Fundamentals of Finance and Accounting for


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Fundamentals of Finance and Accounting for Nonfinancial Managers Lesson Worksheets

2218V• Updated 01/2016

© American Management Association. All rights reserved.

Fundamentals of Finance and Accounting for Nonfinancial Managers

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

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

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

Lesson Four Present Value Tables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .L4.1 Most Important Points (MIPs) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .L4.5 Note: Additional worksheets can be found in the 2218v Handout.xls file.

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LESSON

1

Fundamentals of Finance and Accounting for Nonfinancial Managers

Key Terms Instructions: 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 and expense: Revenues:

Stockholder’s equity:

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L1.1

LESSON

1

Fundamentals of Finance and Accounting for Nonfinancial Managers

L1.2

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



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



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



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



With multinational companies, the accounting rules of the parent company’s country are normally used in the consolidated statements. Thus, a U.S. company with international subsidiaries 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, a business’s tax accounting will comply with the tax laws of the countries in which it does business. As a result, the numbers on the tax return will often differ from those on the financial statements.

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



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



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



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

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LESSON

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Fundamentals of Finance and Accounting for Nonfinancial Managers

L1.3

Understanding the Accounting Process The 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., retained earnings)



Revenues—what the organization earned from selling its products or services; there may also be 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 during an accounting period. These transactions are then classified and summarized through a process that ultimately yields a set of financial statements. Transactions A transaction is a business event, expressed in monetary terms, that is entered into the accounting records. Purchasing equipment, paying staff members, and recording a sale are all examples of accounting transactions. Journal Entries Journal entries record transactions in the order in which they occur. They contain “supporting details” 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 financial statements 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. For example, the accounts receivable subsidiary ledger lists all the customers of the business, their balances, and the transactions that have taken place in each account.

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LESSON

1

Fundamentals of Finance and Accounting for Nonfinancial Managers

L1.4

Adjusting Entries At the end of an accounting period, various adjustments are made to account balances to reflect economic events that occurred but did not cause a transaction. Examples of such adjusting entries include recording depreciation expenses or accruing liabilities for expenses that were incurred during the period, such as salaries that have not been paid. Closing the Books At the end of each accounting period, revenue and expense accounts are consolidated to determine if the organization made or lost money and are reset to zero. This process allows the organization to identify its revenues and expenses for that particular period. The profit or loss for the period is then transferred to the retained earnings account of the Balance Sheet. Then the financial statements are prepared. Double-Entry Accounting Business transactions are recorded in a double-entry accounting system that involves the use of debits and credits. This procedure requires that every transaction be recorded two ways: as one or more debit entries and as one or more credit entries. The debit entries must equal the credit entries. Debit is probably the most misunderstood of all accounting terms. Most people think a debit is always a negative. In reality, a debit entry is merely a left-hand entry in a ledger account, while a credit is a right-hand entry. Debits can be positive or negative depending on the account type. For example, 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, but increases a revenue account. Practically speaking, for most nonfinancial managers, it is unimportant to know whether an account is “debited” or “credited.” However, it is extremely important to understand the impact of various transactions on the different accounts (i.e., whether an account is increased or decreased). In the following exercise, your team will check and broaden your understanding of different transactions and their impact on the accounting system.

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LESSON

1

Fundamentals of Finance and Accounting for Nonfinancial Managers

Financial Statements Overview The 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 of Statement

Purpose

Information Presented

Income Statement

Presents the organization’s Revenues earned operating performance Expenses incurred during a period of time Profit, Income, or Loss, the difference between revenues and expenses

Balance Sheet

Reports the organization’s financial condition at a point in time

Assets, what the organization owns Liabilities, what the organization owes to others Stockholders’ Equity, the difference between assets and liabilities, i.e., what belongs to the shareholders (may be called Net Assets for a not-for-profit or government entity)

Statement of Describes what was done Retained Earnings with the profits reported on the Income Statement

Dividends paid to the shareholders Retained Earnings, the profits left in the business, i.e., reinvested

Statement of Cash Flow

Operating Cash Flow, the cash generated by the day-to-day operations of the organization Investing Cash Flow, the cash reinvested in the business or generated by selling off pieces of the business Financing Cash Flow, the cash generated by borrowing or selling stock to investors and the cash disbursed to pay off debt, buy back stock, or pay dividends

Describes how cash came into the business and how it was used

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L1.5

LESSON

1

Fundamentals of Finance and Accounting for Nonfinancial Managers

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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L1.6

LESSON

1

Fundamentals of Finance and Accounting for Nonfinancial Managers

L1.7

Preparation of Financial Statements The following is a list of the account balances for Compton’s Computers, Inc., a distributor of computer equipment. Use each item only once when you are preparing the financial statement.Use the Income Statement, Statement of Retained Earnings, Balance Sheet, and Statement of Cash Flow formats on the following pages to prepare the firm’s financial statements on the Compton’s Computers tab of the 2218v Handout Excel file. Use each item only once when you are preparing the financial statement. Balance

I/S

B/S

R/E

_______ _______ _______ _______

_______ _______ _______ _______

Accounts payable

210,000

Accounts receivable

300,000

Accumulated depreciation Advertising and selling expenses

140,000 60,000

_______ _______ _______ _______

Building

600,000

_______

_______

_______

Cash

100,000

_______ _______ _______

_______ _______ _______

_______ _______ _______

_______ _______

_______ _______

Cost of goods sold Common stock

1,200,000 500,000

Depreciation expense

80,000

Dividends paid

20,000

_______ _______

240,000

_______

_______

_______

_______ _______ _______ _______

_______ _______ _______ _______

_______ _______ _______ _______

_______ _______

_______ _______

Furniture and equipment Income tax expense

35,000

Interest expense

25,000

Interest income

5,000

Inventory

250,000

Long-term debt

470,000

_______ _______

Retained earnings, beginning balance

175,000

_______

_______

_______

1,800,000

_______

_______

_______

40,000

_______

_______

_______

300,000

_______

_______

_______

Land

Sales Telephone and utility expense Wage and salary expense

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50,000

LESSON

1

Fundamentals of Finance and Accounting for Nonfinancial Managers

To prepare the Cash Flow Statement, you will need to use the statements you have already prepared, as well as the following information. Account balances from one year earlier: Cash

95,000

Accounts receivable

240,000

Inventory

200,000

Accounts payable

170,000

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.

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L1.8

LESSON

1

Fundamentals of Finance and Accounting for Nonfinancial Managers

L1.9

Financial Ratios There 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 must examine the range of ratios and understand the business in relation to its industry and particular environment 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 financial obligations



Leverage—the portion of assets that have been financed through debt vs. equity financing and 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 by the shareholders or in the business

The following table summarizes the categories and their ratios: Liquidity Ratios

Leverage Ratios

Profitability Ratios

Current Ratio Acid-Test or Quick Ratio

Debt to Equity Debt to Capital

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

Days Sales Outstanding (DSO)

Interest Coverage

Profit Margin or Return on Sales (ROS)

Accounts Receivable Turnover

Cash Flow to Current Maturity of Long-Term Debt

Return on Assets (ROA); DuPont Formula; Economic Value Added (EVA®); Cash Flow Return on Investment (CFROI)

Inventory Turnover (DIOH)

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Earnings per Share (EPS)

LESSON

2

Fundamentals of Finance and Accounting for Nonfinancial Managers

Calculating Financial Ratios for J&J Instructions: Use the Johnson & Johnson annual report to calculate the following ratios. Liquidity Ratios Current Ratio

Acid Ratio Days Sales Outstanding (DSO) Ratio

Current Assets Current Liabilities (Cash + Marketable Securities + Accounts Receivable) /Current Liabilities

Avg. Accounts Receivable x 365 Annual Credit Sales

365 DSO

Accounts Receivable Turnover Ratio Days Sales in Inventory (DSI)

(Avg. Inventory/COGS) x 365

Inventory Turnover Ratio

365 DSI

Leverage Ratios Debt to Equity Ratio

Long-term debt equity

total liabilities equity

Debt to Capital Ratio

Long-term debt long-term debt + equity

Interest Coverage (Times Interest Earned) Ratio

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

Cash Flow to Current Maturity of LongTerm Debt Ratio

Net income + depreciation + amortization Current maturity of long-term debt

Profitability Ratios Return on Equity (ROE) Ratio Return on Invested Capital (ROIC) Ratio

Net income Total shareholder’s equity Net operating profit after tax = Long-term debt + equity

Profit Margin or Return on Sales (ROS) Ratio Return on Assets (ROA) Ratio

(NOPAT) (CAPITAL)

Net income Net sales Whole Company

Net income Total assets

Division/Unit

Pre-tax income of unit Assets allocated to unit

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L2.1

LESSON

2

Fundamentals of Finance and Accounting for Nonfinancial Managers

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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L2.2

LESSON

2

Fundamentals of Finance and Accounting for Nonfinancial Managers

Lesson Three: Key Terms Instructions: Write a definition for the phrases below. Fixed costs:

Three examples of fixed costs: 1. 2. 3.

Variable costs:

Three examples of variable costs: 1. 2. 3. Absorption costing:

Direct costing:

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L2.3

LESSON

3

Fundamentals of Finance and Accounting for Nonfinancial Managers

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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L3.1

LESSON

3

Fundamentals of Finance and Accounting for Nonfinancial Managers

Lesson Four: Key Terms Instructions: 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

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L3.2

LESSON

4

Fundamentals of Finance and Accounting for Nonfinancial Managers

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L4.1

LESSON

4

Fundamentals of Finance and Accounting for Nonfinancial Managers

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L4.2

LESSON

4

Fundamentals of Finance and Accounting for Nonfinancial Managers

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L4.3

LESSON

4

Fundamentals of Finance and Accounting for Nonfinancial Managers

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L4.4

LESSON

4

Fundamentals of Finance and Accounting for Nonfinancial Managers

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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L4.5