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Accounting summary book partexams 1
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Summary of the book for the first partentamen for Accounting, block 2 Bachelor year 1Business Administration. Can also be used for IBA (is in English)
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AccountingBoek
1 Introducing Financial Accounting
Identify the users of accounting information and discuss the costs and
benefits of disclosure:
Financial accounting: designed primarily for decision makers outside of the
company.
Managerial accounting: designed primarily for decision makers within the
company.
There are many diverse decision makers who use financial information.
o Shareholders & potential shareholders
o Creditors & suppliers
o Managers & directors
o Financial analysts
o Prospective employees, labour unions, customers
The benefits of disclosure of credible financial information must exceed the
costs of providing the information, because it lowers financing and operating
costs (reduces the company’s costs of borrowing)
Disclosure: the act of providing financial information to external users.
Nadelen disclosure:
o Costs; accountants, political
o Disclosing too much information can place a company at a competitive
disadvantage
o Disclosure can raise investors’ expectations about a company’s future
profitability.
Describe a company’s business activities and explain how these activities
are represented by the accounting equation:
To effectively manage a company or infer whether it is well managed, we must
understand its activities as well as the competitive and regulatory environment
in which it operates.
All corporations plan business activities, finance and invest in them, and then
engage in operations. Companies conduct all these activities while confronting a
variety of external forces.
Planning activities strategy: describes how it plans to achieve its goals.
Financing is obtained partly from shareholders and partly from creditors,
including suppliers and lenders. Liabilities are obligations the company must
repay in the future.
Investing activities involve the acquisition and disposition of the company’s
productive resources called assets. Assets provide further benefits to the
company.
Accounting equation: assets (investing) = liabilities (creditor financing) + equity
(owner financing)
Operating activities include the production of goods or services that create
operating revenues (sales) and expenses (costs). Operating profit (income)
arises when operating revenues exceed operating expenses.
o Income = revenues - expenses
Introduce the four key financial statements including the balance sheet,
income statement, statement of change in equity, and statement of cash
flows:
, The four basic financial statements used to periodically report the company’s
progress are the balance sheet, the income statement, the statement of
changes in equity, and the statement of cash flows. These statements articulate
with one another.
The balance sheet reports the company’s financial position at a point in time. It
lists the company’s asset, liability, and equity items, and is typically aggregates
similar items.
o Balance sheet equation: assets = liabilities + equity
The income statement reports the firm’s operating activities to determine
income earned, and thereby the firm’s performance over a period of time.
o Net income: increase in equity after subtracting expenses from revenues.
o Cost of goods sold: important expense that is typically disclosed
separately in the income statement immediately following revenues.
The changes in equity statement reports the changes in the key equity accounts
over a period of time.
o Contributed capital (includes share capital and contributed surplus)
o Retained earnings (includes cumulative net income or loss, and deducts
dividends)
o Other equity
The statement of cash flows reports the cash flows into and out of the firm from
its operating, investing and financing sources over a period of time.
Describe the institutions that regulate financing accounting and their role in
establishing generally accepted accounting principles/practices:
Generally Accepted Accounting Principles/Practices (GAAP) are established
standards and accepted practices designed to guide the preparation of the
financial statements. Each country or jurisdiction has its own GAAP.
International Financial Reporting Standards (IFRS) are set by the International
Accounting Standards Board (ISAB).
IFRS are an attempt to achieve a greater degree of commonality in financial
reporting across different countries. IFRS has been adopted by many countries
and jurisdictions.
Compute to key ratios that are commonly used to assess profitability and
risk - return on equity and the debt-to-equaity ratio
Profitability reveals whether or not a company is able to bring its product or
service to the market in an efficient manner, and whether the market values
that product or service.
Return on equity (ROE) - a measure of profitability that assesses the
performance of the firm relative to the investment made by shareholders
(equity financing)
Return on equity (ROE) is an important profitability metric for shareholders
ROE = net income / average total equity
Solvency refers to the ability of a company to remain in business and avoid
bankruptcy or financial distress.
Debt-to-equity ratio - a measure of long-term solvency that relates the amount
of creditor financing to the amount of equity financing
The debt-to-equity ratio is an important measure of long-term solvency, a
determinant of overall company risk
D/E = total liabilities / total equity
Explain the conceptual framework for financial reporting.
, The conceptual framework includes, among other things, a statement of the objective
of financial reporting along with a discussion of the qualitative characteristics of
accounting information that are important to users.
Objective of general purpose financial reporting provide information about the
reporting entity that is useful to current and potential investors, lenders and other
creditors in making decisions about investing in equity or debt instruments and
providing or settling loans in other forms of credits.
Financial qualitative characteristics if useful financial information are relevance and
faithful representation:
Relevance: accounting information must have the ability to make a difference in
a decision
o Predictive value: the ability of the information to increase the accuracy of
a forecast.
o Confirmatory value: the ability of the information to enable users to
confirm or change prior expectations.
Materiality: entity-specific aspect of relevance based on the nature and/or
magnitude of the items. Information is material if its omission or misstatement
would influence the judgement of a reasonable maker.
Faithful representation: accounting information that is complete, neutral and
free from error
o Complete: a complete depiction includes all necessary descriptions and
explanations for users to understand the item being represented.
o Neutral: the selection of presentation of accounting information must be
free of any bias intended to attain a predetermined result or to induce a
particular mode of behaviour
o Free from error: there are no omissions in the description of the item and
no errors in selecting and applying the process used to produce the
reported information.
Enhancing qualitative characteristic:
Comparability: accounting information should enable users to identify
similarities and differences between sets of economic phenomena.
Verifiability: this characteristic implies that consensus among measures assures
that the information faithfully represented.
Timeliness: the information must be available to decision makers before it loses
its capacity to influence decisions.
Understandability: accounting information should be presented clearly and
concisely so that a knowledgeable reader can understand how it relates to
decision problem at hand.
Underlying assumptions and features:
Going concern: companies are assumed to have continuity in that they can be
expected to continue in operation over time essential for valuing assets and
liabilities.
Reporting frequency: company operations must be reported periodically.
Consistency: information supplied to decision makers should exhibit conformity
from one reporting period to the next with unchanging policies and procedures.
Coast constraint: cost is pervasive constraint on the information that can be
provided.
2 Constructing Financial Statements
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