Chapter 12 notes.docx

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Northeastern University
Business Administration
BUSN 1101
William Shimer

Chapter 12: The Role ofAccounting in Business 12.1 The Role ofAccounting Accounting. The process of measuring and summarizing business activities, interpreting financial information, and communicating the result to management and other decision makers Fields ofAccounting ◦ Management accounting provides information and analysis to decision makers inside the organization (such as owners and managers) to help them operate the business. ◦ Financial accounting provides information not only to internal managers, but also to people outside the organization (such as investors, creditors, government agencies, suppliers, employees, and labor unions) to assist them in assessing a firm’s financial performance. Who uses financial accounting? Owners and Managers: They look at financial statements as a report card to see if the company did or did not make profit this helps them take corrective decisions. Investors and Creditors: Since they put on the money they want to look at statements to see the financial health and performance of the company to decide about continued investments GovernmentAgencies: Business have to give financial information to a number of government agencies such as taxing agencies etc. -Preparing the organization’s financial statements including the income statement, the statement of the owner’s equity, the balance sheets the statement of cash flows (summarize a company’s past performance and evaluate current financial situation) Financial accountants in U.S companies have to follow the GAAP (generally accepted accounting principles) set of rules; this is done for accuracy purposes and to compare one company to another. These are issued by FASB (financial accounting standards board) Companies outside the U.S follow other rules called IFRS (International financial reporting standards) 12.2 Understanding Financial Statements INCOME STATEMENT Income statement : shows revenues, or sales, and expenses You divide your expenses into two categories: ◦ Cost of goods sold: the total cost of the goods that you’ve sold ◦ Operating expenses: the costs of operating your business except for the costs of things that you’ve sold Now you need to do a little subtracting: 1. The positive difference between sales and cost of goods sold is your gross profit or gross margin. The positive difference between gross profit and operating expenses is your net income or profit, which is the proverbial “bottom line.” (If this difference is negative, you took a loss instead of making a profit.) To make more money? ◦ Reduce your cost of goods sold (say, package four toys instead of five) ◦ Increase the quantity of units sold ◦ Reduce your operating costs (salaries, advertising, table rental) Increase the quantity of units sold To consider the possibilities above you have to make new income statements for each option. Use “what if” technique likes a hypothetical income statement to see what will work the best. BREAKEVENANALYSIS Break even. Have no profit or loss. Total sales revenue=Expenses (variable and fixed) To determine the level of sales at which this will occur, you need to do the following: ◦ Determine your total fixed costs ◦ Identify your variable costs (vary as the quantity of goods sold changes but is constant on a per-unit basis) ◦ Determine your contribution margin per unit Selling price per unit – variable cost per unit ◦ Calculate your breakeven point in units Fixed costs ÷ contribution margin per unit THE BALANCE SHEET Balance sheet tells you what you have (and where it came from) at a specific point in time. Reports-: -Assets: Resources from which it expects to gain some future benefit -Liabilities: Debts that it owes to outside individual and organizations -Owner’s Equity: investment in your own business Most companies prepare financial statements on a twelve-month basis—that is, for a fiscal year. Logical dates are picked. End date is usually at the end of the peak selling period. THEACCOUNTING EQUATION The balance sheet is based on this equation. Assets = liabilities + owner’s equity Company’s assents come from▯ loans (liabilities) or investment made my owners (owner’s equity) STATEMENT OF OWNERS’S EQUITY Statement of owner’s equity: reports changes in owner’s equity for the reporting period How Do Financial Statements Relate to OneAnother? When you prepare your financial statements, you should complete them in a certain order as they are interrelated: ◦ Income statement ◦ Statement of owner’s equity ◦ Balance Sheet If the interlinking numbers are carried forward correctly, and if assets and liabilities are listed correctly, then the balance sheet will balance: Total assets will equal the total of liabilities plus owner’s equity. 12.3Accrual accounting Companies using cash-basis accounting recognize revenue as earned only when cash is received and recognize expenses as incurred only when cash is paid out. Companies using accrual accounting recognize revenues when they’re earned (regardless of when the cash is received) and expenses when they’re incurred (regardless of when the cash is paid out). Cases: timing plays a role in making and receiving payments Account receivable. When customers buy something and pay later the seller is owed money. Account payable. When companies don’t pay cash for materials and other expenses the buyer has to pay later Inventory. When companies manufacture or buy goods and hold them in an inventory before selling them, in this case they don’t report payment for the goods until they have been sold. Long term assets/fixed assets: things they plan to use for an extended period of time ( as a rule, for more than one year.) e.g. vehicle, building, machine In such situations firms use accrual accounting-: Accrual account:An accounting system that records transactions when they occur, regardless of when cash is received or paid. Basic Principles ofAccrual Accounting . Sale is recognized on income statement when it takes place, regardless of when cash is collected . Expense is recognized on income statement when it takes place, regardless of when payment is made .An item manufactured for later sale or bough for resale becomes part of inventory and appears in the balance sheet until it is actually sold, at this point it goes under income statement under cost of goods sold .Along-term asset will appear on the balance sheet; its cost will be spread over its useful life (number of years that it will be used). The annual cost allocated will appear on the income statement as depreciation expense. Beginning Balance Sheet Classified balance sheet: classifies assets and liabilities into separate categories, here assets are listed in order of liquidity (how easily they can be converted into cash) 1. Current assets: assets that you intent to convert into cash within a year 2. Long-term assets: assets that you intent to hold for more than a year Types of Liabilities Liabilities are grouped in much the same manner as assets: ◦ Current liabilities—liabilities that you’ll pay off within one year ◦ Long-term liabilities- liabilities that don’t become due for more than one year (due in 5years) Income Statement Merchandiser—a company that makes a profit by selling goods Merchandising company: you must sell goods at a profit (called gross profit=sales –cost of goods) that i
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