As a non-traditional MBA candidate, I am learning accounting the summer before my program starts. I thought it would be helpful to publish these notes for people like me to reference as they learn accounting.
I find it extremely helpful to reference other people’s notes when studying new material, and I will update these notes as I go along.
Accounting Cycle / Process
1) Identify economic events = transactions
2) Measure in standardized units (dollars, etc)
3) Record transactions
4) Classify & summarize them
5) Report in form of financial statements
| Cash | Accrual |
| Recorded when cash paidTracks when cash changes hands | Revenues recorded when goods / services deliveredExpenses recorded when expense matches revenues or when it’s used up |
The chart below is one of my recent favorites. In trying to understand the relationship between the balance sheet, income statement and statement of cash flows, observe how the other two statements help bridge the gap between a beginning year balance sheet and an end of year balance sheet. The statement of cash flows illustrates what happened to the cash between those two periods, while the income statement shows the changes in the owner’s equity. Cool!
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Balance Sheet St. of Financial Position
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Income Statement St. of Operations
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Cash Flow St. of Retained Earnings |
| Snap shot = everything from dawn of time UNTIL NOWA = L + OE | Revenue flow over a period of time ( R – expenses) | – Shows gross margins, retained earnings & how dividends distributed- GAAP demands CF every time a company issues $ statements |
| Retained Earnings in OE contains Income Statement in different form! BS(IS) | – Accrual, not cash (??)- ALL the information contained in Retained Earnings Account | – Discloses cash to & from firm- Summarizes sources where cash came from & purposes they were applied to- Helps people know how trustworthy income streams are |
| Net worth = Equity = A – L | 1) Revenue / Net Sales / Retained Earnings 2) Cost of Goods Sold margin |
Sales – COGS = Gross MarginMinus ExpensesNet IncomePlus Retained EarningsLess Cash Dividend= Total Retained Earnings |
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Purpose |
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| – Show financial position at one point in time- Demonstrate balance of ALOE | – Evaluate company performance over a period of time- Illustrate inflows & outflows | – Shows how much of retained earnings distributed to owners- Links net income from income statement to change in retained earnings on balance sheet |
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Convention |
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At the top: Name of firm, name of statement, & date
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| Date = one point in timeSnapshot | Date = period of timeQuarter, month, week, etc. | Date = Fiscal Year ending 20XXOne specified fiscal year |
Capital expenditure ““ total $ spent on equipment
Cost of goods sold ““ cost of raw materials to produce the sold item
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Balance Sheet as of March 26, 2014
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Assets
Total Assets – $120,800 |
Liabilities
Total Liabilities – $40,800 Owner’s Equity – $80,000 Total Liabilities + Equity = $120,800 |
It’s good to understand how to do the “old school” way of recording transactions. While software programs automate everything these days, learning the old school way will help you know where on earth the numbers are coming from. In homework assignments, this understanding will help you solve “accounting mysteries” the professor makes up to ensure you understand the concepts.
Accruals ““ Liabilities and / or non-cash assets
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Ordering the Balance Sheet: A = L + OE
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Asset
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Liability |
Owner’s Equity |
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Includes |
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| Accounts ReceivableCashPrepaid InsuranceInventoryPlant & EquipmentInvestments | Accounts PayableBonds PayableUnearned Revenues | Capital StockRetained Earnings(Sales – Cost of Goods Sold, Salaries Expense, Interest Expense) | |||
| Cash, stuff that can be liquidated | Loans, IOU’s | Net worth, profit, A-L, “Equity”, Revenue ““ Expenses, “bottom line” | |||
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Liquidity Order |
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| Current AssetsCashCertificate of Deposit (CD)Accounts ReceivableAccrued Interest ReceivableInventory (Office Supplies, etc.)
Prepaid Insurance Total Current Assets = X Notes Receivable Plants & Equipment Machinery Building Land Total P&E = X Total Assets = X
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Current LiabilitiesAccounts PayableWages PayableIncome Tax PayableInterest PayableTotal Current Liabilities = X
Long-Tern Liabilities Notes Payable Mortgage Payable Total Long-Term Liabilities = X OE |
Owner’s EquityCapital StockRetained EarningsTotal Liabilities & OE = X (Market’s valuation different; price / share * # shares outstanding) | |||
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Current = Within 1 Year |
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| Accounts Receivable, Accrued Interest Receivable, Cash, Office Supplies, Prepaid Expenses | Rent payable, accrued salaries payable (???), trade payables | ||||
| Long-Term = More than 1 Year | |||||
| Machinery, Notes Receivable, Property |
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Translation & Application |
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| Cash = coins, dollars, checks to be deposited, BAFAccounts Receivable = Pay check, Renters’ checksAccrued Interest Receivable = BAF?, Interest on loan to familyNotes Receivable = loan to family | Accounts Payable = utilities, CapitalOne, WendyWages Payable = FranIncome Tax Payable = taxesNotes Payable = Mortgage | Retained Earnings = Margin on rent checks (can take the form of ANY asset account: cash, inventory, accounts receivable, property, equipment, etc.) | |||
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↑ |
↓ |
↓ |
↑ |
↓ |
↑ |
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Increase |
Decrease |
Decrease |
Increase |
Decrease |
Increase |
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+ |
– |
– |
+ |
– |
+ |
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Debit |
Credit |
Debit |
Credit |
Debit |
Credit |
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More on Debits & Credits
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Asset |
Liability |
Owner’s Equity |
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| Usually Debit | Usually Credit | Usually Credit | |||
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When It’s Opposite |
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| Deducting CashDepreciation | ExpensesCOGS | ||||
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Contra Accounts |
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| Accumulated DepreciationAllowance for Doubtful Accounts | Sales Discounts, Returns & Allowances | Purchase Returns, Discounts & AllowancesTreasury Stock | |||
Depreciation ““ distribute cost of large assets evenly over useful life
(Deduct cost from cash, add back depreciation amount?)
Amortization ““ same thing as depreciation but for intangibles
Straight-line ““ depreciates at a constant rate over its useful life
Sum of the years; digits & Double-declining balance ““ Asset depreciates faster in early life and slower in later years
**Changes are always ++ or — unless they’re done in the same category (A, L or OE) +- or -+
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Income Statement
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| Net Sales | |
Cost of Good Sold
Gross Margin
Expenses
Wages Expense
Administration Expense
Utilities Expense
Depreciation Expense
Total Expenses
Income Before Taxes
Income Tax Expense
Net Income = XRetained Earnings 20WW
Add: Net Earnings for 20XX
Less: Dividends
Retained Earnings for 20XX
Asset Contra Account ““ Balance either credit (negative / be subtracted ) zero
Accumulated Depreciation
Sales = Revenue
Cost of Goods Sold = Expense
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Stocks: Growth vs. Value
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Growth |
Value |
| Higher risk | Lower Risk |
| Pay larger proportion of dividend to shareholders | Reinvest larger proportion of retained earnings |
| Company whose goal is aggressive growth | More stable, wanting to maintain what it has and please shareholders, giving back to them |
| Examples: | Examples: P&G |
Retained Earnings = Net income ““ Dividends
Income Statement for March 26, 2014
Revenue
- Sales Revenue – $800
- Service Revenue – $400
- Interest – $20
Total Revenue – $1,220Expenses
- Advertising – $5
- Cost of Goods Sold – $5
- Other – $10
Total Expenses – $20Net Income – $1,200
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Cash Flow
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| Created from comparative balance sheet and / or income statement | |||
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Net income + Depreciation for the Period
Net Income + Noncash Expense ““ Noncash Revenue
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| Noncash Expense = Amortization of intangibles, depreciation of plan assets, depletion of natural resources | Noncash Revenue = accrued rev not yet collected (often depreciation expense only one reported) | ||
Increase or Decrease?
Increase ↑
Cash Flow Into Business
“Source”
Decrease ↓
Cash Flow Out of Business
“Use”
↑ Cash
↓ Cash
↓ Noncash A
↑ L
↑ OE↑ Noncash A
↓ L
↓ OE
Classifying Different Activities
Operating
Investing
Financing
OA
IA
FA
Internal activities, Inventory, etc.Property, P&E, LT Investments & noncurrent assetsLong-term debt
Common stock
DividendsUses info from income statement + current accounts from balance sheetUses info from noncurrent asset section of balance sheetUses info from retained earnings, long-term debt + stockholder’s equity on BSReceivables, Inventory, Other Current Assets, Payables & Accruals, Taxes Notes payable, stock
Two Cash Flow Methods
Direct
Indirect
Preferred by FASB
Shows more detail about cash payments
Starts with net income & shows changes to convert it to cashShows cash collected from customers & paid to suppliers, employees, interest & taxes
Positive cash flows = revenues
Negative cash flows = expenses
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Ratios |
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Profitability |
Liquidity |
Financial |
| Efficiency in generating profits | Ability to pay off debts | Stability of capital structure |
| Investors | Creditors | |
| Profit Margin = Return on Sales | ||
Gross Sales
Return on Assets
Return on Equity
Asset Turnover
Earnings / Share
Price-Earnings
Payout
Times Interested Earning
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Profitability Ratios
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Abbreviation |
How to Calculate |
What It Measures |
Ideal |
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ROS |
NI / NS | Ability to turn sales into profits |
↑ |
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GM |
GM / NS | Relates COGS to Sales |
↑ |
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ROA |
NI / Avg A | Earning power of A |
↑ |
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ROE |
NI / Avg OE | Earning power of OE |
↑ |
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A/T |
NS / Avg A | Productivity of A |
↑ |
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EPS |
NI / Avg # ShOut | Earnings / share of stock |
↑ |
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P/E |
MP / EPS | Value of earnings in marketplace |
↑ |
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PO |
Div / NI | Share of earnings that owners receive |
↑ |
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X/I |
PBIT / IE | Coverage of interest charges | |
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Liquidity Ratios
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Abbreviation |
How to Calculate |
What It Measures |
Ideal |
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WC |
CA – CL | Excess funds available |
↑ |
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Cur |
CA / CL | Short-term debt payment ability |
↑ |
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Quick |
Quick A / CL | ST liquidity |
↑ |
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R/T |
NS / Avg Rec | Reasonableness of A/R level |
↑ |
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ACP |
Avg Rec / Daily S or NS | Effectiveness of collections |
↓ |
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I/T |
COGS / Avg Inv | Effect. Of inventory investment |
↓ |
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AIP |
Avg Inv / Daily COGS | Ability to control inventory |
↑ |
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OC |
Avg Rec + Avg Inv | Time required from production to cash |
↓ |
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Financial Ratios
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Abbreviation |
How to Calculate |
What It Measures |
Ideal |
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D/A |
L / A | % of A financed by debt |
↓ |
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E/A |
OE / A | Protection to creditors |
↑ |
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D/E |
L / OE | Relationship b/w borrowing & capital |
↓ |
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D/C |
LT Debt / LTD + OE | % of permanent debt in firm |
↓ |