Chapter 17. Understanding Accounting and Financial Information

journal

an accounting record in which transactions are initially recorded in chronological order The word journal comes from the French word jour, which means "day." Therefore, a journal is where the day's transactions are kept.

retained earnings

are accumulated earnings from the firm's profitable operations that are reinvested in the business and not paid out to stockholders in distributions of company profits.

general expenses

are administrative expenses of the firm such as office salaries, insurance, and rent.

operations

are cash transactions associated with running the business.

investments

are cash used in or provided by the firm's investment activities.

Accounts Payable

are current liabilities or bills the company owes others for merchandise or services it purchased on credit but has not yet paid for.

Assets

are economic resources (things of value) owned by a firm. Assets include productive, tangible items such as equipment, buildings, land, furniture, and motor vehicles that help generate income, as well as intangible items with value like patents, trademarks, copyrights, and goodwill.

net sales

are gross sales minus returns, discounts, and allowances.

current asset

are items that can or will be converted into cash within one year. They include cash, accounts receivable, and inventory.

fixed assets

are long-term assets that are relatively permanent such as land, buildings, and equipment. (On the balance sheet we can also refer to these as property, plant, and equipment.)

Intangeible assets

are long-term assets that have no physical form but do have value.10 Patents, trademarks, copyrights, and goodwill are intangible assets.

Bonds Payable

are long-term liabilities; money lent to the firm by bondholders that it must pay back.

selling expenses

are related to the marketing and distribution of the firm's goods or services, such as advertising, salespeople's salaries, and supplies.

Liabillities

are what the business owes to others—its debts. Current liabilities are debts due in one year or less. Long-term liabilities are debts not due for one year or more

Notes Payable

can be short-term or long-term liabilities (like loans from banks) that a business promises to repay by a certain date.

Financial Accounting

generates financial information and analyses for people primarily outside the organization.

Basic Earnings Per Share (EPS)

helps determine the amount of profit a company earned for each share of outstanding common stock. Net Income / Reported Shares Outstanding

Return on Equity (ROE)

indirectly measures risk by telling us how much a firm earned for each dollar invested by its owners. Net Income/Total Equity

Accounting Cycle

is a six-step procedure that results in the preparation and analysis of the major financial statements

financial statement

is a summary of all the financial transactions that have occurred over a particular period. Financial statements indicate a firm's financial health and stability, and are key factors in management decision making

independent audit

is an evaluation and unbiased opinion about the accuracy of a company's financial statements. Annual reports often include an auditor's unbiased written opinion.

financing

is cash raised by taking on new debt, or equity capital or cash used to pay business expenses, past debts, or company dividends.

cash flow

is simply the difference between cash coming in and cash going out of a business.

ratio analysis

is the assessment of a firm's financial condition, using calculations and financial ratios developed from the firm's financial statements.

balance sheet

is the financial statement that reports a firm's financial condition at a specific time.

revenue

is the monetary value of what a firm received for goods sold, services rendered, and other payments (such as rents received, money paid to the firm for use of its patents, interest earned, etc.).

Accounting

is the recording, classifying, summarizing, and interpreting of financial events and transactions in an organization to provide management and other interested parties the financial information they need to make good decisions about its operation.

Depreciation

is the systematic write-off of the cost of a tangible asset over its estimated useful life.

tax accountant

is trained in tax law and is responsible for preparing tax returns, or developing tax strategies.

Liquidity Ratios

measure a company's ability to turn assets into cash to pay its short-term debts (liabilities that must be repaid within one year).

Profitability Ratios

measure how effectively a firm's managers are using its various resources to achieve profits.

leverage (debt) ratios

measure the degree to which a firm relies on borrowed funds in its operations.

Diluted earnings per share (DEPS)

measures the amount of profit earned for each share of outstanding common stock, but also considers stock options, warrants, preferred stock, and convertible debt securities the firm can convert into common stock.

Acid-test (quick) ratio

measures the cash, marketable securities (such as stocks and bonds), and receivables of a firm, compared to its current liabilities. (Current Assets - Inventory) / Current Liabilities

cost of goods sold (or cost of goods manufactured)

measures the cost of merchandise the firm sells or the cost of raw materials and supplies it used in producing items for resale.

debt to owners' equity ratio

measures the degree to which the company is financed by borrowed funds that it must repay. total liabilities/owner's equity

Inventory Turnover Ratio

measures the speed with which inventory moves through the firm and gets converted into sales. Idle inventory sitting in a warehouse earns nothing and costs money. cost of goods sold/average inventory

double-entry bookkeeping

practice of writing every transaction in two places

Statement of Cash Flows

provides a summary of money coming into and going out of the firm. It tracks a company's cash receipts and cash payments.

public accountant

provides accounting services to individuals or businesses

Managerial Accounting

provides information and analysis to managers inside the organization to assist them in decision making.

gross sales

refers to the total of all sales the firm completed.

Income Statement

summarizes revenues, cost of goods sold, and expenses (including taxes) for a specific period and highlights the total profit or loss the firm experienced during that period.

government and not-for-profit accounting

supports organizations whose purpose is not generating a profit, but serving ratepayers, taxpayers, and others according to a duly approved budget.

Return on Sales (ROS)

tells us whether the firm is doing as well as its competitors in generating income from sales. Net Income/Sales

Owner's Equity

the amount of the business that belongs to the owners, minus any liabilities the business owes. The formula for owners' equity, then, is assets minus liabilities.

Liquidity

the ease with which an asset can be converted into cash

Financial Accounting Standards Board (FASB)

the private board that establishes the generally accepted accounting principles used in the practice of financial accounting

Current Ratio

the ratio of a firm's current assets to its current liabilities. current assets divided by current liabilities

bookeeping

the recording of business transactions, is a basic part of financial reporting.

Equity

the value of things you own (assets) minus the amount of money you owe others (liabilities)

bottom line

which is the net income (or perhaps net loss) the firm incurred from revenue minus sales returns, costs, expenses, and taxes over a period of time.

private acountant

works for a single firm, government agency, or nonprofit organization.

6 steps of the accounting cycle

1. Analyzing Documents 2. Recording information into journals 3. Posting that information into ledgers 4. Developing a trial balance 5. Preparing financial statements 6. Analyzing Financial Statements

account receivable

A claim against the customer created by selling merchandise or services on credit.

balance sheet

A financial statement that reports assets, liabilities, and owner's equity on a specific date.

LIFO (last in, first out)

A method of costing inventory that assumes the costs of the most recent purchases are the first costs charged to cost of goods sold when the company actually sells the goods.

ledger

A specialized accounting book or computer program in which information from accounting journals is accumulated into specific categories and posted so that managers can find all the information about one account in the same place.

Certified Public Accountant (CPA)

An accountant who passes a series of examinations established by the American Institute of Certified Public Accountants (AICPA) and meets the state's requirement for education and experience

Fundamental Accounting Equation

Assets = Liabilities + Owners' equity; this is the basis for the balance sheet

operating expenses

Costs involved in operating a business, such as rent, utilities, and salaries.

Financial Statements

Financial reports that summarize the financial condition and operations of a business

capital account

For sole proprietors and partners, owners' equity means the value of everything owned by the business minus any liabilities of the owner(s), such as bank loans. Owners' equity in these firms is called the capital account.

net income or net loss

Revenue left over after all costs and expenses, including taxes, are paid.

Auditing

Reviewing and evaluating the information used to prepare a company's financial statements

stokholders equity

The value of what stockholders own in a firm (minus liabilities)

Generally Accepted Accounting Principles (GAAP)

a set of accounting standards that is used in the preparation of financial statements If accounting reports are prepared in accordance with GAAP, users can expect the information to meet standards upon which accounting professionals have agreed.

Trial Balance

a summary of all the financial data in the account ledgers that ensures the figures are correct and balanced.

annual report

a yearly statement of the financial condition, progress, and expectations of an organization.