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Exploring Financial Statements
Sales revenue and receivables Cost of goods sold and inventory Fixed assets and depreciation costs. Receivables and sales revenue Inventory and costs of goods expense Fixed assets and depreciation costs.
Accounting in Managing a Business
Recognize the leverage effect caused by fixed operating expenses. Don't underestimate the impact of small changes in selling price Know your opportunities to improve profits. Exploring the Reasons for Budgeting Modeling the Reasons for Budgeting Planning Reasons for Budgeting Control Reasons for Budgeting Additional Benefits of Budgeting Budgeting is worth it.
Preparing and Using Financial Reports
Developing your profit improvement strategy and profit budget Cash flow budget for the coming year. Digging Deeper into Profit Margin's Return on Equity (ROE) Measure: The Profit Catalyst.
The Part of Tens
Introduction
In the example, three expenses are specified in addition to the cost of goods. Dollar amounts in a column are always right aligned, as you see in the income statement example.
Opening the Books on Accounting
In For Dummies style, I close the book with a pair of chapters on "Part Tens." I summarize the main lessons from the book's chapters into two lists of ten vital points each. This icon highlights particularly important accounting ideas and concepts that especially deserve your attention.
Opening the Books on Accounting
Without accounting, a business could not function, would not know if it is making a profit and would be ignorant of its financial condition. Bookkeeping—the record-keeping part of accounting—must be done well to ensure that a business's financial information is timely, complete, accurate, and reliable—especially the numbers reported in its financial statements and tax returns.
Accounting: The Language of Business, Investing, Finance, and Taxes
Financial statements are sent to people who have an interest in the results of activities. Accounting information is essential for planning and controlling financial performance and business condition.
A pop quiz
The financial position of the business in this example is summarized in the following accounting equation (in millions): The statement of cash flows summarizes the cash inflows and outflows of the business during the period.
The CPA as a brand
The controller is the main person in the financial planning and budgeting process of the business organization. State incorporation laws typically require that someone in the business be designated as the treasurer, who has fiduciary responsibilities.
Financial Statements and Accounting Standards
The third imperative is reported in the statement of cash flows, which is a summary of the business's sources and use of cash during the period of the income statement. In the example of a manufacturing company, the company earned $520,000 in profit (net income) during the year (see Figure 2-1).
Is making profit ethical?
In the example, the company has a closing cash balance corresponding to 35 days of sales, calculated as follows: But in the example, the company made no cash distributions from profits—even though it earned $520,000. Ideally, company directors would explain their decision not to distribute money from profits to shareholders.
Financial accounting and reporting by government and not- for-profit entities
Today, however, we are witnessing a growing distinction between accounting and accounting standards for public versus private companies. At the same time, however, there is little doubt that some private companies' financial reports fall short. The result appears to be that we are moving towards separate accounting standards for larger public companies versus smaller private companies.
Depending on estimates and assumptions
I warn you at several points in this book about these creative accounting techniques – also known as massaging the numbers. Massaging the numbers can get out of hand and result in accounting fraud, also known as cooking the books. Cooking the books goes far beyond interpreting facts; this fraud consists of fabricating facts and old-fashioned deceit.
Keeping the Books
- Prepare source documents for all transactions, operations, and other events of the business; source documents are the starting point in the
- Determine the financial effects of the transactions, operations, and other events of the business
- Make original entries of financial effects in journals, with appropriate references to source documents
- Post the financial effects of transactions to accounts, with references to and tie-ins to original journal entries
- Perform end-of-period procedures — the critical steps for getting the accounting records up-to-date and ready for the preparation of
- Compile the adjusted trial balance for the accountant, which is the basis for preparing management reports, tax returns, and financial
- Close the books — bring the bookkeeping for the fiscal year just ended to a close and get things ready to begin the bookkeeping process
The chief accountant of the company establishes the rules and methods for measuring the financial effects of transactions. The accountant folds all these accounts into one summary inventory account which is presented in the balance sheet of the business. The chart of accounts is the formal index of these accounts — the complete list and classification of the accounts used by the business to record its transactions.
More than you may want to know right now about types of accounts
Source documents serve as legal evidence of the terms and conditions agreed upon by the company and the other person or. You can find many of the basic forms and documents that you need to conduct and record business transactions. Accountants and accountants must be honest people because of the control they have over your company's financial records.
Internal controls against mistakes and theft
The CPA's external auditor (assuming the business has an independent audit of its financial statements) often gets in the middle of the argument. The accounting equation reflects that there are claims against assets, which are the liabilities and equity of the owners of the economic entity. Or, to put it another way, accounting keeps track of sources of assets (liabilities and owners' equity) as well as assets.
A gray area in financial reporting
This money can hardly be recorded as "income from drug sales" in the accounts of the enterprise. Lenders, other creditors and the owners who have invested capital in the business rely on the company's financial statements. Alternatively, a business can do some or most of its bookkeeping in the cloud as it is called.
Exploring Financial Statements
The income statement summarizes a company's profitable activities and its final profit or loss for the period. The balance sheet reports the financial position of the company at a specific point in time - especially on the last day of the profit period. One caveat: the numbers you see in its financial statements depend largely on which accounting methods a company chooses.
Reporting Profit
But this financial report is designed for you to read from the top line (sales revenue) and continue to the last - the bottom line (net income). The cost of goods sold expense is the cost of products sold to customers, the sales revenue of which is reported on the sales revenue line. The idea is to match the sales revenue from goods sold to the cost of goods sold and show the gross margin (also called gross profit), which is the profit before other expenses are deducted.
How big is a big business, and how small is a small business?
I mention earlier in this chapter (see “Looking at a service . business”) that accounting standards are relatively silent on which expenses should be disclosed on the face of an income statement or. Another set of questions you should ask when reading an income statement concerns the profit performance of the business.
The P word
In Figure 4-3 I expand the accounting equation (Assets = Liabilities + Owners' Equity) by separating two distinct types of liabilities and two distinct sources of owners' equity. Naturally, a business maintains two types of owners' equity accounts: one for invested capital and one for retained earnings. An important lesson of Figure 4-3 is that debt and equity invested in owners' equity are not included in the recording of income and expenses.
So why is it called retained earnings?
Cost of goods sold is one of the primary costs of businesses that sell products. When a business acquires a product, the cost of the product goes to an inventory asset account (and of course the cost is either deducted from the cash account or added to the liability account, depending on whether the business pays with cash or buys on credit). In this case, the asset inventory account is increased by the purchase value of the unsold products.
Depreciation and cash flow
Income Tax Payable: This account is used for income taxes that a business still owes to the IRS at the end of the year. Another serious misconception is that if the profit is good, the financial condition of the company is good. On the contrary, the managing director and the accounting manager in the company fiddle with the accounts to some extent.
Reporting Financial Condition
The balance sheet in Figure 5.1 is shown in the vertical layout, with assets at the top and liabilities and equity at the bottom. The balance sheet in Figure 5-1 contains a column for the changes in assets, liabilities and equity during the year (from the end of 2012 to the end of 2013). Balance sheets presented in external financial reports (sent to investors and lenders) do not contain much more detail than the balance sheet in Figure 5.1.
Preparing multiyear statements
The balance sheet is a snapshot of the financial position of a. operating at a moment in time – the most important moment in time is the end of the last day of the income statement period. The company's financial situation is in constant flux because the company's activities are continuous. A summary of changes in the balance sheet, as shown in Figure 5-2, can be helpful to business managers planning and controlling changes in a company's assets and liabilities.
Turning over assets
The following sections discuss the relative sizes of the assets and liabilities in the balance sheet resulting from sales and expenses (for fiscal year 2013). Rather, depreciation expense for the period is that quota of the total cost of a business's fixed assets that is allocated to the period to record the cost of using the assets during the period. The annual depreciation charge of a business is rarely more than 10 to 15 percent of the original cost of its fixed assets.
What about cash?
The company's actual taxable income for the year is likely to differ from this amount due to the many complexities in income tax law. Borrowed money is known as debt; capital invested in the business by the owners and retained earnings are the two sources of equity. The company in the example has a large amount of debt relative to the owner's equity, which would cause many entrepreneurs to become owners.
Financial leverage: Taking a chance on debt
The dollar amounts reported in a balance sheet are the result of the. transactions recorded in the assets, liabilities and owners' equity accounts. Book values are the amounts recorded in the accounting process and reported in financial statements. Do not assume that the book values reported in a balance sheet are equal to the current market values.
Reporting Cash Flows and Changes in Stockholders’ Equity
What you see in the first section of the statement of cash flows is called the direct method of reporting cash flows from operating activities. One of the first demands on cash flow from operating activities is for capital expenditure. Notice in the annual statement of cash flows for the business example (refer to Figure 6-1 or 6-2) that cash flow from operating activities is positive.
Accounting Alternatives
The dollar amounts reported in a company's financial statements are not just "facts" that depend only on good bookkeeping. A CPA should also test for possible fraud and any accounting fraud in the financial statements. The financial statements would be different if alternative accounting methods were used to record sales revenues and expenses and if the company did not deal with a specific period end. maneuvering to make its financial statements look better.
Faking the financials
In the alternative scenario, these key assets of the business just have a much lower reported value. In Figure 7-1, we see that inventory is $700,000 lower in the alternative accounting scenario and that cost of goods sold is expense. The $412 total cost of the four units acquired minus the $312 cost of goods sold expense leaves $100 in the inventory asset account.