Financial Accounting: An overview

The content and The qualitative

Recording
purpose of characteristics of
transactions and
financial financial
events
reporting information

The use of double and accounting systems

Preparing a trial balance

Preparing basic financial statements

Interpretation of
Preparing simple consolidated financial
financial
statements
statements
Chapter (1)
Basis of accounting
The purpose of financial reporting
Financial reporting is a way of recording, analyzing and summarizing financial data.

Financial data is the name given to the actual transactions carried out by a business e.g.
sales of goods, purchases of goods, payment of expenses.

Recording Analyzing Summarizing

Source General Trial

Day Book
Document Ledger Balance
Different Types of businesses

What is business?
Businesses of whatever size or nature exit to make profit.

Types of business

Sole Trader Limited Liability

Partnership
Company
 One person owns and  Two or more persons owns  Shareholders and a
runs the business. and runs the business. number of appointed
 The sole trader and the  The partners and the directors own and run the
business are legally the business are legally the business.
same entity and therefore same entity and therefore  A company is a legal
the sole trader is the partners are jointly entity in its own right, and
personally liable for any liable for any business therefore the shareholders
business debts. debts, unless it is a limited only have limited liability
liability partnership (LLP). for any business debts.
 Types of
Partnership

General Limited Limited Liability

Partnership (GP) Partnership (LP) Partnership (LLP)

 Not separate  Separate + Not  Separate

Separate
 All partners are  All partners are
personally liable  Some partners not personally
for business are personally liable for
debts. liable for business debts
business debts
while some are
not.
 Advantages and Disadvantages of Sole Traders
Advantages Disadvantages

This type of structure is ideal if the  Owner is personally liable for all debts
business is not complicated, and (unlimited liability).
especially if it does not require a great  Personal property may be vulnerable
deal of outside capital. Advantages for debts and other business liabilities.
include:  Large sums of capital are less likely to
 Limited paperwork and therefore cost be available to a sole trader, leading
in establishing this type of structure. to reliance on overdrafts and personal
 Owner has complete control over the savings.
business.  May lead to long working hours
 Owner is entitled to profits and the without the normal employee
ownership of assets. recreation leave and other benefits.
 Less stringent reporting obligations  May be issues of continuity of business
compared with other business in the event of death or illness of the
structures – no requirement to make owner.
financial accounts publicly available,
no audit requirement.
 Can be highly flexible.
 Advantages and Disadvantages of Partnerships
Advantages Disadvantages

 Less stringent reporting obligations –  Partners are jointly personally liable for
no requirement to make financial all debts (unlimited liability) unless they
accounts publicly available, no audit have formed a limited liability
requirement, unless the partnership partnership.
has LLP status.  There are costs associated with setting
 Additional capital can be raised up partnership agreements.
because more people are investing in  There may be issues of continuity of
the business. business in the event of death or illness
 Division of roles and responsibilities of the partners.
and an increased skill set.  Slower decision making due to the
 Sharing of risk and losses between need for consensus between partners.
more people.  Unless a clause is written into the
 No company tax on the business original agreement, when one partner
(profits are distributed to partners and leaves, the partnership is
then subject to personal tax). automatically dissolved and another
agreement is required between
existing partners.
Advantages and Disadvantages of Limited Liability Companies
Advantages Disadvantages

 Limited liability makes investment less  Limited liability companies have to

risky than being a sole trader or investing
in a partnership. publish annual financial statements.
 Limited liability makes raising finance
 Limited liability companies’ financial
easier (e.g. through the sale of shares)
and there is no limit on the number of statements have to comply with legal
shareholders.
 A limited liability company has a and accounting requirements. In
separate legal identity from its particular, the financial statements
shareholders. So a company continues
to exist regardless of the identity of its have to comply with accounting
owners. standards.
 There are tax advantages to being a
limited liability company. The company  The financial statements of larger
is taxed as a separate entity from its
limited liability companies have to be
owners and the tax rate on companies
may be lower than the tax rate for audited.
individuals.
 It is relatively easy to transfer shares from  Share issues are regulated by law.
one owner to another.
Different Types of Accounting

Financial Management
Accounting Accounting

 Financial accounting is mainly a  Management (or cost) accounting is a

method of reporting the financial management information system
performance and financial which analyses data to provide
position of a business. It is not information as a basis for managerial
primarily concerned with action. The concern of a
providing information towards the management accountant is to present
more efficient running of the accounting information in the form
business. most helpful to management.

 Report – External / Shareholders  Report – Internal / Management

 Information – Historical information  Information – Past/ Present / Future
 Timing – Quarterly / Yearly  Timing – Monthly (at least)
Users’ and stakeholders' needs
The objective of financial statements is to provide information about the
financial position, performance and changes in financial position of an entity
that is useful to a wide range of users in making economic decisions.

Users of financial
statements
 Management
 Investors and potential
investors different users have
 Employees and trade different needs
union representatives
 Lenders
 Government agencies
 Suppliers
 Customers
 Competitors
 The public
Corporate Governance

Corporate governance is the system by which companies and other entities

are directed and controlled. Good corporate governance is important
because the owners of a company and the people who manage the
company are not always the same, which can lead to conflicts of interest.

Those charged with governance of a company are responsible for the

preparation of the financial statements.
The main elements of financial reports
Accounting
Principal Financial Equation
Statements Asset
=
Capital
+
Statement of Statement of Liability
profit or loss financial position

 Income: An income is increases in economic  Asset: An asset is a resource controlled by

benefits during the accounting period in the the entity as a result of past events and from
form of inflows or enhancements of assets or which future economic benefits are
decreases of liabilities that result in increases expected to flow to the entity.
in equity, other than those relating to  Liability: A liability is an obligation arising from
contributions from equity participants. a past transaction or event which is
 Expense: An expense is an outflow of expected to be settled by an outflow of
economic benefit in an accounting period economic benefit.
as a result of the using up of resources or a  Equity: Equity is the residual interest in the
fall in the value of an asset assets of the entity after deducting all its
liabilities.
Chapter (2)
The regulatory framework
The following factors that have shaped financial accounting can
be identified.
 National/local legislation
 Accounting concepts and individual judgment
 Accounting standards
 Other international influences
 Generally accepted accounting principles (GAAP)
 Fair presentation
 IFRS Foundation

Report The IASB develops IASs / IFRSs.

The main objectives of the IFRS
Foundation are to raise the
IFRS Advisory Council IASB
Advise standard of financial reporting
and eventually bring about global
The IFRS Advisory Council is harmonization of accounting
essentially a forum used by the IASB Report standards.
to consult with the outside world.
IFRS Interpretations
Committee

The IFRS Interpretations Committee (formerly called as

IFRIC) was set up in March 2002 and provides guidance
on specific practical issues in the interpretation of IFRSs.
Chapter (3)
The qualitative characteristics
of financial information
Underlying Assumption

The Conceptual Framework sets out one important underlying assumption for financial
statements, the going concern concept

Going concern. The financial statements are normally prepared on the assumption
that an entity is a going concern and will continue in operation for the foreseeable
future (at least the next 12 months). Hence, it is assumed that the entity has neither the
intention nor the need to liquidate or curtail materially the scale of its operations.
QUESTION

A retailer commences business on 1 January and buys inventory of 20 washing machines,

each costing $100. During the year he sells 17 machines at $150 each. How should the
remaining machines be valued at 31 December in the following circumstances?

a) He is forced to close down his business at the end of the year and the remaining
machines will realize only $60 each in a forced sale.

b) He intends to continue his business into the next year.

ANSWER

a) If the business is to be closed down, the remaining three machines must be valued at
the amount they will realize in a forced sale, i.e. 3 × $60 = $180.

b) If the business is regarded as a going concern, the inventory unsold at 31 December

will be carried forward into the following year, when the cost of the three machines
will be matched against the eventual sale proceeds in computing that year's profits.
The three machines will therefore be valued at cost, 3 × $100 = $300.
Accruals basis

The effects of transactions and other events are recognized when they occur (and not as
cash or its equivalent is received or paid) and they are recorded in the accounting records
and reported in the financial statements of the periods to which they relate.

According to the accruals assumption, in computing profit revenue earned must be

matched against the expenditure incurred in earning it. This is also known as the matching
convention.

Consistency

It refers to the use of the same methods for the same items (i.e. consistency of treatment)
either from period to period within a reporting entity or in a single period across entities.

To maintain consistency, the presentation and classification of items in the financial

statements should stay the same from one period to the next, except as follows.

 There is a significant change in the nature of the operations or a review of the financial
statements indicates a more appropriate presentation.
 A change in presentation is required by an IFRS.
 Qualitative
characteristics

Fundamental Enhancing

Relevance Reliable Comparability Verifiability Timeliness Understandability

Faithful representation

Relevance: The information provided satisfies the needs of users, helping them
to evaluate past, present or future events and confirming or correcting their
past evaluations.

Faithful representation (Reliable): The information gives full details of its effects
on the financial statements and is only recognized if its financial effects are
certain. To be a faithful representation information must be complete, neutral
and free from error.
Comparability: The information should be produced on a consistent basis so that valid
comparisons can be made with previous periods and with other entities.

Verifiability: Verifiability helps assure users that information faithfully represents the
economic phenomena it purports to represent. It means that different knowledgeable and
independent observers could reach consensus that a particular depiction is a faithful
representation.

Timeliness: Timeliness means having information available to decision-makers in time to be

capable of influencing their decisions. Generally, the older information is the less useful it is.

Understandability: Information may be difficult to understand if it is incomplete, but too

much detail can also confuse the issue.

Neutral
A neutral depiction is without bias in the selection or presentation of financial information.
This means that information must not be manipulated in any way in order to influence the
decisions of users.
Substance over form
It is accounted for according to its substance and economic reality.

Materiality
Materiality. Information is material if omitting it or misstating it could influence decisions that
users make on the basis of financial information about a specific reporting entity.
Determining whether or not an item is material is a very subjective exercise. There is no
absolute measure of materiality. It is common to apply a convenient rule of thumb (for
example material items are those with a value greater than 5% of net profits).

In assessing whether or not an item is material, it is not only the value of the item which
needs to be considered. The context is also important.

The business entity concept

Financial statements always treat the business as a separate entity. The business entity
concept is always to treat a business as a separate entity from its owner(s). This means the
transactions of the owner should never be mixed with the business's transactions.
Chapter (4)
Sources, records and books of prime entry
Types of source documents
Quotation
Customer Supplier
Purchase Order
/ Sale Order
Customer Supplier

Invoice / Goods dispatched note

Customer Supplier

Goods received note (for its own warehouse or goods receiving area)

Remittance advice
Customer Supplier
Receipt
Customer Supplier
Return Goods

Purchase Return Sale Return

Return Goods
Customer Supplier
Issued Debit Note Issued Credit Note

Received Credit Note Received Debit Note

Statement
Customer Supplier
What does an invoice show?

Information usually shown on an invoice includes the following.

(a) Name and address of the seller and the purchaser
(b) Date of the sale
(c) Description of what is being sold
(d) Quantity and unit price of what has been sold (e.g. 20 pairs of shoes
at $25 a pair)
(e) Details of trade discount, if any (e.g. 10% reduction in cost, if buying
over 100 pairs of shoes)
(f) Total amount of the invoice including (usually) details any of sales
tax
(g) Sometimes, the date by which payment is due, and other terms of
sale
Books of prime entry
The main books of prime entry are as follows.

Book of prime entry Transaction type

Sales day book Record credit sales to customers
Purchase day book Record credit purchases from suppliers
Sales returns day book Record the return of credit sales
Purchase returns day book Record the return of credit purchases
Cash book Record all the payments and receipts at the Bank
Petty cash book Record all small payments and receipts of cash in hand
Journal Entry Other transactions, unusual movements and correction of errors
 Chapter (7) Sales Tax
 Sales Tax

 Commercial Tax (In Myanmar)

 Collected on Sales

 Indirect Tax

consumer Government

consumer Seller Government

Indirect Tax
 Registered Business

Sales – 1,000 Purchases – 800

Sales tax – 5% Sales tax – 5%
Sales

Debit - Cash / Receivable – 1,050 Debit – Purchase - 800

Credit – Sales – 1,000 Gov Debit – Sales Tax – 40 (Offset able with Gov)
Purchases
Credit – Sale Tax – 50 (Payable to Government) Credit – Payable - 840

Offset with Gov

Sales Tax Payable A/c
 Sales Tax on Sales
(Output sales tax) Input sales tax - 40 Output sales tax - 50

 Sales Tax on
Payable to Gov - 10
Purchases
(Input sales tax)
 Non-Registered Business

Sales – 1,000 Purchases – 800

Sales tax – X Sales tax – 5%

Debit - Cash / Receivable – 1,000 Debit – Purchase - 840

Credit – Sales – 1,000 Credit – Payable - 840

 6 24 18 24

Supplier Manufacturer Wholesaler Retailer

Input- Output-6 Input-6 Output-30 Input-30 Output-48 Input-48 Output-72
 Chapter (8) Inventory
Inventories
Inventories include assets held for sale in the ordinary course of business (finished goods),
assets in the production process for sale in the ordinary course of business (work in process),
and materials and supplies that are consumed in production (raw materials).

Inventory Valuation

Lower of Cost And NRV (Net Realizable Value)

FIFO (First In, First Out) Periodic

WAC (Weight Average Cost) Est: Selling Price – Est: cost to sales
Perpetual
1st Batch - $2 (Continuous)
2nd Batch - $3
3rd Batch - $4