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ACCOUNTING IN BUSINESS

Dr Winston Kwok
Learning Objectives

1. Explain the purpose, importance, users, and


uses of accounting
2. Explain generally accepted accounting
principles and the Conceptual Framework
3. Define and interpret the accounting equation
4. Identify the typical financial statements and
explain how they interrelate
Learning Objective 1
Explain the purpose, importance, users,
and uses of accounting
Accounting is Multi-faceted

Information System

Language of
Business
Standards for
Compliance
Purpose and Importance of Accounting
is a
Accounting Identifies
system that

Records

information
Relevant Communicates
that is

Reliable
to help users make
Comparable better decisions.
Purpose and Importance of Accounting

Identifying
Select transactions and events

Recording
Input, measure and classify

Communicating
Prepare, analyze and interpret
Users of Accounting Information

External Users Internal Users

Shareholders
(Investors) Consumer Groups Managers Sales Staff
Lenders External Auditors Officers/Directors Budget Officers
(Creditors)
Customers Internal Auditors Controllers
Governments
External Users and Uses of Financial Information

A listed company is one which shares are listed on a stock


exchange.
E.g. 361 Degrees annual reports on its corporate website
http://ir.361sport.com/html/ir_report.php
The external users of the financial information would be
the shareholders (investors) or lenders (creditors).
The listed company is required by law to issue an annual
report which contains financial statements, auditors
report, notes to accounts and other information such as
chairmans statement.
The annual report is an important source of information for
investors and creditors.
The uses of the information include making economic
decisions such as whether to buy the companys shares or
lend money to the company.
ACCOUNTING
(analyses and professional
judgment)

BOOKKEEPING
(recording)
Financial Accounting versus
Tax Accounting

Financial Accounting based on guidelines on


how best to reflect the economic nature or
economic reality of business.
Tax accounting influenced by economic and
political objectives of governments.
Learning Objective 2
Explain generally accepted accounting
principles and the Conceptual Framework
Ethics - A Hallmark of a Professional

Ethics

Beliefs that Accepted


distinguish standards of good
right from and bad behavior
wrong
Generally Accepted Accounting Principles
Financial accounting practice is governed by
generally accepted accounting principles (GAAP).

Relevant Information Affects the decision of its


users.

Reliable Information Is trusted by users.

Comparable Used in comparisons across


Information years & companies.
Generally Accepted Accounting Principles
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.
Generally Accepted Accounting Principles
General Accounting Principles
Measurement or Cost Principle
Accounting information is based on actual
or historical cost which is considered
objective or reliable.
A business transaction recorded at the
original price paid at the time of the
transaction.
Accounting records reflect original cost as
long as organization holds asset.
Profession moving towards fair values
which involves revaluation subsequent to
cost (lecture on long-term assets).
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, i.e. a credit sale
when cash will be paid in future.
Measure revenue by cash received plus cash
value of items received.
General Accounting Principles

Expense Recognition or
Matching Principle

A company must record its expenses incurred to


generate the revenue reported.
General Accounting Principles

Full Disclosure Principle

Report the details behind financial statements


that would impact users decisions.
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.
Accounting Assumptions
Monetary 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.
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 financial year is any consecutive 12-month time
period which may be different from the calendar year.
Accounting Assumptions
Business Entity
A business is accounted for separately from other business entities,
including its owner. Separate information is necessary for good
decisions.
3 general business entity forms:
Sole Partnership Corporation or
Proprietorship Company
The Audit Report or Auditors Report
Listed 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.
The Audit Report or Auditors Report
Such reports are opinions on the financial statements,
not guarantees about future profitability.
Big 4 accounting firms:
Deloitte, Ernst & Young, KPMG, PricewaterhouseCoopers
Financial statements are the responsibility of the
companys management and not the auditors.
Setting Specific Accounting Principles or
Accounting Standards
U.S. International
Financial Accounting Standards The International Accounting
Board (FASB) is the private group Standards Board (IASB) issues
that sets both broad and specific International Financial Reporting
principles. Standards (IFRS).
http://www.fasb.org/home If IFRS are adopted worldwide, a
company can potentially use a
single set of financial statements in
all financial markets.
IAS were published between 1973
and 2001, while IFRS were
published from 2001 onwards.
Some IAS are still in use.
http://www.ifrs.org/Home.htm
The Big 2 Accounting Standards
U.S.
IFRS/IAS
Accounting
Not examinable for this course.
Singapore
FRS

Malaysia FRS

Australia
accounting
standards

China
accounting
standards

Europe
accounting
standards
IASBs Conceptual Framework
Assists in the development of future IFRS and review of
existing IAS/IFRS.
States the Qualitative Characteristics of financial
information that distinguish better (more useful)
information from inferior (less useful) information for
decision-making purposes.
GAAP

Conceptual
Framework
Conceptual Framework
2 Fundamental
Qualitative
Characteristics

4 Enhancing
Qualitative
Characteristics

Cost-benefit constraint: The cost of providing the information must be weighed


against the benefits that can be derived from using it.
Fundamental Qualitative Characteristics

Relevant financial information is capable of making a difference


in users decisions.
Predictive value: can be used as an input to processes to
predict future outcomes
Confirmatory value: provides feedback about (confirms or
changes) previous evaluations.

Materiality: Information is material if omitting it or misstating it


could influence decisions.
Fundamental Qualitative Characteristics

Complete: includes all information necessary for a user to


understand the phenomenon.
Neutral: without bias in the selection or presentation of
financial information.
Free from error: no errors or omissions in the description of the
phenomenon, and the process used to produce the reported
information.
Enhancing Qualitative Characteristics

Comparability: enables users to identify and understand


similarities in, and differences among, items.
Verifiability: different knowledgeable and independent observers
could reach consensus.
Timeliness: having information available to decision-makers in
time.
Understandability: Classifying, characterising and presenting
information clearly and concisely makes it understandable. Users
are assumed to have reasonable knowledge of business.
Learning Objective 3
Define and interpret the accounting equation
Assets = Liabilities + Equity

Liabilities &
Assets Equity
Assets = Liabilities + Equity

Resources a Claims against the companys resources


company owns
or controls Claims by Claims by owners
creditors (investors or
(lenders) shareholders)
BUSINESS ACTIVITIES
Can be transactions or events.
Record those that affect the accounting equation
and can be reliably measured.
Examples of transactions:
Selling products and services.
Borrowing money.
Purchasing products and services.
Examples of events:
Decreases in the value of assets such as investments.
Technological advances rendering patents (or other
assets) worthless.
Natural events such as floods and fires that destroy
assets and create losses.
Assets
Cash
Accounts Notes
Receivable Receivable

Resources
Vehicles owned or
controlled Land

Store Buildings
Supplies
Equipment
Liabilities

Accounts Notes
Payable Payable

Creditors
claims on
assets
Taxes Wages
Payable Payable
Equity is Assets less Liabilities

Whats left (residual)


of the companys
assets after it pays
liabilities.
Also called net assets,
net worth, or residual
equity.
Equity

Contributed capital: amount invested in


company, represented by ordinary shares
issued to shareholders.
Retained earnings: amount earned and
retained in the business.
Equity
Owners
Claims on
Assets

Expanded Accounting Equation


Net Income or Net Profit
The common measure of a companys result
for a period:
Net Income = Revenues - Expenses

Revenues: Sales of products or services.


Expenses: Cost incurred to provide products
or services.
Net income increases equity.
If expenses more than revenues, then net loss
which decreases equity.
Dividends
Disbursement of cash or other business assets
to the shareholders.
Not compulsory to be paid but up to directors
to decide whether to pay.
Dividends decrease retained earnings.
Learning Objective 4
Identify typical financial statements and explain
how they interrelate
The Four Typical
Financial Statements
Statement of Profit or Loss and Other
Comprehensive Income (including the Income
Statement)
Statement of Changes in Equity
Statement of Financial Position (Balance Sheet)
Statement of Cash Flows
These titles are recommended by IAS 1 Presentation of Financial
Statements but not mandatory; Balance Sheet instead of Statement
of Financial Position is still the favorite title of many reporting entities.
Prior to 1 July 2012, the recommended title for Statement of Profit or
Loss and Other Comprehensive Income was Statement of
Comprehensive Income.
Financial Statement
Nestl:
Heading
Name of company
Title of statement
Reporting period
Currency and units
Adidas:
Links 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.
The statement of profit or loss and other comprehensive
income, statement of changes in equity and statement of
cash flows are flow statements (showing the inflows and
outflows during the period).
for the year ended December 31, 2014
The statement of financial position is a stock statement
(showing at a point in time).
as at December 31, 2014
Links by time periods

At
beginning At end of
of period Time period

Statement of Statement of
Financial Financial
Position Position
Statement of Profit or Loss and
Other Comprehensive Income

Statement of Changes in Equity

Statement of Cash Flows


Understanding Financial Statements

Income Statement
Statement of Changes in Equity
Statement of Financial Position
Statement of Cash Flows

We will illustrate the statements using a company called FastForward, a


start-up consulting (service) business, in its first month of operations
December 2012.
Comprehensive income will be explained in a future lecture; we focus on
the income statement for now.
INCOME STATEMENT
The income statement describes a companys revenues and
expenses along with the resulting net income or loss over a
period of time due to earnings activities.

to Statement of
Changes in Equity
STATEMENT OF CHANGES IN EQUITY
The statement of changes in equity reports information about
how equity changes over the reporting period.
from Income
Statement

to Statement of
Financial Position
STATEMENT OF FINANCIAL POSITION
The statement of financial position describes a companys
financial position at a point in time.
from Statement of
Changes in Equity

to Statement of Cash Flows


STATEMENT OF CASH FLOWS
The statement of cash flows describes a companys cash
from Statement of
flows for operating, investing, and financing activities.
Financial Position

from Statement of
Financial Position
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.
Full disclosure principle.