Chapter 1: Financial reporting and Accounting Standards
The essential characters of accounting are:
- The identification, measurement, and communication of financial information
- About economic entities
- To interested parties.
Financial accounting is the process that culminates in the perpetration of financial reports on
the enterprise for use by both internal and external parties.
Managerial accounting is the process of identifying, measuring, analyzing and
communicating financial information needed by management to plan, control and evaluate a
company’s operation.
The most important financial statements are:
- Statement of financial position (balance)
- The income statements.
- The statement of cashflow
- The statement of changes in equity
For investors to decide where to invest in, they are interested in assessing the company’s
ability to generate net cash inflows and management’s ability to protect and enhance the
capital provider’s investment.
Accrual-basis accounting ensures that a company records events that changes its financial
statements in periods in which the events occur, rather than only in the periods in which it
receives or pays cash.
Due to the size and the number of fraudulent reporting cases, some question whether the
accounting profession is doing enough. The expectations gap: what the public thinks
accountant should do and what accountants think they can do, is difficult to close. It is also a
company’s obligation to detect fraud.
A reporting entity is an entity that is required (or chooses) to prepare financial statements.
Requirement in the Netherlands:
- IFRS: Listed firms report consolidated financial statements in accordance with IFRS.
- Dutch GAAP – Based on the size of the organization:
Micro – (<350k assets; <700k sales; <10 employees): Limited balance sheet
and income statement
Small – (<6m assets; <12m sales; <50 employees): Limited balance sheet and
income statement + audit
Medium – (<20m assets; <40m sales; <250 employees): Limited financial +
management report + audit
, Large – (>20m assets; >40m sales; >250 employees): Full financial statements
+ management report + audit
Chapter 2: Conceptual Framework for financial reporting
Accounting information is useful for decision-making when:
- It is relevant (predicative, confirmatory and materiality); Accounting information is
relevant when it can make a difference in a decision.
- It is faithfully represented (completeness, neutrality and free from error); the
numbers and descriptions need to match what really existed or happened.
Elements of financial statements:
- Asset: A presented economic resource controlled by the entity because of past
events (Machines, accounts receivable).
- Liability: A present obligation of the entity to transfer an economic resource because
of past events (accounts payable, unpaid rent)
- Equity: The residual interest in the assets of the entity after deducting all its liabilities
(eigen vermogen)
- Income: Increases in assets, or decreases in liabilities, that result in increases in
equity, other than those relating to contributions from holders of equity claims.
- Expenses: Decreases in assets, or increases in liabilities, that result in decreases in
equity, other than those relating to distributions to holders of equity claims.
5 basic assumptions of accounting:
- Economic entity assumption: The economic activity can be identified with a particular
unit of accountability (a company keeps its activity separate from its owners and any
other business units).
- Going concern assumption: We expect companies to last long enough to fulfill their
objectives and commitments.
- Monetary unit assumption: Money is the common denominator of economic activity
and provides an appropriate basis for accounting measurement and analysis.
- Periodicity assumption: A company can divide its economic activities into artificial
time periods (monthly, quarterly, and yearly).
- Accrual assumption: transactions that change a company’s financial statement are
recorded in the periods in which the events occur.
We use 4 basic principles of accounting to record and report transactions:
- Measurement: We presently have a ‘mixed attribute’ system in which one of two
measurements principles is used. The most used measurements are based on the
historical and current cost.
- Revenue recognition: This principle requires that companies recognize revenue in the
accounting period in which the performance obligation is satisfied.
- Expense recognition: Companies recognized expenses not when they pay wages or
make a product, but when the work (service) or the product contributes to revenue.
- Full disclosure: The nature and amount of information included in financial reports
reflects series of judgmental trade-offs.
, 2 types of measurement principles:
- Historical costs principle: what did we pay in the past?
o Disadvantage: No consideration of current value.
- Current value principle reflects conditions of asset/liability o the measurement date.
o Fair value: Price that would be received to sell an asset or paid to transfer a
liability.
o Value in use/fulfilment value: The present value that a company expects to
derive from the use of an asset. (You use this method for example when a
company uses a machine no other company has)
o Current cost: The costs on an asset at the measurement date, plus the
transaction costs that date.
Recognitions: the process of capturing for inclusion in the statement of financial position or
the statement of financial performance an item that meets the definitions of an asset, a
liability, equity, income, or expenses.
Derecognition: The removal of all or part of a recognized asset or liability from an entity’s
statement of financial position
In deciding what information to report, companies follow the general practice of providing
information that is important to influence the judgment and discission of an informed user.
The full disclosure principle recognize that the nature and amount of information included in
financial reports reflects a series of judgmental trade-offs.
Cost constraint: Companies must weigh the costs of providing the information against the
benefits that can be derived from using it.
Chapter 3: The accounting information system
Basis terminology:
- Real/permanent accounts are assets, liabilities, and equity accounts; they appear on
the statement of financial position.
- Nominal/temporary accounts are revenue, expense, and dividend accounts; expect
for dividend, they appear on the income statement. Companies periodically close
nominal accounts.
The accounting information system:
1. Transactions
2. Journalizing and posting T-accounts.
3. Trial balance: A list of accounts and their balances at a given time. A company
usually prepares a trial balance at the end of an accounting period.
4. Adjusted entries: For revenues to be recorded in the period in which services are
performed and for expenses to be recognized in the period in which they are
incurred, companies make adjusting entries.
