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Introduction 1
Introduction
Accounting → Collecting and delivering information to help stakeholders make better decision
Finance → Ways to raise and invest funds to help stakeholders in their decision making process
Stakeholders
user group (internal or external) which have an interest within the business
INTERESTS DECISION
Employees future plans, profit whether or not working in the company
Customers reliability, prices whether or not buying goods or services
Lenders receive their money back whether or not lending money
Investors pay for the services supplied whether or not investing
Owners look for profit whether or not investing
Community new workplaces provide economic support
Purpose of a business
satisfy all stakeholders
reaching targets
customer is a king
Financial objectives
main → enhance wealth of its owner
secondary → good working conditions, product quality
Information
Sources
meeting with managers
newspapers
announcements made by the company
internet → reports
Weighing costs and benefits
if costs < benefits then the information should be produced
optimal quantity → when the gap costs - value is at its greatest
Usefulness
Fundamental
Relevance
influencing decision → predict future events and confirm past ones
Materiality → if the omission of a certain information would affect the decision making process
Faithful representation
Complete
free from error
neutral
Introduction 2
Enhancing
Comparability
Verifiability
Timeliness
Understandability
System
graph LR
id 1 (Information IDENTIFICATION) - -> id 2 (Information RECORDING) - -> id 3 (Information ANALYSIS)--> id 4 (Information REPORTING)
Three major financial statement 1
Three major financial statement
Cash flow statement → cash movements over a period of time
Income statement → wealth generated over a period of time
Balance sheet → wealth accumulated, sets out the positions at a single moment in time.
Assets
Resources of the business
Characteristics
ability to provide future benefits
existence of the right to control the benefit
the benefit has to be a result from a past transaction
reliable measurement in monetary terms
NB: we cannot put on the balance sheet:
something we created
something we rented
a person
Can be:
tangible → physical substance
intangible → no physical substance
Yes
No
Probable future economic
benefit?
No
Does the benefit arise from a
past transaction?
No
Is there a right to control the
resource?
No
Can the resource be
measured in financial terms?
Accounting asset
Yes
Yes
Yes
Not an accounting
asset
Classifying assets
non current assets → > 1 year
held for use for a long term
Examples:
property
Assets = Equity + Liabilities
Assets = Equity + P rofit + Liabilities
Three major financial statement 2
vehicles
furniture
computers
NB: if the company sells computers or vehicles they are a current asset
current assets → < 1 year
held for sale for the current commercial year
expected to be sold in a year
Assets valuation
Non current assets
have useful lives that are either finite or indefinite
finite lives → provide benefits for a limited period of time which is depleted by depreciation
indefinite lives → provide benefits without a foreseeable time limit
Depreciation → amount used up, it is an expense which occurs each period
the accumulated depreciation must reduce the shown value: Net figure (carrying amount or net book value)
depreciation is deducted from the cost of the asset
Impairment → where the amount that can be recovered from the non-current assets is below the net book value
standard valuation → historic cost
we can also use fair value
only if they can be measured reliably
are market based → represent the selling price that can be obtained in an orderly transaction under
current market conditions
Current assets
shown at their historic cost
Claims
Equity → owner’s capital in a sole proprietorship
Liabilities → claims of individuals/businesses apart from the business
Classifying claims
non current liabilities → > 1 year
amount due in the long term
current liabilities → < 1 year
due within the current business cycle or within a year
result of trading
no right to defer settlement beyond a year
Net figure = Cost of the asset − T otal depreciation
Three major financial statement 4
Profit of the year
NB:
non operating income → trade receivables
interests expenses → loans, trade payables
Layout
Sales revenue
Cost of sales ( )
Gross profit
Expenses ( )
Operating profit
Interests ( )
Non operating income
Net profit
Revenue
when the business has satisfied its obligations towards the owner
realisation convention → revenue is recognised when it has been realised
Revenue has to be recognised at the time ownership and control it the items pass to the buyer
Revenue has to be recognised at the time the amount of revenue can be measured reliably and it is probable that
the economic benefit will be received
in long term contracts → reporting at the time of completion results in misleading information
recognise the revenue before the work has been completed
Examples :
Sales of goods
fees for services
Subscriptions
Interest received
Expenses
matching convention → expenses should be matched to the revenue they helped generating
the expenses associated with a particular revenue must be taken into account in the same reporting period as that
in which the item of revenue is included. This often means that a particular expense reported for a period may
not be the same figure as the cash paid during the period.
when the expense do not match the amount paid:
accruals
Operating profit = Gross P rofit − Operating expenses
P rofit of the year = Operating P rofit + Non operating income − Interests expenses
Three major financial statement 5
prepayment
Costs to operate the asset (fuel) are not treated as part of the balance sheet
Example :
Cost of sales or cost of goods sold
Salaries and wages
Rent and rates
Motor vehicle running expenses
Insurance
Accruals and prepayments
Considered only if it is an important amount
materiality convention → where the amounts are trivial we should only consider what is useful
accruals → we did not pay the full amount
NB: in the income statement we put the whole amount → amount paid + amount outstanding
in the balance sheet the amount outstanding will be classified as a current liability under accrued
expenses
accruals convention → profit = revenue - expenses
profit is the excess of revenue over expenses, not the excess of cash receipts over cash payments
prepayments → we paid more than we needed for the year
NB: in the income statement we put only the amount used up, without the prepayment
in the balance sheet will be classified as a current asset under prepaid expenses
in the next year will appear as an expense in the income statement and will cease to be an asset
Depreciation
it is a loss of wealth
On the balance sheet the accumulated amount of depreciation will be deducted from its historic cost
Requires a consideration of:
the cost
the method of depreciation
the useful life
the residual value
residual value → disposal of value at the end of economic lifetime
Calculation methods:
Straight line method → amount to be depreciated evenly over the useful life of the asset
the written down value declines constantly each year
P ayment received = Residual value
Three major financial statement 7
R → residual value
C → Cost
Example:
R = 2k
C =
n = 4
year 1 → 78.124 * 0,6 = 46.874 Rest: 78.124 - 46.874 = 31.
year 2 → 31.250 * 0,6 = 18.750 Rest: 31.250 - 18.750 = 12.
year 3 → 12.500 * 0,6 = 7.500 Rest: 12.500 - 7.500 = 5.
year 4 → 5.000 * 0,6 = 3.000 Rest: 5.000 - 3.000 = 2.000 →
UHVLGXDOYDOXH
Reducing balance by an arithmetic progression
NB:
d → Depreciation
Example:
R = 2k
C =
n = 4
year 1 → 4 * 7.612,4 = 30.449,6 Rest: 78.124 - 30.449,6 = 47.674,
year 2 → 3 * 7.612,4 = 22.837,2 Rest: 47.674,40 - 22.837,2 =
24.837,
year 3 → 2 * 7.612,4 = 15.224,8 Rest: 24.837,2 - 15.224,8 = 9.612,
year 4 → 1 * 7.612,4 = 7.612,4 Rest: 9.612,4 - 7.612,4 = 2.000 →
UHVLGXDOYDOXH
Over depreciation → profit on sale of non current asset
when the residual value is lower than the profit
Under depreciation → loss on sale of non current asset
when the residual value is greater than the profit
Cash flow statement
Designed to reveal cash movements over a period
cannot be readily detected from the income statement → focuses on revenue and expenses rather than cash receipts
and cash payments
Profit and loss are rarely equal to the cash generated for the period
NB: if there are effects on the profit there are effect on the income statement
Purchasing inventories has effect on the income statement only if sold
P = 1 − ∗
4
d =
1 + 2 + 3 ... + n
C − R
d = =
1 + 2 + 3 + 4
Three major financial statement 8
Layout
contains three categories:
- cash flow from operating activities
Profit for the year
± Increase (minus) or decrease (plus) in inventories
± Increase (minus) or decrease (plus) in receivables
± Increase (plus) or decrease (minus) in payables
- Interest paid
- Corporation tax paid
- Dividend paid
= Net cash flow from operating activities
- cash flow from investing activities
a. Depreciation charges = start - end non current assets value + additions
Payments to acquire tangible non-current assets
= Net cash flow from investing activities
- cash flow from financing activities
= Net cash flow from financing activities
Direct vs indirect method
The direct method is based on an analysis of the cash records for the period
The indirect method uses information contained in the income statement and in the balance sheet of the business
Indirect method
Profit for the year
Expenses without payment
(depreciation)
- Revenues without cash receipts
- Non expense payments
- Cash receipts on revenues
= Cash Flow
Direct method
Profit for the year
= Cash Flow
Additions = Depreciation charges −
start + end non current assets value
Costing inventories 2
The cost of sales is the quantity of goods sold multiplied by their cost per ton
NB: if the business decides to sell its goods or services for an higher price than the cost per ton it will have a sales revenue and a gross profit
the sales revenue will be calculated by multiplying the quantity of goods sold by the price the business sells them (in this case 30)
the gross profit will be calculated by deducting the cost of sales from the sales revenue
LIFO
Tons Cost per ton Total Sold Cost per ton Total
Opening
inventories
20 18 10 25
2 september 48 20 15 24
4 september 15 24 35 20
6 september 10 25
Closing
inventories
Cost of sales
Sales revenue
Gross profit
To calculate the cost per ton of the goods sold I need to multiply the goods sold with their cost per ton.
In this case i know the business sold 60 inventories, therefore I take the last 10 inventories which have a cost per ton of 25, then the
other 15 from the day before and other 35 from the 2nd of September.
To calculate the closing inventories I have to take the tons I have not sold and multiply them for their cost per ton
The cost of sales is the quantity of goods sold multiplied by their cost per ton
NB: if the business decides to sell its goods or services for an higher price than the cost per ton it will have a sales revenue and a gross profit
the sales revenue will be calculated by multiplying the quantity of goods sold by the price the business sells them (in this case 30)
the gross profit will be calculated by deducting the cost of sales from the sales revenue
AVCO
Tons Cost per ton Total Average cost per ton
Opening
inventories
20 18
2 september 48 20
4 september 15 24
6 september 10 25
Total: Total:
Ton sold 60
Closing inventories
Cost of sales
Sales revenue
20 ∗ 18 = 360 10 ∗ 25
48 ∗ 20 = 960 15 ∗ 24
15 ∗ 24 = 360 35 ∗ 20
10 ∗ 25 = 250
250 +
360 +
1310
13 ∗ 20 +
20 ∗ 18 = 620
250 +
360 + 700 =
1310
( 10 + 15 +
35 ) ∗ 30 =
1800
1800 −
1310 = 490
20 ∗ 18 = 360 = 93
1930 20 , 75
48 ∗ 20 = 960
15 ∗ 24 = 360
10 ∗ 25 = 250
20 + 48 +
15 + 10 = 93
360 + 960 +
360 + 250 = 1930
( 93 − 60 ) ∗ 20 , 75 =
685
60 ∗ 20 , 75 = 1245
60 ∗ 30 = 1800
Costing inventories 3
Tons Cost per ton Total Average cost per ton
Gross profit
First of all I need to understand how many inventories I have and I do that by summing all the tons
Secondly I multiply the tons with their respective costs and sum the results
To calculate the average cost per ton of the goods sold I need to divide the total cost per ton by the total of tons.
To calculate the closing inventories I have to subtract the tons sold from the total and multiply them for the average cost per ton.
The cost of sales is the quantity of goods sold multiplied by their average cost per ton
NB: if the business decides to sell its goods or services for an higher price than the cost per ton it will have a sales revenue and a gross profit
the sales revenue will be calculated by multiplying the quantity of goods sold by the price the business sells them (in this case 30)
the gross profit will be calculated by deducting the cost of sales from the sales revenue
1800 − 1245 = 555
Limited companies 1
Limited companies
Limited liability company
Artificial person created by law
It has a separated life from its owner and its granted perpetual life
can have one or more owners
ownership is divided by number of shares → number of shares determines the ownership
Governed by the board of directors → elected by shareholders
Limited companies can enter in contracts or sue someone or be sued in court
A limited company has many of the rights and obligations that real people have.
Shareholders or court can end the existence of a limited company
A limited company takes responsibility for its own debts and losses
Safeguard
limited liability
shareholders pay what they agreed to pay for the shares
loss for shareholders is limited by this amount
restrictions for shareholders to withdraw their equity
required to produce financial statements and make them public
Taxation
based on the year profit
shown in the income statement
Stock exchange
2 functions
1. PRIMARY capital market → enables companies to raise new markets
2. SECONDARY capital market → enables investors to sell and buy their shares
Limited companies 2
EQUITY
Share capital Reserves
Ordinary shares Preference shares Capital reserves Other reserves
Ordinary shares capital
all companies issue ordinary shares
nominal value is decision of people that
start the company
all shares must have equal value
main risk takers
have voting rights
Preference shares
guarantee a prior or fixed dividend
no voting rights
Capital reserves
issuing shares above normal value
cannot be withdrawn
“share premium account”
Reserves ≠ provisions
Revenue reserves
“retained earnings”
result of a former profit
can be withdrawn
Nominal value
unadjusted rate or current price of an asset without taking into account deductions
(expenses, taxes)
example: we need more money for the company and we want to issue some shares
we need $160k
we have a total of 10k shares
Nominal value =
n of shares
o
Share value
160000
Double entry bookkeeping 1
Double entry bookkeeping
Double entry bookkeeping
A system for keeping accounts by hand
There is a separate account for each transaction
Each account looks like a letter T
The left side is the debit side →records increases in assets and decreases in equity and
liabilities
The right side is the credit side → records decreases in assets and increases in equity and
liabilities
1. Analysing transaction
Does the event cause any change in assets, liabilities or equity?
If yes, which accounts are changed?
When did it happen?
Event
No Change in assets,
liability, equity
No transaction
Nature of
transaction
Yes
Journal entry
2. Journalising transaction
Assets + Expenses = Equity + Revenues + Liabilities
Double entry bookkeeping 2
Recording the transaction into the general journal
Chronological documentation of the transactions
Example
March 15
Machine 2.
Cash 2.
3. Posting to the general ledger
Sorting data in a way to generate information on each accounting element
each account is a sheet of paper
4. Preparing the trial balance
is a list of each ledger account balance to verify that the general ledger is in balance
Debits Credit
Inventories 4.
Cash 2.
Equity 5.
5. Adjusting the accounts
at the end of the period accountant adjust
accruals
deferrals
error corrections
6 - 7. Adjusting the Trial balance
correcting errors and adjusting general ledger
8. Preparing financial statements
Income statement
Statement of owner’s equity
