Financial Accounting

(General) Performance/Results =

Output - Input

Measuring the results of a company is useful for:

* The State- to learn about the income generated by the enterprise, and determine the taxes that the company owes.
* The shareholders/ "owners"- to find out what made the invested capital.
* The management- to monitor its progress and understand the need for possible remedies

(General) Inputs include:

human resources; raw materials, semi-finished and finished goods acquired from the supplier; services; facilities and technologies used in the enterprise; and finally, the money needed to buy these inputs

(General) Outcome (or) Results =

the monetary value of the output - the monetary value of the Input

*we need to identify a unit of measurement that could be used for all outputs and inputs, in this case - money*

Monetary Value of Input is

Measured by how much the company spends for the resources used to make products: how much we pay employees for their labour, how much we pay suppliers for goods and services that we buy from them, the interest we pay to banks that lend us money.

Reporting period

The time period over which the enterprise performance is measured, for the purpose of external reporting.

Fixed Capital Investment

Fixed capital consists of assets that are not consumed or destroyed in the production of a good or service and can be used multiple times.
Property, plant, and equipment are standard fixed capital items.
Fixed capital assets are usually illiquid items and are depreciated over time.
The opposite of fixed capital is variable capital.

Time lag between the different phases of the current cycle of an enterprise:

- The time of purchase of an input and the payment of the supplier (with the possible establishment of a trade payable)
- The time of purchase of input, the time of its transformation into output and the time of its sale to the customer (by creating inventories)
- The time of sale of the product and the payment by the client (with the possible establishment of a trade receivable).

Operational processes:

common, routine, everyday business processes such as procurement and sales

The two main logics of measurement of the results of an enterprise are:

The financial logic and the economic logic

Financial Logic =

Money flows in a given period (consider only the phenomena that generate cash flows in that period)

Financial Outputs

Generate cash flows when clients make payments. According to the financial logic, the value of the output is measured by cash inflows that occur in a reporting period, regardless of whether the goods and services that have generated these revenues were sold or supplied in that period or in a different one.

Financial Inputs

Generate cash flows when payments are made to external suppliers/employees of the company.
The input value is expressed by the outflows generated by these payments in a reporting period, regardless of whether those payments are related to resources that you acquired in that period or a different one.

(Financial Logic) Cash Flow =

cash inflow - cash outflow

Economic Logic

Measures the results of the enterprise through the comparison between "economic" positive flows- revenues (Measure the value of products sold in a period regardless of when the payment occurred) (and negative- costs (that is, the value of the resources used to realize the products)

Revenues

Sales/ The total amount of income generated by the sale of goods and services related to the primary operations of the business.

Revenues of a reporting period

The value of the products that the company has alienated and the services they have provided during the reporting period.

invoices

Billing statements that list the amount owed for goods or services purchased.

costs of a reporting period

The value of the resources used to achieve revenues in that period (equipment, raw materials, semi-finished goods, employees, services acquired from outside)

accounting profit

total revenue - total explicit costs

Profit for the fiscal year

Accrual Revenues- Accrual Costs

accrual revenue

revenue that you have earned and for which you are yet to receive payment.

accrual cost

The cost of goods or services received or incurred during a period when the lack of a supplier billing forces the buyer to accrue the related cost

Matching Principle

the ability to match the results to the period during which these results were determined

Principle of Comparability

the objectivity of the evaluation

Who could benefit from the use of the economic logic with the matching principle?

It is particularly important for one of the stakeholders of the company, the State, which must know every year, the "surplus" the enterprise has created, in order to determine its tax burden correctly.

Why is the financial logic more consistent with the principle of comparability?

To determine the Cash Flow value is sufficient to monitor the incoming and outgoing cash flows of the enterprise, without the need to spell out specific hypothesis; the resulting outcome is then essentially objective.

income statement (profit and loss statement)

The document that allows us to determine the profit of an enterprise in a certain reporting period (the synthesis of the economic flows affecting the enterprise in an accounting period)

In accordance to which principle is the income statement prepared?

The matching principle, comparing the revenues of the period with its costs.

What "activities" are included in the structure of the income statement?

Operational activities; Financial activities; Fiscal activities; Discontinued operations.

Ordinary operations of the company (operational activities + financial activities)

Represents the activities in which the undertaking operates continuously; they are crucial for defining the behaviour over time

What are the two structures that the income statement may follow in regards to operational activities?

By destination - the costs are aggregated based on the activities where resources are used within the operational processes (-the cost of the realization of sales, -costs of distribution, -administrative costs, +revenues + other revenues).
By nature - the costs are aggregated according to the nature of the resources that are used (+ revenues, + other revenues, +changes in inventories, - raw materials and consumables, -the cost of personnel, - depreciation and variation of the value of non-current activities, - other operating costs such as costs related to multiannual goods, i.e. equipment and buildings)

EBIT (operating income)

Earnings (from operations) Before Interest and Taxes/ EBIT is calculated by subtracting a company's cost of goods sold (COGS) and its operating expenses from its revenue.

EBIT by function

The structure of the income statement by destination fully reflects the matching principle

EBIT by nature

In the income statement by nature, the operating profit is obtained instead by comparing the value of what the enterprise has produced in the period with all the costs that it incurred in for production.

Units produced =

units sold + closing stock - initial stocks

What are the three fundamental cost components that the income statement by nature identifies?

- costs related to the consumption of raw materials and consumables
- costs of personnel
- costs related to multi-annual goods (such as equipment and buildings).

Costs related to the consumption of raw materials and consumables

All materials used to carry out the production of the period. This cost figure does not coincide with the value of the materials purchased in the accounting year, since the company may have used previously purchased materials or, conversely, may buy materials that will be used in future years.

Cost of materials =

purchases of materials + initial stocks of materials - closing stock of materials

During periods when the price of the materials varies, this phenomenon presents an element of discretion- there are two logics used to calculate the price

The FIFO logic and the average cost logic /once all units have been used, the overall costs of materials are independent from the criteria that we adopted; the discretion of the company shall not affect then on its cumulative profit, but only on the distribution of profit among the accounting periods/.

FIFO

First In, First Out. Rotation system that uses the oldest products first

Average Cost logic

which assumes that all units have one cost, equal to the average price of products in stock. In our example, the cost of materials would be (€10 + €12 + 14€)/3 = €12

Personnel expenses

include everything that the company spends to remunerate their employees: wages and salaries, social security contributions, and severance payments.

cost of using multi-annual assets

Depreciation (represents the share of the total cost of an asset used for several years due to production carried out in a single year) and eventual change in the value of the multi-annual assets

Depreciable Value =

Acquisition cost - Residual value

straight line depreciation

For example, if we purchased a facility for €100,000, with a useful life of 5 years, using the straight-line method of depreciation, the value of depreciation for each of the 5 years shall be: 100'000 €/5 = €20'000

The increasing balance method

usable if the deterioration of the plant is more significant in the "latter" years of its useful life

units of production method

A depreciation method allocates a varying amount of depreciation each year based on an asset's usage. / As the asset functions for several years, its value (and its useful life) may be different from the forecasted value: therefore, the value of the asset can be "re-valuated" each year (fair value). If the value is lower than the value previously subscribed, this reduction in value is considered as a cost of the period. Imagine the extreme case of an asset "thrown away" in the same year it was bought: the asset's cost would be correctly attributed to that accounting year.

Re-evaluation

Consider the case of the facility that we purchased for €100'000, with a useful life of 5 years. After two years, the asset is revalued to €120'000; for the remaining three years, the depreciation therefore will be: €120'000 / 3 = €40'000

Value adjustment of long-term assets

Fair value

Financial Activities /result of three main items, whose weight changes significantly depending on the industry where a company operates in/

borrowing costs
financial income
Profit (loss) from subsidiaries and associated companies.

Borrowing costs

Interest and other costs incurred by an entity in connection with the borrowing of funds /burdens the company must pay for any financing by third parties. The most common one- interests that need to be paid to credit institutions that provided financial resources to the company. Example: a funding of € 1 million is granted, at an annual interest rate of 5%, generating a burden to the company equal to 5% of 1 million euros every year, then €50'000./

Liquid assets

A liquid asset is an asset that can easily be converted into cash in a short amount of time. Liquid assets include cash, money market instruments, and marketable securities.

Equity

Typically referred to as shareholders' equity (or owners' equity for privately held companies), represents the amount of money that would be returned to a company's shareholders if all of the assets were liquidated and all of the company's debt was paid off in the case of liquidation. In the case of acquisition, it is the value of company sales minus any liabilities owed by the company not transferred with the sale.

interest income & interests on financial credits

the interest earned on money loaned

businesses that operate directly on the credit market

banks and insurance companies

financial income

- capital gains on the securities held
- profits from trading of securities

profit (loss) from subsidiaries and associates

gains and losses of controlled companies and subsidiaries

EBT (Earnings Before Taxes)

A calculation of a firm's earnings before the taxes are deducted.
It is calculated by subtracting all expenses, excluding taxes, from revenue. It can be found in a company's income statement, a synthetic representation of the "ordinary" capacity of the enterprise to generate income in a reporting year.

Net Income

Financial income - Borrowing costs + Profit (loss) from subsidiaries and associates

Net Income = (Revenue + Gains) - (Expenses + Losses)

EBT is a measure of:

how much the firm has generated, through its operating and financial activities, to reward two important stakeholders, the shareholders, namely the owners of the company, and the State, through taxation.

How do we get net profit from continuing operations?

By subtracting the income tax from the EBT

discontinued, or "soon to be" discontinued operations

example: An undertaking might have sold during the year one of its own branches of activity (which we define as "discontinued"); during the period when it was still owned by the enterprise, it will have generated profits or losses that must of course be booked on the income statement. However, we have to keep these entries separate with regard to the operating assets of the company, in order to highlight that they are not going to be reflected in subsequent years. In this way, we are able to highlight the contribution to income of the activity that the company intends to divest completely or partially, or to shut down.

Discontinuation conditions:

- the activities constitute a major line of business or geographical area of activity — i.e., they are sizable activities, so that their separate treatment from the rest of the enterprise is justified
-the activity can be identified from an operational and budgetary point of view, namely that it is actually possible to isolate the contribution analytically.

income (loss) from discontinued operations

revenues and the operating costs (purchase of materials net of changes in inventory, payroll costs including social security expenses, depreciation and costs for external services), financial income, borrowing costs and taxes. To these entries, you add the ones related to discontinued operations, in fact, discontinuation can occur at a different price than the one booked on the financial statement.

Net income (loss) from discontinued/intended to be discontinued operations

the last contribution to the determination of operating profit of an enterprise

net income /discontinued operations included for broader explanation/

By adding the net profit from continuing operations to the net income (loss) from discontinued operations, you get the net income, which is the synthetic representation of all economic flows that in the reporting year the enterprise have been involved in, and shows the economic result of the ownership of the enterprise

earnings per share

income generated through a single outstanding share; expressed in two ways:
- basic earnings per share, which is defined as the ratio between earnings and weighted average of the common shares during the year
- diluted earnings per share, which is defined as the ratio between earnings and weighted average of common shares and securities convertible into shares. (The two values may be different when there are bonds "convertible" into shares- the number of shares among which the net income must be divided, may vary, depending on the number of bondholders who decide to convert their bonds during the year; the basic earnings per share will be the maximum value that the earnings per share can have (assuming that no bondholder exercises the right of conversion), while the diluted earnings per share will be the minimum value.

Balance Sheet

A financial statement that reports assets, liabilities, and owner's equity on a specific date, comparing the company's situation at the beginning and at the end of a fiscal year; it is a measure of state, not of flow (hence, economic logic).

Balance Sheet configuration

Assets on the left, Liabilities on the right

Assets (balance sheet)

Resources that an enterprise has at a certain point in time (usually, the end of an accounting year), that can potentially contribute to its operations. The assets headings include both the resources that are owned by the enterprise and the resources to which the enterprise has transferred risks and rewards (like in the case of leasing). So, assets = resources. The assets part includes only resources (physical, technological, financial, image) that can be expressed in monetary terms; so, we will have the assets owned by the enterprise systems, but not the quality of skills of the people who work there.

The criteria of valuation - a combination of three different modes of valuation

- the purchase cost- the price that the company has actually paid to own the resource; for instance, the cost of a finished good coincides with the value of the resources that have been used to create it;
-the market value (fair value)- the price at which the resource can be traded on the market: in the case of a manufacturing plant, it is measured as the price that another company would pay to buy the plant.
- the usage value- the actual value of the financial flows that the enterprise is able to gain by using the asset.

Categories of stakeholders

- the shareholders, those who own the shares of the company; - The third parties, or all other subjects other than shareholders, who have claims towards the company.

third party stakeholders

- explicit financiers of the enterprise (credit institutions/ bondholders, and the implicit financiers). Third parties have the "priority" compared to shareholders- if the company's resources aren't sufficient to cover all the claims, the third parties are the first actor to be paid, and then shareholders, as residuals.

implicit financiers

Can be the suppliers that have claims towards the company, the employees that partially "fund" the enterprises by retaining their severance pay, or the State, through the taxes that are not paid yet by the enterprise.

The first layer of liabilities of discontinued operations (balance sheet):

- (own) equity (or net worth), that is, claims by shareholders; - Loan capital (or liabilities), or claims by third parties.

liabilities of discontinued operations (balance sheet):

Further divided, according to their "maturity", into non-current liabilities, which will be extinct beyond 12 months; current liabilities, which will be extinct within 12 months; and liabilities attributable to discontinued/discontinuing operations

The fundamental law total assets = total liabilities is valid because:

We are taking into account the meaning of assets and liabilities; since every resource should be "entitled" to an actor, there must be, at any time, a perfect correspondence between total assets and total liabilities, i.e., between the resources available and the description of who are the holders of claims on those resources., P.S. Equity is included in the liabilities side of the column, so that's why it is basically (equity+liabilities=assets)

3 categories of operations (balance sheet)

-Exchange (Swap) transactions;
-Operations of balanced variations of claims and resources
-Operations that unbalance the balance sheet.

exchange/swap transaction

A transaction involving the simultaneous purchase and sale of a foreign currency with delivery at two different points in time;
- They affect one of the two sections of the balance sheet and consist of a transfer between different resources (when operating on the assets part) or between different claims (when operating in the liabilities part)

Operations of balanced variations of claims and resources

Create a variation of total resources available to the enterprise (then of total assets), but balanced by a corresponding change in claims (then of total liabilities) An operation of this type manifests itself, for example, when a company has contracted a financial debt with a bank. This additional claim (the bank's) will be recorded in liabilities in the loan capital item; overall, then, the assets and the liabilities increase by the same magnitude, the remaining balance between them

Do exchange transactions and the operations of balanced variations of claims and resources affect the income statement of the company?

NO.

Operations that unbalance the balance sheet

The case is different for the operations that unbalance the balance sheet- their effect on the two parts of the balance sheet (assets and liabilities) is different:
- the operations that unbalance the balance sheet are the only ones that have an effect on the income statement of the company and thus on the operating profit
- Since these operations can contribute positively or negatively to operating profit, the operating profit is the only item of the balance sheet that can have a positive or negative sign, all the others are always positive.

Equity formula

Assets - Liabilities

Passive part of the balance sheet

Describes the claims to the resources of the enterprise. As a first layer, passive is divided into equity, that records the various claims by shareholders of the company, and liabilities, in which third-party claims are registered.

Value of equity

Defined as residual with regard to third parties' loan capital- what remains of the company's activities, after deducting all the liabilities. Thus, the capital provided by shareholders to the company is called risk capital: it increases if the business gets positive results, but otherwise it can decrease, even to zero.

Claims by shareholders are generated essentially from two different phenomena:

- Shareholders' capital payments to the company
- Profits generated by the company.

Capital

the account used to summarize the owner's equity in a business;
It is paid at the time of the establishment of the company, either directly or through a commitment by the shareholders to make the payment at the request of the company. The capital is equal to the number of shares issued by the undertaking, multiplied by their nominal value.

capital increase

1. number of new shares x the nominal value

The second equity component manifests itself as a result of operations that unbalance the balance sheet. In particular, the algebraic sum of the various management operations that unbalance the balance sheet in a reporting period generates a difference between total assets and total liabilities; If this difference is positive, the company generates "new claims" to its shareholders. These claims are reflected on the liabilities side under net item income of the year. If the total liabilities increase more than the total assets, shareholders "lose" some of their claims; a loss is generated, which is always listed on the liabilities side of the balance sheet under "net income of the year", which assumes a negative value. The rules underlying accounting systems ensure that this value is identical to the net income derived from the income statement.

Net Income - balance sheet

The net income represents a claim of shareholders and, as such, is located on the liabilities side of the balance sheet; please remember that the net income is the only item that can be positive or negative (in the case of loss).

retained earnings

An amount earned by a corporation and not yet distributed to stockholders; possible source of self-financing

Reserves

The retained earnings are part of a set of entries in the equity part, reserves, which represent altogether the rights claimed by the shareholders, which are generated during the operating cycle of the enterprise.

Other reserves - regulatory constraints

The legal reserve, which is generated by the mandatory allocation to reserve of a portion of the net income. In Italy, this portion is equal to 5% of the income, and it has to be done each year until you reach the 20% of capital of the company.

Other reserves - special management operations

The premium share reserve is generated when the company issues shares at a higher price than the nominal value, or the revaluation reserve, which compensates for changes in value arising from the application of fair value.

Non-current liabilities

- Financial debt
- Provisions
- Employee Benefit liabilities

long-term borrowings

Loans and other finances provided by lenders to finance the long-term, non-current assets of the business /loans from banks and bonds/

risk and charges provisions

liabilities of uncertain amount or "maturity", example: "prizes" & coupons

employee-related long-term provisions

obligations of the company to its staff: severance pay, etc.

Current Liabilities

Obligations that a company expects to pay within the next year or operating cycle, whichever is longer.
-Spontaneous liabilities (account payables, advances, taxes)
-Debts to banks / bonds
-Liabilities of discontinued operations

Trade payables

Money the business owes for purchased supplies that aren't paid for yet