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Principles of Accounting

This document provides an overview of accounting principles and concepts. It defines accounting and key accounting terms like assets, liabilities, equity, revenues and expenses. It describes the main financial statements - the balance sheet, income statement, and statement of cash flows. It also discusses tools and methods used in accounting like the accounting equation, double-entry bookkeeping, budgets, audits and GAAP. Finally, it introduces various ratios used to analyze financial statements, including liquidity, profitability and activity ratios.

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134 views28 pages

Principles of Accounting

This document provides an overview of accounting principles and concepts. It defines accounting and key accounting terms like assets, liabilities, equity, revenues and expenses. It describes the main financial statements - the balance sheet, income statement, and statement of cash flows. It also discusses tools and methods used in accounting like the accounting equation, double-entry bookkeeping, budgets, audits and GAAP. Finally, it introduces various ratios used to analyze financial statements, including liquidity, profitability and activity ratios.

Uploaded by

yasir
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPT, PDF, TXT or read online on Scribd
You are on page 1/ 28

CHAPTER 17

Understanding
Principles of Accounting

1
Chapter Outline
 What Is Accounting and Who Uses
Accounting Information?
 Who Are Accountants and What Do
They Do?
 Tools of the Accounting Trade
 Financial Statements
 Analyzing Financial Statements
 International Accounting

2
What Is Accounting and Who
Uses Accounting Information?
 Accounting is a comprehensive system for
collecting, analyzing and communicating
financial information
 Bookkeeping is the recording of
transactions

3
What Is Accounting and Who
Uses Accounting Information?

 Accounting
information system
(AIS) is an organized
means by which
financial information is
identified, measured,
recorded and retained
for use in accounting
statements and
management reports

4
Users of Accounting
Information

 Business Managers
 Employees and Unions
 Investors and Creditors
 Tax Authorities
 Government Regulatory Agencies

5
What is a Controller?

Person who manages all


of a firm’s accounting
activities (chief
accounting officer

6
Who Are Accountants and What
Do They Do?

 Financial Versus Managerial


Accounting
 Financial accounting system is
concerned with external information
users
 Managerial (or Management) accounting
system serves internal users

7
What is an Audit?

Systematic examination
of a company’s
accounting system to
determine whether its
financial reports fairly
represent its operations

8
What is GAAP (or Generally
Accepted Accounting Principles)?

Accepted rules and


procedures governing
the content and form
of financial reports

9
The Accounting Equation

Assets = Liabilities + Owners’ Equity

10
The Accounting Equation

 Asset is any economic resource expected


to benefit a firm or an individual who owns it
 Liability is a debt owned by a firm to an
outside organization or individual
 Owners’ equity is the amount of money
that owners would receive if they sold all of
a firm’s assets and paid all of its liabilities

11
What is Double-Entry
Accounting?

Bookkeeping system
that balances the
accounting equation by
recording the dual
effects of every financial
transaction

12
Financial Statements
 Balance sheets supply detailed
information about the accounting
equation factors:
 Assets
 Current Assets
 Fixed Assets
 Intangible Assets

13
Financial Statements

 Balance sheets supply


detailed information about the
accounting equation factors:
 Liabilities
 Current Liabilities
 Long-Term Liabilities

 Owners’ Equity
 Common Stock
 Paid-in Capital
 Retained Earnings

14
Perfect Posters’ Balance Sheet

15
Financial Statements

 Income statement (or Profit-and-loss


statement) lists a firm’s annual revenues
and expenses so that a bottom line shows
annual profit or loss. Three major
categories:
 Revenues
 Cost of Goods Sold
 Gross Profit (or Gross Margin)
 Operating Expenses
 Operating and Net Income

16
Perfect Posters’ Income Statement

17
Financial Statements
 Statement of cash flows describes a
firm’s yearly cash receipts and cash
payments. Three activities:
 Cash Flows from Operations
 Cash Flows from Investing
 Cash Flows from Financing

18
An Internal Financial Statement:
What is the Budget?

Detailed statement of
estimated receipts and
expenditures for a
future period of time

19
Perfect Posters’ Sales Budget

20
Analyzing Financial Statements

Solvency Ratio
Financial ratio, either short- or long-term, for
estimating the risk in investing in a firm
Profitability Ratio
Financial ratio for measuring a firm’s potential
earnings
Activity Ratio
Financial ratio for evaluating management’s use of a
firm’s assets

21
Analyzing Financial Statements

 Solvency ratios, both short- and long-term,


estimate risk. They include:

 Short-Term Solvency Ratios


 Liquidity ratio measures a firm’s
ability to pay its immediate debts
 Current Ratio
 Working Capital

22
Short-Term Solvency Ratios
Liquidity Ratio
Solvency ratio measuring a firm’s ability to pay its immediate
debts

Current Ratio
Solvency ratio that determines a firm’s credit worthiness by
measuring its ability to pay current liabilities

Current assets $57,210


  2.61
Current liabilities $21,935

23
Short-Term Solvency Ratios
Working Capital
Difference between a firm’s current assets and current
liabilities
Quick (or Acid-Test) Ratio
Solvency ratio for determining a firm’s ability to meet
emergency demands for cash
Quick Asset
Cash plus assets one step removed from cash (marketable
securities and accounts receivable)

Quick assets $7,050  2,300  26,210  650


  1.59
Current liabilities $21,935

24
Long-Term Solvency Ratios

Debt Ratio  
Solvency ratio measuring a firm’s ability to meet its long-term
debts
Debt-to-Owners’ Equity Ratio (or Debt-to-Equity Ratio)  
Solvency ratio describing the extent to which a firm is financed
through borrowing
Debt  
A firm’s total liabilities

Debt $61,935
  0.56
Owners' equity $111,155
25
Profitability Ratios
Net Profit Margin (or Return on Sales)
Profitability ratio indicating the percentage of its income that is
a firm’s profit

Net income $12,585


  0.049  4.9%
Sales $256,425

Return on Equity
Profitability ratio measuring income earned for each
dollar invested

Net income $12,585


  11 .3%
Total owners' equity $111,155

26
Profitability Ratios
Earnings Per Share
Profitability ratio measuring the size of the dividend that a firm
can pay shareholders

Net income $12,585


  $1.57 per share
Number of common shares outstanding 8,000

27
Activity Ratios
Inventory Turnover Ratio
Activity ratio measuring the average number of times that
inventory is sold and restocked during the year

Cost of goods sold Cost of goods sold



Average inventory (Beginning inventory  Ending inventory)/2

$104,765
 4.8 times
($22,380  $21,250)/2

28

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