2 Definition of Accounting Accounting is a system of dealing with financial information that provides information for decision-making
3 Accounting vs. Bookkeeping The process of recording, analyzing, and interpreting the economic activities of a businessBOOKKEEPINGA method of recording all transactions for a business in a specific format
4 Why is Accounting Important AccountabilityPeople who handle cash in the company are responsible for itBudgetingThis allows businesses to estimate its future sales and expensesTaxationRecords must be kept in order to pay taxes
5 Why is Accounting Important Financial StatementsThese are reports that summarize the financial performance of a businessThese reports indicate the business’s economic healthAnnual ReportsFinancial statements are presented to shareholders and potential investors in the form of annual reports
6 An Information SystemWhat financial questions might you have about your business?Is the business earning profit?Are selling prices to high/low?How much does ABC company owe me?What is the value of my inventory?How much did John Smith earn last year?Do we have enough money to pay our bills?
7 An Information SystemWho else may want financial information about the business?GovernmentBankersLendersPotential InvestorA Lawyer
8 OWNING A BUSINESSIf you decide to operate your own business you will find yourself facing such accounting tasks as:BankingPayrollKeeping track of amounts owed by and owed to customersKeeping track of amounts owed to the governmentProducing an income statement for income tax purposes
9 Categories of Accounting Work Routine Daily ActivitiesProcessing BillsPreparing ChequesDaily BankingRecording TransactionsPreparing Business PapersPeriodic Accounting Activities (these activities occur at regular intervals)Paycheques(bi-weekly)Bank accounts (balanced monthly)Financial reports (monthly, quarterly, yearly)Income tax returns (yearly)
10 Categories of Accounting Work Miscellaneous ActivitiesEmployee resignationAn advertisement is preparedNew capital equipment is purchasedA new loanA new employee is hired
11 The Fundamental Accounting Equation The fundamental accounting equation states that:ASSETS – LIABILITIES = OWNER’S EQUITYORASSETS = LIABILITIES + OWNER’S EQUITY
12 ASSETS An asset is anything that the business owns that has value What are some examples of personal assets?HouseCarCashRRSP’s
13 LIABILITIESA liability is anything that the business owes; any debts of the businessWhat are some examples of personal liabilities?Credit LineMortgageOwed to ParentsCredit cards
14 OWNER’S EQUITYOwner’s Equity is also referred to as capital or net worthIt is the difference between the total assets and total liabilities of a business
15 PERSONAL NET WORTH Here is a list of my assets: House Car Furniture Cash in BankSavingsRRSP’sTeachers Pension
16 PERSONAL NET WORTH Here is a list of my liabilities: Mortgage Credit card ( paid of every month, but still a potential liability)Line of credit
17 PERSONAL NET WORTH What do I need to do to calculate my net worth? Take my total assets and subtract them from my total liabilities
18 PERSONAL NET WORTHWe can see how this looks by examining a Balance Sheet containing my personal assets, liabilities, and net worthMrs. DrummondBalance SheetMay 20, 2012AssetsLiabilitiesCash in Bank$ 2,000.00Credit Card$ 1,500.00SavingsCar Loan$ 25,000.00RRSP's$ 5,000.00Credit Line$ 10,000.00Teachers PensionMortgage$ 170,000.00Household Items$ 20,000.00Car$ 30,000.00Total Liabilities$ 206,000.00House$ 400,000.00Net WorthMrs. Drummond’s Equity$ 258,000.00Total Assets$ 464,000.00Total Liabilities and Equity
19 YOUR NET WORTHMake a list of all of your assets and all of your liabilitiesCalculate your total assets and your total liabilitiesNow calculate your net worth (remember the fundamental accounting equation)Make a new net worth statement for yourself for 10 years from now!
21 BALANCE SHEET = a statement of financial position Liabilities(debts you owe)+Owners Equity(the owner’s share of the assets)Assets (Things owned) =
22 THE ACCOUNTING EQUATION ASSETS = LIABILITIES + OWNERS EQUITYA=L+OE
23 BALANCE SHEETA “freeze frame” or snapshot of what the business owns, owes and the owners invested interest.A financial picture of the business at a point in time.The balance sheet does not indicate whether a business has made a profit, only whether it is financially strong.
24 Features of the Balance Sheet The Balance Sheet looks like the Fundamental Accounting EquationA = L + OEAssets are on the left side and the liabilities and owner’s equity are on the right side
25 Features of the Balance Sheet A Three Line Heading is UsedWHO? – The name of the individual, business or other organizationWHAT? – The name of the financial statement (in this case the balance sheet)WHEN? – The date on which the financial position is determined
26 WHO? – The name of the individual, business or other organization What?WHO? – The name of the individual, business or other organizationWhen?
27 CASH AND LIQUIDITY Liquidity – how easily an Cash is arguably the MOST valuable asset of a business.WHY??It can easily be exchanged for other assetsLiquidity – how easily anasset can be exchanged forany other asset or convertedto cash.
28 ASSETSOwnership (title- legal right to use) is separate from financing (source of funds used to purchase asset).With ASSETS, an owner can:UseSellGive awayLeave to heirsWhether bought for cash or on credit, the owner still has “title” to his/her property
29 CATEGORIZING ASSETSCurrent Assets – things a business owns that disappear quickly, usually in less than one year. Long-term Assets (Capital Assets or Fixed Assets) – assets that a business keeps for a long time.
30 ASSETS In order of liquidity, assets include: cash, bank balances, accounts receivable (listed in alphabetical order),inventory and supplies, andfurniture, equipment, fixtures, vehicles, property and buildings (listed in the order in which they will be used up).
31 ACCOUNTS RECEIVABLECustomers of the business will often buy goods or services with the understanding that they will be paid for in the futureThese debts owed represent a dollar value to the business, so the business has a right to include them among the assets on the balance sheetEach of these customers that owes money to the business is one of its debtors
32 CURRENT ASSETS Current Assets Cash $ 50,000 Accounts Receivable $ 30,000Inventory $120,000Supplies $ 15,000Total Current Assets $215,000ORDEROfLIQUIDITYCLOSESTTOCASHFARTHEST FROMCASH
33 FIXED ASSETS Fixed Assets Land $ 200,000 Building $ 1,100,000 IN ORDER OF REVERSE DEPRECIATIONFixed AssetsLand $ ,000Building $ ,100,000Equipment $ ,000Furniture $ ,000Vehicles $ ,000Total Fixed Assets $ ,690,000ONE THAT WILL BE AROUND THE LONGESTONE THAT WILL BE AROUND THE LEAST AMOUNT OF TIME
34 LIABILITIESLiabilities are the debts of a business. Businesses acquire debt in two main ways:1) Accounts Payable – purchasing inventory and supplies on credit.2) Loans Payable (Notes Payable) – acquired by borrowing money from investors, banks, etc.
35 CATEGORIZING LIABILITIES Liabilities are listed in order of priority, or how quickly they need to be paid off.Current Liabilities – debts such as invoices for merchandise inventory, that are paid off quickly.Long-term Liabilities – debts such as a mortgage loan, that may not be repaid for decades.
36 ACCOUNTS PAYABLEA business often purchases goods and services from its suppliers with the understanding that payment will be made laterThese debts to suppliers represent a dollar obligation of the business, the business must include them among its liabilitiesEach of the suppliers owed money by the business is one of its creditors
37 CURRENT LIABILITIES Current Liabilities Wages Payable $ 10,000 ORDEROfMATURITY*Current LiabilitiesWages Payable $ 10,000Accounts Payable $ 80,000Other Liabilities $ 50,000Current Portion - Mortgage $ 15,000Total Current Liabilities $ ,000* Maturity – When a debt is “mature” it’s payment is dueFIRSTTO BEPAIDLASTTO BEPAID
38 LONG TERM LIABILITIES Long Term Liabilities Vehicle Loans $ 150,000 Equipment Loan $ 900,000Mortgage $ 850,000Total Long Term Liabilities $1,900,000ORDER OFMATURITY*SHORTEST TERMLONGEST TERM
39 OWNER’S EQUITY Owner’s Equity Owner’s Capital $ 750,000 ORDER SHOWNOwner’s EquityOwner’s Capital $ 750,000Plus: Net Income $ 150,000$ 900,000Less: Drawings ($ 50,000)Total Owner’s Equity $ 850,000CAPITAL +/(-)INCOME/ (LOSS)THEN SUBTOTALSUBTRACTDRAWINGSAND THEN TOTAL
42 MEASURING SUCCESS WITH A BALANCE SHEET Working Capital = Current Assets – Current LiabilitiesWorking capital indicates a business’s ability to pay its short-term debts.Working Capital has to be positiveCurrent Ratio = Total Current Assets / Total Current LiabilitiesCurrent Ratio shows how many dollars of liquid assets (cash or near cash) a business has for every dollar of short-term debt.Current ratio has to be over 1.2
43 MEASURING SUCCESS WITH A BALANCE SHEET Total Debt to Total Asset Ratio = Short Term Debt + Long Term Debt/Total AssetsA metric used to measure a company's financial risk by determining how much of the company's assets have been financed by debt. Calculated by adding short-term and long-term debt and then dividing by the company's total assets.
44 Current Assets – Current Liabilities = (1150+2000+1400)-(1350)= 3200 Working CapitalCurrent RatioCurrent Assets/Current Liabilities =( )/(1350)= 3.37
46 WHAT IS AN INCOME STATEMENT? Remember: a Balance Sheet is a snapshot of a business on one day in timeAn Income Statement shows what happens over a period of time in a business, it could be one month, six months, or a yearAn Income Statement shows how much money a business made or lost over a period of time
47 THE INCOME STATEMENTAs a business operates it makes money from daily activitiesThrough these daily activities the business also accumulates expensesWhat are some of the expenses of day to day operations for a business?
48 THE INCOME STATEMENT RECALL: What is the difference between a cost and an expense?Cost Expense
49 Order of Entries on an Income Statement Just like the Balance Sheet, the Income Statement has a three line heading:Who? (the name of the business/individual)What? (in this case, an Income Statement)When? (period of time ending on a certain date)
50 The Income Statement The sources of Revenue are listed next These are listed in alphabetical orderRevenue (Sales or Income) is the money, or the promise of money, received from the sale of goods or services
51 The Income StatementThen Cost of Goods Sold is listed or calculated (if applicable)Cost of Goods Sold is the cost of inventory that was sold to generate business revenue for a specific period of timeCost of Goods Sold is calculated using information from the balance sheet, from invoices that detail the year’s purchases, & from the physical inventory count at the end of the fiscal year Purchases show the total amount of the goods bought by the business in a year.
52 COST OF GOODS SOLD COST OF GOOD SOLD (COGS) = BEGINNING INVENTORY + PURCHASES – ENDING INVENTORYExample:Inventory, May 1st, $50,000Inventory, May 31st, $20,000Purchases - $30,000COGS = $50,000 + $30,000 – $20,000
53 The Income Statement Then Gross Profit is calculated (if applicable) Gross Profit = Total Revenue – COGSGross Profit shows how much money covers the cost of the product and how much is left over to cover the business expenses.
54 The Income Statement Expenses are listed next, in alphabetical order Operating expenses or overhead are the costs of operating the business during the period the sales took place.Expenses include things like salaries, advertising, maintenance, and utilities, and are used to help generate the revenue of a business.
55 The Income StatementMatching Principle – all the costs of doing business in a particular time period are matched with the revenue generated during the same period.Example:If you run a hot dog stand, you would report the cost of the buns & sausages in the same period that you sell the hot dog
56 The Income Statement Lastly, a net income, or net loss is calculated This is calculated by subtracting the expenses from the revenueNet Income/Net Loss = Gross Profit – ExpensesA net income occurs when the revenue is larger than the expenses, and a net loss occurs when expenses are greater than revenue
57 For the Year Ending December 31, 2011 Donahue's Shoe StoreIncome StatementFor the Year Ending December 31, 2011RevenueShoe Sales$250,000Total RevenueCost of Goods SoldBeginning Inventory, Jan 1, 2011$50,000Inventory Purchased$75,000Cost of goods available for sale$125,000Ending Inventory, Dec. 31, 2011$40,000Total Cost of Goods Sold (COGS)$85,000Gross Profit$165,000ExpensesAdvertising$1,200Rent$12,000Salaries$60,000Supplies$350Utilities$15,000Total Expenses$88,550Net Income$76,450
58 Measuring SuccessManagement looks at income statements to measure profitability.Rate of Return on Net Sales = (Net Profit / Total Revenue) x 100%Rate of Return on net sales indicates, as a percentage, the portion of a business’ sales that are kept as profit.
59 Measuring SuccessGross Profit Percentage = (Gross Profit / Total Revenue) x 100%The gross profit percentage indicates how much of the revenue is left after costs (COGS) have been covered.Management can see how much of its potential profit pays for product (cost of goods sold) and how much is left to pay for expenses (overhead).
60 Gross Profit Percentage If a business has a high gross profit percentage, it means the business is earning a high margin on its sales.Margin is the difference between the cost of the product and the selling price of the product.
61 Measuring Success Profit Margin= (Net Income/ Total Revenue) x 100% A ratio of profitability calculated as net income divided by revenues, or net profits divided by sales. It measures how much out of every dollar of sales a company actually keeps in earnings. Profit margin is very useful when comparing companies in similar industries. A higher profit margin indicates a more profitable company that has better control over its costs compared to its competitors. Profit margin is displayed as a percentage; a 20\% profit margin, for example, means the company has a net income of $0.20 for each dollar of sales. Also known as Net Profit Margin.