{"appState":{"pageLoadApiCallsStatus":true},"categoryState":{"relatedCategories":{"headers":{"timestamp":"2023-02-01T16:01:11+00:00"},"categoryId":34226,"data":{"title":"Accounting","slug":"accounting","image":{"src":null,"width":0,"height":0},"breadcrumbs":[{"name":"Business, Careers, & Money","_links":{"self":"https://dummies-api.dummies.com/v2/categories/34224"},"slug":"business-careers-money","categoryId":34224},{"name":"Business","_links":{"self":"https://dummies-api.dummies.com/v2/categories/34225"},"slug":"business","categoryId":34225},{"name":"Accounting","_links":{"self":"https://dummies-api.dummies.com/v2/categories/34226"},"slug":"accounting","categoryId":34226}],"parentCategory":{"categoryId":34225,"title":"Business","slug":"business","_links":{"self":"https://dummies-api.dummies.com/v2/categories/34225"}},"childCategories":[{"categoryId":34227,"title":"Audits","slug":"audits","_links":{"self":"https://dummies-api.dummies.com/v2/categories/34227"},"image":{"src":"/img/background-image-2.fabfbd5c.png","width":0,"height":0},"hasArticle":true,"hasBook":true,"articleCount":126,"bookCount":3},{"categoryId":34228,"title":"Bookkeeping","slug":"bookkeeping","_links":{"self":"https://dummies-api.dummies.com/v2/categories/34228"},"image":{"src":"/img/background-image-1.daf74cf0.png","width":0,"height":0},"hasArticle":true,"hasBook":true,"articleCount":117,"bookCount":6},{"categoryId":34229,"title":"Calculation & Analysis","slug":"calculation-analysis","_links":{"self":"https://dummies-api.dummies.com/v2/categories/34229"},"image":{"src":"/img/background-image-2.fabfbd5c.png","width":0,"height":0},"hasArticle":true,"hasBook":true,"articleCount":216,"bookCount":3},{"categoryId":34230,"title":"General Accounting","slug":"general-accounting","_links":{"self":"https://dummies-api.dummies.com/v2/categories/34230"},"image":{"src":"/img/background-image-1.daf74cf0.png","width":0,"height":0},"hasArticle":true,"hasBook":true,"articleCount":678,"bookCount":13}],"description":"Accounting is the language of business. With help from Dummies, you can be fluent in no time.","relatedArticles":{"self":"https://dummies-api.dummies.com/v2/articles?category=34226&offset=0&size=5"},"hasArticle":true,"hasBook":true,"articleCount":1137,"bookCount":25},"_links":{"self":"https://dummies-api.dummies.com/v2/categories/34226"}},"relatedCategoriesLoadedStatus":"success"},"listState":{"list":{"count":10,"total":1139,"items":[{"headers":{"creationTime":"2016-03-26T08:13:24+00:00","modifiedTime":"2022-10-06T17:13:01+00:00","timestamp":"2022-10-06T18:01:03+00:00"},"data":{"breadcrumbs":[{"name":"Business, Careers, & Money","_links":{"self":"https://dummies-api.dummies.com/v2/categories/34224"},"slug":"business-careers-money","categoryId":34224},{"name":"Business","_links":{"self":"https://dummies-api.dummies.com/v2/categories/34225"},"slug":"business","categoryId":34225},{"name":"Accounting","_links":{"self":"https://dummies-api.dummies.com/v2/categories/34226"},"slug":"accounting","categoryId":34226},{"name":"Calculation & Analysis","_links":{"self":"https://dummies-api.dummies.com/v2/categories/34229"},"slug":"calculation-analysis","categoryId":34229}],"title":"Business Statistics: Test the Estimated Regression Equation","strippedTitle":"business statistics: test the estimated regression equation","slug":"test-the-estimated-regression-equation-using-the-coefficient-of-determination-r2","canonicalUrl":"","seo":{"metaDescription":"You can check whether a regression equation makes sense by using the coefficient of determination, also known as R2 (R squared).","noIndex":0,"noFollow":0},"content":"After you estimate the population regression line, you can check whether the regression equation makes sense by using the coefficient of determination, also known as <i>R</i><sup>2</sup> (<i>R</i> squared). This is used as a measure of how well the regression equation actually describes the relationship between the dependent variable (<i>Y</i>) and the independent variable (<i>X</i>).\r\n\r\nIt may be the case that there is no real relationship between the dependent and independent variables; simple regression generates results even if this is the case. It is, therefore, important to subject the regression results to some key tests that enable you to determine if the results are reliable.\r\n\r\nThe coefficient of determination, <i>R</i><sup>2</sup>, is a statistical measure that shows the proportion of <i>variation</i> explained by the estimated regression line. Variation refers to the sum of the squared differences between the values of <i>Y</i> and the mean value of <i>Y</i>, expressed mathematically as\r\n\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460867.image0.png\" alt=\"image0.png\" width=\"91\" height=\"53\" />\r\n\r\n<i>R</i><sup>2</sup> always takes on a value between 0 and 1. The closer <i>R</i><sup>2</sup> is to 1, the better the estimated regression equation fits or explains the relationship between <i>X</i> and <i>Y</i>.\r\n\r\nThe expression\r\n\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460868.image1.png\" alt=\"image1.png\" width=\"91\" height=\"53\" />\r\n\r\nis also known as the <i>total sum of squares</i> (TSS).\r\n\r\nThis sum can be divided into the following two categories:\r\n<ul class=\"level-one\">\r\n \t<li>\r\n<p class=\"first-para\"><b>Explained sum of squares (ESS):</b> Also known as the <i>explained variation</i>, the ESS is the portion of total variation that measures how well the regression equation explains the relationship between <i>X</i> and <i>Y</i>.</p>\r\n<p class=\"child-para\">You compute the ESS with the formula</p>\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460869.image2.png\" alt=\"image2.png\" width=\"143\" height=\"53\" /></li>\r\n \t<li>\r\n<p class=\"first-para\"><b>Residual sum of squares (RSS):</b> This expression is also known as <i>unexplained variation</i> and is the portion of total variation that measures discrepancies (errors) between the actual values of <i>Y</i> and those estimated by the regression equation.</p>\r\n<p class=\"child-para\">You compute the RSS with the formula</p>\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460870.image3.png\" alt=\"image3.png\" width=\"147\" height=\"53\" /></li>\r\n</ul>\r\nThe smaller the value of RSS relative to ESS, the better the regression line fits or explains the relationship between the dependent and independent variable.\r\n<ul class=\"level-one\">\r\n \t<li>\r\n<p class=\"first-para\"><b>Total sum of squares (TSS):</b></p>\r\n<p class=\"child-para\">The sum of RSS and ESS equals TSS.</p>\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460871.image4.png\" alt=\"image4.png\" width=\"297\" height=\"53\" />\r\n<p class=\"child-para\"><i>R</i><sup>2</sup> is the ratio of explained sum of squares (ESS) to total sum of squares (TSS):</p>\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460872.image5.png\" alt=\"image5.png\" width=\"83\" height=\"47\" />\r\n<p class=\"child-para\">You can also use this formula:</p>\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460873.image6.png\" alt=\"image6.png\" width=\"105\" height=\"47\" />\r\n<p class=\"child-para\">Based on the definition of <i>R</i><sup>2</sup>, its value can never be negative. Also, <i>R</i><sup>2</sup> can't be greater than 1, so</p>\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460874.image7.png\" alt=\"image7.png\" width=\"77\" height=\"24\" /></li>\r\n</ul>\r\nWith simple regression analysis, <i>R</i><sup>2</sup> equals the square of the correlation between <i>X</i> and <i>Y</i>.\r\n\r\nThe coefficient of determination is used as a measure of how well a regression line explains the relationship between a dependent variable (<i>Y</i>) and an independent variable (<i>X</i>). The closer the coefficient of determination is to 1, the more closely the regression line fits the sample data.\r\n\r\nThe coefficient of determination is computed from the sums of squares. These calculations are summarized in the following table.\r\n\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460875.image8.png\" alt=\"image8.png\" width=\"447\" height=\"319\" />\r\n\r\nTo compute ESS, you subtract the mean value of <i>Y</i> from each of the estimated values of <i>Y</i>; each term is squared and then added together:\r\n\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460876.image9.png\" alt=\"image9.png\" width=\"205\" height=\"53\" />\r\n\r\nTo compute RSS, you subtract the estimated value of <i>Y</i> from each of the actual values of <i>Y</i>; each term is squared and then added together:\r\n\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460877.image10.png\" alt=\"image10.png\" width=\"197\" height=\"53\" />\r\n\r\nTo compute TSS, you subtract the mean value of <i>Y</i> from each of the actual values of <i>Y</i>; each term is squared and then added together:\r\n\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460878.image11.png\" alt=\"image11.png\" width=\"191\" height=\"53\" />\r\n\r\nAlternatively, you can simply add ESS and RSS to obtain TSS:\r\n\r\nTSS = ESS + RSS = 0.54 + 0.14 = 0.68\r\n\r\nThe coefficient of determination (<i>R</i><sup>2</sup>) is the ratio of ESS to TSS:\r\n\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460879.image12.png\" alt=\"image12.png\" width=\"204\" height=\"47\" />\r\n\r\nThis shows that 79.41 percent of the variation in <i>Y</i> is explained by variation in <i>X</i>. Because the coefficient of determination can't exceed 100 percent, a value of 79.41 indicates that the regression line closely matches the actual sample data.","description":"After you estimate the population regression line, you can check whether the regression equation makes sense by using the coefficient of determination, also known as <i>R</i><sup>2</sup> (<i>R</i> squared). This is used as a measure of how well the regression equation actually describes the relationship between the dependent variable (<i>Y</i>) and the independent variable (<i>X</i>).\r\n\r\nIt may be the case that there is no real relationship between the dependent and independent variables; simple regression generates results even if this is the case. It is, therefore, important to subject the regression results to some key tests that enable you to determine if the results are reliable.\r\n\r\nThe coefficient of determination, <i>R</i><sup>2</sup>, is a statistical measure that shows the proportion of <i>variation</i> explained by the estimated regression line. Variation refers to the sum of the squared differences between the values of <i>Y</i> and the mean value of <i>Y</i>, expressed mathematically as\r\n\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460867.image0.png\" alt=\"image0.png\" width=\"91\" height=\"53\" />\r\n\r\n<i>R</i><sup>2</sup> always takes on a value between 0 and 1. The closer <i>R</i><sup>2</sup> is to 1, the better the estimated regression equation fits or explains the relationship between <i>X</i> and <i>Y</i>.\r\n\r\nThe expression\r\n\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460868.image1.png\" alt=\"image1.png\" width=\"91\" height=\"53\" />\r\n\r\nis also known as the <i>total sum of squares</i> (TSS).\r\n\r\nThis sum can be divided into the following two categories:\r\n<ul class=\"level-one\">\r\n \t<li>\r\n<p class=\"first-para\"><b>Explained sum of squares (ESS):</b> Also known as the <i>explained variation</i>, the ESS is the portion of total variation that measures how well the regression equation explains the relationship between <i>X</i> and <i>Y</i>.</p>\r\n<p class=\"child-para\">You compute the ESS with the formula</p>\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460869.image2.png\" alt=\"image2.png\" width=\"143\" height=\"53\" /></li>\r\n \t<li>\r\n<p class=\"first-para\"><b>Residual sum of squares (RSS):</b> This expression is also known as <i>unexplained variation</i> and is the portion of total variation that measures discrepancies (errors) between the actual values of <i>Y</i> and those estimated by the regression equation.</p>\r\n<p class=\"child-para\">You compute the RSS with the formula</p>\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460870.image3.png\" alt=\"image3.png\" width=\"147\" height=\"53\" /></li>\r\n</ul>\r\nThe smaller the value of RSS relative to ESS, the better the regression line fits or explains the relationship between the dependent and independent variable.\r\n<ul class=\"level-one\">\r\n \t<li>\r\n<p class=\"first-para\"><b>Total sum of squares (TSS):</b></p>\r\n<p class=\"child-para\">The sum of RSS and ESS equals TSS.</p>\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460871.image4.png\" alt=\"image4.png\" width=\"297\" height=\"53\" />\r\n<p class=\"child-para\"><i>R</i><sup>2</sup> is the ratio of explained sum of squares (ESS) to total sum of squares (TSS):</p>\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460872.image5.png\" alt=\"image5.png\" width=\"83\" height=\"47\" />\r\n<p class=\"child-para\">You can also use this formula:</p>\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460873.image6.png\" alt=\"image6.png\" width=\"105\" height=\"47\" />\r\n<p class=\"child-para\">Based on the definition of <i>R</i><sup>2</sup>, its value can never be negative. Also, <i>R</i><sup>2</sup> can't be greater than 1, so</p>\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460874.image7.png\" alt=\"image7.png\" width=\"77\" height=\"24\" /></li>\r\n</ul>\r\nWith simple regression analysis, <i>R</i><sup>2</sup> equals the square of the correlation between <i>X</i> and <i>Y</i>.\r\n\r\nThe coefficient of determination is used as a measure of how well a regression line explains the relationship between a dependent variable (<i>Y</i>) and an independent variable (<i>X</i>). The closer the coefficient of determination is to 1, the more closely the regression line fits the sample data.\r\n\r\nThe coefficient of determination is computed from the sums of squares. These calculations are summarized in the following table.\r\n\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460875.image8.png\" alt=\"image8.png\" width=\"447\" height=\"319\" />\r\n\r\nTo compute ESS, you subtract the mean value of <i>Y</i> from each of the estimated values of <i>Y</i>; each term is squared and then added together:\r\n\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460876.image9.png\" alt=\"image9.png\" width=\"205\" height=\"53\" />\r\n\r\nTo compute RSS, you subtract the estimated value of <i>Y</i> from each of the actual values of <i>Y</i>; each term is squared and then added together:\r\n\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460877.image10.png\" alt=\"image10.png\" width=\"197\" height=\"53\" />\r\n\r\nTo compute TSS, you subtract the mean value of <i>Y</i> from each of the actual values of <i>Y</i>; each term is squared and then added together:\r\n\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460878.image11.png\" alt=\"image11.png\" width=\"191\" height=\"53\" />\r\n\r\nAlternatively, you can simply add ESS and RSS to obtain TSS:\r\n\r\nTSS = ESS + RSS = 0.54 + 0.14 = 0.68\r\n\r\nThe coefficient of determination (<i>R</i><sup>2</sup>) is the ratio of ESS to TSS:\r\n\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460879.image12.png\" alt=\"image12.png\" width=\"204\" height=\"47\" />\r\n\r\nThis shows that 79.41 percent of the variation in <i>Y</i> is explained by variation in <i>X</i>. Because the coefficient of determination can't exceed 100 percent, a value of 79.41 indicates that the regression line closely matches the actual sample data.","blurb":"","authors":[{"authorId":9080,"name":"Alan Anderson","slug":"alan-anderson","description":" <p><b>Alan Anderson</b>, PhD is a teacher of finance, economics, statistics, and math at Fordham and Fairfield universities as well as at Manhattanville and Purchase colleges. Outside of the academic environment he has many years of experience working as an economist, risk manager, and fixed income analyst. Alan received his PhD in economics from Fordham University, and an M.S. in financial engineering from Polytechnic University.</p>","hasArticle":false,"_links":{"self":"https://dummies-api.dummies.com/v2/authors/9080"}}],"primaryCategoryTaxonomy":{"categoryId":34229,"title":"Calculation & Analysis","slug":"calculation-analysis","_links":{"self":"https://dummies-api.dummies.com/v2/categories/34229"}},"secondaryCategoryTaxonomy":{"categoryId":0,"title":null,"slug":null,"_links":null},"tertiaryCategoryTaxonomy":{"categoryId":0,"title":null,"slug":null,"_links":null},"trendingArticles":null,"inThisArticle":[],"relatedArticles":{"fromBook":[{"articleId":207822,"title":"Business Statistics For Dummies Cheat Sheet","slug":"business-statistics-for-dummies-cheat-sheet","categoryList":["business-careers-money","business","accounting","calculation-analysis"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/207822"}},{"articleId":162083,"title":"How Businesses Use Regression Analysis Statistics","slug":"how-businesses-use-regression-analysis-statistics","categoryList":["business-careers-money","business","accounting","calculation-analysis"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/162083"}},{"articleId":162074,"title":"Random Variables and Probability Distributions in Business Statistics","slug":"random-variables-and-probability-distributions-in-business-statistics","categoryList":["business-careers-money","business","accounting","calculation-analysis"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/162074"}},{"articleId":162073,"title":"Explore Hypothesis Testing in Business Statistics","slug":"explore-hypothesis-testing-in-business-statistics","categoryList":["business-careers-money","business","accounting","calculation-analysis"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/162073"}},{"articleId":162066,"title":"3 Ways to Describe Populations and Samples in Business Statistics","slug":"3-ways-to-describe-populations-and-samples-in-business-statistics","categoryList":["business-careers-money","business","accounting","calculation-analysis"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/162066"}}],"fromCategory":[{"articleId":254831,"title":"Important Terms in Game Theory","slug":"important-terms-game-theory","categoryList":["business-careers-money","business","accounting","calculation-analysis"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/254831"}},{"articleId":254827,"title":"How to Create a Matrix from a Transition Diagram","slug":"create-matrix-transition-diagram","categoryList":["business-careers-money","business","accounting","calculation-analysis"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/254827"}},{"articleId":254821,"title":"How to Use Transition Matrices","slug":"use-transition-matrices","categoryList":["business-careers-money","business","accounting","calculation-analysis"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/254821"}},{"articleId":254814,"title":"How to Analyze Arguments with Euler Diagrams","slug":"analyze-arguments-euler-diagrams","categoryList":["business-careers-money","business","accounting","calculation-analysis"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/254814"}},{"articleId":254811,"title":"How to Analyze Compound Statements","slug":"analyze-compound-statements","categoryList":["business-careers-money","business","accounting","calculation-analysis"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/254811"}}]},"hasRelatedBookFromSearch":false,"relatedBook":{"bookId":282040,"slug":"business-statistics-for-dummies","isbn":"9781118630693","categoryList":["business-careers-money","business","accounting","calculation-analysis"],"amazon":{"default":"https://www.amazon.com/gp/product/1118630696/ref=as_li_tl?ie=UTF8&tag=wiley01-20","ca":"https://www.amazon.ca/gp/product/1118630696/ref=as_li_tl?ie=UTF8&tag=wiley01-20","indigo_ca":"http://www.tkqlhce.com/click-9208661-13710633?url=https://www.chapters.indigo.ca/en-ca/books/product/1118630696-item.html&cjsku=978111945484","gb":"https://www.amazon.co.uk/gp/product/1118630696/ref=as_li_tl?ie=UTF8&tag=wiley01-20","de":"https://www.amazon.de/gp/product/1118630696/ref=as_li_tl?ie=UTF8&tag=wiley01-20"},"image":{"src":"https://www.dummies.com/wp-content/uploads/business-statistics-for-dummies-cover-9781118630693-203x255.jpg","width":203,"height":255},"title":"Business Statistics For Dummies","testBankPinActivationLink":"","bookOutOfPrint":false,"authorsInfo":"<p><b data-author-id=\"9080\">Alan Anderson</b>, PhD is a teacher of finance, economics, statistics, and math at Fordham and Fairfield universities as well as at Manhattanville and Purchase colleges. Outside of the academic environment he has many years of experience working as an economist, risk manager, and fixed income analyst. Alan received his PhD in economics from Fordham University, and an M.S. in financial engineering from Polytechnic University.</p>","authors":[{"authorId":9080,"name":"Alan Anderson","slug":"alan-anderson","description":" <p><b>Alan Anderson</b>, PhD is a teacher of finance, economics, statistics, and math at Fordham and Fairfield universities as well as at Manhattanville and Purchase colleges. Outside of the academic environment he has many years of experience working as an economist, risk manager, and fixed income analyst. Alan received his PhD in economics from Fordham University, and an M.S. in financial engineering from Polytechnic University.</p>","hasArticle":false,"_links":{"self":"https://dummies-api.dummies.com/v2/authors/9080"}}],"_links":{"self":"https://dummies-api.dummies.com/v2/books/"}},"collections":[],"articleAds":{"footerAd":"<div class=\"du-ad-region row\" id=\"article_page_adhesion_ad\"><div class=\"du-ad-unit col-md-12\" data-slot-id=\"article_page_adhesion_ad\" data-refreshed=\"false\" \r\n data-target = \"[{&quot;key&quot;:&quot;cat&quot;,&quot;values&quot;:[&quot;business-careers-money&quot;,&quot;business&quot;,&quot;accounting&quot;,&quot;calculation-analysis&quot;]},{&quot;key&quot;:&quot;isbn&quot;,&quot;values&quot;:[&quot;9781118630693&quot;]}]\" id=\"du-slot-633f17df596c3\"></div></div>","rightAd":"<div class=\"du-ad-region row\" id=\"article_page_right_ad\"><div class=\"du-ad-unit col-md-12\" data-slot-id=\"article_page_right_ad\" data-refreshed=\"false\" \r\n data-target = \"[{&quot;key&quot;:&quot;cat&quot;,&quot;values&quot;:[&quot;business-careers-money&quot;,&quot;business&quot;,&quot;accounting&quot;,&quot;calculation-analysis&quot;]},{&quot;key&quot;:&quot;isbn&quot;,&quot;values&quot;:[&quot;9781118630693&quot;]}]\" id=\"du-slot-633f17df59dd3\"></div></div>"},"articleType":{"articleType":"Articles","articleList":null,"content":null,"videoInfo":{"videoId":null,"name":null,"accountId":null,"playerId":null,"thumbnailUrl":null,"description":null,"uploadDate":null}},"sponsorship":{"sponsorshipPage":false,"backgroundImage":{"src":null,"width":0,"height":0},"brandingLine":"","brandingLink":"","brandingLogo":{"src":null,"width":0,"height":0},"sponsorAd":"","sponsorEbookTitle":"","sponsorEbookLink":"","sponsorEbookImage":{"src":null,"width":0,"height":0}},"primaryLearningPath":"Advance","lifeExpectancy":"Five years","lifeExpectancySetFrom":"2022-10-06T00:00:00+00:00","dummiesForKids":"no","sponsoredContent":"no","adInfo":"","adPairKey":[]},"status":"publish","visibility":"public","articleId":145936},{"headers":{"creationTime":"2016-03-26T08:14:22+00:00","modifiedTime":"2022-09-22T16:12:14+00:00","timestamp":"2022-09-22T18:01:03+00:00"},"data":{"breadcrumbs":[{"name":"Business, Careers, & Money","_links":{"self":"https://dummies-api.dummies.com/v2/categories/34224"},"slug":"business-careers-money","categoryId":34224},{"name":"Business","_links":{"self":"https://dummies-api.dummies.com/v2/categories/34225"},"slug":"business","categoryId":34225},{"name":"Accounting","_links":{"self":"https://dummies-api.dummies.com/v2/categories/34226"},"slug":"accounting","categoryId":34226},{"name":"Calculation & Analysis","_links":{"self":"https://dummies-api.dummies.com/v2/categories/34229"},"slug":"calculation-analysis","categoryId":34229}],"title":"How to Convert a Sampling Distribution Using the Central Limit Theorem","strippedTitle":"how to convert a sampling distribution using the central limit theorem","slug":"how-to-convert-a-sampling-distribution-to-a-standard-normal-random-variable-using-the-central-limit-theorem","canonicalUrl":"","seo":{"metaDescription":"Learn how to convert a sampling distribution to a standard normal random variable using the central limit theorem in business statistics.","noIndex":0,"noFollow":0},"content":"You can use the Central Limit Theorem to convert a sampling distribution to a standard normal random variable. Based on the Central Limit Theorem, if you draw samples from a population that is greater than or equal to 30, then the sample mean is a normally distributed random variable. To determine probabilities for the sample mean\r\n\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460170.image0.png\" alt=\"image0.png\" width=\"35\" height=\"25\" />\r\n\r\nthe standard normal tables requires you to convert\r\n\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460171.image1.png\" alt=\"image1.png\" width=\"20\" height=\"21\" />\r\n\r\nto a standard normal random variable.\r\n<p class=\"Remember\">The standard normal distribution is the special case where the mean</p>\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460172.image2.png\" alt=\"image2.png\" width=\"27\" height=\"23\" />\r\n\r\nequals 0, and the standard deviation\r\n\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460173.image3.png\" alt=\"image3.png\" width=\"28\" height=\"23\" />\r\n\r\nequals 1.\r\n\r\nFor any normally distributed random variable <i>X</i> with a mean\r\n\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460174.image4.png\" alt=\"image4.png\" width=\"16\" height=\"19\" />\r\n\r\nand a standard deviation\r\n\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460175.image5.png\" alt=\"image5.png\" width=\"20\" height=\"17\" />\r\n\r\nyou find the corresponding standard normal random variable (<i>Z</i>) with the following equation:\r\n\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460176.image6.png\" alt=\"image6.png\" width=\"80\" height=\"47\" />\r\n\r\nFor the sampling distribution of\r\n\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460177.image7.png\" alt=\"image7.png\" width=\"23\" height=\"24\" />\r\n\r\nthe corresponding equation is\r\n\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460178.image8.png\" alt=\"image8.png\" width=\"92\" height=\"52\" />\r\n\r\nAs an example, say that there are 10,000 stocks trading each day on a regional stock exchange. It's known from historical experience that the returns to these stocks have a mean value of 10 percent per year, and a standard deviation of 20 percent per year.\r\n\r\nAn investor chooses to buy a random selection of 100 of these stocks for his portfolio. What's the probability that the mean rate of return among these 100 stocks is greater than 8 percent?\r\n\r\nThe investor's portfolio can be thought of as a sample of stocks chosen from the population of stocks trading on the regional exchange. The first step to finding this probability is to compute the moments of the sampling distribution.\r\n<ul class=\"level-one\">\r\n \t<li>\r\n<p class=\"first-para\"><b>Compute the mean: </b></p>\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460179.image9.png\" alt=\"image9.png\" width=\"112\" height=\"27\" /></li>\r\n</ul>\r\nThe mean of the sampling distribution equals the population mean.\r\n<ul class=\"level-one\">\r\n \t<li>\r\n<p class=\"first-para\"><b>Determine the standard error:</b> This calculation is a little trickier because the standard error depends on the size of the sample relative to the size of the population. In this case, the sample size (<i>n</i>) is 100, while the population size (<i>N</i>) is 10,000. So you first have to compute the sample size relative to the population size, like so:</p>\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460180.image10.png\" alt=\"image10.png\" width=\"227\" height=\"25\" />\r\n<p class=\"child-para\">Because 1 percent is less than 5 percent, you don't use the finite population correction factor to compute the standard error. Note that in this case, the value of the finite population correction factor is:</p>\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460181.image11.png\" alt=\"image11.png\" width=\"323\" height=\"53\" /></li>\r\n</ul>\r\nBecause this value is so close to 1, using the finite population correction factor in this case would have little or no impact on the resulting probabilities.\r\n\r\nAnd because the finite population correction factor isn't needed in this case, the standard error is computed as follows:\r\n\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460182.image12.png\" alt=\"image12.png\" width=\"91\" height=\"197\" />\r\n\r\nTo determine the probability that the sample mean is greater than 8 percent, you must now convert the sample mean into a standard normal random variable using the following equation:\r\n\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460183.image13.png\" alt=\"image13.png\" width=\"92\" height=\"52\" />\r\n\r\nTo compute the probability that the sample mean is greater than 8 percent, you apply the previous formula as follows:\r\n\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460184.image14.png\" alt=\"image14.png\" width=\"252\" height=\"55\" />\r\n\r\nBecause\r\n\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460185.image15.png\" alt=\"image15.png\" width=\"197\" height=\"27\" />\r\n\r\nthese values are substituted into the previous expression as follows:\r\n\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460186.image16.png\" alt=\"image16.png\" width=\"423\" height=\"55\" />\r\n\r\nYou can calculate this probability by using the properties of the standard normal distribution along with a standard normal table such as this one.\r\n<table><caption>Standard Normal Table — Negative Values</caption>\r\n<tbody>\r\n<tr>\r\n<th><b><i>Z</i></b></th>\r\n<th>0.00</th>\r\n<th>0.01</th>\r\n<th>0.02</th>\r\n<th>0.03</th>\r\n</tr>\r\n<tr>\r\n<td>–1.3</td>\r\n<td>0.0968</td>\r\n<td>0.0951</td>\r\n<td>0.0934</td>\r\n<td>0.0918</td>\r\n</tr>\r\n<tr>\r\n<td>–1.2</td>\r\n<td>0.1151</td>\r\n<td>0.1131</td>\r\n<td>0.1112</td>\r\n<td>0.1093</td>\r\n</tr>\r\n<tr>\r\n<td>–1.1</td>\r\n<td>0.1357</td>\r\n<td>0.1335</td>\r\n<td>0.1314</td>\r\n<td>0.1292</td>\r\n</tr>\r\n<tr>\r\n<td>–1.0</td>\r\n<td>0.1587</td>\r\n<td>0.1562</td>\r\n<td>0.1539</td>\r\n<td>0.1515</td>\r\n</tr>\r\n</tbody>\r\n</table>\r\nThe table shows the probability that a standard normal random variable (designated <i>Z</i>) is <i>less than or equal to</i> a specific value. For example, you can write the probability that\r\n\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460187.image17.png\" alt=\"image17.png\" width=\"77\" height=\"19\" />\r\n\r\n(one standard deviation below the mean) as\r\n\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460188.image18.png\" alt=\"image18.png\" width=\"108\" height=\"31\" />\r\n\r\nYou find the probability from the table with these steps:\r\n<ol class=\"level-one\">\r\n \t<li>\r\n<p class=\"first-para\">Locate the first digit before and after the decimal point (–1.0) in the first (<i>Z</i>) column.</p>\r\n</li>\r\n \t<li>\r\n<p class=\"first-para\">Find the second digit after the decimal point (0.00) in the second (0.00) column.</p>\r\n</li>\r\n \t<li>\r\n<p class=\"first-para\">See where the row and column intersect to find the probability:</p>\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460189.image19.png\" alt=\"image19.png\" width=\"176\" height=\"31\" /></li>\r\n</ol>\r\nBecause you're actually looking for the probability that <i>Z</i> is greater than or equal to –1, one more step is required.\r\n\r\nDue to the symmetry of the standard normal distribution, the probability that <i>Z</i> is greater than or equal to a negative value equals one minus the probability that <i>Z</i> is less than or equal to the same negative value.\r\n\r\nFor example,\r\n\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460190.image20.png\" alt=\"image20.png\" width=\"224\" height=\"31\" />\r\n\r\nThis is because\r\n\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460191.image21.png\" alt=\"image21.png\" width=\"188\" height=\"19\" />\r\n\r\nare <i>complementary</i> events. This means that <i>Z</i> must either be greater than or equal to –2 or less than or equal to –2. Therefore,\r\n\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460192.image22.png\" alt=\"image22.png\" width=\"224\" height=\"31\" />\r\n\r\nThis is true because the occurrence of one of these events is <i>certain</i>, and the probability of a certain event is 1.\r\n\r\nAfter algebraically rewriting this equation, you end up with the following result:\r\n\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460193.image23.png\" alt=\"image23.png\" width=\"224\" height=\"31\" />\r\n\r\nFor the portfolio example,\r\n\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460194.image24.png\" alt=\"image24.png\" width=\"256\" height=\"57\" />\r\n\r\nThe result shows that there's an 84.13 percent chance that the investor's portfolio will have a mean return greater than 8 percent.","description":"You can use the Central Limit Theorem to convert a sampling distribution to a standard normal random variable. Based on the Central Limit Theorem, if you draw samples from a population that is greater than or equal to 30, then the sample mean is a normally distributed random variable. To determine probabilities for the sample mean\r\n\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460170.image0.png\" alt=\"image0.png\" width=\"35\" height=\"25\" />\r\n\r\nthe standard normal tables requires you to convert\r\n\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460171.image1.png\" alt=\"image1.png\" width=\"20\" height=\"21\" />\r\n\r\nto a standard normal random variable.\r\n<p class=\"Remember\">The standard normal distribution is the special case where the mean</p>\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460172.image2.png\" alt=\"image2.png\" width=\"27\" height=\"23\" />\r\n\r\nequals 0, and the standard deviation\r\n\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460173.image3.png\" alt=\"image3.png\" width=\"28\" height=\"23\" />\r\n\r\nequals 1.\r\n\r\nFor any normally distributed random variable <i>X</i> with a mean\r\n\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460174.image4.png\" alt=\"image4.png\" width=\"16\" height=\"19\" />\r\n\r\nand a standard deviation\r\n\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460175.image5.png\" alt=\"image5.png\" width=\"20\" height=\"17\" />\r\n\r\nyou find the corresponding standard normal random variable (<i>Z</i>) with the following equation:\r\n\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460176.image6.png\" alt=\"image6.png\" width=\"80\" height=\"47\" />\r\n\r\nFor the sampling distribution of\r\n\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460177.image7.png\" alt=\"image7.png\" width=\"23\" height=\"24\" />\r\n\r\nthe corresponding equation is\r\n\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460178.image8.png\" alt=\"image8.png\" width=\"92\" height=\"52\" />\r\n\r\nAs an example, say that there are 10,000 stocks trading each day on a regional stock exchange. It's known from historical experience that the returns to these stocks have a mean value of 10 percent per year, and a standard deviation of 20 percent per year.\r\n\r\nAn investor chooses to buy a random selection of 100 of these stocks for his portfolio. What's the probability that the mean rate of return among these 100 stocks is greater than 8 percent?\r\n\r\nThe investor's portfolio can be thought of as a sample of stocks chosen from the population of stocks trading on the regional exchange. The first step to finding this probability is to compute the moments of the sampling distribution.\r\n<ul class=\"level-one\">\r\n \t<li>\r\n<p class=\"first-para\"><b>Compute the mean: </b></p>\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460179.image9.png\" alt=\"image9.png\" width=\"112\" height=\"27\" /></li>\r\n</ul>\r\nThe mean of the sampling distribution equals the population mean.\r\n<ul class=\"level-one\">\r\n \t<li>\r\n<p class=\"first-para\"><b>Determine the standard error:</b> This calculation is a little trickier because the standard error depends on the size of the sample relative to the size of the population. In this case, the sample size (<i>n</i>) is 100, while the population size (<i>N</i>) is 10,000. So you first have to compute the sample size relative to the population size, like so:</p>\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460180.image10.png\" alt=\"image10.png\" width=\"227\" height=\"25\" />\r\n<p class=\"child-para\">Because 1 percent is less than 5 percent, you don't use the finite population correction factor to compute the standard error. Note that in this case, the value of the finite population correction factor is:</p>\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460181.image11.png\" alt=\"image11.png\" width=\"323\" height=\"53\" /></li>\r\n</ul>\r\nBecause this value is so close to 1, using the finite population correction factor in this case would have little or no impact on the resulting probabilities.\r\n\r\nAnd because the finite population correction factor isn't needed in this case, the standard error is computed as follows:\r\n\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460182.image12.png\" alt=\"image12.png\" width=\"91\" height=\"197\" />\r\n\r\nTo determine the probability that the sample mean is greater than 8 percent, you must now convert the sample mean into a standard normal random variable using the following equation:\r\n\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460183.image13.png\" alt=\"image13.png\" width=\"92\" height=\"52\" />\r\n\r\nTo compute the probability that the sample mean is greater than 8 percent, you apply the previous formula as follows:\r\n\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460184.image14.png\" alt=\"image14.png\" width=\"252\" height=\"55\" />\r\n\r\nBecause\r\n\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460185.image15.png\" alt=\"image15.png\" width=\"197\" height=\"27\" />\r\n\r\nthese values are substituted into the previous expression as follows:\r\n\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460186.image16.png\" alt=\"image16.png\" width=\"423\" height=\"55\" />\r\n\r\nYou can calculate this probability by using the properties of the standard normal distribution along with a standard normal table such as this one.\r\n<table><caption>Standard Normal Table — Negative Values</caption>\r\n<tbody>\r\n<tr>\r\n<th><b><i>Z</i></b></th>\r\n<th>0.00</th>\r\n<th>0.01</th>\r\n<th>0.02</th>\r\n<th>0.03</th>\r\n</tr>\r\n<tr>\r\n<td>–1.3</td>\r\n<td>0.0968</td>\r\n<td>0.0951</td>\r\n<td>0.0934</td>\r\n<td>0.0918</td>\r\n</tr>\r\n<tr>\r\n<td>–1.2</td>\r\n<td>0.1151</td>\r\n<td>0.1131</td>\r\n<td>0.1112</td>\r\n<td>0.1093</td>\r\n</tr>\r\n<tr>\r\n<td>–1.1</td>\r\n<td>0.1357</td>\r\n<td>0.1335</td>\r\n<td>0.1314</td>\r\n<td>0.1292</td>\r\n</tr>\r\n<tr>\r\n<td>–1.0</td>\r\n<td>0.1587</td>\r\n<td>0.1562</td>\r\n<td>0.1539</td>\r\n<td>0.1515</td>\r\n</tr>\r\n</tbody>\r\n</table>\r\nThe table shows the probability that a standard normal random variable (designated <i>Z</i>) is <i>less than or equal to</i> a specific value. For example, you can write the probability that\r\n\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460187.image17.png\" alt=\"image17.png\" width=\"77\" height=\"19\" />\r\n\r\n(one standard deviation below the mean) as\r\n\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460188.image18.png\" alt=\"image18.png\" width=\"108\" height=\"31\" />\r\n\r\nYou find the probability from the table with these steps:\r\n<ol class=\"level-one\">\r\n \t<li>\r\n<p class=\"first-para\">Locate the first digit before and after the decimal point (–1.0) in the first (<i>Z</i>) column.</p>\r\n</li>\r\n \t<li>\r\n<p class=\"first-para\">Find the second digit after the decimal point (0.00) in the second (0.00) column.</p>\r\n</li>\r\n \t<li>\r\n<p class=\"first-para\">See where the row and column intersect to find the probability:</p>\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460189.image19.png\" alt=\"image19.png\" width=\"176\" height=\"31\" /></li>\r\n</ol>\r\nBecause you're actually looking for the probability that <i>Z</i> is greater than or equal to –1, one more step is required.\r\n\r\nDue to the symmetry of the standard normal distribution, the probability that <i>Z</i> is greater than or equal to a negative value equals one minus the probability that <i>Z</i> is less than or equal to the same negative value.\r\n\r\nFor example,\r\n\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460190.image20.png\" alt=\"image20.png\" width=\"224\" height=\"31\" />\r\n\r\nThis is because\r\n\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460191.image21.png\" alt=\"image21.png\" width=\"188\" height=\"19\" />\r\n\r\nare <i>complementary</i> events. This means that <i>Z</i> must either be greater than or equal to –2 or less than or equal to –2. Therefore,\r\n\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460192.image22.png\" alt=\"image22.png\" width=\"224\" height=\"31\" />\r\n\r\nThis is true because the occurrence of one of these events is <i>certain</i>, and the probability of a certain event is 1.\r\n\r\nAfter algebraically rewriting this equation, you end up with the following result:\r\n\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460193.image23.png\" alt=\"image23.png\" width=\"224\" height=\"31\" />\r\n\r\nFor the portfolio example,\r\n\r\n<img src=\"https://www.dummies.com/wp-content/uploads/460194.image24.png\" alt=\"image24.png\" width=\"256\" height=\"57\" />\r\n\r\nThe result shows that there's an 84.13 percent chance that the investor's portfolio will have a mean return greater than 8 percent.","blurb":"","authors":[{"authorId":9080,"name":"Alan Anderson","slug":"alan-anderson","description":" <p><b>Alan Anderson</b>, PhD is a teacher of finance, economics, statistics, and math at Fordham and Fairfield universities as well as at Manhattanville and Purchase colleges. Outside of the academic environment he has many years of experience working as an economist, risk manager, and fixed income analyst. Alan received his PhD in economics from Fordham University, and an M.S. in financial engineering from Polytechnic University.</p>","hasArticle":false,"_links":{"self":"https://dummies-api.dummies.com/v2/authors/9080"}}],"primaryCategoryTaxonomy":{"categoryId":34229,"title":"Calculation & Analysis","slug":"calculation-analysis","_links":{"self":"https://dummies-api.dummies.com/v2/categories/34229"}},"secondaryCategoryTaxonomy":{"categoryId":0,"title":null,"slug":null,"_links":null},"tertiaryCategoryTaxonomy":{"categoryId":0,"title":null,"slug":null,"_links":null},"trendingArticles":null,"inThisArticle":[],"relatedArticles":{"fromBook":[{"articleId":207822,"title":"Business Statistics For Dummies Cheat Sheet","slug":"business-statistics-for-dummies-cheat-sheet","categoryList":["business-careers-money","business","accounting","calculation-analysis"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/207822"}},{"articleId":162083,"title":"How Businesses Use Regression Analysis Statistics","slug":"how-businesses-use-regression-analysis-statistics","categoryList":["business-careers-money","business","accounting","calculation-analysis"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/162083"}},{"articleId":162074,"title":"Random Variables and Probability Distributions in Business Statistics","slug":"random-variables-and-probability-distributions-in-business-statistics","categoryList":["business-careers-money","business","accounting","calculation-analysis"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/162074"}},{"articleId":162073,"title":"Explore Hypothesis Testing in Business Statistics","slug":"explore-hypothesis-testing-in-business-statistics","categoryList":["business-careers-money","business","accounting","calculation-analysis"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/162073"}},{"articleId":162066,"title":"3 Ways to Describe Populations and Samples in Business Statistics","slug":"3-ways-to-describe-populations-and-samples-in-business-statistics","categoryList":["business-careers-money","business","accounting","calculation-analysis"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/162066"}}],"fromCategory":[{"articleId":254831,"title":"Important Terms in Game Theory","slug":"important-terms-game-theory","categoryList":["business-careers-money","business","accounting","calculation-analysis"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/254831"}},{"articleId":254827,"title":"How to Create a Matrix from a Transition Diagram","slug":"create-matrix-transition-diagram","categoryList":["business-careers-money","business","accounting","calculation-analysis"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/254827"}},{"articleId":254821,"title":"How to Use Transition Matrices","slug":"use-transition-matrices","categoryList":["business-careers-money","business","accounting","calculation-analysis"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/254821"}},{"articleId":254814,"title":"How to Analyze Arguments with Euler Diagrams","slug":"analyze-arguments-euler-diagrams","categoryList":["business-careers-money","business","accounting","calculation-analysis"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/254814"}},{"articleId":254811,"title":"How to Analyze Compound Statements","slug":"analyze-compound-statements","categoryList":["business-careers-money","business","accounting","calculation-analysis"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/254811"}}]},"hasRelatedBookFromSearch":false,"relatedBook":{"bookId":282040,"slug":"business-statistics-for-dummies","isbn":"9781118630693","categoryList":["business-careers-money","business","accounting","calculation-analysis"],"amazon":{"default":"https://www.amazon.com/gp/product/1118630696/ref=as_li_tl?ie=UTF8&tag=wiley01-20","ca":"https://www.amazon.ca/gp/product/1118630696/ref=as_li_tl?ie=UTF8&tag=wiley01-20","indigo_ca":"http://www.tkqlhce.com/click-9208661-13710633?url=https://www.chapters.indigo.ca/en-ca/books/product/1118630696-item.html&cjsku=978111945484","gb":"https://www.amazon.co.uk/gp/product/1118630696/ref=as_li_tl?ie=UTF8&tag=wiley01-20","de":"https://www.amazon.de/gp/product/1118630696/ref=as_li_tl?ie=UTF8&tag=wiley01-20"},"image":{"src":"https://www.dummies.com/wp-content/uploads/business-statistics-for-dummies-cover-9781118630693-203x255.jpg","width":203,"height":255},"title":"Business Statistics For Dummies","testBankPinActivationLink":"","bookOutOfPrint":false,"authorsInfo":"<p><b data-author-id=\"9080\">Alan Anderson</b>, PhD is a teacher of finance, economics, statistics, and math at Fordham and Fairfield universities as well as at Manhattanville and Purchase colleges. Outside of the academic environment he has many years of experience working as an economist, risk manager, and fixed income analyst. Alan received his PhD in economics from Fordham University, and an M.S. in financial engineering from Polytechnic University.</p>","authors":[{"authorId":9080,"name":"Alan Anderson","slug":"alan-anderson","description":" <p><b>Alan Anderson</b>, PhD is a teacher of finance, economics, statistics, and math at Fordham and Fairfield universities as well as at Manhattanville and Purchase colleges. Outside of the academic environment he has many years of experience working as an economist, risk manager, and fixed income analyst. Alan received his PhD in economics from Fordham University, and an M.S. in financial engineering from Polytechnic University.</p>","hasArticle":false,"_links":{"self":"https://dummies-api.dummies.com/v2/authors/9080"}}],"_links":{"self":"https://dummies-api.dummies.com/v2/books/"}},"collections":[],"articleAds":{"footerAd":"<div class=\"du-ad-region row\" id=\"article_page_adhesion_ad\"><div class=\"du-ad-unit col-md-12\" data-slot-id=\"article_page_adhesion_ad\" data-refreshed=\"false\" \r\n data-target = \"[{&quot;key&quot;:&quot;cat&quot;,&quot;values&quot;:[&quot;business-careers-money&quot;,&quot;business&quot;,&quot;accounting&quot;,&quot;calculation-analysis&quot;]},{&quot;key&quot;:&quot;isbn&quot;,&quot;values&quot;:[&quot;9781118630693&quot;]}]\" id=\"du-slot-632ca2df3290a\"></div></div>","rightAd":"<div class=\"du-ad-region row\" id=\"article_page_right_ad\"><div class=\"du-ad-unit col-md-12\" data-slot-id=\"article_page_right_ad\" data-refreshed=\"false\" \r\n data-target = \"[{&quot;key&quot;:&quot;cat&quot;,&quot;values&quot;:[&quot;business-careers-money&quot;,&quot;business&quot;,&quot;accounting&quot;,&quot;calculation-analysis&quot;]},{&quot;key&quot;:&quot;isbn&quot;,&quot;values&quot;:[&quot;9781118630693&quot;]}]\" id=\"du-slot-632ca2df3320d\"></div></div>"},"articleType":{"articleType":"Articles","articleList":null,"content":null,"videoInfo":{"videoId":null,"name":null,"accountId":null,"playerId":null,"thumbnailUrl":null,"description":null,"uploadDate":null}},"sponsorship":{"sponsorshipPage":false,"backgroundImage":{"src":null,"width":0,"height":0},"brandingLine":"","brandingLink":"","brandingLogo":{"src":null,"width":0,"height":0},"sponsorAd":"","sponsorEbookTitle":"","sponsorEbookLink":"","sponsorEbookImage":{"src":null,"width":0,"height":0}},"primaryLearningPath":"Advance","lifeExpectancy":"Five years","lifeExpectancySetFrom":"2022-09-22T00:00:00+00:00","dummiesForKids":"no","sponsoredContent":"no","adInfo":"","adPairKey":[]},"status":"publish","visibility":"public","articleId":146051},{"headers":{"creationTime":"2016-03-26T13:14:25+00:00","modifiedTime":"2022-09-15T15:39:27+00:00","timestamp":"2022-09-15T18:01:20+00:00"},"data":{"breadcrumbs":[{"name":"Business, Careers, & Money","_links":{"self":"https://dummies-api.dummies.com/v2/categories/34224"},"slug":"business-careers-money","categoryId":34224},{"name":"Business","_links":{"self":"https://dummies-api.dummies.com/v2/categories/34225"},"slug":"business","categoryId":34225},{"name":"Accounting","_links":{"self":"https://dummies-api.dummies.com/v2/categories/34226"},"slug":"accounting","categoryId":34226},{"name":"Audits","_links":{"self":"https://dummies-api.dummies.com/v2/categories/34227"},"slug":"audits","categoryId":34227}],"title":"13 Ways to Spot Fraud in Business Financial Statements","strippedTitle":"13 ways to spot fraud in business financial statements","slug":"13-ways-to-spot-fraud-in-business-financial-statements","canonicalUrl":"","seo":{"metaDescription":"These 13 scenarios, including inventory growth that doesn't match sales growth, are indications of business financial fraud.","noIndex":0,"noFollow":0},"content":"Financial statement fraud, commonly referred to as \"cooking the books,\" involves deliberately overstating assets, revenues, and profits and/or understating liabilities, expenses, and losses. When a forensic accountant investigates business financial fraud, she looks for red flags or accounting warning signs that indicate suspect business accounting practices.\r\n\r\nThese red flags include the following:\r\n<ul class=\"level-one\">\r\n \t<li>\r\n<p class=\"first-para\">Aggressive revenue recognition practices, such as recognizing revenue in earlier periods than when the product was sold or the service was delivered</p>\r\n</li>\r\n \t<li>\r\n<p class=\"first-para\">Unusually high revenues and low expenses at period end that can't be attributed to seasonality</p>\r\n</li>\r\n \t<li>\r\n<p class=\"first-para\">Growth in inventory that doesn't match growth in sales</p>\r\n</li>\r\n \t<li>\r\n<p class=\"first-para\">Improper capitalization of expenses in excess of industry norms</p>\r\n</li>\r\n \t<li>\r\n<p class=\"first-para\">Reported earnings that are positive and growing but operating cash flow that's declining</p>\r\n</li>\r\n \t<li>\r\n<p class=\"first-para\">Growth in revenues that's far greater than growth in other companies in the same industry or peer group</p>\r\n</li>\r\n \t<li>\r\n<p class=\"first-para\">Gross margin or operating margins out of line with peer companies</p>\r\n</li>\r\n \t<li>\r\n<p class=\"first-para\">Extensive use of off–balance sheet entities based on relationships that aren't normal in the industry</p>\r\n</li>\r\n \t<li>\r\n<p class=\"first-para\">Sudden increases in gross margin or cash flow as compared with the company's prior performance and with industry averages</p>\r\n</li>\r\n \t<li>\r\n<p class=\"first-para\">Unusual increases in the book value of assets, such as inventory and receivables</p>\r\n</li>\r\n \t<li>\r\n<p class=\"first-para\">Disclosure notes so complex that it's impossible to determine the actual nature of a particular transaction</p>\r\n</li>\r\n \t<li>\r\n<p class=\"first-para\">Invoices that go unrecorded in the company's financial books</p>\r\n</li>\r\n \t<li>\r\n<p class=\"first-para\">Loans to executives or other related parties that are written off</p>\r\n</li>\r\n</ul>\r\n<p class=\"Warning\">A business that engages in such fraudulent practices stands to lose a tremendous amount of money when penalties and fines, legal costs, the loss of investor confidence, and a tarnished reputation are taken into account.</p>","description":"Financial statement fraud, commonly referred to as \"cooking the books,\" involves deliberately overstating assets, revenues, and profits and/or understating liabilities, expenses, and losses. When a forensic accountant investigates business financial fraud, she looks for red flags or accounting warning signs that indicate suspect business accounting practices.\r\n\r\nThese red flags include the following:\r\n<ul class=\"level-one\">\r\n \t<li>\r\n<p class=\"first-para\">Aggressive revenue recognition practices, such as recognizing revenue in earlier periods than when the product was sold or the service was delivered</p>\r\n</li>\r\n \t<li>\r\n<p class=\"first-para\">Unusually high revenues and low expenses at period end that can't be attributed to seasonality</p>\r\n</li>\r\n \t<li>\r\n<p class=\"first-para\">Growth in inventory that doesn't match growth in sales</p>\r\n</li>\r\n \t<li>\r\n<p class=\"first-para\">Improper capitalization of expenses in excess of industry norms</p>\r\n</li>\r\n \t<li>\r\n<p class=\"first-para\">Reported earnings that are positive and growing but operating cash flow that's declining</p>\r\n</li>\r\n \t<li>\r\n<p class=\"first-para\">Growth in revenues that's far greater than growth in other companies in the same industry or peer group</p>\r\n</li>\r\n \t<li>\r\n<p class=\"first-para\">Gross margin or operating margins out of line with peer companies</p>\r\n</li>\r\n \t<li>\r\n<p class=\"first-para\">Extensive use of off–balance sheet entities based on relationships that aren't normal in the industry</p>\r\n</li>\r\n \t<li>\r\n<p class=\"first-para\">Sudden increases in gross margin or cash flow as compared with the company's prior performance and with industry averages</p>\r\n</li>\r\n \t<li>\r\n<p class=\"first-para\">Unusual increases in the book value of assets, such as inventory and receivables</p>\r\n</li>\r\n \t<li>\r\n<p class=\"first-para\">Disclosure notes so complex that it's impossible to determine the actual nature of a particular transaction</p>\r\n</li>\r\n \t<li>\r\n<p class=\"first-para\">Invoices that go unrecorded in the company's financial books</p>\r\n</li>\r\n \t<li>\r\n<p class=\"first-para\">Loans to executives or other related parties that are written off</p>\r\n</li>\r\n</ul>\r\n<p class=\"Warning\">A business that engages in such fraudulent practices stands to lose a tremendous amount of money when penalties and fines, legal costs, the loss of investor confidence, and a tarnished reputation are taken into account.</p>","blurb":"","authors":[{"authorId":9050,"name":"Kenneth Boyd","slug":"kenneth-boyd","description":"Ken Boyd, a former CPA, has more than 37 years of experience in accounting, education, and financial services. He is the owner of Accounting Accidentally (<a href=\"https://www.accountingaccidentally.com/\" target=\"_blank\" rel=\"noopener\">www.accountingaccidentally.com</a>), which provides written and video content on accounting, personal finance, and entrepreneurship topics. His YouTube channel (<a href=\"https://www.youtube.com/user/kenboydstl\" target=\"_blank\" rel=\"noopener\">kenboydstl</a>) has hundreds of videos on accounting and finance.\r\n\r\nIn recent years, Boyd has served as an adjunct professor of accounting at the Cook School of Business at St. Louis University. He has written hundreds of articles for QuickBooks, Investopedia, and a number of other publications.","hasArticle":false,"_links":{"self":"https://dummies-api.dummies.com/v2/authors/9050"}},{"authorId":8974,"name":"Lita Epstein","slug":"lita-epstein","description":" <b>Lita Epstein,</b> who earned her MBA from Emory University&#8217;s Goizueta Business School, enjoys helping people develop good financial, investing and tax-planning skills.<br /> While getting her MBA, Lita worked as a teaching assistant for the financial accounting department and ran the accounting lab. After completing her MBA, she managed finances for a small nonprofit organization and for the facilities management section of a large medical clinic.<br /> She designs and teaches online courses on topics such as investing for retirement, getting ready for tax time and finance and investing for women. She&#8217;s written over 20 books including <i>Reading Financial Reports For Dummies</i> and <i>Trading For Dummies.<br /> </i>Lita was the content director for a financial services Web site, MostChoice.com, and managed the Web site, Investing for Women. As a Congressional press secretary, Lita gained firsthand knowledge about how to work within and around the Federal bureaucracy, which gives her great insight into how government programs work. In the past, Lita has been a daily newspaper reporter, magazine editor, and fundraiser for the international activities of former President Jimmy Carter through The Carter Center.","hasArticle":false,"_links":{"self":"https://dummies-api.dummies.com/v2/authors/8974"}},{"authorId":9468,"name":"Mark P. Holtzman","slug":"mark-p-holtzman","description":" <p><b>Mark P. Holtzman, PhD, CPA</b>, is Chair of the Department of Accounting and Taxation at Seton Hall University. He has taught accounting at the college level for 17 years and runs the Accountinator website at www.accountinator.com, which gives practical accounting advice to entrepreneurs.</p>","hasArticle":false,"_links":{"self":"https://dummies-api.dummies.com/v2/authors/9468"}},{"authorId":9469,"name":"Frimette Kass-Shraibman","slug":"frimette-kass-shraibman","description":" <p><b>Frimette Kass&#45;Shraibman</b> is Associate Professor of Accounting at Brooklyn College &#151; CUNY. <b>Vijay S. Sampath</b> is Managing Director in the Forensic and Litigation Consulting business segment of FTI Consulting, Inc. ","hasArticle":false,"_links":{"self":"https://dummies-api.dummies.com/v2/authors/9469"}},{"authorId":9470,"name":"Maire Loughran","slug":"maire-loughran","description":" <b>Maire Loughran</b> is a self-employed certified public accountant (CPA) who has prepared compilation, review, and audit reports for fifteen years. Additionally, she is a university professor of undergraduate- and graduate-level accounting classes.","hasArticle":false,"_links":{"self":"https://dummies-api.dummies.com/v2/authors/9470"}},{"authorId":9471,"name":"Vijay S. Sampath","slug":"vijay-s-sampath","description":" <p><b>Frimette Kass&#45;Shraibman</b> is Associate Professor of Accounting at Brooklyn College &#151; CUNY. <b>Vijay S. Sampath</b> is Managing Director in the Forensic and Litigation Consulting business segment of FTI Consulting, Inc. ","hasArticle":false,"_links":{"self":"https://dummies-api.dummies.com/v2/authors/9471"}},{"authorId":9472,"name":"John A. Tracy","slug":"john-a-tracy","description":" <b>John A. Tracy</b> is a former accountant and professor of accounting. He is also the author of Accounting For Dummies. ","hasArticle":false,"_links":{"self":"https://dummies-api.dummies.com/v2/authors/9472"}},{"authorId":9473,"name":"Tage C. Tracy","slug":"tage-c-tracy","description":" <b>John A. Tracy</b> is a former accountant and professor of accounting. He is also the author of Accounting For Dummies. ","hasArticle":false,"_links":{"self":"https://dummies-api.dummies.com/v2/authors/9473"}},{"authorId":9474,"name":"Jill Gilbert Welytok","slug":"jill-gilbert-welytok","description":" <b>Jill Gilbert Welytok, JD, CPA, LLM,</b> practices in the areas of corporate law, nonprofit law, and intellectual property. She is the founder of Absolute Technology Law Group, LLC (www.abtechlaw.com). She went to law school at DePaul University in Chicago, where she was on the Law Review, and picked up a Masters Degree in Computer Science from Marquette University in Wisconsin where she now lives. Ms. Welytok also has an LLM in Taxation from DePaul. She was formerly a tax consultant with the predecessor firm to Ernst &amp; Young. She frequently speaks on nonprofit, corporate governance&#8211;taxation issues and will probably come to speak to your company or organization if you invite her. You may e-mail her with questions you have about Sarbanes-Oxley or anything else in this book at [email protected] You can find updates to this book and ongoing information about SOX developments at the author&#8217;s website located at www.abtechlaw.com. <p><b>Daniel S. Welytok, JD, LLM,</b> is a partner in the business practice group of Whyte Hirschboeck Dudek S.C., where he concentrates in the areas of taxation and business law. Dan advises clients on strategic planning, federal and state tax issues, transactional matters, and employee benefits. He represents clients before the IRS and state taxing authorities concerning audits, tax controversies, and offers in compromise. He has served in various leadership roles in the American Bar Association and as Great Lakes Area liaison with the IRS. He can be reached at [email protected]</p>","hasArticle":false,"_links":{"self":"https://dummies-api.dummies.com/v2/authors/9474"}}],"primaryCategoryTaxonomy":{"categoryId":34227,"title":"Audits","slug":"audits","_links":{"self":"https://dummies-api.dummies.com/v2/categories/34227"}},"secondaryCategoryTaxonomy":{"categoryId":0,"title":null,"slug":null,"_links":null},"tertiaryCategoryTaxonomy":{"categoryId":0,"title":null,"slug":null,"_links":null},"trendingArticles":null,"inThisArticle":[],"relatedArticles":{"fromBook":[],"fromCategory":[{"articleId":209222,"title":"Sarbanes-Oxley For Dummies Cheat Sheet","slug":"sarbanes-oxley-for-dummies-cheat-sheet","categoryList":["business-careers-money","business","accounting","audits"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/209222"}},{"articleId":209016,"title":"Auditing For Dummies Cheat Sheet","slug":"auditing-for-dummies-cheat-sheet","categoryList":["business-careers-money","business","accounting","audits"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/209016"}},{"articleId":199122,"title":"Taking a Look at a Sarbanes-Oxley Overview","slug":"taking-a-look-at-a-sarbanes-oxley-overview","categoryList":["business-careers-money","business","accounting","audits"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/199122"}},{"articleId":197953,"title":"Watching for Illegal Accounting Practices in Your Business","slug":"watching-for-illegal-accounting-practices-in-your-business","categoryList":["business-careers-money","business","accounting","audits"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/197953"}},{"articleId":197915,"title":"How to Decide Whether Your Business Needs an Audit","slug":"how-to-decide-whether-your-business-needs-an-audit","categoryList":["business-careers-money","business","accounting","audits"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/197915"}}]},"hasRelatedBookFromSearch":false,"relatedBook":{"bookId":0,"slug":null,"isbn":null,"categoryList":null,"amazon":null,"image":null,"title":null,"testBankPinActivationLink":null,"bookOutOfPrint":false,"authorsInfo":null,"authors":null,"_links":null},"collections":[],"articleAds":{"footerAd":"<div class=\"du-ad-region row\" id=\"article_page_adhesion_ad\"><div class=\"du-ad-unit col-md-12\" data-slot-id=\"article_page_adhesion_ad\" data-refreshed=\"false\" \r\n data-target = \"[{&quot;key&quot;:&quot;cat&quot;,&quot;values&quot;:[&quot;business-careers-money&quot;,&quot;business&quot;,&quot;accounting&quot;,&quot;audits&quot;]},{&quot;key&quot;:&quot;isbn&quot;,&quot;values&quot;:[null]}]\" id=\"du-slot-63236870f0b25\"></div></div>","rightAd":"<div class=\"du-ad-region row\" id=\"article_page_right_ad\"><div class=\"du-ad-unit col-md-12\" data-slot-id=\"article_page_right_ad\" data-refreshed=\"false\" \r\n data-target = \"[{&quot;key&quot;:&quot;cat&quot;,&quot;values&quot;:[&quot;business-careers-money&quot;,&quot;business&quot;,&quot;accounting&quot;,&quot;audits&quot;]},{&quot;key&quot;:&quot;isbn&quot;,&quot;values&quot;:[null]}]\" id=\"du-slot-63236870f13fd\"></div></div>"},"articleType":{"articleType":"Articles","articleList":null,"content":null,"videoInfo":{"videoId":null,"name":null,"accountId":null,"playerId":null,"thumbnailUrl":null,"description":null,"uploadDate":null}},"sponsorship":{"sponsorshipPage":false,"backgroundImage":{"src":null,"width":0,"height":0},"brandingLine":"","brandingLink":"","brandingLogo":{"src":null,"width":0,"height":0},"sponsorAd":"","sponsorEbookTitle":"","sponsorEbookLink":"","sponsorEbookImage":{"src":null,"width":0,"height":0}},"primaryLearningPath":"Advance","lifeExpectancy":"Five years","lifeExpectancySetFrom":"2022-09-15T00:00:00+00:00","dummiesForKids":"no","sponsoredContent":"no","adInfo":"","adPairKey":[]},"status":"publish","visibility":"public","articleId":156777},{"headers":{"creationTime":"2016-03-27T16:56:22+00:00","modifiedTime":"2022-09-02T13:54:11+00:00","timestamp":"2022-09-14T18:20:01+00:00"},"data":{"breadcrumbs":[{"name":"Business, Careers, & Money","_links":{"self":"https://dummies-api.dummies.com/v2/categories/34224"},"slug":"business-careers-money","categoryId":34224},{"name":"Business","_links":{"self":"https://dummies-api.dummies.com/v2/categories/34225"},"slug":"business","categoryId":34225},{"name":"Accounting","_links":{"self":"https://dummies-api.dummies.com/v2/categories/34226"},"slug":"accounting","categoryId":34226},{"name":"General Accounting","_links":{"self":"https://dummies-api.dummies.com/v2/categories/34230"},"slug":"general-accounting","categoryId":34230}],"title":"Accounting Workbook For Dummies Cheat Sheet","strippedTitle":"accounting workbook for dummies cheat sheet","slug":"accounting-workbook-for-dummies-cheat-sheet","canonicalUrl":"","seo":{"metaDescription":"Learn about some of the core accounting activities, including preparing financial statements, financial analyses, and accounting reports.","noIndex":0,"noFollow":0},"content":"As a business manager or owner, taking care of your company’s accounting needs is a top priority. Correctly preparing financial statements, financial analyses, and accounting reports involves knowing all the financial data and information that needs to appear in these items.\r\n\r\nMaking a profit helps keep you in business, while maintaining a strong balance sheet ensures you can stay in business. So, make sure you understand the financial statements, record adjustments if needed, and follow some basic rules for presenting accounting information to your business’s managers, owners, investors, and creditors.","description":"As a business manager or owner, taking care of your company’s accounting needs is a top priority. Correctly preparing financial statements, financial analyses, and accounting reports involves knowing all the financial data and information that needs to appear in these items.\r\n\r\nMaking a profit helps keep you in business, while maintaining a strong balance sheet ensures you can stay in business. So, make sure you understand the financial statements, record adjustments if needed, and follow some basic rules for presenting accounting information to your business’s managers, owners, investors, and creditors.","blurb":"","authors":[{"authorId":9472,"name":"John A. Tracy","slug":"john-a-tracy","description":" <b>John A. Tracy</b> is a former accountant and professor of accounting. He is also the author of Accounting For Dummies. ","hasArticle":false,"_links":{"self":"https://dummies-api.dummies.com/v2/authors/9472"}}],"primaryCategoryTaxonomy":{"categoryId":34230,"title":"General Accounting","slug":"general-accounting","_links":{"self":"https://dummies-api.dummies.com/v2/categories/34230"}},"secondaryCategoryTaxonomy":{"categoryId":0,"title":null,"slug":null,"_links":null},"tertiaryCategoryTaxonomy":{"categoryId":0,"title":null,"slug":null,"_links":null},"trendingArticles":null,"inThisArticle":[],"relatedArticles":{"fromBook":[{"articleId":192701,"title":"Formulas and Functions for Financial Statements","slug":"formulas-and-functions-for-financial-statements","categoryList":["business-careers-money","business","accounting","general-accounting"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/192701"}},{"articleId":192700,"title":"Making Accounting Adjustments to Reach Profit Potential","slug":"making-accounting-adjustments-to-reach-profit-potential","categoryList":["business-careers-money","business","accounting","general-accounting"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/192700"}},{"articleId":189270,"title":"Knowing Your Debits from Your Credits","slug":"knowing-your-debits-from-your-credits","categoryList":["business-careers-money","business","accounting","general-accounting"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/189270"}},{"articleId":189255,"title":"Choosing an Accounting Method for Your Business","slug":"choosing-an-accounting-method-for-your-business","categoryList":["business-careers-money","business","accounting","general-accounting"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/189255"}},{"articleId":189109,"title":"Classifications of Business Transactions","slug":"classifications-of-business-transactions","categoryList":["business-careers-money","business","accounting","general-accounting"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/189109"}}],"fromCategory":[{"articleId":277438,"title":"Financial Accounting: The Effect of Business Transactions","slug":"financial-accounting-the-effect-of-business-transactions","categoryList":["business-careers-money","business","accounting","general-accounting"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/277438"}},{"articleId":277429,"title":"What Are Accounting Journals?","slug":"what-are-accounting-journals","categoryList":["business-careers-money","business","accounting","general-accounting"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/277429"}},{"articleId":277423,"title":"How to Read Corporate Annual Reports","slug":"how-to-read-corporate-annual-reports","categoryList":["business-careers-money","business","accounting","general-accounting"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/277423"}},{"articleId":277418,"title":"Showing the Money: The Statement of Cash Flows","slug":"showing-the-money-the-statement-of-cash-flows","categoryList":["business-careers-money","business","accounting","general-accounting"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/277418"}},{"articleId":277410,"title":"10 Accounting Career Opportunities","slug":"10-accounting-career-opportunities","categoryList":["business-careers-money","business","accounting","general-accounting"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/277410"}}]},"hasRelatedBookFromSearch":false,"relatedBook":{"bookId":281923,"slug":"accounting-workbook-for-dummies","isbn":"9781119897637","categoryList":["business-careers-money","business","accounting","general-accounting"],"amazon":{"default":"https://www.amazon.com/gp/product/1119897637/ref=as_li_tl?ie=UTF8&tag=wiley01-20","ca":"https://www.amazon.ca/gp/product/1119897637/ref=as_li_tl?ie=UTF8&tag=wiley01-20","indigo_ca":"http://www.tkqlhce.com/click-9208661-13710633?url=https://www.chapters.indigo.ca/en-ca/books/product/1119897637-item.html&cjsku=978111945484","gb":"https://www.amazon.co.uk/gp/product/1119897637/ref=as_li_tl?ie=UTF8&tag=wiley01-20","de":"https://www.amazon.de/gp/product/1119897637/ref=as_li_tl?ie=UTF8&tag=wiley01-20"},"image":{"src":"https://www.dummies.com/wp-content/uploads/accounting-workbook-for-dummies-2nd-edition-cover-9781119897637-204x255.jpg","width":204,"height":255},"title":"Accounting Workbook For Dummies","testBankPinActivationLink":"","bookOutOfPrint":true,"authorsInfo":"<p><b><b data-author-id=\"9472\">John A. Tracy</b></b> is a former accountant and professor of accounting. He is also the author of Accounting For Dummies. <b>John A. Tracy</b> is a former accountant and professor of accounting. He is also the author of Accounting For Dummies.</p>","authors":[{"authorId":9472,"name":"John A. Tracy","slug":"john-a-tracy","description":" <b>John A. Tracy</b> is a former accountant and professor of accounting. He is also the author of Accounting For Dummies. ","hasArticle":false,"_links":{"self":"https://dummies-api.dummies.com/v2/authors/9472"}},{"authorId":9473,"name":"Tage C. Tracy","slug":"tage-c-tracy","description":" <b>John A. Tracy</b> is a former accountant and professor of accounting. He is also the author of Accounting For Dummies. ","hasArticle":false,"_links":{"self":"https://dummies-api.dummies.com/v2/authors/9473"}}],"_links":{"self":"https://dummies-api.dummies.com/v2/books/"}},"collections":[],"articleAds":{"footerAd":"<div class=\"du-ad-region row\" id=\"article_page_adhesion_ad\"><div class=\"du-ad-unit col-md-12\" data-slot-id=\"article_page_adhesion_ad\" data-refreshed=\"false\" \r\n data-target = \"[{&quot;key&quot;:&quot;cat&quot;,&quot;values&quot;:[&quot;business-careers-money&quot;,&quot;business&quot;,&quot;accounting&quot;,&quot;general-accounting&quot;]},{&quot;key&quot;:&quot;isbn&quot;,&quot;values&quot;:[&quot;9781119897637&quot;]}]\" id=\"du-slot-63221b5116c3d\"></div></div>","rightAd":"<div class=\"du-ad-region row\" id=\"article_page_right_ad\"><div class=\"du-ad-unit col-md-12\" data-slot-id=\"article_page_right_ad\" data-refreshed=\"false\" \r\n data-target = \"[{&quot;key&quot;:&quot;cat&quot;,&quot;values&quot;:[&quot;business-careers-money&quot;,&quot;business&quot;,&quot;accounting&quot;,&quot;general-accounting&quot;]},{&quot;key&quot;:&quot;isbn&quot;,&quot;values&quot;:[&quot;9781119897637&quot;]}]\" id=\"du-slot-63221b511762b\"></div></div>"},"articleType":{"articleType":"Cheat Sheet","articleList":[{"articleId":192701,"title":"Formulas and Functions for Financial Statements","slug":"formulas-and-functions-for-financial-statements","categoryList":["business-careers-money","business","accounting","general-accounting"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/192701"}},{"articleId":192700,"title":"Making Accounting Adjustments to Reach Profit Potential","slug":"making-accounting-adjustments-to-reach-profit-potential","categoryList":["business-careers-money","business","accounting","general-accounting"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/192700"}}],"content":[{"title":"Formulas and functions for financial statements","thumb":null,"image":null,"content":"<p>As the accounting controller, you’re in command of your business’s accounting needs, so you need a strong understanding of the ins and outs of financial statements, including what goes on them and in what order.</p>\n<p>If you don’t prepare them correctly, they won’t reflect a true picture of your business’s financial status. Keep the following important rules and points in mind as you prepare and use your business’s financial statements.</p>\n<h2>Accounting equation</h2>\n<p>Assets = Liabilities + Owners’ Equity</p>\n<p>Liabilities and owners’ equity are the two basic types of claims on the assets of an entity. The two-sided nature of the accounting equation is the basis for double entry accounting that records both sides of the entity’s transactions — what is received and what is given in the economic exchange.</p>\n<h3>Financial effects of revenues and expenses</h3>\n<p>Revenue = Asset increase (debit) or Liability decrease (debit)<br />\nExpense = Asset decrease (credit) or Liability increase (credit)</p>\n<h3>Connections between income statement and balance sheet accounts</h3>\n<p>Sales revenue → Cash and Accounts receivable</p>\n<p>Cost of goods sold expense ← Inventory</p>\n<p>Operating expenses → Cash</p>\n<p>Operating expenses ← Prepaid expenses</p>\n<p>Operating expenses → Accounts payable</p>\n<p>Operating expenses → Accrued expenses payable</p>\n<p>Depreciation expense ← Fixed assets</p>\n<p>Interest expense → Accrued expenses payable</p>\n<p>Income tax expense → Accrued expenses payable</p>\n<h3>Bookkeeping cycle</h3>\n<p>In today’s economy and digital world, most of the bookkeeping cycle is handled by computers, which process vast amounts of digital data by capturing financial transactions and processing the information through original entries (in journals) and postings in the general ledger chart of accounts.</p>\n<p>As a refresher, the following bookkeeping cycle remains intact, whether the accounting function is fully automated or completed manually:</p>\n<blockquote><p>Financial Transactions (and certain other events) → Original Entries in Journals → Postings in General Ledger Chart of Accounts → End-of-Period Adjusting Entries → Preparation of Financial Statements, Tax Returns, and Internal Accounting Reports → Closing Entries at End of Year.</p></blockquote>\n"},{"title":"Making accounting adjustments to reach profit potential","thumb":null,"image":null,"content":"<p>Having your business reach a profit is important; if it doesn’t, sooner or later the business will fail. As a business manager, you want to keep a close eye on the financial statements and make the necessary (and legal) accounting adjustments to your financial records as needed.</p>\n<p>These tips can help you make the necessary adjustments to your business’s net income, eye two different profit analysis models, and communicate the reports to your managers.</p>\n<h3>Adjustments to net income for determining sash flow from operating activities</h3>\n<p>Accounts payable and accrued expenses payable are operating liabilities used in the profit-making process.</p>\n<ul class=\"level-one\">\n<li>\n<p class=\"first-para\">Operating asset increases and operating liability decreases are negative adjustments (decrease cash flow from operating activities)</p>\n</li>\n<li>\n<p class=\"first-para\">Operating asset decreases and operating liability increases are positive adjustments (increase cash flow from operating activities)</p>\n</li>\n<li>\n<p class=\"first-para\">Depreciation and amortization expenses are positive adjustments (increase cash flow from operating activities)</p>\n</li>\n</ul>\n<p><b>Cardinal Rule:</b> Make all cash flow adjustments to net income; do not simply add back depreciation and amortization, which could be seriously misleading.</p>\n<h3>Two profit analysis models for management decision making</h3>\n<p><b>Contribution margin minus fixed expenses model</b><b>:</b></p>\n<table>\n<tbody>\n<tr>\n<td>Sales price</td>\n<td>$100</td>\n</tr>\n<tr>\n<td>Less variable costs per unit</td>\n<td><u>$60</u></td>\n</tr>\n<tr>\n<td>Equals contribution margin per unit</td>\n<td>$40</td>\n</tr>\n<tr>\n<td>Times annual sales volume, in units</td>\n<td><u>120,000</u></td>\n</tr>\n<tr>\n<td>Equals total contribution margin</td>\n<td>$4,800,000</td>\n</tr>\n<tr>\n<td>Less fixed operating expenses</td>\n<td><u>$3,000,000</u></td>\n</tr>\n<tr>\n<td>Equals operating profit</td>\n<td>$1,800,000</td>\n</tr>\n</tbody>\n</table>\n<p><b>Excess of sales over breakeven model:</b></p>\n<p>$3,000,000 annual fixed operating expenses ÷ $40 contribution margin per unit = 75,000 units breakeven point (volume)</p>\n<table>\n<tbody>\n<tr>\n<td>Annual sales volume for year, in units</td>\n<td>120,000</td>\n</tr>\n<tr>\n<td>Less annual breakeven volume, in units</td>\n<td><u>75,000</u></td>\n</tr>\n<tr>\n<td>Equals excess over breakeven, in units</td>\n<td>45,000</td>\n</tr>\n<tr>\n<td>Times contribution margin per unit</td>\n<td><u>$40</u></td>\n</tr>\n<tr>\n<td>Equals operating profit</td>\n<td>$1,800,000</td>\n</tr>\n</tbody>\n</table>\n<h3>Guidelines for internal accounting reports to managers</h3>\n<p>When you’re preparing financial information for your business’s managers, follow these tips:</p>\n<ul class=\"level-one\">\n<li>\n<p class=\"first-para\">Follow the organizational structure (responsibility accounting)</p>\n</li>\n<li>\n<p class=\"first-para\">Orient your report based on whether organization unit is a profit center or a cost center</p>\n</li>\n<li>\n<p class=\"first-para\">Know the mind of the manager</p>\n</li>\n<li>\n<p class=\"first-para\">Highlight significant factors and deemphasize non-significant factors</p>\n</li>\n<li>Keep in mind the acronym CART — always prepare <strong>C</strong>omplete, <strong>A</strong>ccurate, <strong>R</strong>eliable, and <strong>T</strong>imely financial reports, statements, and information</li>\n</ul>\n"},{"title":"Choosing an accounting method for your business","thumb":null,"image":null,"content":"<p>Different businesses make different accounting decisions. Some businesses choose conservative accounting methods, while others choose liberal accounting methods.</p>\n<p>Accounting is more than just reading the facts or interpreting the financial outcomes of business transactions. It also requires accountants to choose between alternative methods and why accounting being is as much of a form of art as science.</p>\n<p>Similar to the conservative states and liberal states addressed in politics, accounting has:</p>\n<ul>\n<li><strong>Conservative accounting methods:</strong> These tend to delay the recording of revenue and accelerate the recording of expenses. Profit is reported slowly and, generally, at lower levels in early reporting periods.</li>\n<li><strong>Liberal accounting methods:</strong> These tend to accelerate the recording of revenue and defer or delay the recording of expenses. Profit is reported quickly and, generally, at higher levels in early reporting periods.</li>\n</ul>\n<p>In general terms, conservative accounting methods are pessimistic, and liberal methods are optimistic. The choice of accounting method also affects the values reported for assets, liabilities, and owners’ equities in the balance sheet.</p>\n<p>Accounting methods must stay within the boundaries of Generally Accepted Accounting Principles (GAAP). A business can’t conjure up accounting methods out of thin air. GAAP isn’t a straitjacket; it leaves plenty of wiggle room. But the one fundamental constraint is that a business must stick with its accounting method once it makes a choice. If the business elects to change the accounting method, it must be fully and clearly disclosed.</p>\n<p>Consistency is the rule; the same accounting methods must be used year after year. The Internal Revenue Service allows businesses to change their accounting methods once in a while, but the justification has to be persuasive.</p>\n<p>A new business with no accounting history has to make accounting decisions, such as the following, for the first time:</p>\n<ul>\n<li>If the business sells products, it has to select which cost of goods sold expense method to use.</li>\n<li>If the business owns fixed assets, it has to select which depreciation method to use.</li>\n<li>If the business owns intangible assets, such as patents, it has to select an appropriate method to amortize the value of the intangible asset.</li>\n<li>If the business makes sales on credit, it has to decide which bad debts expense method to use.</li>\n<li>If the business offers a product warranty, it must establish a reasonable method to estimate future warranty claims for current products sold.</li>\n</ul>\n<p>The choices of accounting methods for these five expenses — cost of goods sold, depreciation, amortization, warranty, and bad debts — can make a sizable difference in the amount of profit or loss recorded for the year.</p>\n<p>Choosing conservative accounting methods for these three expenses can cause profit for the year to be lower by a relatively large percent compared with using liberal accounting methods for the expenses.</p>\n"},{"title":"Knowing your debits from your credits","thumb":null,"image":null,"content":"<p>Accountants and bookkeepers record transactions as debits and credits, while keeping the accounting equation constantly in balance. This process is called <a href=\"https://www.dummies.com/business/accounting/the-basics-of-double-entry-bookkeeping/\" target=\"_blank\" rel=\"noopener\"><em>double-entry bookkeeping</em></a>. Double-entry bookkeeping records both sides of a transaction — debits and credits — and the accounting equation remains in balance as transactions are recorded.</p>\n<p>For example, if a transaction decreases cash $25,000, then the other side of the transaction is a $25,000 increase in some other asset, or a $25,000 decrease in a liability, or a $25,000 increase in an expense (to cite three possibilities).</p>\n<p>The illustration below summarizes the basic rules for debits and credits. By long-standing convention, debits are shown on the left and credits on the right.</p>\n<p>An increase in a liability, owners’ equity, revenue, and income account is recorded as a credit, so the increase side is on the right. The recording of all transactions follows these rules for debits and credits:</p>\n<div class=\"figure-container\"><figure id=\"attachment_18207\" aria-labelledby=\"figcaption_attachment_18207\" class=\"wp-caption alignnone\" style=\"width: 545px\"><img loading=\"lazy\" class=\"size-full wp-image-18207\" src=\"https://www.dummies.com/wp-content/uploads/239192.image0.jpg\" alt=\"Rules for debits and credits.\" width=\"535\" height=\"187\" /><figcaption id=\"figcaption_attachment_18207\" class=\"wp-caption-text\">Rules for debits and credits.</figcaption></figure></div><div class=\"clearfix\"></div>\n<p>Notice the horizontal and vertical lines under the accounts in the illustration above. These lines form the letter T. Although the actual accounts maintained by a business don’t necessarily look like T accounts, they usually have one column for increases and another column for decreases. In other words, an account has a debit column and a credit column.</p>\n<p>Also, an account may have a running balance column to continuously keep track of the account’s balance. While T accounts represent an old school accounting concept (back in the days when accountants wore green eye shades and had no personalities), they do drive home a key concept in accounting related to ensuring debits and credits are properly recorded.</p>\n<p>Practically everyone has trouble with the rules of debits and credits. The rules aren’t very intuitive, but learning them is a rite of passage for bookkeepers and accountants. The only way to really understand the rules is to make accounting entries — over and over again. After a while, using the rules becomes like tying your shoes — you do it without even thinking about it.</p>\n"},{"title":"Classification of business transactions","thumb":null,"image":null,"content":"<p>In understanding accounting, you need to be very clear about which classification of business transaction you’re looking at. Almost all businesses are profit-motivated, so one basic type of transaction is obvious: profit-making transactions. In a nutshell, profit-making transactions consist of generating sales revenue and incurring business expenses.</p>\n<p>A business may have other income in addition to sales revenue, and it may record losses in addition to expenses. But the bread and butter profit-making activities of a business are generating sales and controlling expenses. The profit-making transactions of a business over a period of time are reported in its income statement.</p>\n<p>A business’s other transactions fall into three basic categories:</p>\n<ul>\n<li><strong>Set-up and follow-up transactions for sales and expenses: </strong>Includes collecting cash from customers after sales made on credit are recorded; the purchase of products (goods) that are held for some time before being sold, at which time the expense is recorded; and making cash payments for expenses some time after the expenses are recorded.</li>\n<li><strong>Investing activities (transactions):</strong> Includes the purchase, construction, and disposals of long-term operating assets such as buildings, machinery, equipment, and tools or investing in intangible assets, such as patents, or acquiring goodwill.</li>\n<li><strong>Financing activities (transactions):</strong> Includes borrowing money and repaying amounts borrowed; owners investing capital in the business and the business returning capital to them; and making cash distributions to owners based on the profit earned by the business.</li>\n</ul>\n<p>Investing and financing activities of a particular period are reported in that period’s statement of cash flows. In contrast, set-up and follow-up transactions for sales and expenses stay in the background, meaning that they are not reported in a financial statement. Nevertheless, these transactions are essential to the profit-making process.</p>\n<p>Consider, for instance, the purchase of products for inventory. As far as profit is concerned, nothing happens until the business makes a sale of that inventory and records the cost of goods sold expense against the revenue from the sale. Because the business needs to have the products available for sale, the purchase of inventory is the important first step, or set-up transaction.</p>\n"}],"videoInfo":{"videoId":null,"name":null,"accountId":null,"playerId":null,"thumbnailUrl":null,"description":null,"uploadDate":null}},"sponsorship":{"sponsorshipPage":false,"backgroundImage":{"src":null,"width":0,"height":0},"brandingLine":"","brandingLink":"","brandingLogo":{"src":null,"width":0,"height":0},"sponsorAd":"","sponsorEbookTitle":"","sponsorEbookLink":"","sponsorEbookImage":{"src":null,"width":0,"height":0}},"primaryLearningPath":"Advance","lifeExpectancy":"Two years","lifeExpectancySetFrom":"2022-02-28T00:00:00+00:00","dummiesForKids":"no","sponsoredContent":"no","adInfo":"","adPairKey":[]},"status":"publish","visibility":"public","articleId":209042},{"headers":{"creationTime":"2016-09-29T19:41:44+00:00","modifiedTime":"2022-08-19T17:07:05+00:00","timestamp":"2022-09-14T18:19:56+00:00"},"data":{"breadcrumbs":[{"name":"Business, Careers, & Money","_links":{"self":"https://dummies-api.dummies.com/v2/categories/34224"},"slug":"business-careers-money","categoryId":34224},{"name":"Business","_links":{"self":"https://dummies-api.dummies.com/v2/categories/34225"},"slug":"business","categoryId":34225},{"name":"Accounting","_links":{"self":"https://dummies-api.dummies.com/v2/categories/34226"},"slug":"accounting","categoryId":34226},{"name":"General Accounting","_links":{"self":"https://dummies-api.dummies.com/v2/categories/34230"},"slug":"general-accounting","categoryId":34230}],"title":"10 Tips for Reading a Financial Report","strippedTitle":"10 tips for reading a financial report","slug":"10-tips-reading-financial-report","canonicalUrl":"","seo":{"metaDescription":"Learn what to focus on in a business's financial report, including the relevant numbers, what parts to read, profit performance, and more.","noIndex":0,"noFollow":0},"content":"You can compare reading a business’s financial report with shucking an oyster: You have to know what you’re doing and work to get at the meat. You need a good reason to pry into a financial report. The main reason to become informed about the financial performance and condition of a business is <em>because you have a stake in the business.</em> The financial success or failure of the business makes a difference to you.\r\n<h2 id=\"tab1\" >Get in the right frame of mind</h2>\r\nYou don’t have to be a math wizard or rocket scientist to extract the essential points from a financial report. You can find the bottom line in the income statement and compare this profit number with other relevant numbers in the financial statements. You can read the amount of cash in the balance sheet. If the business has a zero or near-zero cash balance, you know that this is a serious — perhaps fatal — problem.\r\n\r\nGet in the right frame of mind. Don’t let a financial report bamboozle you. Locate the income statement, find bottom-line profit (or loss!), and get going. You can do it!\r\n<h2 id=\"tab2\" >Decide what to read</h2>\r\nSuppose you want more financial information than you can get in news articles. The annual financial reports of public companies contain lots of information: a letter from the chief executive, a highlights section, trend charts, financial statements, extensive footnotes to the financial statements, historical summaries, and a lot of propaganda. In contrast, the financial reports of most private companies are significantly smaller; they contain financial statements with footnotes and not much more.\r\n\r\nYou could read just the highlights section and let it go at that. This might do in a pinch. You should read the chief executive’s letter to shareowners as well. Ideally, the letter summarizes in an evenhanded and appropriately modest manner the main developments during the year. Be warned, however, that these letters from the top dog often are self-congratulatory and typically transfer blame for poor performance on factors beyond the control of the managers. Read them, but take these letters with a grain of salt.\r\n<p class=\"article-tips tip\">Many public businesses release a condensed summary version in place of their much longer and more detailed annual financial reports. The scaled-down, simplified, and shortened versions of annual financial reports are adequate for average stock investors. They aren’t adequate for serious investors and professional investment managers. These investors and money managers should read the full-fledged financial report of the business, and they perhaps should study the company’s annual 10-K report that is filed with the Securities and Exchange Commission (SEC).</p>\r\n\r\n<h2 id=\"tab3\" >Improve your accounting savvy</h2>\r\nFinancial statements — the income statement, balance sheet, and statement of cash flows — are the core of a financial report. To make sense of financial statements, you need at least a rudimentary understanding of financial statement accounting. You don’t have to be a CPA, but the accountants who prepare financial statements presume that you’re familiar with accounting terminology and financial reporting practices. If you’re an accounting illiterate, the financial statements probably look like a Sudoku puzzle. There’s no way around this demand on financial report readers. After all, accounting is the language of business.\r\n<h2 id=\"tab4\" >Judge profit performance</h2>\r\nA business earns profit by making sales and by keeping expenses less than sales revenue, so the best place to start in analyzing profit performance is not the bottom line but the top line: <em>sales revenue.</em> Here are some questions to focus on:\r\n<ul>\r\n \t<li><strong>How does sales revenue in the most recent year compare with the previous year’s?</strong></li>\r\n \t<li><strong>What is the gross margin ratio of the business?</strong></li>\r\n \t<li><strong>Based on information from a company’s most recent income statement, how do gross margin and the company’s bottom line (net income, or net earnings) compare with its top line (sales revenue)?</strong></li>\r\n</ul>\r\nOne last point: Put a company’s profit performance in the context of general economic conditions.\r\n<h2 id=\"tab5\" >Test earnings per share (EPS) against change in bottom line</h2>\r\nAs you know, public companies report net income in their income statements. Below this total profit number for the period, public companies also report <a href=\"https://www.dummies.com/business/accounting/calculating-the-earnings-per-share-eps-ratio/\" target=\"_blank\" rel=\"noopener\">earnings per share</a> (EPS), which is the amount of bottom-line profit for each share of its stock. Strictly speaking, therefore, the bottom line of a public company is its EPS. Private companies don’t have to report EPS; however, the EPS for a private business is fairly easy to calculate: Divide its bottom-line net income by the number of ownership shares held by the equity investors in the company.\r\n\r\nThe market value of ownership shares of a public company depends mainly on its EPS. Individual investors obviously focus on EPS, which they know is the primary driver of the market value of their investment in the business. The book value per share of a private company is the closest proxy you have for the market value of its ownership shares. The higher the EPS, the higher the market value for a public company. And the higher the EPS, the higher the book value per share for a private company.\r\n\r\nNow, you would naturally think that if net income increases, say, 10 percent over last year, then EPS would increase 10 percent. Not so fast. EPS — the driver of market value and book value per share — may change more or less than 10 percent:\r\n<ul>\r\n \t<li>Less than 10 percent: The business may have issued additional stock shares during the year, or it may have issued additional management stock options that get counted in the number of shares used to calculate diluted EPS. The profit pie may have been cut up into a larger number of smaller pieces. How do you like that?</li>\r\n \t<li>More than the 10 percent: The business may have bought back some of its own shares, which decreases the number of shares used in calculating EPS. This could be a deliberate strategy for increasing EPS by a higher percent than the percent increase in net income.</li>\r\n</ul>\r\n<p class=\"article-tips tip\">Compare the percent increase/decrease in total bottom-line profit over last year with the corresponding percent increase/decrease in EPS. Why? Because the percent changes in EPS and profit can diverge. For a public company, use its diluted EPS if it’s reported. Otherwise, use its basic EPS.</p>\r\n\r\n<h2 id=\"tab6\" >Tackle unusual gains and losses</h2>\r\nMany income statements start out normally: sales revenue less the expenses of making sales and operating the business. But then there’s a jarring layer of <em>unusual gains and losses</em> on the way down to the final profit line. This could be the result of a flooded building or a lawsuit. What’s a financial statement reader to do when a business reports such unusual, nonrecurring gains and losses in its income statement?\r\n\r\nThere’s no easy answer to this question. You could blithely assume that these things happen to a business only once in a blue moon and should not disrupt the business’s ability to make profit on a sustainable basis. Think of this as the <em>earthquake mentality</em> approach: When there’s an earthquake, there’s a lot of damage, but most years have no serious tremors and go along as normal. Unusual gains and losses are supposed to be nonrecurring in nature and recorded infrequently. In actual practice, however, many businesses report these gains and losses on a regular and recurring basis — like having an earthquake every year or so.\r\n<h2 id=\"tab7\" >Check cash flow from profit</h2>\r\nThe objective of a business is not simply to make profit but to generate cash flow from making profit as quickly as possible. <a href=\"https://www.dummies.com/article/business-careers-money/business/accounting/general-accounting/the-relationship-between-cash-flow-and-profit-in-business-156778\" target=\"_blank\" rel=\"noopener\">Cash flow from making profit</a> is the most important stream of cash inflow to a business. A business could sell off some assets to generate cash, and it can borrow money or get shareowners to put more money in the business. But cash flow from making profit is the spigot that should always be turned on. A business needs this cash flow to make cash distributions from profit to shareowners, to maintain liquidity, and to supplement other sources of capital to grow the business.\r\n<p class=\"article-tips remember\">The income statement does not — this bears repeating, does not — report the cash inflows of sales and the cash outflows of expenses. Therefore, the bottom line of the income statement is not a cash flow number. The net cash flow from the profit-making activities of the business (its sales and expenses) is reported in the statement of cash flows. When you look there, you’ll undoubtedly discover that the cash flow from operating activities (the official term for cash flow from profit-making activities) is higher or lower than the bottom-line profit number in the income statement.</p>\r\n\r\n<h2 id=\"tab8\" >Look for signs of financial distress</h2>\r\nA business can build up a good sales volume and have very good profit margins, but if the company can’t pay its bills on time, its profit opportunities could go down the drain. <em>Solvency</em> refers to a business’s prospects of being able to meet its debt and other liability payment obligations on time, in full. <a href=\"https://www.dummies.com/business/start-a-business/business-solvency-measurements-tools/\" target=\"_blank\" rel=\"noopener\">Solvency analysis</a> looks for signs of financial distress that could cause serious disruptions in the business’s profit-making operations. Even if a business has a couple billion bucks in the bank, you should ask, “How does its solvency look? Is there any doubt it can pay its bills on time?”\r\n<h2 id=\"tab9\" >Recognize the possibility of restatement and fraud</h2>\r\nWhen a business restates its original financial report and issues a new version, it doesn’t make restitution for any losses that investors suffered by relying on the originally reported financial statements. In fact, few companies even say they’re sorry when they put out revised financial statements.\r\n\r\nAll too often, the reason for the restatement is that someone later discovered that the original financial statements were based on fraudulent accounting. Frankly speaking, CPAs don’t have a very good track record for discovering financial reporting fraud. What it comes down to is this: Investors take the risk that the information in the financial statements they use in making decisions is subject to revision at a later time.\r\n<h2 id=\"tab10\" >Remember the limits of financial reports</h2>\r\nThere’s a lot more to investing than reading financial reports. Financial reports are an important source of information, but investors also should stay informed about general economic trends and developments, political events, business takeovers, executive changes, technological changes, and much more.\r\n\r\nWhen you read financial statements, keep in mind that these accounting reports are somewhat tentative and conditional. Accountants make many estimates and predictions in recording sales revenue and income and recording expenses and losses. Some soft numbers are mixed in with hard numbers in financial statements. In short, financial statements are iffy to some extent. There’s no getting around this limitation of accounting.","description":"You can compare reading a business’s financial report with shucking an oyster: You have to know what you’re doing and work to get at the meat. You need a good reason to pry into a financial report. The main reason to become informed about the financial performance and condition of a business is <em>because you have a stake in the business.</em> The financial success or failure of the business makes a difference to you.\r\n<h2 id=\"tab1\" >Get in the right frame of mind</h2>\r\nYou don’t have to be a math wizard or rocket scientist to extract the essential points from a financial report. You can find the bottom line in the income statement and compare this profit number with other relevant numbers in the financial statements. You can read the amount of cash in the balance sheet. If the business has a zero or near-zero cash balance, you know that this is a serious — perhaps fatal — problem.\r\n\r\nGet in the right frame of mind. Don’t let a financial report bamboozle you. Locate the income statement, find bottom-line profit (or loss!), and get going. You can do it!\r\n<h2 id=\"tab2\" >Decide what to read</h2>\r\nSuppose you want more financial information than you can get in news articles. The annual financial reports of public companies contain lots of information: a letter from the chief executive, a highlights section, trend charts, financial statements, extensive footnotes to the financial statements, historical summaries, and a lot of propaganda. In contrast, the financial reports of most private companies are significantly smaller; they contain financial statements with footnotes and not much more.\r\n\r\nYou could read just the highlights section and let it go at that. This might do in a pinch. You should read the chief executive’s letter to shareowners as well. Ideally, the letter summarizes in an evenhanded and appropriately modest manner the main developments during the year. Be warned, however, that these letters from the top dog often are self-congratulatory and typically transfer blame for poor performance on factors beyond the control of the managers. Read them, but take these letters with a grain of salt.\r\n<p class=\"article-tips tip\">Many public businesses release a condensed summary version in place of their much longer and more detailed annual financial reports. The scaled-down, simplified, and shortened versions of annual financial reports are adequate for average stock investors. They aren’t adequate for serious investors and professional investment managers. These investors and money managers should read the full-fledged financial report of the business, and they perhaps should study the company’s annual 10-K report that is filed with the Securities and Exchange Commission (SEC).</p>\r\n\r\n<h2 id=\"tab3\" >Improve your accounting savvy</h2>\r\nFinancial statements — the income statement, balance sheet, and statement of cash flows — are the core of a financial report. To make sense of financial statements, you need at least a rudimentary understanding of financial statement accounting. You don’t have to be a CPA, but the accountants who prepare financial statements presume that you’re familiar with accounting terminology and financial reporting practices. If you’re an accounting illiterate, the financial statements probably look like a Sudoku puzzle. There’s no way around this demand on financial report readers. After all, accounting is the language of business.\r\n<h2 id=\"tab4\" >Judge profit performance</h2>\r\nA business earns profit by making sales and by keeping expenses less than sales revenue, so the best place to start in analyzing profit performance is not the bottom line but the top line: <em>sales revenue.</em> Here are some questions to focus on:\r\n<ul>\r\n \t<li><strong>How does sales revenue in the most recent year compare with the previous year’s?</strong></li>\r\n \t<li><strong>What is the gross margin ratio of the business?</strong></li>\r\n \t<li><strong>Based on information from a company’s most recent income statement, how do gross margin and the company’s bottom line (net income, or net earnings) compare with its top line (sales revenue)?</strong></li>\r\n</ul>\r\nOne last point: Put a company’s profit performance in the context of general economic conditions.\r\n<h2 id=\"tab5\" >Test earnings per share (EPS) against change in bottom line</h2>\r\nAs you know, public companies report net income in their income statements. Below this total profit number for the period, public companies also report <a href=\"https://www.dummies.com/business/accounting/calculating-the-earnings-per-share-eps-ratio/\" target=\"_blank\" rel=\"noopener\">earnings per share</a> (EPS), which is the amount of bottom-line profit for each share of its stock. Strictly speaking, therefore, the bottom line of a public company is its EPS. Private companies don’t have to report EPS; however, the EPS for a private business is fairly easy to calculate: Divide its bottom-line net income by the number of ownership shares held by the equity investors in the company.\r\n\r\nThe market value of ownership shares of a public company depends mainly on its EPS. Individual investors obviously focus on EPS, which they know is the primary driver of the market value of their investment in the business. The book value per share of a private company is the closest proxy you have for the market value of its ownership shares. The higher the EPS, the higher the market value for a public company. And the higher the EPS, the higher the book value per share for a private company.\r\n\r\nNow, you would naturally think that if net income increases, say, 10 percent over last year, then EPS would increase 10 percent. Not so fast. EPS — the driver of market value and book value per share — may change more or less than 10 percent:\r\n<ul>\r\n \t<li>Less than 10 percent: The business may have issued additional stock shares during the year, or it may have issued additional management stock options that get counted in the number of shares used to calculate diluted EPS. The profit pie may have been cut up into a larger number of smaller pieces. How do you like that?</li>\r\n \t<li>More than the 10 percent: The business may have bought back some of its own shares, which decreases the number of shares used in calculating EPS. This could be a deliberate strategy for increasing EPS by a higher percent than the percent increase in net income.</li>\r\n</ul>\r\n<p class=\"article-tips tip\">Compare the percent increase/decrease in total bottom-line profit over last year with the corresponding percent increase/decrease in EPS. Why? Because the percent changes in EPS and profit can diverge. For a public company, use its diluted EPS if it’s reported. Otherwise, use its basic EPS.</p>\r\n\r\n<h2 id=\"tab6\" >Tackle unusual gains and losses</h2>\r\nMany income statements start out normally: sales revenue less the expenses of making sales and operating the business. But then there’s a jarring layer of <em>unusual gains and losses</em> on the way down to the final profit line. This could be the result of a flooded building or a lawsuit. What’s a financial statement reader to do when a business reports such unusual, nonrecurring gains and losses in its income statement?\r\n\r\nThere’s no easy answer to this question. You could blithely assume that these things happen to a business only once in a blue moon and should not disrupt the business’s ability to make profit on a sustainable basis. Think of this as the <em>earthquake mentality</em> approach: When there’s an earthquake, there’s a lot of damage, but most years have no serious tremors and go along as normal. Unusual gains and losses are supposed to be nonrecurring in nature and recorded infrequently. In actual practice, however, many businesses report these gains and losses on a regular and recurring basis — like having an earthquake every year or so.\r\n<h2 id=\"tab7\" >Check cash flow from profit</h2>\r\nThe objective of a business is not simply to make profit but to generate cash flow from making profit as quickly as possible. <a href=\"https://www.dummies.com/article/business-careers-money/business/accounting/general-accounting/the-relationship-between-cash-flow-and-profit-in-business-156778\" target=\"_blank\" rel=\"noopener\">Cash flow from making profit</a> is the most important stream of cash inflow to a business. A business could sell off some assets to generate cash, and it can borrow money or get shareowners to put more money in the business. But cash flow from making profit is the spigot that should always be turned on. A business needs this cash flow to make cash distributions from profit to shareowners, to maintain liquidity, and to supplement other sources of capital to grow the business.\r\n<p class=\"article-tips remember\">The income statement does not — this bears repeating, does not — report the cash inflows of sales and the cash outflows of expenses. Therefore, the bottom line of the income statement is not a cash flow number. The net cash flow from the profit-making activities of the business (its sales and expenses) is reported in the statement of cash flows. When you look there, you’ll undoubtedly discover that the cash flow from operating activities (the official term for cash flow from profit-making activities) is higher or lower than the bottom-line profit number in the income statement.</p>\r\n\r\n<h2 id=\"tab8\" >Look for signs of financial distress</h2>\r\nA business can build up a good sales volume and have very good profit margins, but if the company can’t pay its bills on time, its profit opportunities could go down the drain. <em>Solvency</em> refers to a business’s prospects of being able to meet its debt and other liability payment obligations on time, in full. <a href=\"https://www.dummies.com/business/start-a-business/business-solvency-measurements-tools/\" target=\"_blank\" rel=\"noopener\">Solvency analysis</a> looks for signs of financial distress that could cause serious disruptions in the business’s profit-making operations. Even if a business has a couple billion bucks in the bank, you should ask, “How does its solvency look? Is there any doubt it can pay its bills on time?”\r\n<h2 id=\"tab9\" >Recognize the possibility of restatement and fraud</h2>\r\nWhen a business restates its original financial report and issues a new version, it doesn’t make restitution for any losses that investors suffered by relying on the originally reported financial statements. In fact, few companies even say they’re sorry when they put out revised financial statements.\r\n\r\nAll too often, the reason for the restatement is that someone later discovered that the original financial statements were based on fraudulent accounting. Frankly speaking, CPAs don’t have a very good track record for discovering financial reporting fraud. What it comes down to is this: Investors take the risk that the information in the financial statements they use in making decisions is subject to revision at a later time.\r\n<h2 id=\"tab10\" >Remember the limits of financial reports</h2>\r\nThere’s a lot more to investing than reading financial reports. Financial reports are an important source of information, but investors also should stay informed about general economic trends and developments, political events, business takeovers, executive changes, technological changes, and much more.\r\n\r\nWhen you read financial statements, keep in mind that these accounting reports are somewhat tentative and conditional. Accountants make many estimates and predictions in recording sales revenue and income and recording expenses and losses. Some soft numbers are mixed in with hard numbers in financial statements. In short, financial statements are iffy to some extent. There’s no getting around this limitation of accounting.","blurb":"","authors":[{"authorId":9472,"name":"John A. Tracy","slug":"john-a-tracy","description":" <b>John A. Tracy</b> is a former accountant and professor of accounting. He is also the author of Accounting For Dummies. ","hasArticle":false,"_links":{"self":"https://dummies-api.dummies.com/v2/authors/9472"}}],"primaryCategoryTaxonomy":{"categoryId":34230,"title":"General Accounting","slug":"general-accounting","_links":{"self":"https://dummies-api.dummies.com/v2/categories/34230"}},"secondaryCategoryTaxonomy":{"categoryId":0,"title":null,"slug":null,"_links":null},"tertiaryCategoryTaxonomy":{"categoryId":0,"title":null,"slug":null,"_links":null},"trendingArticles":null,"inThisArticle":[{"label":"Get in the right frame of mind","target":"#tab1"},{"label":"Decide what to read","target":"#tab2"},{"label":"Improve your accounting savvy","target":"#tab3"},{"label":"Judge profit performance","target":"#tab4"},{"label":"Test earnings per share (EPS) against change in bottom line","target":"#tab5"},{"label":"Tackle unusual gains and losses","target":"#tab6"},{"label":"Check cash flow from profit","target":"#tab7"},{"label":"Look for signs of financial distress","target":"#tab8"},{"label":"Recognize the possibility of restatement and fraud","target":"#tab9"},{"label":"Remember the limits of financial reports","target":"#tab10"}],"relatedArticles":{"fromBook":[{"articleId":226417,"title":"Accounting and the Theory of Financial Reporting","slug":"accounting-theory-financial-reporting","categoryList":["business-careers-money","business","accounting","general-accounting"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/226417"}},{"articleId":226414,"title":"Beware of Accounting Tricks: Smoothing the Rough Edges Off Year-to-Year Profit Fluctuations","slug":"beware-accounting-tricks-smoothing-rough-edges-off-year-year-profit-fluctuations","categoryList":["business-careers-money","business","accounting","general-accounting"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/226414"}},{"articleId":226410,"title":"Beware of Window Dressing in Accounting: Pumping Up the Ending Cash Balance and Cash Flow","slug":"beware-window-dressing-accounting-pumping-ending-cash-balance-cash-flow","categoryList":["business-careers-money","business","accounting","general-accounting"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/226410"}},{"articleId":226406,"title":"Using Accounting Information to Make Investment Choices","slug":"using-accounting-information-make-investment-choices","categoryList":["business-careers-money","business","accounting","general-accounting"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/226406"}},{"articleId":226403,"title":"Reading Financial Reports of Private Versus Public Businesses","slug":"reading-financial-reports-private-versus-public-businesses","categoryList":["business-careers-money","business","accounting","general-accounting"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/226403"}}],"fromCategory":[{"articleId":277438,"title":"Financial Accounting: The Effect of Business Transactions","slug":"financial-accounting-the-effect-of-business-transactions","categoryList":["business-careers-money","business","accounting","general-accounting"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/277438"}},{"articleId":277429,"title":"What Are Accounting Journals?","slug":"what-are-accounting-journals","categoryList":["business-careers-money","business","accounting","general-accounting"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/277429"}},{"articleId":277423,"title":"How to Read Corporate Annual Reports","slug":"how-to-read-corporate-annual-reports","categoryList":["business-careers-money","business","accounting","general-accounting"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/277423"}},{"articleId":277418,"title":"Showing the Money: The Statement of Cash Flows","slug":"showing-the-money-the-statement-of-cash-flows","categoryList":["business-careers-money","business","accounting","general-accounting"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/277418"}},{"articleId":277410,"title":"10 Accounting Career Opportunities","slug":"10-accounting-career-opportunities","categoryList":["business-careers-money","business","accounting","general-accounting"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/277410"}}]},"hasRelatedBookFromSearch":false,"relatedBook":{"bookId":281922,"slug":"accounting-for-dummies","isbn":"9781119837527","categoryList":["business-careers-money","business","accounting","general-accounting"],"amazon":{"default":"https://www.amazon.com/gp/product/1119837529/ref=as_li_tl?ie=UTF8&tag=wiley01-20","ca":"https://www.amazon.ca/gp/product/1119837529/ref=as_li_tl?ie=UTF8&tag=wiley01-20","indigo_ca":"http://www.tkqlhce.com/click-9208661-13710633?url=https://www.chapters.indigo.ca/en-ca/books/product/1119837529-item.html&cjsku=978111945484","gb":"https://www.amazon.co.uk/gp/product/1119837529/ref=as_li_tl?ie=UTF8&tag=wiley01-20","de":"https://www.amazon.de/gp/product/1119837529/ref=as_li_tl?ie=UTF8&tag=wiley01-20"},"image":{"src":"https://www.dummies.com/wp-content/uploads/9781119837527-203x255.jpg","width":203,"height":255},"title":"Accounting For Dummies","testBankPinActivationLink":"","bookOutOfPrint":true,"authorsInfo":"<p><b>John A. Tracy</b> is a former accountant and professor of accounting. He is also the author of Accounting For Dummies. <b><b data-author-id=\"9472\">John A. Tracy</b></b> is a former accountant and professor of accounting. He is also the author of Accounting For Dummies.</p>","authors":[{"authorId":9473,"name":"Tage C. Tracy","slug":"tage-c-tracy","description":" <b>John A. Tracy</b> is a former accountant and professor of accounting. He is also the author of Accounting For Dummies. ","hasArticle":false,"_links":{"self":"https://dummies-api.dummies.com/v2/authors/9473"}},{"authorId":9472,"name":"John A. Tracy","slug":"john-a-tracy","description":" <b>John A. Tracy</b> is a former accountant and professor of accounting. He is also the author of Accounting For Dummies. ","hasArticle":false,"_links":{"self":"https://dummies-api.dummies.com/v2/authors/9472"}}],"_links":{"self":"https://dummies-api.dummies.com/v2/books/"}},"collections":[],"articleAds":{"footerAd":"<div class=\"du-ad-region row\" id=\"article_page_adhesion_ad\"><div class=\"du-ad-unit col-md-12\" data-slot-id=\"article_page_adhesion_ad\" data-refreshed=\"false\" \r\n data-target = \"[{&quot;key&quot;:&quot;cat&quot;,&quot;values&quot;:[&quot;business-careers-money&quot;,&quot;business&quot;,&quot;accounting&quot;,&quot;general-accounting&quot;]},{&quot;key&quot;:&quot;isbn&quot;,&quot;values&quot;:[&quot;9781119837527&quot;]}]\" id=\"du-slot-63221b4c8aa27\"></div></div>","rightAd":"<div class=\"du-ad-region row\" id=\"article_page_right_ad\"><div class=\"du-ad-unit col-md-12\" data-slot-id=\"article_page_right_ad\" data-refreshed=\"false\" \r\n data-target = \"[{&quot;key&quot;:&quot;cat&quot;,&quot;values&quot;:[&quot;business-careers-money&quot;,&quot;business&quot;,&quot;accounting&quot;,&quot;general-accounting&quot;]},{&quot;key&quot;:&quot;isbn&quot;,&quot;values&quot;:[&quot;9781119837527&quot;]}]\" id=\"du-slot-63221b4c8b44a\"></div></div>"},"articleType":{"articleType":"Articles","articleList":null,"content":null,"videoInfo":{"videoId":null,"name":null,"accountId":null,"playerId":null,"thumbnailUrl":null,"description":null,"uploadDate":null}},"sponsorship":{"sponsorshipPage":false,"backgroundImage":{"src":null,"width":0,"height":0},"brandingLine":"","brandingLink":"","brandingLogo":{"src":null,"width":0,"height":0},"sponsorAd":"","sponsorEbookTitle":"","sponsorEbookLink":"","sponsorEbookImage":{"src":null,"width":0,"height":0}},"primaryLearningPath":"Advance","lifeExpectancy":"Five years","lifeExpectancySetFrom":"2022-08-19T00:00:00+00:00","dummiesForKids":"no","sponsoredContent":"no","adInfo":"","adPairKey":[]},"status":"publish","visibility":"public","articleId":226420},{"headers":{"creationTime":"2016-03-26T14:45:15+00:00","modifiedTime":"2022-08-11T17:10:57+00:00","timestamp":"2022-09-14T18:19:53+00:00"},"data":{"breadcrumbs":[{"name":"Business, Careers, & Money","_links":{"self":"https://dummies-api.dummies.com/v2/categories/34224"},"slug":"business-careers-money","categoryId":34224},{"name":"Business","_links":{"self":"https://dummies-api.dummies.com/v2/categories/34225"},"slug":"business","categoryId":34225},{"name":"Accounting","_links":{"self":"https://dummies-api.dummies.com/v2/categories/34226"},"slug":"accounting","categoryId":34226},{"name":"General Accounting","_links":{"self":"https://dummies-api.dummies.com/v2/categories/34230"},"slug":"general-accounting","categoryId":34230}],"title":"Separable Cost Reduction in Cost Accounting","strippedTitle":"separable cost reduction in cost accounting","slug":"separable-cost-reduction-in-cost-accounting","canonicalUrl":"","seo":{"metaDescription":"In cost accounting, you want to reduce separable costs, when possible. Learn how to figure joint costs and separable cost reduction.","noIndex":0,"noFollow":0},"content":"In cost accounting, the cost of goods available for sale represents the product’s total costs. Total costs have two components — joint costs and separable costs. When possible, you want to reduce separable costs, but first take a look at your company’s joint costs.\r\n\r\nAssume you manufacture leaf blowers. Your two products are heavy-duty blowers and yardwork blowers. The separable costs are $1,200,000 for the heavy-duty blower and $912,000 for the yardwork blower. If you know the separable costs and the cost of goods available for sale, you can compute the joint cost allocation. This table shows the process.\r\n<table><caption>Joint Cost Allocation</caption>\r\n<tbody>\r\n<tr>\r\n<th></th>\r\n<th>Heavy-Duty</th>\r\n<th>Yardwork</th>\r\n<th>Total</th>\r\n</tr>\r\n<tr>\r\n<td>Cost of goods available for sale</td>\r\n<td>$1,751,163</td>\r\n<td>$1,260,837</td>\r\n<td>$3,012,000</td>\r\n</tr>\r\n<tr>\r\n<td>Less separable costs</td>\r\n<td>$1,200,000</td>\r\n<td>$912,000</td>\r\n<td>$2,112,000</td>\r\n</tr>\r\n<tr>\r\n<td><b>Equals joint cost allocation</b></td>\r\n<td><b>$551,163</b></td>\r\n<td><b>$348,837</b></td>\r\n<td><b>$900,000</b></td>\r\n</tr>\r\n</tbody>\r\n</table>\r\nEach company division provides the separable costs. So altogether, this table gives you a joint cost allocation.\r\n\r\nNow assume that the heavy-duty blower division is able to sharply reduce its separable costs to an amazingly low $500,000. The first table listed heavy-duty separable costs of $1,200,000. Consider what now happens to heavy-duty’s joint cost allocation. Take a look at the next table.\r\n<table><caption>Cost Allocation — Less Heavy Duty Separable Costs</caption>\r\n<tbody>\r\n<tr>\r\n<th></th>\r\n<th>Heavy-Duty</th>\r\n<th>Yardwork</th>\r\n<th>Total</th>\r\n</tr>\r\n<tr>\r\n<td>Cost of goods available for sale</td>\r\n<td>$1,751,163</td>\r\n<td>$1,260,837</td>\r\n<td>$3,012,000</td>\r\n</tr>\r\n<tr>\r\n<td>Less separable costs</td>\r\n<td>$500,000</td>\r\n<td>$912,000</td>\r\n<td>$1,412,000</td>\r\n</tr>\r\n<tr>\r\n<td><b>Equals joint cost allocation</b></td>\r\n<td><b>$1,251,163</b></td>\r\n<td><b>$348,837</b></td>\r\n<td><b>$1,600,000</b></td>\r\n</tr>\r\n</tbody>\r\n</table>\r\nHeavy-duty’s joint cost allocation increases to $1,251,163 (from $551,163). That doesn’t seem right. The goal is to analyze costs to reduce or eliminate them. If you do, supposedly you increase your profits.\r\n\r\nIn this case, the heavy-duty division’s reducing separable costs <i>increased</i> its joint cost allocation. There doesn’t seem to be a benefit to operating more efficiently.\r\n\r\nHere’s an explanation: The gross margin percentage method (calculated as gross margin ÷ total sales value x 100) <i>locks</i> in total costs as a percentage of sales value. If the gross margin is about 12.5 percent of sales value, it means that costs must be about 87.5 percent of sales value. For heavy-duty, that 87.5 percent total cost number is $1,751,163. Those costs are either separable or joint costs. If one increases, the other decreases.\r\n\r\nThe heavy-duty manager may have a problem with this process. The manager works hard (using good old cost accounting) to lower the separable costs. The manager’s “reward” is a higher joint cost allocation. The heavy-duty division has lowered costs but doesn’t get any savings in total costs.\r\n\r\nThe constant gross margin percentage method clarifies the revenue and profit calculations company-wide. This method eliminates some of the variation between company divisions. Although some managers may complain, each division has the same gross margin percentage. The process makes managing company profit easier.\r\n<p class=\"Tip\">This is one of those “Here’s why the chief financial officer (CFO) makes the big bucks” moments. As CFO, you explain the gross margin percentage method to the heavy-duty division manager. The goal is to allocate joint costs so that each product maintains the same gross margin percentage of about 12.5 percent. If a division reduces separable costs, it must get a bigger joint cost allocation — <i>otherwise, the gross margin percentage would increase</i>.</p>\r\nNow heavy-duty’s manager should be evaluated based on the successful cost reduction. The manager had a success, and you want to encourage more cost savings. Although the gross margin percentage process requires a bigger joint cost allocation, that must not take away from the manager’s good performance.","description":"In cost accounting, the cost of goods available for sale represents the product’s total costs. Total costs have two components — joint costs and separable costs. When possible, you want to reduce separable costs, but first take a look at your company’s joint costs.\r\n\r\nAssume you manufacture leaf blowers. Your two products are heavy-duty blowers and yardwork blowers. The separable costs are $1,200,000 for the heavy-duty blower and $912,000 for the yardwork blower. If you know the separable costs and the cost of goods available for sale, you can compute the joint cost allocation. This table shows the process.\r\n<table><caption>Joint Cost Allocation</caption>\r\n<tbody>\r\n<tr>\r\n<th></th>\r\n<th>Heavy-Duty</th>\r\n<th>Yardwork</th>\r\n<th>Total</th>\r\n</tr>\r\n<tr>\r\n<td>Cost of goods available for sale</td>\r\n<td>$1,751,163</td>\r\n<td>$1,260,837</td>\r\n<td>$3,012,000</td>\r\n</tr>\r\n<tr>\r\n<td>Less separable costs</td>\r\n<td>$1,200,000</td>\r\n<td>$912,000</td>\r\n<td>$2,112,000</td>\r\n</tr>\r\n<tr>\r\n<td><b>Equals joint cost allocation</b></td>\r\n<td><b>$551,163</b></td>\r\n<td><b>$348,837</b></td>\r\n<td><b>$900,000</b></td>\r\n</tr>\r\n</tbody>\r\n</table>\r\nEach company division provides the separable costs. So altogether, this table gives you a joint cost allocation.\r\n\r\nNow assume that the heavy-duty blower division is able to sharply reduce its separable costs to an amazingly low $500,000. The first table listed heavy-duty separable costs of $1,200,000. Consider what now happens to heavy-duty’s joint cost allocation. Take a look at the next table.\r\n<table><caption>Cost Allocation — Less Heavy Duty Separable Costs</caption>\r\n<tbody>\r\n<tr>\r\n<th></th>\r\n<th>Heavy-Duty</th>\r\n<th>Yardwork</th>\r\n<th>Total</th>\r\n</tr>\r\n<tr>\r\n<td>Cost of goods available for sale</td>\r\n<td>$1,751,163</td>\r\n<td>$1,260,837</td>\r\n<td>$3,012,000</td>\r\n</tr>\r\n<tr>\r\n<td>Less separable costs</td>\r\n<td>$500,000</td>\r\n<td>$912,000</td>\r\n<td>$1,412,000</td>\r\n</tr>\r\n<tr>\r\n<td><b>Equals joint cost allocation</b></td>\r\n<td><b>$1,251,163</b></td>\r\n<td><b>$348,837</b></td>\r\n<td><b>$1,600,000</b></td>\r\n</tr>\r\n</tbody>\r\n</table>\r\nHeavy-duty’s joint cost allocation increases to $1,251,163 (from $551,163). That doesn’t seem right. The goal is to analyze costs to reduce or eliminate them. If you do, supposedly you increase your profits.\r\n\r\nIn this case, the heavy-duty division’s reducing separable costs <i>increased</i> its joint cost allocation. There doesn’t seem to be a benefit to operating more efficiently.\r\n\r\nHere’s an explanation: The gross margin percentage method (calculated as gross margin ÷ total sales value x 100) <i>locks</i> in total costs as a percentage of sales value. If the gross margin is about 12.5 percent of sales value, it means that costs must be about 87.5 percent of sales value. For heavy-duty, that 87.5 percent total cost number is $1,751,163. Those costs are either separable or joint costs. If one increases, the other decreases.\r\n\r\nThe heavy-duty manager may have a problem with this process. The manager works hard (using good old cost accounting) to lower the separable costs. The manager’s “reward” is a higher joint cost allocation. The heavy-duty division has lowered costs but doesn’t get any savings in total costs.\r\n\r\nThe constant gross margin percentage method clarifies the revenue and profit calculations company-wide. This method eliminates some of the variation between company divisions. Although some managers may complain, each division has the same gross margin percentage. The process makes managing company profit easier.\r\n<p class=\"Tip\">This is one of those “Here’s why the chief financial officer (CFO) makes the big bucks” moments. As CFO, you explain the gross margin percentage method to the heavy-duty division manager. The goal is to allocate joint costs so that each product maintains the same gross margin percentage of about 12.5 percent. If a division reduces separable costs, it must get a bigger joint cost allocation — <i>otherwise, the gross margin percentage would increase</i>.</p>\r\nNow heavy-duty’s manager should be evaluated based on the successful cost reduction. The manager had a success, and you want to encourage more cost savings. Although the gross margin percentage process requires a bigger joint cost allocation, that must not take away from the manager’s good performance.","blurb":"","authors":[{"authorId":9050,"name":"Kenneth Boyd","slug":"kenneth-boyd","description":"Ken Boyd, a former CPA, has more than 37 years of experience in accounting, education, and financial services. He is the owner of Accounting Accidentally (<a href=\"https://www.accountingaccidentally.com/\" target=\"_blank\" rel=\"noopener\">www.accountingaccidentally.com</a>), which provides written and video content on accounting, personal finance, and entrepreneurship topics. His YouTube channel (<a href=\"https://www.youtube.com/user/kenboydstl\" target=\"_blank\" rel=\"noopener\">kenboydstl</a>) has hundreds of videos on accounting and finance.\r\n\r\nIn recent years, Boyd has served as an adjunct professor of accounting at the Cook School of Business at St. Louis University. He has written hundreds of articles for QuickBooks, Investopedia, and a number of other publications.","hasArticle":false,"_links":{"self":"https://dummies-api.dummies.com/v2/authors/9050"}}],"primaryCategoryTaxonomy":{"categoryId":34230,"title":"General Accounting","slug":"general-accounting","_links":{"self":"https://dummies-api.dummies.com/v2/categories/34230"}},"secondaryCategoryTaxonomy":{"categoryId":0,"title":null,"slug":null,"_links":null},"tertiaryCategoryTaxonomy":{"categoryId":0,"title":null,"slug":null,"_links":null},"trendingArticles":null,"inThisArticle":[],"relatedArticles":{"fromBook":[{"articleId":208104,"title":"Cost Accounting For Dummies Cheat Sheet","slug":"cost-accounting-for-dummies-cheat-sheet","categoryList":["business-careers-money","business","accounting","general-accounting"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/208104"}},{"articleId":171024,"title":"Must Know Formulas for Cost Accounting","slug":"must-know-formulas-for-cost-accounting","categoryList":["business-careers-money","business","accounting","general-accounting"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/171024"}},{"articleId":171020,"title":"Important Terms and Principles Cost Accountants Should Know","slug":"important-terms-and-principles-cost-accountants-should-know","categoryList":["business-careers-money","business","accounting","general-accounting"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/171020"}},{"articleId":171019,"title":"Avoiding Pitfalls on Cost Accounting Exams","slug":"avoiding-pitfalls-on-cost-accounting-exams","categoryList":["business-careers-money","business","accounting","general-accounting"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/171019"}},{"articleId":166828,"title":"Accrual Accounting in Cost Accounting","slug":"accrual-accounting-in-cost-accounting","categoryList":["business-careers-money","business","accounting","general-accounting"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/166828"}}],"fromCategory":[{"articleId":277438,"title":"Financial Accounting: The Effect of Business Transactions","slug":"financial-accounting-the-effect-of-business-transactions","categoryList":["business-careers-money","business","accounting","general-accounting"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/277438"}},{"articleId":277429,"title":"What Are Accounting Journals?","slug":"what-are-accounting-journals","categoryList":["business-careers-money","business","accounting","general-accounting"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/277429"}},{"articleId":277423,"title":"How to Read Corporate Annual Reports","slug":"how-to-read-corporate-annual-reports","categoryList":["business-careers-money","business","accounting","general-accounting"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/277423"}},{"articleId":277418,"title":"Showing the Money: The Statement of Cash Flows","slug":"showing-the-money-the-statement-of-cash-flows","categoryList":["business-careers-money","business","accounting","general-accounting"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/277418"}},{"articleId":277410,"title":"10 Accounting Career Opportunities","slug":"10-accounting-career-opportunities","categoryList":["business-careers-money","business","accounting","general-accounting"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/277410"}}]},"hasRelatedBookFromSearch":false,"relatedBook":{"bookId":282119,"slug":"cost-accounting-for-dummies","isbn":"9781119856023","categoryList":["business-careers-money","business","accounting","general-accounting"],"amazon":{"default":"https://www.amazon.com/gp/product/1119856027/ref=as_li_tl?ie=UTF8&tag=wiley01-20","ca":"https://www.amazon.ca/gp/product/1119856027/ref=as_li_tl?ie=UTF8&tag=wiley01-20","indigo_ca":"http://www.tkqlhce.com/click-9208661-13710633?url=https://www.chapters.indigo.ca/en-ca/books/product/1119856027-item.html&cjsku=978111945484","gb":"https://www.amazon.co.uk/gp/product/1119856027/ref=as_li_tl?ie=UTF8&tag=wiley01-20","de":"https://www.amazon.de/gp/product/1119856027/ref=as_li_tl?ie=UTF8&tag=wiley01-20"},"image":{"src":"https://www.dummies.com/wp-content/uploads/9781119856023-203x255.jpg","width":203,"height":255},"title":"Cost Accounting For Dummies","testBankPinActivationLink":"","bookOutOfPrint":true,"authorsInfo":"<p><p><b><b data-author-id=\"34810\">Kenneth W. Boyd</b></b> has 30 years of experience in accounting and financial services. He is a four&#45;time Dummies book author, a blogger, and a video host on accounting and finance topics.</p>","authors":[{"authorId":34810,"name":"Kenneth W. Boyd","slug":"kenneth-w-boyd","description":" <p><b>Kenneth W. Boyd</b> has 30 years of experience in accounting and financial services. He is a four&#45;time Dummies book author, a blogger, and a video host on accounting and finance topics. ","hasArticle":false,"_links":{"self":"https://dummies-api.dummies.com/v2/authors/34810"}}],"_links":{"self":"https://dummies-api.dummies.com/v2/books/"}},"collections":[],"articleAds":{"footerAd":"<div class=\"du-ad-region row\" id=\"article_page_adhesion_ad\"><div class=\"du-ad-unit col-md-12\" data-slot-id=\"article_page_adhesion_ad\" data-refreshed=\"false\" \r\n data-target = \"[{&quot;key&quot;:&quot;cat&quot;,&quot;values&quot;:[&quot;business-careers-money&quot;,&quot;business&quot;,&quot;accounting&quot;,&quot;general-accounting&quot;]},{&quot;key&quot;:&quot;isbn&quot;,&quot;values&quot;:[&quot;9781119856023&quot;]}]\" id=\"du-slot-63221b49e71ab\"></div></div>","rightAd":"<div class=\"du-ad-region row\" id=\"article_page_right_ad\"><div class=\"du-ad-unit col-md-12\" data-slot-id=\"article_page_right_ad\" data-refreshed=\"false\" \r\n data-target = \"[{&quot;key&quot;:&quot;cat&quot;,&quot;values&quot;:[&quot;business-careers-money&quot;,&quot;business&quot;,&quot;accounting&quot;,&quot;general-accounting&quot;]},{&quot;key&quot;:&quot;isbn&quot;,&quot;values&quot;:[&quot;9781119856023&quot;]}]\" id=\"du-slot-63221b49e7b3a\"></div></div>"},"articleType":{"articleType":"Articles","articleList":null,"content":null,"videoInfo":{"videoId":null,"name":null,"accountId":null,"playerId":null,"thumbnailUrl":null,"description":null,"uploadDate":null}},"sponsorship":{"sponsorshipPage":false,"backgroundImage":{"src":null,"width":0,"height":0},"brandingLine":"","brandingLink":"","brandingLogo":{"src":null,"width":0,"height":0},"sponsorAd":"","sponsorEbookTitle":"","sponsorEbookLink":"","sponsorEbookImage":{"src":null,"width":0,"height":0}},"primaryLearningPath":"Advance","lifeExpectancy":"Five years","lifeExpectancySetFrom":"2022-08-11T00:00:00+00:00","dummiesForKids":"no","sponsoredContent":"no","adInfo":"","adPairKey":[]},"status":"publish","visibility":"public","articleId":164989},{"headers":{"creationTime":"2016-03-26T14:45:17+00:00","modifiedTime":"2022-08-11T17:07:36+00:00","timestamp":"2022-09-14T18:19:53+00:00"},"data":{"breadcrumbs":[{"name":"Business, Careers, & Money","_links":{"self":"https://dummies-api.dummies.com/v2/categories/34224"},"slug":"business-careers-money","categoryId":34224},{"name":"Business","_links":{"self":"https://dummies-api.dummies.com/v2/categories/34225"},"slug":"business","categoryId":34225},{"name":"Accounting","_links":{"self":"https://dummies-api.dummies.com/v2/categories/34226"},"slug":"accounting","categoryId":34226},{"name":"General Accounting","_links":{"self":"https://dummies-api.dummies.com/v2/categories/34230"},"slug":"general-accounting","categoryId":34230}],"title":"Cost Accounting: Joint Cost Allocation and Gross Margin Percentage","strippedTitle":"cost accounting: joint cost allocation and gross margin percentage","slug":"cost-accounting-joint-cost-allocation-and-gross-margin-percentage","canonicalUrl":"","seo":{"metaDescription":"In cost accounting, if you know the separable costs and costs of goods for sale, you can calculate joint cost allocation. Here's how.","noIndex":0,"noFollow":0},"content":"In cost accounting, the cost of goods available for sale represents the product’s total costs. Total costs have two components — joint costs and separable costs.\r\n\r\nAssume the <i>cost of goods</i><i> available for sale</i> are $1,751,163 and $1,260,837 for the heavy-duty blower and the yardwork blower. Say the <i>separable costs</i> are $1,200,000 and $912,000. If you know the separable costs and the cost of goods available for sale, you can compute the joint cost allocation. The first table shows the process.\r\n<table><caption>Joint Cost Allocation</caption>\r\n<tbody>\r\n<tr>\r\n<th></th>\r\n<th>Heavy-Duty</th>\r\n<th>Yardwork</th>\r\n<th>Total</th>\r\n</tr>\r\n<tr>\r\n<td>Cost of goods available for sale</td>\r\n<td>$1,751,163</td>\r\n<td>$1,260,837</td>\r\n<td>$3,012,000</td>\r\n</tr>\r\n<tr>\r\n<td>Less separable costs</td>\r\n<td>$1,200,000</td>\r\n<td>$912,000</td>\r\n<td>$2,112,000</td>\r\n</tr>\r\n<tr>\r\n<td><b>Equals joint cost allocation</b></td>\r\n<td><b>$551,163</b></td>\r\n<td><b>$348,837</b></td>\r\n<td><b>$900,000</b></td>\r\n</tr>\r\n</tbody>\r\n</table>\r\nEach company division provides the separable costs. So altogether, the table gives you a joint cost allocation.\r\n\r\nNow calculate the <i>gross margin percentage</i>. Say your <i>sales values</i> are $2,000,00 and $1,440,000 for heavy-duty and yardwork blowers. The total cost is the cost of goods available for sale from the first table. The gross margin percentage is the gross margin divided by the sales value. For each product, the gross margin percentage is the same (12.442 percent) as the company’s overall gross margin.\r\n<table><caption>Verifying Gross Margin Percentage</caption>\r\n<tbody>\r\n<tr>\r\n<th></th>\r\n<th>Heavy-Duty</th>\r\n<th>Yardwork</th>\r\n<th>Total</th>\r\n</tr>\r\n<tr>\r\n<td>Sales value (<i>A</i>)</td>\r\n<td>$2,000,000</td>\r\n<td>$1,440,000</td>\r\n<td>$3,440,000</td>\r\n</tr>\r\n<tr>\r\n<td>Total cost (<i>B</i>)</td>\r\n<td>$1,751,163</td>\r\n<td>$1,260,837</td>\r\n<td>$3,012,000</td>\r\n</tr>\r\n<tr>\r\n<td><b>Gross margin (</b><b><i>A</i></b> <b>–</b>\r\n<b><i>B</i></b><b>)</b></td>\r\n<td><b>$248,837</b></td>\r\n<td><b>$179,163</b></td>\r\n<td><b>$428,000</b></td>\r\n</tr>\r\n<tr>\r\n<td>Gross margin percentage</td>\r\n<td>12.442</td>\r\n<td>12.442</td>\r\n<td></td>\r\n</tr>\r\n</tbody>\r\n</table>\r\nHere’s the point of this table: it uses the traditional formula to compute gross margin and gross margin percentage. The table verifies that the calculations are correct.\r\n\r\nIf the heavy-duty product has the higher sales value, it ends up with a higher gross margin in dollars than the yardwork product. However, both sale values are multiplied by the same gross margin percentage. Both products have a gross margin of about 12.5 percent (rounded). That means that about 87.5 percent of sales value represents cost of goods available for sale.","description":"In cost accounting, the cost of goods available for sale represents the product’s total costs. Total costs have two components — joint costs and separable costs.\r\n\r\nAssume the <i>cost of goods</i><i> available for sale</i> are $1,751,163 and $1,260,837 for the heavy-duty blower and the yardwork blower. Say the <i>separable costs</i> are $1,200,000 and $912,000. If you know the separable costs and the cost of goods available for sale, you can compute the joint cost allocation. The first table shows the process.\r\n<table><caption>Joint Cost Allocation</caption>\r\n<tbody>\r\n<tr>\r\n<th></th>\r\n<th>Heavy-Duty</th>\r\n<th>Yardwork</th>\r\n<th>Total</th>\r\n</tr>\r\n<tr>\r\n<td>Cost of goods available for sale</td>\r\n<td>$1,751,163</td>\r\n<td>$1,260,837</td>\r\n<td>$3,012,000</td>\r\n</tr>\r\n<tr>\r\n<td>Less separable costs</td>\r\n<td>$1,200,000</td>\r\n<td>$912,000</td>\r\n<td>$2,112,000</td>\r\n</tr>\r\n<tr>\r\n<td><b>Equals joint cost allocation</b></td>\r\n<td><b>$551,163</b></td>\r\n<td><b>$348,837</b></td>\r\n<td><b>$900,000</b></td>\r\n</tr>\r\n</tbody>\r\n</table>\r\nEach company division provides the separable costs. So altogether, the table gives you a joint cost allocation.\r\n\r\nNow calculate the <i>gross margin percentage</i>. Say your <i>sales values</i> are $2,000,00 and $1,440,000 for heavy-duty and yardwork blowers. The total cost is the cost of goods available for sale from the first table. The gross margin percentage is the gross margin divided by the sales value. For each product, the gross margin percentage is the same (12.442 percent) as the company’s overall gross margin.\r\n<table><caption>Verifying Gross Margin Percentage</caption>\r\n<tbody>\r\n<tr>\r\n<th></th>\r\n<th>Heavy-Duty</th>\r\n<th>Yardwork</th>\r\n<th>Total</th>\r\n</tr>\r\n<tr>\r\n<td>Sales value (<i>A</i>)</td>\r\n<td>$2,000,000</td>\r\n<td>$1,440,000</td>\r\n<td>$3,440,000</td>\r\n</tr>\r\n<tr>\r\n<td>Total cost (<i>B</i>)</td>\r\n<td>$1,751,163</td>\r\n<td>$1,260,837</td>\r\n<td>$3,012,000</td>\r\n</tr>\r\n<tr>\r\n<td><b>Gross margin (</b><b><i>A</i></b> <b>–</b>\r\n<b><i>B</i></b><b>)</b></td>\r\n<td><b>$248,837</b></td>\r\n<td><b>$179,163</b></td>\r\n<td><b>$428,000</b></td>\r\n</tr>\r\n<tr>\r\n<td>Gross margin percentage</td>\r\n<td>12.442</td>\r\n<td>12.442</td>\r\n<td></td>\r\n</tr>\r\n</tbody>\r\n</table>\r\nHere’s the point of this table: it uses the traditional formula to compute gross margin and gross margin percentage. The table verifies that the calculations are correct.\r\n\r\nIf the heavy-duty product has the higher sales value, it ends up with a higher gross margin in dollars than the yardwork product. However, both sale values are multiplied by the same gross margin percentage. Both products have a gross margin of about 12.5 percent (rounded). That means that about 87.5 percent of sales value represents cost of goods available for sale.","blurb":"","authors":[{"authorId":9050,"name":"Kenneth Boyd","slug":"kenneth-boyd","description":"Ken Boyd, a former CPA, has more than 37 years of experience in accounting, education, and financial services. He is the owner of Accounting Accidentally (<a href=\"https://www.accountingaccidentally.com/\" target=\"_blank\" rel=\"noopener\">www.accountingaccidentally.com</a>), which provides written and video content on accounting, personal finance, and entrepreneurship topics. His YouTube channel (<a href=\"https://www.youtube.com/user/kenboydstl\" target=\"_blank\" rel=\"noopener\">kenboydstl</a>) has hundreds of videos on accounting and finance.\r\n\r\nIn recent years, Boyd has served as an adjunct professor of accounting at the Cook School of Business at St. Louis University. He has written hundreds of articles for QuickBooks, Investopedia, and a number of other publications.","hasArticle":false,"_links":{"self":"https://dummies-api.dummies.com/v2/authors/9050"}}],"primaryCategoryTaxonomy":{"categoryId":34230,"title":"General Accounting","slug":"general-accounting","_links":{"self":"https://dummies-api.dummies.com/v2/categories/34230"}},"secondaryCategoryTaxonomy":{"categoryId":0,"title":null,"slug":null,"_links":null},"tertiaryCategoryTaxonomy":{"categoryId":0,"title":null,"slug":null,"_links":null},"trendingArticles":null,"inThisArticle":[],"relatedArticles":{"fromBook":[{"articleId":208104,"title":"Cost Accounting For Dummies Cheat Sheet","slug":"cost-accounting-for-dummies-cheat-sheet","categoryList":["business-careers-money","business","accounting","general-accounting"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/208104"}},{"articleId":171024,"title":"Must Know Formulas for Cost Accounting","slug":"must-know-formulas-for-cost-accounting","categoryList":["business-careers-money","business","accounting","general-accounting"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/171024"}},{"articleId":171020,"title":"Important Terms and Principles Cost Accountants Should Know","slug":"important-terms-and-principles-cost-accountants-should-know","categoryList":["business-careers-money","business","accounting","general-accounting"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/171020"}},{"articleId":171019,"title":"Avoiding Pitfalls on Cost Accounting Exams","slug":"avoiding-pitfalls-on-cost-accounting-exams","categoryList":["business-careers-money","business","accounting","general-accounting"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/171019"}},{"articleId":166828,"title":"Accrual Accounting in Cost Accounting","slug":"accrual-accounting-in-cost-accounting","categoryList":["business-careers-money","business","accounting","general-accounting"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/166828"}}],"fromCategory":[{"articleId":277438,"title":"Financial Accounting: The Effect of Business Transactions","slug":"financial-accounting-the-effect-of-business-transactions","categoryList":["business-careers-money","business","accounting","general-accounting"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/277438"}},{"articleId":277429,"title":"What Are Accounting Journals?","slug":"what-are-accounting-journals","categoryList":["business-careers-money","business","accounting","general-accounting"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/277429"}},{"articleId":277423,"title":"How to Read Corporate Annual Reports","slug":"how-to-read-corporate-annual-reports","categoryList":["business-careers-money","business","accounting","general-accounting"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/277423"}},{"articleId":277418,"title":"Showing the Money: The Statement of Cash Flows","slug":"showing-the-money-the-statement-of-cash-flows","categoryList":["business-careers-money","business","accounting","general-accounting"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/277418"}},{"articleId":277410,"title":"10 Accounting Career Opportunities","slug":"10-accounting-career-opportunities","categoryList":["business-careers-money","business","accounting","general-accounting"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/277410"}}]},"hasRelatedBookFromSearch":false,"relatedBook":{"bookId":282119,"slug":"cost-accounting-for-dummies","isbn":"9781119856023","categoryList":["business-careers-money","business","accounting","general-accounting"],"amazon":{"default":"https://www.amazon.com/gp/product/1119856027/ref=as_li_tl?ie=UTF8&tag=wiley01-20","ca":"https://www.amazon.ca/gp/product/1119856027/ref=as_li_tl?ie=UTF8&tag=wiley01-20","indigo_ca":"http://www.tkqlhce.com/click-9208661-13710633?url=https://www.chapters.indigo.ca/en-ca/books/product/1119856027-item.html&cjsku=978111945484","gb":"https://www.amazon.co.uk/gp/product/1119856027/ref=as_li_tl?ie=UTF8&tag=wiley01-20","de":"https://www.amazon.de/gp/product/1119856027/ref=as_li_tl?ie=UTF8&tag=wiley01-20"},"image":{"src":"https://www.dummies.com/wp-content/uploads/9781119856023-203x255.jpg","width":203,"height":255},"title":"Cost Accounting For Dummies","testBankPinActivationLink":"","bookOutOfPrint":true,"authorsInfo":"<p><p><b><b data-author-id=\"34810\">Kenneth W. Boyd</b></b> has 30 years of experience in accounting and financial services. He is a four&#45;time Dummies book author, a blogger, and a video host on accounting and finance topics.</p>","authors":[{"authorId":34810,"name":"Kenneth W. Boyd","slug":"kenneth-w-boyd","description":" <p><b>Kenneth W. Boyd</b> has 30 years of experience in accounting and financial services. He is a four&#45;time Dummies book author, a blogger, and a video host on accounting and finance topics. ","hasArticle":false,"_links":{"self":"https://dummies-api.dummies.com/v2/authors/34810"}}],"_links":{"self":"https://dummies-api.dummies.com/v2/books/"}},"collections":[],"articleAds":{"footerAd":"<div class=\"du-ad-region row\" id=\"article_page_adhesion_ad\"><div class=\"du-ad-unit col-md-12\" data-slot-id=\"article_page_adhesion_ad\" data-refreshed=\"false\" \r\n data-target = \"[{&quot;key&quot;:&quot;cat&quot;,&quot;values&quot;:[&quot;business-careers-money&quot;,&quot;business&quot;,&quot;accounting&quot;,&quot;general-accounting&quot;]},{&quot;key&quot;:&quot;isbn&quot;,&quot;values&quot;:[&quot;9781119856023&quot;]}]\" id=\"du-slot-63221b49dd44e\"></div></div>","rightAd":"<div class=\"du-ad-region row\" id=\"article_page_right_ad\"><div class=\"du-ad-unit col-md-12\" data-slot-id=\"article_page_right_ad\" data-refreshed=\"false\" \r\n data-target = \"[{&quot;key&quot;:&quot;cat&quot;,&quot;values&quot;:[&quot;business-careers-money&quot;,&quot;business&quot;,&quot;accounting&quot;,&quot;general-accounting&quot;]},{&quot;key&quot;:&quot;isbn&quot;,&quot;values&quot;:[&quot;9781119856023&quot;]}]\" id=\"du-slot-63221b49de094\"></div></div>"},"articleType":{"articleType":"Articles","articleList":null,"content":null,"videoInfo":{"videoId":null,"name":null,"accountId":null,"playerId":null,"thumbnailUrl":null,"description":null,"uploadDate":null}},"sponsorship":{"sponsorshipPage":false,"backgroundImage":{"src":null,"width":0,"height":0},"brandingLine":"","brandingLink":"","brandingLogo":{"src":null,"width":0,"height":0},"sponsorAd":"","sponsorEbookTitle":"","sponsorEbookLink":"","sponsorEbookImage":{"src":null,"width":0,"height":0}},"primaryLearningPath":"Advance","lifeExpectancy":"Five years","lifeExpectancySetFrom":"2022-08-11T00:00:00+00:00","dummiesForKids":"no","sponsoredContent":"no","adInfo":"","adPairKey":[]},"status":"publish","visibility":"public","articleId":164995},{"headers":{"creationTime":"2016-03-26T15:35:26+00:00","modifiedTime":"2022-08-02T18:46:54+00:00","timestamp":"2022-09-14T18:19:50+00:00"},"data":{"breadcrumbs":[{"name":"Business, Careers, & Money","_links":{"self":"https://dummies-api.dummies.com/v2/categories/34224"},"slug":"business-careers-money","categoryId":34224},{"name":"Business","_links":{"self":"https://dummies-api.dummies.com/v2/categories/34225"},"slug":"business","categoryId":34225},{"name":"Accounting","_links":{"self":"https://dummies-api.dummies.com/v2/categories/34226"},"slug":"accounting","categoryId":34226},{"name":"General Accounting","_links":{"self":"https://dummies-api.dummies.com/v2/categories/34230"},"slug":"general-accounting","categoryId":34230}],"title":"What Capital Is in Corporate Finance","strippedTitle":"what capital is in corporate finance","slug":"what-capital-is-in-corporate-finance","canonicalUrl":"","seo":{"metaDescription":"Learn about the types of assets and capital within a corporation, including the cash used to launch the venture.","noIndex":0,"noFollow":0},"content":"Everything that makes up a corporation and everything a corporation owns, including the building, equipment, office supplies, brand value, research, land, trademarks, and everything else, are considered <i>assets.</i> Believe it or not, when you start a corporation, that company’s assets aren’t just included in a Welcome Letter; you have to go out and acquire them. Generally speaking, you start off with cash, which you then use to purchase other assets.\r\n\r\nFor most new companies, this cash consists of a combination of the following:\r\n<ul class=\"level-one\">\r\n \t<li>\r\n<p class=\"first-para\"><b>The owner’s own money:</b> This money is considered <i>equity</i> because the owner can still claim full possession over it.</p>\r\n</li>\r\n \t<li>\r\n<p class=\"first-para\"><b>Small loans, such as business and personal loans from banks, business and personal lines of credit, and government loans:</b> The money obtained through loans is considered a <i>liability</i> because the corporation has to pay it back at some point. In other words, these loans are a form of debt.</p>\r\n</li>\r\n</ul>\r\nThe combination of these two funding sources leads to the explanation of the most fundamental equation in corporate finance:\r\n<blockquote>Assets = Liabilities + Equity</blockquote>\r\nThe total value of assets held by a company is equal to the total liabilities and total equity held by the company. Because the total amount of debt a company incurs goes into purchasing equipment and supplies, increasing debt through loans increases a company’s liabilities and total assets.\r\n\r\nAs an owner contributes his own funding to the company’s usage, the total amount of company equity increases along with the assets. <b><i>Note:</i></b> <i>Capital, assets, money,</i> and <i>cash</i> are basically all the same thing at this point; after a company raises the original capital, or cash, it exchanges that cash for more useful forms of capital, such as erasable markers.\r\n\r\nUnlike liabilities,<i> </i>equity represents ownership in the company. So if a company owns $100,000 in assets and $50,000 was funded by loans, then the owner still holds claim over $50,000 in assets, even if the company goes out of business, requiring the owner to give the other $50,000 in assets back to the bank.\r\n\r\nFor corporations, the equity funding varies a bit, however, because the owners of a corporation are the stockholders. The equity funding of corporations comes from the initial sale of stock, which exchanges shares of ownership for cash to be used in the company.","description":"Everything that makes up a corporation and everything a corporation owns, including the building, equipment, office supplies, brand value, research, land, trademarks, and everything else, are considered <i>assets.</i> Believe it or not, when you start a corporation, that company’s assets aren’t just included in a Welcome Letter; you have to go out and acquire them. Generally speaking, you start off with cash, which you then use to purchase other assets.\r\n\r\nFor most new companies, this cash consists of a combination of the following:\r\n<ul class=\"level-one\">\r\n \t<li>\r\n<p class=\"first-para\"><b>The owner’s own money:</b> This money is considered <i>equity</i> because the owner can still claim full possession over it.</p>\r\n</li>\r\n \t<li>\r\n<p class=\"first-para\"><b>Small loans, such as business and personal loans from banks, business and personal lines of credit, and government loans:</b> The money obtained through loans is considered a <i>liability</i> because the corporation has to pay it back at some point. In other words, these loans are a form of debt.</p>\r\n</li>\r\n</ul>\r\nThe combination of these two funding sources leads to the explanation of the most fundamental equation in corporate finance:\r\n<blockquote>Assets = Liabilities + Equity</blockquote>\r\nThe total value of assets held by a company is equal to the total liabilities and total equity held by the company. Because the total amount of debt a company incurs goes into purchasing equipment and supplies, increasing debt through loans increases a company’s liabilities and total assets.\r\n\r\nAs an owner contributes his own funding to the company’s usage, the total amount of company equity increases along with the assets. <b><i>Note:</i></b> <i>Capital, assets, money,</i> and <i>cash</i> are basically all the same thing at this point; after a company raises the original capital, or cash, it exchanges that cash for more useful forms of capital, such as erasable markers.\r\n\r\nUnlike liabilities,<i> </i>equity represents ownership in the company. So if a company owns $100,000 in assets and $50,000 was funded by loans, then the owner still holds claim over $50,000 in assets, even if the company goes out of business, requiring the owner to give the other $50,000 in assets back to the bank.\r\n\r\nFor corporations, the equity funding varies a bit, however, because the owners of a corporation are the stockholders. The equity funding of corporations comes from the initial sale of stock, which exchanges shares of ownership for cash to be used in the company.","blurb":"","authors":[{"authorId":9764,"name":"Michael Taillard","slug":"michael-taillard","description":" <p><b>Kenneth W. Boyd</b> has 30 years of experience in accounting and financial services. He is a four&#45;time Dummies book author, a blogger, and a video host on accounting and finance topics. ","hasArticle":false,"_links":{"self":"https://dummies-api.dummies.com/v2/authors/9764"}}],"primaryCategoryTaxonomy":{"categoryId":34230,"title":"General Accounting","slug":"general-accounting","_links":{"self":"https://dummies-api.dummies.com/v2/categories/34230"}},"secondaryCategoryTaxonomy":{"categoryId":0,"title":null,"slug":null,"_links":null},"tertiaryCategoryTaxonomy":{"categoryId":0,"title":null,"slug":null,"_links":null},"trendingArticles":null,"inThisArticle":[],"relatedArticles":{"fromBook":[{"articleId":208127,"title":"Corporate Finance For Dummies Cheat Sheet","slug":"corporate-finance-for-dummies-cheat-sheet","categoryList":["business-careers-money","business","accounting","general-accounting"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/208127"}},{"articleId":171478,"title":"Pursuing Corporate Finance Professionally","slug":"pursuing-corporate-finance-professionally-2","categoryList":["business-careers-money","business","accounting","general-accounting"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/171478"}},{"articleId":171477,"title":"Understanding How Behavior Affects Corporate Finance","slug":"understanding-how-behavior-affects-corporate-finance","categoryList":["business-careers-money","business","accounting","general-accounting"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/171477"}},{"articleId":169321,"title":"The Gross Profit Portion of the Corporate Income Statement","slug":"the-gross-profit-portion-of-the-corporate-income-statement","categoryList":["business-careers-money","business","accounting","general-accounting"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/169321"}},{"articleId":169320,"title":"How Corporate Finance Rules Your Life","slug":"how-corporate-finance-rules-your-life","categoryList":["business-careers-money","business","accounting","general-accounting"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/169320"}}],"fromCategory":[{"articleId":277438,"title":"Financial Accounting: The Effect of Business Transactions","slug":"financial-accounting-the-effect-of-business-transactions","categoryList":["business-careers-money","business","accounting","general-accounting"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/277438"}},{"articleId":277429,"title":"What Are Accounting Journals?","slug":"what-are-accounting-journals","categoryList":["business-careers-money","business","accounting","general-accounting"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/277429"}},{"articleId":277423,"title":"How to Read Corporate Annual Reports","slug":"how-to-read-corporate-annual-reports","categoryList":["business-careers-money","business","accounting","general-accounting"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/277423"}},{"articleId":277418,"title":"Showing the Money: The Statement of Cash Flows","slug":"showing-the-money-the-statement-of-cash-flows","categoryList":["business-careers-money","business","accounting","general-accounting"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/277418"}},{"articleId":277410,"title":"10 Accounting Career Opportunities","slug":"10-accounting-career-opportunities","categoryList":["business-careers-money","business","accounting","general-accounting"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/277410"}}]},"hasRelatedBookFromSearch":false,"relatedBook":{"bookId":282117,"slug":"corporate-finance-for-dummies","isbn":"9781119850311","categoryList":["business-careers-money","business","accounting","general-accounting"],"amazon":{"default":"https://www.amazon.com/gp/product/1119850312/ref=as_li_tl?ie=UTF8&tag=wiley01-20","ca":"https://www.amazon.ca/gp/product/1119850312/ref=as_li_tl?ie=UTF8&tag=wiley01-20","indigo_ca":"http://www.tkqlhce.com/click-9208661-13710633?url=https://www.chapters.indigo.ca/en-ca/books/product/1119850312-item.html&cjsku=978111945484","gb":"https://www.amazon.co.uk/gp/product/1119850312/ref=as_li_tl?ie=UTF8&tag=wiley01-20","de":"https://www.amazon.de/gp/product/1119850312/ref=as_li_tl?ie=UTF8&tag=wiley01-20"},"image":{"src":"https://www.dummies.com/wp-content/uploads/9781119850311-1-203x255.jpg","width":203,"height":255},"title":"Corporate Finance For Dummies","testBankPinActivationLink":"","bookOutOfPrint":true,"authorsInfo":"<p><p><b>Kenneth W. Boyd</b> has 30 years of experience in accounting and financial services. He is a four&#45;time Dummies book author, a blogger, and a video host on accounting and finance topics.</p>","authors":[{"authorId":9764,"name":"Michael Taillard","slug":"michael-taillard","description":" <p><b>Kenneth W. Boyd</b> has 30 years of experience in accounting and financial services. He is a four&#45;time Dummies book author, a blogger, and a video host on accounting and finance topics. ","hasArticle":false,"_links":{"self":"https://dummies-api.dummies.com/v2/authors/9764"}}],"_links":{"self":"https://dummies-api.dummies.com/v2/books/"}},"collections":[],"articleAds":{"footerAd":"<div class=\"du-ad-region row\" id=\"article_page_adhesion_ad\"><div class=\"du-ad-unit col-md-12\" data-slot-id=\"article_page_adhesion_ad\" data-refreshed=\"false\" \r\n data-target = \"[{&quot;key&quot;:&quot;cat&quot;,&quot;values&quot;:[&quot;business-careers-money&quot;,&quot;business&quot;,&quot;accounting&quot;,&quot;general-accounting&quot;]},{&quot;key&quot;:&quot;isbn&quot;,&quot;values&quot;:[&quot;9781119850311&quot;]}]\" id=\"du-slot-63221b4680962\"></div></div>","rightAd":"<div class=\"du-ad-region row\" id=\"article_page_right_ad\"><div class=\"du-ad-unit col-md-12\" data-slot-id=\"article_page_right_ad\" data-refreshed=\"false\" \r\n data-target = \"[{&quot;key&quot;:&quot;cat&quot;,&quot;values&quot;:[&quot;business-careers-money&quot;,&quot;business&quot;,&quot;accounting&quot;,&quot;general-accounting&quot;]},{&quot;key&quot;:&quot;isbn&quot;,&quot;values&quot;:[&quot;9781119850311&quot;]}]\" id=\"du-slot-63221b468131f\"></div></div>"},"articleType":{"articleType":"Articles","articleList":null,"content":null,"videoInfo":{"videoId":null,"name":null,"accountId":null,"playerId":null,"thumbnailUrl":null,"description":null,"uploadDate":null}},"sponsorship":{"sponsorshipPage":false,"backgroundImage":{"src":null,"width":0,"height":0},"brandingLine":"","brandingLink":"","brandingLogo":{"src":null,"width":0,"height":0},"sponsorAd":"","sponsorEbookTitle":"","sponsorEbookLink":"","sponsorEbookImage":{"src":null,"width":0,"height":0}},"primaryLearningPath":"Advance","lifeExpectancy":"Five years","lifeExpectancySetFrom":"2022-08-02T00:00:00+00:00","dummiesForKids":"no","sponsoredContent":"no","adInfo":"","adPairKey":[]},"status":"publish","visibility":"public","articleId":169309},{"headers":{"creationTime":"2016-03-26T14:50:25+00:00","modifiedTime":"2022-08-01T16:38:29+00:00","timestamp":"2022-09-14T18:19:50+00:00"},"data":{"breadcrumbs":[{"name":"Business, Careers, & Money","_links":{"self":"https://dummies-api.dummies.com/v2/categories/34224"},"slug":"business-careers-money","categoryId":34224},{"name":"Business","_links":{"self":"https://dummies-api.dummies.com/v2/categories/34225"},"slug":"business","categoryId":34225},{"name":"Accounting","_links":{"self":"https://dummies-api.dummies.com/v2/categories/34226"},"slug":"accounting","categoryId":34226},{"name":"General Accounting","_links":{"self":"https://dummies-api.dummies.com/v2/categories/34230"},"slug":"general-accounting","categoryId":34230}],"title":"Theoretical and Practical Capacity in Cost Accounting","strippedTitle":"theoretical and practical capacity in cost accounting","slug":"theoretical-and-practical-capacity-in-cost-accounting","canonicalUrl":"","seo":{"metaDescription":"Learn about theoretical and practical capacity in cost accounting, including factors to consider and how to calculate them.","noIndex":0,"noFollow":0},"content":"In cost accounting, two types of capacity focus on production<i>: theoretical capacity</i> and <i>practical capacity</i>. Consider how much you could produce if customer demand was unlimited. Select a capacity method that makes sense to you, and use that as a tool to plan production and spending.\r\n\r\n<i>Theoretical capacity</i> assumes that nothing in your production ever goes wrong. Accountants describe this capacity as working at full efficiency all the time.\r\n\r\nConsider what your pie-in-the-sky or perfect-world capacity would be. It’s a world in which everything runs perfectly and no machines or equipment ever break down. It’s utopia where no worker ever makes a mistake. That would be great, wouldn’t it? That’s theoretical capacity, and you can’t reach it. It seems silly, but you need to see this level of capacity to understand the others.\r\n\r\nSay you own a business that makes athletic running shorts and other clothing. At maximum capacity, you can make 200 pairs of shorts per shift. You run three 8-hour shifts per day, 365 days a year. Based on those numbers, here is your theoretical capacity:\r\n<blockquote>Theoretical capacity = shorts x shifts x 365 days</blockquote>\r\n<blockquote>Theoretical capacity = 200 x 3 x 365 days</blockquote>\r\n<blockquote>Theoretical capacity = 219,000</blockquote>\r\nUnfortunately, this level of capacity isn’t attainable. You need to take into account the unavoidable. That gets you to practical capacity.\r\n\r\n<i>Practical capacity</i> is the level of capacity that includes unavoidable operating interruptions. Another description is unavoidable losses of operating time. Consider maintenance on equipment, employee vacations, and holidays. You’re willing to accept a good, rather than perfect, capacity level.\r\n\r\nThe people in your company can help you determine your practical capacity. Your production and engineering staff can answer questions about machine capacity and repair time. Your human resources staff can forecast employee availability, based on vacations and holidays.\r\n\r\nYou determine that 250 days is a more realistic number of production days, given unavoidable operating interruptions. Also, you decide that two shifts per day are realistic. Here’s the practical capacity calculation:\r\n<blockquote>Practical capacity = shorts x shifts x days</blockquote>\r\n<blockquote>Practical capacity = 200 x 2 x 250</blockquote>\r\n<blockquote>Practical capacity = 100,000</blockquote>\r\nThe practical capacity is 100,000 units (pairs of shorts) per year.","description":"In cost accounting, two types of capacity focus on production<i>: theoretical capacity</i> and <i>practical capacity</i>. Consider how much you could produce if customer demand was unlimited. Select a capacity method that makes sense to you, and use that as a tool to plan production and spending.\r\n\r\n<i>Theoretical capacity</i> assumes that nothing in your production ever goes wrong. Accountants describe this capacity as working at full efficiency all the time.\r\n\r\nConsider what your pie-in-the-sky or perfect-world capacity would be. It’s a world in which everything runs perfectly and no machines or equipment ever break down. It’s utopia where no worker ever makes a mistake. That would be great, wouldn’t it? That’s theoretical capacity, and you can’t reach it. It seems silly, but you need to see this level of capacity to understand the others.\r\n\r\nSay you own a business that makes athletic running shorts and other clothing. At maximum capacity, you can make 200 pairs of shorts per shift. You run three 8-hour shifts per day, 365 days a year. Based on those numbers, here is your theoretical capacity:\r\n<blockquote>Theoretical capacity = shorts x shifts x 365 days</blockquote>\r\n<blockquote>Theoretical capacity = 200 x 3 x 365 days</blockquote>\r\n<blockquote>Theoretical capacity = 219,000</blockquote>\r\nUnfortunately, this level of capacity isn’t attainable. You need to take into account the unavoidable. That gets you to practical capacity.\r\n\r\n<i>Practical capacity</i> is the level of capacity that includes unavoidable operating interruptions. Another description is unavoidable losses of operating time. Consider maintenance on equipment, employee vacations, and holidays. You’re willing to accept a good, rather than perfect, capacity level.\r\n\r\nThe people in your company can help you determine your practical capacity. Your production and engineering staff can answer questions about machine capacity and repair time. Your human resources staff can forecast employee availability, based on vacations and holidays.\r\n\r\nYou determine that 250 days is a more realistic number of production days, given unavoidable operating interruptions. Also, you decide that two shifts per day are realistic. Here’s the practical capacity calculation:\r\n<blockquote>Practical capacity = shorts x shifts x days</blockquote>\r\n<blockquote>Practical capacity = 200 x 2 x 250</blockquote>\r\n<blockquote>Practical capacity = 100,000</blockquote>\r\nThe practical capacity is 100,000 units (pairs of shorts) per year.","blurb":"","authors":[{"authorId":9050,"name":"Kenneth Boyd","slug":"kenneth-boyd","description":"Ken Boyd, a former CPA, has more than 37 years of experience in accounting, education, and financial services. He is the owner of Accounting Accidentally (<a href=\"https://www.accountingaccidentally.com/\" target=\"_blank\" rel=\"noopener\">www.accountingaccidentally.com</a>), which provides written and video content on accounting, personal finance, and entrepreneurship topics. His YouTube channel (<a href=\"https://www.youtube.com/user/kenboydstl\" target=\"_blank\" rel=\"noopener\">kenboydstl</a>) has hundreds of videos on accounting and finance.\r\n\r\nIn recent years, Boyd has served as an adjunct professor of accounting at the Cook School of Business at St. Louis University. He has written hundreds of articles for QuickBooks, Investopedia, and a number of other publications.","hasArticle":false,"_links":{"self":"https://dummies-api.dummies.com/v2/authors/9050"}}],"primaryCategoryTaxonomy":{"categoryId":34230,"title":"General Accounting","slug":"general-accounting","_links":{"self":"https://dummies-api.dummies.com/v2/categories/34230"}},"secondaryCategoryTaxonomy":{"categoryId":0,"title":null,"slug":null,"_links":null},"tertiaryCategoryTaxonomy":{"categoryId":0,"title":null,"slug":null,"_links":null},"trendingArticles":null,"inThisArticle":[],"relatedArticles":{"fromBook":[{"articleId":208104,"title":"Cost Accounting For Dummies Cheat Sheet","slug":"cost-accounting-for-dummies-cheat-sheet","categoryList":["business-careers-money","business","accounting","general-accounting"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/208104"}},{"articleId":171024,"title":"Must Know Formulas for Cost Accounting","slug":"must-know-formulas-for-cost-accounting","categoryList":["business-careers-money","business","accounting","general-accounting"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/171024"}},{"articleId":171020,"title":"Important Terms and Principles Cost Accountants Should Know","slug":"important-terms-and-principles-cost-accountants-should-know","categoryList":["business-careers-money","business","accounting","general-accounting"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/171020"}},{"articleId":171019,"title":"Avoiding Pitfalls on Cost Accounting Exams","slug":"avoiding-pitfalls-on-cost-accounting-exams","categoryList":["business-careers-money","business","accounting","general-accounting"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/171019"}},{"articleId":166828,"title":"Accrual Accounting in Cost Accounting","slug":"accrual-accounting-in-cost-accounting","categoryList":["business-careers-money","business","accounting","general-accounting"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/166828"}}],"fromCategory":[{"articleId":277438,"title":"Financial Accounting: The Effect of Business Transactions","slug":"financial-accounting-the-effect-of-business-transactions","categoryList":["business-careers-money","business","accounting","general-accounting"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/277438"}},{"articleId":277429,"title":"What Are Accounting Journals?","slug":"what-are-accounting-journals","categoryList":["business-careers-money","business","accounting","general-accounting"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/277429"}},{"articleId":277423,"title":"How to Read Corporate Annual Reports","slug":"how-to-read-corporate-annual-reports","categoryList":["business-careers-money","business","accounting","general-accounting"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/277423"}},{"articleId":277418,"title":"Showing the Money: The Statement of Cash Flows","slug":"showing-the-money-the-statement-of-cash-flows","categoryList":["business-careers-money","business","accounting","general-accounting"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/277418"}},{"articleId":277410,"title":"10 Accounting Career Opportunities","slug":"10-accounting-career-opportunities","categoryList":["business-careers-money","business","accounting","general-accounting"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/277410"}}]},"hasRelatedBookFromSearch":false,"relatedBook":{"bookId":282119,"slug":"cost-accounting-for-dummies","isbn":"9781119856023","categoryList":["business-careers-money","business","accounting","general-accounting"],"amazon":{"default":"https://www.amazon.com/gp/product/1119856027/ref=as_li_tl?ie=UTF8&tag=wiley01-20","ca":"https://www.amazon.ca/gp/product/1119856027/ref=as_li_tl?ie=UTF8&tag=wiley01-20","indigo_ca":"http://www.tkqlhce.com/click-9208661-13710633?url=https://www.chapters.indigo.ca/en-ca/books/product/1119856027-item.html&cjsku=978111945484","gb":"https://www.amazon.co.uk/gp/product/1119856027/ref=as_li_tl?ie=UTF8&tag=wiley01-20","de":"https://www.amazon.de/gp/product/1119856027/ref=as_li_tl?ie=UTF8&tag=wiley01-20"},"image":{"src":"https://www.dummies.com/wp-content/uploads/9781119856023-203x255.jpg","width":203,"height":255},"title":"Cost Accounting For Dummies","testBankPinActivationLink":"","bookOutOfPrint":true,"authorsInfo":"<p><p><b><b data-author-id=\"34810\">Kenneth W. Boyd</b></b> has 30 years of experience in accounting and financial services. He is a four&#45;time Dummies book author, a blogger, and a video host on accounting and finance topics.</p>","authors":[{"authorId":34810,"name":"Kenneth W. Boyd","slug":"kenneth-w-boyd","description":" <p><b>Kenneth W. Boyd</b> has 30 years of experience in accounting and financial services. He is a four&#45;time Dummies book author, a blogger, and a video host on accounting and finance topics. 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They also feel responsible when it comes to getting customers to pay on time. A good bookkeeper, in other words, is worth their weight in gold.\r\n\r\nThis Cheat Sheet summarizes what you need to know to be an excellent bookkeeper.","description":"A great bookkeeper cares that the financial statements make sense and gets upset when something doesn’t balance or stuff goes missing. They also feel responsible when it comes to getting customers to pay on time. A good bookkeeper, in other words, is worth their weight in gold.\r\n\r\nThis Cheat Sheet summarizes what you need to know to be an excellent bookkeeper.","blurb":"","authors":[{"authorId":9372,"name":"Veechi Curtis","slug":"veechi-curtis","description":" <p><b>Veechi Curtis</b> dis a qualified accountant and consultant who specialises in teaching small businesses about technology and finance. She is the author of <i>Creating a Business Plan For Dummies,</i> Second Edition, <i>Small Business For Dummies,</i> Fourth Edition, and <i>Bookkeeping For Dummies,</i> Australian Edition. ","hasArticle":false,"_links":{"self":"https://dummies-api.dummies.com/v2/authors/9372"}},{"authorId":9373,"name":"Lynley Averis","slug":"lynley-averis","description":"","hasArticle":false,"_links":{"self":"https://dummies-api.dummies.com/v2/authors/9373"}}],"primaryCategoryTaxonomy":{"categoryId":34228,"title":"Bookkeeping","slug":"bookkeeping","_links":{"self":"https://dummies-api.dummies.com/v2/categories/34228"}},"secondaryCategoryTaxonomy":{"categoryId":0,"title":null,"slug":null,"_links":null},"tertiaryCategoryTaxonomy":{"categoryId":0,"title":null,"slug":null,"_links":null},"trendingArticles":null,"inThisArticle":[],"relatedArticles":{"fromBook":[],"fromCategory":[{"articleId":275290,"title":"Break-Even Point Formula for Businesses","slug":"break-even-point-formula-for-businesses","categoryList":["business-careers-money","business","accounting","bookkeeping"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/275290"}},{"articleId":265567,"title":"Accounting and Financial Reporting Standards","slug":"accounting-and-financial-reporting-standards","categoryList":["business-careers-money","business","accounting","bookkeeping"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/265567"}},{"articleId":265558,"title":"Internal Profit Reporting","slug":"internal-profit-reporting","categoryList":["business-careers-money","business","accounting","bookkeeping"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/265558"}},{"articleId":209083,"title":"Nonprofit Bookkeeping & Accounting For Dummies Cheat Sheet","slug":"nonprofit-bookkeeping-accounting-for-dummies-cheat-sheet","categoryList":["business-careers-money","business","accounting","bookkeeping"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/209083"}},{"articleId":208436,"title":"Bookkeeping For Dummies Cheat 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Australia","slug":"register-as-a-bas-agent-in-australia","categoryList":["business-careers-money","business","accounting","bookkeeping"],"_links":{"self":"https://dummies-api.dummies.com/v2/articles/148399"}}],"content":[{"title":"Bookkeeping checklist","thumb":null,"image":null,"content":"<p>This step-by-step bookkeeping checklist should help you sleep easy at night knowing that you have done what you needed to do to get your books in tip-top shape.</p>\n<ol class=\"level-one\">\n<li>\n<p class=\"first-para\">Ensure you set up bank feeds for every account.</p>\n</li>\n<li>\n<p class=\"first-para\">At least once a month, reconcile every bank account against bank statements.</p>\n</li>\n<li>\n<p class=\"first-para\">Look for pre-dated or future-dated transactions.</p>\n</li>\n<li>\n<p class=\"first-para\">Eat a family bar of chocolate in one sitting (oh yes, and clean up the debtors list).</p>\n</li>\n<li>\n<p class=\"first-para\">Sweep through the creditors list.</p>\n</li>\n<li>\n<p class=\"first-para\">Check tax codes on all transactions.</p>\n</li>\n<li>\n<p class=\"first-para\">Reconcile your GST liability accounts.</p>\n</li>\n<li>\n<p class=\"first-para\">Give inventory the once over.</p>\n</li>\n<li>\n<p class=\"first-para\">Reconcile all payroll liability accounts.</p>\n</li>\n<li>\n<p class=\"first-para\">Scan transaction reports for weird stuff or mistakes.</p>\n</li>\n<li>\n<p class=\"first-para\">Read through the financials and check they make sense.</p>\n</li>\n</ol>\n"},{"title":"Understanding account types","thumb":null,"image":null,"content":"<p>Understanding the difference between account types is the secret to coding transactions correctly. Here’s the cheat’s guide to understanding the difference between assets and liabilities, equity and income, bananas and apples.</p>\n<ul class=\"level-one\">\n<li>\n<p class=\"first-para\"><b>Current asset</b>: Anything that a business owns that can realistically be converted into cash within the next 12 months.</p>\n</li>\n<li>\n<p class=\"first-para\"><b>Non-current asset:</b>A physical asset such as office equipment, land, buildings, computers or motor vehicles, that isn’t expected to be converted into cash within the next 12 months.</p>\n</li>\n<li>\n<p class=\"first-para\"><b>Current liability:</b>An amount owed by the business that is due within the next 12 months, including scary stuff such as credit cards.</p>\n</li>\n<li>\n<p class=\"first-para\"><b>Non-current liability:</b> Anything you owe that isn’t due to be paid out within the next 12 months, such as hire purchase debts or bank loans.</p>\n</li>\n<li>\n<p class=\"first-para\"><b>Equity:</b>The ‘interest’ that shareholders or an owner has in the business, including both capital contributed and the profit or loss built up over time.</p>\n</li>\n<li>\n<p class=\"first-para\"><b>Income:</b>Money generated from sales to customers or returns on investments.</p>\n</li>\n<li>\n<p class=\"first-para\"><b>Cost of sales:</b>What it costs in raw materials, supplies or production labour to make the goods that you sell (also called <i>cost of goods sold</i> or <i>variable expenses</i>).</p>\n</li>\n<li>\n<p class=\"first-para\"><b>Expenses:</b>The day-to-day running costs of your business, including things like advertising, bank charges, computer consumables, diamond rings, electricity, motor vehicle expenses, rent, telephone expenses and wages. (Just kidding about the diamonds.) Expenses are sometimes also called <i>fixed expenses</i> or <i>overheads</i>.</p>\n</li>\n</ul>\n"},{"title":"Stay up to date to meet tax deadlines","thumb":null,"image":null,"content":"<p>Forget birthdays, anniversaries and Christmas and instead, punctuate your diary with a list of tax deadlines. Here’s a summary of the deadlines that every Australian bookkeeper needs to know about in order to stay out of trouble.</p>\n<table>\n<caption>Australian Bookkeeping Deadlines</caption>\n<tbody>\n<tr>\n<td>Business Activity Statements</td>\n<td>Monthly payments: 21 days after the end of each month.<br />\nQuarterly payments: 28 days after the end of each quarter, except<br />\nfor the December quarter, where the deadline is February 28</td>\n</tr>\n<tr>\n<td>Payment ummaries</td>\n<td>July 14</td>\n</tr>\n<tr>\n<td>Annual withholding declaration</td>\n<td>August 14</td>\n</tr>\n<tr>\n<td>Superannuation</td>\n<td>28 days after the end of each month or quarter, depending on<br />\nthe fund</td>\n</tr>\n<tr>\n<td>PAYG withholding tax</td>\n<td>21 days after the end of the month for monthly payments, or 28<br />\ndays after the end of the quarter for quarterly payments</td>\n</tr>\n<tr>\n<td>Valentine’s Day</td>\n<td>February 14. Remember chocolates, red wine and roses or<br />\nterrible consequences may ensue</td>\n</tr>\n</tbody>\n</table>\n<table>\n<caption>New Zealand Bookkeeping Deadlines</caption>\n<tbody>\n<tr>\n<td>GST return</td>\n<td>28 days after the end of each reporting period, with the<br />\nexception of the November period, when the deadline is 15 January,<br />\nand the March period, when the deadline is 7 May</td>\n</tr>\n<tr>\n<td>PAYE tax and KiwiSaver</td>\n<td>20 days after the end of each month</td>\n</tr>\n</tbody>\n</table>\n"},{"title":"Know your debits from your credits","thumb":null,"image":null,"content":"<p>Understanding debits and credits is a tricky business. (How did accountants get to be so warped, you may wonder?) Don’t sweat, with this table you can get your debits and credits spot on, every time.</p>\n<table>\n<tbody>\n<tr>\n<th>Account Type</th>\n<th>To increase this account</th>\n<th>To decrease this account</th>\n</tr>\n<tr>\n<td>Asset</td>\n<td>Debit</td>\n<td>Credit</td>\n</tr>\n<tr>\n<td>Liability</td>\n<td>Credit</td>\n<td>Debit</td>\n</tr>\n<tr>\n<td>Equity</td>\n<td>Credit</td>\n<td>Debit</td>\n</tr>\n<tr>\n<td>Income</td>\n<td>Debit</td>\n<td>Credit</td>\n</tr>\n<tr>\n<td>Expenses</td>\n<td>Debit</td>\n<td>Credit</td>\n</tr>\n</tbody>\n</table>\n"},{"title":"What's included in a financial statement","thumb":null,"image":null,"content":"<p>With a bit of practice, understanding financial statements is easy. Think of your Balance Sheet reports as a set of before-and-after photos, with your Profit &amp; Loss report telling the story of what happened in between.</p>\n<ul class=\"level-one\">\n<li>\n<p class=\"first-para\"><b>Balance Sheet report:</b> Provides a snapshot of the value of assets, liabilities and equity at any point in time</p>\n</li>\n<li>\n<p class=\"first-para\"><b>Profit &amp; Loss report:</b> Summarises income, expense and net profit over a specified period of time</p>\n</li>\n<li>\n<p class=\"first-para\"><b>Statement of Cash Flow</b>: Examines the cash flows in and out of a business</p>\n</li>\n<li>\n<p class=\"first-para\"><b>Trial Balance report:</b> Lists the debit and credit balances of all general ledger accounts at any point in time</p>\n</li>\n</ul>\n"},{"title":"Prevent employee fraud with smart business practices","thumb":null,"image":null,"content":"<p>How do you prevent employee fraud in the workplace, and how can you be sure that nobody has their hand in the till? Like double cream and crash diets, keep bookkeeping tasks and the handling of cash or business assets completely separate. This includes</p>\n<ul class=\"level-one\">\n<li>\n<p class=\"first-para\">Authorising online transactions via internet banking</p>\n</li>\n<li>\n<p class=\"first-para\">Working on a cash register and taking cash</p>\n</li>\n<li>\n<p class=\"first-para\">Receiving payments from customers</p>\n</li>\n<li>\n<p class=\"first-para\">Balancing cash registers at the end of the day</p>\n</li>\n<li>\n<p class=\"first-para\">Accessing assets, such as business inventory</p>\n</li>\n</ul>\n"},{"title":"Calculate GST in the blink of an eye","thumb":null,"image":null,"content":"<p>Even with a calculator close to hand, a few shortcuts to help you calculate Goods and Services Tax (GST) are real handy. The whole business of dividing by 11 or multiplying by 0.15 can get very ugly indeed.</p>\n<table>\n<tbody>\n<tr>\n<td></td>\n<th>Australia</th>\n<th>New Zealand</th>\n</tr>\n<tr>\n<td>To calculate how much GST to add</td>\n<td>Multiply by 0.1</td>\n<td>Multiply by 0.15</td>\n</tr>\n<tr>\n<td>To add GST to arrive at a total price</td>\n<td>Multiply by 1.1</td>\n<td>Multiply by 1.15</td>\n</tr>\n<tr>\n<td>To calculate how much GST is included in a price</td>\n<td>Divide by 11</td>\n<td>Multiply by 3 and then divide by 23</td>\n</tr>\n<tr>\n<td>To calculate how much the price was before GST</td>\n<td>Divide by 1.1</td>\n<td>Divide by 1.15</td>\n</tr>\n</tbody>\n</table>\n"},{"title":"Register as a BAS agent in Australia","thumb":null,"image":null,"content":"<p>In Australia, if you’re a contract bookkeeper providing BAS services, then you must register as a BAS agent. The penalty for providing BAS services without registering ranges from a not insignificant $43,000 for an individual to a whopping $212,500 for a body corporate.</p>\n<ul class=\"level-one\">\n<li>\n<p class=\"first-para\">A BAS service includes any bookkeeping activity related to GST or PAYG, including configuring tax codes in accounting software, coding tax invoices, generating employee payment summaries or preparing Business Activity Statements</p>\n</li>\n<li>\n<p class=\"first-para\">You don’t have to register as a BAS Agent if you’re an employee receiving wages or you only do basic bookkeeping data entry based on explicit instructions provided by the client or by their tax agent.</p>\n</li>\n<li>\n<p class=\"first-para\">For details about registering as a BAS Agent page, visit the <a href=\"http://www.tpb.gov.au/\">Tax Practitioners Board website.</a></p>\n</li>\n</ul>\n"}],"videoInfo":{"videoId":null,"name":null,"accountId":null,"playerId":null,"thumbnailUrl":null,"description":null,"uploadDate":null}},"sponsorship":{"sponsorshipPage":false,"backgroundImage":{"src":null,"width":0,"height":0},"brandingLine":"","brandingLink":"","brandingLogo":{"src":null,"width":0,"height":0},"sponsorAd":"","sponsorEbookTitle":"","sponsorEbookLink":"","sponsorEbookImage":{"src":null,"width":0,"height":0}},"primaryLearningPath":"Advance","lifeExpectancy":"Two 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Calculation & Analysis Business Statistics: Test the Estimated Regression Equation

Article / Updated 10-06-2022

After you estimate the population regression line, you can check whether the regression equation makes sense by using the coefficient of determination, also known as R2 (R squared). This is used as a measure of how well the regression equation actually describes the relationship between the dependent variable (Y) and the independent variable (X). It may be the case that there is no real relationship between the dependent and independent variables; simple regression generates results even if this is the case. It is, therefore, important to subject the regression results to some key tests that enable you to determine if the results are reliable. The coefficient of determination, R2, is a statistical measure that shows the proportion of variation explained by the estimated regression line. Variation refers to the sum of the squared differences between the values of Y and the mean value of Y, expressed mathematically as R2 always takes on a value between 0 and 1. The closer R2 is to 1, the better the estimated regression equation fits or explains the relationship between X and Y. The expression is also known as the total sum of squares (TSS). This sum can be divided into the following two categories: Explained sum of squares (ESS): Also known as the explained variation, the ESS is the portion of total variation that measures how well the regression equation explains the relationship between X and Y. You compute the ESS with the formula Residual sum of squares (RSS): This expression is also known as unexplained variation and is the portion of total variation that measures discrepancies (errors) between the actual values of Y and those estimated by the regression equation. You compute the RSS with the formula The smaller the value of RSS relative to ESS, the better the regression line fits or explains the relationship between the dependent and independent variable. Total sum of squares (TSS): The sum of RSS and ESS equals TSS. R2 is the ratio of explained sum of squares (ESS) to total sum of squares (TSS): You can also use this formula: Based on the definition of R2, its value can never be negative. Also, R2 can't be greater than 1, so With simple regression analysis, R2 equals the square of the correlation between X and Y. The coefficient of determination is used as a measure of how well a regression line explains the relationship between a dependent variable (Y) and an independent variable (X). The closer the coefficient of determination is to 1, the more closely the regression line fits the sample data. The coefficient of determination is computed from the sums of squares. These calculations are summarized in the following table. To compute ESS, you subtract the mean value of Y from each of the estimated values of Y; each term is squared and then added together: To compute RSS, you subtract the estimated value of Y from each of the actual values of Y; each term is squared and then added together: To compute TSS, you subtract the mean value of Y from each of the actual values of Y; each term is squared and then added together: Alternatively, you can simply add ESS and RSS to obtain TSS: TSS = ESS + RSS = 0.54 + 0.14 = 0.68 The coefficient of determination (R2) is the ratio of ESS to TSS: This shows that 79.41 percent of the variation in Y is explained by variation in X. Because the coefficient of determination can't exceed 100 percent, a value of 79.41 indicates that the regression line closely matches the actual sample data.

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Calculation & Analysis How to Convert a Sampling Distribution Using the Central Limit Theorem

Article / Updated 09-22-2022

You can use the Central Limit Theorem to convert a sampling distribution to a standard normal random variable. Based on the Central Limit Theorem, if you draw samples from a population that is greater than or equal to 30, then the sample mean is a normally distributed random variable. To determine probabilities for the sample mean the standard normal tables requires you to convert to a standard normal random variable. The standard normal distribution is the special case where the mean equals 0, and the standard deviation equals 1. For any normally distributed random variable X with a mean and a standard deviation you find the corresponding standard normal random variable (Z) with the following equation: For the sampling distribution of the corresponding equation is As an example, say that there are 10,000 stocks trading each day on a regional stock exchange. It's known from historical experience that the returns to these stocks have a mean value of 10 percent per year, and a standard deviation of 20 percent per year. An investor chooses to buy a random selection of 100 of these stocks for his portfolio. What's the probability that the mean rate of return among these 100 stocks is greater than 8 percent? The investor's portfolio can be thought of as a sample of stocks chosen from the population of stocks trading on the regional exchange. The first step to finding this probability is to compute the moments of the sampling distribution. Compute the mean: The mean of the sampling distribution equals the population mean. Determine the standard error: This calculation is a little trickier because the standard error depends on the size of the sample relative to the size of the population. In this case, the sample size (n) is 100, while the population size (N) is 10,000. So you first have to compute the sample size relative to the population size, like so: Because 1 percent is less than 5 percent, you don't use the finite population correction factor to compute the standard error. Note that in this case, the value of the finite population correction factor is: Because this value is so close to 1, using the finite population correction factor in this case would have little or no impact on the resulting probabilities. And because the finite population correction factor isn't needed in this case, the standard error is computed as follows: To determine the probability that the sample mean is greater than 8 percent, you must now convert the sample mean into a standard normal random variable using the following equation: To compute the probability that the sample mean is greater than 8 percent, you apply the previous formula as follows: Because these values are substituted into the previous expression as follows: You can calculate this probability by using the properties of the standard normal distribution along with a standard normal table such as this one. Standard Normal Table — Negative Values Z 0.00 0.01 0.02 0.03 –1.3 0.0968 0.0951 0.0934 0.0918 –1.2 0.1151 0.1131 0.1112 0.1093 –1.1 0.1357 0.1335 0.1314 0.1292 –1.0 0.1587 0.1562 0.1539 0.1515 The table shows the probability that a standard normal random variable (designated Z) is less than or equal to a specific value. For example, you can write the probability that (one standard deviation below the mean) as You find the probability from the table with these steps: Locate the first digit before and after the decimal point (–1.0) in the first (Z) column. Find the second digit after the decimal point (0.00) in the second (0.00) column. See where the row and column intersect to find the probability: Because you're actually looking for the probability that Z is greater than or equal to –1, one more step is required. Due to the symmetry of the standard normal distribution, the probability that Z is greater than or equal to a negative value equals one minus the probability that Z is less than or equal to the same negative value. For example, This is because are complementary events. This means that Z must either be greater than or equal to –2 or less than or equal to –2. Therefore, This is true because the occurrence of one of these events is certain, and the probability of a certain event is 1. After algebraically rewriting this equation, you end up with the following result: For the portfolio example, The result shows that there's an 84.13 percent chance that the investor's portfolio will have a mean return greater than 8 percent.

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Audits 13 Ways to Spot Fraud in Business Financial Statements

Article / Updated 09-15-2022

Financial statement fraud, commonly referred to as "cooking the books," involves deliberately overstating assets, revenues, and profits and/or understating liabilities, expenses, and losses. When a forensic accountant investigates business financial fraud, she looks for red flags or accounting warning signs that indicate suspect business accounting practices. These red flags include the following: Aggressive revenue recognition practices, such as recognizing revenue in earlier periods than when the product was sold or the service was delivered Unusually high revenues and low expenses at period end that can't be attributed to seasonality Growth in inventory that doesn't match growth in sales Improper capitalization of expenses in excess of industry norms Reported earnings that are positive and growing but operating cash flow that's declining Growth in revenues that's far greater than growth in other companies in the same industry or peer group Gross margin or operating margins out of line with peer companies Extensive use of off–balance sheet entities based on relationships that aren't normal in the industry Sudden increases in gross margin or cash flow as compared with the company's prior performance and with industry averages Unusual increases in the book value of assets, such as inventory and receivables Disclosure notes so complex that it's impossible to determine the actual nature of a particular transaction Invoices that go unrecorded in the company's financial books Loans to executives or other related parties that are written off A business that engages in such fraudulent practices stands to lose a tremendous amount of money when penalties and fines, legal costs, the loss of investor confidence, and a tarnished reputation are taken into account.

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General Accounting Accounting Workbook For Dummies Cheat Sheet

Cheat Sheet / Updated 09-02-2022

As a business manager or owner, taking care of your company’s accounting needs is a top priority. Correctly preparing financial statements, financial analyses, and accounting reports involves knowing all the financial data and information that needs to appear in these items. Making a profit helps keep you in business, while maintaining a strong balance sheet ensures you can stay in business. So, make sure you understand the financial statements, record adjustments if needed, and follow some basic rules for presenting accounting information to your business’s managers, owners, investors, and creditors.

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General Accounting 10 Tips for Reading a Financial Report

Article / Updated 08-19-2022

You can compare reading a business’s financial report with shucking an oyster: You have to know what you’re doing and work to get at the meat. You need a good reason to pry into a financial report. The main reason to become informed about the financial performance and condition of a business is because you have a stake in the business. The financial success or failure of the business makes a difference to you. Get in the right frame of mind You don’t have to be a math wizard or rocket scientist to extract the essential points from a financial report. You can find the bottom line in the income statement and compare this profit number with other relevant numbers in the financial statements. You can read the amount of cash in the balance sheet. If the business has a zero or near-zero cash balance, you know that this is a serious — perhaps fatal — problem. Get in the right frame of mind. Don’t let a financial report bamboozle you. Locate the income statement, find bottom-line profit (or loss!), and get going. You can do it! Decide what to read Suppose you want more financial information than you can get in news articles. The annual financial reports of public companies contain lots of information: a letter from the chief executive, a highlights section, trend charts, financial statements, extensive footnotes to the financial statements, historical summaries, and a lot of propaganda. In contrast, the financial reports of most private companies are significantly smaller; they contain financial statements with footnotes and not much more. You could read just the highlights section and let it go at that. This might do in a pinch. You should read the chief executive’s letter to shareowners as well. Ideally, the letter summarizes in an evenhanded and appropriately modest manner the main developments during the year. Be warned, however, that these letters from the top dog often are self-congratulatory and typically transfer blame for poor performance on factors beyond the control of the managers. Read them, but take these letters with a grain of salt. Many public businesses release a condensed summary version in place of their much longer and more detailed annual financial reports. The scaled-down, simplified, and shortened versions of annual financial reports are adequate for average stock investors. They aren’t adequate for serious investors and professional investment managers. These investors and money managers should read the full-fledged financial report of the business, and they perhaps should study the company’s annual 10-K report that is filed with the Securities and Exchange Commission (SEC). Improve your accounting savvy Financial statements — the income statement, balance sheet, and statement of cash flows — are the core of a financial report. To make sense of financial statements, you need at least a rudimentary understanding of financial statement accounting. You don’t have to be a CPA, but the accountants who prepare financial statements presume that you’re familiar with accounting terminology and financial reporting practices. If you’re an accounting illiterate, the financial statements probably look like a Sudoku puzzle. There’s no way around this demand on financial report readers. After all, accounting is the language of business. Judge profit performance A business earns profit by making sales and by keeping expenses less than sales revenue, so the best place to start in analyzing profit performance is not the bottom line but the top line: sales revenue. Here are some questions to focus on: How does sales revenue in the most recent year compare with the previous year’s? What is the gross margin ratio of the business? Based on information from a company’s most recent income statement, how do gross margin and the company’s bottom line (net income, or net earnings) compare with its top line (sales revenue)? One last point: Put a company’s profit performance in the context of general economic conditions. Test earnings per share (EPS) against change in bottom line As you know, public companies report net income in their income statements. Below this total profit number for the period, public companies also report earnings per share (EPS), which is the amount of bottom-line profit for each share of its stock. Strictly speaking, therefore, the bottom line of a public company is its EPS. Private companies don’t have to report EPS; however, the EPS for a private business is fairly easy to calculate: Divide its bottom-line net income by the number of ownership shares held by the equity investors in the company. The market value of ownership shares of a public company depends mainly on its EPS. Individual investors obviously focus on EPS, which they know is the primary driver of the market value of their investment in the business. The book value per share of a private company is the closest proxy you have for the market value of its ownership shares. The higher the EPS, the higher the market value for a public company. And the higher the EPS, the higher the book value per share for a private company. Now, you would naturally think that if net income increases, say, 10 percent over last year, then EPS would increase 10 percent. Not so fast. EPS — the driver of market value and book value per share — may change more or less than 10 percent: Less than 10 percent: The business may have issued additional stock shares during the year, or it may have issued additional management stock options that get counted in the number of shares used to calculate diluted EPS. The profit pie may have been cut up into a larger number of smaller pieces. How do you like that? More than the 10 percent: The business may have bought back some of its own shares, which decreases the number of shares used in calculating EPS. This could be a deliberate strategy for increasing EPS by a higher percent than the percent increase in net income. Compare the percent increase/decrease in total bottom-line profit over last year with the corresponding percent increase/decrease in EPS. Why? Because the percent changes in EPS and profit can diverge. For a public company, use its diluted EPS if it’s reported. Otherwise, use its basic EPS. Tackle unusual gains and losses Many income statements start out normally: sales revenue less the expenses of making sales and operating the business. But then there’s a jarring layer of unusual gains and losses on the way down to the final profit line. This could be the result of a flooded building or a lawsuit. What’s a financial statement reader to do when a business reports such unusual, nonrecurring gains and losses in its income statement? There’s no easy answer to this question. You could blithely assume that these things happen to a business only once in a blue moon and should not disrupt the business’s ability to make profit on a sustainable basis. Think of this as the earthquake mentality approach: When there’s an earthquake, there’s a lot of damage, but most years have no serious tremors and go along as normal. Unusual gains and losses are supposed to be nonrecurring in nature and recorded infrequently. In actual practice, however, many businesses report these gains and losses on a regular and recurring basis — like having an earthquake every year or so. Check cash flow from profit The objective of a business is not simply to make profit but to generate cash flow from making profit as quickly as possible. Cash flow from making profit is the most important stream of cash inflow to a business. A business could sell off some assets to generate cash, and it can borrow money or get shareowners to put more money in the business. But cash flow from making profit is the spigot that should always be turned on. A business needs this cash flow to make cash distributions from profit to shareowners, to maintain liquidity, and to supplement other sources of capital to grow the business. The income statement does not — this bears repeating, does not — report the cash inflows of sales and the cash outflows of expenses. Therefore, the bottom line of the income statement is not a cash flow number. The net cash flow from the profit-making activities of the business (its sales and expenses) is reported in the statement of cash flows. When you look there, you’ll undoubtedly discover that the cash flow from operating activities (the official term for cash flow from profit-making activities) is higher or lower than the bottom-line profit number in the income statement. Look for signs of financial distress A business can build up a good sales volume and have very good profit margins, but if the company can’t pay its bills on time, its profit opportunities could go down the drain. Solvency refers to a business’s prospects of being able to meet its debt and other liability payment obligations on time, in full. Solvency analysis looks for signs of financial distress that could cause serious disruptions in the business’s profit-making operations. Even if a business has a couple billion bucks in the bank, you should ask, “How does its solvency look? Is there any doubt it can pay its bills on time?” Recognize the possibility of restatement and fraud When a business restates its original financial report and issues a new version, it doesn’t make restitution for any losses that investors suffered by relying on the originally reported financial statements. In fact, few companies even say they’re sorry when they put out revised financial statements. All too often, the reason for the restatement is that someone later discovered that the original financial statements were based on fraudulent accounting. Frankly speaking, CPAs don’t have a very good track record for discovering financial reporting fraud. What it comes down to is this: Investors take the risk that the information in the financial statements they use in making decisions is subject to revision at a later time. Remember the limits of financial reports There’s a lot more to investing than reading financial reports. Financial reports are an important source of information, but investors also should stay informed about general economic trends and developments, political events, business takeovers, executive changes, technological changes, and much more. When you read financial statements, keep in mind that these accounting reports are somewhat tentative and conditional. Accountants make many estimates and predictions in recording sales revenue and income and recording expenses and losses. Some soft numbers are mixed in with hard numbers in financial statements. In short, financial statements are iffy to some extent. There’s no getting around this limitation of accounting.

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General Accounting Separable Cost Reduction in Cost Accounting

Article / Updated 08-11-2022

In cost accounting, the cost of goods available for sale represents the product’s total costs. Total costs have two components — joint costs and separable costs. When possible, you want to reduce separable costs, but first take a look at your company’s joint costs. Assume you manufacture leaf blowers. Your two products are heavy-duty blowers and yardwork blowers. The separable costs are $1,200,000 for the heavy-duty blower and $912,000 for the yardwork blower. If you know the separable costs and the cost of goods available for sale, you can compute the joint cost allocation. This table shows the process. Joint Cost Allocation Heavy-Duty Yardwork Total Cost of goods available for sale $1,751,163 $1,260,837 $3,012,000 Less separable costs $1,200,000 $912,000 $2,112,000 Equals joint cost allocation $551,163 $348,837 $900,000 Each company division provides the separable costs. So altogether, this table gives you a joint cost allocation. Now assume that the heavy-duty blower division is able to sharply reduce its separable costs to an amazingly low $500,000. The first table listed heavy-duty separable costs of $1,200,000. Consider what now happens to heavy-duty’s joint cost allocation. Take a look at the next table. Cost Allocation — Less Heavy Duty Separable Costs Heavy-Duty Yardwork Total Cost of goods available for sale $1,751,163 $1,260,837 $3,012,000 Less separable costs $500,000 $912,000 $1,412,000 Equals joint cost allocation $1,251,163 $348,837 $1,600,000 Heavy-duty’s joint cost allocation increases to $1,251,163 (from $551,163). That doesn’t seem right. The goal is to analyze costs to reduce or eliminate them. If you do, supposedly you increase your profits. In this case, the heavy-duty division’s reducing separable costs increased its joint cost allocation. There doesn’t seem to be a benefit to operating more efficiently. Here’s an explanation: The gross margin percentage method (calculated as gross margin ÷ total sales value x 100) locks in total costs as a percentage of sales value. If the gross margin is about 12.5 percent of sales value, it means that costs must be about 87.5 percent of sales value. For heavy-duty, that 87.5 percent total cost number is $1,751,163. Those costs are either separable or joint costs. If one increases, the other decreases. The heavy-duty manager may have a problem with this process. The manager works hard (using good old cost accounting) to lower the separable costs. The manager’s “reward” is a higher joint cost allocation. The heavy-duty division has lowered costs but doesn’t get any savings in total costs. The constant gross margin percentage method clarifies the revenue and profit calculations company-wide. This method eliminates some of the variation between company divisions. Although some managers may complain, each division has the same gross margin percentage. The process makes managing company profit easier. This is one of those “Here’s why the chief financial officer (CFO) makes the big bucks” moments. As CFO, you explain the gross margin percentage method to the heavy-duty division manager. The goal is to allocate joint costs so that each product maintains the same gross margin percentage of about 12.5 percent. If a division reduces separable costs, it must get a bigger joint cost allocation — otherwise, the gross margin percentage would increase. Now heavy-duty’s manager should be evaluated based on the successful cost reduction. The manager had a success, and you want to encourage more cost savings. Although the gross margin percentage process requires a bigger joint cost allocation, that must not take away from the manager’s good performance.

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General Accounting Cost Accounting: Joint Cost Allocation and Gross Margin Percentage

Article / Updated 08-11-2022

In cost accounting, the cost of goods available for sale represents the product’s total costs. Total costs have two components — joint costs and separable costs. Assume the cost of goods available for sale are $1,751,163 and $1,260,837 for the heavy-duty blower and the yardwork blower. Say the separable costs are $1,200,000 and $912,000. If you know the separable costs and the cost of goods available for sale, you can compute the joint cost allocation. The first table shows the process. Joint Cost Allocation Heavy-Duty Yardwork Total Cost of goods available for sale $1,751,163 $1,260,837 $3,012,000 Less separable costs $1,200,000 $912,000 $2,112,000 Equals joint cost allocation $551,163 $348,837 $900,000 Each company division provides the separable costs. So altogether, the table gives you a joint cost allocation. Now calculate the gross margin percentage. Say your sales values are $2,000,00 and $1,440,000 for heavy-duty and yardwork blowers. The total cost is the cost of goods available for sale from the first table. The gross margin percentage is the gross margin divided by the sales value. For each product, the gross margin percentage is the same (12.442 percent) as the company’s overall gross margin. Verifying Gross Margin Percentage Heavy-Duty Yardwork Total Sales value (A) $2,000,000 $1,440,000 $3,440,000 Total cost (B) $1,751,163 $1,260,837 $3,012,000 Gross margin (A – B) $248,837 $179,163 $428,000 Gross margin percentage 12.442 12.442 Here’s the point of this table: it uses the traditional formula to compute gross margin and gross margin percentage. The table verifies that the calculations are correct. If the heavy-duty product has the higher sales value, it ends up with a higher gross margin in dollars than the yardwork product. However, both sale values are multiplied by the same gross margin percentage. Both products have a gross margin of about 12.5 percent (rounded). That means that about 87.5 percent of sales value represents cost of goods available for sale.

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General Accounting What Capital Is in Corporate Finance

Article / Updated 08-02-2022

Everything that makes up a corporation and everything a corporation owns, including the building, equipment, office supplies, brand value, research, land, trademarks, and everything else, are considered assets. Believe it or not, when you start a corporation, that company’s assets aren’t just included in a Welcome Letter; you have to go out and acquire them. Generally speaking, you start off with cash, which you then use to purchase other assets. For most new companies, this cash consists of a combination of the following: The owner’s own money: This money is considered equity because the owner can still claim full possession over it. Small loans, such as business and personal loans from banks, business and personal lines of credit, and government loans: The money obtained through loans is considered a liability because the corporation has to pay it back at some point. In other words, these loans are a form of debt. The combination of these two funding sources leads to the explanation of the most fundamental equation in corporate finance: Assets = Liabilities + Equity The total value of assets held by a company is equal to the total liabilities and total equity held by the company. Because the total amount of debt a company incurs goes into purchasing equipment and supplies, increasing debt through loans increases a company’s liabilities and total assets. As an owner contributes his own funding to the company’s usage, the total amount of company equity increases along with the assets. Note: Capital, assets, money, and cash are basically all the same thing at this point; after a company raises the original capital, or cash, it exchanges that cash for more useful forms of capital, such as erasable markers. Unlike liabilities, equity represents ownership in the company. So if a company owns $100,000 in assets and $50,000 was funded by loans, then the owner still holds claim over $50,000 in assets, even if the company goes out of business, requiring the owner to give the other $50,000 in assets back to the bank. For corporations, the equity funding varies a bit, however, because the owners of a corporation are the stockholders. The equity funding of corporations comes from the initial sale of stock, which exchanges shares of ownership for cash to be used in the company.

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General Accounting Theoretical and Practical Capacity in Cost Accounting

Article / Updated 08-01-2022

In cost accounting, two types of capacity focus on production: theoretical capacity and practical capacity. Consider how much you could produce if customer demand was unlimited. Select a capacity method that makes sense to you, and use that as a tool to plan production and spending. Theoretical capacity assumes that nothing in your production ever goes wrong. Accountants describe this capacity as working at full efficiency all the time. Consider what your pie-in-the-sky or perfect-world capacity would be. It’s a world in which everything runs perfectly and no machines or equipment ever break down. It’s utopia where no worker ever makes a mistake. That would be great, wouldn’t it? That’s theoretical capacity, and you can’t reach it. It seems silly, but you need to see this level of capacity to understand the others. Say you own a business that makes athletic running shorts and other clothing. At maximum capacity, you can make 200 pairs of shorts per shift. You run three 8-hour shifts per day, 365 days a year. Based on those numbers, here is your theoretical capacity: Theoretical capacity = shorts x shifts x 365 days Theoretical capacity = 200 x 3 x 365 days Theoretical capacity = 219,000 Unfortunately, this level of capacity isn’t attainable. You need to take into account the unavoidable. That gets you to practical capacity. Practical capacity is the level of capacity that includes unavoidable operating interruptions. Another description is unavoidable losses of operating time. Consider maintenance on equipment, employee vacations, and holidays. You’re willing to accept a good, rather than perfect, capacity level. The people in your company can help you determine your practical capacity. Your production and engineering staff can answer questions about machine capacity and repair time. Your human resources staff can forecast employee availability, based on vacations and holidays. You determine that 250 days is a more realistic number of production days, given unavoidable operating interruptions. Also, you decide that two shifts per day are realistic. Here’s the practical capacity calculation: Practical capacity = shorts x shifts x days Practical capacity = 200 x 2 x 250 Practical capacity = 100,000 The practical capacity is 100,000 units (pairs of shorts) per year.

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Bookkeeping Bookkeeping For Dummies Cheat Sheet (Australia/New Zealand Edition)

Cheat Sheet / Updated 04-07-2022

A great bookkeeper cares that the financial statements make sense and gets upset when something doesn’t balance or stuff goes missing. They also feel responsible when it comes to getting customers to pay on time. A good bookkeeper, in other words, is worth their weight in gold. This Cheat Sheet summarizes what you need to know to be an excellent bookkeeper.

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