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Summary - Financial Reporting and Auditing
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- Vrije Universiteit Brussel (VUB)
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SAMENVATTINGFINANCIAL REPORTING AND AUDITING
FINANCIAL REPORTING
CHAPTER 1: BASIC ACCOUTING TECHNIQUES
ACCOUNTING: THE LANGUAGE OF BUSINESS
Accounting = process of identifying, recording, summarising, and reporting economic information transactions to decision
makers in the form of financial statements.
We use accounting to be able to summarise financial information into financial statements for the benefit of users such as
stakeholders.
USERS OF FINANCIAL INFORMATION
Accounting information is useful to anyone who makes decisions that influence business activities and have economic results.
Some of the main stakeholders who would be interested in the economic information about how a company is doing, are:
- Investors/shareholders: they would want to know if a company is a good investment with adequate returns
- Creditors (banks, suppliers = short-term creditors) want to know if they should extend credit and how much to extend,
for how long.
- Clients would want to know if they can rely on proper after sales service.
- (Future) Employees who want to know if the company is able to provide job security and a good salary.
- Government agencies for tax collection purposes, grants or statistics
- The public
- …
FINANCIAL ACCOUNTING VS MANAGEMENT ACCOUNTING
The major distinction between financial and management accounting is the users of the information.
- Financial accounting focuses on the specific needs of decision makers that are external to the 1 organisation, such as
shareholders, suppliers, banks, and government agencies.
- Management accounting serves internal users, such as top executives, management, and administrators within the
organisation for a.o. budgets, forecasts, projections, …
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, INTERNATIONAL ACCOUNTING STANDARS (IAS) INTERNATIONAL FINANCIAL REPORTING STANDARDS (IFRS)
Annual financial statements – IAS:
The primary questions about an organisation’s success that decision makers want to know are:
THE BALANCE SHEET
The balance sheet = snapshot at one point in time in the life of a business.
Assets are the resources of the firm that are expected to produce a benefit in the future. They increase or cause future cash
flows (everything the firm owns).
The balance sheet equation:
- Entity approach: Assets = Liabilities + Owners′ equity
- Proprietary approach: Assets − Liabilities = Owners′ equity
The balance sheet equation is the basis for double-entry accounting which is a recording method whereby at least two
accounts are always affected by each transaction.
An account = summary record of the changes in a particular asset, liability or owners’ equity during a period.
Not every set of financial statements is the same because every business is a little different – this slide shows you the types of
line items you might see for each of these Balance Sheet categories. There are also often Off Balance Sheet transactions that
occur, take a lease for example. Companies aren’t required to put them on their balance sheet because they do not own it. It is
important to note that we have to look at these off-balance sheet transactions and make adjustments to incorporate them – in
order to get a realistic picture of value.
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, CURRENT AND NON-CURRENT ASSETS: IASB DEFINITONS AND FORMAT
While most manufacturers have operating cycles of several months, a few industries require very long processing times. This
could result in an operating cycle that is longer than one year. To accommodate those industries, the accountants' definitions
of current assets and current liabilities include the following phrase: ...within one year or within the operating cycle,
whichever is longer. (AccountingCoach.com)
The operating cycle is the time span required for a company to receive inventory, sell the inventory and collect cash from the
customers. Operating cycle = average inventory period + average collection period
ASSETS – ACCORDING TO IAS/IFRS (conceptual framework)
An asset = an economic resource that the company controls at the reporting date as a result of a past event.
- An economic resource = a ‘right’ that has the potential to produce economic benefits.
o It has to have the capacity to contribute directly/indirectly to the company’s future cash flows.
▪ Capacity expenditure
▪ Investment to save costs
▪ Right to use a service
▪ Direct claim to cash inflow
▪ Cash on hand
o There has to be a degree of certainty that the future flow of economic benefits will arise. There is no
minimum probability level, but a reasonable level should be obtained.
- Controls:
o Obtain substantially all of the economic benefits
o Direct use of the resource; decision making right
o Mostly via legal ownership (eg. purchase), but not necessarily. Substance over form (eg. leasing).
- Past event: Mostly via exchange with third parties (cash/credit)
- Measurement = ability to express the asset in monetary terms (cost/value).
o It should be readily available via eg. Purchase contract/invoice.
o But the measurement is not always readily available, then an estimation is needed (based upon future cash
flows). You should obtain a reasonable level of certainty.
Once an item has an existence certainty (at a reasonable level) and a measurement certainty (at a reasonable level), it should
be recognised as an asset.
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, LIABILITIES – ACCORDING TO IAS/IFRS (conceptual framework)
A liability = an obligation to transfer an economic resource as a result of a past event. Existence is a reasonable certainty
Measurement is the ability to express the liability in monetary terms. Measurement is a reasonable certainty.
→ Recognise the liability.
ANNUAL FINANCIAL STATEMENTS
Companies need a way to measure performance over discrete time periods. The most popular period for measuring income is
the calendar year, but many companies use a fiscal year, which is a year that ends on a date other than December 31, usually
at the low point in annual business activity. Companies will also prepare statements for interim periods, generally on a
quarterly or monthly basis.
THE INCOME STATEMENT
The income statement provides a moving picture of events over a span of time and explains the changes that have taken place
between balance sheet dates. The income statement is used to show the (sales) revenues generated and the expenses
incurred over one financial year.
OPERATING EXPENSES
Operating expenses can be categorised by nature, the type of expense. It gives an
overview of added value created by the company in transforming raw materials into
finished goods and selling it to outside parties.
Operating expenses can be categorised by function, the activity to which the expense is assigned. If you look at this portrayal
of an Income Statement, you see that there are many claims on revenue.
- Cost of Goods Sold (COGs): material cost, labor cost associated with generating the material, and production cost
- Selling, General & Administrative (SG&A): all back office expenses: marketing, HR, IT, accounting/finance – when we
talk about outsourcing, we are talking about improving SG&A – our sweet spot with SG&A is outsourcing.
- Interest Expense: claim by debt investor on revenue
- Taxes: this is the government’s claim
- Net Income (NI): the return to the equity holder: theoretically, equity investor has 2 choices, take as a dividend, or
reinvest in the business – where the NI goes back to the Balance Sheet in Retained Earnings
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