This chapter discusses key accounting concepts such as the accounting equation, financial statements, and ratio analysis. It explains that accounting is used to collect, analyze, and communicate financial information to both internal and external users. The chapter outlines the main financial statements - the balance sheet, income statement, and statement of cash flows. It also describes how ratio analysis can be used to evaluate a company's solvency, profitability, and operational efficiency. Common ratios discussed include the current ratio, debt ratio, net profit margin, and inventory turnover ratio.

1. CHAPTER 17
Understanding
Principles of Accounting
1

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. 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. 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. Users of Accounting
Information
 Business Managers
 Employees and Unions
 Investors and Creditors
 Tax Authorities
 Government Regulatory Agencies
5

6. What is a Controller?
Person who manages all
of a firm’s accounting
activities (chief
accounting officer
6

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. What is an Audit?
Systematic examination
of a company’s
accounting system to
determine whether its
financial reports fairly
represent its operations
8

9. What is GAAP (or Generally
Accepted Accounting Principles)?
Accepted rules and
procedures governing
the content and form
of financial reports
9

10. The Accounting Equation
Assets = Liabilities + Owners’ Equity
10

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. What is Double-Entry
Accounting?
Bookkeeping system
that balances the
accounting equation by
recording the dual
effects of every financial
transaction
12

13. Financial Statements
 Balance sheets supply detailed
information about the accounting
equation factors:
 Assets
 Current Assets
 Fixed Assets
 Intangible Assets
13

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. Perfect Posters’ Balance Sheet
15

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. Perfect Posters’ Income Statement
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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. An Internal Financial Statement:
What is the Budget?
Detailed statement of
estimated receipts and
expenditures for a
future period of time
19

20. Perfect Posters’ Sales Budget
20

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. 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. 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. 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. 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. 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. 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
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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
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