ACCOUNTING IN BUSINESS

Dr Winston Kwok

Learning Objectives
1. 2. 3. 4.

Explain the importance of accounting and identify its uses Explain the meaning of GAAP and apply accounting principles and assumptions Define and interpret the accounting equation and each of its components Identify and prepare basic financial statements and explain how they interrelate

OBJECTIVE 1
Explain the importance of accounting and identify its uses

Importance of Accounting
is a Accounting system that Identifies

Records information Relevant Reliable Comparable to help users make better decisions. that is Communicates

Users of Accounting Information

External Users Internal Users

Shareholders (Investors) Lenders (Creditors) Governments

Consumer Groups External Auditors Customers

Managers Officers/Directors Internal Auditors

Sales Staff Budget Officers Controllers

Users of Accounting Information

External Users Internal Users

Financial accounting provides external users with financial statements.

Managerial accounting provides information needs for internal decision makers.

Annual Reports
Required by law to be issued by listed/public companies. An annual report contains financial statements, auditor s report, notes to accounts and other information such as chairman s statement. Important source of information for key users such as investors and creditors.

ACCOUNTING (analyses and professional judgment)

BOOKKEEPING (recording)

Financial Accounting versus Tax Accounting

Financial Accounting based on guidelines on how best to reflect the nature or reality of business. Tax accounting influenced by economic and political objectives of governments.

OBJECTIVE 2
Explain the meaning of GAAP and apply accounting principles and assumptions

Generally Accepted Accounting Principles

Financial accounting practice is governed by concepts and rules known as generally accepted accounting principles (GAAP).
Relevant Information Affects the decision of its users. Is trusted by users.

Reliable Information

Comparable Information

Used in comparisons across years & companies.

GAAP
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.

Setting Specific Accounting Principles or Accounting Standards U.S. International

The International Accounting Standards Board (IASB) issues International Financial Reporting Standards (IFRS). If IFRS are adopted worldwide, a company can potentially use a single set of financial statements in all financial markets. Financial Accounting Standards Board is the private group that sets both broad and specific principles. The Securities and Exchange Commission is the government group that establishes reporting requirements for companies that issue shares to the public.

IFRS
More than 100 countries and more than 40% of Global Fortune 500 companies are already using IFRS.
Blue areas: countries that require or permit IFRS. Grey areas: countries pursuing adoption of IFRS. Asia: Adopted or in-process: Singapore, Malaysia, Taiwan, China, Hong Kong, Australia, India and South Korea

IFRS and FRS

In Singapore, the Accounting Standards Council (ASC) is empowered under the Accounting Standards Act to prescribe financial reporting standards (FRS) for use by companies. http://www.asc.gov.sg/account.htm The broad policy intention is to adopt IFRS, taking into account the local economic and business circumstances and context.

General Accounting Principles and Assumptions

General Accounting Principles

Measurement or Cost Principle
Accounting information is based on actual or historical cost which is considered objective or reliable. Business transactions recorded at the original price paid at the time of the transaction. Accounting records reflect original cost as long as organization holds asset e.g. - a hospital records purchase price of equipment it buys. Profession moving towards market or fair values.

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. 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
Business Entity A business is accounted for separately from other business entities, including its owner. 3 general business entity forms:
Sole Proprietorship Partnership Corporation or Company

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
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
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 fiscal year is any consecutive 12-month time period which may be different from the calendar year.

Accounting Constraints
The materiality constraint prescribes that only information that would influence the decisions of a reasonable person need be disclosed. This constraint looks at both the relative size and importance of an amount. The cost-benefit constraint prescribes that only information with benefits of disclosure greater than the costs of providing it need be disclosed.

The Audit Report or Auditors Report  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.  Financial statements are the responsibility of the company s management and not the auditors.  Big 4 firms:
KPMG Ernst & Young Deloitte PricewaterhouseCoopers

OBJECTIVE 3
Define and interpret the accounting equation and each of its components

Assets

Liabilities

Equity

Assets

Liabilities & Equity

Assets
Resources owned or controlled by an entity

Liabilities

Equity

Claims against the entity s resources Claims by Creditors (lenders) Claims by owners (investors or shareholders)

Assets
Cash Accounts Receivable Notes Receivable

Vehicles

Resources owned or controlled by a company

Land

Store Supplies

Buildings Equipment

Liabilities
Accounts Payable Notes Payable

Creditors claims on assets

Taxes Payable Wages Payable

Equity is Assets less Liabilities

What s left (residual) of the entity s assets after it pays liabilities Also called net assets, net worth, or residual equity

Equity
Owner s Claims on Assets

Expanded Accounting Equation

Net Income or Net Profit

The common measure of a company s 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 greater than revenues, then net loss which decreases equity.

Withdrawals
 Disbursement of cash or other business assets to the owners.  Cash or other property withdrawn from the business by a proprietor or partner.  For a company with issued shares, such cash payments to shareholders (which are owners of the company) are called dividends.

OBJECTIVE 4
Identify and prepare basic financial statements and explain how they interrelate

The Four Basic Financial Statements

Income statement Statement of comprehensive income Statement of changes in equity Balance sheet Statement of financial position Statement of cash flows
These are the titles of financial statements generally used under IFRS. Comprehensive income will be explained in the lecture on corporations.

Relationships 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.

Relationships by time periods

At beginning of period

At end of period

Time
Covering the intervening period: Income Statement Statement of Changes in Equity Statement of Cash Flows Balance Sheet

Balance Sheet

Financial Statement Heading

From Nestl 2010 Annual Report

Name of business or reporting entity Title of statement Reporting period Currency and units

Income Statement

Net income is the difference between Revenues and Expenses. The income statement describes the revenues and expenses of the entity along with the resulting net income or loss over a period of time due to earnings activities.

Statement of Changes in Equity

Scott Consulting Statement of Changes in Equity For Month Ended December 31, 2010 S.Scott, Capital, December 1, 2010 Plus: Investments by owner $ Net income Less: Withdrawals by owner S.Scott, Capital, December 31, 2010 $ 20,000 2,200 22,200 22,200 500 21,700

The statement of changes in equity explains changes in equity from net income (or loss) and from any owner investments and withdrawals over a period of time.

Income Statement and Statement of Changes in Equity

The net income of $2,200 increases equity by $2,200.

Scott Consulting Statement of Changes in Equity For Month Ended December 31, 2010 S.Scott, Capital, December 1, 2010 Plus: Investments by owner $ Net income Less: Withdrawals by owner S.Scott, Capital, December 31, 2010 $ 20,000 2,200 22,200 22,200 500 21,700

Balance Sheet
Scott Consulting Balance Sheet December 31, 2010 Assets $ Liabilities Accounts payable Notes payable Total liabilities Equity S.Scott, Capital Total liabilities and equity

Cash Supplies Equipment

9,700 1,200 16,000

1,200 4,000 5,200 21,700

Total assets

26,900

26,900

The balance sheet describes an entity s financial position at a point in time. It is like taking a snapshot of the assets, liabilities and equity on the last day of the accounting period.

Statement of Changes in Equity and Balance Sheet

Scott Consulting Statement of Changes in Equity For Month Ended December 31, 2010

S.Scott, Capital, December 1, 2010 Plus: Investments by owner $ Net income Less: Withdrawals by owner S.Scott, Capital, December 31, 2010 Scott Consulting Balance Sheet December 31, 2010 Assets $ Liabilities Accounts payable Notes payable Total liabilities Equity S.Scott, Capital Total liabilities and equity

$ 20,000 2,200

22,200 22,200 500 21,700

Cash Supplies Equipment

9,700 1,200 16,000

1,200 4,000 5,200 21,700

Total assets

26,900

26,900

Statement of Cash Flows

Scott Consulting Statement of Cash Flows For Month Ended December 31, 2010 Cash flows from operating activities: Cash received from clients $ 3,000 Cash paid for supplies (1,000) Cash paid to employees (800) Net cash provided by operating activities Cash flows from investing activities: Purchase of equipment (15,000) Net cash used in investing activities Cash flows from financing activities: Investments by owner 20,000 Borrowed from bank 4,000 Withdrawals by owner (500) Net cash provided by financing activities Net increase in cash Cash balance, December 1, 2010 Cash balance, December 31, 2010

1,200

(15,000)

The statement of cash flows explains changes in entity s cash balance during accounting period. 3 sections showing the business activities:
Operating Investing Financing

$ $

23,500 9,700 9,700

Balance Sheet and Statement of Cash Flows

Scott Consulting Balance Sheet December 31, 2010 Liabilities 9,700 Accounts payable Supplies 1,200 Notes payable Cash flows from operating activities: Equipment 16,000 Total liabilities Cash received from clients $ 3,000 Equity Cash paid for supplies (1,000) S.Scott, Capital Cash paid to employees (800) Total activities $ 26,900 Net cash provided by operating assets $ 1,200 Total liabilities and equity
Cash flows from investing activities: Purchase of equipment Net cash used in investing activities Cash flows from financing activities: Investments by owner Borrowed from bank Withdrawals by owner Net cash provided by financing activities Net increase in cash Cash balance, December 1, 2010 Cash balance, December 31, 2010 (15,000) (15,000) 20,000 4,000 (500) 23,500 $ 9,700 $ 9,700 Scott Consulting Statement of Cash Flows Assets For Month Cash December 31, 2010 Ended $

1,200 4,000 5,200 21,700

26,900

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.

Notes can be used to convey information that is too uncertain or needs further explanation.