Financial Accounting with International Financial Reporting Standards
Financial Accounting 1 (FA1) class notes from lectures given by Victor Maas. The notes are 59 pages and includes all the lectures covered in the course 6011P0224Y at UvA.
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Financial Accounting with International Financial Reporting Standards
Lecture 1: Introduction ___________________________________________________________________ 2
Lecture 2: The Recording Process ___________________________________________________________ 4
Lecture 3: The Accounting Cycle ____________________________________________________________ 7
Lecture 4: Accounting for Merchandising Operations __________________________________________ 12
Lecture 5: Inventories ___________________________________________________________________ 17
Lecture 6: Cash and Receivables __________________________________________________________ 20
Lecture 7: Non-Current Assets ____________________________________________________________ 26
Lecture 8: Liabilities ____________________________________________________________________ 32
Lecture 9: Equity and the Structure of Corporations ___________________________________________ 39
Lecture 10: Investments (Financial Assets) __________________________________________________ 44
Lecture 11: A Closer Look at Other Financial Statements, Including the Statement of Cash Flows _______ 49
Lecture 12: Financial Statement Analysis ____________________________________________________ 55
,Financial Accounting with International Financial Reporting Standards
Lecture 1: Introduction
• Accounting is a way of systematically tracking everything that goes on in an organisation and to be
able to know at any point in time what the value of the organisation is.
o Accounting: identifying, recording and communicating an organisation’s economic events
to interested users.
• Organisations that use accounting → companies (from sole proprietorship to huge conglomerates),
non-profit organisations, government organisations
• Sole proprietorships – legally there is no difference between the owner and the company
o No distinction between private money and company money
o Proprietors have unlimited liability for all debts of their company
o Profit is private incomes
• Partnerships – two owners
o Common in professional services (lawyers, medics, accountants)
• Corporations – there is a separation between ownership and management and decision-making
rights
o Private corporation – few owners and certain regulations about selling shares
o Public corporation – everyone and anyone can buy and sell ownership shares
o Corporation is a legal entity → it can own things and owe things
▪ The corporation can buy a good and borrow money from a bank
o Formal separation of ownership and decision making
o A corporation is owned by one or more owners
▪ Owners have limited liability
▪ Each owner owns a percentage of the corporation
▪ Owners can be humans or other corporations
▪ Ownership shares can be transferred
o Owner(s) of corporation own(s) corporation which owns things corporation owns (assets)
o Owner(s) of corporation employ(s) managers who buy and sell corporation’s assets
o Owners of the corporation are not necessarily actively involved in decision making
o Owners (shareholders) invest their money in the corporation with the expectation of
receiving a positive return
o Owners want periodic information about what their share of the corporation is worth
▪ At least once per year; corporations are required to publish an annual report
• The main objective of the company is to create value for the owner
o The value of a company to its owner(s) is called equity
o Note that an increase in equity, is income to the owner
o The value of a corporation to its owners = what the corporation owns – what it owes
• How does the owner know how much value, if any, has been created?
o Necessary to have a system that systemically tracks all the company’s events
• The value of a company after transactions (example: Spicemeup.nl)
o When owner started the company → €25,000 CASH
o Transactions
▪ Storage rent: - €6,000 CASH
▪ Website (made by brother): - €2,000 CASH
▪ GWE expenses: - €4,000 CASH
▪ Computer equipment: - €5,000
▪ Hot sauce: - €10,000
▪ Sold hot sauce that was purchased for €5,000: + €22,000
o What does the owner own now?
▪ Computer equipment, worth €5,000
▪ Hot sauce, worth €10,000 - €5,000 = €5,000 (sold half of the hot sauce)
,Financial Accounting with International Financial Reporting Standards
▪ Website, (subjectivity involved in worth) → €0?
o Cash: €25,000 – 6,000 – 2,000 – 4,000 – 5,000 – 10,000 + 22,000 = €20,000
o What is the value of the firm after one year?
▪ Cash + assets = €20,000 + 5,000 + 5,000 = €30,00
▪ Increase in equity of €5,000
o Ambitious plans and therefore needs €80,000 extra in cash to finance growth plans
▪ One opportunity to start a corporation → this way he can share ownership of the
company with outsiders
▪ The ownership of the new corporation is split in 1,000 shares
• Tom Tabasco, his parents, and an investment firm own Spicemeup.nl BV
which in turn owns cash, equipment and hot sauce
▪ Value of the new corporation = €110,000
• Computer equipment, worth €5,000
• Hot sauce, worth €5,000
• Cash, €20,000 + €80,000 (from investors) = €100,000
▪ So, €110,,000 = €110 per share (and investors bought it for €100 per share)
o After another year the corporation has the following assets
▪ €75,000 cash + equipment worth €40,000 + inventory worth €10,000
▪ In addition, it still needs to pay €5,000 to a supplier in Costa Rica
▪ Value = €75,000 + €40,000 + €10,000 - €5,000 = €120,000
• So, €120 per share
• A euro invested in this corporation has generated a return of 9.09%
• The accounting equation: assets = liabilities + equity
o Assets → what the organisation owns
▪ E.g. cash, inventory, equipment, machines, buildings, patents (exclusive rights),
trademarks, accounts receivable (amounts to be received from customers)
o Liabilities → what the organisation owes
▪ E.g. bank loans, bonds, accounts payable (amounts owed to suppliers), unpaid
salaries (amounts owed to employees), unpaid taxes (amounts owed to the tax
authorities)
o Equity → the value of the corporation to its owners
▪ Equity = assets – liabilities
▪ This equation always holds for any firm at any point in time
▪ The corporation’s equity changes as the corporation does things
• The corporation’s operations affect what it owns and what it owes
o Equity only changes if the total value of what it owns and what it
owes changes
▪ Equity increases when there are revenues or investments by shareholders
▪ Equity decreases when there are expenses or dividends paid to shareholders
o The expanded accounting equation: A = L + SC + ∑(REV – EXP – DIV)
• Economic events → external and internal transactions that affect what the organisation owns
(assets), and/or what the organisation owes (liabilities)
o This includes transactions that do and transactions that do not affect equity
▪ Changes in the value of the firm and changes in how this value is invested in assets
and liabilities
• Company activities result in revenues and expenses
o Revenues: increases in the value of the firm due to the firm’s operations
▪ Common sources → sales, fees, interest, etc.
o Expenses: decreases in the value of the firm due to the firm’s operations; the cost of assets
consumed or services used in the process of earning revenue
▪ Common sources → salaries, rent, utilities, materials, etc.
• Net income: the difference between the revenues and expenses in a period
, Financial Accounting with International Financial Reporting Standards
o The change in the value of a company’s equity in the period due to the company’s
operations in that period
o Total revenue > total expenses → net income
o Total revenue < total expenses → net loss
• The value of a corporation’s equity can change in two different ways
o Operations → daily-basis
▪ Revenues and expenses resulting in a net income (or a net loss)
o Transactions with owners → infrequent
▪ Shareholders can invest in the corporation (buy shares)
▪ Shareholders can be paid by the corporation (dividends)
• Two main components of owner’s equity
o Share capital-ordinary (“paid-in capital”) → old equity → invested by shareholders
▪ Amount that shareholders have invested in the corporation
o Retained earnings → new equity → generated by operations
▪ Income from previous periods not (yet) paid out as dividends
▪ The sum of all the revenues minus all the expenses since the firm was established,
minus what has been paid out in the form of dividends.
• Bookkeeping: the process of identifying and recording transactions
o Each transaction has a dual effect on the accounting equation
• Interested users in accounting information
o Owners, potential owners, creditors (e.g. banks), suppliers, customers, non-profit
organisations, government agencies (Chamber of Commerce, tax authorities), managers
and employees
• Types of accounting
o Identifying and recording economic events and communication information to
▪ Users outside the organisation (including owners) → financial accounting
▪ Users inside the organisation → management accounting
o Financial accounting is subject to laws, regulations and standards
▪ Management accounting is not
▪ In most countries, organisations are required by law to periodically publish specific
financial statement for outside users (at least annually in “annual reports”)
o Financial statements
▪ Annual reports contain several financial statements
• Statement of financial position/ balance sheet
• Income statement
• Comprehensive income statement
• Retained earnings statement
• Statement of cash flows
o Management accounting reports
▪ In most large companies, units and divisions also produce financial statements,
which are submitted to company headquarters
▪ Company accountants (“controllers”) produce all sorts of other reports for
managers (ad hoc)
• Firms need to adhere to the International Financial Reporting Standards (IFRS)
Lecture 2: The Recording Process
• The accounting equation: assets = liabilities + equity
o assets = liabilities + (share capital–ordinary + retained earnings)
o assets = liabilities + (share capital–ordinary + revenues – expenses – dividends)
• Two Main Financial Statements
o Statement of Financial Position (aka. Balance Sheet)
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