Unit 12: Accounting Flashcards
Describe the role of accounting and financial information and key users Distinguish between managerial and financial accounting, and between private and public accounting Describe the role of accounting standards in preparing financial statements Differentiate between the Balance Sheet, Income Statement, and Cash Flow Statement Analyze financial statements using liquidity, leverage, profitability, and activity ratios
what is accounting
Recording, summarizing, and analyzing financial transactions to report financial information to decision makers
what is the financial impact of busness transactions
- Buying supplies; money spent, value of supplies bought
- Paying employees; payroll expense, cash paid to employees
- Obtaining a bank loan; money is received, principal & interest payments
- Selling a product; revenue earned, cash collected
why should transactions be tracked and presented in a meaningful way
- Good record keeping and financial statements can help stakeholders make well-informed decisions
- Financial statements show past performance to external stakeholders when requesting for additional funding
what are the 3 steps accounting information systems collect financial transactions
- inputs; Transactions usually have a “paper trail”; some sort of documentation/proof of the transaction
Ex. receipts, invoice - processing; Recording and categorizing details of the inputs, Can show a glimpse of specific totals
Ex. all sales that have occurred in the past month - outputs; Reports and statements summarizing financial transactions for stakeholders
what can be used to help with AIS, and who can use it
- technology helps individuals and companies maintain their AIS
- Start-ups can use a combination of spreadsheets & software
- Small businesses can use packaged accounting software (ex. QuickBooks) as an affordable option
what is the importance of record keeping & accurate and timely financial records
- Without proper record keeping, there can be issues with managing cash flow, inventory, or incorrectly pricing products
- Accurate and timely financial records are needed for start-ups to make important operational decisions
how can accounting software be helpful
- As companies grow, number of financial transactions will increase, more record keeping is required
- Software can make record keeping efficient, performing routine record keeping tasks and calculations quickly & access up-to-date information when needed
- Can also record similar transactions in a similar manner
- Can also put checks and balances (controls) to verify the accuracy of information added (ex. Another employee verifies the information, balance checks, etc.)
- Software can help crunch data, identify discrepancies, and prepare reports, but not make best decisions for the company moving forward
what are the limits of using accounting software
- Financial statements show what happened in the past, there are many factors that can impact the future
- Qualitative factors like changes in the business environment, strength of management/employees, competitive advantages can impact the success of the company
how does software change the role of accountants today
- Financial experts are needed to apply professional judgment and interpret numbers while considering the qualitative factors
- Since software does all of the tedious number crunching, accountants can spend more time analyzing, interpreting, and making recommendations to grow the company for the future
who assess financial information, and what do they do with it
stakeholders; to make informed decisions
what are examples of internal stakeholders
- Marketing personnel
- Operations personnel
- Human resources personnel
how are financial statements prepared for external stakeholders
- Summarized financial statements are prepared for them
- Each stakeholder may focus on different information within what is given in the statements
- Care more about overall balances in reports
what do internal stakeholders require with the financial statements
more detail
who are examples of external stakeholders
- Investors
- Analysts
- Lenders (banks)
- Government
what does marketing personnel want to know from financial statements
- Want to know the costs of making a product to set the price
- Want to assess sales volumes to determine the impact of their marketing efforts on sales (how should they change their marketing costs based on the results)
what does operations personnel want to know from financial statements
- Monitor production costs
- Keep material/labour costs within budget
what does human resources personnel want to know from financial statements
Managing employee costs like salaries
what does investors want to know from financial statements
- See if the public company is profitable or set up well for the future based on the financial statements
- If it is, they would consider investing
They are expecting to make a ROI
what does analysts want to know from financial statements
Review financial information and recommend investors on where they should invest
what does lenders (banks) want to know from financial statements
- Want to ensure they will be repaid in a timely manner before giving out the loan
- Focus more on current assets and existing debts
- If a company is determined to be more risky, they would grant a lower amount, have higher interest rate, or not grant the loan at all
what does the government want to know from financial statements
Canada Revenue Agency (CRA) wants to look at statements for tax collection purposes
what should entrepreneurs know about accounting & why
- Entrepreneurs may be focused on launching an idea, but also should know the basics of accounting to manage the business well
- Allows the business owner to assess the performance/health of the business, manage cash flow effectively, have control over purchase/selling decisions, develop goals and budget for growth, and comply with tax obligations
what are tasks related to accounting and financial management when starting a business
- set up for operations
- business planning
- tax compliance
how is setting up for operations related to accounting and financial management
- Set up bank accounts & signing authorities
- Design process to send and receive invoices
- Tracking inventory
- Record keeping - keep all receipts, recording transactions using an accounting software, or hiring a bookkeeper if needed
what should be known for cash flow management
- cash burn rate
- Determines how many months the company can continue operating until they run out of cash based on their current conditions and expenses
where is accounting and financial management needed in business planning
- cash flow management
- forecasting
what is cash burn rate
Determines how quickly business is using cash
how is cash burn rate calculated
cash / monthly operating expenses
- Don’t include one time costs in the monthly operating expenses
why is accounting and financial management needed for forecasting
Can help assess if the company can pay for day-to-day operations and plan for unexpected expenses that can happen in the next 12 months
what are 5 skills entrepreneurs need to know
- Managing cash flow - prevent unnecessary shortages
- Maintaining a balance sheet - glimpse of financial health
- Identifying a path to profitability - move beyond losses in early stages
- Communicating about money - can understand/discuss the numbers with variety of stakeholders
- Forecasting the future of the business - understand future revenues, operating costs, and resource needs to support growth
what are taxes entrepreneurs should know about when starting a business
- Sales tax; Varies depending on province/territory Ex. Harmonized Sales Tax (HST) is 13% for most goods and services in Ontario
- Payroll tax; Deducting Canadian Pension Plan (CPP)/Employment Insurance (EI) contribution and income tax on salaries
- corporate tax return; Corporate tax a company owes is net income x corporate tax rate,Due 6 months after the designated year-end
what are the 2 key areas of accounting
- managerial accounting
- financial accounting
what is managerial accounting
- Preparing financial information for decision makers inside a company
- Focuses on optimizing business areas like strategic planning, operations, marketing/sales, finance, and HR
- Can include detailed internal reports on sales, expenses, or inventory
- Help departmental manager compare actual performance to budgets/forecasts
what is financial accounting
- Preparing financial information for disclosure to stakeholders outside a company for their decision-making purposes
- Helps investor to decide to invest or not, or banks to approve loans or not
- External users look at the big picture and assess if the company is profitable or going to be profitable
- Financial information prepared can be financial statements and includes notes to explain the numbers and estimates used
where do public companies show their notes
in the published statements in their annual report
what is an annual report
Document required by law for shareholders, which includes a Management Discussion & Analysis (MD&A) section that shares what happened in the past year, and future plans
What is the CPA designation and who are CPAs
- CPA designation in Canada to become a member of a unified profession to serve the public interest
- CPAs are trusted business advisors and are deemed to be most valuable in a company
- They are relationship builders, strategically savvy, and trusted leaders
- CPAs can work as private or public accountants
who are private accountants (corporate accountants)
- Work in a single company, government, or non-profit organizations
- Organizations can have a few or a large team of accountants
which companies need to do audits
Audits are only required for public companies, but others can choose to do audits for more confidence in the numbers they share
who are public accountants
- Provide professional services for a fee
- Involved with external audits; review companies’ financial statements to see if they are fairly presented, share an accurate story of the company’s position, no misrepresentation or fraud, and is looked at with an unbiased opinion
- Public accountants may also provide consulting services
how are financial statements prepared (format)
- Financial statements prepared based on professional accounting standards followed by a company
- Standard used depends on the type of company & which country they operate in
what is the point of accounting standards
- ensure all reports are consistent
- Makes them comparable and useful to external stakeholders, making them easy to read and comparable for multiple companies
what are the 2 GAAP that can be followed in canada
- International Financial Reporting Standards (IFRS)
- Accounting Standards for Private Enterprises (ASPE)
“Principles” provide guidance and needs professional judgment
who uses IFRS
- Many countries use IFRS
- IFRS is required for all public companies
- Private companies can choose to use ASPE or IFRS
- Not all countries use IFRS
- IFRS is not required for public American companies, they use US GAAP
what is a pro for using ASPE
ASPE is simpler to implement and more relevant/adaptable to private companies
what is good about IFRS
- IFRS is a good because it is common standards to help financial statement users to easily compare one company with another
- IFRS provides a consistent format and set of principles to follow so it can be easy to understand, analyze, and interpret
what do accounting standards do for providing an accounting framework
guides:
- what information to present
- qualitative characteristics of the info presented
- quantifying financial statement elements
how does accounting standards tell what information to present on financial statements
Based on the potential users and decisions they will make based on the information
what are the qualitative characteristics financial statements should have
- Relevance and faithful representation; complete & accurate information is shared
- Comparability; can compare current performance with past performance or with other companies
- Verifiably; numbers and values can be confirmed
- Timeliness; information is provided in a timely manner to make decisions
- Understandability; information is clear and concise
what are quantifiable financial statement elements
- Recognition; when to record financial events
- Measurement; how to measure/value certain financial transactions
how can financial professionals contribute to reporting on the UN SDGs
- Voluntary reporting on progress towards UN SDGs to build a healthier, more prosperous, and inclusive world
- CPA Canada has identified 8 of the 17 SDGs where financial professionals can have the greatest impact
- Ethical professionals that serve the public interest
- Ability to measure, report, and provide assurance on financial and non-financial data
- Known for upholding good governance, risk management, control, business analysis, and decision-making
what do financial statements do
- tells the story of the company
Summarizes past transactions, and provides a glimpse of the overall performance and health of a company - Financial statements can be used to build trust with stakeholders; decision makers (lenders or investors) trust the information in the statements to make decisions
- Entrepreneurs should understand how financial statements can show if a new idea/business would work well
what are 3 financial statements
- balance sheet
- income statement
- cash flow statement
what is the balance sheet also known as
statement financial position
what is the income statement also known as
profit & loss statement
what is the cash flow statement also known as
- statement of cash receipts and disbursements
- statements of changes in financial position
what is the purpose of a balance sheet
Shows what a company owns and owes at a specific point in time (specific date)
what is the purpose of an income statement
Shows earning and expenses over a specific period of time (month, quarter, year)
what is the purpose of a cash flow statement
Shows cash inflows and outflows over a specific period of time (month, quarter, year)
what 3 main areas does a balance sheet highlight
- assets
- liabilities
- owner’s equity
what are assets
- owned economic resources that have value
- are generally recorded if controlled by a company, are a result of a past transaction, and result in future benefit to the company
what is the accounting equation
assets = liabilities + owners’ equity
what is double entry bookkeeping
means that for every financial transaction, there are at least 2 accounts involved to recognize the transaction
what are the types of assets
- current assets; can be converted into cash within 1 year, include: cash, A/R, inventory
- long-term assets (fixed/capital assets); used in operations for more than 1 year, and are generally owned to maintain/grow operations and revenue, include: equipment, buildings, land
- intangible assets; not physical, but have value that should be recognized, include: trademarks, patents, copyrights
how are assets listed on the balance sheet
in order of liquidity
what are the different types of liabilities
- Current liabilities; Obligations due within one year, include: A/Payable, short term loans, current portions of long-term debts
Long-term liabilities; Obligations due beyond one year, include: long-term loans, mortgages
what is owners’ (shareholders’) equity
represents what has been invested by owners plus the accumulated earnings that remain in the company (but have yet to be paid out to owners or used in operations)
what can owner’s equity include
- Common stock; What’s invested by shareholders
- Retained earnings; Accumulated earnings from operations retained and not paid out to shareholders
- Contributed surplus; Earnings generated outside of operations (e.g., selling shares above par value)
what are liabilities
- are amounts that a company owes to others
- are generally recorded if they are a present debt obligation of the company, the result of a past transaction, and result in a future cost to the company
what are the components of income statement
- revenue
- cost of goods sold (cogs)
- expenses
what is revenue
represents the money received for goods/services sold
what is cost of goods sold
represents the direct costs of making a product
what is gross margin & how is it calculated
- shows how much is earned by making/selling products before considering other operating expenses
calculated: revenue - cogs
what are expenses
costs involved in running the company, and are resources used with no residual economic value to recognize
what are the 3 categories of expenses
- selling expenses; costs for advertising and distributing
- general expenses; rent, utilities, supplies used
- administration expenses; employee costs (salaries & benefits)
how to calculate the net income (loss) aka the bottom line
gross margin - (operating expenses + taxes) =
what are the 3 areas of a cash flow statement
- Operating activities; Cash transactions in day-to-day operations, includes: collecting cash from sales & A/R, paying suppliers, paying employees
- Investing activities; Cash used to buy long-term assets like equipment, or cash received from the sale of equipment
- Financing activities; Cash used to finance the business with debt and equity, includes: receiving/repaying loans & dividends paid
what is the point of ratio analysis
- Ratio analysis is used to assess the performance and financial condition of a company
- Helps examine the relationships between various accounts and activities
- Can identify the strengths and weaknesses, and highlight trends overtime
- Can inform you about the earning power, solvency (ability to pay debts), efficiency, and debt load of a business
what are key elements of an auditors report
- What’s the audit opinion?
- What FS + time period is being looked at?
- What accounting standards are being followed?
- What is the company’s management responsible for?
- What is the auditor responsible for?
what are key performance indicators (KPIs)
- Used to regularly track and monitor how well the company is performing
- Specific ratios can be used as KPIs
who uses ratios and what do they use it for
- investors; to decide whether to buy or sell shares
- lenders; to determining if a company is in a good position to pay off their debts
what are liquidity ratios
- Evaluates how fast assets can be converted into cash
- How fast they can pay short-term debts
- Helps lenders gauge if a company has immediate resources to pay short-term obligations
what can you compare ratios with to interpret it
- prior year figures; if the company is doing better or worse compared to prior years, Or compare with goals/targets set
- Competitors; How the company is doing compared to key competitors, Do they have strengths in managing their assets, liabilities, generating revenues, or managing expenses?
- Industry averages; How well is the company doing compared to all other companies in the same industry?, if they are much different from the industry averages, what can the company do to change to remain competitive and succeed?
what does current ratio compare, how to calculate it, how to interpret it
- Current ratio = current assets / current liabilities
- Current ratio compares current assets and current liabilities
- If ratio is > 1, company is financially secure, lenders feel safe lending large amounts to the company
- Strong current ratio can vary depending on industry
- General rule of thumb: 2:1 ratio is ideal (2 assets for every liability)
what are leverage ratios
- Evaluates how much a company uses borrowed funds in their operations compared to investments made by owners
- More debt a company has, the more “levered” they are
what is the quick ratio asset test, how to calculate it, how to interpret it
- Quick ratio asset test = (current assets - inventory - prepaid expenses) / current liability
- Measures immediate short-term liquidity
- Considers current assets that are quite liquid to pay off current liabilities
- Having a 1:1 ratio is ideal, means company can completely pay off current liabilities w/o needing to sell inventory
what are the liquidity ratios
- current ratio
- quick ratio asset test
what are the leverage ratios
- debt to asset ratio
- debt to equity ratio
what is the debt to asset ratio, how to calculate it, how to interpret it
- Debt to asset ratio = Total liabilities / total assets
- Highlights % of assets financed by debt
Ex. 0.4 ratio = 40% of assets are financed by debt
what is the debt to equity ratio, how to calculate it, how to interpret it
- Debt to equity ratio = total liabilities / owners’ equity
- Anything over 1 (100%), means the company has more debt than equity
- Not unusual for companies to manage some level of debt
- Debt is obtained (borrowing) to increase/expand operations to generate more revenue
- High debt levels can be more acceptable/common in some industries than others (ex. manufacturing)
what are profitability ratios
- Evaluates how effectively a company uses its resources to achieve profits
- Sometimes used to assess management performance
what are the profitability ratios
- earnings per share
- return on sales (operating profit margin)
- return on equity (ROE)
what is earnings per share, how to calculate it, how to interpret it
- Earnings per share = Net income / average number of common shares
- Considers how much net income is earned per share
- Shareholders look at positive earnings and year-over-year growth in the EPS as a good sign that a company can continue to grow
what is return on sales, how to calculate it, how to interpret it
- Return on sales (operating profit margin) = net income / net sales
- Looks at operating performance by comparing net sales to net income
- Indirectly looks at how well costs/expenses are managed
- If return on sales increases over time, it means a company is managing costs effectively and retaining more earnings
what is return on equity, how to calculate it, how to interpret it
- Return on equity (ROE) = net income / average owners’ equity
- Measures profitability of an owner’s investment by showing how much is earned for each dollar invested
- Year over year growth in ROE can show that investors’ funds are being used effectively to grow the business
what is the inventory turnover ratio, how to calculate it, how to interpret it
- Inventory turnover ratio = cost of goods sold / average inventory
- Measures how fast a company sells inventory in a year
- Faster they can sell (turnover), the faster they can earn profit
- Quick turnover ensures inventory doesn’t expire or become obsolete (which could be costly)
Inventory turnover ratios can vary across industries (should be faster for a grocery store compared to a ski shop)
what are activity ratios (meaning)
Evaluates how effectively assets are managed to generate returns
what is an activity ratio
inventory turnover ratio
what is ESG
- Environmental; sustainability stuff
- Social; manages relationships (employees, suppliers, customers, communities)
- governance; ethical business conduct
how can CPAs help companies integrate ESG into business planning, financial decision making, and reporting
- Engage top leadership (Align goals with ESG)
- Lead net-zero initiatives (set targets + measure progress)
- Integrate ESG strategies (develop/implement with every decision)
