Chapter 17 - 18 Accounting

Financial Management role

the heartbeat of competitive businesses, and accounting information helps keep the heartbeat stable. 

Accounting reports role:

reveal as much about a business’s health as pulse and blood pressure readings tell us about a person’s health 

Accounting

often called the language of business, allows us to report financial information about nonprofit org. Like church, schools, hospitals, fraternities, and government agencies 

Accounting

the recording, classifying, summarizing, and interpreting of financial events and transactions in an organization to provide management financial information they need to make good decisions about its operation 

Financial Transactions:

include buying and selling goods and services, acquiring insurance, paying employees, and using supplies.

Accounting System

the method used to record and summarize accounting data into reports 

The Independent Financial Accounting Standards Board (FASB)

defines the accepted accounting principles that accountants must follow 

Accounting Cycle

a 6 step procedure that results in the preparation and analysis of the major financial statements. It relies on the work of both a bookkeeper and an accountant 

Bookkeeping

the recording of business transactions, it’s a basic part of financial reporting. 

How is the job of the bookkeeper different from that of an accountant?

the recording of business transactions, it’s a basic part of financial reporting. Accounting, however, goes far beyond the mere recording of financial information. Accountants classify and summarize financial data provided by bookkeepers, and then interpret the data and report the information to management. 

What’s a bookkeeper’s first task?

To divide all the firm’s transactions into meaningful categories like sales documents, purchasing receipts, and shipping documents then record financial data from the original transaction's documents 

Journal

the record book or computer program where accounting data is first entered 

Journal comes from the word French word jour, which means “day.” Therefore, a journal is where the day’s transactions are kept. 

Journal comes from the word French word jour, which means “day.” Therefore, a journal is where the day’s transactions are kept. 

Double-entry Bookkeeping

the practice of writing every business transaction in two places. Required 2 entries in the journal and in the ledgers 

Ledger

used by bookkeepers. A specialized accounting book or computer program in which information from accounting journals is accumulated into specific categories like office supplies or cash in one place

Trial Balance

next step in the accounting cycle. A summary of all the financial data in the account ledgers that ensures the figures are correct and balanced 

How has computer software helped businesses in maintaining and compiling accounting information? 

• Computerized accounting programs can post information from journals from remote locations to laptops or phones, making financial information available whenever. 

• Computerized accounting programs are helpful to small business owners who don't have accounting personnel that large firms enjoy 

• It's the partnership of technology and an accountant’s specialized knowledge that helps a firm make the right financial decisions 

Financial Statement

Summary of all the financial transactions that have occurred over a particular period. Financial statements indicate a firm’s financial health and stability and are the key factors in management decision making.

The Key Financial Statements of a business are: (3) 

1. The balance sheet, which reports the firm’s financial condition on a specific date. 

2. The income statement, which summarize revenues, cost of goods sold, and expenses (including taxes) for a specific period and highlights the total profit or loss the firm experienced during that period. 

3. The statement of cash flows, which provides a summary of money coming into and going out of the firm. It tracks a company’s cash receipts and cash payments. 

The difference among the financial statements can be summarized this way: 

The balance sheet details what the company owns and owes on a certain day, the income statement shows the revenue a firm earned selling its products compared to its selling cost (profit or loss) over a specific period of time, and the statement of cash flows highlights the difference between cash coming in and cash going out of a business. 

The Fundamental Accounting Equation

the basis for the balance sheet

Balance Sheet

financial statement that reports a firm’s financial condition at a specific time and composed of three major accounts: assets, liabilities, and owner’s equity 

How to calculate available resources if you want to buy a house or a car: 

• First add everything (everything you own, cash, property and money owed you) 

• Then subtract that the money you owe others – credit debit card, car loans, student loans. Those are your liabilities 

Assets

are economic resources (things of value) owned by a firm. Assets include productive, tangible times like buildings, equipment, land, furniture, and motor vehicles 

Liquidity

the ease with which an asset can be converted into cash. Land, however, is not considered a liquid asset because it takes time, effort, and paperwork to convert it to cash. 

Assets are divided into 3 things to how quickly they can be turned into cash: 

1. Current assets: are items that can or will be converted into cash within one year 

2. Fixed assets: are long term that are relatively permanent such as land, buildings, and equipment. 

3. Intangible assets: are long term assets that have no physical form but do not have value. Patents, trademark, copyrights, and goodwill are intangible assets 

Liabilities:

what business owes to others – its debts.

Current liabilities

are debts due in one year or less

Long term liabilities

are debts not due for one year or more

Account payable:

are current liabilities or bills the company owes others for merchandise or services it purchased on credit but has not yet paid for 

Note payable:

can be short term or long-term liabilities (like loans from banks) that a business promises to repay by a certain date 

Bonds payable:

are long term liabilities; money lent to the firm by bondholders that it must pay back 

The value of what stockholders own in a firm is called?

Stockholders' equity or shareholders' equity 

Owner’s Equity

the amount of the business that belongs to the owner minus any liabilities owned by the business 

How is an Owner’s Equity determined?

The formula for owner’s equity, then, is assets minus liabilities. 

Retained Earnings

the accumulated earnings from a firm’s profitable operations that were reinvested in the business and not paid out to stockholders in dividends 

Income Statement

financial statement that shows a firm’s profit after costs, expenses, and taxes. 

The income statement summarizes all the resources called?

The revenue 

Net income and Net loss

revenue left over after all the costs and expenses, including taxes, are paid 

Cost of Goods Sold

a measure of the cost of merchandise sold or cost of raw materials and supplies used for producing items for resale

Gross Profit (or gross margin)

how much a business earned by buying (or making) and selling merchandise. 

Operating Expenses

costs involved in operating a business, such as rent, utilities, and salaries 

Depreciation

decrease value over its estimated useful life

The Statement of Cash Flow

financial statement that reports cash receipts to a firm’s three major activities: operations, investments, and financing

3 major activities of a firm: 

1. Operations are cash transactions associated with running the business 

2. Investments are cash used in or provided by the firm’s investment activities 

3. Financing is cash raised by taking on new debt 

Cash flow if not properly managed?

Can cause a business much concern 

Cash Flow

simply the difference between cash coming into and cash going out of a business 

Ratio Analysis

the assessment of a firm’s financial condition using calculations and interpretations of financial ratios developed from the firm’s financial statements

What are financial ratios for?

Used in comparing the company’s performance to its financial objectives and to the performance of other firms in its industry 

What are Liquidity ratios?

Measures a company’s ability to turn assets into cash to pay its short-term debts (that must be repaid within one year) 

The Current Ratio

ratio of a firm’s current assets to its current liabilities 

What is the Acid test or Quick ratio?

Measures the cash, marketable securities (stocks) and receivables of a firm compared to its current liabilities 

What’s Leverage (Debt) Ratios?

Measures the degree to which a firm relies on borred funds in its operations 

What’s Profitability (Performance) Ratios?

Measures how effectively a firm’s manager are using its various resources to achieve profits. 

3 of more important ratios

EPS: earnings per share, return on sales, and return on equity 

What is basic earning per share (basic EPS) ratio?

Helps determine the amount of profit a company earned for each share of outstanding common stock

What are diluted earnings per share (diluted EPS) ratio?

Measures the amount of profit earned for each share of outstanding common stock but also considers stock options, warrants, and debt securities 

The higher the risk of failure or loss in an industry,

the higher the return investors expect on their investment 

What are Activity Ratios for?

Activity ratios tell us how effectively management is turning over inventory. Converting the firm’s inventory to profits is a key function of management. 

What is inventory turnover ratio for?

Measures the speed with which inventory moves through the firm and gets converted into sales 

Financial Accounting 

accounting information and analyses prepared for people outside the organization 

Annual Report

a yearly statement of the financial condition

Private Accountant

who works for a single firm, government agency, or nonprofit organization 

Public Accountant

who provides accounting services to individuals or business on a fee basis 

What does public accountant do?

Designing an accountant system, helping select correct software to run the system, and analysing an organization’s financial performance 

Certified Public Accountant (CPA)

who passes a series of examinations established by the American Institute of Certified Public Accountants (AICPA) 

Managerial Accounting 

• provides information and analysis to managers inside the organization to assist them in making decision 

• What do they do? Concerned with measuring and reporting costs of production, marketing, and other functions; preparing budgets (planning); checking whether or not units are staying within their budgets (controlling); and designing strategies to minimize taxes 

Adulting Accounting

• the job of reviewing the information used to prepare a company’s financial statements 

• Private accountants perform audit to guarantee that the organization is carrying out proper accounting procedures 

Independent audit

an unbiased opinion about the accuracy of a company’s financial statements 

Tax Accountant

trained for tax law and preparing tax returns or developing tax strategies 

Government and Not-for-Profit Accounting

purpose is not generating a profit but serving ratepayers, taxpayers, and others 

Finance

the function in a business that acquires funds for the firm 

Finance activities include: 

Preparing budgets; doing cash flow analysis, and planning for the funds on such assets as plant, equipment, new technology, and machinery 

Financial Management

the job of managing a firm’s resources so it can meet its goals and objectives 

What do financial managers do?

They examine financial data prepared by accountants and recommend strategies for improving

Who are CFO?

Chief final officers the second highest paid person in an organization 

3 reasons a firm fails financially: 

1. Undercapitalization 

2. Poor control over cash flow 

3. Inadequate expense control 

What is Financial Management?

Are responsible for paying the company’s bills and the appropriate time and for collecting overdue payments to make sure the company does not lose too much money to bad debts 

What does financial management need to watch out for due to changes?

Such as changes in tax law 

Financial planning means analysing short term and long-term money flows 

Financial planning means analysing short term and long-term money flows 

3 steps to optimize firm’s profitability (Financial Planning) 

1. Forecast - Forecasting the firm’s short-term and long-term financial needs 

2. Budgeting - Developing budgets to meet those needs 

3. Controls - Establishing financial controls to see whether the company is achieving its goals 

3 types of Forecasts 

1. Short term forecast: expenses for a period of one year or less 

2. Cash flow forecast predicts the cash inflows and outflows in the future period 

3. Long term forecast predicts expenses for a period longer than 1 year sometimes 5 years 

Budget

sets forth management expectation

Types of budgets in a firm’s financial plan (3): 

1. Capital Budget: firm’s spending plans for major asset purchases that requires large sums of money like property, building, and equipment 

2. Cash Budget: budget that estimates cash inflows and outflows during a period like a month or a quarter 

3. Operating or master Budget: ties together the firm’s other budgets and summarizes its proposal financial activities (travel, rent, technology) 

Financial Control

a process in a firm compares its actual revenue, costs, and expenses 

Key Need for Operating Funds: (3) 

1. Managing day-by-day needs of the business: making sure a business has enough money for its everyday needs while also trying to make that money grow. 

2. Controlling credit operations: Offering credit retains existing customers and attracts new ones, which is particularly valuable during difficult economic times when traditional lending is restricted 

3. Acquiring needed inventory helps manage the firm’s available funds and maximize profitability, help control the outflow of cash for inventory 

4. Making capital expenditures: Capital Expenditures = tangible, long-term assets such as land, buildings, and equipment or intangible such as patents, trademarks, and copyright 

Debt Financing:

funds raised through various forms of borrowing that must be repaid 

Equity Financing:

money raised within the firm, from operations or through the sale of ownership in the firm 

Money has time value. What does this mean?

If you have $\$100$ today, you can invest it or put it in a savings account. Over time, that money can earn interest or capital gains. 

Why is accounts receivable major financial concern to the firm?

it ties up substantial funds that cannot be used for daily operations or growth, while carrying the risk of customer default. 

Trade Credit

the practice of buying goods and services now and paying for them later. Widely used source of short-term funding 

If someone ask family or friends for financial assistance, it's important to understand: 

1. Agree to specific loan terms 

2. Put the agreement in writing 

3. Arrange for repayment in the same way they would for a bank loan 

Secured loan

a loan backed by collateral (something valuable, such as property) If the borrower fails to pay the loan, the lender may take possession of the collateral. 

What's an example of secured loan?

an automobile

Unsecured Loan

a loan that doesn’t require any collateral

Line of Credit

unsecured short-term funds a bank will lend to a business

Factoring

the process of selling accounts receivable for cash

Commercial paper

is a type of short-term financing available to large corporations that need funds for just a few months and prefer not to have to negotiate with a commercial bank. 

What does an invoice containing the terms 2/10, net 30 mean?

this means a buyer can take 2% discount for paying the invoice within 10 days. If the terms are 2/10, net 30, the customer will pay 2% more by waiting an extra 20 days to pay the invoice. 

what's the difference between trade credit and a line of credit?

Trade credit = buy now, pay the supplier later. Line of credit = borrow money from a bank when you need it.