Management Accounting My Summery 1'St Term

8/11/2019 Management Accounting My Summery 1'St Term

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Management Accounting Notes by

Ahmed FawzyEslesca 45D

[email protected]


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Summary:

Managerial Accounting, the Business Organization, and Professional Ethics

Understanding Corporate Annual Reports

Basic Financial Statements Breakeven Analyses


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Managerial Accounting, the Business Organization, and Professional Ethics

Learning Objectives1.

Describe the major users and uses of accounting information.

2. Describe the cost-benefit and behavioral issues involved in designing an accounting system.

3. Explain the role of budgets and performance reports in planning and control.

4. Discuss the role accountants play in the companys value-chain functions.

5.

Explain why accounting is important in a variety of career paths.6. Identify current trends in management accounting.

7. Explain why ethics and standards of ethical conduct are important to accountants.

The basic purpose of accounting information is to help decision makers company presidents,

production managers, hospital or school administrators, investors, and others.

Decision makingchoicefrom among a set of alternative courses of action designed to achieve some

objectivedrives the need for accounting information.

Regardless of who is making the decision, understanding accounting information allows for a more

informed, and better, decision. Both internal parties (managers) and external parties use accounting

information, but they often demand different types of information and use it in different ways.

Management Accounting producesinformation for managers within an organization. It is the process of

identifying, measuring, accumulating, analyzing, preparing, interpreting, and communicating information

that helps managers fulfill organizational objectives.

In contrast, Financial Accounting produces information for external parties, such as stockholders,

suppliers, banks, and government regulatory agencies.

What kinds of accounting information do managers need to achieve their goals and objectives?

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Good accounting information helps answer three types of questions:

Scorekeeping: Evaluate Organizational Performance

Attention Directing: Compare Actual Results to Expect

Problem Solving: Assess Possible Courses of Action

1. Scorecard questions: Is the company doing well or poorly?

Scorekeepingis the classification, accumulation, and reporting of data that help usersunderstands and evaluates organizational performance. Scorekeeping information must be

accurate and reliable to be useful.

For example, Starbucks produces numerous reports to evaluate results for stores and divisions.

2. Attention-directing questions: Which areas require additional investigation?

Attention directingusually involves routine reports that compare actual results to before-the-fact

expectations. For example, a manager who sees that a Starbucks store has reported profits of

$120,000 when budgeted profit was $150,000 will look for explanations as to why the store did

not achieve its budget.

Attention-directing information helps managers focus on operating problems, imperfections,inefficiencies, and opportunities.

3. Problem-solving questions: Of the alternatives being considered, which is the best?

The problem-solving aspectof accounting often involves an analysis of the impacts of each

alternative to identify the best course to follow. For example, Starbucks experiments with adding

various items to its menu. After an analysis of how a new product will affect revenues and costs,

management decides which items to add and which to delete

Accounting Information System: Process of gathering, organizing, and communicating financial information

An accounting systemis a formal mechanism for gathering, organizing, and communicating information about anorganizations activities. In order to reduce costs and complexity, many organizations use a general -purpose

accounting system that attempts to meet the needs of both external and internal users. However, as outlined in

Exhibit 1-1, there are important differences between management accounting information and financial

accounting information.

Cost-Benefit Balance: Weigh estimated costs against probable benefits

Behavioral Implications: The system must provide accurate, timely budgets and performance reports in a form

useful to managers

Managers must use accounting reports, or the reports create no benefits

The Cost-Benefit Balanceweighing estimated costs against probable benefits is the primary consideration in

choosing among accounting systems and methods.

We will refer again and again to cost-benefit considerations throughout this book. Accounting systems are

economic goodslike office supplies or laboravailable at various costs.

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Managers should also consider Behavioral Implications,that is, the systems effect on the behavior, specifically

the decisions, of managers. In a nutshell, think of management accounting as a balance between costs and

benefits of accounting information coupled with an awareness of the importance of behavioral effects.

Therefore, management accountants must understand related disciplines, such as economics, the decision

sciences, and the behavioral sciences, to make intelligent decisions about the best information to supply to

managers.

Planning and Control:

Accounting information helps managers plan and control the organizations operations

Planning: Setting objectives and outlining how the objectives will be obtained

Control: Implementing plans and using feedback to evaluate the attainment of objectives.

In practice, planning and control are so intertwined that it seems artificial to separate them. In studying

management, however, we find it useful to concentrate on either the planning phase or the control phase to

simplify our analysis.

Planningrefers to setting objectives for an organization and outlining how it will attain them.

Thus, planning provides the answers to two questions: What objectives does the organization want to achieve?

When and how will the organization achieve these objectives?Control refers to implementing plans and using

feedback to evaluate the attainment of objectives.

Feedbackis crucial to the cycle of planning and control. Planning determines action, action generates feedback,

and the control phase uses this feedback to influence further planning and actions.


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Budget and Performance Reports

Budget: quantitative expression of a plan of action

Performance reports:

compare actual results with budgeted amounts

provide feedback by comparing results with plans

highlight variances

Variances: deviations from plans

A budget is a quantitative expression of a plan of action. Budgets also help to coordinate and implement plans.

They are the chief devices for disciplining management planning, Without budgets, planning may not get the

front-and-center focus that it deserves.

Performance reports provide feedback by comparing results with plans and by highlighting variances,which are

deviations from plans. Organizations use performance reports to judge managers decisions and the productivity

of organizational units.

Example

The Mayfair store report shows that the

store met its targeted sales, but the

$2,500 unfavorable variance for

ingredients shows that these costs were

$2,500 over budget. Other variances show

that store labor costs were $400 under

budget, and other labor was $50 over

budget. At the Mayfair store, management

would undoubtedly focus attention oningredients, which had by far the largest

unfavorable variance.

Product life cycle refers to the various stages through which a product passes: conception and product

development; introduction into the market; maturation of the market; and, finally, withdrawal from the market.

At each stage, managers face differing costs and potential returns.

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The Value Chain: In addition to considering a

products life cycle, managers must recognize

those activities necessary for a company to create

the goods or services that it sells.

These activities comprise the value chain, the set

of business functions or activities that add value to

the products or services of an organization.

Management Accountants Role as Internal Consultant

The role of management accountants in organizationshas changed rapidly over the last decade or so.

Consider the following four work activities of

management accountants:

Collecting and compiling information

Preparing standardized reports

Interpreting and analyzing information

Being involved in decision making

Organizational Authority and Responsibility Line managers: directly involved with making and selling products or services. Staff managers: Advisory Support line managers.

Cross-functional teams: Found in modern, flatter organizations; Functional areas work together indecision-making process.

As an organization grows, it must divide responsibilities among a number of managers and executives,

each with specific responsibilities. Line managers are directly involved with making and selling theorganizations products or services. Their decisions lead directly to meeting (or not meeting) theorganizations objectives.

In contrast, staff managers are advisorythey support the line managers. They have no authority overline managers, but they help the line managers by providing information and advice. The organizationalchart shows how a traditional manufacturing company divides responsibilities between line and staffmanagers. The line managers in manufacturing are supported by sales, engineering, personnel, andfinancial staff support at the corporate level, and by receiving and storeroom, inspection, tool room,purchasing, production control, and maintenance staff at the factory level.

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Accounting Functions

The Chief Financial Officer (CFO),a top executive who deals with all finance and accounting issues,oversees the accounting function in most organizations.Both the treasurerand controllergenerally report to the CFO,

The treasurer is concerned mainly with the companys financialmatters such as raising and managing

cash, while the controller (also called comptroller in many government organizations) is concerned withoperating matters such as aiding management decision making.

In a small company, one person may perform both treasury and controllership functions.

Nevertheless, it is useful to differentiate the two different roles.

Chief Financial Officer (CFO)

Controller Functions

Planning for control

Reporting and interpreting Evaluating and consulting

Tax administration

Government reporting

Protection of assets

Economic appraisal

Treasurer Functions

Provision of capital

Investor relations Short-term financing

Banking and custody

Credits and collections

Investments

Risk management and Insurance

Career Opportunities in Management Accounting

The Certified Management Accountant (CMA) designation is the internal accountants counterpart to

the CPA.

The Institute of Management Accountants (IMA), the largest U.S. professional organization focused oninternal accounting, oversees the CMA program.

CMAs must pass an examination covering(1)Financial planning, performance and control, (2) Financial decision making.

Like the CPA designation, the CMA confers higher status and leads to more responsible positions andhigher pay.

CMAs must pass a four-part examination:

1.

Business Analysis2.

Management accounting and reporting3. Strategic Management, and4. Business Applications.

The accounting systemis used to maintain records for all businesses, whether a multinational corporation or a

small business.

To accountfor something means to keep a record of something in your business by using the accounting system.

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Management Accounting Change Drivers

Four major business trends are influencing management accounting today:1. Shift from a manufacturing-based to a service-based economy in the United States2. Increased global competition3. Advances in technology

4.

Changes in business process management

Major Influences on Management Accounting

Advances in technology:

E-commerce

Enterprise resource planning (ERP)

B2C and B2B

Business process reengineering:

Just-in-time (JIT) philosophy

Lean manufacturing

Computer-integrated manufacturing

Six sigma

A major effect of technology on accounting systems has been the growing use of enterprise resourceplanning (ERP) systems integrated information systems that support all functional areas of a company.Accounting is just one part of such a system.

One of the most rapidly growing uses of technology is electronic commerce or e-commerceconducting business online. While the Internet boom that focused on business-to-consumer (B2C)transactions ended in 2001, e-commerce focusing on business-to-business (B2B) transactions continued togrow at nearly 50% a year.

B2B creates real savings to the companies involved. One management change leading to increased

efficiency in business processes has been the adoption of ajust-in-time (JIT) philosophy.

Another management approach focused on efficiency is lean manufacturing,which applies continuousprocess improvements to eliminate waste from the entire enterprise.

A focus on quality is also important in todays competitive environment. A decade or more ago, manycompanies undertook total quality management (TQM) initiatives. TQM minimizes costs bymaximizing quality. It focuses on continuous improvement in quality and satisfying onescustomers.

Recently the focus on quality has shifted to Six Sigma,a disciplined, data-driven approach to eliminatingdefects in any process.

Ethics: Trust, Reliability, Integrity

No regulation can be as effective in ensuring reliability as high ethical standards of accountants.

Accounting report An accountant (or bookkeeper) collects documentation and records this information,

categorizes it (i.e. organizes the different bits of information under certain categories), and presents it in specific

formats.

Accounting information is finally presented in the form of financial statements the key reports of a business.

Bookkeepers are usually involved more in data collection and entry.

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Understanding Corporate Annual Reports and Basic Financial Statements

Learning Objectives1.

Recognize and define the main types of assets in the balance sheet of a corporation.2.

Recognize and define the main types of liabilities in the balance sheet of a corporation.3.

Recognize and define the main elements of the stockholders equity section of the balance sheet of acorporation.

4.

Recognize and define the principal elements in the income statement of a corporation.

5.

Recognize and define the elements that cause changes in retained earnings.6.

Identify activities that affect cash, and classify them as operating, investing, or financing activities.7.

Assess financing and investing activities using the statement of cash flows.8.

Use both the direct method and the indirect method to explain cash flows from operating activities.9.

Explain the role of depreciation in the statement of cash flows.10.

Describe and assess the effects of the four major methods of accounting for inventories

The Financial Statements are the Annual reports for the company

The facts and figures shown on the financial statements give the people and businesses using them abirds-eye view of how well the business is performing.

For example, looking at the balance sheet, you can see how much debt the business owes and whatresources it has to pay that debt.

The income statementshows how much money the company is making, both before and after businessexpenses are deducted. Finally, the statement of cash flows showshow well the company is using itscash. A company can bring in a boat-load of cash, but if its spending that cashin an unwise manner, itsnot a healthy business.

The Balance Sheet Statement: (also referred to as the Statement of Position) : Describes the financial

position of a company at a specific point in time.A balance sheet may be prepared monthly, quarterly, or annually depending on the needs of managementand external users. The balance sheet is sometimes referred to as the statement of financial position.

Balance sheet:This statement has three sections: assets, liabilities, and equity. Standing on their own,these sections contain valuable information about a company.However, a user has to see all three interacting together on the balance sheet to form an opinionapproaching reliability about the company.

Assets: Resources owned by a company, such as cash, equipment, and buildings.Liabilities: Debt the business incurs for operating and expansion purposes.

Equity: The amount of ownership left in the business after deducting total liabilities from total assets

The Balance Sheet: We will examine the five main sections of the balance sheet:

Assets Liability and Shareholder equity

Current assets Shareholders' equity

Noncurrent assets Current Liabilities

Noncurrent liabilities

Total = XXX Total = XXX

Assets = Liabilities + Equity


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Assets Section

Current assets:

o Cash and equivalentso Short-term investmentso Accounts Receivableo Net Inventorieso Deferred Income Taxeso

Prepaid expenses and other current assetsTotal cur rent assetsNoncurrent assets

o Property, plant, and equipment at costo Less: Accumulated depreciation

o Net property, plant, and equipment

o Identifiable intangible assets, net Goodwillo Deferred income taxes and other assets

Total noncur rent assets

Total Assets = Total current assets + Total noncurrent assets

Operating Cycle: Current assets include cash and all other assets that a company reasonably expects to convertto cash or sell or consume within one year or during the normal operating cycle, if longer than a year.

A companysoperating cycleis the time span during which it spends cash to acquire goods and services that ituses to produce its outputs, which in turn it sells to customers, who in turn pay for their purchases with cash.

Cash Equivalents are short-term investments that can easily be converted into cash with little delay

Cash consists of bank deposits in checking accounts plus money on hand.

Such as money market fundsand Treasury bills. They represent an investment of excess cash that a company does not immediately need. The balance sheet shows these securities at their market price.

Short-Term Investments are temporary investments in marketable securities.Companies often invest cash, which otherwise would be idle, in short-term investments,(items that will beconverted to cash within one operation year) Such as the stocksor bonds of other companies or debt securitiesissued by governments.

Accounts Receivableis the total amount owed to the company by its customers. Accountants often classify all accounts receivable as current assets, even though they may not fully collect

them within one year. Because some customers ultimately will not pay their bill, we reduce the total receivables by an allowance

or provision for doubtful accountsor bad debts.


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Inventories for wholesalers and retailers consist of merchandise held for sale. Manufacturing companies generally have three inventory accounts: raw materials, goods in the process of

being manufactured and finished products.

Accountants regard all inventories as current assets. Companys state inventories at their cost or market price (defined as replacement cost by U.S. GAAP and

net realizable value by IFRS), whichever is lower.

Prepaid Expenses and Other Current Assets

Prepaid expenses are advance payments to suppliers. They are usually small in relation to otherassets. Examples are prepayment of rentand insurancepremiums for coverage over the comingoperating cycle.

They belong in current assets because, if they were not present, the company would need morecash to conduct current operations.

Other current assets are miscellaneous current assets that do not fit into the listed categories.

None-Current Assets: Property, plant, andequipmentare examples of fixed assets or tangible assets physical items that a

person can see and touch.

Companies usually provide details about property, plant, and equipment in a footnote to the financial

statements. Footnotes are an integral part of financial statements. They contain explanations for thesummary figures that appear in the statements.

Depreciation:Depreciation expense= Acquisition costEstimated residual valueo The purpose of depreciation is to allocate the assets original cost to the particular periods

that benefit from the use of the asset.o The value that appears on the balance sheet is the original cost less the accumulated

depreciation (the sum of all depreciation to date on the asset), which we call the net bookvalue. The net book value is simply the result of the allocation process.

o It is not necessarily a good approximation to other common concepts of value, such asreplacement cost or resale value.

Companies typically show land as a separate assetand carry it indefinitely at its original cost.They also initially record buildings and machinery and equipment at cost: the invoice amount, plusfreight and installation, less cash discounts. However, unlike land, the recorded values ofbuildings, machinery, and equipment gradually decline through depreciation.

The amount of depreciation charged as an expense each year depends on three factors:1. The depreciable amount, which is the difference between the total acquisition cost and the

estimated residual value. The residual value is the amount a company expects to receive whenselling the asset at the end of its economic life.

2. The estimate of the assets useful life. This estimate often depends more on technologicalchanges and economic obsolescence than on physical wear and tear. Thus, the useful life is usuallyless than the physical life.

3. The depreciation method. There are three general methods of depreciation:o The straight-line methodallocates the same cost to each year of an assets useful life.

Accelerated methodsallocate more of the cost to the early years and less to the lateryears.

o The activity-basedmethod allocates cost based on either input activity (such as hours ofmachine time used) or output activity (such as units of production).


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The value that appears on the balance sheet is theoriginal cost less the accumulated depreciation(the sum of all depreciation to date on the asset), which we call the net book value.

The net book value is simply the result of the allocation process. It is not necessarily a goodapproximation to other common concepts of value, such as replacement cost or resale value.

Intangible Assets:We can physically observe tangible assets such as cash or equipment. In contrast,intangible assets are a class of long-lived assets that are not physical in nature. They are rights to expectedfuture benefits. Examples are franchises, patents, trademarks, and copyrights.

Liabilities Section

Current Liabilities

o Current portion of long-term debto Notes payableo Accounts payableo Accrued liabilitieso Income taxes payable

Total current l iabili ties

Noncurrent Liabilities

o Long-term debto Deferred income taxes and other liabilities

Total noncurr ent li abil ities

Total liabilities = Total Current Liabilities + Total noncurrent Liabilities

Current Liabilities are an organizations debts that fall due within the coming year or within the normaloperating cycle, whichever is longer.Examples:Notes Payable, Current portion of long-term debt, Accounts Payable, Accrued Liabilities

Assets are only part of the picture of any organizations financial health.Its liabilities, both current and noncurrent, are equally important.

Current liabilities are an organizations debts that fall due within the coming year or within the normaloperating cycle if longer than a year.The first current liability is the current portion of long-term debt, which shows the payments due withinthe next year on bonds and other long-term debt. Notes payableare short-term debts backed by formal promissory notes held by a bank or business

creditors. Accounts payableare amounts owed to suppliers who extended credit for purchases on open

account. Accrued liabilities(also called accrued expenses payable) are amounts owed for wages, salaries,

interest, and similar items.

The accountant recognizes expensesas they occur regardless of when a company pays for them incash. Income taxespayableis a special accrued liability of enough magnitude to warrant a separateclassification.


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Noncurrent liabilities, also called long-term liabilities, are an organizations debts that fall due beyondone year.Examples:Notes Payable, Long-Term Debt and Deferred Income Taxes

Long-term debtmay be secured or unsecured. Secured debt provides debt holders with first claimon specified assets.

Mortgagebonds are an example of secured debt. If the company is unable to meet its regular

obligations on the bonds, it may sell the specified assets and use the proceeds to pay off the firmsobligations to its bondholders, in which case secured debt holders have first claim to theseproceeds.

Unsecured debtconsists of debentures (bonds, notes, or loans), which are formal certificates ofindebtedness accompanied by a promise to pay interest at a specified annual rate. Unsecured debtholders are general creditors who have a general claim against total assets rather than a specificclaim against particular assets.

Stockholders Equity Section

Shareholders equityo Contributed or paid-in capitalo Retained earnings

Total shareholders equity

Total liabilities and shareholders equity

The main elements of stockholders equityarise from two sources: Contributed or paid-in capital Retained income and other comprehensive income.

Paid-in capital typically comes from owners who invest in the business in exchange for shares ofstock that specify their ownership interest.

Holders of stock are stockholders or shareholders. There are two major classes of capital stock:

Common stockand Preferred stock. Some companies have several categories of each, all with a variety of different attributes.

Common stock has no predetermined rate of dividends and is the last to obtain a share in the assets whenthe corporation is dissolved.

Common shares usually have voting power to elect the board of directors of the corporation. All corporations have common stock. Such stock has no predetermined rate of dividends and is the

last to obtain a share in the assets when the corporation liquidates. Common stockholders usually elect the board of directors of the corporation. Common stock is the riskiest investment in a corporation, being unattractive in dire times but

attractive in prosperous times because, unlike other stocks, there is no limit to the stockholderspotential participation in earnings.

The corporate form of ownership provides one additional benefit to shareholderslimited

liability. This means that a companys creditors cannot seek payment from stockholders asindividuals if the corporation itself cannot pay its debts.


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Preferred Stock: Preferred stock has some priority over other shares regarding dividends or theDistribution of assets upon liquidation

About 40% of the major companies in the United States issue preferred stock. It typically hassome priority over other shares in the payment of dividends or the distribution of assets onliquidation.

Treasury Stock This is a corporations own stockthat was issued and subsequently repurchased by the

company and is being held for a specific purpose

Many companies have treasury stock, which is a corporations own stock that the company issuedand subsequently repurchased but has not permanently retired.

It is held only temporarily in the treasury to be distributed later, possibly as a part of anemployee stock purchase plan or as an executive bonus or for use in acquiring another company.Such a repurchase is a decrease in ownership claims.

Therefore, it should appear on a balance sheet as a deduction from total stockholders equity. Acompany does not pay cash dividends on shares held in the treasury.

Companies distribute dividends only to the outstanding shares (those in the hands ofstockholders).

Example:

Assets Liabilities and Equity

Land Capi tal or Owner Equi ty Restricted Equi ty

Building Return Earnings None Restricted Equity

Equipotent

Cash Loans Long Term Liabilities

Inventory

A/R (Account Rece ivables) A/P (Account Payable) Short Term Liabi li ties

Economic Resources ,

None Current Assets

Cash , or assets that

will be converted to

cash within one year

Money the Company have to pay

to the owner in case of

liquidation


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Financial Leverage: The degree to which an investor or business is utilizing borrowed money.Leverage Ratio: The most well-known financial leverage ratio is the debt-to-equity ratio

The use of borrowed money to increase production volume, and thus sales and earnings.

It is measured as the ratio of total debt to total assets. The greater the amount of debt, the greater thefinancial leverage.

Financial Restricting:Get Extra cash from the owners to increase owner equity and increase equity

Equity Ratio or the Owner Equity (What I have after paid all my liabilities)= Capital + Return Earnings / Assets= Restricted Equity + None Restricted Equity / Assets

= Equity / Assets

Owners equityis officially defined as: the residual interest in the assets of the enterprise after

deducting all its liabilities.

The owners equity is simply the owners share of the assets of a business.

You see, assets can only belong to two types of people: the first type is people outside the business youowe money to (liabilities), and the second is the owner himself (owners equity).Owners equity, often just called equity, represents the value of the assets that the owner can lay claim to.

In other words, it's the value of all the assets after deducting the value of assets needed to pay liabilities.

In other words: It is the value of the assets that the owner really owns.

ASSETS = EQUITY + LIABILITIES

Thus the accounting equation indicates how much of the assets of a business belong to, or are owned, bywhom.

These three elements assets, owners' equity and liabilities,When compared to one another, show what we call the financial position of the business.


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Let me give you an example, would you invest in the following business?

Probably not. 90% of the assets of this business will be used to pay debts in future.The equity, which reflects the net worth of the business (the real worth to the owner or owners), is only$10,000.The financial position of this business is thus poor.

What about this businesswould you invest in it?

Well, in this case you certainly would be quite apprehensive about investing.

The total debts of the business are greater than the assets it has to pay off these debts. As a result theowner or owners are making a loss. The owner or owners may have to fork out $20,000 out of their ownpockets to pay the liabilities.Where the total debts of the business are greater than its assets, we say that the business is insolvent. Thismeans that it cannot pay all its debts.

Obviously the financial position of this business is terrible.

Now how about this business?

This business looks a bit healthier. The business can comfortably pay all of its debts. In fact, only 40% of

the assets will be used up to pay the debts60% of the assets are really owned by the owner. The networth of the business is $60,000.The financial position of this business is quite good.

Bear in mind that it is not always a bad thing to have debts where you have a project that will bring you$40,000, but you need to invest $5,000 to start with (and you dont have the money yourself), it would bea wise move to borrow the $5,000 (thereby creating a liability of $5,000 towards the bank).

Maybe it takes you a year to pay the debts, which comes to $6,000 in total after all the bank charges andinterest. Well, youve still made $34,000 from this($40,000-$6,000).


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New Shape of the Balance Sheet or the Statement of Position

Fixed Assets 1000

Current Assets 400

Current Liability -300

Working Capital 100

Working Capital 100

Fixed Assets 1000

Invested Capital 1100

Working Capital = Current Assets+ Current Liability

Invested Capital = Working Capital+ Fixed Assets

Invested Capital (1100) Financed By:

o

Owner Equity (400)o Long Term Liability (700)

Total Assets

Fixed Assets+ Current Assets = 1400

Total Liability

Current Liability+ Long Term Liability=1100

Owner Equity = 1400


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Income Statement(Aka statement of profit or loss or P&L): shows income, expenses, gains, and losses.The income statement shows financial results for the period it represents.It lets the user know how the business is doing in the short-term.

And you have to keep in mind that the companys performance is not just a question ofwhether it madeor lost money during the financial period.The issue at hand is more a matter of the relationship among the different accounts on the income

statement.

Net Revenue 45,000

Less : Cost of goods sold -20,000

Gross Margin 25,000

Less : Operating expenses -10,000

Operating Income 15,000

Less : Other gains and losses -5,000

EBIT (Earnings Before interest and Taxes) 20000

Less : Taxes -4000

EBI (Earnings Before Interest) 16000Less : Interest -3000

Net Income 13000

Revenueis the inflow of assets, such as cash or accounts receivable, that the company brings in by sellinga product or providing a service to its customers. In other words, its the amount of money the companybrings in doing whatever its in the business of doing.The revenue account shows up on the income statement as sales, gross sales, or gross receipts. All threenames mean the same thing: revenue before reporting any deductions from revenue. Deductions fromrevenue can be sales discounts,

Cost of goods sold(COGS) reflects all costs directly tied to any product a company makes or sells,whether the company is a merchandiser or a manufacturing company.If a company is a merchandiser (it buys products from a manufacturer and sells them to the generalpublic), the COGS is figured by calculating how much it cost to buy the items the company holds forresale,Because a manufacturer makes products, its COGS consists of raw material costs plus the labor costsdirectly related to making any products that the manufacturer offers for sale to the merchandiser.COGS also includes factory overhead, which consists of all other costs incurred while making theproducts.

Operating expensesare expenses a company incurs that relate to central operations and arent directly

tied to COGS.

Two key categories of operating Expenses show up on the income statement:

Selling expenses: Any expenses a company incurs to sell its goods or services to customers. Someexamples are salaries and commissions paid to sales staff; advertising expense; store supplies; anddepreciation of a retail shops furniture, equipment, and store fixtures. Typical retail shop depreciableitems include cash registers, display cases, and clothing racks.


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General and administrative (G&A)expenses: All expenses a company incurs to keep up the normalbusiness operations. Some examples are office supplies, officer and office payroll, non-factory rentand utilities, and accounting and legal services. If, after getting an A in your financial accountingclass, youre so bowled over by the subject that you seek employment as a financial accountant, yourpayroll is lumped into G&A too

Other income and expense: You classify all other income the company brings in peripherally as other

revenue or other income; either description is fine. This category includes interest or dividends paid oninvestments or any gain realized when the company disposes of an asset.For example, the company purchases new computers and sells the old ones; the amount the companymakes from the sale of the old ones is included in this category. Other expenses are expenses the companyincurs that arent associated withnormal operations.

Here are two types of expenses you typically see: Interest expense: cost of using borrowed funds for business operations, expansion, and cash flow. Loss on disposal of a fixed asset: If the company loses money on the sale of an asset, you report the

loss in this section of the income statement.

Most investors are vitally concerned about a companys ability to produce long-run earnings anddividends. In this regard, income statements are more important than balance sheets. (Other names for theincome statement include statement of earnings, statement of profit and loss, and P&L statement.)Income statements first list revenues, the total sales value of products delivered and services rendered tocustomers. From revenues they deduct expenses to get net income. We next examine how the format ofthe income statement can help users judge a companys performance.

Operating managementfocuses on the major day-to-day activities that generate sales revenue.

Financial managementfocuses on where to get cash and how to use cash for the benefit of theorganization. That is, financial management attempts to answer such questions as:

How much cash should we hold in our checking accounts?

Should we pay a dividend? Should we borrow money or issue common stock?

The best managers are superb at both operating and financial management.

The amount left after deducting all operatingand none-operating expensesfrom revenue is net income,sometimes called the bottom line. Although this book tends to use the term income most often, you willalso see the terms earnings andprofits used as synonyms.

Earnings Per Share: Income statements conclude with disclosure of earnings per share, which is netincome divided by the average number of common shares outstanding during the year.


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The Statement of Cash Flows (Showing the Money)The purpose of the statement of cash flows is to show cash sources (money coming into the business) anduses (money going out of the business) during a specific period of time. This information is used byinvestors and potential creditors to gauge whether the business should have sufficient cash flow to paydividends or repay loans.

The statement of cash flows is very important for financial accounting because generally accepted

accounting principles require you to use the accrual method of accounting. This means that you recordrevenue when it is earned and realizable (regardless of when money changes hands), and you recordexpenses when they are incurred (regardless of when they are paid). On the flip side, when using the cashmethod of accounting, a transaction isnt acknowledged until money changes hands. (A company may usea cash-basis statement for income tax return preparation.)

There are three sections on a statement of cash flows: operating, investing, and financing. Each sectionaddresses cash ins and outs that the business experiences under completely different circumstances:

Operating: This section shows items reflecting on the income statement. The three bigdifferences between the cash and accrual methods will be accounts receivable, which is moneyowed to the company by its customers; accounts payable, which is money the company owes to its

vendors; and inventory, which are goods held by the business for resale to customers.

Investing: This section usually shows the sale and purchase of long term assets. The purchase of

long-term assets reflects on the balance sheet.The sale of long-term assets reflects both on the balance sheet and income statement, (Incomestatement if we pay it in cash)It reflects on the balance sheet as a reduction of the amount of assets the company owns, and onthe income statement as a gain or loss from disposing of the asset.

Financing: The financing section shows the cash effects of long-term liability items (paying orsecuring loans beyond a period of 12 months from the balance sheet date) and equity items (the

sale of company stock and payment of dividends).


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Investments by and payments to the owners are not included on the Income StatementOperating activities include the cash effects of revenue and expense transactions.

Investing activities include the cash effects of purchasing and selling assetsFinancing activities include the cash effects of transactions with the owners and creditors

Window dressing occurs when management takes measures to make the company appear as strong aspossible in it financial statementsCreditors are more likely to extend credit if financial statements show a strong statement of financialpositionthat is, relatively little debt and large amounts of liquid assets


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Statement of Changes in Stockholders Equity(Return Earning Statement)To explain the changes in the stockholders equityaccounts, companies prepare a statement ofstockholders equity which shows the changes in each of the stockholders equity accounts:

Common Stock, Retained Earnings Capital in Excess of Stated Value, Accumulated Other Comprehensive Income ,

Notes from Lecture:

Managers are responsible for managing assets and liabilities

Manager Role is to get investment with low cost , and get financial resources with higher value

Golden Rule of Finance : Financing Short term liabilities with short term assets, and long term withliabilities with long term assets

Three Types of Decision in Finance: Financing Decision

Investment Decision Operation Decision


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Financial Statement Analysis and How to Interpret & Analyze Financial Statements

Evaluating Financial Performance

This section provides a clear and concise overview of specific financial ratios used to measurefinancial performance.

Performance areas covered include liquidity, asset management, profitability, leverage, marketvalue ratios, and comparative analysis.

The objective of this section is to provide the user with methodologies that can be useful in

measuring and monitoring financial performance.

Why Ratio Analysis? You must measure what you expect to manage and accomplish.

Without measurement, you have no reference to work with, and thus, you tend to operate in thedark.

One way of establishing references and managing the financial affairs of an organization is to usefinancial ratios.

Ratios are simply relationships between two financial balances or financial calculations.

These relationships establish our references so we can understand how well we are performingfinancially.

Ratios also extend our traditional way of measuring financial performance; i.e. relying on financialstatements.

By applying ratios to a set of financial statements, we can better understand financial performance.

The Use of Financial Ratios

Ratio analysis is used to compare a company's performance and status with that of anothercompany or itself over time.

The basic inputs to ratio analysis is items from Income statement and Balance Sheet Whats important in ratio analysis is the interpretation, rather than the calculation itself.

We should Consider the following

A single ratio does not generally provide sufficient information from which to judge the overall

performance of the firm. A group of ratios should be used The financial statements being compared should be dated at the same point in time during the

year. To avoid the effect of seasonality. Use audited financial statements. Compare financial statements with similar accounting treatments.


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Types of Ratio Comparison

Cross Sectional: The comparison of different Companies financial ratios at the same point intime; involves comparing the companys ratios to those of an industry leader or to the industryaverage.

Times series:Evaluation of the companys financial performance over time utilizing financialratio analysis

Combined analysis: Mix from the Cross Sectional and Times series

Dollar and Percentage Changes

Dollar Change = Analysis Period Amount - Base Period Amount

Percent Change = Analysis Period Amount - Base Period Amount

Trend Analysis is used to reveal patterns in data covering successive periods

o

Trend Percentages = (Analysis Period Amount / Base Period Amount ) *100

Component Percentages

Examine the relative size of each item in the financial statements by computing component

(or common-sized) percentages.

Component Percentage = (Analysis Amount / Base Amount) *100

Notes: The owners equity is simply the owners share of the assets of a business.Or In other words, it's the value of all the assets after deducting the value of assets needed to pay liabilities.

In other words: It is the value of the assets that the owner really owns.

Main Groups of Financial Ratios

Analyzing Liquidity

Analyzing Debt

Analyzing Activity (Asset Management)

Market Base Ratios

Analyzing Profitability


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Analyzing Liquidity: The liquidity of a business firm is measured by its ability to satisfy its short-termobligations as they come due.

For all three liquidity measures; the higher the value, the more liquid the firmis typically considered tobe.

However this low risk sacrifices profitability Current assets are less profitable/productive than fixed assets

Current liabilities are a less expensive financing source than long term funding

o Current Ratio: It is a measure of liquidity calculated by dividing the firms current assets by itscurrent liabilities

o Current Ratio = Current Assets / Current Liabilities

o Quick (Acid-test) Ratio: It is similar to the current ratio; except it excludes the inventory; which isgenerally the least liquid current asset.

o Quick Ratio = (Current assetsInventory) / Current Liabilities

o Cash RatioIt is a measure of liquidityo Cash Ratio = Cash / Current Liabilities

o Net Working Capital: A measure of liquidity calculated by subtracting current liabilities fromcurrent assets

o Net Working Capital = Current AssetsCurrent Liabilities

Net Working Capital It is only useful for internal control inside the company, not for comparisonwith other companies

Analyzing Debt: The debt position of a firm indicates the amount of other peoples money being used in

attempting to generate profits.

Generally, the more debt a firm uses in relation to its total assets, the greater its financial leverage.

Debt Ratio: It measures the proportion of total assets financed by the firms creditors

o Debt Ratio = Total Liabilities / Total Assets

Debt to Equity ratio: It measures the ratio of long-term debt to stockholders equity

o Debt to Equity Ratio = Long-Term Debt/Equity

Assets to Equity ratio: It measures an entity's leverage.

o Assets to Equity Ratio = Assets/Equity

Times Interest Earned : It measures the firms ability to make contractual interest payments

o Times Interest Earned= Earnings Before Tax / Interest Expense


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Asset Management: Activity ratios are used to measure the speed in which various accounts areconverted into sales or cash.

Inventory Turnover: It measures the activity or liquidity of a firms inventory

o Inventory Turnover = COGS / Inventory

Inventory Days on Hand (IDOH): It is the average length of time inventory is held by the firm

o Inventory Days on Hand = 365 / Inventory Turnover

Average Collection Period: It is the average amount of time needed to collect accountsreceivable

o Accounts Receivable Turnover= Sales / Accounts Receivableo Average Collection Period(ACP or Days Sales Outstanding) = 365 / A/R

Turnover

Average payment Period: It is the average amount of time needed to pay accounts payableo Accounts Payable Turnover= COGS / Accounts Payableo

Average Payment Period (APP)= 365 / A/P Turnover

Fixed Assets Turnover: It measures the efficiency with which the firm has been using its fixed orearning, assets to generate sales

o Fixed Assets Turnover = Sales / Net Fixed Assets

Total Assets Turnover: It indicates the efficiency with which the firm uses all its assets togenerate sales

o Total Assets Turnover = Sales / Total Assets

Cash conversion Cycle =Inventory Days on Hand + Accounts Receivable Turnover - Accounts Payable Turnover

o CCC= IDOH+ ACP- APP

Market Base Ratios: These ratios evaluate the firms stock price. These are indicators of what investorsthink of their previous and future earnings.

Earnings per Share (EPS): It represents the number of dollars earned on behalf of each

outstanding share of common stock.

o

EPS=Net Profit / Number of Shares of Common Stocks Outstanding

Price/Earnings Ratio (P/E Ratio) : It reflects the amount investors are willing to pay for eachdollar of the firms earnings; the higher the P/E ratio, the greater the investor confidence in the firm

o P/E Ratio=Market Price per Share of Common Stocks/Earnings Per Share


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Analyzing Profitability: Profitability Ratios measure how effectively a firms management is generatingprofits on sales, total assets, and stock holders equity.

Gross Profit Margin : It measures the percentage of each sales dollar remaining after the firmpaid for its goods

o Gross Profit Margin = Gross Profit / Sales

Operating Profit Margin: It measures the percentage of profit earned on each sales dollar beforeinterest and taxes

o Operating Profit Margin= Operating Profit / Sales

Net Profit Margin: It measures the percentage of each sales dollar remaining after all expenses,including taxes, have been deducted

o Net Profit Margin= Net Profit / Sales

Return on Total Assets: It measures the overall effectiveness of management in generatingprofits with its available assets.

o Return on Total Assets=Net Profit after Tax/Total Assets

Return on Assets (ROA):It measures the efficiency with which a company allocates andmanages its resources.

o ROA = Net Income / Assets

o ROA = Net Profit Margin X Assets turnover

Net Income Net income SalesROA = -------------- = ---------------- X -----------

Assets Sales Assets

Return on Equity: It measures the return earned on the owners equity in the firm

o Return on Equity = Net Profit / Stockholders Equity

o ROE = Net Profits Margin x Assets Turnover x Financial Leverage

Net income Sales AssetsROE = __________ x ___________ x _________________

Sales Assets (Shareholder's equity)

Is ROE a reliable Financial Yardstick?

TheTiming Problem: Because ROE necessarily includes only one years earning, it fails tocapture the full impact of multi period decision.

TheRisk Problem: ROE say nothing about what risks a company has taken to generate it

TheValue Problem: The market value of equity is more significant to shareholders because itmeasures the current, realizable worth of the share, while book value is only history.

Return on Investment: It measures the return earned on the Investment in the firm

o ROI = Net Income / Investment

Investment = Equity + Long Term Liability = Fixed Assets + Net working Capital

Documents

Management Accounting My Summery 1'St Term