» Accounting is a system of dealing with financial

information that provides information for

decision-making

ACCOUNTING

» The process of recording, analyzing, and

interpreting the economic activities of a business

BOOKKEEPING

» A method of recording all transactions for a

business in a specific format

» Accountability

˃ People who handle cash in the company are responsible

for it

» Budgeting

˃ This allows businesses to estimate its future sales and

expenses

» Taxation

˃ Records must be kept in order to pay taxes

» Financial Statements

˃ These are reports that summarize the financial

performance of a business

˃ These reports indicate the business’s economic health

» Annual Reports

˃ Financial statements are presented to shareholders and

potential investors in the form of annual reports

What financial questions might you have about your business?˃ Is the business earning profit?˃ Are selling prices to high/low?˃ How much does ABC company owe me?˃ What is the value of my inventory?˃ How much did John Smith earn last year?˃ Do we have enough money to pay our bills?

Who else may want financial information about

the business?˃ Government

˃ Bankers

˃ Lenders

˃ Potential Investor

˃ A Lawyer

If you decide to operate your own business you will find

yourself facing such accounting tasks as:

˃ Banking

˃ Payroll

˃ Keeping track of amounts owed by and owed to customers

˃ Keeping track of amounts owed to the government

˃ Producing an income statement for income tax purposes

Routine Daily

Activities

o Processing Bills

o Preparing Cheques

o Daily Banking

o Recording Transactions

o Preparing Business

Papers

Periodic Accounting Activities (these activities occur at regular intervals)

Paycheques(bi-weekly)

Bank accounts (balanced monthly)

Financial reports (monthly, quarterly, yearly)

Income tax returns (yearly)

Miscellaneous Activities˃ Employee resignation

˃ An advertisement is prepared

˃ New capital equipment is purchased

˃ A new loan

˃ A new employee is hired

» The fundamental accounting equation states that:

ASSETS – LIABILITIES = OWNER’S EQUITY

OR

ASSETS = LIABILITIES + OWNER’S EQUITY

» An asset is anything that the business owns that

has value

» What are some examples of personal assets?

˃ House

˃ Car

˃ Cash

˃ RRSP’s

» A liability is anything that the business owes; any

debts of the business

» What are some examples of personal liabilities?

˃ Credit Line

˃ Mortgage

˃ Owed to Parents

˃ Credit cards

» Owner’s Equity is also referred to as capital or

net worth

» It is the difference between the total assets and

total liabilities of a business

Here is a list of my assets:˃ House˃ Car˃ Furniture˃ Cash in Bank˃ Savings˃ RRSP’s˃ Teachers Pension

Here is a list of my liabilities:˃ Mortgage

˃ Credit card ( paid of every month, but still a potential liability)

˃ Line of credit

» What do I need to do to calculate my net

worth?

» Take my total assets and subtract them from

my total liabilities

» We can see how this looks by examining a Balance Sheet containing my personal assets, liabilities, and net worth

Mrs. DrummondBalance SheetMay 20, 2012

Assets Liabilities Cash in Bank $ 2,000.00 Credit Card $ 1,500.00 Savings $ 2,000.00 Car Loan $ 25,000.00 RRSP's $ 5,000.00 Credit Line $ 10,000.00 Teachers Pension $ 5,000.00 Mortgage $ 170,000.00 Household Items $ 20,000.00 Car $ 30,000.00 Total Liabilities $ 206,000.00 House $ 400,000.00

Net Worth Mrs. Drummond’s Equity $ 258,000.00Total Assets $ 464,000.00 Total Liabilities and Equity $ 464,000.00

» Make a list of all of your assets and all of your liabilities

» Calculate your total assets and your total liabilities

» Now calculate your net worth (remember the fundamental accounting equation)

» Make a new net worth statement for yourself for 10 years from now!

Assets (Things owned) =

Liabilities (debts you owe)

+

Owners Equity (the owner’s share of the assets)

» ASSETS = LIABILITIES + OWNERS EQUITY

A=L+OE

» A “freeze frame” or snapshot of what the business owns, owes and the owners invested interest.

» A financial picture of the business at a point in time.

» The balance sheet does not indicate whether a business has made a profit, only whether it is financially strong.

» The Balance Sheet looks like the Fundamental Accounting Equation

» A = L + OE» Assets are on the left side and the liabilities and

owner’s equity are on the right side

» A Three Line Heading is Used» WHO? – The name of the individual, business or

other organization» WHAT? – The name of the financial statement (in

this case the balance sheet)» WHEN? – The date on which the financial position

is determined

Assets LiabilitiesCash 1 1 5 0 00 Accounts PayableAccounts Receivable Central Supply 1 3 5 0 00

B. Cava 2 0 0 0 00 Loan PayableK. Lincoln 1 4 0 0 00 Mercury Finance 25 1 7 0 00

Equipment 13 5 7 5 00 Total Liabilities 26 5 2 0 00Trucks 42 5 0 0 00

Owners' EquityJ . Hofner, Capital 34 1 0 5 00

Total Assets 60 6 2 5 00 Total Liabilities and Equity 60 6 2 5 00

Metropolitan MoversBalance Sheet

August 31, 2005

WHO? – The name of the individual, business or other

organization

What?

When?

» Cash is arguably the MOST valuable asset of a business. » WHY??

˃ It can easily be exchanged for other assets

» Liquidity – how easily an asset can be exchanged for any other asset or converted to cash.

» Ownership (title- legal right to use) is separate from financing (source of funds used to purchase asset).

» With ASSETS, an owner can: ˃ Use ˃ Sell ˃ Give away ˃ Leave to heirs

» Whether bought for cash or on credit, the owner still has “title” to his/her property

» Current Assets – things a business owns that

disappear quickly, usually in less than one year.

» Long-term Assets (Capital Assets or Fixed

Assets) – assets that a business keeps for a long

time.

»

» In order of liquidity, assets include:

˃ cash, bank balances,

˃ accounts receivable (listed in alphabetical order),

˃ inventory and supplies, and

˃ furniture, equipment, fixtures, vehicles, property and

buildings (listed in the order in which they will be used up).

» Customers of the business will often buy goods or

services with the understanding that they will be

paid for in the future

» These debts owed represent a dollar value to the

business, so the business has a right to include them

among the assets on the balance sheet

» Each of these customers that owes money to the

business is one of its debtors

• Current Assets » Cash $ 50,000 » Accounts Receivable $ 30,000 » Inventory $120,000 » Supplies $ 15,000 » Total Current Assets $215,000

ORDER Of

LIQUIDITY

CLOSEST TO

CASH

FARTHEST FROM

CASH

• Fixed Assets » Land $ 200,000 » Building $ 1,100,000 » Equipment $ 950,000 » Furniture $ 225,000 » Vehicles $ 215,000 » Total Fixed Assets $ 2,690,000

IN ORDER OF REVERSE

DEPRECIATION

ONE THAT WILL BE

AROUND THE LONGEST

ONE THAT WILL BE

AROUND THE LEAST

AMOUNT OF TIME

» Liabilities are the debts of a business. Businesses acquire debt in two main ways:

1) Accounts Payable – purchasing inventory and supplies on credit.

2) Loans Payable (Notes Payable) – acquired by borrowing money from investors, banks, etc.

» Liabilities are listed in order of priority, or how quickly they need to be paid off.

» Current Liabilities – debts such as invoices for merchandise inventory, that are paid off quickly.

» Long-term Liabilities – debts such as a mortgage loan, that may not be repaid for decades.

» A business often purchases goods and services from

its suppliers with the understanding that payment

will be made later

» These debts to suppliers represent a dollar obligation

of the business, the business must include them

among its liabilities

» Each of the suppliers owed money by the business is

one of its creditors

• Current Liabilities » Wages Payable $ 10,000 » Accounts Payable $ 80,000 » Other Liabilities $ 50,000 » Current Portion - Mortgage $ 15,000 » Total Current Liabilities $ 155,000

* Maturity – When a debt is “mature” it’s payment is due

ORDER Of

MATURITY*

FIRST TO BE

PAID

LAST TO BE

PAID

• Long Term Liabilities » Vehicle Loans $ 150,000 » Equipment Loan $ 900,000 » Mortgage $ 850,000 » Total Long Term Liabilities $1,900,000

ORDER OF

MATURITY*

SHORTEST TERM

LONGEST TERM

• Owner’s Equity » Owner’s Capital $ 750,000 » Plus: Net Income $ 150,000 » $ 900,000 » Less: Drawings ($ 50,000) » Total Owner’s Equity $ 850,000

ORDER SHOWN

CAPITAL +/(-) INCOME/ (LOSS) THEN SUBTOTAL

SUBTRACT DRAWINGS AND THEN TOTAL

Working Capital = Current Assets – Current Liabilities˃ Working capital indicates a business’s ability to pay its

short-term debts.˃ Working Capital has to be positive

Current Ratio = Total Current Assets / Total Current Liabilities˃ Current Ratio shows how many dollars of liquid assets (cash

or near cash) a business has for every dollar of short-term debt.

˃ Current ratio has to be over 1.2

Total Debt to Total Asset Ratio = Short Term Debt + Long Term Debt/Total Assets

˃ A metric used to measure a company's financial risk by determining how much of the company's assets have been financed by debt. Calculated by adding short-term and long-term debt and then dividing by the company's total assets.

Assets LiabilitiesCash 1 1 5 0 00 Accounts PayableAccounts Receivable Central Supply 1 3 5 0 00

B. Cava 2 0 0 0 00 Loan PayableK. Lincoln 1 4 0 0 00 Mercury Finance 25 1 7 0 00

Equipment 13 5 7 5 00 Total Liabilities 26 5 2 0 00Trucks 42 5 0 0 00

Owners' EquityJ . Hofner, Capital 34 1 0 5 00

Total Assets 60 6 2 5 00 Total Liabilities and Equity 60 6 2 5 00

Metropolitan MoversBalance Sheet

August 31, 2005

Working CapitalCurrent Assets – Current Liabilities =

(1150+2000+1400)-(1350)= 3200

Current Ratio Current Assets/Current Liabilities =(1150+2000+1400)/(1350)= 3.37

» Remember: a Balance Sheet is a snapshot of a

business on one day in time

» An Income Statement shows what happens over

a period of time in a business, it could be one

month, six months, or a year

» An Income Statement shows how much money a

business made or lost over a period of time

» As a business operates it makes money from daily

activities

» Through these daily activities the business also

accumulates expenses

» What are some of the expenses of day to day

operations for a business?

RECALL:

» What is the difference between a cost and an expense?

» Cost

» Expense

» Just like the Balance Sheet, the Income Statement has a three line heading:

˃ Who? (the name of the business/individual)

˃ What? (in this case, an Income Statement)

˃ When? (period of time ending on a certain date)

» The sources of Revenue are listed next˃ These are listed in alphabetical order

» Revenue (Sales or Income) is the money, or the promise of money, received from the sale of goods or services

» Then Cost of Goods Sold is listed or calculated (if applicable)

» Cost of Goods Sold is the cost of inventory that was sold to

generate business revenue for a specific period of time

» Cost of Goods Sold is calculated using information from the

balance sheet, from invoices that detail the year’s purchases, &

from the physical inventory count at the end of the fiscal year

» Purchases show the total amount of the goods bought by the

business in a year.

COST OF GOOD SOLD (COGS) =

BEGINNING INVENTORY + PURCHASES – ENDING INVENTORY

Example:Inventory, May 1st, 2012 - $50,000

Inventory, May 31st, 2012 - $20,000Purchases - $30,000

COGS = $50,000 + $30,000 – $20,000

» Then Gross Profit is calculated (if applicable)

» Gross Profit = Total Revenue – COGS

» Gross Profit shows how much money covers the cost of the product and how much is left over to cover the business expenses.

» Expenses are listed next, in alphabetical order

» Operating expenses or overhead are the costs of operating the business during the period the sales took place.

» Expenses include things like salaries, advertising, maintenance, and utilities, and are used to help generate the revenue of a business.

» Matching Principle – all the costs of doing business in a particular time period are matched with the revenue generated during the same period.˃ Example:

+ If you run a hot dog stand, you would report the cost of the buns & sausages in the same period that you sell the hot dog

» Lastly, a net income, or net loss is calculated˃ This is calculated by subtracting the expenses

from the revenue˃ Net Income/Net Loss = Gross Profit – Expenses

» A net income occurs when the revenue is larger than the expenses, and a net loss occurs when expenses are greater than revenue

Donahue's Shoe StoreIncome Statement

For the Year Ending December 31, 2011

RevenueShoe Sales $250,000Total Revenue $250,000

Cost of Goods SoldBeginning Inventory, Jan 1, 2011 $50,000Inventory Purchased $75,000Cost of goods available for sale $125,000Ending Inventory, Dec. 31, 2011 $40,000Total Cost of Goods Sold (COGS) $85,000

Gross Profit $165,000

ExpensesAdvertising $1,200Rent $12,000Salaries $60,000Supplies $350Utilities $15,000Total Expenses $88,550

Net Income $76,450

» Management looks at income statements to

measure profitability.

» Rate of Return on Net Sales = (Net Profit / Total

Revenue) x 100%

» Rate of Return on net sales indicates, as a

percentage, the portion of a business’ sales that are

kept as profit.

» Gross Profit Percentage = (Gross Profit / Total Revenue) x 100%

» The gross profit percentage indicates how much of the revenue is left after costs (COGS) have been covered.

» Management can see how much of its potential profit pays for product (cost of goods sold) and how much is left to pay for expenses (overhead).

» If a business has a high gross profit percentage, it

means the business is earning a high margin on its

sales.

» Margin is the difference between the cost of the

product and the selling price of the product.

» Profit Margin= (Net Income/ Total Revenue) x 100%

» A ratio of profitability calculated as net income divided by revenues, or net profits

divided by sales. It measures how much out of every dollar of sales a company

actually keeps in earnings.

Profit margin is very useful when comparing companies in similar industries. A

higher profit margin indicates a more profitable company that has better control

over its costs compared to its competitors. Profit margin is displayed as a

percentage; a 20\% profit margin, for example, means the company has a net

income of $0.20 for each dollar of sales.

Also known as Net Profit Margin.