financial & managerial accounting lecture 1 and 2 1chara charalambous mba cda college

Chara Charalambous MBA CDA COLLEGE 1

Financial & Managerial Accounting

LECTURE 1 and 2

Aims of the Lecture

• What is Accounting and the purpose of Accounting.

• The use of Financial Statements• Users of Financial Statements• Accounting cycle during a period• The accounting equation • Generally accepted accounting principles• Forms of Organizations


• A service that is systematically recording and summarizing the financial (economic) transactions of a business and then analyzing, verifying (confirming)

and reporting the results.

• The person in charge for the execution of accounting is known as an Accountant, and this individual is typically required to follow a set of rules and regulations of the IFRS (International Financial Reporting Standards).


What is Accounting?

• Accounting allows a company to analyze the financial performance of the business and look at statistics such as net profit. Therefore the management is able to make informed judgment and better decision.

• Also Accounting aims to show the relationship of the business with its environment which includes its customers (debtors), suppliers (creditors), employees, owners and lenders.


Purpose of Accounting


Two fields of AccountingManagerial Accounting, in contrast to Financial

Accounting, is aimed to help managers inside the organization to take decisions with the information it provides.

Managerial Accounting also called Cost Accounting is the procedure of identifying, measuring, analyzing and providing information for the pursuit of an organization goals.

Financial Accounting is aimed to provide information to parties outside the organization e.g. Stockholders, Banks, Creditors, investors, Government e.t.c

1. Identification and recording of transactions: A transaction is an economic event which affect the financial

situation of the business. A transaction could be: a sale of a product, the purchases of raw materials , purchase of a machine, payment of salaries or the receive of a loan. The accounting system must be well organized so as all transactions are recognized when they take place and then are recorded in the books of the business using the book-keeping function.

A double-entry bookkeeping system is a set of rules for recording financial information in a financial accounting system in which every transaction or event affects at least two different ledger accounts. The accounting process includes the bookkeeping function, but is just one part of the accounting process

Chara Charalambous MBA CDA COLLEGE6

Accounting is concerned with:

2. Classification and measurement of transactions after they have been recorded. Economic events may create assets (items which the business owns) or liabilities (what is due by the business to others) or revenues (income from sales) or costs/expenses (amounts incurred to make products or operate the business). Therefore correct classification is important. Measurement follows the classification and by this we mean: how mush of the costs or revenues concern this year and how mush must be carried forward to the next year.

3. Summarization and communication. Since the Accountant has record all the transactions a summary is extracted which show the performance of the business during a period – a month or a year . This summary is shown through the financial statements which they communicate information regarding the financial position of the business to a wide range of users.


• The Accounting service is analyzing data with the preparation of financial statements. The most widely used financial statements are:

The Statement of Financial Position (Balance Sheet) and The Income Statement (Trading and Profit & Loss

account). To achieve its goals, an accounting system may make use of

computers and video displays as well as handwritten records and reports printed on paper


Financial Statements

1. Balance Sheet: is a statement of the assets, liabilities and owners’ equities as at a specific point in time (next day things could be different).

– Assets – are things owned by the business such as motor vehicles, machinery, inventory (goods manufactured or purchased for resale), money owed by debtors, balance at bank and prepaid expenses.

Assets are divided into fixed assets: A long-term tangible piece of property that a firm owns and uses in the production of its income and is not expected to be consumed or converted into cash any sooner than at least one year's time, and current assets: the value of all assets that are reasonably expected to be converted into cash within one year in the normal course of business. . Goodwill is an Intangible F.A.

– Liabilities – are amounts owed such as money due to creditors, bank overdrafts, short term loans.

– Owners’ equity – is a type of liability but this amount is due to the owner of the business rather than to ‘outsiders’. It increases by any new capital brought in and by the net profit made by the business and reduces by any amounts withdrawn by the owner. Chara Charalambous MBA CDA COLLEGE 9

Financial Statements

• Goodwill typically reflects the value of intangible assets such as a strong brand name, good customer relations, good employee relations,innovation,new products and favorable location. The evidence that goodwill exists is the proven ability to earn excess profits.

10

Statement of Financial Position (Balance Sheet) as at 31st December 20YY


Fixed Assets

Land and Buildings

Furniture and Fittings

Motor Vechicles

Goodwill

€

X

X

X

X

Current Assets

Stock

Debtors (Accounts Receivable)

Prepayment of Expenses

Bank

Cash

X

X

X

X

X

Capital

Add Net ProfitLess Drawings

X

X

€

XX

Current Liabilities (amounts due within a year)

Creditors (Accounts Payable)

Accrued ExpensesBank Overdraft

Short Term Loan

X

X

X

X

Long-term Loan

X

X X

Long-term Liabilities (repayable later than one year)

• Assets = Liabilities + Capital

Or otherwise : Capital=Assets-Liabilities

The balance sheet must always balance which means must always satisfy the above equation, at any time assets equals liabilities plus the capital .


The Accounting Equation


Balance Sheet as at 31 December Year 20XX

Fixed Assets € €

Land and BuildingsFurnitures and fittings xMotor Vehicles x xGoodwil

Current Assets

Closing Inventory xDebtors xPrepayments xBank xCash x x

xxxxxx

Capital Account xAdd Net Profit xLess Drawings x x

Long-trrm LiabilitiesLong term loan

Current Liabilities

Creditors xAccruals xBank Overdraft xShort term loan x x

xxxxxx

2. Income Statement: Presents the results of operations for a period of time. It usually covers a year of business activity in contrast to balance sheet which is as at a specific point in time.

The income statement is prepared following the accruals concept: the income and expenses are recorded as they occurred regardless of whether cash has been received or paid .

– Income – the sales revenue shows the income from goods/services sold in the year.

– Expenses – in order to make revenues we must incur expenses: an outflow of money to pay for an item or service e.g. wages, rents, electricity e.t.c

The income statement is split into two parts a) the Trading account which gives the gross profit and b) the Profit & Loss account which gives us the Net Profit.


Trading and Profit & Loss account


Opening Stock

Add Purchases

Less Purchases ReturnLess Closing stock

€

X

XX

X

Gross Profit c/d

Wages and SalariesInsuranceRentDepreciation of motor vehiclesand Furniture's

Bad Debts

X

X

X

X

X

SalesLess Sales Returns

X€

X

Discounts Received

X

X

Cost of Sales X

X

Gross Profit b/d

Office Expenses X

Discount allowed X

Net Profit

X

X

X

X

• The above layout of the income statement is not mainly useful but is assists the appreciation of the actual double entry processes and the realization that the income statement is part of the double entry.

• The modern-vertical layout is as follows:

Income statement: Trading and Profit & Loss accountSales xLess Cost of Sales:Op. Stock xPurchases xLess Closing stock (x) (x)GROSS PROFIT xxLess Expenses (x)NET PROFIT xxx


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The modern-vertical layout of Income Statement is as follows:Income statement: Trading and Profit & Loss accountSales xLess Cost of Sales:Op. Stock xPurchases xLess Closing stock (x) (x)GROSS PROFIT xxLess Expenses:

– Wages / Salaries x Heating & Lighting x– Rent x – Insurance x – Advertising x – Bad Debts x– Depreciation x– Stationery x– Commission Paid x– Bank interest & charges x– Cleaning x– Office Expenses x (x)

NET PROFIT xxx


Public Companies deduct from their Net Income the dividends paid:

• Sales • — Variable costs • Contribution margin • — Fixed costs• Operating income or EBIT • — Interest Expense• EBT: Earnings before taxes• — Taxes• EAT: Earnings after taxes (NET INCOME)

• — Dividends of preference shares• Earnings available to common shareholders• Number of ordinary Shares• EPS: Earnings per share

USERS OF FINANCIAL STATEMENTSThe financial accounts provide a wealth of information that is useful to various users of financial information

INVESTORS CUSTOMERS

MANAGEMENT OWNERS SUPPLIERS

EMPLOYEES USERS LENDERS

THE PUBLIC COMPETITORS GOVERNMENT


Managers: need information on a monthly basis to control the business, plan for the future and evaluate profitability. They prepare budgets based on past performance and they compare it to actual results.

Owners: The financial Statements tell the owners just how successful the business has been and also summarise in brief form its present financial position

Investors: are concerned with how secured and the profitable is their investment in the specific company. This is shown in the income statement.

Employees: are interested to know if an employer can offer secure employment, possible salary increases and retirement benefits. They are also interested in the pay and benefits obtained by senior management!


Lenders: Banks and other financial institutions who lend money to a business require to know if they will be repaid. This is shown in the balance sheet which displays the solvency of the firm.

Government: need to know how the economy is performing so as to plan financial policies. Also the tax authorities evaluate the tax witch is payable by the companies with the use of financial statements.

Suppliers: need to know if the business is able to pay short-term

debt when it falls due.

Competitors: wish to compare their own performance against that of other firms that are operating in the same sector.


Internal Users of Accounting Information

Board of Directors Chief Executive Officer Chief Financial Officer Vice Presidents Business Unit Managers Plant Managers Store Managers Line Supervisors Business Owners Employees


USERS OF FINANCIAL INFORMATION QUICK QUIZ • Suppose you are the manager of a famous chain company

which sells cloths and accessories. The company needs a bank loan in order to purchase equipment for its stores. In evaluating the loan request, the banker asks about the assets and liabilities of the business. In particular, the banker wants to know the amount of the business’s stockholders’ equity.

Requirements: 1.Is the banker considered an internal or external user of

financial information? 2.Which financial statement would provide the best

information to answer the banker’s questions?


ANSWERS:1.Is the banker considered an internal or external user

of financial information? The banker is an external user.

2.Which financial statement would provide the best information to answer the banker’s questions? The balance sheet

Main Types of Business Transactions Duality Concept: Each and every transaction that the business

makes has two aspects and has a double effect on the business and accounting equation.

B/ce Sheet Incm Stat.• 1. SALES OF GOODS: If with cash cash sales If with credit debtors sales 2. PURCHASES: If with cash cash purchases If with credit creditors purchases

3. PURCH. OF FIXED ASSETS: If with cash cash F. A If with credit creditors F.A


B/ce Sheet Incm Stat

• 4. PAYMENT OF EXPENSES: cash expense • 5. BRING NEW CAPITAL: cash capital• 6. DRAWINGS: cash capital



Transaction

An event that affects the financial position of the business Can be measured reliably Every transaction affects at least two items in balance sheet or income statement or in both financial statementsThe accounting equation balances before and after each transaction


Accounting Concepts and Principles GAAP - USAGenerally Accepted Accounting Principles Guidelines that govern accounting Based on a conceptual framework Goals include: • Provide useful information for investment and lending decisions • Must be relevant, reliable, and comparable

IFRS – EUROPEInternational Financial Reporting Standards Harmonize accounting across the European Union A common global language for business affairs so that company

accounts are understandable and comparable across international boundaries.

Accepted accounting principles require that a set of financial statements describe a specific business body, which is called business entity.

Financial Accounting information relates only to the activities of the business entity and not to the activities of its owner. For e.g. if the owner buys a car for him and his family to use personally this transaction will not influence the balance sheet elements at all.

The business entity is treaded as separate from its owners. Chara Charalambous MBA CDA COLLEGE 29

The business entity concept

Is concerned with the disclosure (notification , communication) of accounting policies – the guidelines and rules that must followed when preparing the financial statements.

The 5 fundamentals accounting concepts mentioned by the standard are:

a. The going-concern conceptb. The accruals conceptc. The consistency conceptd. The prudence concepte. Cost Principle


Accounting Principles: Statement of Standard Accounting Practice (SSAP)

a. Going concern: the business for which we are preparing the financial statements is going to continue in operation for an undetermined period. Before the accounts are certified as showing a true and fair view , the auditor must be satisfied that the company is a going concern and that it will continue to function successfully in the future. The auditor in order to assume that the company is a going concern is based on the following factors: the demand of the company’s product in the market , if the company have sufficient cash to respond to its liabilities in the future and if it is profitable. Also if the company has sound capital to face any future unexpected events and finally if the company is competitive enough regarding its products, its ability to acquire raw materials and labor.Chara Charalambous MBA CDA COLLEGE 31

b. The income statement for a period is prepared following the accruals concept: the income and expenses are recorded as they happened in the period regardless of whether cash has been received or paid :

Costs which are paid but they are concerning a future period must be carried forward as a prepayment and charged in the period they concern not in the current profit and loss account. The same for income: if there is an income received but it regards a future period for e.g. next year it will not included in the income statement of this period but of the next and for the current year it will consider as prepayment Expenses of the period not yet paid and not entered in the books must be estimated and inserted as accruals.


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The Accrual Basis of Accounting has two parts:

Chara Charalambous MBA CDA COLLEGE

Principle of Revenue Recognition:Revenues are recognized and recorded in the period earned regardless of whether cash has been received.

Matching Principle:Expenses are recognized and recorded in the period incurred regardless of whether cash has been paid. The timing of the recognition of revenues and expenses are matched and reported on the income statement. This principle measures all the expenses incurred during a year and matches them against the revenues of the year.

c. Prudence concept: Business transactions are sometimes uncertain. While making judgment we need to be careful and prudent. Prudence is a key accounting principle which makes sure that assets and income are not overstated and liabilities and expenses are not understated. Accountants must not be very optimism and overstate profits and causing by this unrealized profits to be paid out of capital in the form of dividends. Because there is a danger that the profit might not finally realised since some of the clients of the company might declared bankruptcy and not pay. Therefore Accountants mast be strict with profits but take in mind all possible losses.


d. Consistency: with many accounting transactions there is more than one method which can be used. For example the depreciation method and policy. Accountants must use their judgment to select the most appropriate method, but once that choice is made the same method must be used with consistency (stability) in forthcoming periods. Such consistency enables users to make a useful comparison of results over time. Thus investors can see the level of profit or loss, comparing this year with the last year , and make their investment decisions accordingly. The methods used should only be changed if the new method selected improves the true and fair value given by the accounting statements.

e. Cost Principle: Assets are recorded at purchase price not the price that the owner might believe it deserves to the asset.



Governing OrganizationsFASB• Financial Accounting Standards Board • A privately funded organization, formulates accounting

standards. SEC• Securities and Exchange Commission • U.S. governmental agency that oversees U.S. financial markets.GAAP (USA)• Generally Accepted Accounting Principles • Main U.S. accounting rule book IASP • International Accounting Standards Board • Publishes the International Financial Reporting Standards, the

international accounting rule book


Ethics in Accounting and Business Investors and creditors want reliable financial information Conflict of Interest Companies want to attract investors THUS we have AUDIT• SEC requires companies to have financial statements examined

by independent accountants • Auditors will provide an opinion on financial statements• Also created the Public Companies Accounting Oversight Board

(PCAOB) :Supervisory body of accounting profession


Forms of business organizations

Sole Trader: Owned and operated by one person, although there might be any number of employees. A Sole Trader is fully and personally liable for any losses that the business might take.

Advantages: It is easy and inexpensively formed but in most cases must be

licensed by the municipality in which it operates. Subject to few government regulationsNo corporate income taxes, it is taxed like an individual


Limitations:The owner has unlimited personal liability on business debts

which can result in losses that exceed the money the owner has invested in the company.

Difficult to raise capital because the firm’s financial strength is based on the financial strength of the sole traded

Transferring ownership is difficult – selling of the business is similar to selling a house and the proprietor has to seek out and negotiate with a potential buyer.

Limited life of the business equal to the life of the individual who created it.


Partnership: Owed and operated by two or more people called the ‘partners’.

Partners are ‘jointly and severally’ liable for any losses that the business might make.

Traditionally the big accounting firms have been partnerships

A partnership has roughly the same advantages and limitations as a proprietorship. Also is not a legal entity separate from its partners. And therefore each partner is an agent of the business – a representative.

Regarding liability the partners can lose all of their personal assets even those not invested in the business because under partnership law all each partner is liable for the business’ debts. Thus if any partner is unable to meet his or her prorate claim in the event the partnership goes bankrupt, the remaining partners must cover the unsatisfied claims.


Company: Owned by many people (shareholders) and operated by many people (thought not necessarily the same).

• There can be one shareholder or many thousands of shareholders.

• A company is a legal entity separate from its members• Each shareholder owns part of the company.• Shareholders are not representatives of the company.• As a group, they elect the directors who run the business.• Directors often own shares in theirs companies.• Not all shareholders are directors.• Companies are limited companies (This means that the

shareholders will not be personally liable for any losses the company incurs).

• Their liability is limited to the nominal value of the shares that they own.


Advantages: Unlimited life: it can continue after its original owners are dead. Easy transfer of ownership: ownership can be divided into shares of

stock which in turn can be transferred far more easily than the other two form of organizations.

Limited liability: the loss of a shareholder in case of bankruptcy is limited to the amount he/she initially invested

Ease of raising capital in the financial markets for the above reasons (sell shares e.t.c), because investors will have limited liability and since many will invest funds can be invested in growth opportunities which will increase the value of the firm.

There are two main disadvantages for the corporations:Disadvantages:

Double taxation of earnings: the earnings of the corporation are taxed and then the earnings paid as dividends are taxed again as income to the stockholders

Setting up a corporation and filing required lawyer to prepare regulations and rules regarding the management of the company and reports given to the government , is more complex and time consuming the other two forms of organizations.


CapitalFor all three types of organization, the money contributed by the individual, the partners or the shareholders is referred to as the business capital.In the case of a company the capital is divided into shares. And shareholders receive dividend which is paid at the end of the year out of the profits.Funds raised by issuing shares in return for cash. The amount of share capital a company has can change over time because each time a business sells new shares to the public in exchange for cash, and thus the amount of share capital will increase. Share capital can be composed of both common and preferred shares. .

Also known as "equity financing“. capital

When a corporation issues only one class of stock: ordinary shares, we call it Common stock also generically called capital stock. (or capital stock).


Stockholders’ Equity

Common stock + Retained earnings + Revenues – Expenses – Dividend


Non-Profit OrganizationsNon-profit organizations are organizations whose activities are directed towards completing a social target: for e.g. providing a service, promoting worthwhile principles, raising funds for humanitarian purposes, offering entertainment to their members and the community in general. The main objective of these organizations is not to make a profit. Examples are: Social and athletic clubs, football clubs and charitable organizations. Non-profit organizations include churches, public schools, public charities, public clinics and hospitals, political organizations, legal aid societies, volunteer services organizations, labour unions, professional associations, research institutes, museums, and some governmental agencies.


Examples of Non-Profit Organizations• England: The Wellcome Trust (double ll) was established in 1936 as an

independent charity funding research to improve human and animal health. They do medical research to "achieve extraordinary improvements in health.

• UNESCO United Nations Educational, Scientific and Cultural Organization Its purpose is to contribute to peace and security by promoting international collaboration through education, science, and culture in order to promote universal respect for justice, the rule of law, and human rights, along with fundamental freedom. Projects sponsored by UNESCO include technical and teacher-training programmes; international science programmes; the promotion of independent media and freedom of the press, the promotion of cultural diversity, international cooperation agreements to secure the world cultural and natural heritage (and to preserve human rights. UNESCO’s aim is "to contribute to the building of peace, the elimination of poverty, sustainable development and intercultural dialogue through education, the sciences, culture, communication and information".


• SOS Children’s Villages the largest orphan and abandoned children’s charity in the world they strive to create awareness and build support for SOS Villages around the world.

• Sports Non-Profit Organizations• However, there are also millions of smaller NPOs that provide

social services and relief efforts to people throughout the world. There are more than 1.6 million NPOs in the United States alone.


THANK YOU QUESTIONS

EXERCISES

financial & managerial accounting lecture 1 and 2 1chara charalambous mba cda college

Documents

financial accounting

cost accounting

execution of accounting

financial information

periodthe accounting

financial situation

measurement of transactions

organization goals