Accounting
Chapter 1: Introducing Financial Accounting
Demand for accounting information
Accounting: the process of recording, summarizing and analysing financial transactions.
- Financial accounting: designed primarily for decision makers outside of the company
o Information about company profitability and financial health
- Managerial accounting: designed primarily for decision makers within the company
o Information about profitability of specific products, divisions, or customers.
Who uses Financial Accounting Information?
- Shareholders and Potential Shareholders
Corporation: A form of business organization that is characterized by a large number of
owners who are not involved in managing the day-to-day operations of the company.
Shareholders: the owners of a corporation, managers can own shares in the corporation, but
not all shareholders are managers.
Sole proprietorship: single owner who manages the daily operations.
Partnership: two or more owners who are also usually involved in managing the business.
Advantage of corporation over sole proprietorship / partnership is the ability to raise large
amounts of cash by issuing shares and bonds.
- Creditors and Suppliers
Creditors: Banks or other lenders.
o Interested in the borrower’s ability to repay. Use financial statements to help
determine loan terms, loan amounts, interest rates, and collateral.
Suppliers: A business or person that make goods available to another business or service.
o Use financial statements to establish credit sales terms and to determine their
long term commitment to supply-chain relationships. Suppliers often justify
an expansion of their businesses based on the growth and financial health of
their customers.
, - Managers and Directors
In most companies, management is compensated based on the financial performance of the
company. They often receive cash bonuses, shared of the company, or other incentive
compensation that is linked directly to the information in the financial statements.
- Financial Analysts
Their analysis helps to identify and assess risk, forecast performance, establish prices for
new issues of shares, and make buy or sell recommendations to investors.
- Other Users of Financial Accounting Information
o Prospective employees, to learn about the company before interviewing for
or accepting a job
o Labour unions, to assess the financial health of firms prior to negotiating
labour contracts on behalf of the employees
o Customers, to assess the ability of a company to deliver products or services
and to assess the company’s long term reliability
o Tax agencies, to help establish and implement tax policies
o Government agencies, to develop and enforce regulations.
Costs and Benefits of Disclosure
Disclosure: the act of providing financial information to external users.
Benefits:
It lowers financing and operating costs. Reduces cost of borrowing.
Costs:
Hiring accountants and preparing financial statements. Being imposed by competitors. Not
meeting raised expectations.
Business Activities
Businesses produce accounting information to help develop strategics, attract financing,
evaluate investment opportunities, manage operations, and measure performance.
All corporations plan business activities, finance and invest in them, and then engage in
operations.
Planning activities
A company’s goals and the strategies adopted to reach those goals are the product of its
planning activities. A company’s strategic (business) plan describes how it plans to achieve
its goals. The plan’s success depends on an effective review of market conditions. The plan
must also include competitive analyses, opportunity assessments and considerations of
business threats. Most information is proprietary and guarded closely by managements, but
outsiders can fain insights through media etc.
,Investing activities
Acquiring and disposing of assets (resources needed to produce and sell a company’s
products and services). These resources provide future benefits to the company. Companies
differ on the amount and mix of these resources.
- Short term assests: less than a year.
o Inventory
- Long term assests: more than a year.
o Buildings, cars etc
Financing activities
The methods companies use to fund those investments.
Companies obtain financing from two sources:
- Equity financing: the funds contributed to the company by its owners along with any
income retained by the company.
- Creditor financing: funds contributed by non-owners, which creates liabilities
(obligations the company must repay in the future).
Accounting equation
Operating activities
The production, promotion and selling of a company’s products and services. These activities
extend from input market (suppliers) to the output market (customers). Input markets
generate operating expenses (costs) and output markets generate operating revenues
(sales). Output markets also generate some operating expenses such as marketing and
distributing products and services.
When the revenues exceed the expenses, companies report operating income / profit /
earnings.
When the expenses exceed the revenues, companies report operating losses.
Financial Statements
Financial statements and the accompanying footnotes provide information of the risk and
return associated with owning shares in the corporation, and they reveal how well
management has performed. They provide valuable insights into future performance.
Financial statements are typically required when a business requests a bank loan.
, Four financial statements are used to periodically report on a company’s business activities:
1. Statement of financial position (balance sheet), which lists the company’s
investments and sources of financing using the accounting equation.
2. Income statement, which reports the results of operations. (winst en verlies)
3. Statement of changes in equity, which details changes in owner financing.
4. Statement of cash flows, which details the sources and uses of cash.
Balance sheet (statement of financial position / statement of financial condition)
Reports a company’s financial position at a point in time. Summarises the result of the
company’s investing and financing activities by listing amounts for assets, liabilities, and
equity.
