ENGR 3360U Winter 2014

Unit 17
Introduction to Accounting
Dr. J. Michael Bennett, P. Eng., PMP,
UOIT,
Version 2014-I-01

Unit 17 Introduction to Accounting

Extrapolation Estimating

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Change Record
2014-I-01 Initial Creation

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Unit 17 Introduction to Accounting

Course Outline
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3.
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Engineering Economics
General Economics
1.
Microeconomics
2.
Macroeconomics
3.
Money and the Bank of
Canada
Engineering Estimation
Interest and Equivalence
Present Worth Analysis
Annual Cash Flow
Rate of Return Analysis
Picking the Best Choice
Other Choosing Techniques
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10. Uncertainty and Risk

11. Income and Depreciation
12. After-tax Cash Flows
13. Replacement Analysis
14. Inflation
15. MARR Selection
16. Public Sector Issues
17. What Engineers should know
about Accounting
18. Personal Economics for the
Engineer

Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 17 Introduction to Accounting

Unit 17 Road Map

17.1 Elements of Accounting
17.2 The Balance Sheet
17.3 The Income Statement
17.4 Traditional Cost Accounting

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Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 17 Introduction to Accounting

17.1 Elements of Financial Accounting

Managerial Accounting is concerned with costs and
benefits of activities of an enterprise in providing such to
managers in decision-making
Financial Accounting is concerned with recording /
analyzing the financial data of a business with objective of
providing information to internal management and external
parties who wish to make decisions about an enterprise such
as Managers, investors and creditors.
Project Accounting is concerned with managing the flow of
money through a projects lifespan.

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Unit 17 Introduction to Accounting

.1 Measuring the Performance of a Firm

The flow of money in a company is much like the flow of water
in a network of pipes:
Through variables: These variables are measured with respect
to time (e.g., income statement)
Across variables: These variables are measured at a point in
time. (e.g., balance sheet)
The Balance Sheet: is a snapshot of a firms financial position
at a particular point in time. It summarizes assets, liabilities
and owner equity.
The Income Statement: summarizes revenues and expenses
over a period of time. (revenues, expenses, profits before taxes,
taxes paid and profits after taxes)

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Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

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Unit 17 Introduction to Accounting

17.2 The Balance Sheet

Every organization has assets and liabilities (Table 6.2)
Assets Liabilities is Owners Equity (company value)
Balance Sheet is a snapshot of its financial position. It summarizes assets,
liabilities and owners equity.
Assets: items to which the organization has legal title
Current assets can be converted into cash within one year.
Fixed assets (capital assets) have a life greater than one year.
o Liabilities: debt owed (suppliers, employees, government)
Current Liabilities debt normally paid within a year (accounts
payable, taxes, wages payable, bank loan payable)
Long-term liabilities debt normally paid beyond current year

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Table 1 Balance Sheet of a Company

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Unit 17 Introduction to Accounting

.2 The Balance Sheet (contd)

Owners Equity: The difference between assets and
liabilities is a means of measuring what the
organization is worth its equity:
Assets Liabilities = Owners Equity
Owners equity often appears as two components in a
balance sheet:
Stock, or shares (par value)
Retained earnings (for capital expenditure)
As equity builds up, the better off are the owners (e.g.
a sole proprietor, partnership or shareholders)
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Table 2 Balance Sheet of a Company

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Figure 1 Cash Flow Relationship Between the

Companys Assets and the Financial Markets

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Unit 17 Introduction to Accounting

Example
Count Accountant forgot to include a $10K
loan used to purchase a $25K test stand
(which he forgot to include). What changes
should he make to the BS?

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Deltas to the Balance Sheet

-$15K
+$25K

+$10K

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17.3 The Income Statement

Income Statement summarizes revenues and expenses
over a specified accounting period.
Major components: Revenue, Expenses, Profits
Revenues increase owners equity
usually from sales of goods/services (but others)

Expenses decrease owners equity.

cost of goods sold, rent, insurance, wages, depreciation

Profits before Taxes is Revenue - Expenses

After deducting taxes we arrive at Net Profit
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Income Statement for the Company

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Unit 17 Introduction to Accounting

.1 Estimated Values in Financial Statements

Financial statements are often estimates they may not reflect
market values use cost principle of accounting
Assets are valued on the basis of their cost (book value)
Land is listed at the price paid, not its market value
Plant and equipment is listed at the price paid less accumulated
depreciation.
Depreciation on equipment computed using depreciation model
Stock or Shares are listed at par value (issue price).
Finished goods inventory manufacturing cost
Most firms include their accounting methods/assumptions within
periodic reports to aid interpretation of statements

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Unit 17 Introduction to Accounting

.2 Financial Ratio Analysis

Decision makers (inside and outside) need to know general
health of a firm
Can use balance sheet/income statements to assess
Financial Ratio Analysis key performance indicators
these performance measures are financial ratios calculated from
items on the income statement and balance sheet.
In interpreting ratios analysts should calculate the ratios over a
number of periods to do a trend analysis
Ratios should also be compared to industry standards
Industry standards routinely published by commercial and
government websites/publications (Statistics Canada)

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Unit 17 Introduction to Accounting

.3 Financial Ratios
Liquidity ratios assess firms ability to meet short term financial
obligations & weather fluctuations in cash flows
Reserve of cash and liquid assets called working capital

Working capital = current assets - current liabilities

Current ratio = Current assets/Current liabilities

A current ratio of 2 is considered adequate.

Acid test ratio = Quick assets/Current liabilities

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Quick assets-those that can be quickly converted to cash

An acid test ratio of 1 is considered adequate.

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CR= CA/CL
4314

2489
CR=1.73(2011)

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AT = QA/CL
431+2489

2489
AT = 1.17

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Unit 17 Introduction to Accounting

Financial Ratios (contd)

Debt management ratios - extent firm relies on debt
Equity ratio = Total equity/(Total liabilities + Total equity)
= Total equity/Total assets

smaller the ratio, the more dependent a firm is on debt and the higher
the risk of not being able to manage debt
comparison to industry norms/trend analysis necessary

Efficiency ratios assess efficiency of use of its assets.

Inventory turnover ratio = Sales/Inventories
Profitability ratios - productively assets have been employed
in producing a profit.

Return on assets = Net income/Total assets

Return on equity = Net income/Total equity

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ER=TOE/(TOE+TL)

ER= 3318/8296=0.40
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ITR=Sales/Inventories
ITR=12440/1244=10

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ROA=NPBXI/TA
ROA=781/8296=9.4%

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ROE=NPBXI/TE
ROA=781/3318=
2.3%

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SUMMARY oh-oh OH-NO!

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Summary of Financial Ratios and Definitions

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17.4 Traditional Cost Accounting

Cost accounting:

Used to develop product costs; determine the mix of labour,

materials, and other costs in a production setting; and
evaluate outsourcing and subcontracting possibilities.

Direct costs:

Activities directly associated with the final product

(materials, design, etc.)

Indirect costs:

Costs not easily linked directly to a project (machine

depreciation, management/sales/administration costs etc.)

Unit 17 Introduction to Accounting

Traditional Cost Accounting, contd.

Indirect costs are sometimes allocated across
projects through:

Absorption costing:

Allocating overhead costs based on factors such as

number of direct-labour costs each project has or directlabour hours or direct-material cost or total direct cost

Indirect and overhead costing can distort

product costs.

Some firms are shifting to activity-based costing (ABC)

where activities are linked to specific costs and in this
way overhead is potentially minimized.

Unit 17 Introduction to Accounting

Summary
Elements of Financial Accounting
The Balance Sheet
The Income Statement
Estimated Values in Financial Statements
Financial Ratio Analysis

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