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Financial accounting - full exam summary
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An in-depth summary of the Financial accounting exam, including terms and definitions. The grade of the course was 9.
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EBE – YEAR 1 – FINANCIAL ACCOUNTINGCHAPTER 1 – ACCOUNTING IN ACTION
- THREE ACTIVITIES → identifying, recording, communicating
o Identifying → finding the economic events relevant to the business
o Recording → record the events to see the history of its financial activities
- Recording = keeping a diary of events
- Communicating = collecting information of interested users by means of accounting
report
o Financial statements
- Accountant has to analyse and interpret the information
o Explain the uses, meaning and limitations of reported data
- Bookkeeping = only recording economic events
- USERS OF ECONOMIC DATA
- Internal users
o Managers = marketing managers, production supervisors, finance directors,
company officers…
o Questions asked by internal users:
▪ Is cash sufficient to pay dividends to SAP shareholders?
▪ What price should Nokia charge to maximize net income?
▪ How much Toyota can pay its employees?
▪ Which Pepsi product line is more profitable?
o Need for information on timely basis
o Managerial accounting → internal reports to make decisions about
companies
- External users
o People/companies outside the company
o They want information about the company
o Investors and creditors
▪ Investors use accounting info to decide whether to buy/hold/sell
ownership
▪ Creditors (suppliers/bankers) use accounting info to evaluate the risk
of granting credit/lending money
o Questions asked by external users:
▪ Is Lenovo earning enough?
▪ How is Disney doing in comparison with Time Warner?
▪ Can Singapore Airlines pay off its debts?
- ETHICS IN FINANCIAL REPORTING
- Steps in analysing ethics cases and situations
o 1. Recognize the ethical situations and ethical issues involved
▪ Using personal ethics
o 2. Identify and analyse the principal elements of the situation
▪ Stakeholders → persons/groups which can be harmed/benefited
▪ What are the responsibilities/obligations of the involved parities?
, o 3. Identify the alternatives + weight their impact on stakeholders
▪ Consider the consequences
▪ Find the best alternative
- ACCOUNTING STANDARDS
- More than 130 counties follow standards referred to as International Financial
Reporting Standards (IFRS)
o Determined by IASB
- Most companies in the US follow standards issues by the FASB referred to as
generally accepted accounting principles (GAAP)
- The differences between IFRS and GAAP has been reduces → convergence
- MEASUREMENT PRINCIPLES
- Used by IFRS
- Accounting information has to be relevant and have faithful representation
o Relevance → information is capable to make a difference in a decision
o Faithful representation → number and descriptions are factual
- 2 principles
- Historical cost principle
o Dictates that companies record asset at their cost
o Same cost as when purchased
- Fair value principle
o Liabilities should be reported at their fair value
o The actual price
- ASSUMPTIONS
- Monetary unit assumption
o Requires that companies include in accounting records only transaction data
that can be expressed in money terms
o Using historical cost principle
o Some relevant information are not used (e. quality of service)
- Economic entity assumption
o Any organisation or unit in society
o Activities of the entity are kept separate from the activities of its owner and
all other economic entities
o Eg. The owner of a shop keeps his living expenses separate from the expenses
of his business
- Proprietorship
o Business owned by one person
o Small businesses
o Usually small amount of money is needed to start
o For accounting purposes the living expenses and expenses of the business
have to be separated
- Partnership
o Two or more people – more than one owner
o Initial invenstments, duties of each partner, division of net income…
o The partnership transactions has to be separated from personal activities
, o Retail/service businesses (lawyers, doctors, accountants)
- Corporation
o Separate legal entity
o Shareholders – limited liability(not personally liable for the debts)
▪ Ownership can be transferred
o Corporation can have unlimited life
o Usually bigger
THE ACCOUNTING EQUATION
- Assets = Liabilities + Equity
- Assets
o Resources a business own
o Characteristic – the capacity to provide future services or benefits
o Example: Pizza restaurant: assets – tables, chairs, cash register, cash…
- Liabilities
o Claims against assets
o Debts and obligations
o Example: Pizza restaurant
▪ Has to purchase ingredients → accounts payable
▪ Has a loan → note payable
▪ Salaries and wages payable and sales and real estate taxes payable to
the local government
- Equity
o The ownership claim on a company´s total assets is equity
o Total assets minus total liabilities
o Residual equity → the “left over”
- Share Capital – Ordinary
o Company can obtain funds by selling shares to investors
o The amounts paid in by shareholders for the ordinary shares they purchase
- Retained earnings
o Determined by → revenues, expenses and dividends
o Revenues
▪ Gross increases in equity resulting from business activities
▪ Selling products, providing services…
▪ The effect of revenues is positive → increase in equity coupled with an
increase in assets/decrease in liabilities
o Expenses
▪ Costs of assets consumed/services used in the process of earning
revenue
▪ Decreases in equity
▪ The effect is negative → decrease in equity coupled with decrease in
assets/increase in liabilities
▪ Example: ingrediences, wages..
o Dividends
, ▪ The distribution of cash or other assets to shareholders
▪ Reduce retained earnings
▪ But they are not expenses
ANALYSING BUSINESS TRANSACTIONS
- Accounting transactions
o Business´ economic events recorded by accountants
o External/internal
▪ External → between a company and some other enterprise
• Rent, buying supplies
▪ Internal → events within a company
• Use of cooking and cleaning supplies
o If an asset is increased → there must be a corresponding
▪ Decrease in another asset
▪ Increase in a specific liability
▪ Increase in equity
- Transaction analysis
o Equity has two parts → Share capital – ordinary and retained earnings
▪ Share capital – ordinary → company issues new shares in exchange for
cash
▪ Retained earnings → when company earns revenue/incurs
expenses/pays dividends
o Example: app development company Softbyte SA
1. They invest 15000 cash in the business in exchange for 15000 of ordinary shares
a. Increase in assets and equity
2. They purchases equipment for 7000 cash
a. Equal increase and decrease in assets → they make use of the equipment
b. Everything remains 15000
3. They purchase things for 1600 (allowed to pay in October)
a. Assets increase because of the expected future benefits and liabilities
increase by the amount of money due
b. Total assets are now 16600
4. SA receives 1200 cash from consumers
a. Represents service revenue
b. Total assets are now 17800
5. SA receives a bill for 250 (until later date)
a. Increase in liabilities and decrease in equity
b. Total assets stays 17800
6. SA performs 3500 app development service, receives cash of 1500 and it bills the
balance of 2000 on account
a. Equal increase in assets and equity
b. Total assets are now 21300
7. SA pays: 600 rent, 900 salaries, 200 utilities
a. Equal decrease in assets and equity
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