Financial Analysis

Financial Accounting MidTerm

I. Debit vs. Credit

A. Debit

Debit = left side of T-account

On the Balance Sheet a debit indicates:

1. An increase in an asset

2. A decrease in a liability

3. A decrease in shareholders' equity item

B. Credit

Credit = Right side of T-account

On the Balance Sheet a credit indicates:

1. A decrease in an asset

2. An increase in a liability

3. An increase in shareholders' equity item

** HINT** - Identify two components of each transaction: 1.) what did you get; 2.) where did it come from. The debit is what you got, and the credit is the source of the item you received.

For instance, let's imagine that you purchase a computer with your credit card. Since the computer is what you received it's going to result in a debit to the asset account for your computer. The credit will be applied to the credit card liability account for the same amount.

II. What accounts Increase/Decrease with debits and credits

Account Type Debit Credit

Balance Sheet Assets Increase Decrease

Balance Sheet Liabilities Decrease Increase

Balance Sheet Owner's Equity Decrease Increase

Income Statement Revenue Decrease Increase

Income Statement Cost of goods sold Increase Decrease

Income Statement Expenses Increase Decrease

III. Typical Accounts

A. Assets

Cash Marketable Securities

Accounts receivable Notes receivable

Interest Receivable Merchandise inventory

Raw materials inventory Supplies inventory

Work-in-progress inventory Finished goods inventory

Advances to suppliers Prepaid rent

Prepaid insurance Investment in securities

Land Buildings

Equipment Furniture

Accumulated depreciation Leasehold

Organization costs Patents

Good will

B. Liabilities

Accounts payable Notes payable

Interest payable Income taxes payable

Advances from customers Advances from tenants; rent received in advance

Mortgage payable Bonds payable

Convertible bonds Capitalized lease obligations

Deferred income tax

C. Shareholders' Equity

Common stock Preferred stock

Additional paid-in capital Retained earnings

Treasury shares

IV. Purpose of 3 Main Financial Statements

A. Balance Sheet

Ð'* Statement of financial position

Ð'* Snapshot at a specific point in time

Ð'* Date is last day of accompanying income statement period

Ð'* Valued at historical or current values

Ð'* Includes assets (investing); liabilities (financing); and owners' equity (financing)

Ð'* Picture of financial health of a company Ð'- GOAL of BALANCE SHEET

B. Income Statement

Ð'* Shows net income and earnings

Ð'* Covers a period of time

Ð'* Reflects revenues (inflows of assets or reductions of liabilities) from selling goods/services and expenses (outflows of assets or increases of liabilities) used in generating revenue

Ð'* Net income increases retained earnings on balance sheet

Ð'* Shows how profitable a company is Ð'- GOAL of INCOME STATEMENT

C. Cash Flow Statement

Ð'* Explains change in cash from one balance sheet date to the next

Ð'* Groups activity as operating, investing, or financing

Ð'* Covers a period of time

Ð'* Shows sources and uses of cash and if we have enough cash to continue in business Ð'- GOAL of CFS

V. Accrual vs. Cash Basis Accounting

A. Cash Basis

Ð'* Accounts for cash in and cash out

Ð'* Easy to use

Ð'* Drawbacks

1) Ignores cash received from owners or from borrowing

2) Does not match effort of generating inflows with the inflows themselves

3) Unnecessarily postpones the time to recognize revenues

4) Can distort measurement of operating performance by managing the timing of cash receipts and disbursements

B. Accrual Basis

1.) Revenue Recognition

Ð'* Recognize revenue at sale if,

a. All or most of the services expected to be provided have been performed

b. Received cash or a promise to pay (accounts receivable)