Introduction to Financial Accounting & Key Financial Statements (Chapter 1)

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Cory Fields
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1 Introduction to Financial Accounting & Key Financial Statements (Chapter 1) 14/10/2017 5:29:00 pm Accounting = process of identifying, measuring and communicating economic information to assist users in making decisions. Financial accounting system for external users of enterprise Managerial accounting system for internal users Financial accounting system focuses on reporting financial position and performance Managerial accounting aids in operational planning and controlling Conveying economic information to decision makers is important Accounting is used by: o Management o Shareholders o Board of directors o Bankers o Creditors o Unions Accounting information is related to share prices of companies and can affect them. (eg. Qantas recorded dropped net profit and no dividend resulting in share price dropping) Annual report = magazine showing descriptive information about company & financial statements Key financial statements: o Balance sheet o Income statement (Profit/Loss) o Cash flow Assets = Equity + Liability (basis of accounting entity assumption) Investment = Financing Balance Sheet = snapshot of financial position at a particular time: o Current asset = converted into cash within 12 months o Non-current assets o Current & noncurrent liabilities (CL settled in 12 months) o Stockholders equity Income statement = results of operation during the period o Revenue and expenses (services used to generate revenue) Revenue - operating expenses (including COGS) + operating income +/- non-operating income or expenses = net profit/loss

2 Cash flow shows cash inflows and outflows of a given period o Involves operating, investing and financing activities Cash flow from operating xxx Cash flow from investing xxx Cash flow from financing xxx Change in cash xxx Cash at beginning xxx End cash flow xxx Balance sheet resources and claims Income statement profitability Cash flow receipt and payment of cash Double entry book-keeping = for every transaction there is a two sides (a resource and a source) o Allows to track where money comes from and where it goes o Method of record-keeping Financial statement assumptions: o Accounting entity assumption = activities of entity are separate to that of owner or member Includes but not limited to legal entities o Accounting period assumption = life of business is split into discrete time periods of equal length Production of regular financial statements o Monetary assumption = measure economic activates by common denominator o Historical cost assumption = transactions are recorded at original cost Treats assets for use not resale o Going concern assumption = continued operation for accounting entity in foreseeable future No need to liquidate o Materiality assumption = omission or misstatement could influence economic decisions of users based of financial statements No set rules for determining materiality (auditors us 5%)

3 Measuring & Evaluating Financial Position & Performance (Chapter 2) 14/10/2017 5:29:00 pm Balance sheets and income statements are based on accrual accounting Financial statements final product of accounting process and tells how business is performing and where it stands Balance sheet historically most important financial statement showing organisations resources and claims on resources at a specific time. o Reflects accountability of managers to shareholders o Name on balance sheet (eg Consolidated Woolworths Limited) o Date must include as at (eg as at 24 June 2007) o Currency (eg $m, $AUD) o Assets: Cash, receivables, inventories, investments accounted for using equity method, tax assets, property, intangible assets o Liabilities: Payables, tax liabilities, provisions o Shareholder s equity: Issued capital, reserves, retained profits, outside equity Share capital = companies issue shares to shareholders o Shareholders pay cash, the company records the portion acquired by shareholder. This is recorded as share capital Purpose of balance sheets: o Information on financial position Level of debt/equity (solvency and liquidity) Solvency = ability to pay debts when they fall due (long-term) (Liablity/OE) Liquidity = ease with which assets are converted to cash in short-term (normal course of business) (CA/CL) Asset = resources controlled by the entity as a result of past events from which future economic benefits are expected to flow to the entity o Future economic benefit = useful for business now and future o Ownership and control = most assets typically owned but ownership is not precondition o Past transactions = purchase of assets, contract signed o An asset should be recognised when and only when:

4 It is probably that future economic benefits associated with the item will flow to entity The item has a cost or value that can be measured with reliability Liability = present obligation of entity arising from past events, the settlement of which is expected to result in outflow from entity resources embodying economic benefits o Future sacrifice of economic benefits o Present obligation currently owed by business o Past transaction purchase of asset on credit, contract signed o Liability recognition criteria: It is probable that future sacrifice of economic benefit will be required Amount of liability can be measured reliably Shareholder s equity = residual interest in assets of entity after deducting all its liabilities (components: share capital, retained profits) o Net assests (A L) = OE or SE (shareholder s equity) o Retained profits = when company earns profit and it is reinvested into the business retained profit from period before + net income form this period dividends form this period o Increase in company s wealth means an increase in OE o We use the view that company exists for benefit of shareholders (owners wealth) o Share capital and profit adds to shareholder s equity, whereas dividends deduct from it. o Dividends is not an expense, it is under shareholder s equity Expanded accounting equation: o A(asset) = L(liability) + SC(share capital) + RP(retained profits beginning) + R(revenue) E(expense) D(dividend) Income statement = profit or loss for the period of time under consideration Revenue result from entity s operating activities Revenue = gross inflows of economic benefits during the period arising in the ordinary activities of an entity when those inflows result in increases in equity other than those relating to contributions from equity participants.

5 o Revenue recognition principle recognise when it is earned (accrual accounting) Costs & expenses are incurred in generating revenues and operating the entity Expenses = decreases in economic benefit during the accounting period in the form of outflows or depletions of assets or incurrence of liabilities that result in decreases in equity other than those relating to distributions to equity participants o Recognition probably outflows and reliability of measurement o Consider realised versus unrealised losses and prepaid vs accrued expenses Net sales = amount of sales of merchandise to customers less the amount of customer returns COGS = total cost of merchandise removed from inventory and delivered to customers Gross profit = difference between net sales and COGS; seller s maximum amount of cushion from which all other expenses of business must be met before net profit can be generated Selling, general and admin expenses = operating expenses of the entity Interest expense = cost of using borrowed funds Income taxes - shown all other income statement items Net profit per share of ordinary share in issue = evaluates market value of ordinary share Income = revenue + gains o Revenue = inflows from ordinary activity (eg sales, rent) o Gains = all other inflows (eg sale of NCA) Balance sheet and income statement is connected by net profit after tax If cost incurred and benefit been used in this period, it must be expense. However if future benefit it must be asset Cash vs accrual profit: o Earning of revenue is not necessarily accompanied by inflow of cash o Incurrence f expense is not necessarily accompanied by outflow of cash o Accrual profit is not same as cash profit!

ACCTG 101 Cramming Sesh

ACCTG 101 Cramming Sesh MODULES 1, 3, 6, 7, 8 & 9 MODULES COVERED 1 Introduction 3 Business Plan: Budgeting 6 Accounting System & Balance Sheet & 7 Accounting System & Income Statement 8 Cash Flow Statement