winsem2012 13 cp1056-10-jan-2013_rm01_lecture-3---financial-statements

Financial Statements

Introduction• Basic knowledge of accounting and financial

statements necessary for a chemical professional.

• This will help:– Analyze a firm’s operations.– Discover whether the firm is making a profit, and– Whether the firm will continue making a profit

• Financial reports are important sources of data.• A general knowledge of accounting helps an

engineer communicate with accountants, financial personnel and managers.

Journal and Legder

• Accounting systems have as inputs business transactions in the form of receipts and invoices.

• These events are entered chronologically in a journal.

• These are then classified and posted in an appropriate account in a ledger.

• Periodically – monthly or yearly – accounts are closed and a summary is issued as an income statement and a balance sheet.

An Accounting System

The Accounting Equation• Accounting methods in use today had their origin in 14th century Italy.• A development was the double-entry bookkeeping system which states:

– Assets = Equities• Assets: the economic resources a company owns and which are expected

to benefit future operations.

• Tangible assets:– Equipment– Buildings– Furniture

• Intangible assets:– Franchises– Patents– Trademarks

The Accounting Equation

• Equities: claims against the firm– Liabilities– Owner’s equity

• Assets = Liabilities + Owner’s equity• Liabilities are outside claims against the assets of the firm:– Accounts payable– Borrowed funds– Taxes owed

• These obligations require settlement in the future.• The difference (assets – liabilities) is the amount belonging to

the firm’s owners, i.e., stockholders.

The Accounting Equation

• An increase in assets must be accompanied by one of the following:– Increase in liabilities (e.g. money borrowed to purchase equipment)– Increase in stockholders’ equity– Decrease in assets (perhaps money taken out of cash to purchase

equipment; total assets don’t change but change in distribution of assets)

• Double Entry Bookkeeping – change in one part of the equation accompanied by change in another place.

The Accounting Equation

• The left side of the account book page – debit side.

• The right side of the account book page – credit side.

• Nowadays data entered into computer using software packages.

• Transactions recorded chronologically in a journal.

Debit and Credit

• An increase (+) to an asset account is a debit.• An increase (+) to a liability account is a

credit. • Conversely, a decrease (-) to an asset account

is a credit. • A decrease (-) to a liability account is a debit.

Example of a Journal

The Ledger• Journal entries are transferred to a ledger, via a process called posting.• Separate ledger accounts for each major type of transactions, e.g.,

– Asset account– Liability account– Revenue account– Expense account

• Each debit entry to a ledger account is matched by a credit entry to another account.

• One-to-one correspondence between journal entries and ledger entries – hence the term double-entry bookkeeping.

• The ledger page (LP) is the cross-reference.

The Ledger

• Periodically the ledger sheets are closed and balanced.

• Various reports made.• A consolidated income statement can be

prepared from the ledger revenue and expense account.

• From the asset and liability accounts, a company’s balance sheet is prepared.

Example of a ledger

Journal and Ledger Example

• On January 1, 20XX, three people – Anderson, Burns and Carter – agreed to start a business to manufacture a specialty solvent, Nusolv.

• They named the company Nuchem, Inc.• Their contributions to the venture were:– Anderson: $5000 cash– Burns: $5000 cash– Carter: Basic process development info, a small

reactor, mixing vessels, some raw materials.

Journal and Ledger Example

• The three decided to distribute 1000 shares of stock as follows:– Anderson: 300 shares– Burns: 300 shares– Carter: 400 shares

• All these initial transactions are recorded in a general ledger similar to one shown in next slide.

• Each transaction appears twice, once as credit and once as debit.

Journal and Ledger Example

Journal and Ledger Example

• A ledger set up to record the transactions of Jan 1, 20XX is shown in next slide.

• Note that initially Nuchem, Inc. required only asset and liability accounts.

• However, as the firm grows, more accounts are to be established to record business transactions.

Journal and Ledger Example

Journal and Ledger Example

• Information from the general ledger and ledger accounts was used to prepare a consolidated balance sheet:

Journal and Ledger Example

• During the month of January, manufacturing began.• New asset and liability accounts were created to

accommodate new types of transactions.• Temporary revenue and expense accounts used to

classify changes.• Expense accounts: legal expense (40), depreciation

expense (41), interest expense (42).• Revenue account not needed in January because

there was no income.

Journal and Ledger Example

• The balance of revenue and expense accounts is reduced to zero through an income summary account at the end of the month.

• The ledger for the month of January is shown in next slide.

Journal and Ledger Example

• A consolidated income statement is developed from income and expense accounts:

• Note that this statement reflects no income and a loss of $1045 during the month.

Journal and Ledger Example

• The next slide shows the consolidated balance sheet as of February 1, 20XX.

• Comparing this with the January 1, 20XX balance sheet, we find that the stockholders’ equity decreased on the February statement.

• This reflects the $1045 loss during January.

Journal and Ledger Example

Journal and Ledger Example

• The same procedure can be followed month after month.

• Each transaction will be entered in the general journal and then posted to the appropriate ledger account.

• At the end of each month, an income statement and balance sheet may be prepared.

• In this manner, information for an annual report is assembled.

Additional Points

• Today, transactions are entered into a computer program.• Manual ledgers are no longer kept in modern business firms.• These are the “traditional” methods of cost/ managerial

accounting.• They help finance departments monitor operations and value

inventory.• But focus is more on direct costs.• New tools have come which also look into indirect expenses

of a production unit or of a service.• This will give a better picture of the “real” expenses.