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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