What Is Accounting ?

What is
Accounting ?
ACCOUNTING
Accounting is a systematic record of daily
(or even hourly) events of a business leading
to the presentation of a complete financial
picture.
In simple words:
“Accounting is the recording of all types of
financial transactions in a business.”
Recording can be made of any type of

financial transaction such as Purchase, Sales,
Expense, Profits, Losses, Liabilities, Assets
owned etc.
BUSINESS
 Any activity undertaken with the objective
of earning profit is called a “Business”.
 Business is classified into three groups.
(A) Servicing: E.g. Doctors, Teachers, Tax

Consultants, Law Firms, Mobile Companies etc.
(B) Trading: Petrol Pumps, grocers, motor dealers,

garment shops etc.
(C) Producing or Manufacturing: Sugar Industries,

Cement Industries, Paper Mills etc.
BUSINESS ORGANIZATION
 Sole Proprietorship/Sole
Ownership
 Partnership
 Company/Corporation
HEADS OF ACCOUNTING
 ASSETS
 EXPENSE
 LIABILITY
 REVENUE
 CAPITAL
ASSETS
 “ALL ECONOMIC RESOURCES
OWNED and CONTROLLED BY A
BUSINESS TO GET FUTURE
BENEFITS.”
FOR EXAMPLE
 CASH, MACHINE, EQUIPMENT,
BUILDING, LAND, FURNITURE, BANK

ACCOUNTS ETC
EXPENSE
“AMOUNT PAID FOR BUSINESS

ACTIVITIES”.
For Example:
 RENT EXPENSE
 SALARIES EXPENSE
 REPAIR EXPENSE
 INSURANCE EXPENSE
 UTILITIES CHARGES etc

REVENUE
“Amount received or to be received
from the sale of good or service.”
For example:
 COMMISSION INCOME
 SERVICE INCOME
 SALES REVENUE
 INTEREST INCOME
 RENT INCOME etc

LIABILITY
“AMOUNT DUE ON BUSINESS.”

For Example:
 LOAN TAKEN FROM BANK
 GOODS BOUGHT WITHOUT PAYMENT
 SERVICES TAKEN ON CREDIT
 EXPENSES DUE BUT NOT PAID
CAPITAL
AMOUNT INVESTED BY OWNER IN BUSINESS

DRAWING
 Any amount withdrawn from the
business for personal use.
RULES OF ACCOUNTING
HEAD OF ACCOUNT DEBIT CREDIT
ASSET INCREASE DECREASE
EXPENSE INCREASE DECREASE
LIABILTY DECREASE INCREASE
REVENUE DECREASE INCREASE
CAPITAL DECREASE INCREASE
Users of Accounting Information
 Business Managers
 Employees and Unions
 Investors and Creditors
 Tax Authorities
 Government Regulatory
Agencies
13
What is a Controller?
Person who manages all
of a firm’s accounting
activities (chief
accounting officer
14
What is an Audit?
Systematic examination
of a company’s
accounting system to
determine whether its
financial reports fairly
represent its operations
15
What is GAAP (or Generally Accepted
Accounting Principles)?
Accepted rules and procedures

governing the content and
form of financial reports
16
What is Double-Entry Accounting?
Bookkeeping system
that balances the
accounting equation by
recording the dual
effects of every financial
transaction
17
Financial Statements
 Balance sheets supply
detailed information about the
accounting equation factors:
• Assets
 Current Assets
 Fixed Assets
 Intangible Assets
18
 Balance sheets supply

detailed information about
the accounting equation
factors:
◦ Liabilities
 Current Liabilities
 Long-Term Liabilities
◦ Owners’ Equity
 Common Stock
 Paid-in Capital
 Retained Earnings
19
Perfect Posters’ Balance Sheet
20
 Income statement (or Profit-
and-loss statement) lists a firm’s
annual revenues and expenses so
that a bottom line shows annual
profit or loss. Three major
categories:
◦ Revenues
◦ Cost of Goods Sold
 Gross Profit (or Gross Margin)
◦ Operating Expenses
 Operating and Net Income
21
Perfect Posters’ Income Statement
22
Analyzing Financial Statements
1. Solvency Ratio
2. Profitability Ratio
3. Activity Ratio
23
1. Solvency ratios: Financial ratio, either short- or
long-term, for estimating the risk in investing in a firm
a. Short-Term Solvency Ratios

 Liquidity ratio measures a firm’s ability to pay its immediate
debts
• Current Ratio
• Working Capital
• Quick ratio
b. Long-Term Solvency Ratios
 Debt ratio measures a firm’s ability to meet its long-term debts
• Debt-to-Owners’ Equity Ratio (or Debt-to-Equity Ratio)
 Leverage
24
a. Short-Term Solvency
Ratios
Current Ratio
Solvency ratio that determines a firm’s credit
worthiness by measuring its ability to pay current
liabilities
Current assets $57,210

  2.61
Current liabilities $21,935
Working Capital
Difference between a firm’s current assets and
current liabilities
25
Short-Term Solvency Ratios (cont’d)
Quick (or Acid-Test) Ratio

Solvency ratio for determining a firm’s ability to meet
emergency demands for cash
Quick Asset
Cash plus assets one step removed from cash
(marketable securities and accounts receivable)
Quick assets $7,050  2,300  26,210  650

  1.59
Current liabilities $21,935
26
b. Long-Term Solvency
Ratios
Debt Ratio
Solvency ratio measuring a firm’s ability to meet its
long-term debts
Debt-to-Owners’ Equity Ratio (or Debt-to-Equity
Ratio)
Solvency ratio describing the extent to which a firm is
financed through borrowing
Debt
A firm’s total liabilities
Debt $61,935
  0.56
Owners' equity $111,155
27
2. Profitability ratios Financial ratio for
measuring a firm’s potential earnings. They
include:
a. Net Profit Margin measures the percentage

of income that is a firm’s profit
b. Return on equity measures income for each
dollar invested
c. Earnings per share measures the size of
the dividend that a firm can pay shareholders
28
2. Profitability Ratios
a. Net Profit Margin (or Return on Sales)
Profitability ratio indicating the percentage of its
income that is a firm’s profit
Net income $12,585

  0.049  4.9%
Sales $256,425
b. Return on Equity
Profitability ratio measuring income earned for each dollar invested
Net income $12,585

  11 .3%
Total owners' equity $111,155
29
3. Activity ratios Financial ratio for evaluating

management’s use of a firm’s assets. They
include:
a. Inventory turnover ratio measures the
average number of times that inventory is
sold and restocked during the year
30
Activity Ratios
a. Inventory Turnover Ratio
Activity ratio measuring the average number of times
that inventory is sold and restocked during the year
Cost of goods sold Cost of goods sold


Average inventory (Beginning inventory  Ending inventory)/2
$104,765
 4.8 times
($22,380  $21,250)/2
31
ACCOUNTING EQUATION
ASSETS = LIABILITIES + CAPITAL

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What is

Recording can be made of any type of

 Business is classified into three groups.

(A) Servicing: E.g. Doctors, Teachers, Tax

(B) Trading: Petrol Pumps, grocers, motor dealers,

(C) Producing or Manufacturing: Sugar Industries,

BUILDING, LAND, FURNITURE, BANK

“AMOUNT PAID FOR BUSINESS

 UTILITIES CHARGES etc

 RENT INCOME etc

“AMOUNT DUE ON BUSINESS.”

AMOUNT INVESTED BY OWNER IN BUSINESS

Accepted rules and procedures

 Balance sheets supply

a. Short-Term Solvency Ratios

Current assets $57,210

Quick (or Acid-Test) Ratio

Quick assets $7,050  2,300  26,210  650

a. Net Profit Margin measures the percentage

Net income $12,585

Net income $12,585

3. Activity ratios Financial ratio for evaluating

Cost of goods sold Cost of goods sold

ASSETS = LIABILITIES + CAPITAL

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