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Chapter

Using Financial Informationand Accounting

Using Financial Informationand Accounting

Prepared byNorm Althouse

University of Calgary

Prepared byNorm Althouse

University of Calgary

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Principles of Accounting

Accounting provides a framework to understand thefirm’s financial condition – central to every organization.

Accounting provides a framework to understand thefirm’s financial condition – central to every organization.

AccountingAccounting

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Accounting

The process of collecting, recording, classifying,

summarizing, reporting,and analyzing

financial activities.

The process of collecting, recording, classifying,

summarizing, reporting,and analyzing

financial activities.

AccountingAccounting

Accounting that provides financial information that

managers inside the organization can use to

evaluate and make decisions.

Accounting that provides financial information that

managers inside the organization can use to

evaluate and make decisions.

ManagerialAccounting

ManagerialAccounting

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Users of the Accounting System1

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The Accounting System

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The Accounting Cycle

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1. Analyze business transaction documents

2. Record business transactions in journal

3. Post entriesto ledgers

4. Prepare trial balance

5. Prepare financial statements &

management reports

6. Analyze reports

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The accountant is no longer in a backroom wearing a green eye-shades filling out ledgers by hand, but rather is now engaged in forward planning.

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Accounting calculations are, of course, now done by machine instead of by hand

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…and the machines accountants use are becoming more sophisticated every day. But there is still a lot of number crunching involved in accounting

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…resulting in a lot of stressful work as the year-end financial statements have to be prepared and as audit time comes around.

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Primary Financial Statements1

Balance Sheet

Income Statement

Statement of Cash Flows

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2 The Accounting Profession

Accounting DesignationsAccounting DesignationsAccounting DesignationsAccounting Designations

chartered accountant (CA)chartered accountant (CA)

certified management accountant (CMA)certified management accountant (CMA)

certified general accountant (CGA)certified general accountant (CGA)

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2 The Accounting Profession

PrivateAccountants

PrivateAccountants

Accountants employed to serve one particular organization.

Accountants employed to serve one particular organization.

Public Accountants

Public Accountants

Independent accountants whoserve organizations and

individuals on a fee basis.

Independent accountants whoserve organizations and

individuals on a fee basis.

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3 The Accounting Equation

AssetsAssets__

LiabilitiesLiabilities Owners’Equity

Owners’Equity

____

Things of valueowned by a firm

What a firm owesto its creditors

Investment in the firm minus liabilities;Net Worth

More commonly you will see the accounting equation as

A = L + OE

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4 The Balance Sheet

CategoriesCategoriesCategoriesCategories Company’s obligations(Liabilities)

Company’s obligations(Liabilities)

Resources of a company(Assets)

Resources of a company(Assets)

Owners’ EquityOwners’ Equity

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The Balance Sheet

Summarizes a firm’s financial position at a

specific point in time.

• Assets (resources)

– current, fixed, intangible, depreciation

• Liabilities (obligations)

– current, long-term

• Assets minus obligations (equity)

– retained earnings

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4 Assets

Fixed assetsFixed assets

Current assetsCurrent assets

Intangible assetsIntangible assets

CashMarketable securitiesAccounts receivableInventory

CashMarketable securitiesAccounts receivableInventory

Land and buildingsMachinery and equipmentFurnitureFixtures

Land and buildingsMachinery and equipmentFurnitureFixtures

Patents, CopyrightsTrademarksGoodwill

Patents, CopyrightsTrademarksGoodwill

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4 Liabilities

Long-termliabilities

Long-termliabilities

Current liabilitiesCurrent liabilities

Accounts payableNotes payableAccrued expensesIncome taxes payableCurrent portion of long-term debt

Accounts payableNotes payableAccrued expensesIncome taxes payableCurrent portion of long-term debt

Bank loansMortgages on buildingsCompany’s bonds sold to others

Bank loansMortgages on buildingsCompany’s bonds sold to others

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4 Owners’ Equity

Owners’ EquityOwners’ EquityOwners’ total net worth after

all liabilities have been paid

Owners’ total net worth after all liabilities have been paid

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CategoriesCategoriesCategoriesCategories ExpensesExpenses

RevenuesRevenues

Net Profit or LossNet Profit or Loss

The Income Statement

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The Income Statement

Summarizes the firm’s revenues and

expenses and shows total profit or loss over a period of time.

Revenues

– gross sales, net sales

Expenses

– cost of goods sold, operating expenses

Net profit or loss

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RevenuesRevenues

Gross sales: The total dollar amount of a company’s sales

Gross sales: The total dollar amount of a company’s sales

Net sales: The amount left after deducting sales discounts and returns and allowances from gross sales

Net sales: The amount left after deducting sales discounts and returns and allowances from gross sales

Revenues

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ExpensesExpenses

Cost of goods sold: The total expense of buyingor producing the firm’s goods or services

Cost of goods sold: The total expense of buyingor producing the firm’s goods or services

Operating expenses: The expenses of running a business that are not directlyrelated to producing or buying its products.

Operating expenses: The expenses of running a business that are not directlyrelated to producing or buying its products.

Expenses

Taxes are not an expense but an obligation. Taxes are subtracted after all expenses have been subtracted.

Taxes are not an expense but an obligation. Taxes are subtracted after all expenses have been subtracted.

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Net IncomeNet Income

Net LossNet Loss

Obtained by subtracting a firm’s expenses from revenues (when revenues aremore than expenses)

Obtained by subtracting a firm’s expenses from revenues (when revenues aremore than expenses)

Obtained by subtracting a firm’s expenses from revenues (when expenses aremore than revenues)

Obtained by subtracting a firm’s expenses from revenues (when expenses aremore than revenues)

Net Profit or Loss

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Cash FlowsCash Flowsfrom…from…

Cash FlowsCash Flowsfrom…from… Investment activitiesInvestment activities

Operating activitiesOperating activities

Financing activitiesFinancing activities

Statement of Cash Flows

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Statement of Cash Flows

Summarizes the money flowing into and out of a firm for a period of time.

Sources of cash flow:

– operating expenses

– investment activities

– financing activities

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RatioRatioClassificationsClassifications

RatioRatioClassificationsClassifications

Liquidity

Profitability

Activity

Debt

Ratio Analysis

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Acid-Test(Quick) Ratio

Acid-Test(Quick) Ratio

Ratio of total current assets excluding inventory to

total current liabilities.

Ratio of total current assets excluding inventory to

total current liabilities.

Net WorkingCapital

Net WorkingCapital

The amount obtained by subtractingcurrent liabilities from total current assets.

The amount obtained by subtractingcurrent liabilities from total current assets.

CurrentRatio

CurrentRatio

Ratio of total current assets to totalcurrent liabilities.

Ratio of total current assets to totalcurrent liabilities.

Measure the firm’s ability to pay its short-term debtsMeasure the firm’s ability to pay its short-term debts

Liquidity Ratios

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Return on Equity (ROE)

Return on Equity (ROE)

Ratio of net profit to total owners’ equity.

Ratio of net profit to total owners’ equity.

Earnings Per Share(EPS)

Earnings Per Share(EPS)

Ratio of net profit to the number ofshares of common stock outstanding.Ratio of net profit to the number of

shares of common stock outstanding.

Net ProfitMargin

Net ProfitMargin

Ratio of net profit to net sales. Return on sales.

Ratio of net profit to net sales. Return on sales.

Measure the firm’s use of resources to generate profitMeasure the firm’s use of resources to generate profit

Profitability Ratios

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InventoryTurnover Ratio

InventoryTurnover Ratio

The speed with which inventory moves through the firm and

is turned into sales.

The speed with which inventory moves through the firm and

is turned into sales.

Measure how well a firm uses its assetsMeasure how well a firm uses its assets

Activity Ratios

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Debt-to-EquityRatio

Debt-to-EquityRatio

Measures the relationship between the amount of debt financing and the

amount of equity financing.

Measures the relationship between the amount of debt financing and the

amount of equity financing.

Measure how well a firm uses its assetsMeasure how well a firm uses its assets

Debt Ratios

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8 Trends in Accounting

Role of accountants has been changing and expanding

Valuing knowledge assets

Canada Moves to International Financial Reporting Standards (IFRS)