>>>>>>>> BUS-101

Chapter 15: Understanding Accounting and

Financial Statements

Instructor: SgS
 Ac c o u n t i n g

► Accounting is the process of identifying, recording and communicating

economic events of an organization to interested users.

► Accounting is the process of measuring, interpreting and communicating

the financial information to enable people to make informed decision.

► Accounting Information support internal and external business decision

making process.

► An accountant prepares financial information or economic events or

business transaction in a way that describes the firm’s operation.
E.g. when an organization purchase a computer for office, the
accountant will identify this transaction, record the value of the item and
present this info to the manager.
 I n fo rm at ion
f Ac c ou n t in g
Users o
 ion U s ers
Inform at

• Internal Users Is the company earning

satisfactory income?
- marketing, finance,
HR, management

• External Users
Is cash sufficient to pay
- investors, creditors, bills?
What do we
suppliers, SEC, Tax do if they
catch us?
authorities, etc
Will the company be able to pay its debts as they
come due?
 cc oun t i ng
I n vo lvi ngA
s s A ct ivi ties
Busine

• Operating activities focus on selling goods and

services, but they also consider expenses as
important elements of sound financial
management.
• Investing activities provide valuable assets
required to run a business.
• Financing activities provide necessary funds to
start a business and expand it after it begins
operating.
 n d a ti o n o f
T h e F ou s
t i n g S y s t e m
Accoun
 Generally accepted accounting principles (GAAP)
• encompass the conventions, rules, and procedures for determining
acceptable accounting practices at a particular time.
• It is a guidelines or standards to provide reliable, consistent & unbiased
information

 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 (CEO & CFO) must personally certify that the financial
information reported by the company is correct.
 c c o u n t i n g
The A
Cycle
Accounting process/cycles - set of activities involved in converting
information about transactions into financial statements.
 t i n g Eq ua t i on
The Accoun

• Assets - anything of value owned or leased by a business.

• Liability - claim against a firm’s assets by a creditor.
• Owner’s equity - all claims of the proprietor, partners, or
stockholders against the assets of a firm, equal to the excess of
assets over liabilities.
• Basic accounting equation - relationship that states that
assets equal liabilities plus owners’ equity.

• Double-entry bookkeeping - process by which accounting

transactions are entered; each individual transaction always has
an offsetting transaction.
 e S h e e t
Ba l a nc

 Balance sheet - statement of a firm’s financial

position—what it owns and the claims against its
assets—at a particular point in time.

 Photograph of firm’s assets together with its liabilities

and owner’s equity

 Follows the accounting equation

 a la n c e S he et
S a mp l e B
 t a t e m e n t
Inc om e S

 Income Statement - financial record of a company’s

revenues and expenses, and profits over a period of
time.

 Firm’s financial performance in terms of revenues,

expenses, and profits over a given time period.

 Reports profit or loss.

 Focus on revenues and costs associated with

revenues.
 pl e I nc om e
Sam
Sta te m en t
 St a t e m e n t o f
e r ’ s E q u i t y
Own

 Statement of Owner’s 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.
 S ta t e m e n t o f
Sa m p l e
e r ’ s E qu i t y
Own
 t e m e n t of
The Sta
Ca s h Flo w s

 Statement of cash flows - a firm’s 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.
 S t a t e m en t of
S a mp l e
Ca s h F l o ws
 t io s A n a l y s is
Fi na n ci a l R a

Ratio analysis - tool for measuring a firm’s liquidity, profitability,

and reliance on debt financing, as well as the effectiveness of
management’s resource utilization.
 y R a ti o s
L i q ui d i t
Total current assets

Current ratio compares

current assets to current
liabilities.
Total current liabilities

Acid-test (or quick) Cash and equivalents

ratio measures the + short-term investments
ability of a firm to meet + accounts receivable
its debt payments on
short notice.

Total current liabilities

 i t y R a t i o s
Activ
Net sales

Inventory turnover
ratio indicates the
number of times
merchandise moves
Average of inventory
through a business.

Net sales
Total asset turnover ratio
indicates how much in
sales each dollar invested
in assets generates.
Average of total assets
 l i t y R a t i o s
Profitabi
Profitability ratios measure the organization’s overall financial
performance by evaluating its ability to generate revenues in excess of
operating costs and other expenses.
 e Ra t i o s
Leverag
• Leverage ratios measure the extent to which a firm relies on
debt financing.

• Total liabilities to total assets ratio > 50 percent indicates that a

firm is relying more on borrowed money than owners’ equity.