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Microsoft PowerPoint - Lecture 3 - Intro to Double Entry

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					         An Introduction to Financial
        Statements and Double Entry
                 Accounting
                ENGG 401 Notes – Chapter 2
                  Lecture 3 and Lecture 4




  ENGG 401                                                       1




               The Business Cycle


                       Action / Transaction



    Analysis                                           Bookkeeping




                 Financials               Accounting




  ENGG 401                                                       2




        An Instructional Roadmap for
                 ENGG 401

• We will focus on the business cycle.
• We will start to build a foundation by very briefly
  discussing bookkeeping, and accounting.
• With this foundation we will start to build the various
  Financial Statements that most engineers will
  confront.
• With a firm understanding of Financial Statements
  we will shift the focus of the course to using Financial
  Statements for analysis, considering the various
  analytical tools used to aid in decision-making.

  ENGG 401                                                       3




                                                                     1
                                                          4

  What are Financial Statements? - 1

 • Financial statements are fundamental
   business tools to help managers:
     –   Keep track
     –   Borrow money
     –   Measure success
     –   Manage resources
     –   Stay in business


 • Financial statements apply to all sizes of
   business, from a single proprietor corner
   store to a multinational company.
  ENGG 401                                            4




  What are Financial Statements? - 2

• Types of Financial Statements Include:
   – Income Statement
          – How much money did we make?
   – Statement of Retained Earnings
          – How much money did we keep?
   – Balance Sheet
           – How much money do we have right now?
   – Statement of Cash Flow
          – What did we do with our money?

• We will develop an understanding of each of these
  tools during this course.

  ENGG 401                                            5




         Why are Financial Statements
          Important to Engineers?- 1

• Most engineering jobs are focused on action.
• Financial Statements are critical part of the cycle of
  data collection and analysis that helps managers make
  appropriate decisions.
• Engineers must be able to speak the language of the
  financial decision-makers to successfully execute
  their projects.
• Many engineers will become financial decision-makers.

  ENGG 401                                            6




                                                              2
         Why are Financial Statements
         Important to Engineers? - 2

• An engineer need not become an accountant to
  understand financial statements or do intelligent
  financial analysis!
• An engineer can not be a good manager if they can not
  do analysis of financial statements!
• You can’t manage what you don’t understand!




  ENGG 401                                                       7




          What is Bookkeeping? - 1
• In most businesses:
   – Many transactions occur every business day.
   – Money transactions are carefully recorded.
   – Each transaction creates a record or “paper trail”.

• Bookkeeping captures the raw data and puts it into
  the first level of categorization: a journal.
• Journals are:
   –   Like a database
   –   Chronological and by subject area
   –   The “books of original entry”
   –   They are “double entry”, with offsetting credits and debits.


  ENGG 401                                                       8




          What is Bookkeeping? - 2

• There are different types of Journals:
   –   Cash receipts (sales for cash)
   –   Sales (sales for accounts payable)
   –   Cash disbursements (cash purchases)
   –   Purchases (purchases on account)
   –   Monthly (regular payments every month)
   –   Payroll
   –   General (everything else)




  ENGG 401                                                       9




                                                                      3
         What is Bookkeeping? - 3
• Basic Elements of Financial Position:
   – Assets
      • Properties that are owned and have money value
   – Liabilities
      • Amounts owed to outsiders
   – Equity
      • The interest of the owner in the enterprise (also known
        as capital)

• The Accounting Equation:
                   Assets = Liabilities + Equity

  ENGG 401                                                            10




         What is Bookkeeping? - 4
• The Account
   – A record of the increases, decreases
     and balances in an individual asset,
     liability, equity (incl. income or              Account Name
     expense).
                                                  Debits         Credits
• Simplest form is known as the “T”
  account because it looks like a “T”
   – The left side of the account is the
     debit side.
   – The right side of an account is the
     credit side.
   – Decreases are entered on one side of
     the account increases on the other.


  ENGG 401                                                            11




         What is Bookkeeping? - 4

• By definition:

                               Account Name
                      Debit                       Credit

             An increase in an asset     A decrease in an asset
                    account                     account

             A decrease in a liability   An increase in a liability
                    account                      account




  ENGG 401                                                            12




                                                                           4
         What is Bookkeeping? - 5

• Assets and liabilities are a matter of perspective.
• For a bank account:
   – Your bank account is the bank’s liability. They owe you
     money! Therefore an increase is a credit in a liability
     account. A debit is a decrease in a liability account.

   – However … from your point of view the bank account is an
     asset. Therefore an increase would be a debit in your asset
     account. A decrease would be a credit in your asset account.



  ENGG 401                                                      13




What is Double Entry? An Example - 1

                                        Description   Debit    Credit
                                                      ($K)      ($K)
• Invest $100k into a
  business at startup:          Cash                   $100
                                Shareholder Equity             $100
   – the cash (asset) in the
     business goes up by
     $100k (debit)

   – the shareholders’
     equity (capital) goes
     up by $100k (credit).




  ENGG 401                                                      14




What is Double Entry? An Example - 2

• Borrow $40k and use                   Description   Debit    Credit
  an additional $25k of                               ($K)      ($K)
  cash to buy a packaging       Cash                   $100
  machine:                      Shareholder Equity             $100
                                Fixed Assets           $65
   – Fixed assets increase
     by $65k (a debit)          Loan                            $40
                                Cash                            $25
• Two offsetting credits:

   – Bank loan (liability) of
     $40k
   – Reduction of cash of
     $25k


  ENGG 401                                                      15




                                                                        5
What is Double Entry? An Example - 3

• Sales of $10K for                    Description    Debit   Credit
  goods payable within                                ($K)     ($K)
  30 days:                    Cash                    $100
                              Shareholder Equity              $100
   – Accounts Receivable
     (asset) increases by     Fixed Assets            $65
     $10K (debit)             Loan                             $40
   – Sales (capital)          Cash                             $25
     increases by $10K        Accounts Receivable     $10
     (credit)
                              Sales                            $10




 ENGG 401                                                      16




What is Double Entry? An Example - 4

• Receive payment of                   Description    Debit   Credit
  $10K for sale of goods                              ($K)     ($K)
  30 days ago:                Cash                    $100
                              Shareholder Equity              $100
   – Accounts Receivable
     (asset) decreases by     Fixed Assets            $65
     $10K (credit)            Loan                             $40
   – Cash (asset) increases   Cash                             $25
     by $10K (debit)          Accounts Receivable     $10

                              Sales                            $10

                              Accounts Receivable              $10

                              Cash                    $10

                                     BALANCE TOTALS   $185    $185

 ENGG 401                                                      17




   Double Entry – An Exercise - 1

• Take the following accounts: cash, payables, raw
  materials inventory, work in progress, finished goods
  inventory, receivables, and SG&A (sales, general and
  administrative).
• What are the double entries for:
   –   Receiving material.
   –   Paying for it, 40 days later.
   –   Moving raw materials to the shop floor.
   –   Pay shop floor labor.
   –   Paying a salesperson.


 ENGG 401                                                      18




                                                                       6
   Double Entry – An Exercise - 2

• Categorize each account as liability, asset or equity.
      Cash                                Asset

      Payables                           Liability

      Raw materials inventory             Asset
      Work in progress                    Asset

      Finished goods inventory            Asset

      Receivables                         Asset

      SG&A (sales, general and     Equity (Expense is a
      administrative)            negative equity account)

 ENGG 401                                                   19




   Double Entry – An Exercise - 3

• Receiving material
      Cash                                Asset

      Payables                     + Liability    Credit

      Raw materials inventory       + Asset      Debit
      Work in progress                    Asset

      Finished goods inventory            Asset

      Receivables                         Asset

      SG&A (sales, general and     Equity (Expense is a
      administrative)            negative equity account)

 ENGG 401                                                   20




   Double Entry – An Exercise - 4

• Paying for it, 40 days later
      Cash                          - Asset      Credit

      Payables                     - Liability    Debit

      Raw materials inventory             Asset
      Work in progress                    Asset

      Finished goods inventory            Asset

      Receivables                         Asset

      SG&A (sales, general and     Equity (Expense is a
      administrative)            negative equity account)

 ENGG 401                                                   21




                                                                 7
   Double Entry – An Exercise - 5

• Moving raw materials to the shop floor
      Cash                                Asset

      Payables                           Liability

      Raw materials inventory       - Asset    Credit
      Work in progress              + Asset     Debit

      Finished goods inventory            Asset

      Receivables                         Asset

      SG&A (sales, general and     Equity (Expense is a
      administrative)            negative equity account)

 ENGG 401                                                   22




   Double Entry – An Exercise - 6

• Pay shop floor labor
      Cash                           - Asset      Credit

      Payables                           Liability

      Raw materials inventory              Asset
      Work in progress                     Asset

      Finished goods inventory             Asset

      Receivables                          Asset

      SG&A (sales, general and    + Equity (Expense is a
      administrative)            negative equity account)
                                            Debit
 ENGG 401                                                   23




   Double Entry – An Exercise - 7

• Paying a salesperson
      Cash                           - Asset      Credit

      Payables                           Liability

      Raw materials inventory              Asset
      Work in progress                     Asset

      Finished goods inventory             Asset

      Receivables                          Asset

      SG&A (sales, general and    + Equity (Expense is a
      administrative)            negative equity account)
                                            Debit
 ENGG 401                                                   24




                                                                 8
    Bookkeeping: A Summary - 1

• Ledgers are posted to accounts (the book of final
  entry).
• There are five types of accounts, with subsets:
     • Assets
     • Liabilities
     • Equity
     • Revenues
     • Expenses


 ENGG 401                                                   25




    Bookkeeping: A Summary - 2

• Debits are separated from credits, each being put
  into the appropriate account.

• The sum of all accounts should “balance”, since every
  credit had an offsetting debit.
   – Done periodically, usually monthly.




 ENGG 401                                                   26




   From Bookkeeping to Accounting - 1


• Accounting takes the accounts and consistently
  displays the results in a standard format:
      • Income Statement and Retained Earnings (sometimes
        these are treated as two statements)
      • Balance Sheet
      • Statement of Cash Flow (formerly the Statement of
        Changes in Financial Position)

• “Consolidated” accounts encompass the results from
  all companies in a corporate group.


 ENGG 401                                                   27




                                                                 9
  From Bookkeeping to Accounting - 2


• “Materiality” governs adjustments and corrections
   – Small errors can be tolerated
   – Definition of materiality varies from company to company

• These are the statements are the focus of the next
  few lectures in this course.
• We will learn to use these reports as fundamental
  tools in our financial analysis tool box.



 ENGG 401                                                       28




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