1 7 Unit 7 The System Learning Objectives

1 7 Unit 7 The System Learning Objectives

1 7 Unit 7 The System Learning Objectives 1. Explain the accounting process as an information system 2. Explain the use of Special Journals and Subsidiary Ledgers in the accounting process 3. Identify the components of an Income Statement, Balance Sheet and Statement of Changes in Owners Equity 4. Analysis: Calculate and explain the current ratio and working capital from a Classified Balance Sheet CourseCollege.com 2 Objective 7.1: Accounting as an Information System The accounting process is an excellent example of a modern information system. The system process is characterized by: O7.1 CourseCollege.com 3 Inputs Processing - Outputs INPUTS -The controlled collection of information (example is journalizing); PROCESSING -The reorganization and storage of this information (example is posting and updating account balances) and; OUTPUTS -The production of new information (examples are the financial statements output from the process). O7.1 CourseCollege.com TRANSACTIONS ADJUSMENTS CLOSING ENTRIES INPUTS Feedback from the Outputs is used to improve the system 4 JOURNAL Controls must be adequate to insure the quality of the outputs. O-7.1 OUTPUTS

OUTPUTS PROCESSING ACCOUNT LEDGERS Financial Financial Statements Statements BalanceSheet Sheet Balance IncomeStatement Statement Income Statementof of Statement Changesin inOwners Owners Changes Equity Equity CashFlow Flow Cash CourseCollege.com 5 System Controls Goals Protect assets against loss due to waste or theft Provide reliable financial reports from accurate data Encourage efficient operations Comply with managements goals Achieve compliance with laws and regulations. O-7.1 CourseCollege.com System Controls Issues 6 Segregation of duties Clear definitions of authority and responsibility Safeguards to protect the firms assets Written policies Periodic quality reviews Maintenance of a review (audit) trail Access limitations Management philosophy consistent with good control CourseCollege.com 7 System Controls -Issues Keep in mind the goal of always separating these duties: AUTHORIZATION RECORDING CUSTODY OF ASSETS CourseCollege.com 8 Objective 7.2:

Special Journals & Subsidiary Ledgers Special Journals bring efficiencies to the accounting process by providing books of original entry designed to handle large numbers of similar transactions. O7.2 CourseCollege.com 9 Special Journals Sales Journal All sales from regular operations on credit Purchases Journal All inventory* purchases on credit Cash Receipts Journal All cash received Cash Payments Journal All cash paid * Often expanded to include other purchases on credit such as supplies and equipment CourseCollege.com 10 Special Journals TRANSACTION S JOURNALIZING SALES JOURNAL Many different paths can lead to the GL PURCHASE S JOURNAL CASH RECEIPTS JOURNAL CASH PAYMENTS GENERAL JOURNAL JOURNAL POSTING ACCOUNT LEDGERS (General Ledger) Some accounts will be Control Ledgers CourseCollege.com 11 Objective 7.2: Special Journals & Subsidiary Ledgers Subsidiary ledgers are used to maintain sub accounts within a main or control account. O7.2

CourseCollege.com 12 Example- Subsidiary Ledger An example is customer accounts receivable. Each customers balances must be maintained and all customers must reconcile with the total accounts receivable reported. O7.2 CourseCollege.com 13 Subsidiary Ledgers Control Ledger Accounts Receivable Balance BALANCE SHEET Assets Liabilities INCOME STATEMENT Revenue The Subsidiary Ledgers must add up to the Control Ledger Subsidiary Ledgers AR Customer A Expenses Equity Profit Debit Credit or Loss O7.2 CourseCollege.com 14 Which Journal? Does the transaction. . . 1. Involve Cash? CASH RECEIPTS JOURNAL CASH PAYMENTS JOURNAL 2. Involve sales & purchases On Account? SALES JOURNAL PURCHASES

JOURNAL 3. Remaining transactions go to the General Journal GENERAL JOURNAL O7.2 CourseCollege.com 15 Sales Journal SALES J OURNAL Date For Sales on Credit Only O7.2 Account Debited Page 16 Invoice # PR 5-J ul Customer A 2201 10-J ul Customer B 2202 15-J ul Customer C 2203 25-J ul Customer D 2204 AR Debit Sales Credit 250.00 125.00 2,000.00 1,000.00 500.00 250.00 1,000.00 500.00 3,750.00

1,875.00 (130/ 400) (P) Indicates subsidiary account posting COGS Debit Inv. Credit (520/ 150) Indicates that the total $3,750 has been posted to both the Accounts Receivable and to the Sales Ledgers. Notice the totals under each column are posted to the account ledgers, rather than posting each individual transaction. CourseCollege.com SALES J OURNAL Date Posting Account Debited Page 16 AR Debit Sales Credit Invoice # PR 5-J ul Customer A 2201 10-J ul Customer B 2202 15-J ul Customer C 2203 25-J ul Customer D 2204 16 COGS Debit Inv. Credit 250.00 125.00 2,000.00

1,000.00 500.00 250.00 1,000.00 500.00 3,750.00 1,875.00 (130/ 400) (520/ 150) CONTROL LEDGER Acct #: 130 Account Nam e: ACCOUNT S RECEIVABLE Date 2005 Item Balance Forward Debit Debit Credit 3,750.00 3,750.00 Acct #: 400 Account Nam e: SALES Date 2005 Credit 0.00 S16 31-J ul BALANCE Post Ref. Item Balance Forward BALANCE Post Ref. 31-J ul Debit Debit Credit 0.00 S16 3,750.00

3,750.00 Acct #: 150 Account Nam e: MERCHANDISE INVENT ORY Date 2005 BALANCE SHEET Assets Liabilities INCOME STATEMENT Revenue Item Balance Forward 31-J ul Debit Date 2005 Profit Credit Debit Credit or Loss 31-J ul Item Balance Forward Debit Credit 3250.00 S16 Expenses O7.2 BALANCE Post Ref. 1,875.00 Account Name: COST OF GOODS SOLD Equity Credit Post Ref. 1,375.00 Acct #: 520 BALANCE Debit Credit Debit

Credit 0.00 S16 1,875.00 1,875.00 CourseCollege.com CONTROL LEDGER Account Nam e: ACCOUNT S RECEIVABLE Dual Posting Date 2005 Item Balance Forward 17 Acct #: 130 BALANCE Post Ref. Debit Debit Credit Credit 0.00 31-J ul S16 3,750.00 3,750.00 SUBSIDIARY LEDGER Account Name: Custom er A, RECEIVABLE From Sales Journal Date 2005 Post Ref. Item Balance Forward Acct #: 130.1 BALANCE Debit Debit Credit Credit 0.00 S16

5-J ul 250.00 250.00 SUBSIDIARY LEDGER Account Name: Custom er B, RECEIVABLE Date 2005 Item Balance Forward Post Ref. BALANCE Debit Debit Credit Credit 0.00 S16 10-J ul Acct #: 130.2 2,000.00 2,000.00 SUBSIDIARY LEDGER Acct #: 130.3 Account Nam e: Custom er C, RECEIVABLE Date 2005 BALANCE SHEET Assets Liabilities Item Balance Forward INCOME STATEMENT15-J ul Post Ref. S16 500.00 Credit 500.00 Acct #: 130.4 Account Nam e: Custom er D, RECEIVABLE Date 2005 Profit Credit Credit SUBSIDIARY LEDGER Equity

Debit Debit 0.00 Revenue Expenses O5.2 BALANCE Debit or Loss 25-J ul Item Balance Forward Post Ref. BALANCE Debit Credit Debit Credit 0.00 S16 1,000.00 1,000.00 CourseCollege.com 18 PURCHASES J OURNAL Purchase s Journal Account Credited Date Date of Invoice Terms AP Credit PR 5-J ul Vendor A 5-J ul 2/ 10,n30 10-J ul Vendor B 8-J ul 1/ 10,n30 15-J ul

Supplies\ Vendor C 12-J ul n30 25-J ul Vendor D 25-J ul 2/ 10,n30 Page 10 Inv. Debit Other Debit 550.00 550.00 1,200.00 1,200.00 140\ 750.00 400.00 400.00 2,900.00 2,150.00 (200) 750.00 (150) CONTROL LEDGER Account Name: ACCOUNTS PAY ABLE Date 2005 Notice the Other Debit all purpose column BALANCE SHEET Assets Liabilities Item Balance Forward 31-J ul BALANCE Post Ref. Debit P10

2,900.00 2,900.00 Acct #: 140 Account Name: SUPPLIES Date 2005 INCOME STATEMENT Item Balance Forward 15-J ul Post Ref. BALANCE Debit Credit Debit Credit 150.00 P10 750.00 900.00 LEDGER Revenue Account Nam e: MERCHANDISE INVENT ORY Date 2005 Profit O7.2 Credit 0.00 Equity Credit Debit Credit LEDGER Expenses Debit Acct #: 200 or 31-J ul Item Balance Forward Post Ref. Acct #: 150

BALANCE Debit Credit Debit Credit 1,375.00 P10 2,150.00 3,525.00 Loss CourseCollege.com CONTROL LEDGER Account Nam e: ACCOUNTS PAY ABLE Dual Posting Date 2005 BALANCE Post Ref. Item Balance Forward Debit Debit Credit Credit 0.00 31-J ul P10 2,900.00 2,900.00 SUBSIDIARY LEDGER Account Name: Vendor A, PAY ABLE Date 2005 From Purchase s Journal 19 Acct #: 200 Item Balance Forward Acct #: 200.1 BALANCE Post Ref. Debit

Credit 0.00 P10 5-J ul Debit Credit 550.00 550.00 SUBSIDIARY LEDGER Account Name: Vendor B, PAY ABLE Date 2005 Item Balance Forward Acct #: 200.2 BALANCE Post Ref. Debit Credit 0.00 P10 10-J ul Debit Credit 1,200.00 1,200.00 SUBSIDIARY LEDGER Acct #: 200.3 Account Nam e: Vendor C, PAY ABLE Date 2005 BALANCE SHEET Assets Liabilities INCOME STATEMENT Item Balance Forward BALANCE Post Ref. 15-J ul Debit Credit Debit Credit 0.00

P10 750.00 750.00 SUBSIDIARY LEDGER Revenue Acct #: 200.4 Account Nam e: Vendor D, PAY ABLE Expenses Equity O-5.2 O5.2 Debit Date 2005 Profit Credit or Loss 25-J ul Item Balance Forward Post Ref. BALANCE Debit Credit Debit Credit 0.00 P10 400.00 400.00 CourseCollege.com CASH RECEIPTS J OURNAL Cash Receipts Journal Account Credited Date 26-J ul PR Cash Debit 400 1,250.00 27-J ul T. Hall, Capital 300 2,500.00

31-J ul Customer C 31-J ul Customer D Sales Disc Debit AR Credit Sales Credit 750.00 750.00 990.00 10.00 1,000.00 (415) (130) Item Balance Forward Post Ref. (400) BALANCE Debit Debit Credit 5,490.00 LEDGER Item Balance Forward INCOME STATEMENT Acct #: 415 BALANCE Post Ref. Debit Debit Credit Revenue Item Balance Forward 31-J ul 195.00 Acct #: 130 BALANCE

Post Ref. Debit Credit Debit CR17 Equity Profit Date 2005 Credit 3750.00 1,750.00 2,000.00 Acct #: 400 Account Nam e: SALES Expenses Credit 185.00 LEDGER CR17CONTROL 10.00 Date 2005 Credit 8,513.00 Account Nam e: ACCOUNT S RECEIVABLE O7.2 (520\ 150) 3,023.00 CR17 31-J ul Credit 750.00 Acct #: 100 Account Nam e: CASH Date 2005 Debit 750.00 10.00 1,750.00 1,250.00 2,500.00 Account Nam e: SALES DISCOUNT S Liabilities COGS Debit Inv Credit

LEDGER 31-J ul Assets 20 2,500.00 (100) Date 2005 BALANCE SHEET Other Credit 1,250.00 5,490.00 Dedicated columns are totaled and posted Page 17 Item Balance Forward Post Ref. BALANCE Debit Credit Debit Credit 3,750.00 or Loss 31-J ul CR17 1,250.00 5,000.00 CourseCollege.com CASH RECEIPTS J OURNAL Cash Receipts Journal Account Credited Date 26-J ul Sales Disc Debit PR

Cash Debit 400 1,250.00 27-J ul T. Hall, Capital 300 2,500.00 31-J ul Customer C 31-J ul Customer D AR Credit Sales Credit 750.00 750.00 990.00 10.00 1,000.00 (415) (130) (400) 750.00 (520\ 150) LEDGER Account Name: T. HALL, CAPITAL Date 2005 Item Balance Forward Acct #: 300 BALANCE Post Ref. Debit Debit Credit Item Balance Forward 31-J ul Credit 20,000.00 CR17 Date 2005

Liabilities 750.00 10.00 1,750.00 1,250.00 2,500.00 2,500.00 22,500.00 Acct #: 150 Account Nam e: MERCHANDISE INVENTORY Assets COGS Debit Inv Credit 2,500.00 (100) 31-J ul BALANCE SHEET Other Credit 1,250.00 5,490.00 The Other account column is used for the Owner Investment transaction 21 Page 17 BALANCE Post Ref. Debit Credit Debit Credit 1375.00 CR17 750.00 625.00 INCOME STATEMENT Account Name: COST OF GOODS SOLD Revenue Expenses Date 2005 Equity 31-J ul

Item Balance Forward Post Ref. Acct #: 520 BALANCE Debit Credit Debit Credit 1875.00 CR17 750.00 2,625.00 Profit Debit Credit or Loss O7.2 CourseCollege.com CASH RECEIPTS J OURNAL Cash Receipts Journal Account Credited Date 26-J ul Sales Disc Debit PR Cash Debit 400 1,250.00 27-J ul T. Hall, Capital 300 2,500.00 31-J ul Customer C 31-J ul Customer D Other Credit

COGS Debit Inv Credit 750.00 2,500.00 750.00 750.00 990.00 10.00 1,000.00 (100) Sales Credit 1,250.00 5,490.00 Remember to maintain Subsidiary Ledgers AR Credit 22 Page 17 10.00 1,750.00 1,250.00 2,500.00 (415) (130) (400) 750.00 (520\ 150) SUBSIDIARY LEDGER Acct #: 130.3 Account Nam e: Custom er C, RECEIVABLE Date 2005 Item Balance Forward 31-J ul Post Ref. BALANCE Debit Credit Debit Credit 750.00 CR17 750.00 0.00 SUBSIDIARY LEDGER

Account Nam e: Customer D, RECEIVABLE BALANCE SHEET Assets Liabilities INCOME STATEMENT Revenue Date 2005 31-J ul Expenses Item Balance Forward Post Ref. Acct #: 130.4 BALANCE Debit Credit Debit Credit 1,000.00 CR17 1,000.00 0.00 Equity Profit Debit Credit or Loss O7.2 CourseCollege.com CASH PAYMENTS J OURNAL Cash Payments Journal Date Ck No Account Debited AP Debit PR 15-J ul 110 Vendor B 20-J ul 111 Vendor C

31-J ul 112 Salaries Expense 520 Other Debit Inv. Credit Cash Credit 1,200.00 12.00 1,188.00 750.00 750.00 750.00 750.00 1,950.00 12.00 2,688.00 (200) Cash is reduced with each transaction in this journal 23 Page 14 (150) (100) LEDGER Acct #: 100 Account Nam e: CASH Date 2005 Item Balance Forward Post Ref. BALANCE Debit Credit 4,500.00 CP14 31-J ul Debit Credit 2,688.00

1,812.00 LEDGER Acct #: 150 Account Nam e: MERCHANDISE INVENT ORY The Other account column is used for the Salaries Expense BALANCE SHEET Assets Liabilities Date 2005 Item Balance Forward 31-J ul Post Ref. BALANCE Debit Debit Credit Credit 625.00 CP14 12.00 613.00 CONTROL LEDGER Acct #: 200 Account Name: ACCOUNT S PAY ABLE INCOME STATEMENT Revenue Date 2005 Item Balance Forward 31-J ul Expenses Post Ref. BALANCE Debit Credit Debit 2,150.00 CP14 1,950.00 LEDGER

200.00 Acct #: 565 Account Nam e: SALARIES EXPENSE Equity O7.2 Debit Profit Credit or Loss Date 2005 31-J ul Credit Item Balance Forward Post Ref. BALANCE Debit Credit Debit Credit 7435.00 CP14 750.00 8,185.00 CourseCollege.com 24 Cash Payments Journal CASH PAYMENTS J OURNAL Date Ck No Account Debited AP Debit PR 15-J ul 110 Vendor B 20-J ul 111 Vendor C 31-J ul 112 Salaries Expense

520 Page 14 Other Debit Inv. Credit 1,200.00 12.00 1,188.00 750.00 750.00 750.00 750.00 1,950.00 12.00 2,688.00 (200) Remember to maintain Subsidiary Ledgers Cash Credit (565) (100) SUBSIDIARY LEDGER Account Name: Vendor B, PAY ABLE Date 2005 Item Balance Forward Post Ref. Acct #: 200.2 BALANCE Debit Debit Credit Credit 0.00 10-J ul P10 15-J ul CP14 1,200.00 1,200.00 1,200.00 0.00

SUBSIDIARY LEDGER Acct #: 200.3 Account Name: Vendor C, PAY ABLE Date 2005 O7.2 Item Balance Forward Post Ref. BALANCE Debit Credit Debit Credit 0.00 15-J ul P10 20-J ul CP14 750.00 750.00 750.00 0.00 CourseCollege.com 25 General Journal GENERAL J OURNAL Date 8-J ul 12-J ul Description Page 8 Debit PR Sales Returns & Allowances Customer E, Receivable Sales Returns & Allowances Customer E, Receivable Credit 150.00 420 130/ 150.00 500.00 420 130/ Merchandise Inventory

150 Cost of Goods Sold 520 500.00 250.00 250.00 CONTROL LEDGER Acct #: 130 Account Name: ACCOUNTS RECEIVABLE These transactions dont fit in the other journals they must go in the general journal. Date 2005 BALANCE Debit Credit Debit Credit 3750.00 8-J ul J8 150.00 3600.00 12-J ul J8 500.00 3,100.00 SUBSIDIARY LEDGER Account Name: Customer E, RECEIVABLE Date 2005 O7.2 Item Balance Forward Post Ref. Item Balance Forward Post Ref. Acct #: 130.5 BALANCE Debit

Credit Debit Credit 6,450.00 8-J ul J8 150.00 6,300.00 12-J ul J8 500.00 5,800.00 CourseCollege.com GENERAL J OURNAL General Journal Date 8-J ul 12-J ul Description Debit PR Sales Returns & Allowances Customer E, Receivable Credit 150.00 420 130/ Sales Returns & Allowances Customer E, Receivable 150.00 500.00 420 130/ Merchandise Inventory 150 Cost of Goods Sold 520 26 Page 8 500.00 250.00 250.00 LEDGER Account Nam e: SALES RET URNS & ALLOWANCES Date 2005 Remember

that we are using a Perpetual Inventory System Item Balance Forward BALANCE Post Ref. Debit 150.00 J8 12-J ul Credit Item Balance Forward 500.00 LEDGER Post Ref. 835.00 Acct #: 150 BALANCE Debit Credit Debit 250.00 LEDGER 124,838.00 Account Nam e: COST OF GOODS SOLD Date 2005 12-J ul O7.2 Credit 124,588.00 J8 12-J ul Credit 335.00 Account Name: MERCHANDISE INVENTORY Date 2005 Debit 185.00 J8 8-J ul Acct #: 420

Item Balance Forward Post Ref. Acct #: 520 BALANCE Debit Credit Debit Credit 244,780.00 CR17 250.00 244,530.00 CourseCollege.com 27 Objective 7.3: Identify the components of an Income Statement, Balance Sheet and Statement of Changes in Owners Equity O7.3 CourseCollege.com 28 Web Consulting Income Statement For the year ending December 31, 2007 No cost of goods sold and gross profit section. Sales Separate sections for operating expenses and nonoperating expenses. Further separation of operating expenses into selling and administrative expenses. The other income and expense area segregates nonoperating revenue and expenses Operating expenses: Selling expenses: Sales salaries expense Advertising expense Total selling expense Administrative expenses: Office salaries expense Rent expense Supplies expense Depreciation expense Insurance expense Total admin expense

356,000 124,224 8,545 132,769 54,328 34,790 1,244 588 12,485 103,435 Total operating expenses Other (Income)\ Expense: Interest Income Lease revenue Interest Expense Excess of other expense over other income Service Firm Income Stateme nt Multistep 236,204 (1,355) 3,600 560 BALANCE SHEET Assets Liabilities 2,805 INCOME STATEMENT Revenue Expenses Equity Net income 116,991 Profit O7.3 Debit Credit or Loss CourseCollege.com 29 Boards n Bikes Income Statement For the year ending December 31, 2007 The cost of goods sold and gross profit section is a distinguishin g feature A single step statement

would simply summarize the operating expenses to a single amount.. Sales Less Sales Discounts Less Sales Returns & Allowances Net Sales Cost of Goods Sold 823,488 Gross Profit 519,615 Operating expenses: Selling expenses: Sales salaries expense Advertising expense Total selling expense Administrative expenses: Office salaries expense Rent expense Supplies expense Depreciation expense Insurance expense Total admin expense 286,334 12,488 298,822 54,328 34,790 458 1,250 11,655 102,481 Total operating expenses Other (Income)\ Expense: Interest Income Rent revenue Interest Expense Excess of other expense over other income O7.3 1,387,543 (32,100) (12,340) 1,343,103 Merchandisin g Income Statement 401,303 BALANCE SHEET Assets (11,286) 1,150 3,423 Liabilities INCOME STATEMENT Revenue Expenses Equity

(6,713) Profit Debit Credit or Loss Net income 125,025 CourseCollege.com 30 Current Asset & Liabilities Current assets - assets that are expected to be converted to cash or provide a benefit (consumed) within one year or the firms fiscal period whichever is longer. Examples are Cash, Accounts Receivable, Inventory, Supplies, Prepaid Insurance. Current liabilities- liabilities that are due and payable within the longer of one year or the firms fiscal period. Examples are trade accounts payable, taxes and wages payable, credit lines and notes due within the firms fiscal period CourseCollege.com 31 Classified Balance Sheet Boards n Bikes Balance Sheet As of December 31, 2007 Current Assets: Cash Accounts Receivable Inventory Supplies Prepaid Insurance Total current assets: Separate both assets and liabilities into current and noncurrent. Investments: Securities 10,000 Property, plant & equipment Land 45,000 Building 205,680 Less accumulated depreciation (9,865) Equipment 18,500 Less accumulated depreciation (2,400) Net PP&E 256,915 Intangibles Franchise 50000 Total assets

O7.3 32,155 126,605 246,034 6,784 11,245 422,823 739,738 Current Liabilties: Accounts Payable Wages Payable 235,664 5,434 Total current liabilties: 241,098 Long term liabilities Mortgage Payable 186,950 Total liabilities 428,048 Equity Owner, Capital Less Owner, Drawing Income (Loss) for the period Total equity 250,625 (8,400) 69,465 311,690 Total liabilities & equity 739,738 CourseCollege.com 32 Classified Balance Sheet Boards n Bikes Balance Sheet As of December 31, 2007 More liquid Current assets are listed in order of their liquidity or convertibilit y to cash. Current Assets: Cash Accounts Receivable Inventory Supplies Prepaid Insurance Total current assets: Investments: Securities 10,000

Property, plant & equipment Land 45,000 Building 205,680 Less accumulated depreciation (9,865) Equipment 18,500 Less accumulated depreciation (2,400) Net PP&E 256,915 Intangibles Franchise 50000 Total assets O7.3 32,155 126,605 246,034 6,784 11,245 422,823 739,738 Current Liabilties: Accounts Payable Wages Payable Total current liabilties: Long term liabilities Mortgage Payable Total liabilities Equity Owner, Capital Less Owner, Drawing Income (Loss) for the period Total equity 235,664 5,434 Earlier Payment Dates 241,098 186,950 428,048 250,625 (8,400) 69,465 311,690 Total liabilities & equity 739,738 Liabilities are listed in order of their scheduled due dates. CourseCollege.com 33 Statement of Changes in Owners Equity Boards n Bikes Statement of Changes in Owner's Equity For the year ending December 31, 2007

Owner, Capital J anuary 1, 2007 Less Owner, Drawing Income (Loss) for the year Owner, Capital December 31, 2007 Notice the beginning of the fiscal period Owners Capital, less the Owner draws during the fiscal period and finally the periods income or loss. The total ending equity is the same number that appears on the Balance Sheet of the same date. O7.3 250,625 (8,400) 125,025 367,250 CourseCollege.com 34 Objective 7.4: Analysis: Calculate and explain the current ratio and working capital from a Classified Balance Sheet Current Assets Current Assets O7.4 Current Liabilities Current Ratio Current Liabilities Working Capital CourseCollege.com 35 Liquidity Liquidity The current ratio and working capital are often called liquidity measures. The term liquidity refers the relative cash nature of a particular balance sheet. O7.4 CourseCollege.com 36 Liquidity For example, a highly liquid balance sheet would have a large amount of cash and other current assets, with limited current liabilities that would require the use of that cash (liquidity). O7.4 CourseCollege.com 37 Liquidity Balance Sheet

Current Balance Sheet Current Current Current Liabilitie s Assets Liabilitie s Assets More Liquid Equity More current asset dollars to pay each current liability dollar O4.3 Less Liquid Assets Equity Fewer current asset dollars to pay each current liability dollar CourseCollege.com 38 Current ratio The current ratio answers the following question: How many dollars of current assets are available to pay each dollar of current liabilities scheduled? The higher the number, the more dollars of current assets are available and therefore the Current more liquid is the particular balance sheet being Assets studied. Current Current Ratio Liabilities O7.4 CourseCollege.com 39 Working capital Working capital answers the following question: How many dollars of current assets would remain if all current liabilities were paid using current assets? The resulting answer is expressed in dollars. The higher the number, the more liquidity is Current displayed sheet. Current by the balance Working Liabilities Capital

Assets O7.4 CourseCollege.com 40 Current Ratio Example RAMOS Distributors BALANCE SHEET As of 12/ 31/ 07 ASSETS Cash Accounts Receivable Inventory Supplies Current assets Equipment Total 25,600 56,700 98,200 2,100 182,600 121,000 486,200 LIABILITIES Accounts Payable Current liabilities Notes Payable Total 165,700 165,700 36,750 202,450 EQUITY Owner, Capital Total 283,750 486,200 $1.10 of current assets are available to pay each dollar of current liabilities Current ratio CR = O7.4 Current assets/ Current Liabilities 1.10 1.10 ? CourseCollege.com 41 Working Capital Example RAMOS Distributors BALANCE SHEET As of 12/ 31/ 07 ASSETS Cash Accounts Receivable Inventory Supplies Current assets Equipment Total 25,600

56,700 98,200 2,100 182,600 121,000 486,200 LIABILITIES Accounts Payable Current liabilities Notes Payable Total 165,700 165,700 36,750 202,450 EQUITY Owner, Capital Total 283,750 486,200 $16,900 of current assets would remain if current assets were used to pay all current liabilities Working capital Working capital = O7.4 Current assets - Current Liabilities 16900.00 $16,900 ? CourseCollege.com 42 End Unit 7 CourseCollege.com

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