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01 Accounting Study Notes

This document defines key accounting concepts and terms, and provides an overview of key accounting statements and principles. It discusses: 1) Definitions of accounting concepts like debits, credits, assets and liabilities. 2) The basic components and purpose of key statements - the balance sheet captures assets/liabilities/equity at a point in time, the income statement measures profits over a period, and the cash flow statement reconciles accrual-based profits to actual cash flow. 3) Accounting principles like going concern, consistency and prudence that underlie financial reporting.

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Jonas Scheck
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155 views

01 Accounting Study Notes

This document defines key accounting concepts and terms, and provides an overview of key accounting statements and principles. It discusses: 1) Definitions of accounting concepts like debits, credits, assets and liabilities. 2) The basic components and purpose of key statements - the balance sheet captures assets/liabilities/equity at a point in time, the income statement measures profits over a period, and the cash flow statement reconciles accrual-based profits to actual cash flow. 3) Accounting principles like going concern, consistency and prudence that underlie financial reporting.

Uploaded by

Jonas Scheck
Copyright
© © All Rights Reserved
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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Accounting - 1

Accounting – Introduction

Definitions
 Accounting Concepts refer to the axioms or basic assumptions
underlying the financial accounts (Going concern, Accruals,).
 Credit is an entry recording a sum received, listed on the right-hand side
or column of an account.
 Debit is an entry recording a sum owed, listed on the left-hand side or
column of an account.
 T-account is an informal term for a set of financial records that use
double-entry bookkeeping.
 Short vs. Long-term A liability or an asset is categorised as long-term
when the company expects to benefit from it in over a year.
 Assets are resources controlled by business for business activity.
 Liabilities are obligations to owners and third parties.
 Equity is the owners interest in the business.
 Cash Flow is the movement of money into and out of a business.
 Dividends are the proportion of profit given out to shareholders.

Concepts
Going Concern
 Company continues to trade in foreseeable future and fixed assets and
stock will be used in the normal course of trade (Justify depreciation)
Accruals
 Matching revenues with associated expenses when transaction is made
(cash has not been received).
Consistency
 Similar items are treated with the same method from one period to the
next to enable comparability.
Prudence
 Revenues and profits are only recognised when realised AND expenses
and losses are recognised whether amount is known with certainty, or its
best estimate. This ensures that profits and assets are not overstated,
and losses and liabilities are not understated.
Accounting - 2

Separate Valuation
 Every item on financial statement should be valued independently and
offset should be avoided.
Qualitative Characteristics of financial statements (4 objects)
 Relevance: Predicting Future or Confirming past/present
 Reliability: Transactions are represented faithfully, information is neutral,
free from errors, compete, estimates are made with caution.
 Comparability: Facilitates cross section comparison, e.g. consistency
 Understandability: Users with reasonable knowledge should be able to
understand financial statements
There is a conflict between relevance and reliability because cross-checking
everything to free data from error takes time and becomes less relevant to user
when published.
Accounting - 3

Balance Sheet
 Snapshot
 Shows the net number of, e.g. receivables (usually calculated in the T-
accounts)
 What does the company own, owe and its net-worth
o Assets = Liability+ Net Worth
o Uses of funds = Sources of funds
 Analyse company’s performance
o Analyse relationship between assets and liabilities
 Liquidity (current assets and current liabilities)
o Relationship between output and resources
 Profitability/Efficiency
 Ratio Analysis
 Limitations
o Certain point of time
o Opportunity cost of assets not taken into account
o Off-balance sheet activities
o Real Value of business depends on its ability to generate income
and not on the individual asset and liability values.
Assets (current or short-term)
 Capable of generation cash within a year
 Examples:
o Inventories (stock): Final product/merchandise
o Trade receivables (debtors): Money owed by customers (credit
sales)
o Cash/Bank deposits
o Short-term financial investments
o Prepayments: Expenses paid in advance.
Assets (non-current, long-term or fixed)
 To be used for more than a year.
 Examples:
o Tangible: Property, plant, equipment and depreciation
o Intangible: no physical form, e.g. goodwill, patents, trademarks
o Long-term financial investments
Accounting - 4

Liabilities (current or short-term)


 Payable within a year
 Examples:
o Trade payables (creditors): Money owed to supplier
o Accruals: Services received but not yet paid for, e.g. rent
o VAT and taxes payable
o Bank overdrafts
Liabilities (non-current or long-term)
 Payable in more than a year
 Examples:
o Long-term loans
o Bonds and debentures
o Mortgages
Shareholders Equity/Capital/Net Worth
 Amount invested in firm
 Par value of shared
o Share Premium: Excess paid over the par value of shares
 Retained Profits: Portion of profits re-invested in the business
Accounting - 5

Profit & Loss Account


 Activity of a company for a given period
 States revenue, expenses and profit (loss) during a specific period
 Accounting standards
o Revenue and Expenses incurred during the period
 Underlies accruals concept
 Follows a general form
 Determines:
o EPS (Earnings per share)
o Amount of dividend
o Retained earnings
o Changes in equity
 Limitations
o Different accounting principles and different identification of
capital/asset and liability structures across firms
o Profit not the same as cash flow and it’s not enough to know only
about the profit
Structure and Terminology: Profit and Loss Account
 Terminology
o Revenues/Turnover
 Total amount of sales for the period
o COGS (Cost of Goods Sold)
 Openings Inventory + Purchases – Closing Inventory
o Gross Profit
 Revenues – COGS
 Excludes inventory
o Operating
 Distribution Costs (of products)
 Administration expenses
 Not tied to manufacturing/production or sales but to
the organization, e.g. salaries
 Depreciation
o Operation Profit/EBIT (Earnings before interest and tax)
 Gross Profit – (SUM of Operation Expenses)
o Finance income
 Interest received
o Financing costs
Accounting - 6

 Interest paid
o Profit before tax/EBT (Earnings before tax)
 EBIT + finance income – finance expenses
o Tax payable
o Profit after Tax
 Profit for the period
 EBT – Tax payable
 Feeds organic growth
Depreciation
 Purchase of non-current assets not immediately treated as expense
o An investment into an asset will become an expense through
depreciation only when it helps to generate revenue for the
company
 Cost allocation
o Each year a portion of the cost is shown in the income statement
as expense
 Straight line method
o Takes into account: Initial Cost, Useful Life and Salvage Price
 Diminishing Balance Method
o Takes into account: Initial Cost, Percentage of yearly depreciation
o Higher depreciation in early years and lower depreciation in later
years
Accounting - 7

Cash Flow Statement


 Cash Flow vs. profit
o Profit is not determined by cash inflows – cash outflows is not
profit
o Increasing cash balance does not imply success, e.g. massive
borrowing
o Decreasing cash balance does not imply failure, e.g. investment in
assets
 Aggregate data on all cash inflows and cash outflows
 Facilitates reconciliation (viewing under compatible circumstances)
between “amount of cash generated during period” and “amount by
which cash balances have increased or decreased during period”
 The following activities generate cash
o Operating, Investing and Financing
 There are two ways to present cashflow statements:
o direct and indirect (more complex)
Terminology and Structure: Cash Flow Statement
 Cash start of year + Cash inflows – Cash outflows = Cash at the end of
year
 Operating Activities
o Cash Inflows
 EBIT (If positive)
 Depreciation
 Added back as it is not a cash outflow
 We add it back to cancel the effect in EBIT because
the cashflow statement shows money that goes in
and out of a business for a period BUT the money
has not been paid.
 Add interest received
 Changes in working capital
 Add decrease in inventories and receivables
o We add it back to cancel the effect on EBIT
 Add increase in payables
o We add it back to cancel the effect on EBIT
 Add tax rebate
Accounting - 8

o Cash Outflows
 EBIT (If negative)
 Deduct Interest paid
 Changes in working capital
 Deduct increase in inventories and receivables
 Deduct decrease in payables
 Deduct tax paid
 Deduct dividends paid
 (Operating Activities: Changes in working Capital)
o What are the cash effects of changes in working capital items?
o WC = Current Assets – Current Liabilities
o Inventory increase means cash spent
o Receivables decrease means cash received
o Payables decrease means cash spent
 Investing Activities
o Any transaction related to acquisition or sale of non-current assets
o Cash Inflows
 Sale of property plant or e&Netquipment
 Collection of loans to other entities
 Sale of non-cash equivalent securities
o Cash outflows
 Purchase of property plant or equipment
 Lending of money to subsidiary
 Purchase of non-cash equivalent securities
 Financing Activities
o Any transaction related to borrowing from creditors or involving
owners
o Cash Inflows
 Share issues, e.g. additional capital
 Short term borrowing, e.g. bonds, mortgages
o Cash Outflows
 Payment of cash dividends
 Share repurchases

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