Chapter 16 Understanding Accounting and Financial Statements Overview accounting process of measuring interpreting and communicating financial information to support internal and external business decision making Users of Accounting Information open book management when companies share financial info with employees teach them how to use financial statements owners stockholders evaluate operations make investment decisions management plan control 3 basic activities involving accounting financing investing operating employees unions to use in contract negotiations lenders suppliers evaluate credit ratings government evaluate tax liabilities approve stocks bonds Accounting Professionals Public Accountants public accountant provides accounting services to other organizations o audit examine financial records o prepare taxes o consult managers largest firms Deloitte Touche Ernst young KPMG PricewaterhouseCoopers certified public accountants CPAs meet state requirements for education experience complete tests o certified management accountant certified fraud examiner certified internal auditor Management Accountants management account accountant employed by a business other than a public accounting firm o collects transactions prepares financial statements o cost accountant determines cost of goods services sets prices o o internal auditor examines firm s practices to ensure it complies with laws tax accountant works to minimize a firm s tax bill certified management accountant CMA management accountant who has passed test and achieved experience concern themselves with determining hoe efficiently organizations can accomplish objectives Government and Not for Profit Accountants Agencies that employ accountants NASA FBI IRS Not for profit churches unions hospitals schools Foundation of the Accounting System generally accepted accounting principles GAAP encompass the conventions rules and procedures for determining acceptable accounting practices based on 4 basic principles consistency relevance reliability comparability compared to other businesses financial accounting standards board FASB interprets and modifies GAAP in the US SEC is the chief regulator but relies on the FASB which is appointed by the Financial Accounting Foundation FASB has seven board members each of whom serve 5 year terms Sarbanes Oxley Act SOX created the Public Accounting Oversight Board 5 members set audit standards The Accounting Cycle accounting cycle set of activities involved in converting info and transactions into financial statements basic data transactions receipts invoices processing record classify journal summarize financial statements balance sheet income statements statement of owner s equity state of cash flows The Accounting Equation asset anything of value owned by a firm land buildings supplies accounts receivable cash marketable securities trademarks patents liability claims against assets by creditors accounts payable notes payable debt wages salaries owner s equity funds contributed by owners initial investment profits not distributed to owners in cash dividends accounting equation assets liabilities owner s equity ALOE double entry bookkeeping the process by which accounting transactions are entered each individual transaction has an offsetting transaction o Ex owner spends 5k on property increases equity by 5k left side increases by 5k and right side o Firm has 100k loan from bank and pays it off with cash liability decreases by 100k asset decreases increase by 5k by 100k Financial Statements Balance Sheet Income Statement Statement of Owner s Equity Statement of Cash Flows Financial Ratio Analysis Liquidity Ratios balance sheet statement of a firm s financial positions at one time what it owns and claims against its assets left side of a balance sheet has the firm s assets right side has claims against assets liabilities equity income statement financial record of a company s revenues expense and profits over a period of time Profit Loss summarizes a firm s performance in terms of revenue expenses and profits over a period of time statement of owner s equity record of the change in owners equity from the end of one fiscal period to the end of the next begins with equity from the previous year then adds net income subtracts cash dividends paid to owners statement of cash flows shows sources uses of cash during a period of time accrual accounting records revenues and expenses when they occur not when cash changes hands depreciation companies reduce the value of an asset becomes an expense on income statement liquidity ratios firm s ability to meet short term obligations o high liquidity reduces likelihood that a firm will need to raise funds to repay loans o low liquidity firm may be forced to choose between default or borrowing current ratio current assets current liabilities o shows amt of assets per 1 of liabilities 2 to 1 is considered satisfactory acid test ratio current assets inventory current liabilities o ability of firm to meet debt payments on short notice 1 to 1 is adequate Activity Ratios activity ratios measure the effectiveness of management s use of the firm s resources inventory turnover cost of goods sold average inventory o indicates number of times merchandise moves through a business receivables turnover credit sales average accounts receivable o shows avg age of receivables in days total asset turnover sales average total assets o how much in sales each dollar invested in assets generates higher ratio shows firm operates more profitability ratios measure firm s ability to generate profits by analyzing firm s profit margins return on efficiently Profitability Ratios equity gross profit margin gross profit sales net profit margin net income sales o indicates firm realizes profit of cents on each 1 of merchandise it sells return on equity net income average equity Leverage Ratios leverage ratios measure the extent to which a firm relies on debt financing debt ratio total liabilities total assets o over 50 shows firm relies more on borrowed money than owners equity long term debt to equity long term debt owners equity o shows long term debt to every 1 in equity Budgeting budget organization s plans for how it will raise and spend money during a given period of time cash budget track the firm s cash inflows outflows an exchange rate is the ratio at which a country s currency can be exchanged for other currencies GAAP requires firms to make adjustments to their earning tat
View Full Document
Unlocking...