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Chapter 16- Accounting Information and Financial Activities

The Importance of Accounting and Financial Information
- Financial Information is the heartbeat of competitive business
- Accounting information keeps the heartbeat stable

What is Accounting ?
- The recording, classifying summarizing and interpreting of financial events to provide management and other
interested parties with the information they need to make good decisions.
- Method used to record and summarize accounting data into reports is called accounting system
- Major Purpose
(A) to help managers evaluate the financial conditions and operating performance of the firm
so that they can make well-informed decisions
(B) to report financial information to people outside the firms such as owners, creditors, suppliers, employee
investors, and the government
- Is the measurement and reporting of financial information to various users (inside and outside the
organization) regarding the economic activities of the firm

Areas of Accounting
- Called the language of business
- The language used to report financial information about non-profit organizations such as churches, schools
hospitals, and government agenies
- Divided into 5 areas
1. Managerial Accounting
2. Financial Accounting
3. Compliance (Auditing)
4. Tax accounting
5. Government and non-for-profit accounting

Managerial Accounting
- Used to provide information and analyses to managers within the organization to assist them in decision
making
- Provides must data in the form of budgets
- Decision making is based on
What goods and services are selling the most and what promotional tools are working best?
How quickly is the firm selling what is buys?
Which are the most profitable products?
What is the appropriate allocation of expenses between products
Which expenses change with changes in revenue
How much tax is the firm paying, and how can it minimize that amount?
Will the firm have enough cash to pay its bills? If not, has it made arrangements to borrow that money?

Financial Accounting
- Information and analyses it generates are for people outside the organization
- Information goes to owners, and prospective owners creditors and lenders, employee unions and customers,
suppliers, government agencies, and general public
- Much of information derived from financial accounting is contained in the companys annual report, a yearly
statement of the financial conditions, progress and expectations of an organization
- Financial accounting reports provide the information that allows readers to answer questions such as
Has the companys income been satisfactory? Should we invest in this company?
Should we lend money to this company? Will it be able to pay it back?
Are the companys costs getting out of control?
Is the company financially strong enough to stay in business to honour product warranties?
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Should we sell to this company? Will it be able to pay its bills.

Accounting Designations
- Chartered Accountant (CA) is an accountant who has met the examination, education and experience
requirements of the CA profession, which includes the Uniform Evaluation (UFE)
- Certified Management Accounting (CMA) is a professional accountant who has met certain educational and
experience requirements, passed a qualifying exam in the field, participating in a two year professional
requirements, passed a qualifying exam in the field, participating in a two year professional development
program.
- Certified General Accountants (CGA) those who have met the examination, education, and experience
requirements of CGA-Canada. CGA offers expertise in taxation, finance, information technology and strategic
business management

Private and Public Accountants
- Private Accountants- who work for a single firm, government agency, or non-profit organization.
- Public Accountants- accountant who provide his or her services to individuals or business on a fee basis
- Forensic Accounting a new area of accounting that focuses its attention on fraudulent activity

Compliance
- The job of reviewing and evaluating the records used to prepare a companys financial statement
- Private accountants within the organization often perform internal audits to ensure that proper accounting
procedures and financial reporting are being carried out within the company
- Most important function and income generator for public accounting firm is performing independent audits
(examinations) of the books and financial statements of companies
- Independent audit an evaluation and unbiased opinion about the accuracy of a companys financial
statement.
Tax Accounting
- Federal and provincial government require submission of tax returns that must be filed at specific times and
in a precise format
- A tax accounting is trained in tax law and is responsible for preparing tax returns or developing tax strategies

Governmental and Not-for-Profit Accounting
- Involves working for organization whose purpose is not generating a profit but serving rate payers, tax payers,
an others according to a duly approved budget.
- Primary users of govt accounting information are citizens, special interest groups, legislative bodies, and
creditors
- Non-for-profit organizations also require account professionals. They have a growing need for trained
accountants since contributors to non-profit want to see exactly how and where the funds they contribute are
being spent

Accounting Cycle
- Is a six-step procedure that results in the preparation and analysis of the major financial statements
- Generally involves the work of both the bookkeeper and the accountant
- Bookkeeping involves the recording of business transactions and is an important part of financial reporting
- Accountant classify and summarize financial data provided by bookkeepers and then interpret the data and
report the information to management
- A bookkeepers first task is to divide all of the firms transaction into meaningful categories such as sales
documents, purchasing, receipts and shipping documents. Into a record book called a journal
- Journal where the days transactions are kept

Fundamental Accounting Equation
- Double- entry bookkeeping- the practice of having every transaction affect at least two accounts
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- Accounts are different types of asset, liabilities, and owners equity
- Fundamental Accounting Equation : Assets= Liabilities + Owners Equity
- Bookkeepers make use of a specialized accounting book called a ledger, in which information from accounting
journals is recorded into specific accounts and posted so that managers can find all of the information about a
specific account in one place
- Trial Balance- a summary of all of the accounts in the ledger to check whether the figures are correct and
balanced.

Using Computers in Accounting
- Have been particularly helpful to small-business owners who often lack the strong accounting support within
their companies that larger firms enjoy

Understanding Key Financial Statement
- Financial Statement a summary of all of the transaction that have occurred over a particular period
- It indicates a firms financial health and stability and are a key factor in management decisions making
- Key Financial Statements of a Business
1. The Balance Sheet, which reports the firms financial position at the end of a period
2. The income statement, which summaries revenues, cost of goods and expenses for a specific period of
time and highlights the total profit or loss the firm experienced during a period
3. The cash flow statement, which provides a summary of money coming into and going out of the firm during
a period
- Balance sheet- details what the company owns and owes on a certain day
- Income Statement- what the firm sells its products for and what its selling costs are over a specific period
- Cash Flow Statement- highlights the difference cash coming in and cash going out over a specific
period

The Balance Sheet
- The fundamental accounting equation is the basis for the balance sheet
- The assets are equal to or are balance with the liabilities and owners equity.
- Balance Sheet- is the financial statement that reports a firms financial conditions at a specific time
- Composed for 3 categories : assets, liabilities, owners equity
- Add up everything you own, Subtract from the money you owe and so forth and you have a figure that tells
you your net worth.

Assets
- Economic resources (things of value) owned by a firm.
- Intangibles such as brand names can be among the firms most valuable assets
- Goodwill is the value that can be attributed to factors such as reputation, location and superior products
- Assets are listed on the firms balance sheet according to their liquidity.
- Liquidity- how fast an asset is expected to be converted into cash.
- Current Assets- items that can or will be converted into cash within one year
- Capital Assets- items that are relatively permanent goods acquired to produce products for a business
- Intangible Asset- are long-term assets that have no real physical form but do have value

Liabilities and Owners Equity Accounts
- Liabilities are what the business owes to other debts
- Current liabilities are due in one year or less
- Long-term liabilities are debts not due for one year or long
- Common Liability Accounts
1. Accounts Payables- money owed to others
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2. Notes Payable- short-term/ long-term liabilities
3. Bonds Payable- long-term liabilities represent money lent to the firm
4. Taxes Payable- sales taxes and GST
- Owners Equity in a company consist of all the owners have invested in the company plus all profits that have
accumulated since the business commenced by that have not yet been paid out to them
This figure always equal the book value of the assets minus liabilities of the company
In a partnership, owners equity is called partners equity or capital
In sole proprietorship its called owners proprietors equity or capital

The Income Statement
- The financial statement that shows a firms bottom line
- It summarizes all of the resources ( called revenue) that have been earned by the firms from operating
activities, resources that were used up, expenses incurred in doing business, and the resources left after all
costs and expenses, were incurred.
- Reports the firms financial operations over a particular period of time, usually a year, a quarter of a year, or a
month.

Revenue
- Cost of Goods sold
__________________________________________
Gross Profit (gross margin)
- Operating Expenses
__________________________________________
Net Income before Taxes
- Taxes
__________________________________________
Net Income or Loss

Revenue
- Is the value of what is received for goods sold, services, rendered and other financial sources
- Most revenues come from sales, or other sources of revenue such as rent received.

Cost of Goods Sold (Cost of Goods Manufactured)
- A measure of the cost of merchandise sold or cost of raw materials and supplies used for producing items for
resale
- Includes prices plus any freight charges paid to transport goods ( or all the costs associated with producing
the merchandise)
- All costs of buying (making) are included.
- Gross Profit (gross margin)- how much a firm earned by buying (or making) and selling merchandise.

Operating Expenses
- Are the costs involved in operating a business
- Classified into two categories : selling and general
- Selling expenses- related to the marketing and distribution of the firms goods or servies
- General Expenses- administrative expenses of the firm

Net Profit or Loss
- After all expenses are deducted, the firms net income before taxes is determined

Cash Flow Statement
- Reports cash receipts and disbursement related to the 3 major activities of a firm
1. Operations: cash transaction associated with running the business
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2. Investing: cash used in or provided by the firms investing activities (normally including capital assets)
3. Financing : cash raised from the issuance of new debt or equity capital or cash used to repay loans or
company dividends.

The Importance of Cash Flow Analysis
- It is very possible that a business can increase sales and profits and still suffer greatly from cash flow
problems
- Cash flow- is simply the difference between cash coming in and cash going out of business.
- A common mistake among start-up is to focus on the product and not running the business
- It a constant challenge for businesses of all sizes.
- Cash flow analysis also points out clearly that a business relationship with its banker(s) is critical
- Maintaining a working relationship with bank is a path to preventing cash flow problems that often develop

Applying Accounting Knowledge in Business
Generally Accepted Accounting Principles
- Guidelines that help accountants make proper and consistent decisions
- Published in the handbook of the Canadian Institute of Chartered Accountants

Amortization, LIFO and FIFO
- Amortization
is a systematic, write-off of the cost of tangible asset over its estimated useful life
Buildings, equipment, furniture, fixtures
Costs needs to be matched against the revenues earned from using these assets
Different amortization techniques could result in a different net incme for the firm
- When a firm sells merchandise from its inventory, it can calculate the cost of that item in different ways
- Amortization and Inventory valuation is that generally accepted accounting principles (GAAP) can permit an
accountant to use different methods of amortizing a firms long-term asset and valuing firms inventory

Analyzing Financial Statements:
Ratio Analysis
- Is the assessment of a firms financial condition and performance through calculations and interpretation of
financial ratios developed from the firms financial statements
- Are especially useful in analyzing the actual performance of the company compared to its past performance

Liquidity Ratio
- Refers to how fast an asset can be converted to cash
- Measures a companys ability to turn assts into cash to pay its short-term liabilities
- Current ratio of a firms current assets to its current liabilities
- Acid-Test ratio- measures the cash marketable securities ( such as stocks and bonds) and receiables of a firm,
compared to its current liabilities . important to firms with relatively large inventory, which can take longer
than other current assets to convert into cash

Leverage (Debt) Ratio
- Measures the degree to which firm relies on borrowed funds in its operations
- A firm hat takes too much debt could experience problems repaying lenders or meeting promises made to
shareholders.
- Ratio above 1 shows that a firm has more debt than equity

Profitability (Performance) Ratio
- Measures how effectively a firm is using its various resources to achieve profits
- Companys management performance eis often measured by the firms profitability ratio
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- 3 important ratios are used: earnings per share, return on sales and return on equity.
- Companies report their quarterly earnings per share in two ways : basic and diluted
- Basic earning helps determine the amount of profit earned by a company for each share of outstanding
commons stocks
- Diluted earnings per share ratio measures the amount of profit earned by a company for each share of
outstanding commons tock,. But this ratio also takes into consideration stock options, warrants preferred
stocks and much more
- Basic EPS :
Basic earnings per share = net income after taxes/ avg number of common stock shares outstanding
Return on sales = net income/net sales
Return on equity = net income/ avg total owners equity

Activity Ratio
- Measures the effectiveness of a firms management in using the assets that are available
- The inventory turnover ratio measures the speed of inventory moving through the firm and its conversion
into sales
- Inventory sitting by idly in a business costs money
- Inventory Turnover = costs of goods sold/ average inventory
- A lower-than-average inventory turnover ratio for a firm in an industry often indicates obsolete merchandise
on hand or poor buying practices.
- A higher-than-average ratio may singal lost sales because of inadequate stock.
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