Chapter 2: Financial Statements and the Accounting System

Analyzing Financial Statements

Used by both internal and external users

Assessing Company Resutls

When interpreting, we use standards for comparisons

Intracompany

Comparing results across 2 or more periods

Intercompany

Comparing results across competitiors

Industry

Comparing results to industry norms

Guidlines

Comparing results to standards based on experience

Using Ratios

reveal relations and trends that are difficult to detect by looking at numbers alone

Building Blocks of analysis

Liquidity, Solvency, Profitability, Maker prospects

Liquidity

Ability to meet short-term obligations and generate revenues

Solvency

Ability to meet long-term obligations and generate revenues

Profitability

Ability to provide financial rewards to attract and retain financing

Market Prospects

Ability to generate positive market expectations

The Process to go from transactions and events to financial statements

Identify, Analyze, record, Post, Prepare

1

Identify each transaction and event from source documents

2

Analyze each transaction and event using the accounting equation

3

Record relevant transactions and events in a journal

4

Post journal information to ledger accouts

5

Prepare and analyze the trial balance and financial statements

Source Documents

Identify and describe transactions and events entering the accounting system

Account

Record of increases and decreases in a specific asset, liability, equity, revenue, or expense

Assets

Resources owned or controlled by a company that have future economic benefit

Asset Examples

Cash, Accounts Receivable, Note Receivable, Prepaid Expenses, Prepaid Insurance, Supplies, Store Supplies, Equipment, Buildings, and Land

Accounts Receivable

Promises of payment from customers

Prepaid Accounts

Assets from prepayments of future expenses expected to be incurred in future accounting periods

Liabilities

Claims (by creditors) against assets, which means they are obligations to transfer assets or provide products or services to others

Liabilities Examples

Accounts Payable, Note Payable, Unearned Revenues, and Accrued Liabilities

Accounts Payable

Promise to pay later

Notes Payable

Written promissory note to pay a future amount

Unearned Revenue

Revenue collected before it is earned/before services or goods are provided

Accrued Liabilities

Amounts owed that are not yet paid

Equity

Owner’s claim on a company’s assets

Equity Examples

Common stock, Dividends, Revenues, expenses

Ledger

Collection of all accounts and their balances

Chart of Accounts

List of all accounts in the ledger with their identification numbers

Double-Entry Accounting

At least 2 accounts are involved with at least 1 credit and 1 debit, total amount debited must equal amount credited

T-account

A ledger account and it’s used to understand the effects of 1 or more transactions

Left side of the account

Debit Side

Right Side of the account

Credit side

Double-Entry System

Requires that each transaction affect, and be recorded in, at least two accounts

Assets on T-account

Left side

Liabilities and Equities on T-account

Right Side

Journalizing and Posting Transactions

Identify, Analyze, record, post

Record Journal Entry

Recorded chronologically

Post Entry to Ledger

Processing of transferring entries from the journal to the ledger

Trial Balance

List of all ledger accounts and their balances

Preparing a Trial Balance

List, compute, verify

General Ledger

Collection of ALL accounts with their activity and balance

Journal

Book of OG entry that includes a chronological record of all transactions that have accrued within a business during a period

Debt Ratio

Total Liabilities/Total Assets

Reporting Period

Fiscal year, determined by a business - can be 1 month, 1 quarter, or 1 year