introduction to financial accountingstudent.bms.lk/cbm/slides/36/slides/mf/1.introduction to... ·...

INTRODUCTION TO FINANCIAL ACCOUNTING

Session 01

Certificate in Business Management (CBM)

Session Outline

• Definition of Accounting• Objectives of Accounting• Users of Accounting Information• Book-keeping vs. Accounting• Accounting Process• Source Documents and Prime Entry Books• Qualitative Characteristics of Accounting Information• Accounting Concepts/ Principles• Elements of Accounting• Types of Financial Statements

DEFINITION OF ACCOUNTING

“The process of identifying, measuring and communicating economic information to permit

informed judgments and decisions by users of the information.“

American Accounting Association [AAA]-1941

OBJECTIVES OF ACCOUNTING

Primary Objective:

To provide information for decision making

Other Objectives:

–To keep systematic records

–To ascertain profitability

–To ascertain the financial position of a business

–To comply with laws and regulations

USERS OF ACCOUNTING INFORMATION

USERS OF ACCOUNTING INFORMATION

User Interests

Investors Profitability/ Security

Management Financial progress and the status

Employees Job security/ Pay and benefits

Lenders Repayment capacity

Government Employment creation/ Tax payable

Suppliers Financial health/ Liquidity

Customers Business stability

Public Local welfare/ Environmental concerns (CSR)

Competitors Benchmarking

PRACTICE QUESTION

• List four (4) users of accounting information and briefly explain their information needs.

BOOK KEEPING VS. ACCOUNTING

• Book-keeping is the process of recording data relating to accounting transactions in the accounting books.

• Accounting is concerned with the uses which accountants might make of the bookkeeping information given to them.

ACCOUNTING PROCESS

Source Documents

Prime Entry Books

General Ledger

Trial Balance

Financial Statements

SOURCE DOCUMENTS

• Contains details regarding a business transaction.

• Used to verify that transactions have actually occurred, and is proof for such.

• Usually contains the description of the business transaction, the date of the transaction, monetary values and an authorising signature.

• Important to the accountants, who uses the information on the document as a source to record transactions.

Books of Prime Entry Transaction Type Source Document

Sales Journal Credit Sales Sales Invoice

Purchases Journal Credit Purchases Purchase Invoice

Return Inwards Journal Returns Inwards Credit Notes

Return Outwards Journal Returns Outwards Debit Notes

Cash Book Receipts and Payments of Cash and Cheques Cheque Counterfoils, Paying in slips, Till Rolls

Petty Cashbook All small Cash Transactions Petty Cash Vouchers

General Journal All transactions not recorded elsewhere Everything else not covered by above

QUALITATIVE CHARACTERISTICS

• Accounting information must comply with qualitative characteristics.

• These are the attributes that make information useful for both external and internal users.

• Clear and understandable information is needed for quality decision making.

• If users cannot understand the information; it is considered as a waste of resources.

1. Understandability

• Classifying, characterising and presenting information clearly and concisely makes it understandable.

• To understand accounting information, users are assumed to have a reasonable knowledge of business activities.

• Information on complex issues if relevant, should not be eliminated, even though it is difficult for an average user to understand.


2. Relevance

– To be useful, information must be relevant to the decision making needs of users.

– Information needs to be released on a timely basis.

– Information should be capable of making a difference in the decisions made by users.


3. Reliability

• Information is reliable when it is free from errors and biases.

• A faithful representation of transactions and events


4. Comparability

• Comparability of information allows users to evaluate and choose between alternatives.– Example: Selling or holding an investment.

• Information is more useful if it can be compared with similar information about other entities and with similar information about the same entity for another period.


• Accounting concepts are considered as the basic rules,

assumptions or conventions adopted in preparing financial

statements.

• Accounting concepts are developed to ensure consistency

and uniformity of accounting records.

ACCOUNTING CONCEPTS

1. Business Entity Concept

• A business is considered as an independent entity separated from the owner of the business.

• According to this concept, business transactions are entered in the records of the business, by looking at them from the point of view of the business and not from the point of view of the owner.

• Therefore, any personal incomes and expenses of the owner should not be treated as incomes and expenses of the business.

ACCOUNTING CONCEPTS

2. Dual Aspects Concept

• This concept states that every business transaction has two equal aspects (effects).

– Example: – Purchased a stock worth Rs. 2,000

1st Aspect (Effect) Rise in stock by Rs. 2,000

2nd Aspect (Effect) Fall in cash by Rs. 2,000

ACCOUNTING CONCEPTS

3. Money Measurement Concept

• Transactions and events that are capable of being measured in monetary terms only, are recognized in the financial statements. – Example: Skills and competence of employees cannot be measured in monetary terms,

however salaries paid to them can be.

• Typically, the currency of the respective country will be used to represent the accounting transactions.

ACCOUNTING CONCEPTS

4. Going Concern Concept

• This implies that the business will continue to operate for the foreseeable future.

• Financial Statements are prepared based on a going concern basis, and is assumed that the entity has neither the intention to liquidate or cease trading.

– Example: Classification of Assets in to current and non-current assets.

ACCOUNTING CONCEPTS

5. Accounting Period Concept

• This concept identifies the necessity of dividing the indefinite period of business life into shorter periods and prepare financial statements to represent each period.

• To determine the profit or loss of an entity, and to ascertain its financial position, financial statements should be prepared at regular intervals of time, usually at the end of each year. This one-year cycle is known as the accounting period.

ACCOUNTING CONCEPTS

6. Accruals Concept

• Accrual basis is a method of recording

accounting transactions for revenue when earned and expenses when incurred.

• Simply, revenues and expenses relevant to a particular accounting period must be taken into consideration, irrespective of the date of receipt or payment

– Example: Electricity Bill payments

• A key advantage of the accrual basis is that it matches revenues with related expenses, so that the complete impact of a business transaction can be seen within a single reporting period.

• The alternative method for recording accounting transactions is the cash basis.

ACCOUNTING CONCEPTS

• Identify the accounting concept/ principle for the

following:

– Drawings of the owner is accounted separately as a

reduction in capital.

– The financial statements need to be prepared at annual

intervals.

– The electricity expense of $4,000 has been accounted as an

expense for the period even though it is not yet paid.

CLASS ACTIVITY

Assets Liabilities Capital

Income Expenses

ELEMENTS OF ACCOUNTING

Assets• A resource which a business owns or controls to

benefit from its use.

• An Asset can be recognized when:

– The firm owns or controls the right to use the item

– It is probable that the future economic benefits embodied in the asset will flow to the entity

– The asset cost can be measured reliably

“Asset is a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity “

• Assets may directly generate revenue for the organisation (e.g. inventory) or it may be something which supports the primary operations of the organisation (e.g. buildings).


Assets

• Non-current assets

– Assets whose benefits are expected to last more than one year from the reporting date.

– Examples: Long term investments/ Land/ Equipment/ Buildings

• Current assets

– Assets an organisation expects to use within one-year time from the reporting date

– Assets which are held for the purpose of being traded

– Examples: Inventory/ Cash and Cash equivalents/ Receivables/ Prepaid expenses


Liabilities• An obligation of an organisation to transfer cash or other resources to another

party.

Examples- Bank loans/ Trade payables

• A liability can be recognized when;

– The entity has a present obligation

– It is probable that an outflow of resources will be required to settle the obligation

– A reliable estimate can be made of the amount of the obligation

“A liability is a present obligation of the enterprise arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits”


Liabilities

• Non-current liabilities– A liability which the entity expects to settle after one year from the

reporting date.

– Example- Long term bank loans

• Current liabilities– A liability which the entity expects to pay off within one year from the

reporting date.

– Examples- Short term borrowings/ Trade payables/ Tax liabilities


Capital• Capital is what the owners of an entity have invested in an enterprise

• This represents the amount the business owes to its owners

• Capital also represents what is left to the owners after liabilities are settled (residual value) : Total Assets – Total Liabilities

• Capital is also known as “equity or net assets”

Examples: Share capital/ Retained earnings/ Revaluation surpluses

“Equity is the residual interest in the assets of the entity after deducting all the liabilities”

• Capital is affected by;

– Initial and additional contributions of owners

– Withdrawals made by owners

– Income and Expenses (Profit)


Income

• Income is an increase in the net assets of the entity during an accounting period, except for such increases caused by the contributions from owners.

“Income is increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants.”

• Two types of Incomes:

– Revenue : Income earned in the ordinary course of business activities

– Gains: Income that does not arise from the core operations of the entity.

• Examples:

– Sale revenue generated from the sale of goods

– Interest received on a bank deposit

– Gains by selling an equipment


Expenses

• Expense is a decrease in the net assets of the entity over an accounting period, except for such decreases caused by the distributions to the owners.

“Expenses are the decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrences of liabilities that result in decreases in equity, other than those relating to distributions to equity participants’

• Examples:

– Salaries and Wages

– Utility Expenses

– Administration Expenses

– Finance Costs


Classify the below accounts into the elements of accounting.

– Equipment and Furniture

– Accounts Receivable

– Advertising Expenses

– Bank Loan

– Commission Income

– Cost of Sales

– Delivery Expenses

– Depreciation Expenses

– Income Taxes Payable

– Prepaid Insurance

– Interest Income

– Inventory

– Repairs and Maintenance

– Telephone Expenses

– Salaries Payable

CLASS ACTIVITY

• Reports prepared by an organisation to present their financial performance and the position.

• Provides various financial information for different stakeholders to evaluate an organisation.

FINANCIAL STATEMENTS

• To ascertain the financial performance and the financial position of the business

• To assess the growth of the business

• To make comparisons overtime and with competitors

• To forecast and prepare budgets

• To communicate with various stakeholders

• To provide information for decision making

OBJECTIVES OF FINANCIAL STATEMENTS

• Statement of Comprehensive Income (Income Statement):

• Reports the financial performance of a company in terms of net profit or loss over a specified period.

• Comprised of two elements; Income and Expenses

• Statement of Financial Position (Balance Sheet):

• Presents the financial position of an organisation at a given date.

• Comprised of three elements; Assets, Liabilities and Equity

• Statement of Cash Flows:

• Presents the movement in cash of a business over a period.

• Classified into three segments; Operating Activities, Investing Activities and Financing Activities

• Statement of Changes in Equity:

• Provide details on the movement in Equity over a period.

TYPES OF FINANCIAL STATEMENTS

Thank You

Email – [email protected]