Chapter

1. Chapter Understanding Financial Information and Accounting 17 17-1

2. What is Accounting? Recording, classifying, summarizing, & interpretingfinancial events & transactions to provide management & other parties information to allow them to make good decisions.

3. Financial Transactions Include buying & selling goods & services, acquiring insurance, using supplies, & paying taxes.

4. 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.

5. What Bookkeepers Do • Categorize and • Record the Data in • Books of Original Entry • Journals • Ledgers using • Double Entry

6. 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.

7. General Journal

8. Ledger T-Account

9. The Accounting Cycle

10. Steps In The Accounting Cycle Record Transactions in Journals Analyze Source Documents Post Journal Entries to Ledger Prepare Financial Statements Analyze Financial Statements Take a Trial Balance

11. Financial Statements

12. 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)

13. Balance Sheet Statement of Financial Position (on a specific date)

14. Accounting (Balance Sheet) Equation Assets = Liabilities + Owner’s Equity = Owes + Owners’ Claims Owns

15. Terms Liquidity • How fast an asset can be converted into cash

16. 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.

17. 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.

18. Owners’ Equity Accounts • Retained Earnings -- Accumulated earnings from the firm’s profitable operations that are reinvested in the business.

19. Very Vegetarian’sBalance 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

20. Very Vegetarian’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

21. Income Statement Statement of Revenues, Expenses, & Profits (specific period of time)

22. Income Statement Equation Profit = Revenues – Expenses

23. Income Statement Formula Revenues • Cost of Goods Sold =Gross Profit (Gross Margin) • Operating Expenses = Net Income Before Taxes • Taxes =Net Income (or Loss)

24. Very Vegetarian Income Statement Period Ending 12/31/10 Revenues Net Sales $ 700,000

25. Very Vegetarian 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

26. Income Statement Formula Revenues • Cost of Goods Sold =Gross Profit (Gross Margin) • Operating Expenses = Net Income Before Taxes • Taxes =Net Income (or Loss)

27. Very Vegetarian’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

28. Statement of Cash Flows Statement of Cash Receipts & Disbursements (cash coming in & cash going out)

29. 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 business expenses, past debts, or company dividends Statement of Cash Flows

30. Depreciation • Depreciation -- The systematic write-off of the cost of a tangible asset over its estimated useful life.

31. Ratio Analysis

32. 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

33. Liquidity Ratios

34. 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.

35. Liquidity Ratios Current Ratio Current Assets Current Liabilities Quick (Acid-Test) Ratio Cash + Marketable Securities + Receivables Current Liabilities

36. Liquidity Ratio Current Ratio Current Assets Current Liabilities

37. Current Ratio- Very Vegetarian Current Assets Current Liabilities $600,000 $288,000 = 2.08

38. Quick (Acid-Test) Ratio Cash + Marketable Securities + Receivables Current Liabilities $265,000 $288,000 = 0.92

39. 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.

40. Debt to Equity Ratio Total Liabilities Owners’ Equity $613,000 $213,000 = 287%

41. Activity Ratios Inventory Turnover Cost of Goods Sold Average Inventory Inventory Turnover=$410,000= 1.9 $215,000