Chapter 15

the statement of cash flows

the statement of cash flows indicates a firm's cash receipts and cash payments during an accounting period. It outlines the sources and uses of cash in the basic business activities of operating, investing, and financing.

What is a budget?

A budget is a planning and control tool that reflects the firm's expected sales revenues, operating expenses, cash receipts, and cash outlays.

Define accounting

Accounting is the process of measuring, interpreting, and communicating financial information in a way that describes the status and operation of an organization and aids in decision making.

How is the balance sheet organized?

Assets (what a firm owns) are shown on one side of the balance sheet and are listed in order of convertibility into cash. On the other side of the balance sheet are claims to assets, liabilities (what a firm owes), and owners' equity. Claims are listed in the order in which they are due, so liabilities are listed before owners' equity. Assets always equal liabilities plus owners' equity.

Describe the role of budgets in a business.

Budgets are financial guidelines for future periods reflecting expected sales revenues, operating expenses, and cash receipts and outlays. They reflect management expectations for future occurrences and are based on plans that have been made. Budgets serve as important planning and controlling tools by providing standards against which actual performance can be measured. One important type of budget is the cash budget, which estimates cash inflows and outflows over a period of time.

How is a cash budget organized?

Cash budgets are generally prepared monthly. Cash receipts are listed first. They include cash sales as well as the collection of past credit sales. Cash outlays are listed next. These include cash purchases, payment of past credit purchases, and operating expenses. The difference between cash receipts and cash outlays is net cash flow.

Define GAAP

GAAP stands for generally accepted accounting principles and is a set of standards or guidelines that accountants follow in recording and reporting financial transactions.

What tasks do management accountants perform?

Management accountants work for the organization and are responsible for collecting and recording financial transactions, and preparing and interpreting financial statements.

the statement of owners' equity

The statement of owners' equity shows the components of the change in owners' equity from the end of the prior year to the end of the current year.

What are the three business activities that involve accounting?

The three activities involving accounting are financing, investing, and operating activities.

List the three services offered by public accounting firms

The three services offered by public accounting firms are auditing, management consulting, and tax services.

Explain the functions of accounting, and identify the three basic activities involving accounting.

Accountants measure, interpret, and communicate financial information to parties inside and outside the firm to support improved decision making. Accountants gather, record, and interpret financial information for management. They also provide financial information on the status and operations of the firm for evaluation by outside parties, such as government agencies, stockholders, potential investors, and lenders. Accounting plays key roles in financing activities, which help start and expand an organization; investing activities, which provide the assets it needs to continue operating; and operating activities, which focus on selling goods and services and paying expenses incurred in regular operations.

Define accrual accounting.

Accrual accounting recognizes revenues and expenses when they occur, not when cash actually changes hands. Most companies use accrual accounting to prepare their financial statements.

How are financial statements adjusted for exchange rates?

An exchange rate is the ratio at which a country's currency can be exchanged for other currencies. Fluctuations of exchange rates create either gains or losses for particular companies because data about international financial transactions must be translated into the currency of the country in which the parent company resides.

Discuss how financial ratios are used to analyze a company's financial strengths and weaknesses.

Liquidity ratios measure a firm's ability to meet short-term obligations. Examples are the current ratio and the quick, or acid-test, ratio. Activity ratios, such as the inventory turnover ratio, accounts receivable turnover ratio, and the total asset turnover ratio, measure how effectively a firm uses its resources. Profitability ratios assess the overall financial performance of the business. The gross profit margin, net profit margin, and return on owners' equity are examples. Leverage ratios, such as the total liabilities to total assets ratio and the long-term debt to equity ratio, measure the extent to which the firm relies on debt to finance its operations. Financial ratios help managers and outside evaluators compare a firm's current financial information with that of previous years and with results for other firms in the same industry.

Who uses accounting information?

Managers of all types of organizations use accounting information to help them plan, assess performance, and control daily and longterm operations. Outside users of accounting information include government officials, investors, creditors, and donors

Outline the steps in the accounting cycle

The accounting process involves recording, classifying, and summarizing data about transactions and then using this information to produce financial statements for the firm's managers and other interested parties. Transactions are recorded chronologically in journals, posted in ledgers, and then summarized in accounting statements. Today, much of this activity takes place electronically.

the balance sheet

The balance sheet shows the financial position of a company on a particular date. The three major classifications of balance sheet data are the components of the accounting equation: assets, liabilities, and owners' equity.

Outline accounting issues facing global business and the move toward one set of worldwide accounting rules.

One accounting issue that affects global business is exchange rates. An exchange rate is the ratio at which a country's currency can be exchanged for other currencies. Daily changes in exchange rates affect the accounting entries for sales and purchases of firms involved in international markets. These fluctuations create either losses or gains for particular companies. The International Accounting Standards Board (IASB) was established to provide worldwide consistency in financial reporting practices and comparability of and uniformity in international accounting standards. It has developed International Financial Reporting Standards (IFRS). Many countries have already adopted IFRS, and the United States is in the process of making the transition to it.

Describe the roles played by public, management, government, and not-for-profit accountants.

Public accountants provide accounting services to other firms or individuals for a fee. They are involved in such activities as auditing, tax return preparation, management consulting, and accounting system design. Management accountants collect and record financial transactions, prepare financial statements, and interpret them for managers in their own firms. Government and not-for-profit accountants perform many of the same functions as management accountants, but they analyze how effectively the organization or agency is operating, rather than its profits and losses.

Define double-entry bookkeeping and the accounting equation.

The basic accounting equation states that assets (what a firm owns) must always equal liabilities (what a firm owes creditors) plus owners' equity. This equation also illustrates double-entry bookkeeping, the process by which accounting transactions are recorded. Under double-entry bookkeeping, each individual transaction must have an offsetting transaction.

Define the following ratios: current ratio, inventory turnover, net profit margin, and debt ratio.

The current ratio equals current assets divided by current liabilities; inventory turnover equals cost of goods sold divided by average inventory; net profit margin equals net income divided by sales; the debt ratio equals total liabilities divided by total assets.

What are the four basic requirements to which all accounting rules must adhere?

The four basic requirements to which all accounting rules must adhere are consistency, relevance, reliability, and comparability.

List the four categories of financial ratios.

The four categories of ratios are liquidity, activity, profitability, and leverage.

List the four financial statements

The four financial statements are the balance sheet, the income statement, the statement of owners' equity, and the cash flow statement.

the income statement

The income statement shows the results of a firm's operations over a specific period. It focuses on the firm's activities—its revenues and expenditures—and the resulting profit or loss during the period. The major components of the income statement are revenues, cost of goods sold, expenses, and profit or loss.