chapter 7: the role of accounting in business

Mark's Travel Agency has assets of $120,000 and liabilities of $40,000. How much is Mark's owner's equity?

$80,000

balance sheet

-Your assets: the resources from which it expects to gain some future benefit -Your liabilities: the debts that it owes to outside individuals or organizations -Your owner's equity: your investment in your business

Which of the following statements about financial accountants and management accountants is NOT true?

Both supply information to the company's various stakeholders: investors, creditors, government agencies, suppliers, and labor unions.

The Courtney Kennedy Flower Shop purchased a truck on January 1 of the current year for $24,000. Courtney did this by taking out a loan for the same amount. The annual interest included in the loan payments is $1,200. Courtney estimates that the truck has a useful life of eight years. Courtney's income statement for this year will report which of the following dollar amounts relative to the purchase of the truck?

Depreciation expense of $3,000 and interest expense of $1,200

accounting equation

assets = liabilities + owner's equity

current assets

assets that you intend to convert into cash within a year

long-term assets

assets that you intend to hold for more than a year

account payable

companies often pay later. (it will pay something later).

break even point in units

fixed costs ÷ contribution margin per unit

Financial accountants

furnish information to individuals and groups both inside and outside the organization in order to help them assess its financial performance.

two most common profit margin ratios

gross profit margin and net profit margin (when used vertical percentage analysis to determine the relationship to Sales of each item on The College Shop's income statement)

generally accepted accounting principles (GAAP)

the basic principles for financial reporting issued by an independent agency called the Financial Accounting Standards Board (FASB).

capital structure

the relationship between funds acquired from creditors (debt) and funds invested by owners (equity)

stakeholders

they're interested in its activities because they're affected by them

break even

total sales revenue must exactly equal all your expenses (both variable and fixed).

fixed costs

which are so called because the total cost doesn't change as the quantity of goods sold changes

current ratio

which examines the relationship between a company's current assets and its current liabilities.

This is your first year operating a retail store that sells children's toys. The store had sales of $50,000. You spent $30,000 to buy the toys that you sold and $15,000 in operating costs (that were incurred this year). How much profit did you earn for each dollar in sales?

$0.10

At the beginning of the year, the balance sheet for Spookie and Pumpkin's Kool Aid stand reported assets of $600 and liabilities of $400. During the year, it earned a net income of $100. When it completes its year-end balance sheet it will have total owners' equity of:

$300

This past year, Tara's Bakery had revenues of $50,000. The company spent $2,000 per month on ingredients for the baked goods and $1,400 per month for rent and utilities. What was Tara's net income for the year?

$9,200

When you prepare your financial statements, you should complete them in a certain order:

-Income statement -Statement of owner's equity -Balance sheet

3 ways to make more money

-Reduce your cost of goods sold (say, package four toys instead of five) -Reduce your operating costs (salaries, advertising, table rental) -Increase the quantity of units sold

what are categories of expenses?

-costs of goods sold -operating expenses

government agencies

Businesses are required to furnish financial information to a number of government agencies. Companies must also provide financial information to local, state, and federal taxing agencies, including the Internal Revenue Service.

financing activities

Cash flows from financing activities result from obtaining or paying back funds used to finance your business.

investing activities

Cash flows from investing activities result from buying or selling long-term assets.

operating activities

Cash flows from operating activities come from the day-to-day operations of your main line of business.

fixed assets

Companies buy long-term assets (also called fixed assets), such as cars, buildings, and equipment, which they plan to use over an extended period (as a rule, for more than one year).

Many companies located outside the United States follow a different set of accounting principles than those followed by United States-based companies. The accounting principles followed by these non United States companies are called ____________________.

International Financial Reporting Standards (IFRS)

You own a small store that sells old football cards and memorabilia. In October, you purchased an autographed Tom Brady helmet from a sports card and memorabilia dealer. The helmet was delivered in November of 2011, paid for in December of 2011, and sold by you on account in January 2012. The customer paid for the helmet in February 2012. If you prepare monthly financial statements using accrual-basis accounting, in which month would you report the helmet under cost of goods sold?

January 2012

inventory

Many companies manufacture or buy goods and hold them in inventory before selling them. Under these circumstances, they don't report payment for the goods until they've been sold.

fiscal year

Most companies prepare financial statements on a 12 month basis

what does management accounting do?

Reports are tailored to the needs of individual managers, and the purpose of such reports is to supply relevant, accurate,and timely information in a format that will aid managers in making decisions. In preparing, analyzing, and communicating such information, accountants work with individuals from all the functional areas of the organization—human resources, operations, marketing, and finance.

inventory turnover ratio

Simply convert this ratio into the average number of days that you held an item in inventory. In other words, divide 365 days by your turnover ratio:

Which of the following statements is NOT true about financial accounting?

The format used by financial accountants in preparing financial statements is flexible. It is tailored to the needs of individual managers

International Financial Reporting Standards (IFRS)

These multinational standards, which are issued by the International Accounting Standards Board (IASB) is a little stricter about the ways you can calculate the costs of inventory. Bear in mind, however, that, according to most experts, a single set of worldwide standards will eventually emerge to govern the accounting practices of both U.S. and non-U.S. companies.

merchandiser

a company that makes a profit by selling goods.

accrural accounting

a system in which the accountant records a transaction when it occurs, without waiting until cash is paid out or received

ratio analysis

a technique for evaluating a company's financial performance.

When a customer buys something and agrees to pay your company later, your balance sheet includes a(n) _________________; when your company buys materials and agrees to pay your supplier later, your balance sheet includes a(n)___________________; when you manufacture a product and hold onto it to sell it later, your balance sheet includes a(n) ____________________.

account receivable; account payable; inventory

Management effectiveness ratios

address the question: how well is a company performing with the money that owners and others have invested in it? These ratios are widely regarded as the best measure of corporate performance. final grade depends on how much profit it generates with the money invested by owners and creditors.

what is the hard part?

analyzing, interpreting, and communicating the information

top managers

are now being held accountable (so to speak) for the financial statements issued by the people who report to them.

classified balance sheet

classifies assets and liabilities into separate categories.

what is the easy part?

collecting all the numbers is the easy part—today, all you have to do is start up your accounting software.

variable costs

costs that vary, in total, as the quantity of goods sold changes but stay constant on a per-unit basis. State variable costs on a per-unit basis

A ratio is just one number divided by another, with the result expressing the relationship between the two numbers. The current ratio measures a company's ability to meet short-term obligations. It examines the relationship between a company's _________________ and its ______________.

current assets, current liabilities

how to find current ratio

current assets/current liabilities

account receivable

customers often buy something and pay later. seller is owed money. (it will receive something later).

debt-to-equity ratio (also called debt ratio)

examines the riskiness of a company's capital structure

investors and creditors

furnish the money that a company needs to operate, and not surprisingly, they feel the same way. Because they know that it's impossible to make smart investment and loan decisions without accurate reports on an organization's financial health, they study financial statements to assess a company's performance and to make decisions about continued investment.

Financial condition ratios

help you assess a firm's financial strength. They assess its ability to pay its current bills; and to determine whether its debt load is reasonable, they examine the proportion of its debt to its equity.

management accounting

helps you keep your business running. helping managers carry out their responsibilities

liquidity

how quickly they can be converted into cash.

what does financial accounting do?

including the income statement, the statement of owner's equity, the balance sheet, and the statement of cash flows—that summarize a company's past performance and evaluate its current financial condition

income statement vs. balance sheet

income statement tells you how much income you earned over some period of time, your balance sheet tells you what you have (and where it came from) at a specific point in time.

You started the year with $100,000 cash. During the year, you generated $90,000 in cash from your company's operations. You used $50,000 in cash to pay off a short-term loan. In addition, you purchased a new computer for $10,000. When you prepare your year-end statement of cash flows, it will report a(n)_________________________.

increase in cash of $30,000

Employees and labor unions

interested because salaries and other forms of compensation are dependent on an employer's performance (why interested in financial statements)

To determine how fast your inventory is "turning," you need to examine the relationship between sales and inventory.

inventory turnover= sales/inventory

vertical percentage analysis

it reveals the relationship of each item on the income statement to a specified base—generally sales—by expressing each item as a percentage of that base.

long-term liabilities

liabilities that don't become due for more than one year

current liabilities

liabilities that you'll pay off within one year

depreciation expense

long-term asset's annual allocated cost appears on the income statement as a depreciation expense.

interest coverage ratio

measures the number of times that a firm's operating income can cover its interest expense

net profit

money that a company earns after paying all its expenses, including the costs of buying or making its products, running its operations, and paying interest and taxes.

suppliers

need to know if the company to which they sell their goods is having trouble paying its bills or may even be at risk of going under (why interested in financial statements)

management effectiveness ratios for return on assets

net profit/total assets

accounting

often called "the language of business." Why? Because it communicates so much of the information that owners, managers, and investors need to evaluate a company's financial performance. the purpose of accounting is to help stakeholders make better business decisions by providing them with financial information.

net income (profit)

positive difference between gross profit and operating expenses. "bottom line"

Gross Profit (Profit Margin)

positive difference between sales and cost of goods sold

Management accountants

provide information and analysis to decision makers inside the organization in order to help them run it.

cash

refers to more than just paper money and coins. It also refers to the money that you have in checking and savings accounts and includes items that you can deposit in these accounts, such as money orders and different types of checks.

financial statements

report cards for owners and managers. They show, for example, whether the company did or didn't make a profit and furnish other information about the firm's financial condition. They also provide information that managers and owners can use in order to take corrective action.

revenue

sales

contribution margin

selling price per unit - variable cost per unit

comparative income statement

shows income figures for year 2 and year 1 (accountants generally put numbers for the most recent year in the inside column).

Management effectiveness ratios

tell you how effective management is at running the business and measure overall company performance.

Management efficiency ratios

tell you how efficiently your assets are being managed.

Profit margin ratios

tell you how much of each sales dollar is left after certain costs are covered.

financial accounting

tells you how well you're running your business. responsible for preparing the organization's financial statements

statement of cash flows

tells you where your cash came from and where it went. It furnishes information about three categories of activities that cause cash either to come in (cash inflows) or to go out (cash outflows)

accountants make sure....

that stakeholders understand the meaning of financial information, and they work with both individuals and organizations to help them use financial information to deal with business problems.

expenses

the costs of doing business

total debt to equity equation

= total liabilities/total equity

interest coverage =

operating income/interest expense