Financial Accounting 2

(BM020-3-1)

Review of
Financial Accounting 1

Learning Outcomes

To identify and describe the conceptual

and regulatory framework of financial
accounting.
Overview of nature of accounting
statements.

BM020-3-1-Financial Accounting 2

Introduction & Overview

The Nature of Accounting

The recording, measurement,
and interpretation of financial
information, often used in making
business decisions.

BM020-3-1-Financial Accounting 2

Introduction & Overview

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Uses for Accounting Information

Internal Uses:
Managerial
Accounting
Cash Flow
Budget

BM020-3-1-Financial Accounting 2

External Uses:
Reporting
financial
performance to
outsiders
Filing Income
Taxes
Obtaining Credit
Reporting to
Stockholders

Introduction & Overview

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Internal Accounting Information

Management
- Plan and set goals

Lenders & Suppliers

- Evaluate Credit Risks

- Organize
- Lead and motivate
- Control

BM020-3-1-Financial Accounting 2

Introduction & Overview

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External Accounting Information

Stockholders and
Potential Investors
- Evaluate soundness
of investments

BM020-3-1-Financial Accounting 2

Government Agencies
- Confirm tax liabilities
- Confirm payroll
- Deductions
- Approve new issues of
stocks and bonds

Introduction & Overview

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Areas of Accounting
Managerial Accounting :
Accounting used to provide information and analysis
to managers within the company to assist them in
decision making. E.g. cost accounting, controlling.
Financial Accounting :Field of accounting concerned with external users of
a companys financial information. This information
usually goes to owners and prospective owners,
creditors, employee unions, customers, suppliers and
governments agencies.
BM020-3-1-Financial Accounting 2

Introduction & Overview

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Financial Accounting (cont)

Auditing :Systematic examination of a companys accounting
system to determine whether its financial reports fairly
present its operations.
Independent Audit :An evaluation and unbiased opinion about the accuracy
of a companys financial statements.
Tax accounting :An accountant who is trained in tax law and is responsible
for preparing tax returns or developing tax strategies.
BM020-3-1-Financial Accounting 2

Introduction & Overview

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Accounting versus Bookkeeping

Bookkeeping is much narrower and more

mechanical than accounting.Mainly involves
recording of business transactions.
Bookkeeping is typically limited to routine day-today business transactions and obtaining and
recording information that accountants use in
financial analysis.

BM020-3-1-Financial Accounting 2

Introduction & Overview

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Accounting Cycle - 6 steps

Analyses of
source
documents

Record
transactions
in Journals
&
Daybooks

Transfer
(post)
journal
entries to
ledger

Analyses
Financial
Statements
& Accounting
Ratios

BM020-3-1-Financial Accounting 2

Introduction & Overview

Create
Trial
Balance

Preparing
Financial
Statements

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Accounting Cycle- (cont)

Journal :- The books where accounting data are first entered.
Double-entry:- The concept of writing every transaction in
two places.
Ledger :- Record, divided into accounts & usually compiled
on a monthly basis, containing summaries of all
journal transactions. Sometimes known as T-accounts.
Trial Balance :- A summary of all the data in the accounts
ledgers to show whether the figures are correct
and balanced.
BM020-3-1-Financial Accounting 2

Introduction & Overview

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Understanding Key Financial Statements

Financial Statement: - A summary of all transactions that
have occurred over a particular period.
E.g. of financial statements are Income statement ,
Balance Sheet , & Statement of cash flows.
Income Statement:- The financial statement in which the calculations of
gross profit and net profit are presented.
Balance Sheet:- Financial statement detailing a firms assets,
liabilities and owners equity at a given moment.
Statement of cash flows:- The financial statement that reports the amount
of cash collected and paid out by a firm during a
period of time.

BM020-3-1-Financial Accounting 2

Introduction & Overview

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Income Statement
A financial report that shows an organisations
profitability over a period of time. E.g. a month, quarter
or year.

BM020-3-1-Financial Accounting 2

Introduction & Overview

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Income Statement
(cont)

Revenue Cost of goods sold= *Gross Profit (Gross Margin)

Gross Profit Operating expenses = Net Income before taxes
Net income before taxes Taxes = Net income ( or loss)
Revenue
- Cost of goods sold
Gross Profit
- Operating expenses
Net income before taxes
- Taxes
Net income or loss
*Gross profit or sales profit or gross operating profit is the difference between revenue and the cost of
making a product or providing a service, before deducting overheads, payroll, taxation, and interest payments
BM020-3-1-Financial Accounting 2

Introduction & Overview

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Tans Flowers - Income

Statement
for the year ending 31 December
a)Revenues:
RM
RM 2009
Gross Sales
250,000
Less: Sales discount
Net Sales

10,000
240,000

b) Cost of Goods Sold

c) Gross Profit

(100,000)
140,000

d) Operating expenses:
Selling Expenses
General & Admin.
*Depreciation
Other expenses
12,000
Total Operating Expenses
Net income before taxes
Less: income tax expenses
e) Net Income/Profit

BM020-3-1-Financial Accounting 2

30,000
40,000
8,000
(90,000)
50,000
(11,000)
39,000

Introduction & Overview

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Income Statement
(cont)
a) Revenue: Funds that flow into a business from the sales
of goods or services.
b) Cost of goods sold: Total cost of obtaining materials for making the
products sold by a firm during a year.
c) Gross Profit: How much the firm earned by buying or selling
merchandise.
d) Operating Expenses: Cost incurred in operating a business such as
rent, utilities and salaries.
e) Net income: Profit or loss over a specific period after subtracting
all costs and expenses including taxes.
*Depreciation : Process of distributing the cost of an asset
over its life.
BM020-3-1-Financial Accounting 2

Introduction & Overview

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Understanding Key Financial Statements

Assets :- Any economic resource expected to benefit a firm
or individual who owns it.
Current assets:- Items that can be converted into cash within one
year. E.g. inventory & accounts receivable.
Non-current assets :- Assets with a long-term use or value normal more
that one year, such as land, buildings and
heavy equipments.
Intangible assets:- Items of value such as patents and
copyrights that have no real physical existence.

BM020-3-1-Financial Accounting 2

Introduction & Overview

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Understanding Key Financial Statements

Liability :- Debt owed by a firm to an outside organisation or
individual.
Current Liability :- Debt that must be paid within a year.
E.g. Accounts payable.
Non-current Liability :- Liabilities (Debt) that do not have to be paid within
twelve months of the balance sheet date. E.g. Loan
Capital:- Is the net worth of an individual or business. Or asset minus
liabilities.

BM020-3-1-Financial Accounting 2

Introduction & Overview

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The Accounting Process

The accounting equation is the basis for the
balance sheet:
Assets
Things
of value
that a firm
owns

BM020-3-1-Financial Accounting 2

= Liabilities + Capital
A firms debts
and obligations

The difference between a firms

assets and its liabilities

Introduction & Overview

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The Accounting Process

Double-Entry Accounting System:Bookkeeping system that balances the accounting equation
by recording the dual effects of every financial transaction.

Assets

= Liabilities + Capital

Example 1:
RM 800 = RM 300

+ RM 500

Example 2: If earned RM100, than the accounting equation:

RM 900 = RM 300
+ RM 600
Example 3: If you made a payment of RM 200 for companys
loan in cash than the accounting equation:
RM 700
= RM 100
+ RM 600
[(RM900 200) = (RM 300 200) + RM 600]
BM020-3-1-Financial Accounting 2

Introduction & Overview

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Key Balance Sheet Terms

Assets:
- Cash
- Accounts Receivable
- Inventory

Liabilities
- Accounts Payable
- Notes Payable
Capital
BM020-3-1-Financial Accounting 2

Introduction & Overview

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Tans Flowers - Balance Sheet as at

31
December
2009)
Assets:
RM
RM
Non-Current Assets:
Property & Equipment
Office Building
73,850
Equipment
11,050
Total non-current assets
84,900
Current Assets:
Merchandise Inventory
8,750
Accounts Receivable
10,200
Cash
17,850
Total Current Assets:
36,800
Total Assets:
121,700
Liabilities & Owners Equity
Current Liabilities:
Accts Payable
12,600
Total Current Liabilities
12,600
Non-Current Liabilities:
Mortgage Payable
23,600
Total Liabilities
(36,200)
Net Assets:
85,500
Owners Equity:
Tan Chew, Capital
85,500

BM020-3-1-Financial Accounting 2

Introduction & Overview

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Statement of Cash Flow

Statement of Cash Flow :
Financial statement that describing a firms yearly cash
receipts and cash payment related to a firms major activities;
a) Operations- cash transactions associated with running
the business.
b) Investments- cash used in or provided by the firms
investment activities.
c) Financing- cash raised from issuance of new debt or
equity capital or cash used to pay
business expenses, past debts, or
company dividends.
BM020-3-1-Financial Accounting 2

Introduction & Overview

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Analysing Financial Statements

Financial ratios are certain mathematical relationships
between numbers used to analyse financial statements.
Ratios are normally grouped into 3 major classifications:
a) Solvency ratios: financial ratio either short or long-terms
for estimating the risk in investing in a firm.
b) Profitability: financial ratio for measuring a firms
potential earnings.
c) Activity ratios: financial ratios for evaluating managements
use of a firms assets.

BM020-3-1-Financial Accounting 2

Introduction & Overview

Slide 1 of 13

Financial Ratios : Solvency Ratios

Short-term solvency ratios measures a companys relative
liquidity and thus ability to pay immediate debts. The higher a
firms liquidity ratios, then, lower the risk involved for investors.
Liquidity ratios: measures a companys ability to pay its
short-term debt. Most commonly used is
current ratio and working capital.
Current ratio is the ratio of a firms current assets to its
current liabilities.
Current asset
= 36,800 = 2.92
*Current ratio = Current liabilities
2,600
*(based on Tans Flowers Balance Sheet)

BM020-3-1-Financial Accounting 2

Introduction & Overview

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Financial Ratios : Solvency Ratios

Working capital is the day-to-day finance required to
run a business.
It is the finance required to pay for raw materials, running
costs, labour and to finance credit offered to customers.
Working capital can be calculated using the equation:
Working capital = Current assets current liabilities

BM020-3-1-Financial Accounting 2

Introduction & Overview

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Financial Ratios : Solvency Ratios

Debt ratio:- solvency ratio measuring a firms ability to meet
its long-terms debts. The most commonly used debt ratio is
the debt-to-owners equity ratio (or debt-to-equity ratio),
which describes the extent to which a firms is financed
through borrowed money.
Example:
Total Liabilities
Owners equity (Capital)

RM36,200 = 0.42*
RM85,500

* ( Normal; the lower the better for lenders)

BM020-3-1-Financial Accounting 2

Introduction & Overview

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Financial Ratios : Profitability Ratios

Return on Sales (Net Profit Margin)
= Net Income = RM 39,000 = 0.16 = 16%
Net Sales
RM 240,000
Return on Equity :- measuring income earned for each dollar
invested.
Return on Equity = Net Income = RM 39,000 = 0.45 =45%*
Owners equity RM 85,000
*( If 45% is lower that the ratios of other companies in the same
industry, it will be a concern)
BM020-3-1-Financial Accounting 2

Introduction & Overview

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Financial Ratios : Profitability Ratios

Earnings per share (EPS):
Profitability ratio measuring the size of the dividend that a
firm can pay shareholders.
As the ratio gets higher, the stock value increases, because
investors know the firm can better afford to pay dividends.

EPS =

BM020-3-1-Financial Accounting 2

Net Income
Number of common shares outstanding

Introduction & Overview

Slide 1 of 13

Financial Ratios : Activity Ratios

Activity ratios measure the firms efficiency in using its
resources. Example of activity ratio will be Inventory
Turnover Ratio which measures the speed of inventory
moving through the firm and its conversion into sales.
Inventory = Cost of goods sold = RM100,000 = 11.4
Turnover Average inventory
RM8,750

BM020-3-1-Financial Accounting 2

Introduction & Overview

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Budgeting
Budget A financial plan that sets forth for
the future in which it describes how it
will use its resources to meet
its goals.

BM020-3-1-Financial Accounting 2

Introduction & Overview

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Question and Answer Session

Q&A
BM020-3-1-Financial Accounting 2

Introduction & Overview

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What we will cover next

Financial ratios

BM020-3-1-Financial Accounting 2

Introduction & Overview

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Tutorial Discussions
For each transaction, show the effects on the
accounting equation.
a. Received cash from the proprietor as
additional investment in the business,
RM10,000.
b. Paid cash to Sunshine Company Ltd for
amount owed RM1,850.
c. Paid for purchase of office furniture with
cheque RM3,800.
d. Received cheque RM1,400 from Mrs Maxwell,
a customer, for amount owing.
BM020-3-1-Financial Accounting 2

Introduction & Overview

Tutorial Discussions
e. Repaid loan from the bank by writing a cheque for
RM15,000tothebank.
f.
Paid a 10% cash deposit to Sany Machines by
cheque for the purchase of machinery costing
RM12,000 with the balance to be paid in
instalments.
g. SoldgoodsoncredittoMall&Co,RM9,600
h.PaidchequeRM780forrentalofpremises.
i. Proprietor transferred cash RM5,500 from
personalaccounttobusinessaccount.

BM020-3-1-Financial Accounting 2

Introduction & Overview

BM020-3-1-Financial Accounting 2

Introduction & Overview

Class Exercises

BM020-3-1-Financial Accounting 2

Introduction & Overview

Answer

BM020-3-1-Financial Accounting 2

Introduction & Overview