CHAPTER TEN

Financial
Accounting
10– 1
 LEARNING OUTCOMES

In this chapter, you will learn to:

 Define the accounting system and bookkeeping.
 Differentiate between financial accounting and management
accounting.
 Explain the accountants and accounting profession.
 Identify fundamental accounting concepts.
 Elaborate on financial statements: income statement,
balance sheet and cash flow statement.
 Analyze the financial statements.
 INTRODUCTION

• Ultimate business goal is to maximize owners’ or

shareholders’ wealth.
• Business transactions involve financial matters that
require financial decisions.
• To survive in today’s competitive market,
comprehensive knowledge in accounting and
financial management is vital.

10– 3
 ACCOUNTING

Accounting
• Process of identifying, classifying,
recording and summarizing business
transactions, interpreting and
communicating the results to interested
parties to assist them in making
decisions.

10– 4
 Who Uses
Financial Reports?

Accounting that provides financial

information that managers inside (Internal)
Managerial
the organization can use to evaluate and
Accounting make decisions about current and future
operations.

Accounting that focuses on preparing

external financial reports that are used by
Financial
outsiders (External) such as lenders,
Accounting suppliers, investors, and government
agencies to assess the financial strength of
a business.

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 The Accounting System

1
6
 Reports Provided by the
Accounting System

1
7
 Financial Statements in the Annual
Report

Balance Sheet
Income Statement
Statement of Cash Flows

8
1
 FUNDAMENTAL
ACCOUNTING CONCEPTS

Two fundamental accounting concepts in record

keeping:
• Accounting equation
• Double-entry system

10– 9
ACCOUNTING EQUATIONS

10– 10
 The Accounting Equation

__ __
__ Owners’
Assets Liabilities
Equity

Things of value What a firm Investment in

owned by a firm owes the firm minus
to its creditors; liabilities;
debt Net Worth

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3
 ELEMENTS OF
ACCOUNTING EQUATIONS

• Assets: Economic resources owned by the business.

• Liabilities: Amounts owed by the business to external
parties.
• Owner’s equity: Residual amount after deducting all
business assets with all business liabilities, i.e. owner’s
claim against net assets of a business.
• Capital: Resources supplied by the owner to the business.
• Drawings: Any business resource that is taken by the owner
from the business for personal purposes or uses.
• Revenue: Income earned by a business.
• Expenses: Costs incurred to operate a business.

10– 12
 DOUBLE ENTRY SYSTEM

• Every record of business transaction will affect

two items in the accounting equation.
• Recording is from the business point of view.
• Every transaction involves two accounts: one
account will be recorded in the debit side; at the
same time, the other account will be credited.
• Accounting equations must be maintained.

10– 13
 DETERMINATION OF ACCOUNTS

Debit Group: Asset, Expenses and Drawings

(Increase: Debit, Decrease: Credit)

Credit Group: Capital, Revenue and Liabilities

(Increase: Credit, Decrease: Debit)

10– 14
 Basic Accounting Procedures

What are the six steps in the accounting cycle?

3 15
 The Accounting Cycle

3 16
 The Balance Sheet

In what terms does the balance sheet describe

the financial condition of an organization?

4 17
 The Balance Sheet

Resources of a company
(Assets)

Company’s obligations
Categories
(Liabilities)

Owners’ Equity
(assets minus liabilities)

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 Assets
Cash
Marketable securities
Current assets Accounts receivable
Notes receivable
Inventory

Land and buildings

Machinery and equipment
Fixed assets
Furniture
Fixtures

Patents,
Copyrights
Intangible assets
Trademarks
Goodwill
4
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 Liabilities

Accounts payable
Notes payable
Current liabilities Accrued expenses
Income taxes payable
Current portion of long-term debt

Bank loans
Long-term
Mortgages on buildings
liabilities
Company’s bonds sold to others

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 Owners’ Equity

Owners’ total investment after

Owners’ Equity all liabilities have been paid

4
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 Owner’s Equity

Retained The amounts left over from profitable

Earnings operations since the firm’s beginning;
equal to total profits minus all dividends
paid to stockholders.

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A2 Transaction Analysis

J. Scott invests $20,000 cash to start the

business in return for stock.
Assets = Liabilities + Equity
Accounts Notes Common
Cash Supplies Equipment Payable Payable Stock
(1) $ 20,000 $ 20,000

$ 20,000 $ - $ - $ - $ - $ 20,000

$ 20,000 = $ 20,000
1-23
A2 Transaction Analysis

Purchased supplies paying $1,000 cash.

Assets = Liabilities + Equity
Accounts Notes Common
Cash Supplies Equipment Payable Payable Stock
(1) $ 20,000 $ 20,000
(2) (1,000) $ 1,000

$ 19,000 $ 1,000 $ - $ - $ - $ 20,000

$ 20,000 = $ 20,000

1-24
A2 Transaction Analysis

Purchased equipment for $15,000 cash.

Assets = Liabilities + Equity
Accounts Notes Common
Cash Supplies Equipment Payable Payable Stock
(1) $ 20,000 $ 20,000
(2) (1,000) $ 1,000
(3) (15,000) $ 15,000

$ 4,000 $ 1,000 $ 15,000 $ - $ - $ 20,000

$ 20,000 = $ 20,000

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A2
Transaction Analysis

Purchased Supplies of $200 and

Equipment of $1,000 on account.
Assets = Liabilities + Equity
Accounts Notes Common
Cash Supplies Equipment Payable Payable Stock
(1) $ 20,000 $ 20,000
(2) (1,000) $ 1,000
(3) (15,000) $ 15,000
(4) 200 1,000 $ 1,200

$ 4,000 $ 1,200 $ 16,000 $ 1,200 $ - $ 20,000

$ 21,200 = $ 21,200

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A2 Transaction Analysis

Borrowed $4,000 from Maybank.

Assets = Liabilities + Equity
Accounts Notes Common
Cash Supplies Equipment Payable Payable Stock
(1) $ 20,000 $ 20,000
(2) (1,000) $ 1,000
(3) (15,000) $ 15,000
(4) 200 1,000 $ 1,200
(5) 4,000 $ 4,000
$ 8,000 $ 1,200 $ 16,000 $ 1,200 $ 4,000 $ 20,000

$ 25,200 = $ 25,200

1-27
A2 Transaction Analysis

The balances so far appear below. Note that the

Balance Sheet Equation is still in balance.
Assets = Liabilities + Equity

Accounts Notes Common

Cash Supplies Equipment Payable Payable Stock
Bal. $ 8,000 $ 1,200 $ 16,000 $ 1,200 $ 4,000 $ 20,000

$ 8,000 $ 1,200 $ 16,000 $ 1,200 $ 4,000 $ 20,000

$ 25,200 = $ 25,200

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 P1 Balance Sheet

Scott Company
The Balance Sheet describes
Statement of Retained Earnings
a company’s financial position For Month Ended December 31, 2009
at a point in time.
Retained Earnings, Dec. 1, 2009 $ -
Plus: Net income 2,200
Less: Dividends 500
Scott Company
Retained Earnings, Dec. 31, 2009 $ 1,700
Balance Sheet
December 31, 2009

Assets Liabilities
Cash $ 9,700 Accounts payable $ 1,200
Supplies 1,200 Notes payable 4,000
Equipment 16,000 Total liabilities 5,200
Equity
Common stock 20,000
Retained earnings 1,700
Total assets $ 26,900 Total liabilities and equity $ 26,900
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 The Income Statement

How does the income statement report a firm’s

profitability?

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 The Income Statement

Revenues

Categories Expenses

Net Profit (or Net Loss)

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 Revenues

Gross sales:

The total dollar amount of a

company’s sales

Revenues
Net sales:

The amount left after

deducting sales discounts
and returns and allowances
from gross sales
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 Expenses

Cost of goods sold:

The total expense of buying

or producing the firm’s
goods or services

Expenses
Operating expenses:

The expenses of running a

business that are not directly
related to producing or
5 buying its products

33
 Net Profit or Loss

Obtained by subtracting a
firm’s expenses from
Net Profit revenues (when revenues are
more than expenses)

Obtained by subtracting a
firm’s expenses from
Net Loss revenues (when expenses are
more than revenues)
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P1 Income Statement

Scott Company
Income Statement Net income is the
For Month Ended December 31, 2009
difference
Revenues: between
Consulting revenue $ 3,000 Revenues and
Expenses:
Salaries expense 800 Expenses.
Net income $ 2,200

The income statement describes a

company’s revenues and expenses along
with the resulting net income or loss over a
period of time due to earnings activities.
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 The Statement of Cash Flows

Why is the statement of cash flows an

important source of information?

6 36
 The Statement of Cash Flows

Operating activities

Cash Flows
Investment activities
from…

Financing activities

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P1 Statement of Cash Flows

Scott Company
Statement of Cash Flows
For Month Ended December 31, 2009

Cash flows from operating activities:

Cash received from clients $ 3,000
Purchase of supplies (1,000)
Cash paid to employees (800)
Net cash provided by operating activities $ 1,200
Cash flows from investing activities:
Purchase of equipment (15,000)
Net cash used in investing activities (15,000)
Cash flows from financing activities:
Investment by Shareholders 20,000
Borrowed at bank 4,000
Dividends Paid (500)
Net cash provided by financing activities 23,500
Net increase in cash $ 9,700
Cash balance, December 1, 2009 -
Cash balance, December 31, 2009 $ 9,700
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 Relationship between Balance
sheet, Income statement and
cash flow
Beginning of year (1 Jan 2014) End of year 31 December

Balance sheet Income Statement Balance sheet

Asset Liabilities Event RM RM Asset Liabilities

Cash RM1000 Equity RM1000 Goods sold 1000 Cash RM1300 Equity RM1000

Cost of sale (500) Retain

earning RM 300
Wages (200) (700)
RM1000 RM1000 RM1300 RM1300
Net Profit 300

Cash flow Date Event Dt Cr Balance

statement 1 Jan Cash 1000

1 Jan Purchase stock 500

2 Jan Sell goods 1000

3 Jan Wages 200

Balance 1300
 Breakeven Quantity (BEQ)

10– 40
 Breakeven Quantity (BEQ)
Example (Nasi Ayam)

10– 41
 CHAPTER ELEVEN

Financial Management

11– 42
 LEARNING OUTCOMES

In this chapter, you will learn to:

 Explain what financial management is.
 Relate corporate finance to legal forms of business
organization.
 Discuss the goal of the firm.
 Explain the agency problem.
 Elaborate the firm’s capital structure and the cost of capital.
 Discuss capital raising and elaborate capital markets.
 Elaborate capital budgeting process.
 Discuss corporate costs control.
 Explain time value of money, present and future value.

11– 43
 What is Finance?

• Finance can be define as art and science of managing

money.
• At the macro level, finance is the study of financial
institutions and financial markets and how they operate
within the financial system in both the Malaysian and
global economies.
• At the micro level, finance is the study of financial
planning, asset management, and fund raising for
businesses and financial institutions.
• Financial management can be described in brief using
the following balance sheet.
© 2004 Pearson Education Canada Inc.
1-44
 Relationship to Accounting

• Cash Flows
– Accrual Basis: In preparation of financial
statement, recognizes revenue at the time of sale
and recognizes expenses when they are incurred.
– Cash Basis: Recognize revenue and expenses only
with respect to actual inflows and outflows of
cash.
 Accounting vs. Financial Views

Accounting View Financial View

(Accrual Basis) (Cash Basis)
Income Statement Cash Flow Statement
Peakes Quay, Inc. Peakes Quay, Inc.
For year ended 12/31 For year ended 12/31

Sales revenue $100,000 Cash inflow $ 0

Less: Costs 80,000 Less: Cash outflow 80,000
Net Profit $ 20,000 Net cash flow ($80,000)
 FINANCIAL MANAGEMENT

• Deals with the maintenance and creation of

economic value or wealth.
• Involves the dimensions of:
– Investment decision
– Financing decision

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 FINANCIAL MANAGEMENT
DECISIONS

• Investment decision
– Choose the most promising investment venture
that offers the highest expected return after
considering the risks involved.
• Financing decision
– Decide on how to raise funds (cheapest) to
finance the company’s investment ventures.

11– 48
 TIME VALUE OF MONEY

“A dollar received today is worth more

than a dollar received in the future.”

• Time value of money means money that could

have been obtained sooner would have an
opportunity to earn an interest income.
• Future value is the interest compounded value of
the present value.

11– 49
 The Rule of 72

•
 The Rule of 72

•
 PRESENT AND FUTURE VALUE

• The application to that financial concept of time value of money

is in the computation of present value and future value.
• If you possess RM100 and you deposit that amount into a bank’s
fixed deposit account that gives 10% interest per annum, after a
period of one year, you will see your fixed deposit account
increase to RM110. Why?
• Because apart from the original principal sum of RM100, the
bank will credit RM10 interest payment into your account, that
being the 10% interest earned.
• So, the original RM100 is the present value and RM110 is the
future value in one year given a 10% interest return a year.

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 Simple Interest

Interest is earned on principal

$100 invested at 6% per year

1st year interest is $6.00
2nd year interest is $6.00
3rd year interest is $6.00
Total interest earned: $18.00
 Compound Interest

• When interest paid on an

investment during the first period
is added to the principal; then,
during the second period, interest is
earned on the new sum.
 Compound Interest

Interest is earned on previously earned interest

$100 invested at 6% with annual compounding

1st year interest is $6.00 Principal is $106.00
2nd year interest is $6.36 Principal is $112.36
3rd year interest is $6.74 Principal is $119.11
Total interest earned: $19.11
 Future Value

- The amount a sum will grow in a

certain number of years when
compounded at a specific rate.
 Future Value

FV1 = PV (1 + i)
Where FV1 = the future of the investment at the end of one year
i= the annual interest (or discount) rate
PV = the present value, or original amount invested at the
beginning of the first year
 Future Value

What will an investment be worth in 2 years?

$100 invested at 6%
FV2= PV(1+i)2 = $100 (1+.06)2
$100 (1.06)2 = $112.36
 Future Value

• Future Value can be increased by:

• Increasing number of years of compounding
• Increasing the interest or discount rate
 Future Value

What is the future value of $500 invested at 8% for 7

years? (Assume annual compounding)
Using the tables, look at 8% column, 7 time periods.
What is the factor?
FV2= PV(1+i)7
= $500 (1+.08)7
= $500 (1.714)
= $857
 Present Value

The current value of a future payment

 Present Value

•
 Capital Budgeting Techniques

– Project Evaluation and Selection

 Project Evaluation: Alternative
Methods

– Net Present Value (NPV)

 Proposed Project Data

Julie Miller is evaluating a new project for

her firm, Basket Wonders (BW). She has
determined that the after-tax cash flows for
the project will be $10,000; $12,000;
$15,000; $10,000; and $7,000, respectively,
for each of the Years 1 through 5. The
initial cash outlay will be $40,000.
 Net Present Value (NPV)

NPV is the present value of an

investment project’s net cash flows
minus the project’s initial cash
outflow.

CF1 CF2 CFn

NPV = + +...+ - ICO
(1+k)1 (1+k)2 (1+k) n
 NPV Solution

Basket Wonders has determined that the

appropriate discount rate (k) for this project is
13%.
NPV = $10,000 +$12,000 +$15,000 +
(1.13)1 (1.13)2 (1.13)3
$10,000 $7,000
4 + 5 - $40,000
(1.13) (1.13)
 NPV Solution

NPV = $8,850 + $9,396 + $10,395 +

$6,130 + $3,801 - $40,000
=- $1,428
 NPV Acceptance Criterion

The management of Basket Wonders has

determined that the required rate is 13%
for projects of this type.
Should this project be accepted?

No! The NPV is negative. This means that the

project is reducing shareholder wealth. [Reject
as NPV < 0 ]