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Chap 2

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7 views

Chap 2

Uploaded by

joyroomisgood
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPT, PDF, TXT or read online on Scribd
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2 Review of Accounting

Chapter

McGraw-Hill/Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
What is Accounting?
• Accounting provides financial information about a business
• Of interest to stakeholders in business:
– shareholders
– managers
– creditors
– governments
• Information is used to make decisions about a business
• Financial statements summarize accounting information
• Most important financial statements:
– Income Statement
– Balance Sheet
– Statement of Cash Flows
Income Statement
• Device to measure the profitability of a firm over a period of
time
• An Income Statement shows profitability for a time period (ex.; 1
year)
– It is presented in a stair-step or progressive fashion to examine
profit or loss after each type of expense item is deducted

Revenues
Less: Expenses
Equals: Net Income/Net Loss

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PPT 2-5

Classifications on the Income Statement


Sales
– Cost of Goods Sold
Step 1 = Gross Profit
– Operating Expenses
Step 2 = Operating Profit
– Interest Expense
Step 3 = Earnings Before Taxes
– Income Taxes
Step 4 = Earnings After taxes
Income Statement (cont’d)

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Statement of Retained Earnings

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Limitations of the Income Statement
• Income gained/lost during a given period is a function of verifiable
transactions
– Increase in the value of land
– Elimination of a competitor
– Stockholders, hence, may perceive only a much smaller gain/loss from actual
day-to-day operations
• Flexibility in reporting transactions might result in differing
measurements of income gained from similar events at the end of a
time period

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Price Earning Ratio (P/E Ratio)
• Helps you compare the price of a company’s stock to the
earnings the company generates.

Stock Pr ice
• P/E Ratio=
EarningPerShare

• Undervalued or Overvalued
• Ex: EPS $2 for A & B Co. A=10, B=14

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PPT 2-9

The Balance Sheet


• A Balance Sheet (B/S) shows what a firm owns and how it is
financed at a point in time (ex.; December 31)
• The balance sheet of the firm shows the holdings (assets) and
obligations (liabilities & owner’s equity) of the firm
Remember the ALOE!

Assets = Liabilities + Owners’ Equity


PPT 2-10

Classifications on the Balance Sheet


Assets:what a business Liabilities: what a business owes
owns Current Liabilities
Current Assets –Ex: Accounts payable
–Due within 1 year
–Ex: Accounts receivable,
Inventory Long-term Liabilities
–Due some time after 1 year
–Will be sold or used up
Equity: what the owner(s) have
within 1 year invested in the business
Capital Assets Shareholders’ Equity
–Ex: Building –Capital stock
–Retained earnings
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PPT 2-14

Limitations of Financial Statements


• Based on past transactions rather than future forecasts
• May not recognize important economic changes as they occur
– increase in property values
– new competition
• Variety of accounting policies and methods are used
– amortization
– inventory valuation (LIFO and FIFO)
Concept of Net Worth
• Assets=Liabilities + Shareholder’s Equity
• Book Value=Shareholder’s Equity-Preferred Stock
Component
• If you take everything that the firm owns and subtract the
debt and preferred stock obligation

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Statement of Cash Flows
• Emphasizes critical nature of cash flow to the operations of
the firm
– It represents cash/cash equivalents items easily convertible to
cash within 90 days
• Cash flow analysis helps in combating
discrepancies/differences faced through accrual method of
accounting

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Statement of Cash Flows
• Income Statement & Balance Sheet are based on Accrual Method of
accounting
• Revenue & Expenditure are recognized as they occurred, rather than
when cash actually changes hand.
• $100000 credit sales in December 2018.
 Cash payment will not be received until March 2019
 But credit sales is shown in Financial Statement

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Three Primary Sections
1. Cash flows from operating activities
2. Cash flows from investing activities
3. Cash flows from financing activities

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Indirect Method

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Cash Flows from Operating Activities

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Determining Cash Flows from Investing
Activities
• Investing activities:
– Long-term investment activities in mainly plant and equipment
• Increasing investments represent a use of funds
• Decreasing investments represent a source of funds

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Determining Cash Flows from Financing
Activities
• Financial activities apply to the sale/retirement of:
– Bonds
– Common stock
– Preferred stock
– Other corporate securities
– Payment of cash dividends
• Sale of firm’s securities is a source of funds
• Payment of dividends and repurchase of securities is a use of funds

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Overall Statement
Combining the Three Sections

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28(a)

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Analysis of the Overall Statement
• How are increases in long-term assets being financed?
• Preferably, adequate long-term financing and profits should
exist
• Short-term funds may be used to carry long-term needs –
could be a potential high-risk situation
– Example: trade credit and bank loans

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