Chapter 6: Accounting

Assoc. Prof. Nguyen Phuc

Nguyen, Ph.D
 Learning objective
Introduction to Business - Assoc. Prof. Nguyen Phuc Nguyen

1. Explain why accurate accounting information and audited

financial statements are important.
2. Interpret a balance sheet.
3. Interpret an income statement.
4. Describe business activities that affect a firm’s cash flow.
5. Summarize how managers evaluate the financial health of a
business.

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 What is accounting?
Introduction to Business - Assoc. Prof. Nguyen Phuc Nguyen

➢ Accounting: The process of systematically collecting,

analyzing, and reporting financial information.
✓ Can be used to answer questions about what has happened in
the past or to help make decisions about the future
➢ Audit: An examination of a company’s financial
statements and the accounting practices that produced
them.
✓ To help ensure that corporate financial information is accurate
and to prevent accounting scandals
➢ Accounting problems have forced many investors,
lenders and suppliers, and government regulators to
question the motives behind fraudulent and unethical
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 Different Types of Accounting
Introduction to Business - Assoc. Prof. Nguyen Phuc Nguyen

➢ Managerial accounting: Provides managers and

employees with the information needed to make
decisions about a firm’s financing, investing, marketing,
and operating activities.
➢ Financial accounting: Generates financial statements
and reports for interested people outside an organization.
➢ Additional special areas of accounting include
✓ Cost accounting: Determining the cost of producing specific
products or services.
✓ Tax accounting: Planning tax strategy and preparing tax returns
for firms or individuals.
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 The Accounting Equation
Introduction to Business - Assoc. Prof. Nguyen Phuc Nguyen

➢ Assets: The resources that a business owns

➢ Liabilities: A firm’s debts and obligations
➢ Owners’ equity: The difference between a firm’s assets
and its liabilities
➢ Accounting equation: The basis for the accounting
process:
Assets = Liabilities + Owners’ equity
✓ For every kind of business, the total dollar amount for
assets must equal the sum of its liabilities and owners’
equity.

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 Assets
Introduction to Business - Assoc. Prof. Nguyen Phuc Nguyen

➢ Liquidity: The ease with which an asset can be converted

into cash
✓ On a balance sheet, assets are listed in order from the most
liquid to the least liquid.
➢ Current assets: Assets that can be converted quickly into
cash or that will be used in one year or less
➢ Fixed assets: Assets that will be held or used for a period
longer than one year.
➢ Depreciation: The process of apportioning the cost of a
fixed asset over the period during which it will be used.
➢ Intangible assets: Assets that do not exist physically but
that have a value based on the rights or privileges they
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 The Accounting Equation
Introduction to Business - Assoc. Prof. Nguyen Phuc Nguyen

Liabilities and Owners’ Equity

➢ Current liabilities: Debts that will be repaid in one year or less
✓ Include accounts payable, notes payable, salaries payable, taxes
payable
➢ Long-term liabilities: Debts that need not be repaid for at least one
year
OWNERS’ OR STOCKHOLDERS’ EQUITY
➢ For a sole proprietorship or partnership, the owners’ equity is shown
as the difference between assets and liabilities.
➢ For a corporation, the owners’ equity usually is referred to as
stockholders’ equity.
➢ Retained earnings: The portion of a business’s profits not
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 The Accounting Equation
Introduction to Business - Assoc. Prof. Nguyen Phuc Nguyen

➢ Double-entry bookkeeping system: A system in which

each financial transaction is recorded as two separate
accounting entries to maintain the balance shown in the
accounting equation
✓ A firm’s accountants record the firm’s day-to-day financial
transactions using the double-entry bookkeeping system.
➢ Annual report: A report distributed to stockholders and
other interested parties that describes the firm’s
operating activities and its financial condition
✓ At the end of a specific accounting period, all of the financial
transactions are summarized in the firm’s financial statements
and included in the firm’s annual report.
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 Personal Balance Sheet
Introduction to Business - Assoc. Prof. Nguyen Phuc Nguyen

➢ Balance sheet (or statement of financial position): A

summary of the dollar amounts of a firm’s assets,
liabilities, and owners’ equity accounts at the end of a
specific accounting period.

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 Business Balance Sheet
Introduction to Business - Assoc. Prof. Nguyen Phuc Nguyen

Note that assets ($340,000) equal liabilities plus owners’ equity

($340,000) and the accounting equation is still in balance 0 / 10
 Income Statement
Introduction to Business - Assoc. Prof. Nguyen Phuc Nguyen

➢ Income statement:
A summary of a
firm’s revenues and
expenses during a
specified accounting
period.
➢ The difference
between income and
expenses for an
individual is referred
to as a cash surplus
or cash deficit.
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 Business Income Statement
Introduction to Business - Assoc. Prof. Nguyen Phuc Nguyen

➢ The difference
between income and
expenses for a
business is referred
to as profit or loss
Revenues – Cost of
goods sold –
Operating expenses
= Net income

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 The Income Statement
Introduction to Business - Assoc. Prof. Nguyen Phuc Nguyen

Revenues
➢ Revenues: The dollar amounts earned by a firm from
selling goods, providing services, or performing
business activities
➢ Gross sales: The total dollar amount of all goods and
services sold during the accounting period
Gross sales – Sales deductions = Net sales
✓ Deductions include sales returns, sales allowances, sales
discounts
➢ Net sales: The actual dollar amounts received by a firm
for the goods and services it has sold after adjustment
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 The Income Statement
Introduction to Business - Assoc. Prof. Nguyen Phuc Nguyen

Cost of Goods Sold

➢ Cost of goods sold: The dollar amount equal to
beginning inventory plus net purchases less ending
inventory
Cost of goods sold = Beginning inventory + Net purchases –
Ending inventory
➢ Gross profit: A firm’s net sales less the cost of goods
sold
Gross profit = Net sales – Cost of goods sold

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 The Income Statement
Introduction to Business - Assoc. Prof. Nguyen Phuc Nguyen

Operating Expenses
➢ Operating expenses: All business costs other than the
cost of goods sold
✓ Selling expenses: Costs related to the firm’s marketing activities
✓ General expenses: Costs incurred in managing a business
Net Income
➢ Net income: Occurs when revenues exceed expenses
➢ Net loss: Occurs when expenses exceed revenues
Net income from operations = Gross profit – Total operating expenses
Net income before taxes = Net income from operations – Interest
expense
Net income after taxes = Net income before taxes – Federal income taxes
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 The Statement of Cash Flows
Introduction to Business - Assoc. Prof. Nguyen Phuc Nguyen

➢ Statement of cash flows: A statement that illustrates

how the company’s operating, investing, and financing
activities affect cash during an accounting period.

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Introduction to Business - Assoc. Prof. Nguyen Phuc Nguyen

Flows
of Cash

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Statement
 The Statement of Cash Flows
Introduction to Business - Assoc. Prof. Nguyen Phuc Nguyen

Cash Flow for a Manufacturing Business

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 Average Prime Interest Rate Paid by
U.S. Businesses, 1990–March 2021
Introduction to Business - Assoc. Prof. Nguyen Phuc Nguyen

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 Evaluating Financial Statements
Introduction to Business - Assoc. Prof. Nguyen Phuc Nguyen

Comparisons of Present and Past Financial Statements for

Microsoft Corporation

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 Evaluating Financial Statements
Introduction to Business - Assoc. Prof. Nguyen Phuc Nguyen

Financial Ratios
➢ Financial ratio: A number that shows the relationship
between two elements of a firm’s financial statements
MEASURING A FIRM’S ABILITY TO EARN PROFITS
➢ Net profit margin (return on sales): A financial ratio
calculated by dividing net income after taxes by net
sales
✓ Indicates how effectively the firm is transforming sales into
profits
✓ A higher return is better than a low one
✓ A low return on sales can be increased by reducing expenses
and increasing sales
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 Evaluating Financial Statements
Introduction to Business - Assoc. Prof. Nguyen Phuc Nguyen

MEASURING A FIRM’S ABILITY TO PAY ITS DEBTS

➢ Inventory turnover: A financial ratio calculated by
dividing the cost of goods sold in one year by the
average value of the inventory
✓ A high current ratio indicates that a firm can pay its current
liabilities.
✓ A low current ratio can be improved by repaying current
liabilities, by reducing dividend payments to stockholders to
increase the firm’s cash balance, or by obtaining additional cash
from investors.

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 Evaluating Financial Statements
Introduction to Business - Assoc. Prof. Nguyen Phuc Nguyen

MEASURING HOW WELL A FIRM MANAGES ITS

INVENTORY
➢ Inventory turnover: A financial ratio calculated by
dividing the cost of goods sold in one year by the
average value of the inventory
Average value of the inventory:
(Beginning inventory + Ending inventory) ÷ 2
✓ The average inventory turnover for all firms is about 9 times per
year, but turnover rates vary widely from industry to industry.
✓ The quickest way to improve inventory turnover is to order
merchandise in smaller quantities at more frequent intervals.

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 Group Activity
Introduction to Business - Assoc. Prof. Nguyen Phuc Nguyen

This has been a bad year for Park Avenue Furniture. The firm increased sales
revenues to $1,400,000, but total expenses ballooned to $1,750,000. Although
management realized that some of the firm’s expenses were out of control,
including cost of goods sold ($700,000), salaries ($450,000), and advertising
costs ($140,000), it could not contain expenses. As a result, the furniture
retailer lost $350,000. To make matters worse, the retailer applied for a
$350,000 loan at Fidelity International Bank and was turned down. The bank
officer, Mike Nettles, said the firm had a net loss for the last 12 months and
that the firm already had too much debt. At that time, liabilities totaled
$420,000 and owners’ equity was $600,000.
Working as a team, complete the following activity:
1. Analyze the financial condition of Park Avenue Furniture.
2. Discuss why you think the bank officer turned down Park Avenue’s loan
request.
3. Prepare a detailed plan of action to improve the financial health of Park
Avenue Furniture over the next 12 months. 0 / 24