acc1002 jan 2012 overview

49
ACCOUNTING IN BUSINESS Dr Winston Kwok

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Page 1: ACC1002 Jan 2012 Overview

ACCOUNTING IN BUSINESSDr Winston Kwok

Page 2: ACC1002 Jan 2012 Overview

Learning Objectives1. Explain the importance of accounting and

identify its uses2. Explain the meaning of GAAP and apply

accounting principles and assumptions3. Define and interpret the accounting

equation and each of its components4. Identify and prepare basic financial

statements and explain how they interrelate

Page 3: ACC1002 Jan 2012 Overview

OBJECTIVE 1Explain the importance of accounting and identify its uses

Page 4: ACC1002 Jan 2012 Overview

Importance of Accounting

AccountingAccountingis a

system that IdentifiesIdentifies

RecordsRecords

CommunicatesCommunicatesinformation

that isRelevantRelevant

ReliableReliable

ComparableComparableto help users make

better decisions.to help users make

better decisions.

Page 5: ACC1002 Jan 2012 Overview

Users of Accounting Information

External Users

•Shareholders (Investors)

•Lenders (Creditors)

•Governments

•Consumer Groups

•External Auditors

•Customers

Internal Users

•Managers

•Officers/Directors

•Internal Auditors

•Sales Staff

•Budget Officers

•Controllers

Page 6: ACC1002 Jan 2012 Overview

Users of Accounting Information

External Users

Financial accounting provides external users with financial

statements.

Internal Users

Managerial accounting provides information needs for internal

decision makers.

Page 7: ACC1002 Jan 2012 Overview

Annual Reports

• Required by law to be issued by listed/public companies.

• An annual report contains financial statements, auditor’s report, notes to accounts and other information such as chairman’s statement.

• Important source of information for key users such as investors and creditors.

Page 8: ACC1002 Jan 2012 Overview

ACCOUNTING

(analyses and professional judgment)

BOOKKEEPING

(recording)

Page 9: ACC1002 Jan 2012 Overview

Financial Accounting versusTax Accounting

• Financial Accounting based on guidelines on how best to reflect the nature or reality of business.

• Tax accounting influenced by economic and political objectives of governments.

Page 10: ACC1002 Jan 2012 Overview

OBJECTIVE 2Explain the meaning of GAAP and apply accounting principles and assumptions

Page 11: ACC1002 Jan 2012 Overview

Financial accounting practice is governed by concepts and rules known as generally accepted accounting principles (GAAP).

Financial accounting practice is governed by concepts and rules known as generally accepted accounting principles (GAAP).

Generally Accepted Accounting Principles

Relevant InformationRelevant Information Affects the decision of its users.

Affects the decision of its users.

Reliable InformationReliable Information Is trusted by users.Is trusted by users.

Comparable Information

Comparable Information

Used in comparisons across years & companies.

Used in comparisons across years & companies.

Page 12: ACC1002 Jan 2012 Overview

GAAP

• Help determine what information to be included in financial statements.

• Not physical science laws, but can change based on needs of society.

• Applied based on professional judgment.• Therefore, a business transaction could have

more than one accounting treatment or method resulting in different financial numbers.

Page 13: ACC1002 Jan 2012 Overview

Setting Specific Accounting Principles or Accounting Standards

International• The International

Accounting Standards Board (IASB) issues International Financial Reporting Standards (IFRS).

• If IFRS are adopted worldwide, a company can potentially use a single set of financial statements in all financial markets.

U.S.• Financial Accounting

Standards Board is the private group that sets both broad and specific principles.

• The Securities and Exchange Commission is the government group that establishes reporting requirements for companies that issue shares to the public.

Page 14: ACC1002 Jan 2012 Overview

IFRS• More than 100 countries and more than 40% of Global

Fortune 500 companies are already using IFRS.– Blue areas: countries that require or permit IFRS. – Grey areas: countries pursuing adoption of IFRS.– Asia: Adopted or in-process:

Singapore, Malaysia, Taiwan, China, Hong Kong, Australia, India and South Korea

Page 15: ACC1002 Jan 2012 Overview

IFRS and FRS• In Singapore, the Accounting Standards Council

(ASC) is empowered under the Accounting Standards Act to prescribe financial reporting standards (FRS) for use by companies.http://www.asc.gov.sg/account.htm

• The broad policy intention is to adopt IFRS, taking into account the local economic and business circumstances and context.

Page 16: ACC1002 Jan 2012 Overview

General Accounting Principles and Assumptions

Page 17: ACC1002 Jan 2012 Overview

General Accounting Principles

Measurement or Cost Principle• Accounting information is based on actual

or historical cost which is considered objective or reliable.

• Business transactions recorded at the original price paid at the time of the transaction.

• Accounting records reflect original cost as long as organization holds asset e.g. - a hospital records purchase price of equipment it buys.

• Profession moving towards market or fair values.

Page 18: ACC1002 Jan 2012 Overview

General Accounting Principles

Revenue Recognition Principle

• Recognize or record revenue when it is earned. This is often when the business has delivered the product or provided the service.

• Proceeds need not be in cash.• Measure revenue by cash received plus cash

value of items received.

Page 19: ACC1002 Jan 2012 Overview

General Accounting Principles

Expense Recognition or Matching Principle

A company must record its expenses incurred to generate the revenue reported.

Page 20: ACC1002 Jan 2012 Overview

General Accounting Principles

Full Disclosure Principle

Report the details behind financial statements that would impact users’ decisions.

Page 21: ACC1002 Jan 2012 Overview

Accounting AssumptionsBusiness Entity

• A business is accounted for separately from other business entities, including its owner.• 3 general business entity forms:

Sole Proprietorship

Sole Proprietorship

Corporation or Company

Corporation or Company

PartnershipPartnership

Page 22: ACC1002 Jan 2012 Overview

Accounting AssumptionsMonetary Unit

• Express transactions and events in monetary, or money, units.

• Examples of monetary units are the Singapore dollar, the Euro, the Thai baht, the Japanese yen, the Chinese renminbi.

• The purchasing power of the monetary unit is often assumed to be stable, i.e. inflation is ignored.

Page 23: ACC1002 Jan 2012 Overview

Accounting Assumptions

Going-Concern• The business will continue operating

instead of being closed or sold.• Property is reported at cost instead of

liquidation values that assume closure of business.

Page 24: ACC1002 Jan 2012 Overview

Accounting Assumptions

Time Period Assumption• The life of a business can be divided into time periods,

such as months and years.• Periodic financial statements provide users with relevant

and timely information on each accounting period.• At a minimum, companies prepare financial statements

once each year, which is called a fiscal year or a financial year.

• A fiscal year is any consecutive 12-month time period which may be different from the calendar year.

Page 25: ACC1002 Jan 2012 Overview

Accounting Constraints

• The materiality constraint prescribes that only information that would influence the decisions of a reasonable person need be disclosed. This constraint looks at both the relative size and importance of an amount.

• The cost-benefit constraint prescribes that only information with benefits of disclosure greater than the costs of providing it need be disclosed.

Page 26: ACC1002 Jan 2012 Overview

The Audit Report or Auditor’s Report

Companies are required by law to hire external (independent or statutory) auditors from accounting firms.

These auditors examine financial statements to verify that they are prepared according to GAAP. An unqualified or ‘clean’ opinion.

Page 27: ACC1002 Jan 2012 Overview

The Audit Report or Auditor’s Report

Such reports are opinions on the financial statements, not guarantees about future profitability.

Financial statements are the responsibility of the company’s management and not the auditors.

‘Big 4’ firms:KPMG

Ernst & YoungDeloitte

PricewaterhouseCoopers

Page 28: ACC1002 Jan 2012 Overview

OBJECTIVE 3Define and interpret the accounting equation and each of its components

Page 29: ACC1002 Jan 2012 Overview

AssetsLiabilities &

Equity

LiabilitiesLiabilities EquityEquityAssetsAssets = +

ACCOUNTING EQUATION

Page 30: ACC1002 Jan 2012 Overview

LiabilitiesLiabilities EquityEquityAssetsAssets = +

Resources owned or controlled by an entity

Claims against the entity’s resources

Claims byCreditors (lenders)

Claims by owners(investors or shareholders)

ACCOUNTING EQUATION

Page 31: ACC1002 Jan 2012 Overview

LandLand

EquipmentEquipment

BuildingsBuildings

CashCash

VehiclesVehicles

Store SuppliesStore

Supplies

Notes Receivable

Notes Receivable

Accounts ReceivableAccounts

Receivable

Resources owned or

controlled by a company

Resources owned or

controlled by a company

Assets

Page 32: ACC1002 Jan 2012 Overview

Taxes PayableTaxes

PayableWages

PayableWages

Payable

Notes PayableNotes

PayableAccounts Payable

Accounts Payable

Creditors’ claims on

assets

Creditors’ claims on

assets

Liabilities

Page 33: ACC1002 Jan 2012 Overview

• What’s left (residual) of the entity’s assets after it pays liabilities

• Also called net assets, net worth, or residual equity

Equity is Assets less Liabilities

Page 34: ACC1002 Jan 2012 Overview

Equity

Owner’s Claims on

Assets

Expanded Accounting Equation

Page 35: ACC1002 Jan 2012 Overview

Net Income or Net Profit

• The common measure of a company’s result for a period.

• Revenues: Sales of products or services.• Expenses: Cost incurred to provide products or

services.• Net income increases equity.• If expenses greater than revenues, then net loss

which decreases equity.

RevenuesRevenues ExpensesExpensesNet IncomeNet Income = -

Page 36: ACC1002 Jan 2012 Overview

Withdrawals

Disbursement of cash or other business assets to the owners.

Cash or other property withdrawn from the business by a proprietor or partner.

For a company with issued shares, such cash payments to shareholders (which are owners of the company) are called dividends.

Page 37: ACC1002 Jan 2012 Overview

OBJECTIVE 4Identify and prepare basic financial statements and explain how they interrelate

Page 38: ACC1002 Jan 2012 Overview

The Four Basic Financial Statements

• Income statement• Statement of comprehensive income

• Statement of changes in equity• Balance sheet

• Statement of financial position• Statement of cash flows

These are the titles of financial statements generally used under IFRS.Comprehensive income will be explained in the lecture on corporations.

Page 39: ACC1002 Jan 2012 Overview

Relationships among the Financial Statements

• Each financial statement tells a portion of the story about business operations.

• Users rely on all four statements when analyzing financial performance and fiscal health.

Page 40: ACC1002 Jan 2012 Overview

Relationships by time periods

Time

Covering the intervening period:

Income Statement

Statement of Changes in Equity

Statement of Cash Flows

Balance Sheet

At beginning of period

Balance Sheet

At end of period

Page 41: ACC1002 Jan 2012 Overview

Financial Statement Heading

• Name of business or reporting entity

• Title of statement• Reporting period• Currency and units

From Nestlé 2010 Annual Report

Page 42: ACC1002 Jan 2012 Overview

Net income is the difference between

Revenues and Expenses.

Net income is the difference between

Revenues and Expenses.

Revenues: Consulting revenue 3,000$ Expenses: Salaries expense 800 Net income 2,200$

Scott ConsultingIncome Statement

For Month Ended December 31, 2010

The income statement describes the revenues and expenses of the entity along with the resulting net income or loss over a period of time due to earnings activities.

The income statement describes the revenues and expenses of the entity along with the resulting net income or loss over a period of time due to earnings activities.

Income Statement

Page 43: ACC1002 Jan 2012 Overview

Statement of Changes in Equity

S.Scott, Capital, December 1, 2010 -$ Plus: Investments by owner 20,000$ Net income 2,200 22,200

22,200 Less: Withdrawals by owner 500 S.Scott, Capital, December 31, 2010 21,700$

Statement of Changes in EquityFor Month Ended December 31, 2010

Scott Consulting

The statement of changes in equity explains changes in equity from net income (or loss) and from any owner investments and withdrawals over a period of time.

The statement of changes in equity explains changes in equity from net income (or loss) and from any owner investments and withdrawals over a period of time.

Page 44: ACC1002 Jan 2012 Overview

The net income of $2,200 increases equity by $2,200. The net income of $2,200 increases equity by $2,200.

Income Statement and Statement of Changes in Equity

S.Scott, Capital, December 1, 2010 -$ Plus: Investments by owner 20,000$ Net income 2,200 22,200

22,200 Less: Withdrawals by owner 500 S.Scott, Capital, December 31, 2010 21,700$

Statement of Changes in EquityFor Month Ended December 31, 2010

Scott Consulting

Revenues: Consulting revenue 3,000$ Expenses: Salaries expense 800 Net income 2,200$

Scott ConsultingIncome Statement

For Month Ended December 31, 2010

Page 45: ACC1002 Jan 2012 Overview

The balance sheet describes an entity’s financial position at a point in time. It is like taking a ‘snapshot’ of the assets, liabilities and equity on the last day of the accounting period.

The balance sheet describes an entity’s financial position at a point in time. It is like taking a ‘snapshot’ of the assets, liabilities and equity on the last day of the accounting period.

Balance Sheet

Cash 9,700$ Accounts payable 1,200$ Supplies 1,200 Notes payable 4,000 Equipment 16,000 Total liabilities 5,200

S.Scott, Capital 21,700

Total assets 26,900$ Total liabilities and equity 26,900$

Equity

Assets Liabilities

Scott ConsultingBalance Sheet

December 31, 2010

Page 46: ACC1002 Jan 2012 Overview

Statement of Changes in Equity and Balance Sheet

S.Scott, Capital, December 1, 2010 -$ Plus: Investments by owner 20,000$ Net income 2,200 22,200

22,200 Less: Withdrawals by owner 500 S.Scott, Capital, December 31, 2010 21,700$

Statement of Changes in EquityFor Month Ended December 31, 2010

Scott Consulting

Cash 9,700$ Accounts payable 1,200$ Supplies 1,200 Notes payable 4,000 Equipment 16,000 Total liabilities 5,200

S.Scott, Capital 21,700

Total assets 26,900$ Total liabilities and equity 26,900$

Equity

Assets Liabilities

Scott ConsultingBalance Sheet

December 31, 2010

Page 47: ACC1002 Jan 2012 Overview

Cash flows from operating activities: Cash received from clients 3,000$ Cash paid for supplies (1,000) Cash paid to employees (800) Net cash provided by operating activities 1,200$ Cash flows from investing activities: Purchase of equipment (15,000) Net cash used in investing activities (15,000) Cash flows from financing activities: Investments by owner 20,000 Borrowed from bank 4,000 Withdrawals by owner (500) Net cash provided by financing activities 23,500 Net increase in cash 9,700$ Cash balance, December 1, 2010 - Cash balance, December 31, 2010 9,700$

Statement of Cash FlowsFor Month Ended December 31, 2010

Scott Consulting

Statement of Cash Flows

• The statement of cash flows explains changes in entity’s cash balance during accounting period.

• 3 sections showing the business activities:• Operating• Investing• Financing

• The statement of cash flows explains changes in entity’s cash balance during accounting period.

• 3 sections showing the business activities:• Operating• Investing• Financing

Page 48: ACC1002 Jan 2012 Overview

Cash flows from operating activities: Cash received from clients 3,000$ Cash paid for supplies (1,000) Cash paid to employees (800) Net cash provided by operating activities 1,200$ Cash flows from investing activities: Purchase of equipment (15,000) Net cash used in investing activities (15,000) Cash flows from financing activities: Investments by owner 20,000 Borrowed from bank 4,000 Withdrawals by owner (500) Net cash provided by financing activities 23,500 Net increase in cash 9,700$ Cash balance, December 1, 2010 - Cash balance, December 31, 2010 9,700$

Statement of Cash FlowsFor Month Ended December 31, 2010

Scott Consulting

Balance Sheet and Statement of Cash Flows

Cash 9,700$ Accounts payable 1,200$ Supplies 1,200 Notes payable 4,000 Equipment 16,000 Total liabilities 5,200

S.Scott, Capital 21,700

Total assets 26,900$ Total liabilities and equity 26,900$

Equity

Assets Liabilities

Scott ConsultingBalance Sheet

December 31, 2010

Page 49: ACC1002 Jan 2012 Overview

Notes to the Financial Statements

• Four general types:* Summary of significant accounting policies:

assumptions, estimates, and judgments.* Additional information about the summary totals in

financial statements.* Disclosure of important information that is not

recognized in the financial statements.* Supplementary information.

• Notes can be used to convey information that is too uncertain or needs further explanation.