Abstract This text concerns itself with a number of accounting concepts. In so doing, a concise definition of a number of key accounting terms will be given. Further, the text will also discuss the basic formats of the most common accounting statements. Lastly, the accounting equation will also be explained.
Accounting Concepts and Practice
Income Statement and Balance Sheet
Smith Company
Income Statement
For the Year Ended 31st Dec 2012
Revenue
$406,000
Less cost of goods sold
$234,000
Gross profit
$172,000
Less: Expenses
Depreciation expense
$24,350
Insurance
$1,400
Marketing
$4,500
Property taxes
$8,900
Rent
$18,000
Utilities
$6,700
Salaries
Total expenses
($131,350)
Net Income (Balance C/D)
$40,650
Computations
Retained Earnings: Difference between debit and credit balances.
$760,850 -- $718,000 = $42,850
Retained earnings to be transferred to the balance sheet:
Income statement balance b/f
balance c/d $40,650
$40,650
Add: retained earnings
$42,850
Retained earnings balance c/d $83,500
Smith Company
Balance Sheet
For the Year Ended 31st Dec 2012
Non-Current Assets
Equipment
$316,000
Current Assets
Accounts receivable
$24,500
Cash
$30,000
Inventory
$25,000
Total current assets
$79,500
Total assets
$395,500
Current Liabilities
Accounts payable
$67,000
Non-Current Liabilities
Long-term debt
$145,000
Financed By
Common stock
$10,000
Paid in capital
$90,000
Retained earnings
$83,500
$183,500
Total liabilities
$395,500
Analysis
This section will analyze the success of Smith Company based on information derived from the financial statements I have prepared above. The table below contains some of the ratios I will be making use of in that endeavor.
Table 1
Ratio
Formula
Computation
Value
Return on Assets
Net Income/Total Assets
$40,650/$395,500
0.10
Current Ratio
Current Assets/Current Liabilities
$79,500/$67,000
1.19
Debt ratio
Total Debt/Total Assets
$212,000/$395,500
0.54
Return on Equity
Net Income/Shareholder Equity
$40,650/$183,500
0.22
From the return on assets ratio, it is clear that for each dollar of assets, Smith Company earns $0.10. In my view, the profit per dollar of assets is in this case significantly high and for this reason, one could say that the company's management is effectively utilizing assets in the generation of profits. This is an indicator of managerial competence. In seeking to determine the ability of Smith Company to settle its short-term obligations, it would be prudent to take into consideration its current ratio. From the table above, the firm has a current ratio of 1.19. According to Albrecht, Stice, and Stice (2010), it has been suggested in the past that a current ratio of less than 2 could be a sign that a business has liquidity problems. However, in the words of the authors, "current ratios for successful companies these days are frequently less than 1…" (Albrecht, Stice, and Stice, 2010, p.667). This according to the authors is as a result of advances in technology - a move that has further enhanced the effectiveness of firms in the minimization of the need to hold current assets like inventories and cash. In that regard, a current ratio of less than 2 in the case of Smith Company should not be a cause for alarm. This is particularity the case given that being more than 1, the said ratio indicates that were Smith Company's obligations (current) to become due today, the company would comfortably settle them.
You’re 71% through this paper. Sign up to read the full paper.
Sign Up Now — Instant Access Already a member? Log inAlways verify citation format against your institution’s current style guide requirements.