Changes
- Family living withdrawals
+ Cap...
Income Statement
Will have more than one profit
line
Definition of Profit
• Financial profit is the net return
to busine...
Accrual Adjusted Income
Statement
Cash incomes and expenses must be
adjusted by:
• Changes in non-cash assets
• Inventori...
Statement of Cash Flows
Not the same as a cash flow plan
(Budget)
Is a historical record of sources
and uses of funds
D...
Statement of Owner
Equity
Explains the change in owners
equity between two balances sheets
Changes due to :
• Net income...
Financial Analysis
All business owners should have
a basic set of financial
statements at their disposal
and they should ...
Financial Analysis
Two Objectives
• Measure financial condition of the
business
• Measure financial performance of
the bu...
Financial Analysis
Horizontal Analysis
Vertical Analysis
Ratio Analysis
Horizontal Analysis
Looks at trends in performance
and strength over time
• For example, percent change in
net income fro...
Vertical Analysis
Looks at within year events
rather than over time
• For example, interest expense as
a percent of total...
Ratio Analysis
Allows for consistent
comparison of a single business
over time as well as comparison
between businesses
...
Source of data for Ratio
Analysis
Balance Sheet
Income Statement
Farm Financial Standards
Council (Five Criteria)
Liquidity
Solvency
Profitability
Financial Efficiency
Repayment Capa...
Ratio Analysis
16 different ratios commonly
used
Each has limitations
Proper interpretation is critical
Liquidity
Ability of a business to pay
current liabilities as they come
due
Liquidity
Current Ratio
• Current Assets/Current Liabilities
• Less than one is bad
Working capital
• Current assets min...
Solvency
Ability of the firm to repay all
of its financial obligations
Solvency
Debt to Asset Ratio
• Total liabilities/total assets
• Greater than one bad
Equity to Asset Ratio
• Total equit...
Profitability
Rate of return on assets
Rate of return on equity
Operating profit margin ratio
Financial Efficiency
Measures the intensity with
which a business uses its assets
to generate gross revenues and
the effe...
Financial Efficiency
Asset turnover ratio
Operating expense ratio
Depreciation ratio
Interest expense ratio
Net incom...
Repayment Capacity
Measures the borrower’s ability
to repay term debts and capital
leases rather than financial
position ...
Repayment Capacity
Term debt and capital lease
coverage ratio
Capital replacement and term
repayment margin
Cautions
Measures are only as good as the
data used
Methods must be consistent
between years and between
operations
• Ex...
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Accounting2

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Accounting2

  1. 1. Basic Accounting Principles The Financial Statements
  2. 2. Accounting Terms Account • A group of items having common characteristics Types of Accounts • Asset Liability • Income Expense • Equity
  3. 3. Chart of Accounts Listing of all of the accounts used by a business
  4. 4. Asset Accounts Items of Value Characterized as current and non-current
  5. 5. Liability Accounts Claims that others have against the assets Have a known: • Amount • Date to be paid • Person to whom payment owed Also current and non current
  6. 6. Equity Accounts Claims that the owner has against the assets Sometimes called net worth Difference between value of assets and liabilities
  7. 7. Income and Expense Accounts Types of equity accounts Simple accounting systems often only contain these accounts
  8. 8. Double vs Single Entry Accounting  Single – One account entry for each transaction  Double – Two account entries for each transaction • One debit and one credit Hybrid systems • May not match income with expenses • May not distinguish cash, check, or credit
  9. 9. Basic Accounting Equation Always maintained in double entry accounting Assets will always equal liabilities plus equity
  10. 10. Transactions Will be equal and offsetting Two types: • Income & Expenses • Transfers between accounts
  11. 11. Cash and Accrual Accounting Refers to the timing of entries into the accounting system
  12. 12. Cash Based Records Transactions are recorded when cash is received or paid out
  13. 13. Accrual Based Records Transactions are recorded when they take place Regardless of whether cash is involved
  14. 14. Accrual Adjusted Statements Cash based records are kept throughout the year Non-Cash adjustments are made to the cash based income statement at the end of the year
  15. 15. Account Valuation Income Accounts • Value received is recorded Expense Accounts • Value paid is recorded Liability Accounts • Value is dollar amount owed
  16. 16. Account Valuation Asset Accounts • More difficult because they may not be traded routinely
  17. 17. Asset Valuation Cost Basis Market Value Basis
  18. 18. Cost Basis Asset Valuation Original cost minus depreciation Must establish a depreciation method
  19. 19. Market Basis Asset Valuation Recorded as the price they could bring if sold, less selling expenses Based on recent auctions, appraisals, etc.
  20. 20. Depreciation Section II page 29, (FFSTF Guidelines) Allocation of the expense that reflects the “using up” of capital assets employed by the business Conceptually, this is done over the useful life of the asset in a “systematic and rational” manner
  21. 21. Depreciation Allocation applied to original cost minus salvage value Accelerated versus straight line methods • Example of difference between management records and tax records Can overstate or understate true income
  22. 22. Financial Reports Balance Sheet Income Statement Statement of Cash Flows Statement of Owner Equity
  23. 23. Balance Sheet Represents a financial situation at a single point in time Has a date on it Broken down by: • Type of Asset or liability • Time or life of the account type
  24. 24. Balance Sheet Current Assets • Cash and other assets that will be converted into cash during one operating cycle Non-Current Assets • Those not expected to be converted into cash in one operating cycle
  25. 25. Balance Sheet Current Liabilities • Debts that will come due within one year from the balance sheet date Non-Current Liabilities • Those debts due more that one year from the balance sheet date
  26. 26. Balance Sheet Intermediate Assets and Liabilities Long term Assets and Liabilities Can use cost or market valuations or both Supporting Schedules are very helpful Will need a balance sheet for beginning and ending of accounting period
  27. 27. Income Statement Summary of income and expenses Represents a period of time between two balance sheets Explains the change in equity between two balance sheets Can be divided into enterprise reports Can be cash or accrual
  28. 28. Assets Liabilities Equity Assets Liabilities Equity +/- Net Income +/- Valuation Changes - Family living withdrawals + Capital contributions Beginning Balance Sheet Ending Balance Sheet
  29. 29. Income Statement Will have more than one profit line Definition of Profit • Financial profit is the net return to business equity
  30. 30. Accrual Adjusted Income Statement Cash incomes and expenses must be adjusted by: • Changes in non-cash assets • Inventories • Pre paid expenses • Receivables • Changes in non-cash liabilities • Payables • Accrued interest
  31. 31. Statement of Cash Flows Not the same as a cash flow plan (Budget) Is a historical record of sources and uses of funds Divisions of Statement: • Cash from operating activities • Cash from investing activities • Cash from financing activities
  32. 32. Statement of Owner Equity Explains the change in owners equity between two balances sheets Changes due to : • Net income • Change in inventory valuation • Family living withdrawals • Capital contributions • Capital distributions
  33. 33. Financial Analysis All business owners should have a basic set of financial statements at their disposal and they should know how to analyze and interpret them.
  34. 34. Financial Analysis Two Objectives • Measure financial condition of the business • Measure financial performance of the business
  35. 35. Financial Analysis Horizontal Analysis Vertical Analysis Ratio Analysis
  36. 36. Horizontal Analysis Looks at trends in performance and strength over time • For example, percent change in net income from year to year
  37. 37. Vertical Analysis Looks at within year events rather than over time • For example, interest expense as a percent of total expenses
  38. 38. Ratio Analysis Allows for consistent comparison of a single business over time as well as comparison between businesses Converts nominal dollar amounts to a common basis
  39. 39. Source of data for Ratio Analysis Balance Sheet Income Statement
  40. 40. Farm Financial Standards Council (Five Criteria) Liquidity Solvency Profitability Financial Efficiency Repayment Capacity
  41. 41. Ratio Analysis 16 different ratios commonly used Each has limitations Proper interpretation is critical
  42. 42. Liquidity Ability of a business to pay current liabilities as they come due
  43. 43. Liquidity Current Ratio • Current Assets/Current Liabilities • Less than one is bad Working capital • Current assets minus current liabilities • Negative number is bad
  44. 44. Solvency Ability of the firm to repay all of its financial obligations
  45. 45. Solvency Debt to Asset Ratio • Total liabilities/total assets • Greater than one bad Equity to Asset Ratio • Total equity/total assets Debt to Equity Ratio • Leverage ratio • Less than one better
  46. 46. Profitability Rate of return on assets Rate of return on equity Operating profit margin ratio
  47. 47. Financial Efficiency Measures the intensity with which a business uses its assets to generate gross revenues and the effectiveness of production
  48. 48. Financial Efficiency Asset turnover ratio Operating expense ratio Depreciation ratio Interest expense ratio Net income from operations ratio
  49. 49. Repayment Capacity Measures the borrower’s ability to repay term debts and capital leases rather than financial position or performance
  50. 50. Repayment Capacity Term debt and capital lease coverage ratio Capital replacement and term repayment margin
  51. 51. Cautions Measures are only as good as the data used Methods must be consistent between years and between operations • Example – Asset valuation methods Measures ask the right questions but do not provide the answers

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