Managerial Accounting
Class Notes and Lecture Outline
Understanding Financial Statements 
There are 2 Main Financial Statements
  1. The Balance Sheet
    • reports the financial condition of a business at a point in time
    • Assets  =  Liabilities  +  Owners' Equity
  2. The Income Statement
    • shows the operating results of a business over a period of time
    • Revenues  -  Expenses  =  Net Income
Direct versus Indirect Costs
  1. Direct Costs
    • costs that are directly traceable to a specific department or division
    • Departmental Revenues  -  Direct Costs  =  Departmental Contributory Income
  2. Indirect Costs
    • are not easily traceable to a specific department and are not directly incurred by the department
    • indirect costs are incurred by supporting departments such as administration, marketing, maintenance, and energy
    • indirect costs are allocated using a number of different bases  (e.g., percentage of revenues, square footage, or percentage of employees)
Calculating Inventory Value
  1. Specific Identification
    • records the actual cost of each item
    • assumes the cost of each unsold item can be accurately identified
    • typically used for high priced items
  2. FIFO
    • assumes the first units purchased are the first items sold
  3. LIFO
    • assumes the last items purchased are sold first
  4. Weighted Average
    • calculates a weighted average cost for all items available for sale in a category
Note:  each of the 4 methods will produce a different value for ending inventory, which in turn will produce a different cost of sales
Cost of Sales Equation
     beginning inventory
 +   purchases
 -   ending inventory
     gross cost of sales
+/-  transfers of inventory
     cost of sales
Depreciation Methods
  1. Straight Line
    • (cost of asset - residual value of the asset) / life of asset in time
  2. Units of Production
    • (cost of asset - residual value of the asset) / life of asset in units
  3. Sum-of-the-Years Digits
    • (cost of asset - residual value of the asset) * SYD fraction 
    • this is an accelerated method allowing greater amounts of depreciation in the early years of the asset
  4. Double Declining Balance
    • (2 / years of asset life) * net book value of the asset
    • this method ignores residual value
    • this is an accelerated method allowing greater amounts of depreciation in the early years of the asset
6 Major Categories of Accounts on the Balance Sheet
  1. Current Assets
    • primary operating accounts representing a major part of working capital
    • cash, account receivables, marketable securities, inventories, and prepaid expenses
  2. Fixed Assets
    • land, buildings, FF&E, other inventories not for resale
  3. Other Assets
    • assets that cannot be easily classified as either current or fixed
  4. Current Liabilities
    • the other major part of working capital
    • accounts payable, accrued expenses payable, customer deposits, current amounts due on long-term debt
  5. Long-term Liabilities
    • mortgage payable, notes payable
  6. Owners' / Stockholders' Equity
    • stockholders' equity infers a corporate business form
    • typical accounts are:  capital or common stock, preferred stock, retained earnings
Retained Earnings
  • chronological record of the stockholders' equity
  • describes earnings, losses, cash and stock dividends paid
  • Retained Earnings Equation:
         beginning retained earnings
      +  Net Income  (note: this is negative if we have a net loss)
      -  Dividends
         ending retained earnings

Balance Sheet Limitations
  1. shows all non-current fixed assets at its historical price
    • the actual fair market value may be much higher than the historical price
  2. reports the financial condition of a business at a specific point in time
    • a business may be in a strong cash position today and in a poor cash position tomorrow
  3. the method used to determine inventories and depreciation are left to the judgment of management

Analysis and Interpretation of Financial Statements 
Who Analyzes Financial Statements?
  1. Managers
    • concerned with internal operations, efficiency, and profitability
    • managers must safe guard the assets, produce sales, control costs, and maximize profits
  2. Stockholders
    • concerned with current earnings, potential dividends, and future earnings
  3. Creditors
    • concerned with current and future earnings and the ability to meet current and future debt obligations
Comparative Analysis
  • view changes in the financial condition of the business from one operating period to the next
  • used with the balance sheet and the income statement
  • sometimes called a horizontal analysis
  • looks at both absolute ($change = period 2 - period 1) and relative (%change = $change / period 1) changes from one period to the next
  • example
    Balance Sheet - ABC Corporation
    December 31, 2001 and December 31, 2002

    Change $
    Change %
    Current Assets
    - $4.200
    - 8.7%
    Non-Current Assets
    + $6,000
    Total Assets
    + $2,200
    + 0.9%
Common Size Analysis
  • uses the information for only 1 period
  • also called a vertical analysis
  • expresses each individual account as a percentage of the whole
  • examples
    Balance Sheet for ABC Enterprises
    December 31, 2002
    Current Assets
    $ 48,400
    Non-Current Assets
    Total Assets
    Current Liabilities
    Long-Term Liabilities
    Total Liabilities
    Owners' Equity
    Total Liabilities and OE
    $ 240,400

    Income Statement - ABC Enterprises
    for the Year Ending 12/31/2002
    sales revenue
    $ 548,000
    cost of sales
    - 284,960
    gross margin
    operating expenses
    - 219,200
    operating income before tax
    $ 43,840
Trend Analysis
  • views data over an extended period of time
  • as information is accumulated, trend results show the changes of key elements in the financial statements
  • helpful for forecasting sales and operating costs
  • trend analysis can be combined into a single index also called an Index Trend Schedule
Converting Historic Dollars to Current Dollars
  • use the following equation
                         index number current period
    historic dollars  *  ---------------------------  =  current dollars
                            historic index number
  • index numbers are often derived from the Consumer Price Index

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this page is maintained by Reed Fisher
last updated January 15, 2011