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McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-1 Chapter 1717 Understanding Financial Information and Accounting 17-1
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McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-2 What is Accounting? Recording, classifying, summarizing, & interpreting financial events & transactions to provide management & other parties information to allow them to make good decisions.
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McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-3 Financial Transactions Include buying & selling goods & services, acquiring insurance, using supplies, & paying taxes.
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McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-4 Bookkeeping's Role Bookkeeping -- The recording of business transactions. Bookkeepers divide a firm’s transactions into meaningful categories and post them into a record book or computer program called a journal.
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McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-5 What Bookkeepers Do Categorize Categorize and and Record the Data Record the Data in in Books of Original Entry Books of Original Entry –Journals –Ledgers using using Double EntryDouble Entry
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McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-6 Bookkeeping's Role Double-Entry Bookkeeping -- Bookkeepers record all transactions in two places so they can check one list of transactions against the other for accuracy.
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McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-7 General Journal
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McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-8 Ledger T-Account
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McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-9 The Accounting Cycle
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McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-10 Steps In The Accounting Cycle Analyze Source Documents Record Transactions in Journals Post Journal Entries to Ledger Take a Trial Balance Prepare Financial Statements Analyze Financial Statements
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McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-11 Financial Statements
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McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-12 Financial Statements Balance Shee t – Statement of Financial Position (on a specific date) Income State ment – Statement of Revenues, Expenses, & Profits (specific period of time) Statement of Cash Flows – Statement of Cash Receipts & Disbursements (cash coming in & cash going out)
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McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-13 Balance Sheet Statement of Financial Position (on a specific date)
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McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-14 Accounting (Balance Sheet) Equation Assets Liabilities + Owner’s Equity Owns Owes + Owners’ Claims = =
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McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-15 Terms Liquidity –How fast an asset can be converted into cash
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McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-16 Classifying Assets Current Assets -- Items that can or will be converted to cash within one year. Fixed Assets -- Long-term assets that are relatively permanent such as land, buildings, or equipment. Intangible Assets -- Long-term assets that have no physical form but do have value such as patents, trademarks, and goodwill.
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McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-17 Classifying Liabilities Liabilities -- What the business owes to others - its debts. Accounts Payable -- Current liabilities a firm owes for merchandise or services purchased on credit. Notes Payable -- Short or long-term liabilities a business promises to pay by a certain date. Bonds Payable -- Long-term liabilities that the firm must pay back.
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McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-18 Owners’ Equity Accounts Retained Earnings -- Accumulated earnings from the firm’s profitable operations that are reinvested in the business.
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McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-19 Very Vegetarian’s Balance Sheet (Assets) Period ending 12/31/08 Assets Current Assets Cash$ 15,000 Accounts Receivable 200,000 Notes Receivable 50,000 Inventory 335,000 Total Current Assets$600,000 Fixed Assets Land$ 40,000 Buildings (net) 110,000 Equipment & Vehicles (net) 40,000 Furniture & Fixtures (net) 16,000 Total Fixed Assets$206,000 Intangible Assets Goodwill$ 20,000 Total Intangible Assets$ 20,000 Total Assets$826,000
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McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-20 Very Vegetarian’s Balance Sheet (Liabilities & Owner’s Equity) Period ending 12/31/08 Liabilities & Owners’ Equity Current Liabilities Accounts Payable$ 40,000 Notes Payable 8,000 Accrued Taxes & Salaries 240,000 Total Current Liabilities $288,000 Long-term Liabilities Notes Payable$ 35,000 Bonds Payable 290,000 Total Long-term Liabilities $325,000 Total Liabilities$613,000 Owners’ Equity Common Stock (1M shares) $100,000 Retained Earnings 113,000 Total Owners’ Equity$213,000 Total Owners’ Equity$213,000 Total Liabilities & Owners’ Equity$826,000
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McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-21 Income Statement Statement of Revenues, Expenses, & Profits (specific period of time)
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McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-22 Income Statement Equation Profit = Revenues – Expenses
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McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-23 Income Statement Formula Revenues Revenues –Cost of Goods Sold =Gross Profit (Gross Margin) –Operating Expenses =Net Income Before Taxes –Taxes =Net Income (or Loss)
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McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-24 Very Vegetarian Income Statement Period Ending 12/31/10 Revenues Net Sales$ 700,000
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McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-25 Very Vegetarian Income Statement Period Ending 12/31/10 Revenue Net Sales$ 700,000 Cost of Goods Sold Beginning Inventory $ 200,000 Purchases During the Year $ 440,000 Cost of Goods Available for Sale During the Year $ 640,000 Less: Ending Inventory $ 230,000 Less: Cost of Goods Sold $ 410,000 Gross Profit (Gross Margin)$ 290,000
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McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-26 Income Statement Formula Revenues Revenues –Cost of Goods Sold =Gross Profit (Gross Margin) –Operating Expenses =Net Income Before Taxes –Taxes =Net Income (or Loss)
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McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-27 Very Vegetarian’s Income Statement (cont’d) Gross Profit $290,000 Operating Expenses Selling Expenses Salaries$ 90,000 Advertising & Supplies$ 20,000 Total Selling Expenses$ 110,000 General Expenses Office Salaries$ 67,000 Depreciation$ 1,500 Insurance$ 1,500 Rent$ 28,000 Utilities$ 12,000 Miscellaneous$ 2,000 Total General Expenses$ 112,000 Less: Total Operating Expenses - $ 222,000 Net Income (Profit) Before Taxes$ 68,000 Less: Income Tax Expenses -$ 19,000 Net Income (Profit) After Taxes$ 49,000
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McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-28 Statement of Cash Flows Statement of Cash Receipts & Disbursements (cash coming in & cash going out)
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McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-29 Statement of Cash Flows Reports cash receipts and disbursements related to the firm’s major activities: Operations – cash transactions associated with running the business Investments – cash used in or provided by firm’s investment activities Financing – cash raised from the issuance of new debt or equity capital or cash used to pay business expenses, past debts, or company dividends
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McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-30 Depreciation Depreciation -- The systematic write- off of the cost of a tangible asset over its estimated useful life.
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McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-31 Ratio Analysis
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McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-32 Using Financial Ratios Ratio Analysis -- The assessment of a firm’s financial condition using calculations and financial ratios developed from the firm’s financial statements. Key ratios include: Liquidity ratios Leverage ratios Activity ratios
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McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-33 Liquidity Ratios
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McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-34 Commonly Used Liquidity Ratios Liquidity ratios measure a firm’s ability to turn assets into cash to pay its short-term debts. Two key ratios are: Current ratio Acid-test ratio This information is found on the firm’s Balance Sheet.
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McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-35 Liquidity Ratios Current Assets Current Liabilities Quick (Acid-Test) Ratio Cash + Marketable Securities + Receivables Current Liabilities Current Ratio
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McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-36 Liquidity Ratio Current Assets Current Liabilities Current Ratio
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McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-37 Current Ratio- Very Vegetarian $600,000 $288,000 =2.08 Current Assets Current Liabilities
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McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-38 Quick (Acid-Test) Ratio $265,000 $288,000 =0.92 Cash + Marketable Securities + Receivables Current Liabilities
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McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-39 Leverage (Debt) Ratios Leverage ratios measure the degree to which a firm relies on borrowed funds in its operations. Key ratios include: Debt to Owner’s Equity Ratio This information is found on the firm’s Balance Sheet.
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McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-40 Debt to Equity Ratio $613,000 $213,000 = 287% Total Liabilities Owners’ Equity
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McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-41 Activity Ratios Inventory Turnover = $410,000 = 1.9 $215,000 Inventory Turnover Cost of Goods Sold Average Inventory
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