FINANCIAL ACCOUNTING

Accounting – an information system that identifies, measures, records, summarizes, and reports
economic information (from business activities every transaction that needs to be recorded) to
decision makers in the form of financial statements

Accounting information is useful to anyone who makes decisions that influence business activities
and have economic results.
- Investors / Shareholders want to know if a company is a good investment with adequate
returns
- Creditors (banks/suppliers) want to know if they should extend credit, how much to extend,
and for how long.
- Clients want to know if they can rely on proper after sales service.
- (future) Employees want to know if the company is able to provide job security and a good
salary.
- Government agencies (tax collection, statistics);
- The public (can be competitors etc..)

The major distinction between financial and management accounting is the users of the
information.
Financial accounting focuses on the specific needs of decision makers external to
the organization, such as shareholders, suppliers, banks, and government agencies

Externally disseminated financial statements have to be drawn up by reference to

a set of accounting rules (GAAP = Generally Accepted Accounting Principles). These might be
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

The various forms of business organization

Limited liability is a form of legal protection for shareholders and owners that prevents individuals
from being held personally responsible for their company’s debts or financial losses (eg. PLC,
GmbH, AG, SA, NV)

when a company is not able to payback it goes bankrupt. So company has to sell all the assets to
pay the outstanding liability.

If you have a proprietorship business then if it goes bankrupt in that case even personal assets will
be sold.

1 di 10
There are four financial statements

Balance sheet (T model)

• The balance sheet equation:

Assets = Liabilities + Owners’ Equity or Assets – Liabilities = Owners’ Equity

• The Balance Sheet equation basis for 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
Each transaction will affect at least two accounts

The two main sources of money for a company are, the banks and the INVESTORS.

2 di 10
INCOME STATEMENT
The primary questions about an organization’s success that decision makers want to know are:

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 balance sheet provides a

snapshot of an entity’s financial
position at an instant point in time

The income statement is used to

know revenues (sales) generated
and the expenses incurred over
one financial year.

RETAINED INCOME
Cumulative lifetime earnings of the company less its comulative lifetime losses and dividends.

Retained income - additional owner’s equity generated by income or profits

- revenues increase owners equity
- Expences decrease owners equity

!! Although dividends decreases retained income, they are not treated as expenses: dividends are
not necessary for the generation of revenue, they are the result of the revenue generation process

3 di 10
INCOME STATEMENT
Accrual Basis and Cash Basis
The most common ways of measuring income are the accrual basis and the cash basis.

- Cash basis : recognizes the impact of transactions only when cash is receives or disbursed.
(Answers the question: “ what’s the point In time in which we recognize cash transactions”?)
- Accrual basis : recognizes the impact of transactions for the time periods when revenues
and expenses occur even If no cash changes hands.

AGGIUNGI SLIDE 36

ACCRUAL BASIS
Revenue recognition principle
Under the accrual basis revenues are recognized/ recorded when:
- Transfer : goods are delivered or a service is performed (incl. risk and rewards of ownership)
- Realized : cash or a claim to cash (on credit) is received in exchange for goods or services

- A sale on account is recorded as revenue when the goods are delivered even though the
seller receives no cash at that moment.
- Supplies are sent to customers throughout the month (trial), but the cash is not received
until the customer formally promises to accept the supplies and pay for them.
Revenue can be recognized over time and not just in a point in time

Expenses recognition principle

- Matching : measures the expenses and recognize them in the same period in which any related
revenues are earned.

Ex.1 COGS is recorded in the same time period as the related sales. As long as the
inventory is not yet sold, it remains an asset on the balance sheet.

Ex.2 Rent for January can only be recorded as an expense in January even if the payment
has occurred already in December. In December the prepaid rent will be shown as an
asset on the balance sheet

- Expenses = costs of assets used up

MATCHING AND COST RECOVERY

An example of matching is depreciation.
- DEPRECIATION - the systematic allocation of the acquisition cost of long-lived assets or fixed
assets to the expense accounts of particular periods that benefit from the use of the assets

- Assets are used up over a period of time, so more and more of their original costs are
transferred from asset accounts to expense accounts.

4 di 10
 Identify nancial statements and their interrelationships

BUSINESS TRANSACTION
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.

Recording (journalise and post) transactions in the book

- accountants use a double entry accounting system in which at least two accounts are always
affected by each transaction.
- Some businesses enter into thousands of transactions daily or even hourly.
- Accountants must carefully keep track of and record there transactions in a
systematic manner

Recording process:
Transactions —> documentation —> journal —> ledger —> trial balance —> financial statement

Documentation: The process starts with source documents, which are the supporting original
records of any transaction.
Examples are invoices, receiving reports, cash receipt slips….

Journal:
In the second step, an analysis of the transaction is placed in the general journal, which is a diary
of all transactions in an entity’s life in chronological order
Journal entry – an analysis of the effects of a transaction on the accounts in a standard format,
using debit and credit

The T-Account
The Balance Sheet equation basis for double-entry accounting:
= recording method whereby at least two accounts are always affected by each transaction

5 di 10
fi
cumulative lifetime earnings of the company less its cumulative lifetime losses and dividends.

Ratained income - additional owners’ equity generated by income or profits

- revenue increase owners equity
- Expenses decrease owners equity

Rules of debit and credit:

6 di 10
Journalizing transactions
The conventional form for journal entries includes the following:
- The date and identification number of the entry
- The accounts affected and an explanation of the transaction
- The posting reference, which is the number assigned to each account affected by the
transaction
- The amounts that the accounts are to be debited and credited.

Trial balance

• The fourth step includes the preparation of the trial balance, which is a simple listing of all
accounts in the general ledger with their balances.

• The trial balance is usually prepared with the balance sheet accounts first (assets than liabilities),
followed by the income statement accounts.

• Aids in verifying accuracy in preparing the financial statements

Financial statement

• In the final step, the financial statements are prepared.

• The trial balance is the starting point for the preparation of the balance sheet and the income
statement.

7 di 10
8 di 10
9 di 10
10 di 10