Chapter 13

Copyright © 2011 by the McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

Small Business Accounting

Projecting and EvaluatingPerformance

Learning Objectives

LO1 Review the basic concepts of accountingLO2 Specify the requirements for a small business

accounting systemLO3 Explain the content and format of common

financial statementsLO4 Use accounting information as a tool for

managing your business effectivelyLO5 Develop a complete set of budgets for your

businessLO6 Use accounting information to make better

business decisions

13-2

Why Accounting Matters

Proves what your business did financially Shows how much your business is worth Banks, creditors, development agencies,

and investors require it Provides easy-to-understand plans for

business operations You can’t know how your business is doing

without it

13-3

Types of Accounting

Managerial accounting– Accounting methods that are specifically

intended to be used by managers for planning, directing, and controlling a business.

13-4

Types of Accounting

Tax accounting– An accounting

approach based on specific accounting requirements set by governmental taxing agencies.

Financial accounting– A formal, rule-

based set of accounting principles and procedures intended for use by outside owners, investors, banks, and regulators.

13-5

Basic Accounting Concepts

Business entity concept– The concept that

a business has an existence separate from that of its owners.

Going concern concept– The accounting

concept that a business is expected to continue in existence for the foreseeable future.

13-6

The Accounting Equation

Accounting equation– The statement that assets equal

liabilities plus owner’s equity (assets liabilities owners’ equity).

13-7

The Accounting Equation

Asset – something the business owns that will have

value in the future Liability

– a legal obligation to pay some amount at a time in the future.

Owners’ equity – whatever value is left after all liabilities

have been paid.

13-8

Revenues, Expenses, and Costs

Cost– The value given

up to obtain something that you want.

Expense– A decrease in

owners’ equity caused by consuming your product or service.

13-9

Information Usefulness

Only two reasons to do accounting:1.To produce information that is useful

to you for managing your business2.To meet legal or contractual

requirements

13-10

Why Does Accounting Matter?

MACRS rate– the Modified Accelerated Cost Recovery

System– lets taxpayers depreciate more of the

cost earlier Depreciation

– Regular and systematic reduction in income that transfers asset value to expense over time.

13-11

Accounting Systems for Small Business

Computerized systems simplify the accounting process by providing automatic error checking, entry screens that look like the common business forms, and automatic production of financial statements and management reports.

13-12

Financial Reports

Financial statements– Formal summaries of the content of an

accounting system’s records of transactions.

13-13

Financial Reports

Five common financial statements– Income statement– Statement of retained earnings– Statement of owner’s equity– Balance sheet– Cash flow statement

13-14

Flow of Flow of InformatiInformati

on inon inFinancial Financial StatemenStatemen

tsts

13-15

Figure 13.1

Financial Reports

Retained earnings– The sum of all profits and losses, less all

dividends paid since the beginning of the business.

Articulate– The concept that information flows from

the income statement through the statements of retained earnings and owners’ equity to the balance sheet.

13-16

Everyday Financial Documents and Similar Financial Reports

13-17Figure 13.2

Financial Reports

Income statement – A statement that lists revenues and

expenses and shows the amount of profit a business makes for a specified period of time.

13-18

Organization of theIncome Statement

13-19Figure 13.3

Typical Single-Step Format Income Statement

13-20Figure 13.4A

Typical Multiple-StepIncome Statement

13-21Figure 13.4B

Financial Reports

Balance sheet– A statement of what a business owns

(assets), what it owes to others (liabilities), and how much value the owners have invested in it (equity).

Liquidity– A measure of how quickly a company can

raise money through internal sources by converting assets to cash.

13-22

Organization of theBalance Sheet

13-23Figure 13.5

13-24

Typical Typical Balance Balance

SheetSheet

Figure 13.6

Balance Sheet

Financial flexibility– A business’s ability to manage cash

flows in such a manner that the company can respond appropriately to unexpected opportunities and needs.

Financial strength– The ability of a business to survive

adverse financial events.

13-25

Cash Flow Statement

Cash flow statement– A statement of the sources and uses of cash

in a business for a specific period of time. GAAP

– Generally Accepted Accounting Principles are the standardized rules for accounting procedures

– used in all audits and submissions of accounting reports to the government.

13-26

Typical Cash Inflows and Outflows on the Cash Flow

Statement

13-27Figure 13.7

Cash Flow Statement

Operating activities– Activities involved in

producing and selling goods and services.

Investing activities– The purchase and sale

of land, buildings, equipment, and securities.

Financing activities– Activities through

which cash is obtained from and paid to lenders, owners, and investors.

13-28

Uses of Financial Accounting

13-29

Uses of Managerial Accounting

External (cost) factors– Aspects of the

world outside the business which could cause the business’s costs to change.

Internal (cost) factors– Aspects of or

choices within the business which could cause the business’s costs to change.

13-30

Uses of Managerial Accounting

Cost-volume-profit analysis– A managerial accounting technique

which looks at the fixed and variable costs of a business to arrive at a number of unit sales (volume) to maximize profits.

– Variable, fixed costs

13-31

Total Costs

13-32

Figure 13.8

Breakeven Point

13-33

Figure 13.11

Breakeven point– The point at which

total costs equal gross revenue.

The Business Plan and the Budget Process

Budget– A financial plan for the future, based on

a single level of operations; a quantitative expression of the use of resources necessary to achieve a business’s strategic goals.

Pro forma – indicates estimated or hypothetical

information

13-34

Budgeting Relationships

13-35Figure 13.2

The Business Plan and the Budget Process

Master budget– A budget which consists of sets of

budgets that detail all projected receipts and spending for the budgeted period.

– also referred to as a comprehensive budget

13-36

The Business Plan and the Budget Process

Cost of goods sold budget– A schedule that shows the predicted

cost of product actually sold during the accounting period.

Activity-based cost estimates– An accounting method which assigns

costs based on the different types of work a business does in order to sell a particular product or service.

13-37

Controlling

Variance– The difference between an actual and

budgeted revenue or cost Variance analysis

– The process of determining the effect of price and quantity changes on revenues and expenses.

13-38

Controlling

Favorable/unfavorable variance– A label applied to variances to indicate

their effect upon the income statement; – Favorable variances would result in

profits being greater than budgeted, all other things being equal;

– Unfavorable variances would result in profits being less than budgeted, all other things being equal.

13-39

Decision Making

To make good decisions we need:1.Good information2.Efficient ways to condense

information so it is understandable3.Methods to help compare

alternatives.

13-40