Business Economics- Bachelor 1: Financial Accounting summary
Financial accounting Chapter 1: conceptual framework and financial statements
Accounting vocabulary p 31-32 textbook
1. Accounting ( Language of business)
Accounting -> An information system that identifies, measures, records, summarizes, and
reports economic information (from business activities) to decision makers in the form of
financial statements. Accounting helps companies (shareholders) make decisions
Accounting is the language of communication in all business, the better we understand
this language, the better we can understand finances, businesses, investments.
Business decisions -> shareholders/potential investors make decisions (hold/buy/sell
investment). They asses stewardship/accountability of company’s management and the
profitability, efficiency, liquidity, cash flows.
Decision makers: Accounting information useful to anyone who makes decisions that
influence business activities and have economic results.
- Investors/shareholders -> want to know if company is a good investment with
adequate returns/ own part of company to make a profit.
- Creditors ( bank/suppliers) -> want to know if they should extend credit, how much
and for how long (there are risks)
- Government agencies -> tax collection, statistics
- Employees -> want to know if company is able to provide job security/ good salary
- Clients -> rely on after sales (not possible if company is bankrupt).
- The public -> to do research.
2. Financial accounting <-> management accounting ( 2 perspectives of accounting)
Financial accounting -> focuses on specific needs of decision makers external to the
organisation (shareholders, suppliers, bank).
The primary objective of financial reporting is to provide information useful for making
investments and credit decisions.
Management accounting -> serves internal users like top executives, management,
administrators within organizations (budgets, projections)
Externally disseminated financial statements have to be drawn up by reference to
- A set of accounting rules (GAAP= Generally Accepted Accounting Principles) ->
different depending on the jurisdiction and the form of business organization. This
course focuses on the rules issued by the International Accounting Standards Board
(IASB) – International Accounting Standards/International Financial Reporting
Standards (IAS/IFRS), including a Conceptual Framework.
3. Conceptual framework
Foundation for resolving big issues in accounting. The focus is on general purpose
financial statements.
States that the objective of financial reporting -> to provide financial information that is
useful to existing/potential investors, lenders, creditors
Qualitative characteristics to describe attributes that will make the information provided
in financial statements useful to users -> if the financial information is useful, it must be
relevant and faithfully represent what it is suppose to represent -> fundamental
qualitative characteristics. Information that is relevant/faithfully represented may be
, further enhanced if it is comparable, verifiable, timely und understandable -> enhancing
qualitative characteristics.
We prepare financial statements on accrual basis*.
4. Various forms business organization
Proprietorship -> one owner ( proprietor) , Personally liable ( if company goes bankrupt,
the personal belongings are taken away)
Partnership -> two/more owners, general partners are personally liable, limited partners
not. Not a taxpaying entity -> each partner takes proportionate share of entity’s taxable
income.
- Limited-liability partnerships (LLPs) -> each partner is liable for debts to the extend of
the investment in the partnership -> but they must have one general partner with
unlimited liability.
Corporation -> shareholders, generally many owners, not personally liable (only parts of
company can be taken away) ex. PLC, NV. Ability to raise capital from issuance/shares to
public. Formed under relevant legislations extant in country of incorporation.
5. Financial statements
Business documents that companies use to report the results of their activities to various
user groups (managers/investors) -> use reported information to make decisions.
The primary questions about an organization’s success that decision makers want to
know are (4 questions)
6. What are we accounting for?
Elements of financial statements:
- Assets
- Liabilities
- Equity
- Income
- Expenses
7. Balance sheet
Snapshot at one point in time in the life of a business. Assets on the left, liabilities +
owners’ equity on the rights -> should always be equal.
The Balance sheet equation -> Assets = liabilities + Owners Equity or Assets – Liabilities
= Owners Equity.
, Double entry accounting = recording method whereby at least two accounts are always
affected by each transaction
An account = a summary record of the changes in a particular asset, liability or owners’
equity during a period
Current assets -> To be converted to cash, sold or consumed during the next 12 months/
Current liabilities -> Short-term payables (within the next 12 months).
Companies need a way to measure performance over discrete time periods -> most
popular period to measure income -> calendar year, many companies use fiscal year ->
ends on other date than 31 December, usually at low point in business activity.
IASB conceptual Framework includes a.o. directives with regard to how and when to
recognize items.
- Probable that any future economic benefit associated with the item will flow to or
from the entity (existence)
- The item has a cost/value that can be measured with reliability (measurement)
8. Income statement
Part of the statement of comprehensive income;
Overview of how the company did over a certain amount of time.
The Income Statement is used to show the revenues (sales, not same as profit) generated
and the expenses incurred over one financial year.
Moving picture of events over span of time -> explains changes that have taken place
between balance sheet dates.
9. Revenues and expenses
Expenses need to be deducted from sales price -> net income (positive or negative) for
shareholders in a direct form or dividends, you can also retain it into the company.
Profit = Income (revenue and gains) – expenses (expenses and loses)
, Retained earnings -> net income that you didn’t give to shareholders. Cumulative
revenues - cumulative expenses.
Retained income -> additional owners’ equity generated by income or profits. Dividends
are NOT expenses -> result of revenue generation process.
Revenues increase owners’ equity. Expenses decrease owners’ equity.
10. Accrual Basis and Cash Basis
Most common ways of measuring income.
Cash basis -> recognizes the impact of transactions only when cash is received or
disbursed
*Accrual basis -> recognizes the impact of transactions for the time periods when
revenues and expenses occur even if no cash changes hands
Accrual or cash Basis? -> Accrual basis is the current accounting standard for the
measurement of income -> presents a more complete summary of what happened
during the year as it reports more than only cash transactions, represents best economic
reality. Retained earnings is not a pot of gold !
Accrual accounting records cash transactions -> collection cash from customers,
borrowing money, paying of loans, issuing shares. They also record noncash transactions
-> sales on account, depreciation expense, accrual of expenses incurred but not yet paid.
Revenue is recognized either over time or at a point in time
- At a point in time -> The entity has a present right to payment for the asset, the
costumer has legal title to the asset, the entity has transferred physical possession of
the asset, the customer has the significant risks and rewards related to the
ownership of the asset and the customer has accepted the asset.
- Over time -> The customer simultaneously receive and consumes all of the benefits
provided by the entity as the entity performs, the entity’s performance creates or
enhances an asset that the customer controls as the asset is created or the entity’s
performance does not create an asset with an alternative use to the entity’s and the
entity has an enforceable right to payment for performance completed to date.
11. Accrual Basis
Revenue recognition principle: Under the accrual basis revenues are
recognized/recorded when
- Transfer/earned -> goods are delivered or a service is performed
- Realized -> cash or a claim to cash is received in exchange for goods or services.
- For example -> A sale on account is recorded as revenue when the good are
delivered even though the seller receives no cash at that moment or Suppliers are
sent to customers throughout the month (trail), but the cash is not received until the
customer formally promises to accept the supplies and pay for them (if you pay up
front, revenue not recognized before goods are delivered, company has liability until
goods are delivered.
