Intro to accounting and finance

Process of accounting

Identify the event, record the event and then communicate it through reports. then analyse and interpret for users

Types of accounting

Financial accounting - Published financial statements and other financial report. External user. Investment from outside.

Managerial accounting - Info for decision making, and control of an organisation’s operations. Internal users. Investment from within the business

Main elements in accounting

Assets - Resource controlled by the entity from which future economic benefits are expected to flow to the entity. 

Liability - An entity’s obligation to transfer economic benefits as a result of past events. 

Equity - The residual interest in the assets on entity after deducting all its liabilities. Capital of the business. Value between assets and liabilities. 

Income - Increase in equity (other than those relating to contributions from owners). Any money coming into the business.

Expenses - Decrease in equity (other than those relating to contribution from owners). Any money going out of the business.

Business entity - The business is separate from its owner(s).

Historical cost - Transactions are recorded at the cost when they occurred.,

Going concern - The entity will continue in operation for the foreseeable future.

Accruals - Revenue and cost must be recognised as they are earned or incurred, not as money is received.

Consistency - Presentation and classification of items should stay the same from one period to the next.

Materiality - Information is material if its omission or misstatement could influence the economic decision of users.

Components of financial statements

Purpose of financial statement:

Basic financial; statement purpose

Balance sheet - Snapshot of where the company is at a particular point in time.

Income statement - How the company is doing in terms of sales, expenses and profitability overtime

Statement of cash flow - Tracks the inflow and outflow of cash, providing insights into a company’s financial health

Objective of financial statement:

According to IASB, financial statement is “to provide info about the financial position, financial performance and cash flows of an entity that is useful to a wide range of users in making economic decisions”

This is part of the communication with the users of Accounting info

To prescribe the basis for presentation of general purpose financial statements, in order to ensure comparability both with the entity’s own financial statements of previous periods and with the financial statements of other entities

Qualitative characteristics

IRFS identifies two levels of qualitative characteristics of useful financial information:

1) Fundamental qualitative characteristics - Required for info to be useful. Relevance - info relevant if it influence stakeholder decisions. Faithful representation - Financial statements must capture the economic activity of an entity. Info must be complete, neutral and free from error

2) Enhancing qualitative characteristics - Enhance usefulness of accounting info. Comparability - provides users with info that is readily comparable. Verifiability - Independent and knowledgeable observers should find similar results when measuring an item. Understandability - Accounting info is prepared for stakeholders with reasonable understanding of business. Timeliness - helps users make informed decision.

Types of business

Sole trader - Usually owned by 1 person. Often small service business. Owner receives any profits, suffers and losses and is personally liable for debts. Person can borrow from bank to start business. Owner and business treated as one and the same. Therefore unlimited liability. Owner may hardly feel any need for accounting info because they do not need to submit accounts to companies house. However, accounting info will be needed by government for tax, bank for purposes of lending and a person intending to buy the business when the owner retires.

General partnership Business is legally regarded as not separate from owners. Except when there are more than one owner. Profits split between both but still have unlimited liability.  Owned by two or more. Often retail and service businesses. Generally unlimited personal liability. Partnership agreement.

Limited company - Ownership divided into shares. Separate legal entity organised under state corporation law. Limited liability. Liability of the owners is limited to their investment in the company. Companies have greater scrutiny of their financial situation - including being legally required to produce annual accounts and submit this to companies house. Private has the word limited in its title. Public has the abbreviation plc. Private is prohibited by law from offering its shares to the public. Public limited company is permitted to offer its shares to public. In return has to satisfy more onerous regulations.

Main financial statements

1. Statement of financial position. What is the accumulated wealth of the business and what form does it take?

2. Income statement (profit and loss account): How much wealth is generated?

3. Statement of cash flow. What cash movement took place?

4. Statement of changes in equity. What changes in capital

Statement of financial position

The statement lists the assets, liabilities and equity of an organisation as of the report date.

As such, it provides a snapshot of the financial condition of a business as of a specific date.

Bank accounting equation is assets = liabilities + equity

Assets must equal the sum of liabilities and equity

Can also be shown as assets-liabilities = equity

Assets and liabilities are the net assets

Assets

Resource a business controls

Provide services or benefits

Can be cash, inventory, trade receivables. etc

Liabilities

Claims against assets (debts and obligations)

Creditors (party to whom money is owed) 

Trade payables, notes payables, salaries and wages payable, etc

Equity

Ownership claim on total assets

Referred to as residual equity

E.g. Ordinary share capital and retained earnings in Laymans terms, equity = the net worth of the business

Income statements

Revenue and expenses are on income statements

Each transaction has a dual effect on the accounting equation

Dividends can only be paid if retained profits are positive

Equity

Investments by shareholders represent the total amount paid in by shareholders for the ordinary shares they purchase

Investment of funds with the intention of earning a return

Revenues result from the business activities for the purpose of earning income

Common sources of revenue are sales, fees, services, commissions and rent.

Dividends are the distribution of cash or other assets to shareholders.

Dividends reduce retained earnings

Expenses are the cost of assets consumed or services used in the process of earning revenue.

Common expenses include salaries expense, rent expense, utilities expense, property tax expense, etc.

Revenue - expenses = profit for the year

If you make a profit for the year, equity goes up.

If you make a loss for the year, equity does down.

Every transactions has 2 effects

Each transaction must be analysed in terms of its effect on:

1. The three components of the basic accounting equation 

2. Specific types (kinds) of items within each component 

The two sides of the equation must be equal 

Double entry bookkeeping

Each transaction has a dual effect on the accounting equation so that equality of assets and liabilities are preserved. 

They are based on the same idea as the accounting equation 

Statement of financial position

At the end of the year, the final balances on all the items can be summed up and presented in the Statement of Financial Position (SoFP)

Remember, that the total assets will equal the total liabilities and equity

Income statement 

Reports profitability of the company’s operations over specific period of time 

Share net profit or loss

Profit 

Difference between a company’s revenues and expenses

Profit is used to

Pay dividends to stockholders

Kept as retained earnings to finance future growth 

Income statement is

Record of income generated and expenditure incurred over a given time period.

Revenue

Sale of goods

Fees for services

Other revenues - interests received, subscriptions

Expenses

Cost of good sold

Selling and admin exp 

Interest expense 

Income tac expense 

Profit or loss for the period

Total revenue for the period - Total expenses incurred in generating that revenue

• Excess of income over expenses: Profit is added to equity

4 issues when preparing income statement

• Accrual concept

• Cost of sales

• Depreciation

• Bad debt

Accrual concept

Accountants divide the economic life of a business into artificial time period

• Generally a month, quarter of a yr