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INTRODUCTION TO ACCOUNTING

INTRODUCTION TO ACCOUNTING. Definition of Accounting. Accounting is a system of dealing with financial information that provides information for decision-making. Accounting vs. Bookkeeping . ACCOUNTING The process of recording, analyzing, and interpreting the economic activities of a business

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INTRODUCTION TO ACCOUNTING

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  1. INTRODUCTION TO ACCOUNTING

  2. Definition of Accounting • Accounting is a system of dealing with financial information that provides information for decision-making

  3. Accounting vs. Bookkeeping ACCOUNTING • The process of recording, analyzing, and interpreting the economic activities of a business BOOKKEEPING • A method of recording all transactions for a business in a specific format

  4. Why is Accounting Important • Accountability • People who handle cash in the company are responsible for it • Budgeting • This allows businesses to estimate its future sales and expenses • Taxation • Records must be kept in order to pay taxes

  5. Why is Accounting Important • Financial Statements • These are reports that summarize the financial performance of a business • These reports indicate the business’s economic health • Annual Reports • Financial statements are presented to shareholders and potential investors in the form of annual reports

  6. An Information System What financial questions might you have about your business? • Is the business earning profit? • Are selling prices to high/low? • How much does ABC company owe me? • What is the value of my inventory? • How much did John Smith earn last year? • Do we have enough money to pay our bills?

  7. An Information System Who else may want financial information about the business? • Government • Bankers • Lenders • Potential Investor • A Lawyer

  8. OWNING A BUSINESS If you decide to operate your own business you will find yourself facing such accounting tasks as: • Banking • Payroll • Keeping track of amounts owed by and owed to customers • Keeping track of amounts owed to the government • Producing an income statement for income tax purposes

  9. Categories of Accounting Work Routine Daily Activities • Processing Bills • Preparing Cheques • Daily Banking • Recording Transactions • Preparing Business Papers Periodic Accounting Activities (these activities occur at regular intervals) • Paycheques(bi-weekly) • Bank accounts (balanced monthly) • Financial reports (monthly, quarterly, yearly) • Income tax returns (yearly)

  10. Categories of Accounting Work Miscellaneous Activities • Employee resignation • An advertisement is prepared • New capital equipment is purchased • A new loan • A new employee is hired

  11. The Fundamental Accounting Equation • The fundamental accounting equation states that: ASSETS – LIABILITIES = OWNER’S EQUITY OR ASSETS = LIABILITIES + OWNER’S EQUITY

  12. ASSETS • An asset is anything that the business owns that has value • What are some examples of personal assets? • House • Car • Cash • RRSP’s

  13. LIABILITIES • A liability is anything that the business owes; any debts of the business • What are some examples of personal liabilities? • Credit Line • Mortgage • Owed to Parents • Credit cards

  14. OWNER’S EQUITY • Owner’s Equity is also referred to as capital or net worth • It is the difference between the total assets and total liabilities of a business

  15. PERSONAL NET WORTH Here is a list of my assets: • House • Car • Furniture • Cash in Bank • Savings • RRSP’s • Teachers Pension

  16. PERSONAL NET WORTH Here is a list of my liabilities: • Mortgage • Credit card ( paid of every month, but still a potential liability) • Line of credit

  17. PERSONAL NET WORTH • What do I need to do to calculate my net worth? • Take my total assets and subtract them from my total liabilities

  18. PERSONAL NET WORTH • We can see how this looks by examining a Balance Sheet containing my personal assets, liabilities, and net worth

  19. YOUR NET WORTH • Make a list of all of your assets and all of your liabilities • Calculate your total assets and your total liabilities • Now calculate your net worth (remember the fundamental accounting equation) • Make a new net worth statement for yourself for 10 years from now!

  20. The Balance Sheet

  21. BALANCE SHEET = a statement of financial position Liabilities (debts you owe) + Owners Equity (the owner’s share of the assets) Assets (Things owned) =

  22. THE ACCOUNTING EQUATION • ASSETS = LIABILITIES + OWNERS EQUITY A=L+OE

  23. BALANCE SHEET • A “freeze frame” or snapshot of what the business owns, owes and the owners invested interest. • A financial picture of the business at a point in time. • The balance sheet does not indicate whether a business has made a profit, only whether it is financially strong.

  24. Features of the Balance Sheet • The Balance Sheet looks like the Fundamental Accounting Equation • A = L + OE • Assets are on the left side and the liabilities and owner’s equity are on the right side

  25. Features of the Balance Sheet • A Three Line Heading is Used • WHO? – The name of the individual, business or other organization • WHAT? – The name of the financial statement (in this case the balance sheet) • WHEN? – The date on which the financial position is determined

  26. What? WHO? – The name of the individual, business or other organization When?

  27. CASH AND LIQUIDITY • Cash is arguably the MOST valuable asset of a business. • WHY?? • It can easily be exchanged for other assets • Liquidity – how easily an asset can be exchanged for any other asset or converted to cash.

  28. ASSETS • Ownership (title- legal right to use) is separate from financing (source of funds used to purchase asset). • With ASSETS, an owner can: • Use • Sell • Give away • Leave to heirs • Whether bought for cash or on credit, the owner still has “title” to his/her property

  29. CATEGORIZING ASSETS • Current Assets – things a business owns that disappear quickly, usually in less than one year. • Long-term Assets (Capital Assets or Fixed Assets) – assets that a business keeps for a long time.

  30. ASSETS • In order of liquidity, assets include: • cash, bank balances, • accounts receivable (listed in alphabetical order), • inventory and supplies, and • furniture, equipment, fixtures, vehicles, property and buildings (listed in the order in which they will be used up).

  31. ACCOUNTS RECEIVABLE • Customers of the business will often buy goods or services with the understanding that they will be paid for in the future • These debts owed represent a dollar value to the business, so the business has a right to include them among the assets on the balance sheet • Each of these customers that owes money to the business is one of its debtors

  32. CURRENT ASSETS • Current Assets • Cash $ 50,000 • Accounts Receivable $ 30,000 • Inventory $120,000 • Supplies $ 15,000 • Total Current Assets $215,000 ORDER Of LIQUIDITY CLOSEST TO CASH FARTHEST FROM CASH

  33. FIXED ASSETS • Fixed Assets • Land $ 200,000 • Building $ 1,100,000 • Equipment $ 950,000 • Furniture $ 225,000 • Vehicles $ 215,000 • Total Fixed Assets $ 2,690,000 IN ORDER OF REVERSE DEPRECIATION ONE THAT WILL BE AROUND THE LONGEST ONE THAT WILL BE AROUND THE LEAST AMOUNT OF TIME

  34. LIABILITIES • Liabilities are the debts of a business. Businesses acquire debt in two main ways: 1) Accounts Payable – purchasing inventory and supplies on credit. 2) Loans Payable (Notes Payable) – acquired by borrowing money from investors, banks, etc.

  35. CATEGORIZING LIABILITIES • Liabilities are listed in order of priority, or how quickly they need to be paid off. • Current Liabilities – debts such as invoices for merchandise inventory, that are paid off quickly. • Long-term Liabilities – debts such as a mortgage loan, that may not be repaid for decades.

  36. ACCOUNTS PAYABLE • A business often purchases goods and services from its suppliers with the understanding that payment will be made later • These debts to suppliers represent a dollar obligation of the business, the business must include them among its liabilities • Each of the suppliers owed money by the business is one of its creditors

  37. CURRENT LIABILITIES ORDER Of MATURITY* • Current Liabilities • Wages Payable $ 10,000 • Accounts Payable $ 80,000 • Other Liabilities $ 50,000 • Current Portion - Mortgage $ 15,000 • Total Current Liabilities $ 155,000 * Maturity – When a debt is “mature” it’s payment is due FIRST TO BE PAID LAST TO BE PAID

  38. LONG TERM LIABILITIES • Long Term Liabilities • Vehicle Loans $ 150,000 • Equipment Loan $ 900,000 • Mortgage $ 850,000 • Total Long Term Liabilities $1,900,000 ORDER OF MATURITY* SHORTEST TERM LONGEST TERM

  39. OWNER’S EQUITY ORDER SHOWN • Owner’s Equity • Owner’s Capital $ 750,000 • Plus: Net Income $ 150,000 • $ 900,000 • Less: Drawings ($ 50,000) • Total Owner’s Equity $ 850,000 CAPITAL +/(-) INCOME/ (LOSS) THEN SUBTOTAL SUBTRACT DRAWINGS AND THEN TOTAL

  40. MEASURING SUCCESS WITH A BALANCE SHEET Working Capital = Current Assets – Current Liabilities • Working capital indicates a business’s ability to pay its short-term debts. • Working Capital has to be positive Current Ratio = Total Current Assets / Total Current Liabilities • Current Ratio shows how many dollars of liquid assets (cash or near cash) a business has for every dollar of short-term debt. • Current ratio has to be over 1.2

  41. MEASURING SUCCESS WITH A BALANCE SHEET Total Debt to Total Asset Ratio = Short Term Debt + Long Term Debt/Total Assets • A metric used to measure a company's financial risk by determining how much of the company's assets have been financed by debt. Calculated by adding short-term and long-term debt and then dividing by the company's total assets.

  42. Current Assets – Current Liabilities = (1150+2000+1400)-(1350)= 3200 Working Capital Current Ratio Current Assets/Current Liabilities = (1150+2000+1400)/(1350)= 3.37

  43. The Income Statement

  44. WHAT IS AN INCOME STATEMENT? • Remember: a Balance Sheet is a snapshot of a business on one day in time • An Income Statement shows what happens over a period of time in a business, it could be one month, six months, or a year • An Income Statement shows how much money a business made or lost over a period of time

  45. THE INCOME STATEMENT • As a business operates it makes money from daily activities • Through these daily activities the business also accumulates expenses • What are some of the expenses of day to day operations for a business?

  46. THE INCOME STATEMENT RECALL: • What is the difference between a cost and an expense? • Cost  • Expense 

  47. Order of Entries on an Income Statement • Just like the Balance Sheet, the Income Statement has a three line heading: • Who? (the name of the business/individual) • What? (in this case, an Income Statement) • When? (period of time ending on a certain date)

  48. The Income Statement • The sources of Revenue are listed next • These are listed in alphabetical order • Revenue (Sales or Income) is the money, or the promise of money, received from the sale of goods or services

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