Introduction to Financial Accounting Statements

Financial Accounting 1
Topic 1 Introduction to Financial Accounting

Professor Aileen Pierce Room Q206 Quinn School
Phone 716 4745 (x4745)

aileen.pierce@ucd.ie
UCD Quinn School of Business
Scoil Ghn U Chuinn UCD
Financial accounting
Financial accounting is the process by which financial information is prepared and communicated to users
Prepared and communicated by whom? How? Limited companies are required to provide shareholders with an audited set of accounts, or financial statements
Typically, they do this within the companys Annual Report

Information useful for economic decision-making Corporate reporting Annual Reports Financial Statements e.g. Statements of financial performance Statement of financial position Cash flow statement Notes Accompanying the financial statements e.g. OFR Other means of communication by the company e.g. Investor and analyst briefings Websites Other market information e.g. Analysts' reports
Historical summaries and trends Non-financial information
Industry journals
Interim and quarterly reports Letters to shareholders Press releases
Economic statistics News articles
Figure 1: The communication of decision-useful information Scoil Ghn U Chuinn UCD UCD Quinn School of Business Source: Inside Out: Reporting on shareholder value, ICAEW, 1999
Figure 1.5 Useful information
Objective of Financial Statements
The IASB states that the objective of financial statements is to provide information about the financial position,
performance, and changes in financial position of an entity that is useful to a wide range of users in making economic decisions.
Users of Financial Statements

Put yourself in the position of a business and ask:
Investors
Employees Lenders Customers
Who uses our financial statements?
Suppliers and other trade creditors
And: For what?
Governments and their agencies
Public
Figure 1.4 A set of financial accounting users
Table 1.1 Users and their different needs (1/4)

Users Accounting sourcedocuments Information to plan, make Transaction strategic- and resourcedocuments, allocation decisions and control Financial statements Needs Accessible Delay to obtain information information (Accounting and other) Total access, from Information is source documents to accessible on an financial statements ongoing basis. Its availability depends on the organization itself Financial statements The date on which the plus additional financial statements publicly available must be made information about the available before the successes of the firm in general assembly is its markets and in its regulated in each and operations every country. The trend is towards earlier publication
Management
Shareholders/ Investors
Are concerned with the risk Financial inherent in, and return provided statements by, their investments: Information to help them determine whether they should buy, hold or sell Information to assess the ability of the enterprise to pay dividends
Use with Financial Accounting and Reporting: A Global Perspective, 3rd Edition, ISBN 1-4080-2113-2

Users Bankers, lenders Accounting sourcedocuments Information to determine Financial whether their loans, and the statements, interest attached to them, will both be paid when due historical and pro forma (i.e., forecasts) Information to determine Financial whether amounts owed to them statements will be paid when due. Trade creditors are likely to be interested in an enterprise over a shorter period than lenders unless they are dependent upon the continuation of the enterprise as a major customer. Information to determine whether the studied firm offers better business opportunity in the future and therefore to decide if any preferential treatments should be offered to this particular firm Needs Accessible information (Accounting and other) Financial statements plus additional publicly and privately available information about the successes of the firm in its markets and in its operations In theory these users have no particular claim on financial information beyond the financial statements but by benchmarking and comparative analysis plus an organized intelligence watch, they can interpret financial information in a detailed manner Delay to obtain information A business will produce any additional ad hoc documents whenever it needs to raise funds from banks or on the market Case by case
Suppliers and other trade creditors

Users Customers Accounting Accessible sourceinformation documents (Accounting and other) Information about the going Financial Just like suppliers, concern nature of an enterprise, statements customers will ask especially when they have a information directly long-term involvement with, or and cross-reference it are dependent on, the to be able to have enterprise. Customers are leading signals especially interested in indicating possible evaluating the viability of the opportunities or firm as an ongoing supplier for problems service after sales and/or for future orders To compare relative Financial Competitive analysis performance statements will be the output of large databases of financial statements, cross-referenced with business intelligence and a good understanding of the economic sector Needs Delay to obtain information Case by case
Competitors
Case by case, as a function of the amount of resources dedicated to information gathering

Users Needs Accounting sourcedocuments Financial statements Accessible Delay to obtain information information (Accounting and other) Access is Case by case moderated regulated through by local legislation legislation in every country On a recurring basis the taxformatted financial statements plus, in the case of a tax audit, access to all source documents Regulated access Each country has specific rules. For example, in the UK, most companies are required to pay corporation tax nine months and a day after the end of an accounting period Case by case
Employees
Government, regulatory agencies, tax authorities
Information about the stability and profitability of their employers. Information to assess the ability of the enterprise to provide remuneration, retirement benefits and employment opportunities Are interested in resource allocation and, therefore, want to know about the activities of enterprises. Also use information in decisions to stimulate the economy, to determine taxation policies and assessments. Also use some or all the information in the calculation of national economic statistics
Financial statements, often recast in a pre-defined tax-based format possibly following different rules Financial statements
General public Enterprises affect members of the public individually and collectively. For example, enterprises may make a substantial contribution to the local economy in many ways, including the number of people they employ and their patronage of local suppliers. Financial statements may assist the public by providing information about the trends and recent developments in the prosperity of the enterprise and the range of its activities
The Statement of Financial Position (SoFP)

What is included?
Assets and liabilities Equity Also known as the BALANCE SHEET
What do these terms mean?
How are items in SoFP valued?

What is excluded?
Goodwill? Employees?
The Statement of Financial Position

Is a list of
resources of the firm and claims on those resources Assets Liabilities
Prepared as at a particular date

on a single company basis on a Group or Consolidated basis
Equity
Assets, Liabilities and Equity

Extract from IASBs Framework for the Preparation and Presentation of Financial Statements
An 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
Non-current Assets
Current Assets
Non-current assets - examples

Non-current assets are used on a continuing basis in the organisation
Land and Buildings
Motor Vehicles
Plant and Machinery Furniture Long Term Investments
Glanbia plc Non-current Assets Section of the Group statement of financial position (SoFP)
ASSETS Non-current assets Property, plant and equipment Intangible assets Investments in associates Investments in joint ventures Trade and other receivables Deferred tax assets Available for sale financial assets Derivative financial instruments Notes 14 15 16 17 19 27 18 32 2010 000 369,346 356,830 11,757 58,945 23,084 7,388 14,127 1,643 843,120 2009 000 363,152 342,112 10,041 58,276 50,555 12,022 20,397 2,718 859,273
Current Assets
Receivables (amounts due to the entity from outside the business)
Bank and Cash (amounts owned by the entity) Prepaid Expenses - any guesses? Inventory
There are some underlying assumptions
Underlying assumptions
Items included in financial statements (e.g., assets) are defined in terms of their relationship to the business
The business is the reporting entity Typically, this is a year SFP is a snap-shot as at a particular date
A reporting period is assumed

Glanbia plc Current Assets Section of the Statement of Financial Position (SFP)
Notes 20 19 32 21 Current assets Inventories Trade and other receivables Derivative financial instruments Cash and cash equivalents Total current assets Total assets 2010 000 303,991 246,831 3,912 229,101 783,725 1,626,845 2009 000 201,577 204,326 7,501 152,789 566,193 1,425,466

An 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 A liability is a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits
Current Liabilities
Non-current Liabilities
Current Liabilities
Payables (amounts owed by the organisation to outsiders)
Bank Overdrafts Taxes Accrued Expenses - any guesses?
Glanbia plc Current Liabilities Section of the Statement of Financial Position (SFP)
Notes Current liabilities Trade and other payables Current income tax liabilities Borrowings Derivative financial instruments Provisions for liabilities and charges Total liabilities 31 26 32 29 2010 000 366,246 2,538 972 6,487 21,105 397,348 1,202,441 2009 000 295,481 2,816 945 10,615 27,311 337,168 1,128,078
Non-current Liabilities
When liabilities are not due for payment within one year from the Statement of Financial Position date (balance sheet date), they are classified as non-current liabilities
Equity
Represents owners stake in the business
Amount of assets not funded by liabilities Equity can also be called:
Net Worth (US) Capital Shareholders funds (UK) Stockholders equity (US)

An 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 A liability is a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits Equity is the residual interest in the assets of the entity after deducting all its liabilities.
Another underlying assumption!
Items included in financial statements (e.g., assets) are defined in terms of their relationship to the business
The business is the reporting entity Typically, this is a year
A reporting period is assumed
Assets of a business are funded by liabilities plus equity

Assets equal (liabilities + equity)
Glanbia plc Equity Section of the Group statement of financial position (SoFP)
EQUITY Issued capital and reserves attributable to equity holders of the Parent Share capital and share premium Other reserves Retained earnings Non-controlling interests Total equity Notes 2010 000 2009 000
23 22 24 25
99,741 132,227 185,544 417,512 6,892 424,404
99,219 108,672 83,004 290,895 6,493 297,388
Accounting Equation
Assets = Liabilities + Equity(or Capital/Net
Worth/Shareholders Funds)
Assets - Liabilities = Equity
Simple example:
At 31st December 2010, ABC plc
Has cash in the bank of 1,000 (had 2,000 at end 2009) Owes 300 to DEF plc (owed 500 at end 2009)
How much equity have the owners of ABC plc in the business at 31 December?
Prepare the Statement of Financial Position

How do we work this out?
ABC plc
31.12.2010
Assets -
31.12.2009
2,000 500
Minus
1,000 300
Liabilities Equals = Equity
700
1,500
ABC plc
Suppose the shareholders in ABC plc had originally invested 300 in exchange for all of the issued share capital of ABC plc
Analyse equity of 700 and 1,500 on 31 December 2010 and 2009, respectively, to show original share capital separately
ABC plc
Share capital Retained income Total equity
31.12.2010 300 400 700
31.12.2009 300 1,200 1,500
Profits have been earned and retained in the business

How do we calculate amounts for financial statements?

Cost Resale value (what it could be sold for net realizable value) Value in use (what it is worth to the business)
Replacement cost (what would it cost to replace)

Cost less allowance for wear and tear (depreciation)
How are items valued in SFP?

Accountants use (mainly)
For non-current assets: Cost less depreciation For inventory: Lower of cost and net realizable value (sale value)
Why?
Verifiable (can look at documents to establish cost and realizable value) Expect to recover at least the amount included in the SFP through regular trading
Another underlying assumption!
Accounting entity
The business is the reporting entity
Accounting period
Typically, this is a year
Accounting equation
Assets equal (liabilities + equity)
The business will continue for the foreseeable future

The going concern principle
Objective of Financial Statements
The IASB states that the objective of financial statements is to provide information about the financial position,
performance, and changes in financial position of an entity that is useful to a wide range of users in making economic decisions.
The Income Statement

Example: Glanbia
Overview Income and expenses
Accruals/matching principle
Glanbia plc Group Income Statement

2010 000 Note 5 Revenue Cost of sales Gross profit Distribution expenses Administration expenses Other gains and losses Operating profit Finance income Finance costs Share of results of JVs and Associates Profit before taxation Income taxes Profit for the year Attributable to: Equity holders of the parent Non-controlling interests 2,166,695 (1,784,263) 382,432 (115,896) (130,029) 10,238 146,745 3,290 (25,420) 10,103 134,718 (26,085) 108,633 108,047 586 108,633 2009 000 1,830,327 (1,512,203) 318,124 (117,601) (104,412) 60,730 156,841 5,542 (29,576) 10,225 143,032 (29,873) 113,159 112,676 483 113,159
10 10 11
25
12 12
Basic earnings per share (cents) Diluted earnings per share (cents)
36.86 36.63
38.46 38.35
The Income Statement: Overview

The income statement summarises sources of income and types of expenditure Surplus = profit Deficit = loss
Prepared for the period from x to y or for the year ended
Income and Expenses

Income
Inflow to the business
e.g. sales revenues, fees, interest earned
Increases net assets (Assets-Liabilities)

Expense Outflow from the business
e.g. wages and salaries, cost of goods sold, telephone expense, interest expense
Decrease in net assets

Cost of Goods Sold

This is the cost of buying in (or making) the goods that have been sold in this accounting period
The Gross Profit is sales revenue less cost of goods sold
See CRH Income Statement
Accruals/Matching Basis of Accounting
Under this principle, the effects of transactions and other events are recognized in accounts when they occur (and not as cash or its equivalent is received or paid) and
they are recorded in the accounting records and reported in the financial statements of the periods to which they relate
IASB Definition
To-Do-List
Buy Textbook
Read pages of SL&D specified for Week 1 Attend and participate in Tutorial
Complete Tutorial problems

See Module Outline (Week 1)
Read pages 80-83 of SL&D before next Monday

Introduction to Financial Accounting Statements

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Financial Accounting 1

Topic 1 Introduction to Financial Accounting

Phone 716 4745 (x4745)

UCD Quinn School of Business

Scoil Ghn U Chuinn UCD

Typically, they do this within the companys Annual Report

Scoil Ghn U Chuinn UCD

Historical summaries and trends Non-financial information

Interim and quarterly reports Letters to shareholders Press releases

Economic statistics News articles

Figure 1.5 Useful information

Objective of Financial Statements

UCD Quinn School of Business

Scoil Ghn U Chuinn UCD

Users of Financial Statements

Who uses our financial statements?

Suppliers and other trade creditors

And: For what?

Governments and their agencies

Scoil Ghn U Chuinn UCD

UCD Quinn School of Business

Scoil Ghn U Chuinn UCD

Figure 1.4 A set of financial accounting users

Table 1.1 Users and their different needs (1/4)

Table 1.1 Users and their different needs (2/4)

Suppliers and other trade creditors

Table 1.1 Users and their different needs (3/4)

Case by case, as a function of the amount of resources dedicated to information gathering

Table 1.1 Users and their different needs (4/4)

Government, regulatory agencies, tax authorities

The Statement of Financial Position (SoFP)

What do these terms mean?

How are items in SoFP valued?

UCD Quinn School of Business

Scoil Ghn U Chuinn UCD

The Statement of Financial Position

Prepared as at a particular date

UCD Quinn School of Business

Scoil Ghn U Chuinn UCD

Assets, Liabilities and Equity

UCD Quinn School of Business

Scoil Ghn U Chuinn UCD

Non-current assets - examples

Scoil Ghn U Chuinn UCD

UCD Quinn School of Business

Scoil Ghn U Chuinn UCD

UCD Quinn School of Business

Scoil Ghn U Chuinn UCD

There are some underlying assumptions

UCD Quinn School of Business

Scoil Ghn U Chuinn UCD

A reporting period is assumed

UCD Quinn School of Business

Scoil Ghn U Chuinn UCD

UCD Quinn School of Business

Scoil Ghn U Chuinn UCD

Assets, Liabilities and Equity

UCD Quinn School of Business

Scoil Ghn U Chuinn UCD

UCD Quinn School of Business

Scoil Ghn U Chuinn UCD

UCD Quinn School of Business