Fundamentals of Finance and Accounting for Nonfinancial ...ad706b853cbb6fc5925d-6e5774bf0bfc4cf4fbb56c406d086c23.r51.cf1.r… · Fundamentals of Finance and Accounting ... Fundamentals

Fundamentals of Finance and Accounting for Nonfinancial Managers

Lesson Worksheets

© American Management Association. All rights reserved.

2218V• Updated 01/2016

Table of Contents

Lesson One

Key Terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .L1.1Generally Accepted Accounting Principles (GAAP) Overview . . . . . . . . . . . . . . . . . . . . . . . . . .L1.2Understanding the Accounting Process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .L1.3Financial Statements Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .L1.5Most Important Points (MIPs) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .L1.6Preparation of Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .L1.7Financial Ratios . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .L1.9

Lesson Two

Calculating Financial Ratios for J&J . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .L2.1Most Important Points (MIPs) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .L2.2Lesson Three: Key Terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .L2.3

Lesson Three

Most Important Points (MIPs) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .L3.1Lesson Four: Key Terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .L3.2

Lesson Four

Present Value Tables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .L4.1Most Important Points (MIPs) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .L4.5

Note: Additional worksheets can be found in the 2218v Handout.xls file.

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Key TermsInstructions: Write a definition for the terms and phrases below.

Assets:

Comprehensive income:

Cost of goods sold:

Current assets:

Equity:

Expenses:

Gross profit:

Liabilities:

Long-term assets:

Net income:

Operating expenses:

Other income andexpense:

Revenues:

Stockholder’s equity:

LESSON 1 L1.1



Generally Accepted Accounting Principles(GAAP) OverviewAccounting provides us with a standardized system for recording financial events that occur withinan organization, as well as the organization’s overall financial position. To ensure a reasonabledegree of consistency in the presentation of financial information, a system of Generally AcceptedAccounting Principles (GAAP) has evolved.

◗ GAAP is not a legal requirement. However, if an organization’s financial statements areaudited by an outside Certified Public Accounting (CPA) firm in the United States or by aChartered Accounting (CA) firm in Canada, the auditors are required to disclose deviationsfrom GAAP. Such deviations can jeopardize a firm’s financial credibility. As a result, mostaudited organizations comply with the rules.

◗ In the United States, the Financial Accounting Standards Board (FASB) writes the rules. InCanada, the rule-making body is the Canadian Institute of Chartered Accountants (CICA).

◗ Accounting is not standardized internationally. The United States and Canada are very similarin their GAAP rules and requirements, but other countries often make very different GAAPassumptions. Many large multinational organizations follow the International AccountingStandards (IAS).

◗ With multinational companies, the accounting rules of the parent company’s country arenormally used in the consolidated statements. Thus, a U.S. company with internationalsubsidiaries will follow U.S. GAAP in its annual report, while a British company with U.S.subsidiaries will prepare its statements in accordance with British GAAP.

◗ While GAAP is the system used for reporting to the shareholders, banks, and the public, abusiness’s tax accounting will comply with the tax laws of the countries in which it doesbusiness. As a result, the numbers on the tax return will often differ from those on thefinancial statements.

GAAP rules are extensive and often quite complex. The following are among the most criticalGAAP assumptions:

◗ The fiscal period—While organizations typically prepare monthly, quarterly, and year-to-datefinancial statements, one year—or approximately one year—is usually the critical financialperiod.

◗ The use of historical cost—In most countries, historical cost (i.e., what was paid) is the basis forvaluing assets. This can lead to undervaluing of assets, as the current market value may bemuch greater due to inflation or other factors. However, if an asset is permanently impaired itsvalue must be lowered to what it is now worth.

◗ Conservatism—Conservatism requires that losses be recognized as soon as they can bequantified, while gains must be recorded when earned.

LESSON 1 L1.2



Understanding the Accounting ProcessThe Five Types of Accounts

Although there may be thousands of accounts, they all fall into one of five categories:

◗ Assets—everything the business owns: cash, receivables, inventory, property buildings,equipment, and investments

◗ Liabilities—the debts and financial obligations

◗ Equity—what the shareholders paid for stock and the reinvested profits (i.e., retainedearnings)

◗ Revenues—what the organization earned from selling its products or services; there may alsobe revenues from investments or the sale of assets

◗ Expenses—costs incurred in running the business

The Overall Accounting Process

An organization’s accounting system documents all of the financial transactions that occur duringan accounting period. These transactions are then classified and summarized through a processthat ultimately yields a set of financial statements.

TransactionsA transaction is a business event, expressed in monetary terms, that is entered into the accountingrecords. Purchasing equipment, paying staff members, and recording a sale are all examples ofaccounting transactions.

Journal Entries Journal entries record transactions in the order in which they occur. They contain “supportingdetails” or “backup,” which reference the events or items affected, such as an invoice number.Journal entries are referred to when the accuracy or purpose of a transaction must be checked.

Ledgers

◗ The ledgers are organized by account and record all transactions that involve the account.

◗ The general ledger (GL) includes all accounts used by the business. The primary financialstatements are prepared from the general ledger.

◗ Subsidiary ledgers support certain general ledger accounts such as accounts receivable,accounts payable, and inventory. The subsidiary ledger provides details about the account. Forexample, the accounts receivable subsidiary ledger lists all the customers of the business, theirbalances, and the transactions that have taken place in each account.

LESSON 1 L1.3



Adjusting EntriesAt the end of an accounting period, various adjustments are made to account balances to reflecteconomic events that occurred but did not cause a transaction. Examples of such adjusting entriesinclude recording depreciation expenses or accruing liabilities for expenses that were incurredduring the period, such as salaries that have not been paid.

Closing the BooksAt the end of each accounting period, revenue and expense accounts are consolidated todetermine if the organization made or lost money and are reset to zero. This process allows theorganization to identify its revenues and expenses for that particular period. The profit or loss forthe period is then transferred to the retained earnings account of the Balance Sheet. Then thefinancial statements are prepared.

Double-Entry AccountingBusiness transactions are recorded in a double-entry accounting system that involves the use ofdebits and credits. This procedure requires that every transaction be recorded two ways: as one ormore debit entries and as one or more credit entries. The debit entries must equal the creditentries.

Debit is probably the most misunderstood of all accounting terms. Most people think a debit isalways a negative. In reality, a debit entry is merely a left-hand entry in a ledger account, while acredit is a right-hand entry. Debits can be positive or negative depending on the account type. Forexample, a debit entry increases an asset account while it decreases a liability or equity account.

Likewise, a credit entry can be either positive or negative. A credit decreases an asset account, butincreases a revenue account.

Practically speaking, for most nonfinancial managers, it is unimportant to know whether anaccount is “debited” or “credited.” However, it is extremely important to understand the impactof various transactions on the different accounts (i.e., whether an account is increased ordecreased). In the following exercise, your team will check and broaden your understanding ofdifferent transactions and their impact on the accounting system.

LESSON 1 L1.4



Financial Statements OverviewThe complete set of financial statements includes:

◗ Income Statement (or Statement of Profit & Loss—P&L)

◗ Balance Sheet

◗ Statement of Retained Earnings

◗ Statement of Cash Flow

The purpose of each statement is summarized in the table below:

Name ofStatement Purpose Information Presented

IncomeStatement

Presents the organization’soperating performanceduring a period of time

Revenues earnedExpenses incurredProfit, Income, or Loss, the differencebetween revenues and expenses

Balance Sheet Reports the organization’sfinancial condition at apoint in time

Assets, what the organization ownsLiabilities, what the organization owesto othersStockholders’ Equity, the differencebetween assets and liabilities, i.e., whatbelongs to the shareholders (may becalled Net Assets for a not-for-profit orgovernment entity)

Statement ofRetained Earnings

Describes what was donewith the profits reportedon the Income Statement

Dividends paid to the shareholdersRetained Earnings, the profits left in thebusiness, i.e., reinvested

Statement ofCash Flow

Describes how cash cameinto the business and howit was used

Operating Cash Flow, the cashgenerated by the day-to-day operationsof the organizationInvesting Cash Flow, the cash reinvestedin the business or generated by sellingoff pieces of the businessFinancing Cash Flow, the cash generatedby borrowing or selling stock to investorsand the cash disbursed to pay off debt,buy back stock, or pay dividends

LESSON 1 L1.5



Most Important Points (MIPs)Use the space below to record the most important points that you learned from this lesson. What questions do you still have?

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LESSON 1 L1.6



Preparation of Financial StatementsThe following is a list of the account balances for Compton’s Computers, Inc., a distributor ofcomputer equipment.

Use each item only once when you are preparing the financial statement.Use the IncomeStatement, Statement of Retained Earnings, Balance Sheet, and Statement of Cash Flow formatson the following pages to prepare the firm’s financial statements on the Compton’s Computers tabof the 2218v Handout Excel file. Use each item only once when you are preparing the financialstatement.

Balance I/S B/S R/E

Accounts payable 210,000 _______ _______ _______

Accounts receivable 300,000 _______ _______ _______

Accumulated depreciation 140,000 _______ _______ _______

Advertising and selling expenses 60,000 _______ _______ _______

Building 600,000 _______ _______ _______

Cash 100,000 _______ _______ _______

Cost of goods sold 1,200,000 _______ _______ _______

Common stock 500,000 _______ _______ _______

Depreciation expense 80,000 _______ _______ _______

Dividends paid 20,000 _______ _______ _______

Furniture and equipment 240,000 _______ _______ _______

Income tax expense 35,000 _______ _______ _______

Interest expense 25,000 _______ _______ _______

Interest income 5,000 _______ _______ _______

Inventory 250,000 _______ _______ _______

Land 50,000 _______ _______ _______

Long-term debt 470,000 _______ _______ _______

Retained earnings, beginning balance 175,000 _______ _______ _______

Sales 1,800,000 _______ _______ _______

Telephone and utility expense 40,000 _______ _______ _______

Wage and salary expense 300,000 _______ _______ _______

LESSON 1 L1.7



To prepare the Cash Flow Statement, you will need to use the statements you have alreadyprepared, as well as the following information.

Account balances from one year earlier:

Additional information needed:

◗ The firm repaid $10,000 of long-term debt during the past year.

◗ The firm purchased $40,000 in furniture and equipment during the past year.

Cash 95,000

Accounts receivable 240,000

Inventory 200,000

Accounts payable 170,000

LESSON 1 L1.8



Financial RatiosThere are three categories of financial ratios. Each category is designed to evaluate the financial“health” of the business from a different perspective.

It is important to remember that no ratio alone tells the whole picture. As an analyst, you mustexamine the range of ratios and understand the business in relation to its industry and particularenvironment in order to make your judgment.

The three categories of financial ratios are:

◗ Liquidity—the ability of the organization to generate funds to meet its short-term financialobligations

◗ Leverage—the portion of assets that have been financed through debt vs. equity financingand the organization’s ability to handle the debt that it has

◗ Profitability—the amount of profit generated by the business; the return on the investment bythe shareholders or in the business

The following table summarizes the categories and their ratios:

Liquidity Ratios Leverage Ratios Profitability Ratios

Current Ratio Acid-Test orQuick Ratio

Debt to Equity Debt toCapital

Return on Equity (ROE)Return on Invested Capital(ROIC)

Days Sales Outstanding(DSO)

Interest Coverage Profit Margin or Return onSales (ROS)

Accounts ReceivableTurnover

Cash Flow to CurrentMaturity of Long-Term Debt

Return on Assets (ROA);DuPont Formula; EconomicValue Added (EVA®); CashFlow Return on Investment(CFROI)

Inventory Turnover (DIOH) Earnings per Share (EPS)

LESSON 1 L1.9



Calculating Financial Ratios for J&JInstructions: Use the Johnson & Johnson annual report to calculate the following ratios.

Liquidity Ratios

Leverage Ratios

Profitability Ratios

Current RatioCurrent Assets

Current Liabilities

Acid Ratio (Cash + Marketable Securities + Accounts Receivable)/Current Liabilities

Days SalesOutstanding (DSO)

Ratio

Avg. Accounts Receivable x 365Annual Credit Sales

Accounts ReceivableTurnover Ratio

365

DSO

Days Sales inInventory (DSI) (Avg. Inventory/COGS) x 365

Inventory TurnoverRatio

365

DSI

Debt to Equity Ratio Long-term debtequity

total liabilitiesequity

Debt to Capital Ratio Long-term debtlong-term debt + equity

Interest Coverage(Times InterestEarned) Ratio

Pre-tax income + interest expense (EBIT)interest expense

Cash Flow to CurrentMaturity of Long-Term Debt Ratio

Net income + depreciation + amortizationCurrent maturity of long-term debt

Return on Equity(ROE) Ratio

Net incomeTotal shareholder’s equity

Return on InvestedCapital (ROIC) Ratio

Net operating profit after taxLong-term debt + equity

(NOPAT)(CAPITAL)

=

Profit Margin orReturn on Sales (ROS)

Ratio

Net incomeNet sales

Return on Assets(ROA) Ratio

Net incomeTotal assets

Whole Company

Pre-tax income of unitAssets allocated to unit

Division/Unit

LESSON 2 L2.1





L2.2LESSON 2


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Lesson Three: Key TermsInstructions: Write a definition for the phrases below.

Fixed costs:

Three examples of fixed costs:

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Variable costs:

Three examples of variable costs:

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Absorption costing:

Direct costing:

LESSON 2 L2.3




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LESSON 3 L3.1





L3.2

Lesson Four: Key TermsInstructions: Write a definition for the phrases below.

Capital Budget:

Operating Budget:

Sales/Revenue Forecast:

Production/Expense Budget:

Cash Flow Projection:

Instructions: Explain the difference(s) between the following items.

An Income Statement and a Pro Forma Income Statement

A Balance Sheet and a Pro Forma Balance Sheet

LESSON 3

LESSON 4 L4.1





L4.2LESSON 4

LESSON 4 L4.3



LESSON 4 L4.4




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LESSON 4 L4.5



Documents

Fundamentals of Finance and Accounting for Nonfinancial ...ad706b853cbb6fc5925d-6e5774bf0bfc4cf4fbb56c406d086c23.r51.cf1.r… · Fundamentals of Finance and Accounting ... Fundamentals