Principle of Accounting & Finance

What Is Accounting? A comprehensive system for collecting, analyzing and communicating financial information Users of accounting information: Business managers Employees and unions Investors and creditors Tax authorities Government regulatory agencies

The Nature of Accounting The recording, measurement, and interpretation of financial information, often used in making business decisions. Did You Know? Corporate fraud costs are estimated at $600 billion annually. Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved

Is it Accounting or Bookkeeping? Bookkeepers are responsible for obtaining and recording the information that accountants require to analyze a firm’s financial position Accountants are not only trained to record financial information, but to understand, interpret, and even develop the sophisticated accounting systems necessary to classify and analyze complex financial information Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved

The Accounting Cycle 1. Examining source documents 2. Recording transactions 3. Posting transactions 4. Preparing financial statements Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved

Types of Accountants Public Accountant An independent professional who provides accounting services to the public (individuals or firms) for a fee CPA (Certified Public Accountant) Private Accountant An accountant employed by a corporation, government agency, or other organization CPA or a CMA (Certified Management Accountant) Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved

Accountants and Their Responsibilities Controller: Managers all of a firm’s accounting activities Types of Accounting Financial Accounting Managerial Accounting

Accountants and Their Responsibilities Certified public accountants (CPAs) Auditing and GAAP (Generally Accepted Accounting Principles) Tax services Management advisory services Non-certified public accountants Private accountants

The CPA Vision Project Identifying issues for the future Global forces as drivers of change Recommendations A new direction Core services Core competencies

The Users of Accounting Information Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved

Uses of Accounting Information Internal uses: Managerial accounting Cash flow Budget External uses: Reporting financial performance to outsiders Filing income taxes Obtaining credit Reporting to stockholders Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved

Internal Accounting Information Management Plan and set goals Organize Lead and motivate Control Lenders & suppliers Evaluate credit risks Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved

External Accounting Information Stockholders and Potential Investors Evaluate soundness of investments Government Agencies Confirm tax liabilities Confirm payroll Deductions Approve new issues of stocks and bonds Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved

Key Tools of the Accounting Trade Accounting Equation Assets = Liabilities + Owners’ Equity Assets = Liabilities + Owners’ Equity Assets – Liabilities = Owners’ Equity Assets – Liabilities = Owners’ Equity Double-Entry Accounting Double-Entry Accounting Every transaction affects two accounts Every transaction affects two accounts

The Accounting Equation The relationship between assets, liabilities, and owners’ equity Assets Things of value that a firm owns Liabilities A firm’s debts and obligations Owners’ Equity The difference between a firm’s assets and its liabilities =+ Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved

Double-Entry Bookkeeping A system of recording and classifying business transactions in separate accounts in order to maintain the balance of the accounting equation Assets =Liabilities+ Owners’ Equity $325 = $325 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved

The Accounting Process The accounting equation Double-entry bookkeeping Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved

Equivalent Terms in Accounting Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved

The Accounting Equation and Double- Entry Bookkeeping for Anna’s Flowers Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved

Financial Statements The end results of the accounting process are a series of financial statements Income statement Balance sheet Statement of cash flows Financial statements are provided to Stockholders and potential investors Creditors Government agencies Internal Revenue Service Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved

Financial Statements Balance Sheets Income Statements Statements of Cash Flows

The Balance Sheet A “snapshot” of an organization’s financial position at a given moment Presents an accumulation of all the company’s transactions since it began Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved

Key Balance Sheet Terms Assets Current assets Accounts receivable Liabilities Accounts payable Accrued expenses Owner’s equity Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved

The Income Statement A financial report that shows an organization’s profitability over a period of time: Month Quarter Year Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved

Key Income Statement Terms Revenue Cost of goods sold Gross income Expenses Selling, general & administrative R&D, engineering Interest Depreciation Net income Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved

Anna’s Flowers Income Statement December 31, 2005 Revenues: Net Sales:$123,850 Consulting:73,850 Total Revenues$197,700 Expenses: Cost of Goods Sold$ 72,600 Selling Expenses:37,700 General & Admin.18,400 Other expenses5,600 Total Expenses$134,300 Net Income$ 63,400 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved

The Statement of Cash Flow Explains how the company’s cash changed from the beginning of the accounting period to the end Three categories: 1. Cash from (used for) operating activities 2. Cash from (used for) investing activities 3. Cash from (used for) financing activities Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved

Statements of Cash Flows Cash flows from: OperationsOperations InvestingInvesting FinancingFinancing

GAAP Generally Accepted Accounting Principles (GAAP) Manufacturing firms, service providers, and nonprofit organizations each use a different set of accounting principles or rules upon which the accounting profession has agreed Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved

Reporting Standards and Practices Generally Accepted Accounting Practices (GAAP) Revenue Recognition Matching Full Disclosure

Solvency Ratios Profitability Ratios Activity Ratios Analyzing Financial Statements

Analyzing Financial Statements with Ratio Analysis Profitability ratios Asset utilization ratios Liquidity ratios Debt utilization ratios Per share data Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved

Current Assets Current Liabilities Short Term Solvency Ratios Current Ratio: Current Assets – Current Liabilities Working Capital:

Long-term Solvency Ratios Debt to Owners’ Equity Ratio: The ability to finance an investment through borrowed funds Leverage:Debt Owners’ Equity

Profitability and Activity Ratios Return on Equity: Earnings Per Share: Net Income Total Owners' Equity Inventory Turnover Ratio: Cost of Goods Sold Average Inventory Net Income # of Shares Outstanding

Profitability Ratios Profit margin=Net income Sales Return on assets =Net income Assets Return on equity =Net income Equity Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved

Asset Utilization Ratios Receivables turnover =Sales Receivables Inventory turnover=Sales Inventory Total asset turnover=Sales Total assets Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved

Liquidity Ratios Current ratio=Current assets Current liabilities Quick ratio=Current assets - inventory Current liabilities Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved

Debt Utilization Ratios Debt to total assets=Total debt Total assets Times interest earned=Income before interest & taxes Interest expense Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved

Per Share Data Earnings per share=Net income Number of shares outstanding Dividends per share=Total dividends paid Number of shares outstanding Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved

International Accounting Standards International Transactions Foreign Currency Exchange International Accounting

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Leading Accounting Firms Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved

Anna’s Flowers Balance Sheet December 31, 2005 Assets: Current Assets: Cash:$17,850 Accounts Receivable10,200 Merchandise Inventory8,750 Total Assets:$36,800 Property & Equipment Equipment11,050 Office Building73,850 Total Prop. & Equip.84,900 Total Assets:$121,700 Liabilities & Owner’s Equity Current Liabilities Acct’s Payable$12,600 Total Current Liabilities12,600 Long-term Liabilities Mortgage Payable23,600 Total Liabilities36,200 Owner’s Equity: Anna Rodriguez, Capital85,500 Total Liabilities & Owner’s Equity$121,700 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved

Anna’s Flowers Annual Budget for 2005 SalesConsulting Total January6,500 5,00011,500 February6,000 6,00012,000 March5,800 6,20012,000 April6,100 6,50012,600 May7,000 6,80013,800 June8,100 7,60015,700 July8,600 7,80016,400 August6,900 8,00014,900 September6,700 8,70015,400 October5,900 9,00014,900 November5,000 8,50013,500 December4,500 8,00012,500 Annual $123,850 $73,850 $197,700 Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved

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