Financial Accounting

• Accounting Environment:

  • Process of identifying, measuring, and communicating economic information
  • Users include business competitors, lenders, managers, owners, customers, suppliers, investment analysis, community representatives, government, employees & their representatives
  • Information needs of different types of users of financial statements
• Financial Accounting vs. Management Accounting:

  • External use vs. internal use
  • Reporting the past vs. past and future
  • Highly summarised vs. detailed information
  • Objectivity and verifiability vs. relevance and timeliness
  • Regulations apply vs. do whatever is most useful
• Conceptual Framework:


  •A theory of accounting prepared by a standard-setting body against which practical problems can be tested objectively.

  • Purpose of financial reporting
  • Main users of accounting
  • Main financial statements
  • Type of information included in financial statements
  • How items in financial statements should be defined, recorded, measured, and presented
• Accounting Principles:

  • implies the practices that are widely accepted by the accounting bodies and are adopted by the firm to work as a rule in the preparation of final accounts.
• Accounting Concepts:

  • Entity, periodicity, dual aspect, historical cost, money measurement, materiality, substance over form, true and fair
• Qualities that Influence the Usefulness of Accounting Information:

  • Relevance, faithful representation, confirmatory value, predictive value, neutrality, completeness, freedom from error, comparability, timeliness, understandability, verifiability
• The conceptual framework states that the objective of financial reporting is to provide financial information in the form of general purpose financial statements that are useful to existing and potential investors, lenders, and other creditors making decisions about providing resources to an entity
• General Presentation Requirements of Financial Statements:

  • Labeling of Financial Statements
  • Fair presentation and compliance with IFRS
  • Going concern and accrual basis
  • Materiality and Aggregation
  • Offsetting
  • Frequency of reporting
  • Comparative information and consistency of information
• Income Statement:

  • Comprehensive income includes revenues, expenses, gains, and losses that are recognized because it is probable that any future economic benefit associated with the item will flow to or from the entity and the item has a cost or value that can be measured with reliability
• Statement of Financial Position:

  • Assets represent probable future economic benefits obtained or controlled by an entity as a result of past transactions
  • Liabilities represent probable future sacrifices of economic benefits arising from present obligations of the entity to transfer assets or provide services to other entities in the future as a result of past transactions
  • Equity represents the claim of the owner against the business
• Statement of Changes in Equity reconciles the movement in total equity from the beginning to the end of its financial period, which may come from transactions with owners and dividend payments or from net income (or loss) for the period
• Statement of Cash Flows focuses on cash movements during the accounting period, broken down into key categories such as operating activities, financing activities, and investing activities
• Notes to the Financial Statements contain additional information of accounting policies, presented in a systematic manner, including a summary of significant accounting policies, estimates, and assumptions used, and other disclosure requirements
• Accounting is the process of identifying, measuring and communicating economic information to permit informed judgement and decisions by users of the information.
• Benefits of a conceptual framework for financial reporting include:

  -Establishing precise definitions of accounting issues

  -Providing guidance to accounting standard setters when developing and reviewing financial reporting rules

  -Helping to ensure that accounting standards are internally consistent
• Accounting Principles:

  implies the practices that are widely accepted by the accounting bodies and are adopted by the firm to work as a rule in the preparation of final accounts.
• Accounting Principles:

  •Going concern: the assumption that the entity will continue in operation for the foreseeable future

  •Consistency: accounting treatment of like items should be treated the same within each accounting period and from one period to the next

  •Prudence: a prudent attitude should be taken when preparing financial statements

  •Accruals: Transactions are recorded in the period in which they occur regardless of when cash is paid or received

  •Realisation

  •Matching
• Accruals: the most fundamental principle of accounting which requires recording revenues when they are earned, and recording expenses when they are incurred regardless of when cash is paid or received

  •Realisation – revenue which has been earned is recorded in the financial statements when it is reasonably certain that cash will be collected in the near future

  •Matching – expenses are matched to revenue; expenses are recorded in the period incurred in earning revenue irrespective of when the expenses are paid for
• Accounting concepts refer to the rule of accounting which are to be followed, while recording business transactions and preparing final accounts.
• Qualitative Characteristics - Fundamental:

  -Relevance: Should be capable of influencing user decisions

  • Predictive value: predict future events

  • Confirmatory value: confirm past events (value that enable user to check and confirm earlier prediction)

  • Materiality threshold: when its omission or misstatement could influence the economic decisions that users make on the basis of financial statements
• Entity: the business entity or organisation is separate from the owners of the organisation
• Periodicity: financial statements should be produced on a periodic basis
• Dual aspect: all transactions have two aspects –double entry
• Historic cost: transactions are recorded at the time of completion
• Money measurement: items are measurable in monetary term
• Materiality: information is material if its inclusion/omission would change a users view of the financial statements
• Substance over form: transactions are recorded according to economic reality not legal form
• True and fair: financial statements are prepared and presented with true and fair view
• Qualitative Characteristics - Fundamental

  Faithful representation: should be capable of being relied upon to represent what it is supposed to represent

  •Completeness: all of the information needed for decision-making is provided

  •Neutrality: No bias in selecting and presenting the information

  •Freedom of error: The (estimated) information should have no errors in the way in which information has been selected and described
• Qualitative Characteristics - Enhancing

  •Comparability: ability to identify similarities and differences between items of information

  •Timeliness: ability to produce information to users when it is needed (Relevance)

  •Verifiability: ability to reach a same result when it is reproduced (based on same data/assumptions used) (Faithfully represent)

  •Understandability: sufficiently transparent to users
• Assets =  Liabilities + Shareholders’ Equity

  Assets =  Liabilities + Shareholders’ Equity+ Net Income

  Assets =  Liabilities + (Owner’s capital +Share Issuance – Owner’s drawings – Dividends)+(Income- Expenses)

  Assets+ Expenses + Owner’s drawings + Dividends =  Liabilities + Owner’s capital + Share Issuance +Income

  Assets + Expenses = Liabilities + Shareholders’ Equity + Income

  Owner’s capital = Share capital + Retained earnings
• The Accounting Cycle

  1. Analyse transactions
  2. Record transactions (journal entry)
  3. Amounts from journal posted to the ledger accounts
  4. Prepare trial balance
  5. Prepare financial statements
• •Events that have a financial impact on the business and can be measured reliably

  For example:

  –Selling products –Paying expenses

  •Have two sides:

  –Giving –Receiving

  •Accounting records both sides of transactions
• Assets =  Liabilities + Shareholders’ Equity

  Assets+ Expenses + Owner’s drawings + Dividends =  Liabilities + Owner’s capital + Share Issuance +Income

  Assets + Expenses = Liabilities + Shareholders’ Equity + Income
• The Leger

  • A grouping of all the T-accounts, with their balances.
  • It provides the balance in each of the accounts as well as keep track of changes in these balances
• Recording Transactions in the Ledge

  A.Date of the transactions

  B. List the other account in the transaction

  C. Ledger number of the other account

  D. Either the debit or credit will be filled with the amount of the transaction.

  E. For cash, a debit will increase the balance, and a credit will decrease the balance.
• Trial Balance:

  •Statement produced at the end of the accounting period

  •Lists balances of all accounts with debits in one column and credits in the other.

  •Steps for preparing a trial balance

  • List the account titles and their balances in the appropriate debit or credit column
  • Total the debit and credit columns
  • Verify the equality of the two columns

  •If double entry correct, then total debits = total credits
• Limitations of a trial balance:

  A trial balance does not guarantee freedom from recording errors. A trial balance may balance even when:

  •A transaction is not journalised

  •A correct journal entry is not posted

  •A journal entry is posted twice

  •Incorrect accounts are used in journalising or posting

  •Offsetting errors are made in recording the amount of a transaction
• Accrual vs Cash Basis Accounting

  • The accrual basis of accounting recognises revenues and expenses when they occur regardless of (No Matter) when cash is received or disbursed.
  • The cash basis of accounting recognises revenue and expense when cash is received and disbursed.
• Accrual Basic:

  •Records impact of transactions when they occur

  •Required by IAS1 – Presentation of Financial Statements

  •Records:

  • Revenue when earned
  • Expenses when incurred

  •Use by virtually all businesses