Basic accounting principles

Basic Accounting Basic Accounting PrinciplesPrinciples

The Financial StatementsThe Financial Statements

JOIN KHALID AZIZJOIN KHALID AZIZ ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS OF ICMAP, ICAP, MA-

ECONOMICS, B.COM.ECONOMICS, B.COM. FINANCIAL ACCOUNTING OF ICMAP STAGE FINANCIAL ACCOUNTING OF ICMAP STAGE

1,3,4 ICAP MODULE B, B.COM, BBA, MBA & 1,3,4 ICAP MODULE B, B.COM, BBA, MBA & PIPFA.PIPFA.

COST ACCOUNTING OF ICMAP STAGE 2,3 COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE D, BBA, MBA & PIPFA.ICAP MODULE D, BBA, MBA & PIPFA.

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JOIN KHALID AZIZJOIN KHALID AZIZ FRESH CLASSES FOR ICAP FRESH CLASSES FOR ICAP MODULE B…FINANCIAL ACCOUNTING.MODULE B…FINANCIAL ACCOUNTING. MODULE D…COST ACCOUNTING.MODULE D…COST ACCOUNTING. REGISTER YOUR SELF NOW.REGISTER YOUR SELF NOW. COMPLETION OF SYLLABUS WITH COMPLETION OF SYLLABUS WITH

ACCENTUATE ON BASIC CONCEPTSACCENTUATE ON BASIC CONCEPTS

Accounting TermsAccounting Terms AccountAccount

• A group of items having A group of items having common characteristicscommon characteristics

Types of AccountsTypes of Accounts• Asset LiabilityAsset Liability• Income ExpenseIncome Expense• EquityEquity

Chart of AccountsChart of Accounts Listing of all of the Listing of all of the

accounts used by a accounts used by a businessbusiness

Asset AccountsAsset Accounts Items of ValueItems of Value Characterized as current Characterized as current

and non-currentand non-current

Liability AccountsLiability Accounts Claims that others have Claims that others have

against the assetsagainst the assets Have a known:Have a known:

• AmountAmount• Date to be paidDate to be paid• Person to whom payment owedPerson to whom payment owed

Also current and non currentAlso current and non current

Equity AccountsEquity Accounts Claims that the owner has Claims that the owner has

against the assetsagainst the assets Sometimes called net Sometimes called net

worthworth Difference between value Difference between value

of assets and liabilitiesof assets and liabilities

Income and Expense Income and Expense AccountsAccounts

Types of equity accountsTypes of equity accounts

Simple accounting Simple accounting systems often only systems often only contain these accountscontain these accounts

Double vs Single Entry Double vs Single Entry AccountingAccounting

Single – One account entry for each Single – One account entry for each transactiontransaction

Double – Two account entries for each Double – Two account entries for each transactiontransaction• One debit and one creditOne debit and one credit

Hybrid systemsHybrid systems• May not match income with May not match income with

expensesexpenses• May not distinguish cash, check, or May not distinguish cash, check, or

creditcredit

Basic Accounting Basic Accounting EquationEquation

Always maintained in Always maintained in double entry accountingdouble entry accounting

Assets will always equal Assets will always equal liabilities plus equityliabilities plus equity

TransactionsTransactions Will be equal and offsettingWill be equal and offsetting Two types:Two types:

• Income & ExpensesIncome & Expenses• Transfers between accountsTransfers between accounts

Cash and Accrual Cash and Accrual AccountingAccounting

Refers to the timing of Refers to the timing of entries into the accounting entries into the accounting systemsystem

Cash Based RecordsCash Based Records Transactions are recorded Transactions are recorded

when cash is received or paid when cash is received or paid outout

Accrual Based RecordsAccrual Based Records Transactions are recorded Transactions are recorded

when they take placewhen they take place Regardless of whether cash Regardless of whether cash

is involvedis involved

Accrual Adjusted Accrual Adjusted StatementsStatements

Cash based records are kept Cash based records are kept throughout the yearthroughout the year

Non-Cash adjustments are Non-Cash adjustments are made to the cash based made to the cash based income statement at the end income statement at the end of the yearof the year

Account ValuationAccount Valuation Income AccountsIncome Accounts

• Value received is recordedValue received is recorded Expense AccountsExpense Accounts

• Value paid is recordedValue paid is recorded Liability AccountsLiability Accounts

• Value is dollar amount owedValue is dollar amount owed

Account ValuationAccount Valuation Asset AccountsAsset Accounts

• More difficult because they More difficult because they may not be traded routinelymay not be traded routinely

Asset ValuationAsset Valuation Cost BasisCost Basis Market Value BasisMarket Value Basis

Cost Basis Asset Cost Basis Asset ValuationValuation

Original cost minus Original cost minus depreciationdepreciation

Must establish a depreciation Must establish a depreciation methodmethod

Market Basis Asset Market Basis Asset ValuationValuation

Recorded as the price they Recorded as the price they could bring if sold, less could bring if sold, less selling expensesselling expenses

Based on recent auctions, Based on recent auctions, appraisals, etc.appraisals, etc.

DepreciationDepreciation Section II page 29, (FFSTF Section II page 29, (FFSTF

Guidelines)Guidelines) Allocation of the expense that Allocation of the expense that

reflects the “using up” of capital reflects the “using up” of capital assets employed by the businessassets employed by the business

Conceptually, this is done over Conceptually, this is done over the useful life of the asset in a the useful life of the asset in a “systematic and rational” “systematic and rational” mannermanner

DepreciationDepreciation Allocation applied to original Allocation applied to original

cost minus salvage valuecost minus salvage value Accelerated versus straight line Accelerated versus straight line

methodsmethods• Example of difference between Example of difference between

management records and tax management records and tax recordsrecords

Can overstate or understate true Can overstate or understate true incomeincome

Financial ReportsFinancial Reports Balance SheetBalance Sheet Income StatementIncome Statement Statement of Cash FlowsStatement of Cash Flows Statement of Owner EquityStatement of Owner Equity

Balance SheetBalance Sheet Represents a financial Represents a financial

situation at a single point in situation at a single point in timetime

Has a date on itHas a date on it Broken down by:Broken down by:

• Type of Asset or liabilityType of Asset or liability• Time or life of the account typeTime or life of the account type

Balance SheetBalance Sheet Current AssetsCurrent Assets

• Cash and other assets that will Cash and other assets that will be converted into cash during be converted into cash during one operating cycleone operating cycle

Non-Current AssetsNon-Current Assets• Those not expected to be Those not expected to be

converted into cash in one converted into cash in one operating cycleoperating cycle







Balance SheetBalance Sheet Current LiabilitiesCurrent Liabilities

• Debts that will come due Debts that will come due within one year from the within one year from the balance sheet datebalance sheet date

Non-Current LiabilitiesNon-Current Liabilities• Those debts due more that one Those debts due more that one

year from the balance sheet year from the balance sheet datedate

Balance SheetBalance Sheet Intermediate Assets and LiabilitiesIntermediate Assets and Liabilities Long term Assets and LiabilitiesLong term Assets and Liabilities Can use cost or market valuations Can use cost or market valuations

or bothor both Supporting Schedules are very Supporting Schedules are very

helpfulhelpful Will need a balance sheet for Will need a balance sheet for

beginning and ending of beginning and ending of accounting periodaccounting period

Income StatementIncome Statement Summary of income and Summary of income and

expensesexpenses Represents a period of time Represents a period of time

between two balance sheetsbetween two balance sheets Explains the change in equity Explains the change in equity

between two balance sheetsbetween two balance sheets Can be divided into enterprise Can be divided into enterprise

reportsreports Can be cash or accrualCan be cash or accrual

Assets Liabilities

Equity

Assets Liabilities

Equity

+/- Net Income+/- Valuation Changes

- Family living withdrawals+ Capital contributions

Beginning Balance Sheet Ending Balance Sheet

Income StatementIncome Statement Will have more than one Will have more than one

profit lineprofit line Definition of ProfitDefinition of Profit

• Financial profit is the net Financial profit is the net return to business equityreturn to business equity

Accrual Adjusted Income Accrual Adjusted Income StatementStatement

Cash incomes and expenses Cash incomes and expenses must be adjusted by:must be adjusted by:• Changes in non-cash assetsChanges in non-cash assets

• InventoriesInventories• Pre paid expensesPre paid expenses• ReceivablesReceivables

• Changes in non-cash liabilitiesChanges in non-cash liabilities• PayablesPayables• Accrued interestAccrued interest

Statement of Cash FlowsStatement of Cash Flows Not the same as a cash flow plan Not the same as a cash flow plan

(Budget)(Budget) Is a historical record of sources Is a historical record of sources

and uses of fundsand uses of funds Divisions of Statement:Divisions of Statement:

• Cash from operating activitiesCash from operating activities• Cash from investing activitiesCash from investing activities• Cash from financing activitiesCash from financing activities

Statement of Owner Statement of Owner EquityEquity

Explains the change in owners Explains the change in owners equity between two balances equity between two balances sheetssheets

Changes due to :Changes due to :• Net incomeNet income• Change in inventory valuationChange in inventory valuation• Family living withdrawalsFamily living withdrawals• Capital contributionsCapital contributions• Capital distributionsCapital distributions

Financial AnalysisFinancial Analysis All business owners should All business owners should

have a basic set of financial have a basic set of financial statements at their disposal statements at their disposal and they should know how to and they should know how to analyze and interpret them.analyze and interpret them.

Financial AnalysisFinancial Analysis Two ObjectivesTwo Objectives

• Measure financial condition of Measure financial condition of the businessthe business

• Measure financial performance Measure financial performance of the businessof the business

Financial AnalysisFinancial Analysis

Horizontal AnalysisHorizontal Analysis Vertical AnalysisVertical Analysis Ratio AnalysisRatio Analysis

Horizontal AnalysisHorizontal Analysis Looks at trends in Looks at trends in

performance and strength performance and strength over timeover time• For example, percent change in For example, percent change in

net income from year to yearnet income from year to year

Vertical AnalysisVertical Analysis Looks at within year events Looks at within year events

rather than over timerather than over time• For example, interest expense For example, interest expense

as a percent of total expensesas a percent of total expenses

Ratio AnalysisRatio Analysis Allows for consistent Allows for consistent

comparison of a single comparison of a single business over time as well as business over time as well as comparison between comparison between businessesbusinesses

Converts nominal dollar Converts nominal dollar amounts to a common basisamounts to a common basis

Source of data for Ratio Source of data for Ratio AnalysisAnalysis

Balance SheetBalance Sheet Income StatementIncome Statement

Farm Financial Standards Farm Financial Standards Council (Five Criteria)Council (Five Criteria)

LiquidityLiquidity SolvencySolvency ProfitabilityProfitability Financial EfficiencyFinancial Efficiency Repayment CapacityRepayment Capacity

Ratio AnalysisRatio Analysis 16 different ratios commonly 16 different ratios commonly

usedused Each has limitationsEach has limitations Proper interpretation is Proper interpretation is

criticalcritical

LiquidityLiquidity Ability of a business to pay Ability of a business to pay

current liabilities as they current liabilities as they come duecome due

LiquidityLiquidity Current RatioCurrent Ratio

• Current Assets/Current Current Assets/Current LiabilitiesLiabilities

• Less than one is badLess than one is bad Working capitalWorking capital

• Current assets minus current Current assets minus current liabilitiesliabilities

• Negative number is badNegative number is bad

SolvencySolvency Ability of the firm to repay all Ability of the firm to repay all

of its financial obligationsof its financial obligations

SolvencySolvency Debt to Asset RatioDebt to Asset Ratio

• Total liabilities/total assetsTotal liabilities/total assets• Greater than one badGreater than one bad

Equity to Asset RatioEquity to Asset Ratio• Total equity/total assetsTotal equity/total assets

Debt to Equity RatioDebt to Equity Ratio• Leverage ratioLeverage ratio• Less than one betterLess than one better

ProfitabilityProfitability Rate of return on assetsRate of return on assets Rate of return on equityRate of return on equity Operating profit margin ratioOperating profit margin ratio

Financial EfficiencyFinancial Efficiency Measures the intensity with Measures the intensity with

which a business uses its which a business uses its assets to generate gross assets to generate gross revenues and the revenues and the effectiveness of productioneffectiveness of production

Financial EfficiencyFinancial Efficiency Asset turnover ratioAsset turnover ratio Operating expense ratioOperating expense ratio Depreciation ratioDepreciation ratio Interest expense ratioInterest expense ratio Net income from operations Net income from operations

ratioratio

Repayment CapacityRepayment Capacity Measures the borrower’s Measures the borrower’s

ability to repay term debts ability to repay term debts and capital leases rather and capital leases rather than financial position or than financial position or performanceperformance

Repayment CapacityRepayment Capacity Term debt and capital lease Term debt and capital lease

coverage ratiocoverage ratio Capital replacement and Capital replacement and

term repayment marginterm repayment margin

CautionsCautions Measures are only as good as Measures are only as good as

the data usedthe data used Methods must be consistent Methods must be consistent

between years and between between years and between operationsoperations• Example – Asset valuation methodsExample – Asset valuation methods

Measures ask the right questions Measures ask the right questions but do not provide the answersbut do not provide the answers







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Basic accounting principles