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Understanding Accounting and Financial Statements


15 Chapter Understanding Accounting and Financial Statements * * * * * * * * * * * * * * * * * * * * * * Explain the functions and identify the three basic activities ... – PowerPoint PPT presentation

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Title: Understanding Accounting and Financial Statements

Understanding Accounting and Financial Statements
Learning Goals
Explain the functions and identify the three
basic activities involving accounting. Describe
the roles played by public, management,
government, and not-for-profit accountants. Identi
fy the foundations of the accounting system,
including GAAP and the role of the Financial
Accounting Standards Board (FASB). Outline the
steps in the accounting cycle, and define
double-entry bookkeeping and the accounting
Explain the functions and major components of the
four principal financial statements the balance
sheet, the income statement, the statement of
owners equity, and the statement of cash
flows. Discuss how financial ratios are used to
analyze a companys financial strengths and
weaknesses. Describe the role of budgets in a
business. Outline accounting issues facing global
business and the move toward one set of worldwide
accounting rules.
  • Accounting is the process of measuring,
    interpreting, and communicating financial
    information to enable people inside and outside
    the firm to make informed decisions.

Open Book Management
  • Open book management- sharing sensitive financial
    information with employees and teaching them how
    to understand and use financial statements.
  • Viewing financial information may help them
    better understand how their work contributes to
    the companys success.
  • Outsiders use financial data to evaluate
    investment opportunities.

Business Activities Involving Accounting
  • Financing activities provide necessary funds to
    start a business and expand it after it begins
  • Investing activities provide valuable assets
    required to run a business.
  • Operating activities focus on selling goods and
    services, but they also consider expenses as
    important elements of sound financial management.

Accounting Professionals
  • Public Accountants
  • Provide accounting services (auditing, tax
    preparation, consulting) to individuals or
    business firms for a fee
  • CPA
  • Management Accountants
  • Provide timely, relevant, accurate, and concise
    information that executives can use to operate
    their firms
  • CMA
  • Government and Not-for-Profit Accountants

Foundation of Accounting Systems
  • Generally accepted accounting principles (GAAP)
    encompass the conventions, rules, and procedures
    for determining acceptable accounting practices
    at a particular time.
  • Financial Accounting Standards Board (FASB) is
    primarily responsible for evaluating, setting, or
    modifying GAAP in the U.S.
  • Sarbanes-Oxley Act (SOX) responded to cases of
    accounting fraud.
  • Created the Public Accounting Oversight Board,
    which sets audit standards and investigates and
    sanctions accounting firms that certify the books
    of publicly traded firms.
  • Senior executives must personally certify that
    the financial information reported by the company
    is correct.
  • Resulted in increase in demand for accountants.

The Accounting Cycle
  • Accounting cycle- set of activities involved in
    converting information about transactions into
    financial statements.

The Accounting Equation
  • Assets- anything of value owned or leased by a
  • Liability- claim against a firms assets by a
  • Owners equity- all claims of the proprietor,
    partners, or stockholders against the assets of a
    firm, equal to the excess of assets over
  • Basic accounting equation- relationship that
    states assets equal liabilities plus owners
  • Double-entry bookkeeping- process by which
    accounting transactions are entered each
    individual transaction always has an offsetting

Impact of Technology on Accounting
  • Simplifies the accounting process by automating
    data entry and calculations.
  • Available products are customized for businesses
    of different sizes.
  • Entrepreneurs and small businesses use
    QuickBooks, Peachtree, and BusinessWorks.
  • Larger firms use larger scale software packages
    like Computer Associates, Oracle, and SAP.
  • Software that handles accounting information for
    international businesses is another option.
    Offers different country information/language.
  • Some systems offer web-based packages for small
    and medium businesses.

Balance Sheet
  • Balance sheet statement of a firms financial
    positionwhat it owns and the claims against its
    assetsat a particular point in time
  • Photograph of firms assets together with its
    liabilities and owners equity
  • Follows the accounting equation

Sample Balance Sheet
Income Statement
  • Income Statement financial record of a companys
    revenues and expenses and profits over a period
    of time
  • Firms financial performance in terms of
    revenues, expenses, and profits over a given time
  • Reports profit or loss
  • Focus on revenues and costs associated with

Sample Income Statement
Statement of Owners Equity
  • Statement of Owners Equity is designed to show
    the components of the change in equity from the
    end of one fiscal year to the end of the next
  • Begins with the amount of equity shown on the
    balance sheet
  • Net income is added, and cash dividends paid to
    owners are subtracted

Sample Statement of Owners Equity
Statement of Cash Flows
  • Statement of cash flows a firms cash receipts
    and cash payments that presents information on
    its sources and uses of cash
  • Accrual accounting method that records revenue
    and expenses when they occur, not necessarily
    when cash actually changes hands

Sample Statement of Cash Flows
Financial Ratios Analysis
  • Ratio analysis tool for measuring a firms
    liquidity, profitability, and reliance on debt
    financing as well as the effectiveness of
    managements resource utilization

Liquidity Ratios
Total current assets
  • Current ratio compares current assets to current

Total current liabilities
Cash and equivalents short-term investments
accounts receivable
  • Acid-test (or quick) ratio measures the ability
    of a firm to meet its debt payments on short

Total current liabilities
Activity Ratios
Net sales
  • Inventory turnover ratio indicates the number of
    times merchandise moves through a business.

Average of inventory
Net sales
  • Total asset turnover ratio indicates how much in
    sales each dollar invested in assets generates.

Average of total assets
Profitability Ratios
  • Profitability ratios measure the organizations
    overall financial performance by evaluating its
    ability to generate revenues in excess of
    operating costs and other expenses.

Leverage Ratios
  • Leverage ratios measure the extent to which a
    firm relies on debt financing.
  • Total liabilities to total assets ratio gt 50
    percent indicates that a firm is relying more on
    borrowed money than owners equity.

  • Budget- planning and control tool that reflects a
    firms expected sales revenues, operating
    expenses, and cash receipts and outlays
  • Management estimates of expected sales, cash
    inflows and outflows, and costs
  • Budgets are a financial blueprint that serves as
    a financial plan
  • Cash budget- tracks the firms cash inflows and

Sample Budget
International Accounting
  • Accounting procedures and practices must be
    adapted to accommodate an international business
  • The International Accounting Standards Committee
    (IASC) was established in 1973 to promote
    worldwide consistency in financial reporting
    practices. The IASC soon developed its first set
    of accounting standards and interpretations and,
    in 2001, became the International Accounting
    Standards Board (IASB). International Financial
    Reporting Standards (IFRS) are the standards and
    interpretations adopted by the IASB.
  • Exchange rates- ratio at which a countrys
    currency can be exchanged for other currencies
  • Consolidated financial statements must reflect
    gains and losses due to changes in exchange rates
  • Can have significant impact on financial

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