The Nature of Accounting Systems

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1 Basic Accounting & Budgeting February 4, 2009 The Nature of Accounting Systems Accounting is the process of recording, classifying, summarizing, reporting and interpreting information about the economic activities of an organization. This information is communicated to stakeholders of the organization to help them in decision making. These Stakeholders include: Managers Investors Suppliers Government agencies Employees The financial information captured by the accounting system is usually communicated through reports called financial statements. Including: Income Statements Balance Sheets Cash Flow Statements

2 Income Statement The income statement captures revenue, expenses and net income over a period of time. Important elements of an income statement: Revenue is the monetary compensation given to the organization in exchange for good and services provided Expenses are the cost incurred by the organization in providing the goods and services to its customers Net Income (Losses) is the difference between income and expenses, depending on which is greater Example Income Statement Income Statement For the Period Ending December 31, 2008 As of As a % of Dec 31, 08 Total Revenue REVENUE: Ice Cream Sales $ 6, Baked Goods 2, NET REVENUE $ 8, COST OF GOODS SOLD Labor 2, Materials 1, TOTAL COST OF GOODS SOLD 3, GROSS PROFIT 4, EXPENSES: Selling, General, and Administrative Sales Salaries Management Salaries Utilities Expense Employee benefits TOTAL SG&A EXPENSES OPERATING INCOME (LOSS) $ 3, Interest expense PRE-TAX INCOME $ 3, Income Taxes (1,046) (13.1) NET INCOME (LOSS) $ 2,

3 Balance Sheet The balance sheet shows assets, liabilities and owner s equity at a point in time. Important elements of a balance sheet: Assets are the resources owned by the organization. These resources can be classified as fixed or current, and as tangible or intangible. Liabilities are the obligations of the organization to other organizations. The obligations can be classified as long-term or current. Equity is the residual amount left after liabilities are subtracted from the assets of an organization. This amount represents the actual value of ownership the shareholders have in the organization after all of their obligations are met The accounting equation: The relationship of the three types of accounts listed above is represented by the accounting equation: Assets = Liabilities + Equity Example Balance Sheet Balance Sheet As of December 31, 2008 As at Dec 31, 08 ASSETS: Current Assets Cash 250 As a % of Total Assets $ 33.3 Accounts Receivable Inventory Prepaid Expenses Total Current Assets Fixed Assets Property & Equipment Less: Accumulated Depreciation Total Net Fixed Assets TOTAL ASSETS $ LIABILITIES: Current Liabilities Accounts Payables Current Portion of Long-Term Debt Total Current Liabilities Long-Term Liabilities Long-term Debt Total Long-Term Liabilities TOTAL LIABILITIES SHAREHOLDERS' EQUITY Total Shareholders' Equity TOTAL LIABILITIES & SHAREHOLDERS' EQUITY $

4 Why an Accounting System is Important An effective accounting system captures large amounts of data and organizes it into understandable, useful information This information is used within the organization for a variety of purposes, such as: Development of Business Strategy Identification of Areas of Risk Budgeting Trend Analysis And also by those outside of the organization, for purposes such as: Prospective Investing Creditworthiness Tax Liability Determination Regulatory Compliance The Importance of a Budget A budget gives an organization a method of presenting its future expectations, and measuring actual results against those expectations In measuring differences between expectations and actual results, management can indentify Areas of the business that need improvement Areas of success Unrealistic expectations Developing Trends In Identifying these things, management can better focus its efforts, and gain a clearer understanding of the key factors to the organization s success

5 Creating a Budget Steps in Creating a Budget: Forecast revenue Forecast expenses Record actual results and compare to forecasts Identify variances and determine possible causes Adjust budget to reflect adjusted assumptions, goals and circumstances Example Budget Monthly Budget for 2009 January January February February March March Budget Actual Budget Actual Budget Actual Budget Actual REVENUE: Ice Creame $ 600 $ 575 $ 630 $ 580 $ 650 $ - $ 8,000 $ - Baked Goods NET REVENUE ,800 - COST OF GOODS SOLD Labor ,500 - Materials ,500 - TOTAL COST OF GOODS SOLD ,000 - GROSS PROFIT ,800 - EXPENSES: Selling, General, and Administrative Sales Salaries Management Salaries Utilities Expense Employee benefits TOTAL SG&A EXPENSES ,100 - OPERATING INCOME (LOSS) ,700 - Interest expense PRE-TAX INCOME ,500 - Income Taxes (35) (30) (40) (45) (45) - (500) - NET INCOME (LOSS) $ 185 $ 190 $ 215 $ 200 $ 235 $ - $ 3,000 $ -

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