Summary
Samenvatting Accounting (BT1106)
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This document contains a summary of the book required for the Accounting course.
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Chapter 1 “Introducing Financial Accounting”Accounting = The process of recording, summarising, and analysing
financial transactions. Financial
accounting is designed primarily for decision makers outside of the
company (investors, creditors, suppliers and customers), whereas
managerial accounting is designed primarily for decision makers
within the company (top management).
Demand for financial accounting information derives from numerous users:
Shareholders and potential shareholders
A corporation is a form of business organisation that is characterised by a
large number of owners who are not involved in managing the day-to-day
operations of the company. A corporation exists as a legal entity that issues
shares to its owners in exchange for cash and, therefore, the owners of a
corporation are referred to as shareholders or stockholders. The main
advantage of a corporation over sole proprietorship (single owner) and
partnership (two or more owners), is the ability to raise large amounts of cash
by issuing shares and bonds. Financial statements provide information on the
risk and return associated with owning shares in the corporation, and they
reveal how well management has performed.
Creditors and suppliers
Businesses rely on creditors as well: banks or other lenders who are
interested in the potential borrower’s ability to repay. Furthermore, we have
suppliers, who often justify an expansion of their own business based on the
growth and financial health of their customers. Both creditors and suppliers
rely on financial accounting information to monitor and adjust their contracts
and commitments with the company.
Managers and directors
Publicly traded corporations are required by law to have a board of
directors: they are elected by shareholders to represent shareholder
interests and to oversee management. Both managers and directors use the
published financial statements of other companies to perform comparative
analyses and establish performance benchmarks.
Financial analysts
Financial analysts play an important role in the dissemination of financial
information and often specialise in specific industries. Their analysis helps to
identify and assess risk, forecast performance, establish prices for new issues
of shares, and make buy or sell recommendations to investors.
Disclosure = The act of providing financial information to external users.
Disclosing too much
information can place a company at a competitive disadvantage.
Businesses use accounting information so they can plan business activities,
finance those activities, invest resources (assets) in those activities, and then
engage in operating activities.
Equity financing = The funds contributed to the company by its owners
along with any income
retained by the company.
Creditor financing = The funds contributed by non-owners, which create
liabilities: obligations
the company must repay in the future, e.g. a bank loan.
Whereas creditor
, financing has a legal obligation to repay, usually with interest,
equity financing
does not impose an obligation for repayment.
Accounting equation = Assets (investing) = Liabilities (creditor financing)
+ equity (owner financing)
Operating activities = The production, promotion, and selling of a company’s
products and services.
Equity is the difference between the value of the assets and
the value of the
liabilities of something owned.
Four financial statements are used to periodically report on a company’s business
activities:
Statement of financial position (balance sheet)
Lists the company’s investments and sources of financing using the
accounting equation. A balance sheet reports a company’s financial position
at a point in time.
Income statement
Reports the results of a company’s operating activities over a period of time.
The net income (or loss) can be calculated by subtracting the expenses from
the revenues.
Statement of changes in equity
Reports the changes in the equity accounts over a period of time. Changes
are due to income reinvestment and dividends payment. Dividends are the
rewards from a portion of the company's earnings and is paid to a class of its
shareholders.
Statement of cash flows
Reports net cash flows from operating, investing, and financing activities over
a period of time.
There are three key linkages between the four financial statements:
1. The statement of cash flows links the beginning and ending cash in the
balance sheet;
2. The income statement links the beginning and ending retained earnings in the
statement of changes in equity;
3. The statement of changes in equity links the beginning and ending equity in
the balance sheet.
The generally accepted accounting principles/practice (GAAP) is a set of
standards and accepted practices, based on underlying principles, that are
designed to guide the preparation of the financial statements. GAAP attempts to
strike a balance by imposing constraints on the choice of accounting procedures,
while allowing companies some flexibility within those constraints. The
international accounting standards board (IASB) is an independent
standard-setting body with 16 full-time members. They have worked with
national standard setters to reduce diversity in financial reporting practice and
created the international financial reporting standards (IFRS) that are an
attempt to achieve a greater degree of commonality in financial reporting across
different countries.
To ensure the accuracy and completeness of the financial statements of a
company, publicly traded corporations are required to have their annual financial
statements audited by an independent audit firm. The auditors provide an
opinion as to whether the statements give a fair view of a company’s financial
, condition and the results of its operations in accordance with the required
accounting standards and national laws. However, the audit opinion is not a
guarantee.
Profitability reveals whether or not a company is able to
bring its product or services to the market in anReturn
efficient Net income
on Equity=
manner, and whether the market values that product or Average total equity
service. When the ROE ratio is over 10%, the company is earning reasonable
returns.
Risk associated with investing in or lending to a given Total liabilities
Debt−¿−equity Ratio=
company effects the return demanded by investors.
One of the main factors that contribute to the risk a
Total equity
company faces, is the solvency: the ability of a company to remain in business
and avoid bankruptcy or financial distress. The ratio will be higher if companies
believe they can earn a return above the debt interest cost.
The conceptual framework includes, among other things, a statement of the
objectives of financial reporting along with a discussion of the qualitative
characteristics of accounting information that are important to users.
Chapter 2 “Constructing Financial Statements”
Asset = A resource controlled by a company as a result of past events and
which is expected to
provide the company with future economic benefits. An asset is reported
on the balance
sheet if it satisfies the following two recognition criteria:
1. It is probable that the future economic benefits will flow to the company.
2. It has a cost or value that can be measured reliably.
Companies acquire assets to yield a return for their shareholders. Assets
are expected to
produce revenues, directly or indirectly.
Assets can be presented in order of liquidity, which refers to the ease of
converting noncash assets into cash. We have current and noncurrent assets:
Current assets: assets expected to be converted into cash or used in
operations within the next fiscal year, or within the next operating cycle (e.g.
cash, inventory, marketable securities etc.). Companies require a degree of
liquidity to effectively operate on a daily basis, but they are also expensive to
hold.
Noncurrent assets: assets not expected to expire or be converted into cash
within the next year, or within the next operating cycle (e.g. long-term
financial investments, property, plant, and equipment etc.).
Assets are reported on the balance sheet at their historical cost (original
acquisition cost), which has the advantage of reliability, but the disadvantage of
possible undervalue. Assets reported at fair value have more relevant
information presented in the balance sheet.
Liabilities and equity represent the sources of capital to the company that are
used to finance the acquisition of assets.
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