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.