Chapter 9: Accounting Basic Accounting Concepts

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Chapter 9 AccountingBasic Accounting Concepts

• Businesses engage in activities that concentrate
  on financial worth, such as money, spending,
  expenses, mergers, and costs.
• What Accountants Do
• Accountants make meaningful and effective
  decisions based on up to date and accurate
  records of a company.
• Businesses can conduct hundredseven thousands of
  transactions daily.
• Transactions include paying staff paying bills,
  such as heat and electricity and buying and
  storing inventory.
• Most businesses use accounting software packages,
  such as QuickBooks and Simply Accounting, to
  record and track financial information.
• Accounting is the process of recording,
  analyzing, and interpreting the financial or
  economic activities of a business. Financial
  activities in business are recorded as
  transactions recording something of value for
  something else of value. Bookkeeping is the
  recording of all transactions for a business in a
  specific format.
• Double-Entry Bookkeeping
• The principle that each transaction involves two
  changes is known as double-entry bookkeeping one
  increase results in one decrease, two increases
  results in two decreases, and so on.
• A transaction could result in one increase offset
  by one decrease, two increases, or two decreases.
• An example would be if a business pays 80 for
  labour, it decreases cash while increasing
  expenses.

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Chapter 9 AccountingBasic Accounting Concepts

• Accounting and Individuals
• Individuals need to keep accurate financial
  records. People often allow organizations to take
  preauthorized payments resulting in money taken
  automatically and on a regular basis from their
  bank accounts.
• Personal records or transactions can be recorded
  in a cheque register or on a computer program.
• An example of a preauthorized payment would be a
  utility bill deducted on a monthly basis from a
  chequing account.
• Always keeping accurate records ensures that
  individuals do not find themselves with
  insufficient funds.
• Assets
• Assets are things of value that a business or
  person owns.
• When you take ownership of something, even if you
  owe money on it, it becomes yours and it is an
  asset.
• Liabilities
• Liabilities are debts or amounts of money that
  are owed to others by an individual or a
  business.
• Individuals and businesses may borrow money from
  financial or credit companies.
• Personal Equity or Net Worth
• A persons assets, after all liabilities are
  deducted, is known as personal equity or net
  worth. See equation below Owners Equity on the
  next slide.

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Chapter 9 AccountingBasic Accounting Concepts

• Accounting and Businesses
• A businesses assets and liabilities are used to
  calculate the net worththe owners equity.
• Owners Equity
• Owners equity is the owners investment in the
  business or the financial portion of the business
  that belongs to the owners or shareholders.
• Assets Liabilities Owners Equity
• Balance Sheet Equations
• The balance sheet equation can be expressed in
  two ways
• 1. To determine owners equity Assets
  Liabilities Owners Equity
• 2. To determine total assets Assets
  Liabilities Owners Equity
• A balance sheet is a financial statement that
  shows the financial position of a business on a
  specific date.
• If the information on the balance sheet is
  correct, the left and right side will be equal.

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Chapter 9 AccountingBasic Accounting Concepts

• Cost Principle and Depreciation
• The accounting practice of always recording an
  asset at the actual amount it costs the business
  is known as the cost principle. Even when an
  asset depreciates or loses value over time the
  asset value on the books remains the same.
• Marks Repair Shop
• Here are the assets of Marks Repair Shop.
• cash in the business and in a bank account
  (6500)
• accounts receivable (8100)
• invoicing supplies (500)
• parts inventory (4000)
• business equipment (truck) (25 500)
• building and land (175 000)
• Total Assets 219 600
• Accounts receivable is the money owed to the
  business.

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Chapter 9 AccountingBasic Accounting Concepts

• Marks Repair Shop
• Here are Marks debts or liabilities.
• accounts payable (7350)
• bank loan for truck (11 050)
• mortgage payable (on building) (110 000)
• Total Liabilities 128 400
• Equity calculation for Marks net worth can be
  calculated as follows
• Assets Liabilities Owners Equity
• 219 600 - 128 4000 91 200
• Accounts payable is the money that a business
  owes.
• Mortgage payable is the debt owed on a building.

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Chapter 9 AccountingPreparing Financial
Statements

• The balance sheet, the income statement, and the
  statement of cash flow helps owners and managers
  keep track of the financial health of the
  business. The financial statements provide
  outsiders with accurate information about the
  business.
• Outsiders interested in the business could be
  lenders, government employees, and other business
  people.
• Preparing a Balance Sheet
• The balance sheet shows the financial position on
  any given day of the business, and provides
  information about its assets, liabilities, and
  equity.
• On any given day the balance sheet should be
  different, that is why it is like a snapshot.
• Balance Sheet Equation Method
• The balance sheet gets its name because the left
  side of the equation (assets) always equals the
  right side (liabilities plus owners equity).
• Assets are owned by one of two groups
• owner(s) of the business (owners equity)
• individuals or businesses owed money
  (liabilities)
• If the business did not have any debts the
  balance sheet equation would be Assets Owners
  Equity.

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Chapter 9 AccountingPreparing Financial
Statements
Step 1 Statement Headings

• Marks Repair Shop
• Balance Sheet
• September 30, 20__
• Assets Liabilities
• Cash 6 500
  Accounts Payable 7 350
• Accounts
• Receivable 8 100 Bank Loan
  11 050
• Supplies 500 Mortgage
  Payable 110 000
• Parts Inventory 4 000 Total
  Liabilities 128 400
• Equipment 25 500
• Building and Land 175 000
  Owners Equity
• Mark Bianchet, Equity 91
  200 Total Liabilities and
• Total Assets 219 600
  Owners Equity 219 600

Step 2 List Assets
Step 3 List Liabilities
Step 4 Calculate Owners Equity
Step 5 Put It All Together
Step 1 Fill in the Statement Heading three-line
header, centred, with who, what and when Step 2
List the Assets Assets should be listed in order
of liquidity, the ability to convert an asset or
investment into cash quickly Step 3 List the
Liabilities Liabilities are listed in order of
maturity date, the date by which they must be
repaid. The individuals and business under
liabilities are often called creditors (a person
or business that is owed money one who lends
money. Step 4 Calculate Owners Equity Use the
balance sheet equation Assets Liabilities
Owners Equity to calculate the Marks equity in
the business. 219 600 - 128 000 91
200 Step 5 Put It All Together Using Steps 1
through 4, the balance sheet for Marks Repair
Shop will be as shown.
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Chapter 9 AccountingPreparing Financial
Statements

• Balance Sheet Report Form Method
• Computer programs easily complete the balance
  sheet using an up-and-down column format rather
  than a side-by-side format.
• Preparing an Income Statement
• The income statement is a financial statement
  that shows a businesss profit (or loss) over a
  stated period of time.
• The money, or the promise of money, received from
  the sale of goods or services is called revenue.
• Expenses are expenditures that help a business
  generate revenue.
• An income statement is like a movie that shows
  what happened over a period of time (week, month,
  quarter, or year).
• Examples of expenses include salaries,
  advertising, maintenance, and utilities.

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Chapter 9 AccountingPreparing Financial
Statements
Income Statements for Service Businesses
Step 1 Statement Headings-It answers
Who?What?When?

• Marks Repair Shop
• Balance Sheet
• For the month ending September 30, 20__
• Revenue
• Repairs Revenue 9 900
• Total Revenue 9 900
• Expenses
• Salaries 2 600
• Rent 2 000
• Advertising 850
• Supplies 185
• Utilities 235
• Insurance 150
• Delivery Expense 770
• Total Expenses 6 790
• Net Income 3 110
• When expenses are shown on the income statement
  they
• should be matched with the revenue they
  generate.
• The matching principle states that accurate
  profit reporting

Step 2 Organize Revenue Section-All sources of
revenue should be listed.
Step 3 Organize Expenses Section- Larger
expenses tend to go first, with all of
Septembers expenses listed.
Step 4 Calculate Net Income/Loss-using the
information from steps 2 and 3 and the equation
for calculating profit (Total Revenue Total
Expenses) 9 900 - 6 790 3 110
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Chapter 9 AccountingPreparing Financial
Statements

• Income Statements for Retail Businesses
• Balance sheets for retail businesses are similar
  to those of service businesses. However, retail
  businesses need to take the cost of inventory
  (goods on hand to be sold) into account.
• Inventory is the goods and materials kept on hand
  by a business.
• Income Statement Equations
• Income statement equation for a service business.
• Revenue Expenses Net Income
• Income statement equation for a retail business.
• Revenue Cost of Goods Sold Gross Profit
  Gross Profit Expenses Net Income
• Gross profit, or gross margin, is the money left
  over after deducting the cost of goods sold from
  the revenue, but before deduction the business
  expenses that helped generate the revenue.
• The cost of goods sold is calculated by starting
  with the opening inventory figure (goods and
  services purchased in previous months but not yet
  used), adding the new purchases made during the
  period, and subtracting the inventory remaining
  at the end of the time period.

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Chapter 9 AccountingPreparing Financial
Statements

• Income Statements and Inventory
• Tracking of inventory is critical. It saves the
  retail business money and increases customer
  satisfaction. When a physical count of inventory
  is taken, it is compared to the on-going count
  that is usually maintained by computer systems.

Beginning Inventory, Jan.1, 20__ 50
000 Inventory Purchased 75 000 Costs of All
Goods for Sale 125 000 Ending Inventory, Dec.
20__ - 40 000 Costs of Goods Sold 85
000 Sales Revenue 150 000 Cost of Goods
profit - 85 000 Gross Profit 65
000 Gross Profit 65
000 Expenses - 25 000 Net Profit
40 000
Operating expenses are deducted from the gross
profit to determine net profit.

• A fiscal year, or business year, is any 12-month
  operating period.
• The fiscal year often, but not always,
  corresponds to the calendar year, it could be
  January 1 to December 31, or April 1 to March 31.
• At the beginning of the fiscal year (Jan. 1,
  20__) the shoe store had 50 000 in inventory.
• The shoe store, through the year, buy 75 000
  worth of additional inventory.
• Over the whole year the store has a total of 125
  000 in inventory to sell.
• At the end of the twelve month period an actual
  physical count is done. There is 40 000 in
  unsold inventory.
• Subtract the 40 000 (ending inventory) from the
  125 000 (cost of all goods available for sale)
  and the cost of goods sold in 85 000.
• Remember the cost of goods sold is not the price
  the customer paid.
• The store collected 150 000 in sales revenue
  (from goods sold) during the year.
• 85 000 (cost of goods sold) is deducted from
  150 000 (sales revenue) and the gross profit is
  65 000 (this is the amount before deducting the
  business expenses that helped to generate the
  revenue).
• Expenses (25 000) are deducted from gross profit
  (65 000) and it results in net profit (40 000).
• Net profit is the amount the storeowner can
  declare as income for income tax purposes.

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Chapter 9 AccountingBasic Accounting Concepts
Capital is added to identify the owners account

• Owners Equity Account
• The net profit is calculated first then
  transferred to the balance sheet as part of
  owners equity. Creditors and owners have claims
  on the assets of the business.
• Preparing a Statement of Cash Flow
• Cash flow is the movement of cash-in and cash-out
  of a business. The statement of cash flow is a
  summary of the cash-in and cash-out transactions
  of a business that helps to predict the amount of
  cash it needs to meet obligations.
• Sources of cash moving into a business could
  include sales, interest on investments, accounts
  receivable, the sale of capital equipment, new
  loans, and investments.
• Sources of expenditures, cash moving out of the
  business could include rent, payroll, accounts
  payable, interest payable, and insurance.

• Owners Equity
• C. Donahue, Capital, Jan. 1, 20__
  75 000
• Add Net Income 40 000
• C. Donahue, Capital, Dec. 31, 20__
  115 000
• Projected Cash Flow Statement
• Marks Repair Shop
• October 31, 20__
• Transaction In () Out (-)
• Investment Income 500.00
• Accounts Receivables 750.00
• Equipment to be Sold 1 250.00
• Payroll Not Yet Paid
  - 460.00
• Loan Repayment -930.00
• Insurance Due
  -200.00
• Projected Cash Flow
  910.00

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Chapter 9 AccountingBasic Accounting Concepts

• Ways to Increase Cash Flow
• A business must consider several ways to meet its
  obligations if cash flow is inefficient. A
  business might seek extra investments, reduce
  inventory purchases, and increase efforts to
  collect accounts receivables.
• Cash-flow Implications of Credit and Debit Cards
• Business that allow customers to use a credit
  and/or debit card do not have wait for their
  money (accounts receivables) they receive their
  money (sales revenue) up front. Since these
  businesses take a long time to pay their own
  bills, they invest the customers cash to make
  more money.
• Extra investment sources are increased money from
  owner(s), a short-term loan from a bank, or
  finding new partners or investors.
• See Figure 9.3, Eight Ways to Boost Your Cash
  Flow, page 294.
• Cash-flow Implications of Credit and Debit Cards
• In some cases stores can make as much or more on
  their money-on-money investments as they do
  selling goods in the store.

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Chapter 9 AccountingBasic Accounting Concepts

• Interpreting Financial Statements
• Financial statement information allows
  accountants to make recommendations to owners
  regarding future business decisions.
• Accountants compare data over a set period of
  time, usually two or more years.
• A Final Measure of Success
• For a business to be successful, the return on
  the owners investment should be equal to or
  greater than the return for a savings account,
  bond, or mutual fund.
• See Table 9.2, Comparative Balance Sheet, on
  page 297.
• The comparison gives an indication of where the
  company was and where it is now.
• The comparison balance sheet could demonstrate
  that the business needs to direct more effort to
  collecting accounts receivable.
• The balance sheet can give information concerning
  inventory, show that there is too much debt, or
  if owners net worth has decreased.