CHAPTER 21: Accounting Fundamentals


CHAPTER 21: Accounting Fundamentals
Layout of Chapter:
1.                  What is Accounting
2.                  Types of Accountants
3.                  The Accounting Cycle
4.                  The Accounting Equation
5.                  Analyzing Financial Statements

1.                  What is Accounting
The process of identifying, measuring and communicating economic information to permit informed decisions by users of the information.
2.                  Types of Accountant
Based on the type of Certification:
v      CPA (Certified Public Accountant) (i.e. chartered accountant of Bd)
v      CMA (Certified Management Accountant)
also classified as:
v      Public Accountant
v      Private Accountant
3.                  Accounting Cycle
The steps - analyzing, recording, posting and preparing records - by which the results of the business transactions are communicated.
Journal è Account è General Ledger è Financial Statement
4.                  The Accounting Equation
Assets = Liabilities + Owner’s Equity
This indicates a company’s financial position at any point in time.

East West University
Income Statement
For the year ended December 31, 2003

Details                                                                                        $                      $

Gross Sales                                                                                                   1000

Less:   Sales discounts                                                            25

Sales returns                                                                35
                                                                                                                           ( 60)

Net Sales                                                                                                          940


Less:   Cost of Goods Sold (COGS)                                                                (345)
Gross profit                                                                                                      595

Less:   Selling and Administrative expenses 
(Advertising, salary, rent, utility, insurance, depreciation, transportation)       (165)
EBIT (Earning Before Interest and Tax)                                                      430

Less:   Interest expense                                                                                    ( 85)
EBT (Earning Before Tax)                                                                             345

Less:   Tax                                                                                                        (100)
Net Income/ (Loss)                                                                                          245

EAST WEST UNIVERSITY
Balance Sheet
As at December 31, 2003
Details                                                                                        $                      $

 

ASSETS

a) Currents Assets

Cash                                                                 495

Accounts Receivable                                        150
Inventory                                                            175
Total current Assets                                                                       820

b) Fixed Assets
Land                                                                  500
Building                                                             250
Machinery and Equipment                                100
Furniture and Fixtures                                       100
Total Fixed Assets                                                                          950
TOTAL ASSETS                                                                                             1770
                           

LIABILITIES

a) Current Liabilities
Accounts Payable                                             125
Short-term bank loan                                        175
Total Current Liabilities                                                                   300

b) Long-term Liabilities
Notes Payable                                                   425
Long-term bank loan                                         225
Total Long-term liabilities                                                                650
TOTAL LIABILITIES                                                                                         950

OWNER’S EQUITY

Capital Stock                                                                 325
Retained Earnings                                                        250
Add Current Year’s Profit                                              245
TOTAL OWNERS’ EQUITY                                                                             820

TOTAL liabilities + Equity                                                                       1770

5.                  Analyzing Financial Statements
Ratio Analysis:
Methods of analyzing financial information by comparing logical relationships between various financial statement items.
1.      Liquidity Ratio:
Measure of a firm’s ability to pay its short-term debts as they come due.
a)      Current Ratio measures the firm’s ability to pay off current liabilities from its current assets.

b)      Quick Ratio
*Where quick asset = Total Current Assets – Inventory
{When Ratio is 1:1 then it is adequate}

2.      Activity Ratio:
Measure of how efficiently assets are being used to generate revenue.
a)      Accounts Receivable Turnover
b)      Number of Days Sales in Receivable.

3.      Profitability Ratio:
Financial Performance
a)      Return on Sales
 
(Average is 5%)

b)      Return on Equity
This Ratio measures the return company earns on every taka of shareholders (owner’s) investments.

4.      Debt Ratio:
Ability to pay long-term debts.
a)       
b)       

EBIT = Earnings before Interest & Tax



PRACTICE ACCOUNTING PROBLEM
1.      Dhaka Ltd. exports CK shirts to USA.
Use the following information to prepare
a)     An Income Statement for the year ended on 31 December 2001;
b)     A Balance Sheet as on 31 December 2001.

(All figures are in Bangladeshi Taka)
Advertising expense                  1,500                         Building                       30,000
Utility                                          5,000                         Capital stock               80,000
Income Tax                               1,600                         Rent                              3,600
Accounts payable (A/P)          12,000                         Salary                            6,000
Cost of goods sold                  15,000                         Sales returns                1,000
Retained Earnings (Dec. 31)  1,500                          Insurance                         600
Transportation                           1,300                         Wages                                      2,000
Interest Expense                       2,400                         Cash                           60,000
Accounts receivable               15,000                         Inventory                      17,500
Land                                        50,000                         Notes payable             20,000
Machinery                                20,000                         Gross Sales                60,000
Long-term loan                        40,000                         Short-term loan           19,000

Answer:
                 Net Income                                                                        Tk.   20,000
                 Total Assets                                                                       Tk.1,92,500
                Total Liabilities & Owner’s Equity                                        Tk.1,92,500



Not all the information is required for various calculations. One has to identify which bit of information is required for what calculation.
*        For Income Statement, only the information which is directly related to Revenue, Expenses, Interest and Tax is needed.
*        For Balance Sheet, you need to isolate the data regarding Assets (Current & Fixed), Liabilities (Short-term & Long-term), and Equity Capital & Retained Earnings.

(Figures needed in Income Statement)
Gross Sales                                        60,000
Sales returns                                        1,000
Cost of goods sold                              15,000

Advertising expense                              1,500
Utility                                                      5,000
Rent                                                      3,600
Salary                                                    6,000
Insurance                                                 600
Transportation                                       1,300
Wages                                                              2,000

Interest Expense                                   2,400
Income Tax                                           1,600

(Figures needed in Balance Sheet)
Cash                                                   60,000
Accounts receivable                           15,000
Inventory                                              17,500

Land                                                    50,000
Machinery                                            20,000
Building                                               30,000

Accounts payable (A/P)                      12,000
Short-term loan                                   19,000

Notes payable                                     20,000
Long-term loan                                    40,000

Capital stock                                       80,000
Retained Earnings (Dec. 31)                1,500

Dhaka Ltd.
Income Statement
For the year ended Dec. 31, 2003
           
Gross Sales                                                                                        60,000
Less: Sales returns                                                                              (1,000)
Net Sales                                                                                            59,000
Cost of goods sold                                                                              (15,000)
Gross Profit                                                                                         44,000
Less: Selling & Administrative Expenses
Advertising expense                  1,500
Utility                                          5,000
Rent                                          3,600
Salary                                        6,000
Insurance                                     600
Transportation                           1,300
Wages                                                 2,000
                                                                                                            (20,000)
EBIT (Earnings before Interest & Tax)                                               24,000
Less: Interest Expense                                                                         (2,400)
EBT (Earnings before Tax)                                                                 21,600
Less: Income Tax                                                                                 (1,600)
Net Profit                                                                                             20,000

Dhaka Ltd.
Balance Sheet
At Dec. 31, 2003
Assets
Current Asset
Cash                                                                                                   60,000
Accounts receivable                                                                           15,000
Inventory                                                                                              17,500
Total Current Asset                                                                             92,500
Fixed Asset
Land                                                                                                    50,000
Machinery                                                                                            20,000
Building                                                                                               30,000
Total Fixed Asset                                                                                100,000
Total Assets                                                                                                    192,500
Liabilities
Short-term Liability
Accounts payable (A/P)                                                                      12,000
Short-term loan                                                                                   19,000
Total Short-term Liability                                                                     31,000
Long-term Liability
Notes payable                                                                                     20,000
Long-term loan                                                                                    40,000
Total Long-term Liability                                                                      60,000
Total Liabilities                                                                                                91,000
Owners’ Equity
Capital stock                                                                                         80,000
Retained Earnings (Dec. 31)              1,500
Add Net Profit                                      20,000            
  21,500
Total Owners’ equity                                                                                       101,500

Total Liabilities & Owners’ Equity                                                                   192,500

Analyzing Financial Statement of Dhaka Ltd.
1.      Current Ratio

2.      Quick Ratio
*Where quick asset = Total Current Assets – Inventory
{When Ratio is 1:1 then it is adequate}

3.      Return on Sales
 
4.      Return on Equity
This Ratio measures the return company earns on every taka of shareholders (owner’s) investments.

5.      Debt to Assets Ratio
6.      Time Interest Earned

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