Chapter 16 1 Copyright © 2008 by Nelson, a division of Thomson Canada Limited Chapter Using Financial Information and Accounting Prepared by Norm Althouse University of Calgary Prepared by Norm Althouse University of Calgary 14

Chapter 16 2 Copyright © 2008 by Nelson, a division of Thomson Canada Limited Principles of Accounting Accounting provides a framework to understand the firm’s financial condition – central to every organization. Accounting provides a framework to understand the firm’s financial condition – central to every organization. Accounting

Chapter 16 3 Copyright © 2008 by Nelson, a division of Thomson Canada Limited Accounting The process of collecting, recording, classifying, summarizing, reporting, and analyzing financial activities. Accounting Accounting that provides financial information that managers inside the organization can use to evaluate and make decisions. Managerial Accounting 1

Chapter 16 4 Copyright © 2008 by Nelson, a division of Thomson Canada Limited Users of the Accounting System 1

Chapter 16 The Accounting System 5 Copyright © 2008 by Nelson, a division of Thomson Canada Limited

Chapter 16 The Accounting Cycle 6 Copyright © 2008 by Nelson, a division of Thomson Canada Limited 1. Analyze business transaction documents 2. Record business transactions in journal 3. Post entries to ledgers 4. Prepare trial balance 5. Prepare financial statements & management reports 6. Analyze reports

Chapter 16 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.

Chapter 16 Accounting calculations are, of course, now done by machine instead of by hand

Chapter 16 …and the machines accountants use are becoming more sophisticated every day. But there is still a lot of number crunching involved in accounting

Chapter 16 …resulting in a lot of stressful work as the year-end financial statements have to be prepared and as audit time comes around.

Chapter Copyright © 2008 by Nelson, a division of Thomson Canada Limited Primary Financial Statements 1 Balance Sheet Income Statement Statement of Cash Flows

Chapter Copyright © 2008 by Nelson, a division of Thomson Canada Limited 2 The Accounting Profession Accounting Designations chartered accountant (CA) certified management accountant (CMA) certified general accountant (CGA)

Chapter Copyright © 2008 by Nelson, a division of Thomson Canada Limited 2 The Accounting Profession Private Accountants Private Accountants Accountants employed to serve one particular organization. Public Accountants Independent accountants who serve organizations and individuals on a fee basis.

Chapter Copyright © 2008 by Nelson, a division of Thomson Canada Limited 3 The Accounting Equation Assets __ Liabilities Owners’ Equity __ Things of value owned by a firm What a firm owes to its creditors Investment in the firm minus liabilities; Net Worth More commonly you will see the accounting equation as A = L + OE

Chapter Copyright © 2008 by Nelson, a division of Thomson Canada Limited 4 The Balance Sheet CategoriesCategories Company’s obligations (Liabilities) Resources of a company (Assets) Owners’ Equity

Chapter 16 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 16 Copyright © 2008 by Nelson, a division of Thomson Canada Limited

Chapter Copyright © 2008 by Nelson, a division of Thomson Canada Limited 4 Assets Fixed assets Current assets Intangible assets  Cash  Marketable securities  Accounts receivable  Inventory  Cash  Marketable securities  Accounts receivable  Inventory  Land and buildings  Machinery and equipment  Furniture  Fixtures  Land and buildings  Machinery and equipment  Furniture  Fixtures  Patents,  Copyrights  Trademarks  Goodwill  Patents,  Copyrights  Trademarks  Goodwill

Chapter Copyright © 2008 by Nelson, a division of Thomson Canada Limited 4 Liabilities Long-term liabilities Current liabilities  Accounts payable  Notes payable  Accrued expenses  Income taxes payable  Current portion of long-term debt  Accounts payable  Notes payable  Accrued expenses  Income taxes payable  Current portion of long-term debt  Bank loans  Mortgages on buildings  Company’s bonds sold to others  Bank loans  Mortgages on buildings  Company’s bonds sold to others

Chapter Copyright © 2008 by Nelson, a division of Thomson Canada Limited 4 Owners’ Equity  Owners’ total net worth after all liabilities have been paid

Chapter Copyright © 2008 by Nelson, a division of Thomson Canada Limited 5 CategoriesCategories Expenses Revenues Net Profit or Loss The Income Statement

Chapter 16 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 21 Copyright © 2008 by Nelson, a division of Thomson Canada Limited

Chapter Copyright © 2008 by Nelson, a division of Thomson Canada Limited 5 Revenues 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 Revenues

Chapter Copyright © 2008 by Nelson, a division of Thomson Canada Limited 5 Expenses Cost of goods sold: The total expense of buying or producing the firm’s goods or services Operating expenses: The expenses of running a business that are not directly related 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.

Chapter Copyright © 2008 by Nelson, a division of Thomson Canada Limited 5 Net Income Net Loss Obtained by subtracting a firm’s expenses from revenues (when revenues are more than expenses) Obtained by subtracting a firm’s expenses from revenues (when expenses are more than revenues) Net Profit or Loss

Chapter Copyright © 2008 by Nelson, a division of Thomson Canada Limited 6 Cash Flows from… Investment activities Operating activities Financing activities Statement of Cash Flows

Chapter 16 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 26 Copyright © 2008 by Nelson, a division of Thomson Canada Limited

Chapter Copyright © 2008 by Nelson, a division of Thomson Canada Limited 7 RatioClassificationsRatioClassifications Liquidity Profitability Activity Debt Ratio Analysis

Chapter Copyright © 2008 by Nelson, a division of Thomson Canada Limited 7 Acid-Test (Quick) Ratio Ratio of total current assets excluding inventory to total current liabilities. Net Working Capital Net Working Capital The amount obtained by subtracting current liabilities from total current assets. Current Ratio Ratio of total current assets to total current liabilities. Measure the firm’s ability to pay its short-term debts Liquidity Ratios

Chapter Copyright © 2008 by Nelson, a division of Thomson Canada Limited 7 Return on Equity (ROE) Ratio of net profit to total owners’ equity. Earnings Per Share (EPS) Ratio of net profit to the number of shares of common stock outstanding. Ratio of net profit to the number of shares of common stock outstanding. Net Profit Margin Ratio of net profit to net sales. Return on sales. Measure the firm’s use of resources to generate profit Profitability Ratios

Chapter Copyright © 2008 by Nelson, a division of Thomson Canada Limited 7 Inventory Turnover Ratio The speed with which inventory moves through the firm and is turned into sales. Measure how well a firm uses its assets Activity Ratios

Chapter Copyright © 2008 by Nelson, a division of Thomson Canada Limited 7 Debt-to-Equity Ratio Debt-to-Equity Ratio Measures the relationship between the amount of debt financing and the amount of equity financing. Measure how well a firm uses its assets Debt Ratios

Chapter Copyright © 2008 by Nelson, a division of Thomson Canada Limited 8 Trends in Accounting Role of accountants has been changing and expanding Valuing knowledge assets Canada Moves to International Financial Reporting Standards (IFRS)