FINANCIAL ACCOUNTING

R A M I R E Z H E I D Y, P H D
TOPIC 2

• Chapter 2 Part I: The Balance Statement

• Exercise 1 & Quiz 1

• Chapter 2 Part II: The Income Statement

• Exercise 2 & Quiz 2

• Reading Materials: Remarks on Financial Statements

• Exercise 3
 C H A P T E R 2 PA RT I :
T H E B A L A N C E S TAT E M E N T
 CHAPTER 2:
THE BALANCE SHEET & INCOME STATEMENT

Company, at the end of each financial year (which is

often December, 31st of each year), must submit to the
regulator:

Income Balance Retained

Statement of
Statement Sheet Earnings
Cash Flows
Statement
 THE BALANCE SHEET
PURPOSE of the Balance Sheet

The Balance Sheet (the Statement of Financial Position) is

the basic summary table, which represents the financial
situation of a company at a given date.

This financial situation is presented at one given moment,

in particular at the end of the accounting year, including
three main elements: assets, liabilities (or obligations) of
the company and its shareholders’ equity.
 BALANCE SHEET (PHILOSOPHY I)
BALANCE SHEET

ASSETS EQUITY & LIABILITIES

Examples: Examples:
It is
– Cash and something – Shareholders’
equivalents that a capital
– Lands, buildings business – Reserves
and equipment. It is owes. – Retained
– Intangible something earnings
assets which a
– Inventory business Equity
owns. Liabilities
– Receivables
Amount that is owed to the
Amount a owners (Internally) or it is
business owes the net value of a firm: it
(externally) or represents the value of what
Externally: suppliers, banks, tax obligations to owners possess at the time
authorities & more. pay. They have a of the establishment of the
negative value for balance sheet.
the company.
 BALANCE SHEET (PHILOSOPHY II)
The difference between all assets of the company and all its liabilities
(obligations to do, to pay) represents the net value of what belongs to
the owners: shareholders’ equity (net assets)

BALANCE SHEET
Debit Credit

ASSETS EQUITY &

LIABILITIES

Assets = Liabilities + Equity

 BALANCE SHEET
The International Financing FORMAT of the Balance Sheet
Reporting Standards (IFRS) do
not specify any particular
format for the balance sheet.

However, the following five

columns must appear:
- Long-term (non-current) asset
- Current asset
- Equity capital
- Long-term (non-current) liability
- Current liability

IFRS requires distinction between current vs. non-current items.

 ASSETS
Where does the money go to?

• This column, divided into categories, provides an overview of everything the

company owns.
• An asset is an item, a resource controlled by the firm from which future
economic benefits are expected. It has a positive value for the company.

• It is a list of the assets used by the company, e.g:

• Lands, buildings, and equipment.
• Intangible assets, such as licenses, patents, and software.
• Financial assets: marketable security
• Inventory
• Accounts receivables
• Cash and equivalents
• Entering them in the balance sheet means they can be measurable and their
value monitored over several accounting years.
 ASSETS
Fixed or Non-current assets
- Intangible fixed assets
- Property, plant and equipment (PPE)
- Financial assets
Current assets
The word « current » is opposed to the word « fixed » in the
sense that the assets to which it applies are going to be renewed
quickly and continuously during the operating cycle
of the company:

- Inventories
- Accounts Receivables
- Short-term Investment
- Cash
Long-term asset/non-current asset

• Includes: lands, building, equipment, patents, goodwill, software,

shares in other companies……..

• The value of certain assets decreases over time due to use, wear and
tear or obsolescence
• This decreases in monetary value of an asset is called depreciation.
• The net fixed assets is the difference between the fixed assets at their
purchase price (gross fixed assets) and this accumulated depreciation.
Current asset

• Includes:
• Inventory, categorized into: raw materials, spare parts, packaging materials, semi-
manufactured products and lastly, finished products awaiting sale.
• Accounts receivable: the amount owed by clients.
• Other short-term receivables: suppliers (advance payments for orders) and agencies
(such as the tax collectors) that will soon make payments to the company.
• Current financial assets: financial securities, shares or bonds that the company intends
to hold for less than 12 months. Generally, the company aims for short-term
profitability with these assets.
• Cash: cash available in the bank, and on hand.

• Note that the value of current assets can be impaired due to unfortunate
events.
• That is why the figure that appears on the balance sheet is the net carrying
amount of the inventory, accounts receivable, etc., after these losses are
deducted.
 Equity & Liabilities
Where does the money come from?

• This column gives the name and amount of each of the business’s
sources of financing.
• Equity capital
• Long-term liabilities
• Current liabilities

• A liability (non-current and current) is what the company owes, or an

obligation to do or to pay. It has a negative value for the company
because it sacrifices future economic benefits of the company.
• Accounts payable, loans, debts
• Equity capital is the difference between assets and liabilities. It
represents the net value of the firm.
 LIABILITIES
"Real" debts/obligations to third parties

• A debt can arise when a company borrows from a bank.

• A obligation can arise when the company buys goods or services from a
supplier that allows to pay later. The supplier is also said to have a
claim on the business.
- Loans
- Accounts payable
- Tax and social security debts
- Debts on fixed assets
- Salaries payable

• They will be classified according to their due date.

• In general, if due date ≥ 12 months: non-current / < 12 months: current
Long-term liabilities

• Loans: the amount of loans reaching maturity in more than one year.
• Long-term provisions: provisions that will be accounted for in more
than one year.
• Defined benefit obligations
• Long-term income tax liabilities
• Deferred tax liabilities
Current liabilities

• Accounts payable: money owed by suppliers.

• Other short-term debt: Government taxes, social security contributions,
etc.
• Provisions on operations that will be accounted for less than one year.
• Short-term financial debt: This is debt payable to the bank in less than
one year.
• Other current liabilities.
 Shareholder’s EQUITY
• Share capital: money provided by partners or shareholders.
• Retained earnings (Reserve): the profit made by the company in
previous years that are not distributed and are kept by the company to
be used for financing a position of investments.

+ Shareholder contributions
+ Profits

– Paid to shareholders (Dividends)

Shareholder contributions

1)
Registration of a business

2)
Shareholder contributions = Share capital
Example 100 000 €

ASSETS EQUITY & LIABILITIES

Cash 100,000 Shareholders’ Equity
100,000
Retained Earnings

Retained earnings will increase each year by the portion

of the profit that the shareholders will decide to leave in the company.

Retained Earnings (this year)

= Retained Earnings (last year) + Earnings (this year) – Dividends (this year)
 BALANCE SHEET (SUMMARY)

ASSETS BALANCE SHEET LIABILITIES

FIXED ASSET SHAREHOLDER EQUITY

- Intangible asset - Share capital

- Tangible asset - Retained earnings

- Financial asset

Liabilities
CURRENT ASSET - loans

- Inventories - Accounts payable

- Accounts Receivables - Tax and social security liabilities

- Prepaid expense

- Cash

TOTAL TOTAL

Assets = Liabilities + Equity

EXERCISE 1
Let’s make some exercise!

• Make the right classification for

• Current asset
• Long-term asset
• Current liabilities
• Long-term liabilities
• Equity capital
QUIZ 1
 C H A P T E R 2 PA RT I I :
T H E I N C O M E S TAT E M E N T
 THE INCOME STATEMENT
PURPOSE OF the Income Statement

The Income Statement (Profit and Loss account) shows the

financial performance for a certain time period, e.g. one year
• Net income (Profit or Loss) = sum of income – sum of expenses
• Income: Revenues generated over a period, mostly from sales
• Expense: Consumption of resources over a period

The Income Statement describes the results (i.e., income or

expense) of a company’s business activity during a specific period.
• Income (Expense) increases (decreases) the wealth of the company
• Every item on the Income Statement is either an income or an expense.
 INCOME STATEMENT (PHILOSOPHY)
PROFIT AND LOSS ACCOUNT
EXPENSES REVENUES

The company's main revenues are: sales of goods, products or services, but also
interest on investments, and sales of fixed assets.
The main expenses are the following:
- purchases
- depreciation expense
- distribution expense
- administration expenses
- salaries and wages
- financial expenses, etc. (representing the cost of financing the entity)
 Profit or Loss
TOTAL REVENUES > TOTAL EXPENSES
NET INCOME > 0
=> THE COMPANY gets PROFIT

The total revenues has to be bigger than the expenses

in order to have profit as a positive net income.

EXPENSES REVENUES
800 1 000

Net income 200

 Profit or Loss
Accountants sometimes choose to present things this way:

EXPENSES REVENUES
800 1 000

NET INCOME
200

TOTAL 1,000 TOTAL 1,000

In order to keep the balance between each side, the positive

net income is registered on the expense side of the income
statement; revenues of €1,000 versus expenses of €800
results in a net income of €200.
 Profit or Loss
TOTAL EXPENSES > TOTAL REVENUES
NET INCOME <0
=> THE RESULT IS A NET LOSS

If the total expenses are bigger than the total revenues,

the company reports a loss for the period.

EXPENSES REVENUES
1 000 800

Loss 200
 Profit or Loss
Similar to the previous example,
Accountants sometimes choose to present things this way:

EXPENSES REVENUES
1 000 800

LOSS
200

TOTAL 1,000 TOTAL 1,000

 THE INCOME STATEMENT
BREAKDWON of Income and Expense

Both expenses and income can be classified into the big categories:
1) Operating activities: the major part linked to the company’s core
business; including purchase of merchandise; purchase of raw
material; salary cost; advertisement cost; amortization cost…..

2) Financial activities: including interest income (expense); financial

income (expense) …..

+) Exceptional (Extraordinary) items

 THE INCOME STATEMENT
Three different FORMAT of the Income Statement
: use a two-sided table or one-sided lists or use different ways to
categorize operating expenses (costs).

1) Table Format: This Table Format is compulsory in French GAAP

 THE INCOME STATEMENT
FORMAT of the Income Statement

2) List format by nature:

An income statement by nature is the one in which expenses are disclosed

according to categories they are spent on, such as raw materials, transport
costs, staffing costs, depreciation, employee benefit etc.

The expenses will not be further classified into their functions (i.e cost of
goods sold, selling, administrative, etc).
 THE INCOME STATEMENT
FORMAT of the Income Statement

2) List format by nature: common for consolidated income statement

Merchandising company Manufacturing company

 THE INCOME STATEMENT
FORMAT of the Income Statement

3) List format by function: An income statement by function is the one

in which expenses are disclosed according to different functions they are
spent on (production, selling, administrative, etc.)
 THE INCOME STATEMENT
By nature vs. By function
By nature By function
Cost of merchandise/raw material COGS
Other external purchase It depends
-transportation to customer: marketing
-rent of factory: COGS
-rent of headquarter office: administration

tax It depends
Employment cost It depends
-for production teams: COGS
-for sales teams: marketing expense
-for administration teams: administration
expense

Depreciation cost COGS

EXERCISE 2
Two case studies

• Case study NO.1: NOVIC (a trading company)

• Case study NO.2: CLARINA (an industrial company)

• In Case study NO.1, we assume that the purchase of merchandise

equals to cost of purchase of merchandise sold (CPMS). We don’t
consider stocks of merchandise.
• What if the number of merchandise purchased during a time period
doesn’t equal to the number of merchandise sold during the same
time period?
Take stocks into account

• Initial stock on Jan 1st: 20 bicycles, €250 each

• New purchase on Jan: 100 bicycles, €250 each

• 1st scenario: During Jan, sells 100 bicycles, €480 each

• 2nd scenario: During Jan, sells 110 bicycles, €480 each
• 3rd scenario: During Jan, sells 80 bicycles, €480 each

Q1: what is the purchase of merchandise for Jan?

Q2: what is the profit in 1st scenario? 2nd scenario? 3rd scenario?
Q3: does the cost in the three scenarios always equal to purchase of
merchandise for Jan?
Take stocks into account

• Answer:
Q1: purchase of merchandise=100*250=25000
Q2:
-Scenario 1: profit=100*480-100*250=23000
-Scenario 1: profit=110*480-110*250=25300
-Scenario 1: profit= 80*480-80*250=18400
Q3: The cost equals to purchase of merchandise only in Scenario 1.
• Two different concepts:
-purchase of merchandise
-cost of goods sold (COGS)
Take stock into account

• How to calculate COGS?

COGS = Purchase of merchandise + variation of stock

Variation of stock=initial stock – final stock

-The purchase of merchandise and variation of stock both refer the

value (quantity*price)
-If there is no mentioning of the initial stock and final stock in the
question (e.g. cast study 1), suppose the variation of stock is 0.
Take stock into account

• Scenario 1:
-Variation of stock=initial stock-final stock
=20*250-20*250=0
COGS=100*250+0=25000; Profit=100*480-25000=23000
• Scenario 2:
-Variation of stock=initial stock-final stock
=20*250-10*250=2500
COGS=100*250+2500=27500 ; Profit=110*480-27500=25300
• Scenario 3:
-Variation of stock=initial stock-final stock
=20*250-40*250= - 5000
COGS =100*250-5000=20000 ; Profit=80*480-20000=18400
Take inventories into account

• For accounting, when we make purchase of the merchandise:

-increase purchase of merchandise (expense)
-reduce cash (if payment is by cash) or increase accounts payable ( if payment is by
credit, or to be paid in the future)
• Important:
-we don’t make accounting journals for stock of merchandise (inventory)
-The initial and final value of stock of merchandise are counted in the storage house by
some person at the beginning and ending date of the time period.
-In the questions, you will be provided by the value of merchandise stock at the
beginning and ending date directly.
-Stock of merchandise will be shown under current asset in the Balance Sheet.
-In different situations, it is called: CPMS or cost of goods sold (COGS)
QUIZ 2
 R E A D I N G M AT E R I A L S :
REMARKS ON
F I N A N C I A L S TAT E M E N T S
Balance Sheet vs. Income Statement
Balance sheet is prepared for a specific point (date) of time
• A company has beginning balance sheet (i.e., the ending balance sheet for
the last year) and ending balance sheet for the current year:
- Balance sheet of January 1, 2020 (i.e., Balance sheet of Dec 31, 2019)
- Balance sheet of Dec 31, 2020

Income Statement is prepared for a specific period of time

• A company has the income statements for each year:

- Income statement for 2019 (from January 1 to December 31)

- Income statement for 2020 (from January 1 to December 31)
 INCOME vs. CASH FLOW
The income statement follows accrual accounting, or recognizes revenue when
it's earned and expenses when they're incurred, regardless of when money
actually changes hands. The balance sheet is also prepared following accrual
accounting.
• The revenues listed correspond to the invoices issued. The expenses
correspond to the invoices received.

c.f.) Cash accounting reflects business transactions on a company's financial

statements when the cash flows into or out of the business.

NO DIRECT LINK BETWEEN INCOME AND CASH FLOW.

 Cash-Flow Statement
The Cash flow statement details all the events that generate
cash flows during a fiscal period.
• The purpose of the Cash flow Cash Flow Statement
statement is to show all the
Cash Inflows (+)
transactions that generated cash
Total Cash Inflows
flows during the fiscal year and
thus create a link between the Cash Outflows (-)
amount of the opening and Total Cash Outflows
closing cash balances.
Beginning Cash Flow
Variation
Final Cash Flow (=)