Financial Accounting and Reporting Final Review Purpose of the 4 Financial Statements 1 Balance Sheet reports the financial position of a company at a certain point in time snapshot A L SE 2 Income Statement shows both the income and the expenses of a company indicated how revenue is transformed into income Revenues Expenses Net Income 3 Statement of Retained Earnings outlines the changes in retained earnings for a specific period reconciles the beginning and ending retained earnings for the period using net income Beg RE NI Dividends End RE 4 Statement of cash flow shows how changes in the balance sheet accounts and income effects cash cash equivalents financing activities concerned w the flow of cash in out of the business CFO CFI CFE Cash Financial Statement Indicators Current Ratio creditors and analysts use the current ratio to measure the ability of a company to pay off its short term obligations with short term assets a The higher the ratio the more room a company has to pay its current obligations However too high of a ratio suggests inefficient use of resources b Rule of Thumb companies should have a current ratio between 1 0 and 2 0 Current Ratio Current assets Current Liabilities Average days in Inventory use the Inventory Turnover Ratio to determine how many times average inventory was produced and sold during the period A A higher ratio reflects that inventory moves more quickly through the production process to the customer Inventory Turnover Cost of Goods Sold Average Inventory B Average days to sell inventory ratio indicates the average time it takes the company to produce and deliver inventory to customers Average Days to Sell Inventory 365 Inventory Turnover xx days C These ratios effect a company s statement of cash flows The effects of changes in inventory are that buying increasing inventory eventually decreases cash while selling decreasing inventory eventually increases cash Earnings Per Share popular measure because income numbers are easier to compare on a per share basis and also useful for comparing companies of different sizes Earnings per share Net Income Average Number of Common Shares Outstanding A This is reported on the income statement P E Ratio The Price Earnings ratio measures how many times current year s earnings investors are willing to pay for a company s stock A A higher P E ratio means that investors have more confidence in the company s ability to produce higher profits in the future years B Aka price multiple or earnings multiple P E Ratio Market Value Per Share Earnings Per Share EPS Gross Profit Percentage measures a company s ability to charge premium prices and produce goods and services at low cost A A higher gross profit results in a higher net income Gross Profit Percentage Gross Profit Net Sales CHAPTER 4 Completing the Accounting Cycle Adjusting Entries entries necessary at the end of the accounting period to measure all revenues and expenses of that period They are recorded so that A Revenues are recorded when they are earned revenue principle B Expenses are recorded when they are incurred to generate revenue maturing principle the end of the period C Assets are reported at amounts that represent probably future benefits remaining at D Liabilities are reported at amounts that represent the probable future sacrifices of assets or services owed at the end of the period Types of Adjustments A Deferred Revenues previously recorded liabilities that were created when cash was received in advance and that must be reduced for the amount of revenue actually earned during that period B Deferred Expenses Previously recorded assets prepaid rent supplies equipment that were created when cash was paid in advance and that must be reduced for the amount of expense actually incurred during that period EXAMPLE Deferred Revenue If cash was received previously recorded Unearned Revenue L XX Revenue R SE XX Deferred Expenses if cash was paid previously recorded Expense E SE XX Prepaid Expense A XX C Accrued Revenues Revenues that have been earned but not yet recorded because cash will be received after the services are performed or goods are delivered D Accrued Expenses Expenses that have been incurred but not yet recorded because cash will be paid after goods or services are used EXAMPLE Accrued Revenues if cash will be received Receivable A XX Revenue R SE XX Accrued Expenses if cash will be paid Expense E SE XX Payable L XX Preparing the Financial Statements The Income Statement is prepared first because net income is a component of returned earnings RE Closing the Books End of Accounting Cycle A You close temporary accounts revenue expense gain loss because those accounts are used to accumulate data for the current accounting period only B A closing entry s purpose it to 1 Transfer balances in the temporary accounts income statement accounts to 2 Establish a 0 balance in each of the temporary accts to start the accumulation in the Retained Earnings next acting period Net Profit Margin measures how much of every sales dollar generated during the period is profit Net Profit Margin Net Income Net Sales Operating Revenues CHAPTER 6 Cash and A R Bank Reconciliation process of verifying the accuracy of both the bank statement and the cash accounts of a business Allowance Method of Accounting for Bad Debt A An adjusting journal entry at the end of the accounting period records the bad debt estimate Bad Debt Expense XX Allowance for doubtful Accounts XX B Once an uncollectible account has been identified it is then written off Allowance for doubtful Accounts XX Accounts Receivable XX Estimating Bad Debts the bad debt recorded in the end of period adjusting entry often is estimated based on either 1 Percentage of total sales for the period or 2 Aging of accounts receivable Percentage of Credit Sales Method bases bad debt expense on the historical percentage of credit sales that result in bad debts 1 A company that has been operating for some years has enough experience to project probable future bad debt losses EXAMPLE Company A knows to expect bad debt losses of 1 0 percent of credit sales and its credit sales were 900 000 it would estimate the current year s bad debt as Credit Sales 900 000 X Bad Debt Loss 01 Bad Debt Expense 9 000 Recorded as Bad Debt Expense 9 000 Allowance for Doubtful Accts 9 000 Aging of Accounts Receivable Method relies on the fact that as accounts receivable become older it is less likely that will be collectible For example
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