financial accounting, Appunti di Contabilità Finanziaria

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Financial Accounting Exam: Chapter 1-9 Chapter 1: Introduction to Accounting and Finance What are accounting and finance? • Accounting is collecting, analyzing and communicating financial information • The ultimate aim is to use the information to make more informed decisions • Accounting reports are a major source of information for financing and investment decisions • Accountant must be clear for whom the information is being prepared to and for what purpose • Accounting can play an important role in monitoring and reporting how various groups benefit from the business Fundamental Qualities: • Relevance (help predict future events, or help to confirm past events) • Faithful Representation (the information should be complete, neutral and free from error) Further Qualities: • Comparability • Verifiability • Timeliness • Understandability Weighing up the costs and benefits: • The cost-benefit issue will limit the amount of accounting information provided • The benefits of accounting information eventually decline, the cost of providing information however, will rise with each additional piece of information Accounting information system: • Information identification • Information recording • Information analysis • Information reporting Management accounting and Financial accounting: Management accounting: • Accounting needs of managers • Specific purpose reports • Very detailed • Internal use only, have no regulations • Produced as frequently as needed by managers • Provide info concerning both future and past performance • Contain financial and non-financial information, often use information that cannot be identified Financial accounting: • Accounting needs of all of the users identified earlier (lenders, suppliers, competitors, employees, customers, owners, government, investment analysts…) except managers • General purpose • Provide broad overview • Are subject to accounting regulations • Produced on an annual basis or bi-annual • Provide info concerning the past • Focus on financial information great emphasis on objective verifiable evidence The changing face of accounting: • The environment for businesses became increasingly turbulent and competitive • Internationalization of businesses led to change in accounting rules • Harmonization of accounting rules across national frontiers Accounting for business: Three arrangements for private-sector businesses: • Sole proprietorship • Partnership • Limited company Sole proprietorship: • An individual is the sole owner of the business • Small in size (measured by sales revenue generated or number of staff employed) • Found particularly in service sector • The law does not recognize the sole-proprietor business as being separate from the owner, so the business will cease on the death of the owner • No requirement to produce accounting information • Unlimited liability (no distinction between personal and business wealth) Partnership: • Two or more individuals carry on a business • Quite small in size • Not recognized in law as separate entities • Unlimited liability Limited Company: • Number of individuals who subscribe capital and become the owners maybe be unlimited • Large-scale business • Liability is limited (designed to limit risk and to produce greater confidence to invest) • Framework of regulations exist to conduct their affairs • Annual financial reports to be made available to owners and lenders • Annual general meeting of the owners has to be held to approve the reports • A copy of the annual financial reports must be lodged for public inspection Closing balance of cash 45$ (The statements show that Paul placed 40$ cash into the business. The business received 45$ of cash from customers, but paid 40$ cash to buy the wrapping paper. This left 45$ of cash by Monday evening.) • How much wealth (profit) was generated by the business during Monday? Income statement for Monday Sales Revenue 45 Costs of goods sold (3/4 of 40$) (30) Profit 15 • What is the accumulated wealth on Monday evening and what form does it take? Statement of financial position as at Monday evening Cash (closing balance) 45 Inventories of goods for resale (1/4 of 40$) 10 Total assets 55 Equity 55 Assets: Business resources (things to value to the business) and include cash and inventories Equity: Word used in accounting to describe the investment, or stake of the owner Example 2: On Tuesday, Paul bought more wrapping paper for 20$ cash. He managed to sell all of the new inventories and all of the earlier inventories, for a total of 48$. The statement of cash flows for Tuesday will be as follows: Statement of cash flows for Tuesday Opening balance (from Monday evening) 45$ Cash from sales of wrapping paper 48$ Cash paid to buy wrapping paper (20) Closing balance 73 Income Statement for Tuesday Sales Revenue 48 Costs of goods sold (20$+10$) (30) Profit 18 Statement of financial position as at Tuesday evening Cash (closing balance) 73 Inventories - Total assets 73 Equity 73 Income statement Statement of cash flows • Concerned with measuring flows of wealth and cash (respectively over time) Statement of financial position • Measuring the amount of wealth at a particular moment in time Statement of financial position Assets: An asset is a resource of a business • A probable future economic benefit must exist • The benefit must arise from some past transaction or event • The business must have the right to control the resource • The asset must be capable of measurement in monetary terms Sorts of items that appear as assets: • Property • Plant and equipment • Fixtures and fittings • Patents and trademarks • Trade receivables (Debtors) • Investments outside the business Tangible assets: Assets that have a physical substance and can be touched (such as inventories) Intangible assets: No physical substance, but do provide expected future benefits (such as patents 专利 ) Claims: an obligation of the business to provide cash, or some other form of benefit to an outside party. It will normally arise as a result of the outside party providing assets for use by the business. There are two types of claim against a business. Equity: • Represent the claim of the owners against the business. • Referred to as the owner’s capital • Any funds contributed by the owner will be seen as coming from outside the business and will appear as a claim against the business in its statement of financial position Liabilities: • Represent the claims of all individuals and organizations, apart from the owners • Arise from past transactions or events such as supplying goods or lending money to the business • Liability will be settled through an outflow of assets (usually cash) Example: Jerry and Company is a new business that was created by depositing 20,000$ in a bank account on 1 March. This amount was raised partly from the owner (6000$) and partly from borrowing (14,000$). Raising funds in this way will give rise to a claim on the business by both the owner (equity) and the lender (liability). Jerry and Company Statement of financial position as at 1 March Assets Cash at bank 20,000 Total assets 20,000 Equity and Liabilities Equity 6,000 Liabilities – borrowing 14,000 Total equity and liabilities 20,000 Assets= Equity + Liabilities • There is no right to defer settlement beyond a year after the date of the relevant statement of financial position Non-current liabilities: Amounts due that do not meet the definition of current liabilities and so represent long-term liabilities The role of accounting conventions • Conventions have evolved as attempts to deal with practical problems experienced by preparers and users of financial statements Business entity convention: • Business and its owner are separate entities and are distinct • This is why owners are treated as being claimants against their own business • The Business Entity Conventions must be distinguished from the legal position that may exist between business and their owners • For sole proprietorships and partnerships, the law does not make distinction Historic cost convention: • Holds that value of assets shown on the statement of financial position should be based on their historic cost • The use of historic cost means that problems of measurement reliability are minimized as the amount paid for a particular asset is often a matter of demonstrable fact • However, information provided may not be relevant to user needs • Historic costs may become outdated compared to current market value Prudence Convention: • Prudence convention holds that caution should be exercised when making accounting judgements • Application of the convention involves recording all losses at once • Profits are recognized only when they actually arise • Greater emphasis on expected losses than on expected profits • The convention requires that expected loss from future sales be recognized immediately rather than when the goods are eventually sold • The convention is the opposite of optimism, designed to prevent an overstatement of financial position and performance Going concern convention • The financial statements should be prepared on the assumption that the business will continue (There is no intention, or need to sell off the non-current assets of the business) Dual Aspect convention: • The convention asserts that each transaction has two aspects, both of which will affect the statement of financial position Statement of Financial position: 1) Business entity convention 2)Historic cost convention 3) Prudence convention 4) Dual Aspect convention 5) Going concern convention Money measurement: • Using money as the unit of measurement limits the scope of the statement of financial position • Certain resourced such as goodwill, product brands and human resourced are difficult to measure. An ‘arm’s-length transaction’ is normally required before such assets can be reliably measured and reported on the Statement of financial position • Money is not a stable unit of measurement – it changes in value over time The usefulness of the statement of financial position: • The statement of financial position shows how finance has been raised and how it has been deployed • It provides a basis for valuing the business, though it can only be a starting point • Relationships between various statement of financial position items can usefully be explored • Relationships between wealth generated and wealth invested can be helpful indicators of business effectiveness Chapter 3: Measuring and reporting financial performance Summary: The income statement (profit and loss account) • The income statement reveals how much profit (or loss) has been generated over a period and links the statements of financial position at the beginning and end of a reporting period • Profit (or loss) is the difference between total revenue and total expenses for a period. • There are 3 main measures of profit: 1. Gross profit – which is calculated by deducting the cost of sales from the sales revenue 2. Operating profit – which is calculated by deducting overheads from the gross profit 3. Profit for the period – which is calculated by adding non-operating income and deducting finance costs from the operating profit Expenses and revenue: • Cost of sales may be identified by matching the cost of each sale to the particular sale or by adjusting the goods bought during a period by the opening and closing inventories • Classifying expenses is often a matter of judgement, although there are rules for businesses that trade as limited companies • Revenue is recognized when the amount of revenue can be measured reliably and is probable that the economic benefits will be received • Where there is a sale of goods, there is an additional criterion that ownership and control must pass to the buyer before revenue can be recognized • Revenue can be recognized after partial completion provided that the outcome from the contract can be measured reliably • The matching convention states that expenses should be matched to the revenue that they help generate • A particular expense reported in the income statement may not be the same as the cash paid. This will result in accruals or prepayments appearing in the statement of financial position • The materiality convention states that where the amounts are immaterial, we should consider only what is expedient • The accruals convention states that profit= revenue- expenses (not cash receipts, cash payments) Depreciation of non-current assets • Depreciation requires a consideration of the cost (or fair value), useful life and residual value of an asset. It also requires a consideration of the method of depreciation: The straight-line method: allocates the amount to be depreciated evenly over the useful life of an asset. Reducing-balance method: applies a fixed percentage rate of depreciation to the carrying amount of an asset each year • The depreciation method chosen should reflect the pattern of consumption of economic benefits of an asset • Depreciation allocates the cost (or fair value), less the residual value, of an asset over its useful life. It does not provide funds for replacement of the asset Costing Inventories: • The way in which we derive the cost of inventories is important in the calculation of profit and the presentation of financial position • The first in, first out (FIFO): assumption that the earliest inventories held are the first to be used • The last in, first out (LIFO): assumption that the latest inventories are the first to be used • The weighted average cost (AVCO): assumption applies an average cost to all inventories used • When the pricing are rising, FIFO gives the lowest cost of sales figure and highest closing inventories figure and for LIFO, it’s the other way around. AVCO gives figures for cost of sales and closing inventories that lie between FIFO and LIFO • When prices are falling, the positions of FIFO and LIFO are reversed • Inventories are shown at the lower of cost and net realizable value