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That sequence looks like this:Cost of goods sold Selling, general and administrative expenses Income taxes Extraordinary items THREE-DIGIT ACCOUNT CODE STRUCTURE A three-digit account co

This appendix describes the types of account numbering formats that can be used to struct a chart of accounts, and also lists sample charts of accounts that use each of the for-mats All of the charts of accounts shown in this appendix follow the same generalsequence of account coding, which itemizes the accounts in the balance sheet first, and theincome statement second That sequence looks like this:

Cost of goods sold

Selling, general and administrative expenses

Income taxes

Extraordinary items

THREE-DIGIT ACCOUNT CODE STRUCTURE

A three-digit account code structure allows one to create a numerical sequence of accountsthat contains up to 1,000 potential accounts It is useful for small businesses that have nopre-defined departments or divisions that must be broken out separately A sample chart

of accounts using this format is shown below:

553

The Chart of Accounts

Account Number Description

080 Finished goods inventory

090 Reserve for obsolete inventory

100 Fixed assets — Computer equipment

110 Fixed assets — Computer software

120 Fixed assets — Furniture and fixtures

130 Fixed assets — Leasehold improvements

140 Fixed assets — Machinery

150 Accumulated depreciation — Computer equipment

160 Accumulated depreciation — Computer software

170 Accumulated depreciation — Furniture and fixtures

180 Accumulated depreciation — Leasehold improvements

190 Accumulated depreciation — Machinery

310 Accrued payroll liability

320 Accrued vacation liability

330 Accrued expenses liability — Other

340 Unremitted sales taxes

350 Unremitted pension payments

360 Short-term notes payable

370 Other short-term liabilities

400 Long-term notes payable

510 Retained earnings

700 Cost of goods sold — Materials

710 Cost of goods sold — Direct labor

720 Cost of goods sold — Manufacturing supplies

730 Cost of goods sold — Applied overhead

Account Number Description

845 Travel and entertainment

860 Interest expense

900 Extraordinary itemsNotice how each clearly definable block of accounts begins with a different set ofaccount numbers For example, current liabilities begin with “300,” revenues begin with

“600,” and cost of goods sold items begin with “700.” This not only makes it easier tonavigate through the chart of accounts, but is also mandated by many computerizedaccounting software packages

FIVE-DIGIT ACCOUNT CODE STRUCTURE

A five-digit account code structure is designed for those organizations with clearly defineddepartments, each of which is tracked with a separate income statement This format usesthe same account codes for the balance sheet accounts that we just saw for three-digitaccount codes, but replicates at least the operating expenses for each department (andsometimes for the revenue accounts, too) An example of this format is as follows, usingthe engineering and sales departments to illustrate the duplication of accounts:

00-090 xxx Reserve for obsolete inventory

00-100 xxx Fixed assets — Computer equipment

00-110 xxx Fixed assets — Computer software

00-120 xxx Fixed assets — Furniture and fixtures

00-130 xxx Fixed assets — Leasehold improvements

00-150 xxx Accumulated depreciation — Computer equipment00-160 xxx Accumulated depreciation — Computer software00-170 xxx Accumulated depreciation — Furniture and fixtures00-180 xxx Accumulated depreciation—Leasehold improvements00-190 xxx Accumulated depreciation — Machinery

(continued)

Account Number Department Description

00-310 xxx Accrued payroll liability

00-320 xxx Accrued vacation liability

00-330 xxx Accrued expenses liability— Other

00-370 xxx Other short-term liabilities

00-700 xxx Cost of goods sold — Materials

00-710 xxx Cost of goods sold — Direct labor

00-720 xxx Cost of goods sold — Manufacturing supplies00-730 xxx Cost of goods sold — Applied overhead

10-800 Engineering Bank charges

10-805 Engineering Benefits

10-810 Engineering Depreciation

10-815 Engineering Insurance

10-825 Engineering Office supplies

10-830 Engineering Salaries and wages

10-835 Engineering Telephones

10-840 Engineering Training

10-845 Engineering Travel and entertainment

10-850 Engineering Utilities

10-855 Engineering Other expenses

10-860 Engineering Interest expense

20-845 Sales Travel and entertainment

In this example, all expense accounts are replicated for every department This does

not mean, however, that all accounts must be used for every department For example, it

is most unlikely that bank charges will be ascribed to either the engineering or salesdepartments Accordingly, those accounts that are not to be used can be rendered inactive

in the accounting system, so that they never appear in the general ledger

556 Appendix A The Chart of Accounts

SEVEN-DIGIT ACCOUNT CODE STRUCTURE

A seven digit account code structure is used by those companies that not only have tiple departments, but also multiple divisions or locations, for each of which the manage-ment team wants to record separate accounting information This requires the same codingstructure used for the five-digit system, except that two digits are placed in front of thecode to signify a different company division These new digits also apply to balance sheetaccounts, since most organizations will want to track assets and liabilities by division Thefollowing chart of accounts, which identifies accounts for divisions in Atlanta and Seattle,and which continues to use the engineering and sales departments, is an example of howthe seven-digit account code structure is compiled

10-00-030 Atlanta xxx Accounts receivable

10-00-040 Atlanta xxx Reserve for bad debts

10-00-050 Atlanta xxx Marketable securities

10-00-060 Atlanta xxx Raw materials inventory

10-00-070 Atlanta xxx Work-in-process inventory

10-00-080 Atlanta xxx Finished goods inventory

10-00-090 Atlanta xxx Reserve for obsolete inventory

10-00-100 Atlanta xxx Fixed assets — Computer equipment

10-00-110 Atlanta xxx Fixed assets — Computer software

10-00-120 Atlanta xxx Fixed assets — Furniture and fixtures

10-00-130 Atlanta xxx Fixed assets — Leasehold improvements10-00-140 Atlanta xxx Fixed assets — Machinery

10-00-150 Atlanta xxx Accumulated depreciation — computer

equipment10-00-160 Atlanta xxx Accumulated depreciation — Computer

software10-00-170 Atlanta xxx Accumulated depreciation — Furniture and

fixtures10-00-180 Atlanta xxx Accumulated depreciation — Leasehold

improvements10-00-190 Atlanta xxx Accumulated depreciation — Machinery

10-00-300 Atlanta xxx Accounts payable

10-00-310 Atlanta xxx Accrued payroll liability

10-00-320 Atlanta xxx Accrued vacation liability

10-00-330 Atlanta xxx Accrued expenses liability — other

10-00-340 Atlanta xxx Unremitted sales taxes

10-00-350 Atlanta xxx Unremitted pension payments

10-00-360 Atlanta xxx Short-term notes payable

10-00-370 Atlanta xxx Other short-term liabilities

10-00-400 Atlanta xxx Long-term notes payable

(continued)

Account No Division Department Description

10-00-510 Atlanta xxx Retained earnings

10-00-700 Atlanta xxx Cost of goods sold — Materials

10-00-710 Atlanta xxx Cost of goods sold — Direct labor

10-00-720 Atlanta xxx Cost of goods sold — Manufacturing supplies10-00-730 Atlanta xxx Cost of goods sold — Applied overhead10-10-800 Atlanta Engineering Bank charges

10-10-805 Atlanta Engineering Benefits

10-10-810 Atlanta Engineering Depreciation

10-10-815 Atlanta Engineering Insurance

10-10-825 Atlanta Engineering Office supplies

10-10-830 Atlanta Engineering Salaries and wages

10-10-835 Atlanta Engineering Telephones

10-10-840 Atlanta Engineering Training

10-10-845 Atlanta Engineering Travel and entertainment

10-10-850 Atlanta Engineering Utilities

10-10-855 Atlanta Engineering Other expenses

10-10-860 Atlanta Engineering Interest expense

10-20-800 Atlanta Sales Bank charges

10-20-805 Atlanta Sales Benefits

10-20-810 Atlanta Sales Depreciation

10-20-815 Atlanta Sales Insurance

10-20-825 Atlanta Sales Office supplies

10-20-830 Atlanta Sales Salaries and wages

10-20-835 Atlanta Sales Telephones

10-20-840 Atlanta Sales Training

10-20-845 Atlanta Sales Travel and entertainment

10-20-850 Atlanta Sales Utilities

10-20-855 Atlanta Sales Other expenses

10-20-860 Atlanta Sales Interest expense

10-00-900 Atlanta xxx Extraordinary items

20-00-030 Seattle xxx Accounts receivable

20-00-040 Seattle xxx Reserve for bad debts

20-00-050 Seattle xxx Marketable securities

20-00-060 Seattle xxx Raw materials inventory

20-00-070 Seattle xxx Work-in-process inventory

20-00-080 Seattle xxx Finished goods inventory

20-00-090 Seattle xxx Reserve for obsolete inventory

20-00-100 Seattle xxx Fixed assets — Computer equipment

20-00-110 Seattle xxx Fixed assets — Computer software

20-00-120 Seattle xxx Fixed assets — Furniture and fixtures

20-00-130 Seattle xxx Fixed assets — Leasehold improvements

558 Appendix A The Chart of Accounts

Account No Division Department Description

20-00-140 Seattle xxx Fixed assets — Machinery

20-00-150 Seattle xxx Accumulated depreciation — Computer

equipment20-00-160 Seattle xxx Accumulated depreciation — Computer

software20-00-170 Seattle xxx Accumulated depreciation — Furniture and

fixtures20-00-180 Seattle xxx Accumulated depreciation — Leasehold

improvements20-00-190 Seattle xxx Accumulated depreciation — Machinery

20-00-300 Seattle xxx Accounts payable

20-00-310 Seattle xxx Accrued payroll liability

20-00-320 Seattle xxx Accrued vacation liability

20-00-330 Seattle xxx Accrued expenses liability — other

20-00-340 Seattle xxx Unremitted sales taxes

20-00-350 Seattle xxx Unremitted pension payments

20-00-360 Seattle xxx Short-term notes payable

20-00-370 Seattle xxx Other short-term liabilities

20-00-400 Seattle xxx Long-term notes payable

20-00-510 Seattle xxx Retained earnings

20-00-700 Seattle xxx Cost of goods sold — Materials

20-00-710 Seattle xxx Cost of goods sold — Direct labor

20-00-720 Seattle xxx Cost of goods sold — Manufacturing supplies20-00-730 Seattle xxx Cost of goods sold — Applied overhead20-10-800 Seattle Engineering Engineering — Bank charges

20-10-805 Seattle Engineering Engineering — Benefits

20-10-810 Seattle Engineering Engineering — Depreciation

20-10-815 Seattle Engineering Engineering — Insurance

20-10-825 Seattle Engineering Engineering — Office supplies

20-10-830 Seattle Engineering Engineering — Salaries and wages

20-10-835 Seattle Engineering Engineering — Telephones

20-10-840 Seattle Engineering Engineering — Training

20-10-845 Seattle Engineering Engineering — Travel and entertainment20-10-850 Seattle Engineering Engineering — Utilities

20-10-855 Seattle Engineering Engineering — Other expenses

20-10-860 Seattle Engineering Engineering — Interest expense

20-20-800 Seattle Sales Sales — Bank charges

20-20-805 Seattle Sales Sales — Benefits

20-20-810 Seattle Sales Sales — Depreciation

20-20-815 Seattle Sales Sales — Insurance

20-20-825 Seattle Sales Sales — Office supplies

(continued)

Account No Division Department Description

20-20-830 Seattle Sales Sales — Salaries and wages20-20-835 Seattle Sales Sales — Telephones

20-20-840 Seattle Sales Sales — Training

20-20-845 Seattle Sales Sales — Travel and entertainment20-20-850 Seattle Sales Sales — Utilities

20-20-855 Seattle Sales Sales — Other expenses

20-20-860 Seattle Sales Sales — Interest expense

20-00-900 Seattle xxx Extraordinary items

560 Appendix A The Chart of Accounts

This appendix contains a list of the most common journal entries that an accountant islikely to deal with There are a plethora of possible transactions that would require animmense tome to address, so the emphasis here is solely on the most common journalentries, not on those that will only crop up on rare occasions.

The journal entries are listed in alphabetical order, and include explanatory text.This text may be sufficient for one to copy into actual journal entry descriptions, withslight modifications The text makes additional explanatory notations where necessary,but the main focus is on presenting a brief summarization of each entry

A set of accounts are listed for each sample journal entry, which may vary what from the titles of accounts used in one’s company If there are a wide range of pos-sible entries to different accounts, then this is noted with an entry in brackets, such as

some-“[Salaries — itemize by department].” A triple “x” is noted under the debit or credit ing for each entry, denoting the most likely entry that would be made If there is a rea-sonable chance that either a debit or credit entry would be made, then this is noted in thedescription

head-There are a few instances in which journal entries should be reversed in the ing accounting period When this is necessary, a warning note is attached to the bottom ofthe relevant journal entries

follow-Accounts Payable, Reversal: To reverse an account payable transaction that had

previ-ously been entered There are a variety of possible accounts to which a reversal could becredited, so many possible accounts are noted in brackets

Accounts Payable, Void Company Check: To reverse a previous check payment to a

sup-plier This entry assumes that there is an additional charge from the bank for a stop ment on the check, as well as the reversal of an early payment discount on the originalpayment

Bank charges (stop payment) xxx

payment was made]

Accounts Receivable, Write Off: To cancel an account receivable by offsetting it against

the reserve for bad debts located in the bad debt accrual account

Accrue Benefits: To accrue for all employee benefit expenses incurred during the month,

for which an associated accounting entry has not yet been made

Disability insurance expense xxx

This entry should be reversed in the following accounting period.

Accrue Property Taxes: To accrue for the property tax liability incurred during the

accounting period based on the known base of fixed assets

This entry should not be reversed in the following accounting period, since the tax

pay-ment will not normally occur in the following period, but instead only a few times peryear Instead, the actual payment should be charged directly against the accrual account

562 Appendix B Journal Entries

Accrue Salaries & Wages: To accrue for salaries and wages earned through the end of the

accounting period, but not yet paid to employees as of the end of the accounting period

[Salaries — itemize by department] xxx

This entry should be reversed in the following accounting period.

Accrue Vacation Pay: To accrue vacation pay earned by employees, but not yet used by

them, subject to the year-end maximum vacation carryforward limitation The same entrycan be used to record accrued sick time

[Salaries — itemize by department] xxx

This entry should not be reversed in the following accounting period, since the vacation

time may not be used in the following period Instead, the actual vacation-related paymentshould be charged directly against the accrual account

Acquisition, Pooling Method: To record an acquisition using the book value of assets and

liabilities This should be essentially all balance sheet accounts currently in use

Acquisition, Purchase Method: To record an acquisition using the fair market value of

assets and liabilities, with an entry to goodwill that records the difference between thistotal and the price paid

Bank Reconciliation: To adjust the accounting records to reflect differences between the

book and bank records The cash entry is listed as a credit, on the assumption that related expenses outweigh the interest income

Depreciation: To record the depreciation incurred during the month The amortization

account is used to write off goodwill

Depreciation, computer equipment xxxDepreciation, computer software xxxDepreciation, furniture & fixtures xxxDepreciation, leasehold improvements xxxDepreciation, manufacturing equipment xxx

564 Appendix B Journal Entries

Dividend Declaration: To separate the sum total of all declared dividends from retained

earnings once dividends have been approved by the Board of Directors

Fixed Asset (Sale of ): To record the cash received from the sale of an asset, as well as any

gain or loss in its sale This entry also eliminates all associated accumulated depreciationthat has built up over the term of the company’s ownership of the asset

Fixed Asset (Write off ): To record the unreimbursed disposal of an asset This entry also

eliminates all associated accumulated depreciation that has built up over the term of thecompany’s ownership of the asset

Loss on disposal of assets xxx

Foreign Currency Gain/Loss: To record in the first entry the loss expected to occur on

foreign currency accounts payable at the end of the accounting period To record in the

second entry the income arising from a gain on foreign currency accounts payable at the

end of the accounting period

Goodwill, Amortization: To record the periodic reduction in the amount of recorded

goodwill There are two methods available for making this entry The first entry charges amortized goodwill directly to the goodwill asset account, while the second entry charges

it to a contra account that is netted against the goodwill asset account

Goodwill amortization expense xxx

Goodwill amortization expense xxx

Interest, Imputed: To reduce the balance of a note payable by the difference between the

market interest rate and the interest rate itemized on the note ( first entry), as well as to recognize the associated interest expense over time (second entry).

Inventory, Adjust to Physical Count: To adjust inventory balances, either up or down, as

a result of changes in the inventory quantities that are noted during a physical count Thefollowing entries assume that there are increases in inventory balances If there aredeclines in the inventory balances, then the debits and credits are reversed

566 Appendix B Journal Entries

Inventory, Obsolescence: To charge an ongoing expense to the cost of goods sold that

increases the balance in a reserve against which obsolete inventory can be charged ( first

entry) The second entry charges off specific inventory items against the reserve.

Investment (Equity Method), Record Share of Investee Income: To record the company’s

proportional share of the income reported by [name of company in which investment was

made] ( first entry), as well as the income tax associated with this income recognition (second entry).

Investment in [company name] xxx

investment

Investment (Equity Method): To record the company’s cash or loan investment in another

Lease, Capital (Initial Record by Lessee): To record the initial capitalization of a lease,

including imputed interest that is associated with the transaction and both the short-term

and long-term portions of the associated account payable A second entry records the interest expense associated with each periodic payment on the capital lease A third entry

records the depreciation expense associated with the capital lease in each accountingperiod

Debit Credit

leases

Life Insurance Transactions: To record the net increase in the cash surrender value of

officer’s life insurance for which the company is the beneficiary, as well as that portion ofthe life insurance that is used in the current period and therefore charged to expense

Cash surrender value of life insurance xxx

Marketable Security (Acquisition): To record the acquisition of marketable securities If

the security purchased is one that cannot be liquidated in the short term, then the debitwould instead be to the long-term asset account, listed here as “marketable securities, longterm.”

Marketable securities, short-term xxxMarketable securities, long-term xxx

Marketable Security (Adjust to Fair Market Rate): To charge to expense the amount of a

reduction in the market value of a marketable security below its purchase price

Unrealized investment losses xxxReserve for losses on marketable securities xxx

Marketable Security (Disposition): To record the sale of a marketable security, while also

eliminating all earlier reserves for losses on its market value The entry includes line itemsfor the sale of both short-term and long-term marketable securities

Reserve for losses on marketable xxxsecurities

568 Appendix B Journal Entries

Overhead, Allocation: To allocate the contents of all cost pools to cost objects, which are

contained within the cost of goods sold and all inventory accounts The raw materialsaccount is included in this categorization, since this inventory can accumulate overheadcosts associated with the purchasing, receiving, and materials handling activities

cost pool]

Overhead, Transfer to Cost Pools: To transfer manufacturing expenses into one or more

overhead cost pools for later allocation to cost objects

department

department

Revenue (Installment Basis): To record installment sales as a liability, as noted in the first entry As the revenue is earned over time, the second entry is used to recognize portions

of the installment sales as current revenue

Unearned installment revenue xxx

Standard Costing, Labor Rate Variance: To record the difference between standard and

actual direct labor rate costs This entry assumes that the variance results in a write up oflabor rates If the result is a write down, then reverse all debits and credits

Standard Costing, Price Variance: To record the difference between the standard and

actual purchase price for materials This entry assumes that the variance results in a write

up of material prices If the result is a write down, then reverse all debits and credits

Transfer to General Ledger from Disbursements Journal: To transfer the summary totals

for all cash payments made through the disbursements journal to the general ledger for thecurrent accounting period If cash disbursements are made with ACH or wire transfers andthere is a known bank charge for this service, then the associated bank charge can berecorded as an expense, as well

Transfer to General Ledger from Payables Journal: To transfer the summary totals for all

accounts payable recorded in the payables journal to the general ledger for the currentaccounting period

Raw materials inventory account xxx[Various expense accounts] xxx[Various fixed asset accounts] xxx

Transfer to General Ledger from Payroll Journal: To transfer the summary totals for all

payroll transactions recorded in the payroll journal to the general ledger for the currentaccounting period It may also be necessary to credit various expense accounts if employ-ees are paying back the company for any purchases they have made through it

570 Appendix B Journal Entries

Debit Credit

[Salaries — itemize by department] xxx

payable

Transfer to General Ledger from Receipts Journal: To transfer the summary totals for all

cash receipts recorded in the receipts journal to the general ledger for the current ing period

Transfer to General Ledger from Sales Journal: To transfer the summary totals for all

sales transactions recorded in the sales journal to the general ledger for the currentaccounting period The freight expense is credited if the company bills customers forfreight charges incurred

Treasury Stock, Purchase: To record the acquisition by the company of stock, which is

paid for in cash

Treasury Stock, Sale: To record the sale of treasury stock to investors by the company,

with payments in excess of treasury stock cost being credited to the additional paid-in ital account

SIMPLE INTEREST TABLE

The simple interest table in Exhibit C-1 is used to find the total interest expense on aninvestment or debt that is to be completed in some future period, without factoring in theimpact of any compounding of interest The calculation is:

(interest rate ⫻ number of years that interest accrues)For example, to determine the total amount of an investment of $50,000 at the end

of seven years, using an interest rate of 9%, go to the simple interest table Then movedown to the row that contains interest rate factors for seven years, and move across to findthe cell for the 9% interest rate, which contains a factor of 1.63 Then multiply this by

of interest The calculation is:

(1 + interest rate)number of years

APPENDIX C

Interest Tables

For example, to determine the total amount of an investment of $50,000 at the end

of 11 years, using an interest rate of 8%, go to the compound interest table for futureamounts, move down to the row that contains interest rate factors for 11 years, and moveacross to find the cell for an 8% interest rate, which contains a factor of 2.3316 Then mul-tiply this by $50,000 to arrive at $116,580

COMPOUND INTEREST (PRESENT VALUE OF 1 DUE IN N PERIODS)

The table in Exhibit C-3 is used to determine the discounted current value of an investmentthat will be payable in a fixed amount at some point in the future The calculation is:

1 _

(1 + interest rate)number of yearsFor example, to determine the discounted current value of a payment of $50,000that will occur in 17 years, assuming a compounded rate of investment in the interim of7%, go to the compound interest table for the present value of money due in future peri-ods Move down to the row that contains discounting factors for 17 years, and moveacross to find the cell for a 7% interest rate, which contains a factor of 3166 Then mul-tiply this by $50,000 to arrive at $15,830

PRESENT VALUE OF ORDINARY ANNUITY OF 1 PER PERIOD

The table in Exhibit C-4 is used to find the present value of a fixed number of payments

in the future The calculation is:

$2,500 for the next 22 years at a discount rate of 13%, go to the table for the present value

of an ordinary annuity of 1 per period Move down to the row that contains discountingfactors for 22 years, and move across to find the cell for a 13% interest rate, which con-tains a discount factor of 7.1695 Then multiply this by $2,500 to arrive at a present value

of $17,923.75

FUTURE AMOUNT OF ORDINARY ANNUITY OF 1 PER PERIOD

The table in Exhibit C-5 is used to determine the future value of a series of fixed ments The calculation is:

pay-(1 + interest rate)number of years– 1 _

interest rate

For example, to determine the future value of a series of 10 $5,000 annual payments

at an interest rate of 5%, go to the table for the future amount of an ordinary annuity Movedown to the row that contains compounding factors for 10 years, and move across to findthe cell for a 5% interest rate, which contains a discount factor of 12.5779 Then multiplythis by $5,000 to arrive at a future value of $62,889.50

574 Appendix C Interest Tables

This appendix contains the formulas needed to calculate many of the most commonaccounting ratios, as well as brief explanations for each one They are listed in alphabeti-cal order

• Accounts payable days This formula is similar to the accounts payable turnover

calculation, except that it converts the amount of outstanding payables into theaverage number of days of purchases that are currently unpaid The formula is:

Ending accounts payable _

Annual purchases / 365

• Accounts payable turnover This formula reveals the speed with which a company

is paying its accounts payable, and is a particularly effective way to determine pany liquidity levels when tracked on a time line, so that changes in payment pat-terns are readily apparent The formula is:

com-Total purchases

Average level of accounts payable

• Accounts receivable days This formula is similar to the accounts receivable

turnover calculation, except that it converts the amount of outstanding receivablesinto the average number of days it will take to collect them The formula is:(Beginning accounts receivable + ending accounts receivable) / 2

_

Annualized revenue / 365

• Accounts receivable turnover This formula is used to determine the number of

days over which the average account receivable is outstanding It is best used whenplotted on a trend line, in order to spot and act upon any unfavorable changes Theformula is:

APPENDIX D

Ratios

Annualized credit sales _

(Beginning accounts receivable + ending accounts receivable) / 2

* Backlog to sales ratio This formula is a good way to determine if there will be

trouble achieving sales goals in the near term, since a low proportion of backlog tosales reveals that only some last-minute orders will allow a company to reach itssales targets However, the ratio can be misleading if sales are highly seasonal,since the backlog will drop significantly once the prime sales season is over Theformula is:

Dollar total of all orders not yet in production

Average monthly revenue

• Backlog days ratio This formula is similar to the backlog to sales ratio, except that

it converts the backlog amount into the number of days sales that they represent.The formula is:

Total backlog _

Annualized revenue / 365

• Bill of material accuracy This formula reveals the percentage of line items on a

company’s bills of material that contain accurate part numbers, quantities, and units

of measure Though this is not strictly an accounting measure, the accuracy of acompany’s bill of material records has a major impact on the accuracy of its fin-ished goods and work-in-process inventory, and so is of concern to the accountant.The formula is:

Number of accurate parts itemized on a bill of material

_

Total number of parts itemized on a bill of material

• Book value This formula results in a price per share that should theoretically be

realized if a company were to liquidate, paying off all liabilities It is strictly retical, for it presumes that the liquidation value of all assets and liabilities on thebooks exactly matches the amounts shown on the balance sheet The formula is:

theo-Stockholder’s equity

Number of common shares outstanding

• Breakeven plant capacity This formula reveals the manufacturing capacity level at

which a company will break even This formula must be used with some caution,for the fixed expense level used in its calculation is assumed to be constant through

a wide range of capacity levels (which is not always true), while it also assumesthat the current level of capacity usage is known (which may be difficult to deter-mine) Consequently, the results may not be precise The formula is:

Fixed expenses ⫻ current percent of plant usage _

Revenue – variable expenses

• Breakeven point This formula is used to determine the minimum sales level at

which a company or some smaller business unit will generate a profit of exactlyzero It is particularly useful when compared to production capacity, since it canreveal that a company may use nearly all of its capacity just to reach breakeven,and so has no chance to earn more than a small profit even at full capacity Theformula is:

Total operating expenses _

Average gross marginTotal operatuing expenses are defined as all expenses related to the business unitthat are not part of the cost of goods sold

• Capital employed ratio This formula is used to determine how efficiently capital

is being used to generate sales It subtracts all assets not directly associated withoperations, such as investments, and divides the remainder into annual sales Theformula is:

Annualized revenue

(Capital) – (assets not directly related to operations)

• Cash flow adequacy This formula is the most comprehensive one for determining

if a company’s cash flows are sufficient to meet all ongoing commitments outside

of standard operations, such as asset purchases, dividend payouts, and debt ments A ratio of more than one indicates a sufficient level of cash flow The for-mula is:

pay-Cash flow from operations

All budgeted payments for asset purchases, debt, and dividend payments

• Cash ratio This formula is more restrictive than the quick ratio, because it

com-pares only those assets that can be immediately converted to cash to any current bilities (for example, it excludes accounts receivable from the calculation) Thisgives the best picture of extremely short-term liquidity for an organization Theformula is:

lia-Cash + Marketable securities

Current liabilities

• Cash turnover ratio This formula is used to determine the level of efficient use

that management is making of its cash Ideally, there should be only the minimumamount of cash on hand to deal with operating needs, while all other cash is shifted

to investments The formula is:

Total sales

Total period-end cash

582 Appendix D Ratios

• Collection period This formula is used to determine the average number of days

that invoices are outstanding Any changes in the collection period over time areindicative of either changes in the level of collection effort, or in the credit policiesbeing extended to customers The formula is:

Average annualized accounts receivable _

Average daily credit sales

• Current ratio This is a simple means for determining a company’s level of

liquidity If the ratio of current assets to current liabilities is substantially greaterthan one, then the company can be said to have good liquidity However, since acomponent of this calculation is inventory (which may not be readily convertible

to cash), it can be misleading A better calculation for the purposes of determiningliquidity is the quick ratio The formula for the current ratio is:

Cash + accounts receivable + marketable securities + inventory

Accounts payable + other short-term liabilities

• Debt/equity ratio This formula is used by lenders to determine the degree of

lever-age that a manlever-agement team has created Though this measure will vary widely byindustry, a debt level that is higher than the amount of equity will generally be anindication of excessive leverage The formula is:

Long-term debt + short-term debt

Total equity

• Dividend payout ratio This formula is used to determine the proportion of cash

flow that is being consumed by dividend payments It is most useful when tracked

on a time line, so that one can see if there is a trend that may result in a company’sinability to pay dividends The formula is:

Total dividend payments

Cash flow from operations

• Economic value added This formula is used to determine if a company is earning

a return on capital that is higher than its cost of capital, and is useful for tracking acompany’s ability to provide good returns on invested capital to its investors Theformula is:

(Net investment) ⫻ (actual return on assets—required minimum rate of return)

• Fixed asset turnover This formula is used to determine the amount of fixed assets

needed to obtain a specified sales level It should not be relied upon for precise dictions of asset investments that will be needed to support increased sales levels,but can be a reasonable method for cross-checking the adequacy of budgetedcapital purchases at various levels of sales activity The formula is: