Accounting For Dummies

Few skills are as useful as a basic understanding of accounting language. And with the right resources, learning the language of business can be intuitive, empowering, and fun.

Accounting For Dummies is the perfect place to start, whether you're operating a small business, just need help managing the family budget, or you're a rising star in corporate America. It's a financial blueprint for the everyday person, easy-to-understand, and full of practical advice.

You'll learn the basic ABC's of accounting, how to read and understand financial statements, create best in class budgets & forecasts, craft profitable business plans, take control of your own finances, gain insight on how companies get money from investors and banks, and avoid common money mistakes that trip up even the best of us. You'll also find out how to:

• Diagnose the financial health of your business and make a realistic plan to grow your company
• Improve your own or your family's money situation with sound financial planning and understanding
• Understand each of the three basic financial statements and what they say about a company's past, present, and future
• Enhance your knowledge of how accounting functions and operates in today's digital age and cloud-based world

As a useful tool for business or as a guide to your personal finances, nothing compares to accounting mastery. And once you've nailed the basics, you'll wonder how you ever lived without this universal and beautiful language.

John A. Tracy, CPA, is an award-winning professor emeritus of accounting at the University of Colorado at Boulder. He has authored The Fast Forward MBA in Finance, 2nd Edition, and Accounting Workbook For Dummies.

Tage C. Tracy, CPA, operates a financial consulting firm focused on offering CFO support and planning services to private companies. He is the author of Business Financial Information Secrets and has coauthored several For Dummies titles.

Introduction 1

About This Book 1

Foolish Assumptions 2

Icons Used in This Book 3

Beyond the Book 4

Where to Go from Here 4

Part 1: Opening the Books on Accounting 5

Chapter 1: Accounting in Today’s New Economy 7

Checking Your Preconceptions about Accounting 8

Thinking about where assets come from 9

Asking about profit 9

Sorting out stereotypes of accountants 10

Providing Vital Financial Information 11

Recognizing users of accounting information 12

Using accounting in your personal financial life 13

Seeing accounting at work 14

Accounting’s Two Primary Roles 15

Taking a Peek behind the Scenes 16

Focusing on Transactions 19

Separating basic types of transactions 20

Knowing who’s on the other side of transactions 21

Recording events 21

Taking the Financial Pulse of a Business 22

Meeting the balance sheet (statement of financial condition) 23

Reporting profit and loss 25

Reporting cash flows and changes in owners’ equity 26

Remembering management’s role 26

Accounting as a Form of Art 27

Chapter 2: Introducing Financial Statements 29

Setting the Stage for Financial Statements 30

Offering a few preliminary comments about financial statements 31

Looking at other aspects of reporting financial statements 32

The Income Statement 33

Presenting the components of the income statement 33

Income statement pointers 35

The Balance Sheet 36

Presenting the components of the balance sheet 36

Balance sheet pointers 38

The Statement of Cash Flows 40

Presenting the components of the statement of cash flows 40

Statement of cash flows pointers 43

A Note about the Statement of Changes in Shareowners’ Equity 44

Gleaning Important Information from Financial Statements 44

How’s profit performance? 44

Is there enough cash? 45

Can you trust financial statement numbers? 46

Why no (or limited) cash distribution from profit? 47

Complying with Accounting and Financial Reporting Standards 48

Looking at who makes the standards 49

Knowing about GAAP 50

Divorcing public and private companies 51

Following the rules and bending the rules 52

Chapter 3: Safeguarding Company Assets 53

Separating the Duties of Bookkeepers and Accountants 54

Pedaling through the Bookkeeping Cycle 56

Getting to the end of the period 56

Finishing up for the period 58

Managing Accounting Systems 60

Categorize financial information: The chart of accounts 60

Standardize source documents and data-entry procedures for recording activities 62

Hire competent personnel 63

Get involved in end-of-period procedures 65

Leave good audit trails 66

Keep alert for unusual events and developments 66

Design truly useful reports for managers 67

Enforcing Strong Internal Controls 68

Double-Entry Accounting 70

Juggling the Books to Conceal Embezzlement and Fraud 73

Chapter 4: Accounting in the Digital Age 75

Noting a Few Foundational Accounting Concepts Related to Technology 76

Using Accounting Software in the Cloud and on the Ground 78

Controlling and Protecting Money Flows in the Electronic Age 80

Processing payroll 81

Controlling bank accounts 82

Surveying bank forms of electronic payments 82

Checking out non-bank forms of electronic payments 83

Using enhanced accounting controls 84

Managing the Accounting Function in the On-Demand World 86

Source documentation 86

Data rooms 86

Financial reporting 87

Flash reports and KPIs 87

Accounting and financial analysis tools 88

Chapter 5: Recognizing the Legal and Accounting Entity 89

Being Aware of the Legal Roots of Business Entities 90

Sole proprietorship 91

Partnerships 91

S corporations 92

Limited liability companies (LLCs) 93

C corporations 94

Going It Alone: Sole Proprietorships 95

Differentiating Partnerships and Limited Liability Companies 96

Looking at important features 96

Understanding profit allocation 97

Incorporating a Business 99

Issuing stock shares 100

Distinguishing different classes of stock shares 101

Determining the market value of stock shares 103

Watching out for dilution of share value 104

Recognizing conflicts between stockholders and managers 105

Part 2: Exploring Financial Statements 109

Chapter 6: Reporting Profit or Loss in the Income Statement 111

Presenting Typical Income Statements 112

Looking at businesses that sell products 113

Looking at businesses that sell services 115

Looking at investment businesses 117

Taking Care of Housekeeping Details 118

Being an Active Reader 121

Deconstructing Profit 122

Revenue and expense effects on assets and liabilities 123

Comparing three scenarios of profit 124

Folding profit into retained earnings 126

Pinpointing the Assets and Liabilities Used to Record Revenue and Expenses 127

Making sales: Accounts receivable and deferred revenue 127

Selling products: Inventory 128

Prepaying operating costs: Prepaid expenses 129

Understanding fixed assets: Depreciation expense 129

Figuring unpaid expenses: Accounts payable, accrued expenses payable, and income tax payable 130

Reporting Unusual Gains and Losses 132

Watching for Misconceptions and Misleading Reports 134

Chapter 7: Reporting Financial Condition in the Balance Sheet 137

Expanding the Accounting Equation 138

Presenting a Proper Balance Sheet 139

Doing an initial reading of the balance sheet 140

Kicking balance sheets out into the real world 143

Judging Liquidity and Solvency 144

Current assets and liabilities 145

Current and quick ratios 145

Understanding That Transactions Drive the Balance Sheet 146

Sizing Up Assets and Liabilities 149

Sales revenue and accounts receivable 150

Cost of goods sold expense and inventory 151

Fixed assets and depreciation expense 152

Operating expenses and their balance sheet accounts 153

Intangible assets and amortization expense 153

Debt and interest expense 155

Income tax expense and income tax payable 156

Net income and cash dividends (if any) 156

Financing a Business: Sources of Cash and Capital 157

Recognizing the Hodgepodge of Values Reported in a Balance Sheet 158

Chapter 8: Reporting Cash Sources and Uses in the Statement of Cash Flows 161

Meeting the Statement of Cash Flows 162

Presenting the direct method 163

Opting for the indirect method 165

Explaining the Variance between Cash Flow and Net Income 167

Accounts receivable change 168

Inventory change 169

Prepaid expenses change 170

Depreciation: Real but noncash expense 170

Changes in operating liabilities 172

Putting the cash flow pieces together 173

Sailing through the Rest of the Statement of Cash Flows 174

Understanding investing activities 174

Looking at financing activities 175

Reading actively 177

Pinning Down “Free Cash Flow” 178

Limitations of the Statement of Cash Flows 180

Chapter 9: Financial Accounting Issues 183

Reporting Changes in Owners’ Equity 185

Recognizing Reasons for Accounting Differences 186

Looking at a More Conservative Version of the Company’s Income Statement 188

Presenting an alternative income statement 188

Spotting significant differences 190

Explaining Differences 190

Accounts receivable and sales revenue 191

Inventory and cost of goods sold expense 192

Fixed assets and depreciation expense 193

Accrued expenses payable, income tax payable, and expenses 194

Wrapping things up 195

Calculating Cost of Goods Sold Expense and Inventory Cost 195

FIFO (first-in, first-out) 196

LIFO (last-in, first-out) 197

Recording Depreciation Expense 200

Scanning the Revenue and Expense Radar Screen 202

Using the Statement of Cash Flows as an Audit/Sanity Test 205

Part 3: Understanding Financial Reports, Financial Statements, and Financial Information 207

Chapter 10: Producing Financial Reports 209

Quickly Reviewing the Theory of Financial Reporting 210

Starting with the financial statements 210

Keeping in mind the reasons for financial reports 211

Recognizing Top Management’s Role 212

Keeping Current with Financial Accounting and Reporting Standards 214

Making Sure Disclosure Is Adequate 215

Footnotes: Nettlesome but needed 216

Other disclosures in financial reports 218

Putting a Spin on the Numbers (Short of Cooking the Books) 220

Window dressing: Pumping up the ending cash balance and cash flow 221

Smoothing the rough edges off year-to-year profit fluctuations 223

Comparing Public and Private Companies 226

Reports from publicly owned companies 226

Reports from private businesses 227

Dealing with Information Overload 228

Browsing based on your interests 229

Recognizing condensed versions 229

Using other sources of business information 230

Chapter 11: Deciphering a Financial Report 231

Knowing the Rules of the Game 232

Making Investment Choices 233

Managing investments alone or using a third party 234

Finding and understanding information sources 235

Contrasting Reading Financial Reports of Private Versus Public Businesses 236

Explaining the Role of MDORs and MD&As 237

Frolicking through the Footnotes 238

Checking Out the Auditor’s Report 240

Why audits? 241

What’s in an auditor’s report? 241

Discovering fraud, or not 243

Chapter 12: Analyzing Financial Information with Ratios 245

Understanding the Importance of Using Ratios to Digest Financial Statements 246

Improving Your Knowledge of Financial Language and Lingo 246

Starting with Sample Company Financial Statements 248

Benchmark Financial Ratios: Financial Strength and Solvency 252

Current ratio 254

Net working capital 254

Acid test ratio (aka quick ratio) 255

Debt-to-equity ratio 256

Debt-to-tangible net equity 257

Benchmark Financial Ratios: Financial Performance 258

Return on sales (ROS) 258

Return on equity (ROE) 260

Return on assets (ROA) 261

Earnings per share (EPS), basic and fully diluted 261

Price/earnings (P/E) ratio 263

Debt service coverage ratio 264

Making Time for Additional Ratios (If Needed) 265

Chapter 13: Generating Internal Financial Information for Management Use 267

Building on the Foundation of the External Financial Statements 268

Seeking out problems and opportunities 269

Avoiding information overload 269

Distinguishing Internal and External Financial Statements 270

Format 270

Detail 271

Confidentiality 271

Timeliness 271

Completeness 272

Gathering Financial Condition Information 272

Cash 275

Accounts receivable 276

Inventory 276

Fixed assets less accumulated depreciation 277

Intangible assets 278

Accounts payable 279

Accrued expenses payable 280

Income tax payable 281

Interest-bearing debt 281

Owners’ equity 282

Culling Profit Information 283

Presenting an income statement for managers 283

Calculating cash flow on the back of an envelope 284

Managing operating cash flows 286

Scrutinizing sales revenue and expenses 286

Avoiding Rookie Mistakes 287

Chapter 14: Applying Wall Street’s Tricks and Treats to Engineer Financial Results 289

Knowing What Financial Engineering Is Not 290

Defining What Financial Engineering Is 291

Identifying Commonly Used “Tricks of the Trade” 293

Using tricks that fit within GAAP but need more digging 293

Understanding commonly used tricks outside the realm of GAAP 295

Manufacturing Imaginary Profits (and, Yes, Losses) 297

Reviewing examples of “manufacturing” profits 297

Keeping critical points in mind 299

Looking Out for Particular Trends and Terminology 299

Part 4: Leveraging Accounting in Managing a Business 301

Chapter 15: Analyzing Profit 303

Helping Managers: The Fourth Pillar of Accounting 304

Branching out in the field of management accounting 304

Following the organizational structure 305

Centering on profit centers 306

Internal Profit Reporting 307

Designing internal profit (P&L) reports 307

Reporting operating expenses 308

Looking at Strategic Profit Analysis 309

Presenting a profit analysis template 310

Separating variable and fixed expenses 311

Stopping at operating earnings 313

Focusing on margin — the catalyst of profit 314

Using the template to explain profit 315

Taking a Closer Look at the Lines in the Profit Template 316

Sales revenue 316

Cost of goods sold 317

Variable operating expenses 318

Fixed operating expenses 318

Using the Profit Template for Decision-Making Analysis 320

Tucking Away Some Valuable Lessons 321

Recognize the leverage effect caused by fixed operating expenses 321

Don’t underestimate the impact of small changes in sales price 322

Know your options for improving profit 323

Chapter 16: Accounting for Costs 325

Looking Down the Road to the Destination of Costs 326

Are Costs Really That Important? 327

Becoming More Familiar with Costs 330

Direct versus indirect costs 330

Fixed versus variable costs 331

Relevant versus irrelevant costs 332

Actual, projected, and standard costs 333

Product versus period costs 334

Assembling the Product Cost of Manufacturers 334

Minding manufacturing costs 335

Classifying costs properly 337

Calculating product cost 339

Examining fixed manufacturing costs and production capacity 340

Puffing Profit by Excessive Production 343

Shifting fixed manufacturing costs to the future 343

Cranking up production output 345

Being careful when production output is out of kilter with sales volume 346

Chapter 17: Preparing Best-in-Class Forecasts, Projections, and Budgets 347

Focusing on Key Forecasting Concepts 348

Putting Forecasting in Its Place 349

Planning reasons for forecasting 350

Control reasons for preparing forecasts 351

Exploring Forecasting 352

The living and breathing business forecast 353

Projections as financial models 356

Increasing the Power of Your Forecasts 357

The SWOT 358

Top down or bottom up 358

What if? 360

Rolling forecasts 361

Seeing a Financial Forecast in Action 362

The income statement 362

The balance sheet 364

The statement of cash flows 366

Rehashing the Value of Forecasts 367

Chapter 18: Capitalizing a Business: How, When, Why, and What 369

Identifying the Elements of a Business Plan 370

Capturing the most critical material 371

Providing a few examples 372

Valuing Businesses: A Crash Course in the Basics 373

Why businesses are valued 373

How businesses are valued 375

Surveying Commonly Used Business Valuation Techniques 377

Cash flow multiple method 378

Price earnings multiple method 379

Summarizing the Two Basic Types of Available Capital 379

Realizing when to raise equity 380

Knowing when debt is the best source of capital 381

Taking a Deeper Dive into Raising Debt Capital 383

Maturity and security 383

Debt sources (loans) 383

Debt underwriting and costs 384

Debt structure 384

Debt covenants 385

Digging Further into the World of Equity Capital 386

Disguising equity as debt 388

Structuring equity with preferences 390

Reaching the end of the line with equity capital 393

Raising Capital: Tips, Tidbits, and Traps 394

Part 5: The Part of Tens 397

Chapter 19: Ten Tips for Managers 399

Reach Breakeven and Then Rake in Profit 400

Set Sales Prices Right 401

Don’t Confuse Profit and Cash Flow 401

Call the Shots on Accounting Policies 402

Prepare Accurate Forecasts and Projections 403

Demand the Accounting Information You Want 404

Tap into Your CPA’s Expertise 405

Critically Review Your Controls over Employee Dishonesty and Fraud 406

Lend a Hand in Preparing Your Financial Reports 406

Speak about Your Financial Statements as a Pro 407

Chapter 20: Ten Tips for Reading a Financial Report 409

Get in the Right Frame of Mind 410

Decide What to Read 410

Improve Your Accounting Savvy 411

Judge Profit Performance 412

Test Earnings Per Share (EPS) against Change in Bottom Line 413

Tackle Unusual Gains and Losses 414

Check Cash Flow from Profit 415

Look for Signs of Financial Distress 416

Recognize the Possibility of Restatement and Fraud 417

Remember the Limits of Financial Reports 417

Index 419

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