Financial Accounting

Anna Kuzior
Department of Accounting
Content of lecture
1. Introduction to financial accounting
2. Accounting principles (concepts), standards, systems
3. Assets, liabilities, equity – characteristic, valuation rules, recording,
FAB Group – please send your group – mail
Erasmus Students – please send your personal e – mails (mention that you are
students of financial accounting)

anna.kuzior@ue.katowice.pl

Office hours Tuesday 9.50 – 11.20, room 317A (department of Accounting

webside)

4 tests during semester

INTRODUCTION TO FINANCIAL ACCOUNTING

Accounting – Language of business

Accounting – the means by which businesses’

financial information is communicated to users

Accounting is the art of measuring,

communicating and interpreting financial
activity
INTRODUCTION TO FINANCIAL ACCOUNTING

Objective of accounting – to provide financial information about an

economic entity (relevant and timly).

Kind of information – recourses , sources of financing and changes

in them.
INTRODUCTION TO FINANCIAL ACCOUNTING

Users of accounting information:

 Management,

 Investors, Lenders,
 Employees,
 Suppliers and other trade creditors,
 Customers,
 Government and their agencies,
 Public interest
INTRODUCTION TO FINANCIAL ACCOUNTING

Users :
 Internal,
 External,

Accounting:
 Management,
 Financial – more standardized

Management accounting - deals with planning and control, have

responsibility to employ the resources of business in efficient way
and to meet the objectives of the business, has access to a wide
range of information (often confidential)
INTRODUCTION TO FINANCIAL ACCOUNTING

The basic way of communication between company and it’s surrounding –

financial statement
Financial statements (traditional point of view) :
 Balance – sheet,
 Income statement (profit and loss account),
 Statement of changes in equity,
 Cash flow statement,
 Notes, comprising a summary of significant accounting policies and other
explanatory notes.
INTRODUCTION TO FINANCIAL ACCOUNTING

Financial statement – prepared in accordance with a set of standards:

Standards explain:
 How information should be measured (problem of valuation) ,
 What information should be disclosed,
 How information should be disclosed,
 Which elements of financial statement should be prepared and issued,
INTRODUCTION TO FINANCIAL ACCOUNTING

Standardization of accounting (financial reporting) – need of comparability

of financial statement
Accounting standards:
 National - Generally Accepted Accounting Principles (Practice) , Act of Law
 International – International Accounting Standards, International Financial
Reporting Standards
INTRODUCTION TO FINANCIAL ACCOUNTING

The main accounting terms

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.

To achieve benefits asset can be:

 Used singly or in combination with other assets in the production of goods
or services to be sold by the entity,
 Exchange for other assets,
 Used to settle a liability,
 Distributed to the owners of the entity,

 Fixed (long term) assets

 Current assets (short term) assets
INTRODUCTION TO FINANCIAL ACCOUNTING
The main accounting terms

A liability is a present obligations of an entity to transfer economic benefits

as a result of past transaction or events

Ways of settlement of present liabilities:

 Payment of cash,
 Transfer to other assets,
 Provision of services,
 Replacement of that obligation with another obligation
 Conversion of the obligation to equity

 Long term liabilities,

 Current liabilities,
INTRODUCTION TO FINANCIAL ACCOUNTING
The main accounting terms

Equity (owners equity/interest) is the residual interest in the assets of an entity

that remains after deducting all its liabilities

Assets, liabilities, equity represent (describe) financial position of the entity

INTRODUCTION TO FINANCIAL ACCOUNTING
Assets

Fixed assets
1. Intangible assets
 (non – monetary assets without physical substance) – concession,
patents, trade marks purchased,
2. Tangible assets
 lands, buildings, plant, machinery, tools, equipment, assets under
construction
3. Investments
 financial investments (financial assets)
 investment property,
INTRODUCTION TO FINANCIAL ACCOUNTING
Assets

Current assets
1. Stock (inventories)
 (row) materials, work in progress, finish goods, goods for resale,
2. Debtors (receivables)
 trade debtors,
3. Investment (also cash in bank and in hand)
5. Prepayments (payments in advance)
INTRODUCTION TO FINANCIAL ACCOUNTING
Liabilities

Current liabilities
 debenture loans
 amounts owed to credit institutions
 trade creditors
 bills of exchange payable
 other liabilities including tax and social security
 accruals and deferred income
INTRODUCTION TO FINANCIAL ACCOUNTING
Liabilities

Long term liabilities (creditors, payables)

 debenture loans
 amounts owed to credit institutions

Provisions (for pensions and similar obligations)

INTRODUCTION TO FINANCIAL ACCOUNTING
Equity

Equity
 subscribed capital
 share premium account
 revaluation reserve
 profit or loss (brought forward, for the financial year)
INTRODUCTION TO FINANCIAL ACCOUNTING
The main accounting terms

Equity (owners equity/interest) is the residual interest in the assets of an

entity that remains after deducting all its liabilities

The accounting equation:

 ASSETS minus LIABILITIES equals EQUITY

Or

 ASSETS equals LIABILITIES plus EQUITY

Income & expenses

 Income (revenues + gains) is increases in economic benefits during an

accounting period in the form of inflows or enhancements of assets or
reduction of liabilities that result in increases in equity, other than those
relating to contributions from equity participants

 Revenues of entities normally arise from the ordinary activity - sale of

goods, services , rent, interests, dividends, fees
 Gains
Income & expenses

Expenses (and losses) are 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 distribution to equity participants
Temporary accounts

 Revenues – result - increase in assets, decrease in liabilities

 Expenses – result – decrease in assets, increase in liabilities,
 Revenue and expense accounts – temporary
 Temporary accounts – their balances are brought down to zero at
the end of each period by closing it out to some other account (loss /
profit account)
Temporary accounts, income statement

Income statement can be presented

 by nature (if company records expenses by nature)
 by function (if company records expenses by functions
THE MAIN REPORTING TERMS
Income statement by function– trading, manufacturing company

 Revenue (sales) (+)

 Cost of goods sold (goods for resale and finished goods sold) (-)
 Gross profit
 Distribution expenses (-)
 Administrative expenses (-)
 Profit /loss from operating activity
 Other operating revenues/ gains
 Other operating expenses /losses
 Financial revenues / gains
 Financial expenses/ losses
 Profit/loss before tax
 Coroprate income tax
 Net profit/loss
THE MAIN REPORTING TERMS
Income statement by nature (a part) - based on trading company
 Revenue (sales) (+)
 Cost of goods sold (goods for resale sold) (-)
 Gross profit
 Expenses by nature (-)
 Profit /loss from operating activity

Income statement by function (a part) - based on manufacturing

company
 Revenue (sales) (+)

 Variation in stock (+/-)

 Expenses by nature (-)

 Profit /loss from operating activity

THE MAIN REPORTING TERMS

Expenses by nature:
 Consumption of materials and energy,
 Depreciation and amortisation,
 External services,
 Wages/ salaries expenses,
 Social security expenses,
 Taxes and charges,
 Other expenses (by nature),
Accounting concepts
Accounting concept refers to the basic assumptions and
rules and principles which work as the basis of recording of
business transactions and preparing financial statements

I. True and fair view

It suggests that an enterprise should provide a true and fair view (fairly, in
accordance with the actual state) about its financial conditions and operating
results, to enable effective control of transactions, as well as the proper
valuation of assets and liabilities

I. Going concern concept

This concept states that a business firm will continue to carry on its activities
for an indefinite period of time

I. Accural concept
Business transactions are recorded when they occur and not when the
related payments are received or made.
Accounting concepts

I. Matching concept

The concept states that the revenue and the expenses incurred to earn
the revenues must belong to the same accounting period.

I. Prudence concept

According to this concept, assets and revenue can not be overstated

while liabilities and losses can not be understated

I. Consistency concept (method)

All similar items need to be given the same accounting treatment
the same accounting period and from one period to another
VAT and its accounting
treatment
 Step Elements VAT charged on VAT charged on VAT paid to the
of price sales purchases state budget

(output VAT) (input VAT)

(1) (2) (3) (4) (5) = (3) – (4)

Step I – Company A
(registered for VAT)
1.Selling price of row 200
materials
2.VAT 23% on sales 46 46 46

3. Selling price with VAT 246

Step II – Company B
registered for VAT
1. Value of purchases from 200 46
Company A
2. Value added 300
( cost of convertion and
profit)
3. Selling price 500

4. VAT 23% .on sales 115 115

5. Selling price with VAT 615 69

Account payable Materials Sales Accounts receivable

246 (1a) (1b) 200 500 (2a) (2c) 615

Input VAT Output VAT

(recaivables) (liability)

(1c) 46 46 (3) (4) 115 115 (2b)

VAT account

(3) 46 115 (4)

CB Ct 69
Expenses
classifications and entries
Expenses

Expenes and losses

Expenses (and losses) are 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 distribution to equity participants
Classification of expenses (costs) from a company’s activity point of viev (
according to profit and loss account presentation)

 Expenses (costs) of operating activity (basic activity) –

service, merchandising, manufactoring)
 Expenses of other operating activity
 Expenses of financing activity
 Corporate income tax
Expenses (costs) of operating activity

 Divided by nature,
 Divided by products and functions,
Expenses by nature

 Consumption of materials and energy,

 Depreciation and amortisation,
 External services,
 Wages/ salaries expenses,
 Social security expenses,
 Taxes and charges,
 Other expenses (by nature),
Expenses by nature:
Example

In September a company consumed materials:

 During a process of production (product A) 200,-
 As indirect production materials 100,-
 By accountants (stationary) 50,-
 As additional package of sold goods 80,-
Total 430,-

Opening balance of Materials 500,-

 Basic features of accounts used for expenses by nature

 Simple system of expenses recording,

 Classification by nature is common for all companies ( comparability),
 Information is used for reporting and statistic purposes,
 Information about expenses by nature is not enough for calculation of cost
of product,
Costs/expenses in manufacturing business

Structure of costs in manufacturing business

1. Production cost/ Cost of production (Product cost)
2. Administrative expenses influence profit/ loss account
3. Distribution expenses
Costs in manufacturing business

Product cost and period costs

 Product costs – costs which are identified with goods
intended for sale to customers (these costs belong to the
products and stay with them until they are sold; if goods
remain unsold then the product costs are a part of stock
value)
 Period costs - costs with are treated as expenses of a
period in which they are incurred and are not carried as part
of the stock value
Costs in manufacturing business

Basic product costs classification

1. Direct costs and indirect costs
 Direct costs – directly related to a particular object (product
which has been manufactured), directly traceable to a
particular object,
 Indirect costs (of products) – overhead(s) – cannot be
directly related to a particular object, have to be apportioned
on a basic which is as fair as can be devised,
 Costs in manufacturing business

Statement of product cost

1. Direct materials
2. Direct labour
3. Other direct costs
4. Prime cost (1+2+3)
5. Indirect materials
6. Indirect labour
7. Other indirect costs
8. Production overhead (5+6+7)
9. Total product cost (4+8)
Other indirect costs (of products)– depreciation, repair of machinery,
electricity, rent of factory buildings, safety procedures,
 Costs in manufacturing business

Total costs of manufacturing business

1. Direct materials
2. Direct labour
3. Other direct costs
4. Prime cost (1+2+3)
5. Indirect materials
6. Indirect labour
7. Other indirect costs
8. Production overhead (5+6+7)
9. Total product cost (4+8)
10. Administrative expenses
11. Distribution expenses
 Costs
(a physical quantity measurement multiplied by a price measurement)

Connected Not connected

with with production
production process
process

Production cost Administrative

(direct and expenses
overheads) Distribution expenses

Finish goods
and work in Income
progress statement
(product cost) Cost of goods sold (period cost)
Costs in manufacturing business

Period costs – cost of goods sold, distribution expenses,

administrative expenses
Recording by nature and function

Accounts of Expenses
assets & liabilities by nature
(1)

Expenses Expenses
accounted for by function
(2)

Recording of expenses must be done with a proper VAT entries

Costs in manufacturing business - Production costs

Direct costs of Direct costs of Direct costs of

product A product B product C

(1) (1) (1)

Product A Product B Product C

(2)
Production overheads (indirect costs)
Absorbed into products (A, B, C)

(1) direct tracing of direct cost

(2) absorbing of indirect costs (overheads) into products
Costs in manufacturing business - Production costs

Absorbing overhead costs into products

Methods of absorbing:
 Cost per labour hour,
 Cost per machine hour,
 Cost per $ of labour cost,
 Cost per unit,
The method must make use of the best measure of work done
on a product.