financial accounting part 1 complete

whats a company information system?

a company performs hundreds of operations every day: buying goods, selling goods, paying salaries, receiving cash and paying suppliers. All these activities generate information, their collection is the company info system.

purpose of company info system

1.collect info 2. organize info 3. support decision-making

-think of it as the nervous system of a company. without it management is blind.

eg- a company sells 100 products a day. info system answers questions like: for how much? to whom? was cash received?

what is the accounting info system?

is a subset of the company info system. it focuses only on Quantitative monetary information, meaning: euros, cash, debts, credits, costs and revenues.

eg- a customer compliments your product. useful info-yes, accounting info- no

a customer pays 500 euros. useful info- yes, accounting info- yes (b/c money is involved)

what is management

Management (Gestione)- totality of all operations performed during company life.

management consists of:

a. Internal events- inside company only. eg- employee training

b. external events- b/n company and outside world. eg- purchase, sale, loan, payment. only external events are recorded using double-entry bookkeeping

Double entry bookkeeping

is an accounting system where every financial transaction is recorded in at least two accounts as equal and opposite entries (debits and credits).

Luca Pacioli- father of accounting, published 1st explanation of double-entry bk.

The four fundamental rules

Rule 1: every external event has 2 dimensions= financial profile and economic profile.

Rule 2: Every debit has a corresponding credit.

Rule 3: Total debits= Total Credits (always)

Rule 4: All entries use the same monetary unit. (euro, dollar, pound, etc)

Financial profile vs Economic profile

a. Financial accounting- what happened to the money? Focuses on: cash, bank, receivables, payables

b. Economic profile- why did money change? Focuses on: costs, revenues, capital

eg- Purchase inventory for 100 euro cash.

financial profile- cash decr. by 100 euro

economic profile- cost incr by 100 euro.

both must be recorded.

What is an Account?

An account is a table divided into two sides. (Debit | Credit)

every accounting movt goes to one side.

there are two types of accounts- 1. Financial Accounts 2. Economic Accounts

Financial Accounts

-refers to a specific record where financial transactions of a similar nature are grouped and tracked (e.g., Cash, Accounts Receivable, Inventory)

A. Definite financial Accounts- absolutely certain. eg- cash, bank account

you know exactly how much exists.

B. Similar Financial Accounts- represent Credits and Debts

eg- Accounts Receivable, Accounts payable. Money isnt here yet but will move later.

C. Presumed Financial Accounts- estimated values.

eg- Accrued liabilities, Accrued revenues. the exact amount may still be uncertain.

Positive Financial Changes (PFC)

Good financial effects, occurs when:

i. Cash increases eg- receive 100 euro

ii. Credits increase eg- customer owes you 500$

iii. Debts decrease eg- pay supplier 300$

=>they’re all recorded on DEBIT

Negative Financial Changes (NFC)

occurs when:

i. Cash decreases

ii. Credits decrease

iii. Debts increase

=> Recorded on CREDIT

Economic Accounts of Capital

Concern: Owner’s equity. eg- Capital contribution, Capital withdrawal

question- Did owner wealth increase or decrease?

Capital increase- Credit

Capital decrease- Debit

Economic Accounts of Earning

Concern: Business performance. eg-

• Costs (Rent, Salaries, Electricity, purchases)

• Revenues (Sales, Service income)

Question: did the company earn or spend?

Positive Economic Changes (PEC)

occurs when: Revenue increases, Costs decrease, Equity increases

Recorded on CREDIT

Negative Economic Changes (NEC)

Occurs when: costs increase, revenue decreases, equity decreases.

Recorded on DEBIT

TYPES OF BUSINESS OPERATIONS

a. purchase of simple productive goods

used once. example- raw materials, inventory, consumables.

benefit lasts one operating cycle.

b. Purchase of repeated productive goods

benefit lasts many years eg- buildings, machinery, vehicles, equipment

these become assets and later get depreciated

c. purchase of services

eg- electricity, telephone, consulting, rent

d. Sale of Goods- selling products to customers

Journal and Ledger

Ledger- shows movt within individual accounts. eg- cash account

Debit | Credit

200 |

| 100

Journal- shows transactions in chronological order

eg- Cash Dr 200

To sales 200

journal entry construction process

step 1: identify transaction step 2: identify financial effect

3.identify economic effect 4. determine Debit account 5. determine credit acc

6. prepare journal entry

what is VAT?

Value Added Tax.

an indirect tax imposed on Goods and Services.

VAT is not revenue, not expense and it belongs to the govt

input VAT- when company purchases it pays VAT. therefore, company has a claim against govt. input vat behaves like: Receivable Debit.

eg- buy goods at 100$, VAT 22%= 22$. company paid: 122$→input vat= 22$

output VAT- when company sells, company collects VAT. must later transfer it to govt. output VAT behaves like: payable Credit.

eg- sell goods 200$, VAT 44$, customer pays 244$. output VAT= 44$

=> VAT is important because it helps the govt

Accounts Payable & Receivable

Accounts Payable- money owed to suppliers. think: Buy now, pay later. →Liability

eg- buy 500$ goods + 110 VAT→total owed 610$

Journal: purchase Goods Dr 500, input VAT Dr 110, To Accounts payable 610

Accounts Receivable- money customers owe us. Think: Sell now, collect later.

→Asset

eg- Sell goods at 700$ + 140$ VAT. customer owes 840$

Journal: Receivable Dr 840, to sales revenue 700, to output VAT 140

Purchase side

eg- transport, packaging, insurance, warehouse. These increase costs. therefore: DEBIT

eg- goods= 100$, Transport= 10$, VAT 20%= 22$. total=122$

purchase goods Dr 100, transport cost Dr 10, Input VAT Dr 22→to accounts payable 132

Additional Revenues

when company charges customer for: packaging, delivery, insurance.

these become revenues- Credit.

eg- good sold- 300, packaging- 20 vat 64. total 384

Accounts receivable Dr 384, to sales revenue 300, to packaging revenue 20, to output vat 64

the Accrual principle (Financial income vs Accrued income)

Financial Direct Derivation Income (FDD)- this is the income obtained directly from recorded transactions.

Revenue FDD - Expense FDD (often inaccurate b/c some costs and revenues belong to different accounting periods)

Accrued Income- reflects: i. revenues earned during the year ii. costs incurred during the year. →regardless of when cash moves, this is true profit.

formula: Accrued income= Income FDD ± Adjusting Entries

eg- revenue received- 10k, expenses paid 7k. →financial income- 10k-7k= 3k

but if 1k of income belongs to next year:

Accrued income = 3k + 1k = 4k (this is why adjusting entries exists)

Categories of adjusting entries

A. Depreciation

B. Integrative Entries (adding missing costs/ revenues)

C. Rectification entries (remove costs/ revenues belonging to future years)

Depreciation

→the allocation of a long term asset cost across its useful life.

why it exists? →suppose a company buys an equipment for 100k

will the benefit last only this year? No. Maybe 5 years. Therefore, charging the entire 100k this year would be unfair. instead we spread the cost across the useful years.

eg- equipment cost- 100k, useful life 5 yrs.

Annual Depreciation: 100k/5= 20k

Purchase entry: Equipment Dr 100k, To bank 100k.

year-end depreciation: Depreciation Expense Dr 20k, To Equipment 20k

Residual value: After 1 yr: 100k - 20k = 80k. remaining asset value 80k

(shortcut: Depreciation always: Debit→Expense, Credit→Asset)

Purpose of Ending Recordings

At year-end all revenues and expenses must be transferred to the income statement. Think of it as: Closing the books for the year.

Cost summary- transfer: wages, rent, purchases, interest expenses to income statement

Revenue summary- transfer: sales, interest revenue, rental revenue to income statement.

Integrative Entries

→These are entries that ADD costs or revenues that belong to the current year but have not yet had a financial manifestation.

Think: Earned but not received. or Incurred but not paid.

Two types:

a. Completion Entries: interest to be received/ paid, Invoices to issue, Invoices to receive, Bad debts, TFR fund.

b. Strict Integrative Entries: Accrued income, Accrued Liabilities, Risk funds, Future Liability Funds.

Invoices to be issued:

Concept: Goods already sold, invoices not yet prepared, Revenue belongs to this year. Therefore, record it

Journal entry: Invoice to be issued Dr →To sales Revenue

Memory trick: Sold goods? Revenue exists, Invoice missing? create a presumed receivable

Invoices to be Received

Concept: Goods already received, Invoice not yet arrived, Cost belongs to this year. Record it.

Journal Entry: Purchasd of Goods Dr→ To invoice to be Received

Memory trick: Received goods? Cost exists. Invoice missing? Create presumed payable.

Bad Debts

Concepts: customer probably wont pay, receivable is overstated, reduce it, Italian accounting requires credits to be shown at realizable value.

Entry: Bad Debt Expense Dr→ To Accounts Receivable

TFR Fund

=> Employee severance compensation/ money owed to employees when employment ends. Italian accounting treats this as a growing liability.

Entry: Provision to TFR Fund Dr →To TFR Fund

exam shortcut: TFR Fund = Future Employee Liability

Accrued Income

→Revenue that belongs to current year, cash arrives next year, record revenue now.

eg- rent 600$, period nov 1→ apr 30. current year includes: nov + dec=2 months.

revenue: 600 ×2/6= 200

Entry: Accrued income Dr 200→ To Rent Revenue 200

memory trick: