hartfm.qxp 9/6/2005 4:08 PM Page xii hartfm.qxp 9/6/2005 4:08 PM Page i Accounting Demystified hartfm.qxp 9/6/2005 4:08 PM Page ii OTHER BOOKS IN THE DEMYSTIFIED SERIES Advanced Statistics Demystified Algebra Demystified Anatomy Demystified Astronomy Demystified Biology Demystified Business Statistics Demystified C++ Demystified Calculus Demystified Chemistry Demystified College Algebra Demystified Databases Demystified Data Structures Demystified Differential Equations Demystified Digital Electronics Demystified Earth Science Demystified Electricity Demystified Electronics Demystified Environmental Science Demystified Everyday Math Demystified Geometry Demystified Home Networking Demystified Investing Demystified Java Demystified JavaScript Demystified Macroeconomics Demystified Math Proofs Demystified Math Word Problems Demystified Microbiology Demystified OOP Demystified Options Demystified Personal Computing Demystified Physics Demystified Physiology Demystified Pre-Algebra Demystified Precalculus Demystified Probability Demystified Project Management Demystified Quantum Mechanics Demystified Relativity Demystified Robotics Demystified Six Sigma Demystified Statistics Demystified Trigonometry Demystified hartfm.qxp 9/6/2005 4:08 PM Page iii Accounting Demystified A Self-Teaching Guide LEITA A HART, CPA McGRAW-HILL New York Chicago San Francisco Lisbon London Madrid Mexico City Milan New Delhi San Juan Seoul Singapore Sydney Toronto hartfm.qxp 9/6/2005 4:08 PM Page iv Copyright © 2006 by The McGraw-Hill Companies, Inc All rights reserved Printed in the United States of America Except as permitted under the United States Copyright Act of 1976, no part of this publication may be reproduced or distributed in any form or by any means, or stored in a data base or retrieval system, without the prior written permission of the publisher FGR/FGR ISBN 0-07-145083-1 This publication is designed to provide accurate and authoritative information in regard to the subject matter covered It is sold with the understanding that neither the author nor the publisher is engaged in rendering legal, accounting, or other professional service If legal advice or other expert assistance is required, the services of a competent professional person should be sought ––From a Declaration of Principles jointly adopted by Committee of the American Bar Association and a Committee of Publishers McGraw-Hill books are available at special quantity discounts to use as premiums and sales promotions, or for use in corporate training programs For more information, please write to the Director of Special Sales, McGraw-Hill Professional, Two Penn Plaza, New York, NY 10121-2298 Or contact your local bookstore This book is printed on recycled, acid-free paper containing a minimum of 50% recycled, de-inked fiber hartfm.qxp 9/6/2005 4:08 PM Page v CONTENTS Acknowledgments Introduction xiii xv PART ONE THE BIG PICTURE CHAPTER Where Did All This Lingo Come From? The Birth of the Accountant Gaps in GAAP? One Huge Database The Three Key Financial Statements Are Just Summaries Liquidity, Profitability, Growth, and Financing Quiz CHAPTER The Balance Sheet—The Mother of All Financial Statements Assets, Liabilities, and Equity: Another Way to Look at Them Two Mistakes in Reasoning Now, How Do We Use the Balance Sheet to Make Decisions? A Quickie Analysis Quiz 10 10 13 14 16 16 31 32 v hartfm.qxp 9/6/2005 4:08 PM Page vi vi Contents CHAPTER CHAPTER CHAPTER The Income Statement—A Focus on Earnings Memorize This Formula! Cost Terminology The Significance of Gross Profit Margin and Operating Profit Margin The Income Statement Tells a Story about Profitability Quiz The Cash Flow Statement—Do We Have Enough for Payroll? Cash versus Accrual Method of Accounting A Real-Life Example of How Cash and Profit Differ Why Was the Cash Flow Statement Added Recently? Classifying Cash Flows into Three Categories What Stories Does the Cash Flow Statement Tell You? Quiz How the Financial Statements Are Related How the Income Statement, Cash Flow Statement, and Balance Sheet Are Related What Each Financial Statement Tracks Simple Transactions and How They Impact the Three Key Financial Statements Cash Sale 34 34 35 40 41 43 45 46 47 49 51 53 54 56 56 58 59 59 hartfm.qxp 9/6/2005 4:08 PM Page vii vii Contents Credit Sale: Part One Credit Sale: Part Two Purchasing a Fixed Asset Quiz 61 63 64 70 TEST Part One 73 PART TWO AN OVERVIEW OF COMMON ACCOUNTING REPORTS 77 Different Systems, Different Reports Cost Accounting Systems Budgets Tax Accounting Quiz 79 80 82 87 88 CHAPTER CHAPTER Quarterly and Annual Financial Reports—A Tour The 10-K How Do You Get a 10-K? Annual Reports Are Not 10-Ks The Cover of the 10-K Part I of the 10-K Part II of the 10-K Quiz 91 92 92 92 93 95 99 107 TEST Part Two 110 PART THREE DEBITS AND CREDITS DETAIL— RULES, RULES, RULES 113 How to Tell if Something Is a Debit or a Credit A Few Key Formulas 115 116 CHAPTER hartfm.qxp 9/6/2005 4:08 PM Page viii viii Contents A Special Way of Recording Transactions Chart of Accounts Quiz 118 118 127 CHAPTER A Few Simple Transactions Cash Sale Credit Sale: Part One Credit Sale: Part Two Purchasing a Fixed Asset Lease versus Buy Decision Quiz 128 128 130 133 134 138 140 CHAPTER 10 Inventory Valuation Service Business: Minimal or No Inventory Manufacturing Business: Inventory, Inventory, Inventory Moving Inventory Through Raw Materials, Work-in-Process, and Finished Goods Quiz 141 141 CHAPTER 11 CHAPTER 12 Guiding Principles of Accounting and Adjusting Entries Guiding Principles of Accounting Adjusting Entries Closing the Books Quiz Governmental and Not-for-Profit Accounting Key Differences Between Proprietary and Governmental and Not-for-Profit Accounting GAAP for Government and Not-for-Profits 142 143 147 149 150 158 166 167 170 171 171 hartindex.qxp 9/6/2005 5:28 PM Page 332 332 INDEX Deficits, in governmental accounting, 184 Dell, 24, 26 cash flow statement, 273 financial analysis and, 226–227 income statement and example, 42 10-K statement and, 93–107, 94, 101–103 Depreciation, 66–70, 66–70, 138, 163–164 accumulated, 134–135, 162 adjusting entries and, 161–162 book value and, 162 contra accounts and, 135, 162 depreciation impact ratio in, 285 depreciation to total fixed assets in, 286–287 double-declining balance (DDB), 163–164, 164 earnings before interest, taxes, depreciation, and amortization (EBITDA) in, 42–43 fixed asset purchase in, 64–70, 65–70, 134–138 lease vs buy decisions, 138–139 modified accelerated cost recovery system (MACRS), 164 straight-line, 162, 163 sum of the years’ digits (SYD), 163, 163 taxes and, 69 units of production, 164 Depreciation impact ratio in, 285 Depreciation to total fixed assets in, 286–287 Direct costs, 37–39, 80, 81 Direct vs Indirect presentation methods for cash flow statement and, 49, 50 Dividend payout of cash from operations in, 284–285 Dividend payout ratio, 298 Dividends, 18–19 cash to cash dividends in, 281 dividend payout of cash from operations in, 284–285 dividend payout ratio in, 298 10-K statement and, 99 Dollars vs Percentages in financial analysis and, 218 Donations, in not-for-profit accounting and, 186 Double-declining balance (DDB) depreciation, 163–164, 164 Double-entry accounting system, 4–5 Dun and Bradstreet, 226 Earnings debt and financing ratios in, 290–291 percentage of earnings retained ratio in, 298–299 Earnings before interest and taxes (EBIT) in, 42–43 Earnings before interest, taxes, depreciation, and amortization (EBITDA), 42–43 Earnings per share, 240–242 Earnings statement See income statement Economic value added (EVA) See dollar/economic value added, 243, 245 Encumbrance, 187 Endowment funds, in not-for-profit accounting and, 192 Enron, 6, 151, 152 Enterprise funds, in governmental accounting and, 175–176 Entitywide perspective, governmental accounting and, 178 Environmental and market trends in financial analysis, 216 hartindex.qxp 9/6/2005 5:28 PM Page 333 333 INDEX Equipment, in balance sheet and balance, 29 Equity, 116, 117 See also fund balance balance sheet and, 13–15, 30 credits, 116, 117 debits, 116, 117 debt and financing ratios in, 290 debt to equity in, 291–292 equity ratios in, 298 10-K statement and, 99 Ethics See guiding principles of accounting and adjusting ethics Excel spreadsheets, 81 Executive officers, 10-K statement and, 98 Expenses, 34–35, 116, 117, adjusting entries and, 160–165 cash sale transaction in, 59–61, 60, 129–130 credit sale transaction in, 61–63, 61, 63, 64, 131 credits, 116, 117 debits, 116, 117 lease vs buy decisions, 138–139 matching principle and, 157, 159 noncash, 68, 136 not-for-profit accounting and, 188 temporary accounts in, 166 wages as, 161 External financing index in, 299 Factors affecting business and prospects, 10-K statement and, 96–97 Fidelity investments, 241–242 Fiduciary funds, in governmental accounting and, 173, 174–175 Final exam, 307–319 Financial Accounting Standards Board (FASB), 6, 9, 49, 149, 152, 153, 171 Financial accounting system, 79 Financial analysis, 201–230 accounts payables in, 213 accounts receivables in, 213 aggregates in, 238 audited vs unaudited financial statements in, 214, 215 balanced scorecard model for, 204–207 benchmark comparison in, 224–225 budget in, 215 business or strategic plans in, 215 cash flow statement in, 213 cash ratios in, 271–288 See also cash ratios; ratios in financial analysis cautions about, 201–210 common size analysis in, 217–220, 218, 219, 220 competitor information in, 214 conclusions in, 225–226 customer information in, 214 debt and terms of loans and, 213 Dell and Gateway example in, 226–227 distributions of owners in, 213 dollars vs percentages in, 218 environmental and market trends in, 216 financial statements in, 215–216 financing history in, 213 financing ratios in, 223, 289–302 See also financing ratios fluctuation (flux) analysis in, 216–217 gathering information for, 212–214 good vs bad results in, 203 graphs and charts for, 225–226 growing firms and, 208 hartindex.qxp 9/6/2005 5:28 PM Page 334 334 INDEX health of business indicated by, 201–202 horizontal analysis in, 221–226, 221 income statement in, 214 inventory in, 213 liquidity in, 250–270 liquidity ratio in, 223 maturing firms and, 208 maturity of company vs., 208 metrics used in, 202, 203, 218 open book management and, 223–224 perspective in, 214–215 preparation for, 211–230 profitability in, 243 profitability ratio in, 223 project-related ratios in, 243–247 ratios in, 223, 228, 231–250 See also ratios in financial analysis recommendations from, 227 reports on, 225–226 return metrics in, 237 right vs wrong approach to, 207–208 scaling in, 222 shareholder earnings ratios in, 241 standards for choosing metrics in, 204 step-by-step process of, 214–226 success factors for each entity in, 215 sustaining firms and, 208 vendor information in, 214 Financial component of balanced scorecard model, 206 Financial data, in 10-K statement and, 99–100, 101–103 Financial data subscription services, 93 Financial statements, financial analysis and, audited vs unaudited, 214–216 governmental accounting and, 177–178 not-for-profit accounting and, 186–191 10-K statement and, 103–107 financing See debt and financing Financing activities, cash flow statement and, 52 Financing cash flow, 271, 272, 274, 276 Financing ratios, 223, 289–302 Finished goods inventory, 142 First in first out (FIFO) inventory, 142 Fixed asset purchase, 64–70, 65–70, 134–138 lease vs buy decisions in, 138–139 Fixed assets, 21–22, 21 depreciation and, 66–70, 66–70 See also depreciation depreciation to total fixed assets in, 286–287 sales to fixed assets ratio and, 237–238 Fixed charge coverage, 296–297 Fixed cost in, 35–39, 35, 80, 81 Fluctuation (flux) analysis, 216–217 Focus, from budget, 83 For-profit (proprietary) accounting, 170–171 Forbes magazine, 226 Fortune magazine, 226 Franchise tax, 88 Full disclosure, 156 Fund balance, 15 See also equity hartindex.qxp 9/6/2005 5:28 PM Page 335 335 INDEX governmental accounting and, 179 Funds, in not-for-profit accounting and, 184–185 Further reading, 325–326 Gateway, 93, 95 cash flow statement, 274, 275 financial analysis and, 226–227 General Accounting Office (GAO), 184 General fund, in governmental accounting and, 173, 176 General ledger, adjusting, at end of period, 158–159 budgetary accounting and, 87–88 chart of accounts in, 118–126, 118–126 cost accounting and vs., 80 Generally Accepted Accounting Principles (GAAP), 6, 152, 156, 171 auditor opinions and, 104 governmental and not-for-profit accounting, 171 tax accounting and, 87–88 Going-concern concept, 150 Government Accountability Office (GAO), 184 Governmental accounting, 170–171, 172–183 agency funds in, 174 capital projects funds in, 176–177 debt service funds in, 177 deficits in, 184 encumbrance in, 187 enterprise funds in, 175–176 entitywide perspective in, 178 fiduciary funds in, 173, 174–175 financial statements for, 177–178 fund balance in, 179 funds in, 172–177 general funds in, 173, 176 Generally Accepted Accounting Principles (GAAP) and, 171 Government Accountability Office (GAO) and, 184 governmental funds supercategory in, 176–177 internal service funds in, 176 investment trust funds in, 174–175 pension trust funds in, 174 permanent funds in, 177 private-purpose trust funds in, 175 profit vs., 178 proprietary (for-profit) accounting vs., 171 proprietary funds in, 173, 175–176 separateness of funds in, 172 special revenue funds in, 176 statement of activities for, 178, 179, 180–182 Governmental Accounting Standards Board (GASB), 6, 149, 152, 171 Governmental funds supercategory, 176–177 Graphs and charts for financial analysis, 225–226 Great Game of Business, The, 225 Gross profit margin in, 40–41, 233–234 Growing firms, financial analysis and, 208 Growth, 10, 18–19 Growth component of balanced scorecard model, 206–207 hartindex.qxp 9/6/2005 5:28 PM Page 336 336 INDEX Guiding principles of accounting, 149–169 adjusting entries and, 158–165 business entity defined by, 150 closing books and, 166–167 conservatism in, 151 consistency in, 154–155 continuing concern defined by, 150 cost defined in, 154 full disclosure in, 156 internal controls and, 153–154 matching principle in, 157, 159 materiality in, 156 money measurement in, 156 not-for-profit accounting and, 185 objectivity in, 151 permanent accounts in, 166 relevance in, 151 reliability in, 153 revenue recognition in, 153–154 Sarbanes-Oxley Act (Public Company Accounting Reform and Investor Protection Act ) and, 152–153 temporary accounts in, 166 time period in, 153 trial balance in, 166–167 History of accounting, 4–5 Homestead Exemption Act, 27 Impact ratio, depreciation, 285 Income statement, 8, 9, 34–44, 40 activity-based costing (ABC) in, 39, 81 balance sheet links to, 56–57, 57 burden rate in, 38 capitalizing in, 66–70, 66–70 cash sale transaction and, 59–61, 60, 129–130, 129 cost applied in, 37–39 cost terminology in, 35–39 credit sale transaction in, 61–64, 61, 62, 63, 131, 132, 133, 133 Dell example of, 42 depreciation in, 66–70, 66–70 direct costs in, 37–39, 80, 81 dollar/economic value added (EVA), 243, 245–246, 246–247 earnings before interest and taxes (EBIT) in, 42–43 earnings before interest, taxes, depreciation, and amortization (EBITDA) in, 42–43 earnings per share, 240–242 expenses in, 34–35, 116, 117 expensing in, 64, 65 financial analysis and, 214 fixed asset purchase, 64–70, 65–70, 135, 135, 136, 136 fixed costs in, 35–39, 35, 80, 81 formula for, 34–35 gross profit margin in, 40–41, 233–234 indirect cost allocation method in, 38 indirect cost pool in, 38 indirect costs in, 37–39, 80, 81 internal rate of return (IRR), 243, 244–245, 246–247 lease vs buy decisions, 138–139 margin ratios in, 231–232 net profit margin percentage, 232–233 nonoperating items in, 40–41 operating profit margin in, 40–41, 234–235 percentages shown in, 41–43 price/earnings, 241–242 profit in, 34–35, 40–43 profit ratios and, 231–250 hartindex.qxp 9/6/2005 5:28 PM Page 337 337 INDEX relationship of balance sheet and cash flow statement to, 56–72 See also relationship of financial relative R&D, 235–236 return metrics in, 237 return on assets, 236–237 return on equity (ROE), 239–240 return on investment (ROI), 238–239, 243, 246, 246–247 revenues in, 34–35, 116, 117 sales to fixed assets, 237–238 semivariable cost in, 36–39, 36 10-K statement and, 105–106 tracked items in, 58 variable cost in, 35–39, 36, 80, 81 Indirect cost allocation method in, 38 Indirect cost, 37–39, 80, 81 Indirect cost pool in, 38 Inflow vs Outflow, cash flow statement and, 51–53 Insurance, adjusting entries and, 161 Intellectual property, 26, 29 Interest earnings before interest and taxes (EBIT) in, 42–43 earnings before interest, taxes, depreciation, and amortization (EBITDA) in, 42–43 Internal business processes component of balanced scorecard model, 207 Internal controls, 155 Internal rate of return (IRR), 243 Internal service funds, in governmental accounting and, 176 Inventory, 5, 22, 26, 141–148 balance sheet and, 28, 29 cash conversion cycle in, 267–268 cash sale transaction in, 59–61, 60, 129–130 credit sale transaction in, 131 days’ supply of inventory in, 258–259 financial analysis and, 213 finished goods, 142 first in first out (FIFO), 142 inventory to working capital ratio in, 257 inventory turnover in, 259–260 last in first out (LIFO), 142 manufacturing business and, 142–143 moving through, 143–147, 144–147 raw materials, 142 service business and, 141 valuation of, 141–148 weighted average method in, 142–143 work-in-process/progress, 142 working capital and, ratios for, 257 Inventory to working capital ratio, 257 Inventory turnover in, 259–260 Investing activities, cash flow statement and, 52–53 Investing cash flow in, 271–272, 274, 276 Investment trust funds, in governmental accounting and, 174–175 Investments capital investment per dollar of cash in, 300–301 reinvestment ratio in, 299–300 Investor relations, 243 Kaplan, Robert, 205 hartindex.qxp 9/6/2005 5:28 PM Page 338 338 INDEX Last in first out (LIFO) inventory, 142 Laws regulating accounting, Learning and growth component of balanced scorecard model, 206–207 Lease vs Buy decisions, 138–139 Legal proceedings, in 10-K statement and, 98–99 Lenders, Liabilities, 116, 117 credits, 116, 117 balance sheet and, 13–15 current, 21–22, 21 debits, 116, 117 long-term, 21–22, 21 working capital and, 251–270 Line-item budgets in, 84, 85 Liquidity, 10, 23–27, 25, 250–270 accounts payable component of working capital in, 264 accounts payable to working capital in, 264–265 accounts receivable and, 25 accounts receivable component of working capital in, 260 accounts receivable to accounts payable, 266–267 accounts receivable to working capital in, 260 accounts receivable turnover in, 262–263 acid test ratio See quick ratio bad debt percentage in, 263–264 bankruptcy and, 27 cash conversion cycle in, 267–268 cash in, 23, 252 current ratio in, 255 days’ payable outstanding, 265–266 days’ sales outstanding (days of accounts receivable) in, 261–262 days’ supply of inventory in, 258–259 financial flexibility and, 250–270 inventory component of working capital in, 257 inventory to working capital ratio in, 257 inventory turnover in, 259–260 liquidation of assets and, 24–27 quick ratio in, 256 scale of, 250, 251 working capital and, 251–270 working capital contrast ratios in, 255 working capital to sales ratio in, 253 working capital turnover ratio in, 254 Liquidity ratios, 223 Litigation See legal proceedings Littlefield, Nathan, 184 Loan covenants, 17 Loans See Debt and financing Long-term assets, 21–22, 21 Long-term debt payment ratio, 294 Long-term debt to all debt ratio in, 296 Long-term liabilities, 21–22, 21 Management discussion/analysis of company, in 10-K statement and, 100–103 Mandatory cash flows index, 283 Manufacturing business, inventory of, 142–143 Manufacturing equipment, 26, 28 Margin ratios in, 231–232 Market trends in financial analysis and, 216 hartindex.qxp 9/6/2005 5:28 PM Page 339 339 INDEX Market value, 154 Matching principle, 157, 159 Materiality in accounting, 156 Maturing firms, financial analysis and, 208 Metrics used in financial analysis and, 202, 203, 218 Modified accelerated cost recovery system (MACRS) depreciation, 164 Money measurement principle, 156 Motorola, 29 Net profit margin percentage, 232–233 Noncash expense, 68, 136 Noncash transactions, 161 Nonoperating items, 40–41 Not-for-profit accounting, 170–171, 184–192 accounting standards for, 185 donations in, 186 encumbrance in, 187 endowment funds in, 192 examples of organizations considered, 185 expenses in, 188 financial statements for, 186–191 funds in, 184–185 Generally Accepted Accounting Principles (GAAP) and, 171 internal use of the funds and, 192 plant funds in, 192 proprietary (for-profit) accounting vs., 171 restricted funds in, 192 sales of goods and services in, 186 separateness of funds in, 183–184 statement of activities for, 187, 189–190 statement of cash flows for, 188, 191 statement of financial position for, 187, 188 taxes in, 186 unique concerns of, 185 unrestricted funds in, 192 Notes to financial statements, in 10-K statement and, 106–107 Objectivity in accounting, 151 Office equipment, 26 Open book management, 223–224 Operating activities, cash flow statement and, 51–52 Operating cash flow, 271, 272–273, 274 Operating cash index, 276–277 Operating profit margin in, 40–41 Operating profit margin, 234–235 Ownership ascertained by balance sheet, 16–20 financial analysis and, 213 10-K statement and, 99 Patents, 26, 29 Pension trust funds, in governmental accounting and, 174 Percentage of cash sources required for long-term debt, 295 Percentage of earnings retained ratio in, 298–299 Percentages vs Dollars in financial analysis and, 218 Performance-based budgets in, 84, 85–86 Permanent accounts, 166 Permanent funds, in governmental accounting and, 177 Perspective, in financial analysis and, 214–215 hartindex.qxp 9/6/2005 5:28 PM Page 340 340 INDEX Pie chart, 31–32, 31, 32 Plant funds, in not-for-profit accounting and, 192 Preferred stock, 27, 281 Prepaid insurance, in adjusting entries and, 161 Price/earnings ratio, 241–242 PricewaterhouseCoopers LLP, 104, 226 Private-purpose trust funds, governmental accounting and, 175 Profit, 30–31, 34–35, 40–43 balance sheet and, 19 cash vs., 47–48 financial analysis of, 243 governmental accounting and, 178 gross profit margin in, 40–41 matching principle and, 157, 159 operating profit margin in, 40–41 profit ratios and, 231–250 See also profit ratios Profit and loss statement See Income statement Profit ratios, 231–250 aggregates in, 238 dollar/economic value added (EVA), 243, 245–246, 246–247 earnings per share, 240–242 gross profit margin, 233–234 internal rate of return (IRR), 243, 244–245, 246–247 margin ratios in, 231–232 net profit margin percentage, 232–233 operating profit margin, 234–235 price/earnings, 241–242 project-related, 243–247 relative R&D, 235–236 return metrics in, 237 return on assets, 236–237 return on equity (ROE), 239–240 return on investment (ROI), 238–239, 243, 246, 246–247, sales to fixed assets, 237–238 shareholder earnings, 241 Profitability analysis, 10, 243 Profitability ratios, 223 Project-related ratios, 243–247 Properties, in 10-K statement and, 98 Proprietary accounting, 170–171 Proprietary funds, in governmental accounting and, 173, 175–176 Public Company Accounting Oversight Board (PCAOB), 153 Public Company Accounting Reform and Investor Protection Act (Sarbox), 152–153 Qualified auditor’s opinion, 104 Quarterly reports (10-Qs), 91 Quick ratio, 256 Ratios in financial analysis, 223, 228, 271–288 accounts payable to working capital in, 264–265 accounts receivable to accounts payable, 266–267 accounts receivable to working capital in, 261–262 accounts receivable turnover in, 262–263 acid test ratio See quick ratio aggregates in, 238 bad debt percentage in, 263–264 capital investment per dollar of cash in, 300–301 hartindex.qxp 9/6/2005 5:28 PM Page 341 341 INDEX capital investment ratios in, 299 cash conversion cycle in, 267–268 cash flow adequacy ratio in, 282–283 cash flow ratio in, 280 cash ratio in, 277–278 cash ratios in, 271–288 cash to cash dividends in, 281 cash to current maturities of long-term debt in, 296 cash to long-term debt in, 293–294 cash to working capital, 278–279 cash turnover ratio in, 279–280 current ratio in, 255 days’ payable outstanding, 265–266 days’ sales outstanding (days of accounts receivable) in, 261–262 days’ supply of inventory in, 258–259 debt ratio in, 292–293 debt ratios in, 291 debt to equity in, 291–292 debt to sales ratio in, 297–298 defensive interval in, 284 depreciation impact ratio in, 285 depreciation to total fixed assets in, 286–287 dividend payout of cash from operations in, 284–285 dividend payout ratio in, 298 dollar/economic value added (EVA), 243, 245–246, 246–247 earnings per share, 240–242 equity ratios in, 298 external financing index in, 299 financing ratios in, 289–302 See also financing ratios fixed charge coverage in, 296–297 gross profit margin, 233–234 internal rate of return (IRR), 243, 244–245, 246–247 inventory to working capital ratio in, 257 inventory turnover in, 259–260 long-term debt payment ratio in, 294 long-term debt to all debt ratio in, 296 mandatory cash flows index in, 283 margin ratios in, 231–232 net profit margin percentage, 232–233 operating cash index in, 276–277 operating profit margin, 234–235 percentage of cash sources required for long-term debt, 295 percentage of earnings retained ratio in, 298–299 price/earnings, 241–242 profit, 231–250 See also profit ratios project-related, 243–247 quick ratio in, 256 receivables to long-term debt in, 297–298 reinvestment ratio in, 299–300 relative R&D, 235–236 return metrics in, 237 return on assets, 236–237 return on equity (ROE), 239–240 return on investment (ROI), 238–239, 243, 246, 246–247 sales to fixed assets, 237–238 shareholder earnings, 241 hartindex.qxp 9/6/2005 5:28 PM Page 342 342 INDEX short-term debt to all debt ratio in, 295 working capital contrast ratios in, 255 working capital to sales ratio in, 253 working capital turnover ratio in, 254 Raw materials inventory, 26, 142 Receivables to long-term debt in, 297–298 Reinvestment ratio, 299–300 Relationship of financial statements, 56–72 balance sheet to cash flow statement in, 57, 57 balance sheet to income statement, 57–57, 57 capitalizing in, 66–70, 66–70 cash sale transaction and, 59–61, 60 credit sale transaction in, 61–64, 61, 62, 63 depreciation in, 66–70, 66–70 expensing in, 64, 65 fixed asset purchase transaction in, 64–70, 65–70 items tracked by each financial statement and, 58–59 transactions and, 59 Relative R&D, 235–236 Relevance in accounting, 151 Reliability in accounting, 153 Renaissance accounting systems, 4–5 Reports on financial analysis, 225–226 Resources, 325–326 Restricted funds, in not-for-profit accounting and, 192 Retained earnings shown in balance sheet and, 19 Retained earnings, 30–31 Return metrics in, 237 Return on assets, 236–237 Return on equity (ROE), 239–240 Return on investment (ROI), 238–239, 243, 246, 246–247 Revenue receivable, adjusting entries and, 165 Revenue recognition in accounting, 153–154, 153 Revenues, 34–35, 116, 117 adjusting entries and, 162, 165, 162 credit sale transaction in, 131 credits, 116, 117 debits, 116, 117 matching principle and, 157, 159 recognition of, 153–154 temporary accounts in, 166 unearned, 162, 165 Risk Management Association, 226 Sales of goods and services, in notfor-profit accounting and, 186 Sales to fixed assets, 237–238 Sarbanes-Oxley Act, 152–153 Say It with Charts…, 227 Scaling, financial analysis and, 222 Scandals related to accounting, Securities and Exchange Commission (SEC), 91, 152 Semivariable cost, 36–39, 36 Service business, inventory of, 141 Shareholder earnings ratios, 241 Short-term debt to all debt ratio in, 295 Signature page, in 10-K statement and, 107 Southwest Airlines, 29 Special revenue funds, governmental accounting and, 176 Stack, Jack, 223–224 Standard cost, 80, 81 hartindex.qxp 9/6/2005 5:28 PM Page 343 343 INDEX Standards, financial analysis and, 204 Statement of activities in governmental accounting and, 178, 179, 180–182 in not-for-profit accounting and, 186, 188–189 Statement of cash flows, in not-forprofit accounting and, 188, 191 Statement of earnings See income statement Statement of financial position, in not-for-profit accounting and, 186, 187 Stocks and stockholders balance sheet and, 18–19, 30 common stock and, 27, 281 liquidation of assets and, 27 preferred stock and, 27, 281 price/earnings ratio and, 241–242 shareholder earnings ratios, 241 10-K statement and, 99 Straight-line depreciation, 162, 163 Strategic plans, financial analysis and, 215 Submission of matters to a vote of security holders, in 10-K statement and, 99 Success factors for each entity, financial analysis and, 215 Sum of the years’ digits (SYD) depreciation, 163, 163 Supplies, adjusting entries and, 160 Sustaining firms, in financial analysis and, 208 Systems of accounting, 79–90 budgetary accounting in, 80, 83–87 cost accounting in, 79, 80–82 deciding on which to use, 81 Excel spreadsheets and, 81 financial accounting system in, 79 tax accounting in, 80, 87–88 Tax accounting, 80, 87–88 Taxes annual reports and, 91 audits and, 105 depreciation and, 66–70, 66–70, 163–164 earnings before interest and taxes (EBIT) in, 42–43 earnings before interest, taxes, depreciation, and amortization (EBITDA) in, 42–43 not-for-profit accounting and, 186 quarterly reports and, 91 tax accounting and, 80, 87–88 Temporary accounts, 166 10-K, 91–93 annual reports vs., 92–93 auditor’s opinion in, 103–105 balance sheet in, 105–106 business strategy explained in, 96 cash flow statement in, 105–106 contingencies and concentrations in, 106–107 cover of, information on, 93–95, 94 Dell example of, 93–107, 94, 101–103 executive officers listed in, 98 factors affecting business and prospects explained in, 96–97 financial statements and supplementary data in, 103–107 income statement in, 105–106 legal proceedings described in, 98–99 management discussion/analysis of company in, 100–103 hartindex.qxp 9/6/2005 5:28 PM Page 344 344 INDEX notes to financial statements in, 106–107 obtaining, 92 ownership, equity, dividends described in, 99 Part I of, information in, 95–99 Part II of, information in, 99–107 properties listed in, 98 selected financial data in, 99–100, 101–103 signature page of, 107 submission of matters to a vote of security holders given in, 99 10-Q, 91 See also quarterly reports Terminology of accounting, 3–12 Time period, 153 Tracor, 23–24 Transactions, 128–140 cash sale transaction in, 59–61, 60, 128–130 credit sale transaction in, 130–133 fixed asset purchase in, 64–70, 65–70, 134–138 recording, 118 relationship of financial statements and, 59 Trial balance in, 166–167 Unearned revenue, 162–165 Units of production depreciation, 164 Unqualified auditor’s opinion, 104 Unrestricted funds, in not-for-profit accounting and, 192 Variable cost, 35–39, 36, 80, 81 Vendor information, financial analysis and, 214 Venture capital, 20 Wages, adjusting entries and, 161 Weighted average method, inventory, 142–143 Work-in-process/progress inventory, 142 Working capital, 20–23, 251–270 accounts payable component of, 264 accounts payable to working capital in, 264–265 accounts receivable component of, 260 accounts receivable to working capital in, 260 cash conversion cycle in, 267–268 cash to working capital, 278–279 working capital contrast ratios, 255 working capital to sales ratio, 253 working capital turnover ratio, 254 WorldCom, Zelazny, Gene, 227 Zero-based budgets in, 86–87 hartindex.qxp 9/6/2005 5:28 PM Page 345 345 About the Author Leita Hart makes finance fun and easy She is a certified public accountant and a certified government financial manager She is the author of The Four Principles of Happy Cash Flow and STEP-by-STEP Building a Persuasive Audit Report Leita has developed and taught over 20 courses on finance, auditing, balanced scorecard management, and business writing She writes for two monthly e-zines for auditors and the accounting challenged To find out more about her and to subscribe to her e-zines, please see her Web sites at www.happycashflow.com, www.leitahart.com, and www.auditskills.com hartindex.qxp 9/6/2005 5:28 PM Page 346 ... PM Page 6 PART ONE The Big Picture Gaps in GAAP? Nowadays accounting rules are voluminous The standards that accountants use to create financial statements are called generally accepted accounting. .. Income Statement, Cash Flow Statement, and Balance Sheet Are Related What Each Financial Statement Tracks Simple Transactions and How They Impact the Three Key Financial Statements Cash Sale 34... really isn’t all that hard It is just a system and a language Hey, if I can learn it, so can you! Accounting Is Just a System and a Language You see, accounting is one of the oldest systems around