Module 7 - Understanding Accounting and Financial Information - STUDENT PDF

Module 07: Understanding Accounting and Financial Information  Why does financial literacy matter? “Weak financial literacy...

Module 07: Understanding Accounting and Financial Information  Why does financial literacy matter? “Weak financial literacy may be the single biggest reason why small businesses don’t succeed” Image source: https://business.financialpost.com/entrepreneur/fp-startups/its-time-to-bridge-the-entrepreneur-financial-literacy-gap  Why does financial literacy matter? The most common ways for businesses to fail financially Image source: theseamuss/iStock/Thinkstock Optional* If you are having difficulty understanding finance, accounting and how it all fits together, please watch this video. https://www.youtube.com/watch?v=WEDIj9JBTC8  Accounting and Financial Information and the BMC mage source: https://strategyzer.com/canvas/business-model-canvas 6 6 Topics for discussion 1. What is accounting and the accounting system and what is its importance to business and its stakeholders? 2. How do each of the different accounting disciplines meet the needs of the stakeholders they serve? 3. How has technology impacted accounting and bookkeeping? 4. What are the basics of every accounting framework and why are generally accepted accounting rules and principles necessary? 5. What are the 3 main financial statements and what information do they each provide? 6. How do financial ratios enhance the value of accounting information and what are the basic 7 7 Role of accounting and financial information Accounting: – recording, classifying, summarizing, and interpreting financial events (transactions) to provide management and other interested parties (stakeholders) with the information they need to make good decisions. 8 8 Role of accounting and financial information What are financial events? transactions that have taken place – e.g. Buying supplies Paying employees Receiving or repaying a loan Selling a product or service Paying expenses like rent, insurance etc. 9 9  Test your knowledge Keeping track of financial transactions is very important to a firm's operations. All of the following activities would be considered a financial event EXCEPT: A. buying and selling goods and services. B. using supplies. C. paying taxes.  D. forecasting consumer demand. 10 10  Role of accounting and financial information Who are stakeholders? - Examples of internal stakeholders: Marketing Operations Human resources staff staff management staff Image source: leremy/iStock/Thinkstock 11 11  Role of accounting and financial information Who are stakeholders? - Examples of external stakeholders: Investors Creditors Suppliers Government (use debt covenants) Image sources: investor – Created by Luis Prado from the Noun Project; bank – Created by Kelcey Hurst from the Noun Project; 12 12 truck – Created by Jonathan Li from the Noun Project; government – Created by Mike Gifford from the Noun Project  Role of accounting and financial information Figure: Figure 16.1, Understanding Canadian Business, 9th Cdn ed. © 2016 McGraw-Hill Education Limited 13 13  Test your knowledge The reports and financial statements prepared by accountants: A. are much more useful for profit-seeking businesses than for non-profit organizations. B. are mainly used to help the firm complete its tax forms.  C. provide information that can be used by decision- makers both inside and outside the organization. D. have lost much of their relevance as firms have moved into a more global environment. 14 14 Module 07: Understanding Accounting and Financial Information Accounting disciplines and serving the needs of stakeholders Accounting disciplines Accounti Key stakeholders Examples of Examples of ng types of types of disciplin information decisions es Manageri Internal Daily, Strategy and al Management weekly, direction – monthly short and long reports (e.g. (eg. term sales, Buy vs. lease production) Breakeven KPIs Monitoring Internal F/S variances to Budgets and plan and forecasts making adjustments Financial External Quarterly or Lending Lenders/ annual Investing Creditors financial Meeting Investors statements covenants or Government/ Annual other 16 16 Regulators report regulatory Accounting disciplines Accounti Key Examples of Examples of types ng stakeholders types of of decisions disciplin information es Complianc Lenders/ Audit Lending e – Audit Creditors opinions Investing Investors Internal Granting or renewal Government/ audit of licenses Regulators reports Monitoring controls Management Tax Government Tax returns Tax planning Management and related Charge and collect reporting taxes Tax opinions Maintain special tax status, eligibility for grants, credits and other tax incentives Consultin Anyone with a Research Investing g& problem to reports, Valuation Advisory solve opinions Buy/Sell 17 17 Accounting disciplines Government and not-for-profit accounting – Government:public sector financial standards and sharing information with taxpayers – Not-for-profit: making financial information available to donors (eg. Charities) 18 18  Accounting disciplines Accounting professionals Private accountant: works for a single firm, government agency, or non-profit organizations Public provides services to accountant: individuals or businesses on a fee –basis Compliance (audit, tax, regulatory etc.) – Consulting Image source: Discussion & Analysis Magazine, Chartered Professional Accounts of Ontario 19 19 Module 07: Understanding Accounting and Financial Information Technology and Accounting  Technology and Accounting Accounting technology Accounting software has simplified the accounting process – Inputs – Processing – Outputs Advantages: – Efficiency – Timeliness – Consistency & accuracy Disadvantages: – Set-up and customization Still require financial Image source: Intuit, Inc. experts! 21 21  Technology and Accounting Accounting vs. bookkeeping Recording Bookkeepin Accountin Summarizing and g g and classifying interpreting Focus on Focus on inputs and processing processing and outputs 22 22 Figure: Figure 16.1, Understanding Canadian Business, 9th Cdn ed. © 2016 McGraw-Hill Education Limited  Test your knowledge Today's computerized accounting programs are:  A. very helpful for small business owners who lack strong accounting support within their companies. B. too expensive for most small businesses. C. easily affordable, but seldom necessary for the simple needs of the typical small business. D. so sophisticated that they can make most financial decisions without the aid of an accountant. 23 23  Test your knowledge Konrad is exhausted after working a 70-hour week. Late Friday night he receives a call from a potential investor, asking why meals & entertainment expenses in his business are so high in 2018. Since he’s too tired to research the explanation, he could really use the services of a(n) _____________ : A. bookkeeper  B. accountant C. cloud accounting software D. psychiatrist 24 24 Module 07: Understanding Accounting and Financial Information The basics Accounting - the basics… Accounts: for each type of asset, liability, revenue, expense, owner’s contributions Double-entry:every transaction affects at least two accounts Example Account Account OSAP Cash (asset) OSAP loan (liability) Purchasing office supplies Cash (asset) Supplies (expense) Sale of a product for Cash (asset) Sales (revenue) cash 26 26 Accounting - the basics… Balanced (the fundamental accounting equation): Assets - Liabilities =Owners’ Equity What was invested by the owners (owner’s contributions) AND retained earnings (revenue less expenses – cumulative) Own – Owe = Worth 27 27 Accounting - the basics… Balanced (the fundamental accounting equation): Own - Owe = Worth (Assets) (Liabilitie (Owners’ s) Equity) OSAP increase - increase = no impact Supplies decrease - no impact = decrease Sale increase - no impact = increase 28 28  Test your knowledge Vanessa has just spent $1,500 on Jimmy Choo shoes. They’re expected to be unusable in less than one year. How would you journalize this transaction? A. Increase cash $1,500 & Increase supplies expense $1,500 B. Decrease cash $1,500 & Increase supplies expense $1,500 C. Decrease cash $1,500 & Increase wardrobe assets $1,500 D. Decrease cash $1,500 & Decrease wardrobe 29 29  Test your knowledge How would the previous transaction look in the fundamental accounting equation? Recall: decrease cash $1,500 & increase supplies expense $1,500 A. Assets ↓ $1,500 – Liabilities N/A = Owner’s Equity ↓ $1,500 B. Assets ↓ $1,500 – Liabilities ↓ $1,500 = Owner’s Equity N/A C. Assets ↓ $1,500 – Liabilities ↑ $1,500 = Owner’s Equity N/A D. Assets ↓ $1,500 – Liabilities ↑ $1,500 = Owner’s 30 30 Module 07: Understanding Accounting and Financial Information Accounting rules and principles  Accounting rules and principles Guidelines for proper and consistent reporting and disclosure of transactions – Generally Accepted Accounting Principles (GAAP) International Financial Reporting Standards (IFRS) Accounting Standards for Private Enterprises (ASPE) Image source: CPA Canada 32 32 Accounting rules and principles Why are generally accepted and used accounting standards and rules necessary? To ensure: consistency and comparability understandability usefulness accuracy 33 33 Accounting rules and principles Basic framework outlines – What information to present – Format of presentation – Characteristics of the information presented Relevant Faithful representation (complete, accurate, neutral/free of bias) Comparability (consistency) Verifiability Timeliness Understandability – Measurement – Recognition 34 34  Accounting rules and principles Measurement: Example: Car – at cost or market value? – at time of purchase or at a given point in time? Image source: https://www.autotrader.co.uk/used-cars 35 35 Accounting rules and principles Recognition: Accrual vs Cash – record revenues when earned – record expenses in the same period as the revenues they relate to (matching) – regardless of the timing of cash inflows and outflows related to these financial events 36 36 Practice – Accrual vs Cash It’s early December and one of your customers has ordered 1,000 widgets from you on account. You complete the order and deliver them, but don’t receive payment until January. Taking into account the basics you’ve just learned, what should be recorded in each of the months noted below to properly account for sale transaction? December – Record sale of 1,000 widgets to customer January Record receipt of payment from customer Own (Assets) - Owe = Worth (Liabilitie (Owners’ s) Equity) December December A/R (asset) - - No impact = Sales (revenue) increase –- increase increase January Cash (asset) – - No impact = No impact increase & A/R (asset) – decrease 37  Accounting rules and principles Recognition Matching – Prepaid expenses E.g. Rent Own (Assets) - Owe = Worth (Liabilitie (Owners’ s) Equity) Beginning Prepaid - No impact = No impact of month 1 expenses (asset) – increase & Cash (asset) - decrease Months 1 - Prepaid Image source: Elvetica/iStock/Thinkstock - No impact = Rent (expense) 38 38  Accounting rules and principles Recognition Matching – Capital Assets E.g. Delivery truck Own (Assets) - Owe = Worth (Liabilitie (Owners’ s) Equity) Purchase of Capital asset – - No impact = No impact truck increase & Cash – decrease Years 1-4 Capital asset – - No impact = Amortization / decrease depreciation (expense) - decrease 39 39 Image source: Iurii Lupol/iStock/Thinkstock Module 07: Understanding Accounting and Financial Information Financial statements Financial statements Balance sheet (or statement of financial position) – Assets and liabilities (difference = owner’s equity) – At a point in time Income statement (or statement of revenues and expenses, profit and loss [P&L]) – Revenues and expenses (difference = profit or loss) – For a period of time Cash flow statement (or statement of cash receipts and disbursements) – Cash inflows and outflows – For a period of time 41 41 Financial statements The balance sheet Balance sheet: reports a company’s financial condition at a specific time The basis of the balance sheet is the fundamental accounting equation Assets – Liabilities = Owner’s Equity 42 42  Financial statements The balance sheet includes: Assets: economic resources owned (listed by liquidity) – Current assets – Capital assets (fixed assets) – Intangible assets Liabilities: what the business owes to others – Current liabilities – Long-term liabilities Owners’ equity: investments by owners + profits that have accumulated since the business commenced – Or shown as “Shareholder’s equity” Common stock Retained earnings 43 43  Financial statement s Figure: Figure 16.6, Understanding Canadian Business, 9th Cdn ed. © 2016 McGraw-Hill Education 44 44 Limited  Financial statements The balance sheet Image source: Loblaw Companies Limited 45 45  Financial statements The income statement Income statement: shows profit (profit = revenues - expenses) – “Bottom line”  net income/loss Profit maximization – Revenue maximization – Cost minimization 46 46 Financial statements The income statement includes: Revenue – value received for goods sold or services provided Cost of goods sold – the costs associated with producing the goods that were sold – significant costs include: materials, direct labour and overhead Gross profit/margin – Revenue less cost of goods sold Operating expenses – costs in operating a business selling expenses general or administrative expenses Net income/loss after tax 47 47  Financial statement s Figure: Figure 16.8, Understanding Canadian Business, 9th Cdn ed. © 2016 McGraw-Hill Education 48 48 Limited  Financial statements The income statement Image source: Loblaw Companies Limited 49 49 Financial statements Cash flow statement Reports cash receipts and disbursements – Operating – relate to day-to-day operations – Investing – primarily relate to long-term assets – Financing – primarily relate to long-term liabilities or owners’ transactions e.g. dividends 50 50  Financial statemen ts Figure: Figure 16.9, Understanding Canadian Business, 9th Cdn ed. © 2016 McGraw-Hill Education 51 51 Limited  Financial statements Cash flow statement Image source: Loblaw Companies Limited 52 52  How is this possible? How can a profitable company, with growing sales, be forced to close their doors? - cash flow statement can provide some clues 53 53 Image source: James Pauls/iStock/Thinkstock  Test your knowledge Which financial statement represents what the company owns and owes as of a specific date? A. Income statement.  B. Balance sheet. C. Cash flow statement. D. Trial balance. 54 54 Module 07: Understanding Accounting and Financial Information Ratio analysis  Ratio analysis Ratio assess a firm’s financial condition analysis: and evaluate relationships between various accounts/activities – Identify strengths/weaknesses – Identify trends – KPIs – Allow for comparison Image source: vasabii/iStock/Thinkstock 56 56  Ratio analysis Once you calculate a financial ratio, what should you compare it with? Prior years, budget, objectives/targets Competitors Industry averages/rules of thumb Image source: MPFphotography/iStock/Thinkstock 57 Ratio analysis Liquidity ratios – measure a company’s ability to turn assets into cash and pay its short term debts Current assets Current ratio= Current liabilities 2:1 ratio is ideal Acid-test Cash + receivables + marketable securities = (quick) ratio Current liabilities Ignores inventory to assess immediate short-term liquidity 1:1 ratio is ideal 58 58 Ratio analysis Leverage (debt) ratios – measure the degree to which a firm relies on borrowed funds to operate Total liabilities Debt to owners’ equity= Owners’ equity Less than 1:1 is ideal 59 Ratio analysis Profitability (performance) ratios – measure how effectively management is using its resources to achieve profits Net income after tax Earnings per share = # of common shares outstanding Net income after tax Return on sales = Net sales Net income after tax Return on equity = Average owners’ equity 60 60  Ratio analysis Activity ratios – measures how effective management is at turning over inventory Cost of goods sold Inventory turnover = Average inventory Can vary across industries Ski shop Grocery store Image source: Grocery – Created by A.M. Briganti from the Noun Project; Skis – Created by Norbert Kucsera from the Noun Project 61 61  Test your knowledge The financial ratios that measure a firm's ability to pay its short-term debts are called: A. leverage ratios.  B. liquidity ratios. C. equity ratios. D. profitability ratios. 62 62  Ratio analysis Practice! Review financial statements Calculate ratios – Current ratio – Acid Test ratio – Debt to Equity ratio – Return on Sales – Return on Equity – Inventory Turnover Image source: Loblaw Companies Limited 63 63  Financial statements The balance sheet Current ratio Current assetsAcid-test (A) ratio 2,947,536,000 Current liabilities (B) Cash (A) 2,064,832,000 66,290,000 A/B receivable (B) Accounts 1.43 540,132,000 Debt to owners' equity Marketable securities (C ) - Total liabilities (A) 3,109,140,000 Current assets excluding inventory - A+B+CShareholders' (D) equity 606,422,000 (B) 4,515,681,000 Current liabilities (E) 2,064,832,000 A/B 0.69 D/E 0.29 Current ratio = 1.43 Acid-test ratio = 0.29 Debt to equity = 0.69 Image source: Loblaw Companies Limited 64 64  Financial statements The income statement Return on equity Net earnings (A) 601,685,000 Return on sales Shareholders' equity - opening (B) 4,318,450,000 Net earnings (A) 601,685,000 Shareholders' Inventory equity - ending (C ) turnover 4,515,681,000 Sales Cost (B) Average of goods 11,057,659,000 sold (A) shareholders' equity B+C/2 (D) 6,793,334,000 4,417,065,500 A/B Inventory A/D - opening (B) 5.44% 2,148,484,000 13.62% Inventory - ending (C ) 2,299,418,000 Average inventory - B+C/2 (D) 2,223,951,000 A/D 3.05 Return on sales: 5.44% Return on equity: 13.62% Inventory turnover: 3.05 times 65 65 Image source: Loblaw Companies Limited  Financial statements Cash flow statement Image source: Loblaw Companies Limited 66 66 For next week 8 : d u le Mo cial t a n e n Fin agem ter 17 a n M e ad C h ap R rg et: iz ’ t fo 8 q u Don odule ember M e N ov du efore h b 8t 9 pm 5 11: 67 67