Accounting

Professor Myles Bassell

Bus 50.5 Small Business Management

Accounting is important to business for two reasons:

  • it helps managers plan and control a company’s operation
  • it helps outsiders evaluate a business.

Basic Accounting Equation

Assets = Liabilities + Owners’ Equity

Cash Basis vs. Accrual Basis

Cash basis accounting recognizes revenue at the time payment is received

Accrual basis accounting recognizes the revenue at the time of sale, even if payment is not made.

Financial Statements

  • Balance sheet – the balance sheet provides a snapshot of the business at a particular point in time. For example, a snapshot as of June 30, 2008 it shows the size of the company, the major assets owned, how the assets are financed, and the amount of owners’ investment in the business. Its three main sections include assets, liabilities, and equity of owners.
  • Current Assets – cash and other items that can be easily be converted to cash within one year. Expenses paid in advance are also classified as current assets.
  • Accounts receivables – amounts that are currently due to the company
  • Fixed Assets – assets such as buildings, equipment, furniture, and other property expected to be used for longer than one year.
  • Current Liabilities – amounts owed that are due to be repaid within in one year.
  • Accounts payable – short-term credit or debt the company owes its suppliers
  • Long-term Liabilities – debts that are due a year or more after the date of the balance sheet.
  • Shareholders’ Equity – money invested in the company for ownership interest, plus accumulated earnings.
  • Income Statement – the income statement reflects the results of operations over a period of time. It is the financial record of a company’s revenues, expenses, and profits over a given period of time. For example, from May 30, 2007 to June 30, 2008 we can examine the gross revenues, cost of goods sold, operating expenses, and net income for this time period.
  • Statement of Cash Flows – the statement of cash flows shows how a company’s cash was received and spent in three areas: operations, investments, and financing. It gives a sense of the amount of cash generated or consumed by daily operations, fixed assets, investments, and debt over a period of time.

1.What is GAAP?

GAAP is generally accepted accounting principles that apply to all published financial statements; all U.S. public companies must comply with GAAP. They include basic accounting standards and procedures that have been agreed on by the accounting profession.

  1. What is the matching principle?

The matching principle requires that expenses incurred in producing revenue be deducted from the revenue they generated during the accounting period.

  1. What are the three main profitability ratios, and how is each calculated?

The three main profitability ratios are return on sales, return on equity, and earnings per share. Return on sales is calculated by dividing net income after taxes by net sales. Return on equity is calculated by dividing net income after taxes by total equity. Earnings per share are calculated by dividing net income after taxes by the average number of common shares outstanding for that period.

  1. Why is accounting important to business?

Accounting is important to business for two reasons: First, it helps managers plan and control a company’s operation. Second, it helps outsiders evaluate a business.

  • Profitability ratios:
  • return on sales;
  • return on equity;
  • earning per share
  • Liquidity ratios:
  • current ratio;
  • quick ratio
  • Activity ratios:
  • inventory turnover;
  • accounts receivable turnover
  • Leverage ratios:
  • debt to equity;
  • debt to total assets