Engineering Economy

Principles of Accounting

Introduction

Accounting is the process of recording all the transactions of

the company which affect any investment of capital, so that at

any time the results of the investment may be known.

Accounting has also been defined as the body of principles by

means of which all business transactions expressible in terms

of money are recorded, classified, and periodically

summarized and interpreted.

Bookkeeping

Is the systematic recording of all business transactions in

financial terms. The study of bookkeeping usually emphasizes

technique, while the study of accounting gives emphasis on

theory. Accounting is a more comprehensive process as

compared to bookkeeping.

Accounting

The main purpose of accounting for any business enterprise

is to provide all the necessary financial information to the

management for the proper and efficient operation of the

enterprise. Errors in judgement of the management are

minimized if the records are presented in a proper manner by

the accountant. Records are needed by entities operated for

profit as well as non-profit making organizations, such as the

government and associations operating for religious,

philanthropic or fraternal purposes. Records are also need to

record financial transactions of individuals for taxation and

other purposes.

Accounting Terms

Assets are defined as anything of value possessed by an

enterprise. They consist of property and the right to

property, tangible, or intangible, which may be used for the

payment of debt.

Liabilities are debts or claims of anyone other than the

owners of the property upon the assets of the company. They

consist of all the obligations of the company to other persons

in the form of money, other assets, services, to be paid now

or in the future.

Accounting Terms

Ownership or proprietorship is the excess of assets over

liabilities. It represents the investment of a person or several

persons in the enterprise.

Equities are the claims of anyone against the assets of the

enterprise. It therefore includes the liabilities to creditors as

well as the claims of the owners.

Types of Assets

Assets are classified and described as follows:

Fixed Assets – properties that will not be converted into

cash or transformed into saleable form. Buildings, land,

machinert, equipment, furniture, and fixtures which are used

in the productions of goods. It does not mean however that

fixed assets are stationary or incapable of motion. The buses

of a transportation company or the airplanes of an airplane

are fixed assets, but they are not stationary.

Types of Assets Current or Liquid Assets – These are the items of value which

include cahs, accoutns receivable within a short time or at least

within the present accounting period, raw materials, goods in the

process of production, and finished goods ready for sale.

Prepaid Expense – these are the assets in the form of money

paid for certain materials not yet delivered or services not yet

rendered to the company. The advance payment for insurance or

rental are prepaid expenses until the term for which they were

paid has expired. In certain cases the company may order and pay

for its materials well in advance of delivery date of the same, in

which case the amount paid is considered an asset until delivery is

made.

Types of Assets

Intangible Assets – have no physical substance. Principal

examples are: goodwill, leaseholds, copyrights, patents,

franchises, licenses, and trademarks. Accounting for an

intangible asset os rendered somewhat difficult because the

lack of physical substance makes evidence of its existence

more elusive, may make its value debatable, and its useful life

may be questionable. The inclusion of intangible assets on the

balance sheet is justified only when there is good evidence

that future earnings will be obtained from these assets.

Types of Assets Copyright – is an exclusive right granted by the government to

protect the production and sale of literary or artistic work for a

period of 50 years or during the lifetime of the author.

Patent – is an exclusive right granted by the government fro the

manufacture, use, and sale of a specific product. When a company

acquires a patent or copyright by purchase from the owner, the

purchase price is classified as an asset.

To obtain the exclusive right to the use of a trademark,

brandname, or commercial symbol all one has to do is to register

it with the proper government entity. The expenses incurred in

registering it is included in the balance sheet as an intangible asset.

Types of Liabilities

Fixed Liabilities – which are not due payment until sometime

in the future, usually after a period exceeding one year.

Current Liabilities – these are the liabilities which mature

within a short time; usually a year

Prepaid Income – these are the liabilities representing

income which have been paid to the enterprise, but for which

the goods have not been delivered or any service rendered to

the payer.

Types of Ownership

For an individual ownership or sole propriertorship, the

owneship will be in the capital account of the sole owner.

For a partnership, the ownership will be in the capital

account of the partner.

For a corporation, the ownership is vested in the shares of

common and preferred stock of the persons who have

invested in them.

Fundamentals Equation of AccountingThe fundamental equation of accounting is:

Assets = Equities

Equities = Liabilities + Ownership

Assets = Liabilities + Ownership

In other words, the sum total of the things of value possessed by the enterprise equals the sum total of the claim against the enterprise which consist of the claims of persons aside from the owners and claims of the owners themselves against the enterprise.

Balance Sheet

Is a financial summary showing the relationship among assets,

liabilities, and ownership in the corporation on a specific

date. It is considered to be the most important financial

statement of any enterprise and is conceded to the goal of all

accounting activity. Basically, it enumerates the nature and

amount of the assets, liabilities, and ownership in the

company.

Balance Sheet

There are two forms of balance sheets.They are:

The account or Horizontal Form: In this form, the assets are

summarized on the left side of the page, and the liabilities

and ownership on the right side. The totals on either side are

equal, thus conforming to the fundamental equation of

accounting

Assets = Liabilities + Ownership

Balance Sheet

The report or Vertical Form: The assets are listed first and

immediately below them the liabilities followed by the

ownership. As required by the fundamental equation of

accounting, the total assets must equal the total of the

liabilities and ownership.

It is important to note that the balance sheet must be

prepared as of a given date, for any transaction, no matter

how small, will effect the totals on either side of the balance

sheet.

Balance Sheet

The Profit and Loss Statement Is a summary of the income and expenses of an individual or

company for a given period. Profit results from an excess of income over expenses. A loss is indicated if the expenses exceed the income for the given period.

Income is defined to be the value of personal and professional services rendered or of goods sold in the operation of the business. It is classified into two divisions:

Operating Income results from the primary operation of the company from the sale of its products or from the rendering of the services for which the enterprise was established.

Non Operating Income this is due to the loan or sale of the assets not needed in the primary operation of the business or in the rendering of unusual service not included in the basic services rendered by the company.

The Profit and Loss Statement

Expense is defined as the cost of producing income or

revenue. It is subdivided into

Operating Expense are incurred in the pursuit of the primary

operations of the business.

Non-operating Expense are incurred in operations different

from the basic operations of the business.

Financial Ratios

A ratio is a simple mathematical expression of the

relationships between two items. For a ratio to have a

meaning, there must be a significant relationship between

two figures. Ratios are an aid to analysis and interpretation of

financial statements.

Financial Ratios

Current Ratio

Indicates capacity of the company to pay short-term debts

Quick ratio (Acid-test ratio)

Indicates the short-term liquidity of a firm

Financial Ratios

Inventory Turnover

Shows the ability of management to control investment in

inventory

Accounts Receivable Turnover

Indicates effectiveness of collections

Financial Ratios

Asset Turnover

A high asset turnover indicates that the management makes

better use of the assets

Debt Ratio

Gives the percentage of assets financed through borrowing

Financial Ratios

Number of times interest earned

Indicates capacity to pay on interest on debts, particularly

long-term debts

Equity Ratio

Shows the protection to creditors and measures proportion

of total assets financed by stockholders

Financial Ratios

Return on total assets

Measures the productivity of assets

Operating expense ratio

Indicates adequacy of control over expenses

Financial Ratios

Price earnings ratio

Indicates whether price of stock is compatible with earnings

Dividend yield

Gives the rate earned per share based on current price per

share

Financial Ratios

Times preferred dividends earned

Indicates the adequacy of current earnings to pay dividends

on preferred stock

Return on common stockholders equity

Gives the earning power of common stockholders equity

Financial Ratios

Earnings per share on common stock

Gives the amount of earnings of one share of common stock

Book value per share of common stock

Indicates the recorded value of net assets for each share of

common stock