Accounting: Framework and Financial Statements

Chapter 1: Conceptual Framework and Financial Statements

• The basic accounting equation states that Assets = Liabilities + Equity.
• Net Income is calculated as Total Income less Total Expenses.
• Assets are divided into Current Assets (Cash, Short Term Investments, Receivables, Inventory, Prepaid Expenses) and Non-Current Assets (Property, Plant and Equipment, Long Term Investments, Intangible Assets, Other non-current assets, Accumulated Depreciation).
• Liabilities include Current Liabilities (Accounts Payables, Tax Payables, Short-term Notes Payables, Salary Payables, Dividends) and Non-Current Liabilities (Long-Term Loans, Bonds Payables, Deferred tax Liabilities).
• Equity consists of Share Capital, Retained Earnings, and Other Equity Items.

Reading Financial Statements

• The current ratio calculates a company's ability to cover short-term liabilities with its current assets, using the formula: Current Assets / Current Liabilities.
• Profit margin is calculated by (Net Profit / Revenue) * 100, indicating the percentage of revenue remaining after subtracting all costs.
• Comparing statements involves ensuring that the fiscal year-end date is the same, that the statements contain equivalent information, and that the statements have used the same standard

IFRS and Accounting Statement Characteristics

• In 2002, it was decided that listed companies should make consolidated statements in accordance with IFRS.
• Listed companies are those whose shares can be bought by the public.
• Key characteristics of accounting statements include relevance, faithful representation (neutrality, free from errors), timeliness, comparability, materiality, verifiability, and understandability.

Chapter 2: Recording Business Transactions

• A business transaction is any measurable event that financially impacts a business, requiring a change to occur before classification.
• The five elements of financial statements are assets, liabilities, equity, income, and expenses.

Assets

• Cash includes money and any medium of exchange, such as bank account balances, checks, and deposits.
• Accounts receivable represents promises of cash collection after sales.
• Inventory is all stock a company possesses.
• Prepaid expenses are prepayments the company makes for future economic benefits.
• Property, Plant, and Equipment (PPE) includes assets expected to last multiple business cycles, like land, buildings, and equipment.

Liabilities

• Accounts payable is the direct opposite of accounts receivables and includes all upcoming payments.
• Notes payable are long-term liabilities for money a company owes to financial institutions, typically payable beyond 12 months.
• Accrued liabilities are liabilities for expenses not yet received or incurred.

Equity

• Equity represents the owners' claim to the assets of the corporation, calculated as assets minus liabilities.
• Share capital is the owner's investment in the company, where the company receives cash and issues shares to shareholders.
• Retained earnings are the amount of net income left after paying dividends to shareholders
• Remaining transferred retained earnings (positive) are always credited.
• Dividends are payments made to shareholders from profits, and declared by the board of directors
• If dividends have been paid out, the decrease in retained earnings would be higher than the net loss including relevant earnings per share if present on the income statement
• Incomes increase equity by delivering goods or services
• It is usually held on several income accounts, for each “type” of good or service they provide.
• Gains are a one-time event, low probability of reoccurrence, and always credited
• Expenses: Are all costs of operating the business and are always debited
• It is helpful to seperate the account for each type of expenses, for instance COGS, salary, rent, etc.

Double Entry Accounting

• Double entry accounting involves each transaction affecting at least two accounts.
• The T-account is split in two with debit on the left and credit on the right, ensuring that total debits equal total credits for every transaction.
• Increases in assets are debited; decreases are credited. The inverse is true for liabilities and equity.
• A debit increases an asset account, while a credit decreases it.
• A credit increases liability and shareholders' equity accounts, while a debit decreases them.
• Credits increase income, which ultimately increases equity, while debits decrease income.
• Debits increase dividends and expenses, decreasing equity, while credits decrease dividends and expenses.

Ledger and Trial Balance

• The ledger records a business's financial transactions and groups them by balance sheet accounts (assets, liabilities, equity) and income statement accounts (income, expenses).
• The income statement covers items pertaining to one period only
• The Trial Balance lists all accounts and balances to confirm that total debits equal total credits.

Analyzing and Correcting Errors

• Values from accounts and balances can be computed.
• For corrections, calculate the difference between total debits and credits.
• Detect error by by dividing the out-of-balance transaction by 2, or if the result is an integer (no decimals), divide the out-of-balance amount by 9.

Chapter 3: Accrual Accounting vs. Cash-Basis Accounting

• Accrual accounting records all transactions, regardless of payment status, if the service has been performed. The inverse is also true.
• Cash-basis accounting records only cash transactions.

Matching Principle and Adjusting Entries

• The matching principle matches expenses with revenues in the period which the revenue is earned.
• Adjusting journal entries might span through several accounting periods.
• Accounts must be updated to prepare financial statements, typically adjusted at the end of the reporting period.
• Adjusting entries ALWAYS involve either expenses or income.
• Note cash fails to capture the underlying economic phenomenon

Deferrals of Expense and Revenue

• Deferred expenses (assets) involve adjustments for items where cash was paid in advance. These include prepaid expenses and unearned revenues.
• Deferred revenue involves cash received in advance with an obligation to provide goods or services.

Accruals

• Accruals are the opposite of deferrals.
• For accrued expenses, the business records expenses before payment.
• For accrued revenues, the business records revenue before cash collection
• Depreciation allocates the cost of PPE over the asset's lifetime.

Four Situations:

• Cash Outflow Before Expense is Incurred → Deferred Expense (Asset)
• Cash Inflow Before Revenue is Earned → Deferred Revenue (Liability)
• Cash Inflow After Revenue is Earned → Accrued Asset
• Cash Outflow After Expense is Incurred → Accrued Liability

Prepaid Expenses

• Prepaid expenses are assets that provide a future benefit
• The adjustments can be calculated by Beginning balance + additional expenses - ending balance
• To measure supplies expenses, count supplies on hand at month's end.

Unearned Revenue

• Unearned revenues are cash collected before revenue is earned, creating a liability because there is an obligation to provide the service.

Accrued/Earned Revenue

• It is a revenue that has been earned however not yet collected
• Accrued expenses are liabilities that arise from an unpaid expense.
• Revenues and expenses recorded through adjustments

Depreciation

• Depreciation allows companies to depreciate a property, plant or equipment by refering to long-lived tangible assets, such as buildings, land, depreciating "spreading out" the costs of the investment over the expected lifetime
• This is done by dividing the total costs, with the expected useful lifetime under the equation: Acquisition cost-residual value/useful life

Accumulated Depreciation Account

• Accumulated depreciation shows the sum of all depreciation expenses from using the asset, with accounts always increasing over time, as the amount gets bigger
• It's normal balance is located on the opposite of the normal companion account. - With the balance sheet subtracting from the opposite account, giving the total of that account.
  • The carrying amount is the net amount of a PPE, therefore the cost-accumulated depreciation).

The Four Types of Adjusting Entries

• All summarized in table format, and can be remembered using this pneumonic device
• "Cash Before, Record Earlier/After"

Financial Statements

• The income statement reports net income/loss by accounting for the results of revenue and expenses
• Income statement effects shareholders equity, and will be transferred into current retained earnings
• Closing the books preps the accounts for transactions in the next period. With closing entries setting the revenue, expenses and dividends balances back to zero at the end of the period
  • All temporary accounts can be used In this process
  • With permanent accounts balance will be the same at the start of the new period

Closing Books Steps

• Debit each income account for the amount of its credit balance, then credit the remaining Retained Earnings.
• Credit each expense account for the amount of its debit balance.
• Debit the remaining Retained Earnings with Credit the Dividends account for the amount of its debit balance.

Accounting Misstatements

• Misstatements refer to unexpected deviations in financial reporting:
  • Understatements: Unexpected gains or incomes
  • Overstatements: Unexpected expenses or losses

Chapter 5: Understanding Fraud

• Definition: Intentional misrepresentation of facts aiming to deceive and cause harm.

• Impact (2016 ACFE report):

  • Organizations lose about 5% of revenue annually to fraud.
  • The median loss in occupational fraud cases amounts to $150,000.
  • Asset misappropriation is the most common form of fraud.
  • Loss increases with the duration of the fraud.
  • Nearly 80% of fraudsters display behavioral red flags.

• Misappropriation of Assets:

  • Involves employees stealing company money, concealed through false accounting entries.
  • Examples include theft of inventory or inflating expense amounts.

• Fraudulent Financial Reporting:

  • Occurs when managers manipulate accounting records to present a better financial image.
  • Involves making inaccurate estimates.
  • Aims to attract investors and creditors by presenting a misleading view.

The Fraud Triangle

• Elements:

  • Pressure:
    • Financial or personal stress.
    • Debts, greed, or financial issues.
  • Opportunity:
    • Weak internal controls.
    • Breakdown in key control elements.
    • Management’s ability to override controls.
  • Rationalization:
    • Self-justification belief

• Fraudulent Decision Making: Requires the presence of all triangle elements.

Ethics and Internal Controls

• Ethics: Fraud is illegal and morally unsound, violating stakeholders' rights for short-term gains

• Internal*: Control is a system of procedures to safeguard assets, promote policy adherence, ensure efficiency, guarantee accurate accounting, and ensure legal compliance.

• Objectives:

  • Protect against waste, inefficiency, and fraud.
  • Enforce company policies to treat employees and customers fairly.
  • Minimize waste to lower costs.
  • Maintain precise accounting for profitability analysis.
  • Adhere to regulatory standards to avoid penalties.

The Sarbanes-Oxley Act (SOX)

• Purpose: To restore confidence post-corporate scandals by reforming governance
• Key Requirements:
  • Public companies must report on internal controls.
  • Creation of the Public Company Accounting Oversight Board.
  • Restrictions on audit firms offering consulting services to audit clients.
  • Increased penalties for securities fraud and false statements by executives.

Internal Control Procedures

• Practices:

  • Smart hiring and separation of duties.
  • Thorough background checks and supervision.
  • Market-rate salaries.
  • Clear job descriptions.
  • Separation of accounting from operations.
  • Restriction of cash handling for accountants.

• Transaction Processing: Involves separating asset handling, record-keeping, and approval

• Monitoring: Uses cross-checking and operating/cash budgets, which involves cross checking in order to be able to complete a transaction.

• Record Keeping: Uses hard copy or electronic documents.

Safeguarding Cash

• The stricter the internal control system is, the more cost it will incurr and is required through the use of accounting systems that relies more on IT based systems
• Specific Controls:
  • Cash requires specific control, as it is relatively easy to steal.
  • Specific control needs are cash receipts, which are handled with a point of sale terminal.
  • Point of sale terminals provide control over the cash receipts, while also recording and accounting for the appropriate costs of the product.
  • Create daily sales journals, which turn and interface with the general ledger .
  • Depository bank accounts should be used, they will be deposited in the bank and transfered to the company's centralized account.

Payments through check

Methods for Payment through check is an important internal control, as follows:

• The check provides a record of the payment.
• The check must be signed by an authorized official. The official must before signing the check study evidence to supoort this
• To avoid these problems, companies will slit the roles among different employees:

Petty Cash

For small amounts, petty cash on hand must be kept.

Bank Reconciliation:

• To control a bank reconciliation involves signing a signature card, for each person allowed onthe authorization process It also to use deposit, to make each amount transaction, and keep receipts for payments
• It is important the maker/drawer, the one signing the check and the payee, who will be paid.

Bank Statements record transactions

They include beginning and ending balances, receipts and payments to be be sent monthly to each customer Reconcilation is done with people use Electronic Fond Transfers

Bank Reconcilliation

In there, there are always two records of books, the bank statement, and also with the use of the company’s general ledger this avoids the issue with balances There are usually a time lag, so they should to be reconciled in case fraud is detected The employee who prepares the reconciliation should not have other cash duties, or else the person can steal cash and manipulate the reconciliation to hide the theft.

• This includes in transit deposits, or outstanding checks and errors to have a perfect analysis

Bank Corrections that are Possible, and should be recorded

• You must correct all errors made by the bank. For instance, if the bank has subtracted a check written by someone else
• Book side of the reconciliation (bank collections)
• -Cash receipts that the bank to get their money back, for instance a customer can often pay this directly, this avoids service changes and interest revenue
• You can give an EFT which adds receipts and subtract payments, after subtracting from non-sifficuent funds checks.
• You have to make corrections in the reconcilation record and Journalize what is transacted (with banks), this helps seperate from ledger and journals, and the bank requires you to make journal entries to account for what is up to date.

Account receivables, and impairment for note

Receivables can be a problem for notes, as they have lower payment, so to account for these issues you sell on credit, the issue here is that there a lot if companies that have a high degree of problems

• In an allowanced method, The alllowance method records collection losses based on estimates developed from the company's collection experience and information about debtor and receivables, using the allowance for collectibles account.

If account receivbles balance and allowance does not align you can Aged them, analyse with low overdue payments, and if there is still issues direct write off.

The accounting procedure is to credit the receivables and account balance

• The final procedure is the reverse: Debit expense first At first, you debit the bad debt expense, and credit the bad debt allowance. If we have the 1000 and 5000, then you are only able to debit 4000.

Accounting and Notes

Notes receivables are formal notes that can ve current or long term assets, depending on the due date and involves Borrowers( The party receiving and Creditors()

Terms

• Maturity date Principal
• intrest rate

Chapter 6

Inventory will be sold, and the cost goes away when the asset goes to an expense (you give them the goods)

• A sale goes to revenue, however to account this well each value will cost a certan amount Inventory is considered on the balance sheet, and there are some shipping costs involved

Term (or Shipping Terms)

• Indicates all the goods with shipping costs, they provide insight on who pays with there ownership (Freight On Board)

• Inventory = Beginning inventory -Ending

Inventory Tracking

The value for a cheap material to inventory can be done in periodic tracking cycles, where a company will have status chacks yearly to check When doing that one account with inventory and debit the amount.

There are system to account

These include shipping the costs of the buyer, there is a debit/credit memo, depending of the terms, or sales the way the assets are moving

The buyer gets some discount depending on the method

FIFO allows companies to track oldest as first out/ newest is the inverse and they account by average, or just identify the issue

IFRS Standard

Note ifrs standard does not allow all inventory

There is also the Net relisable value, which the sell price - costs

The same is calculated with the cost method.

Inventory

Shows how many inventories there area available , the greater the inventory is, it means the more is sold.

Property

PPE are fixed, and with the accunulated deprecciated ammount is the carrying, or net book value.

To calculate depreciation, there are three types,

The allocation of the asset cost, all measured to indicate useful life, there a wide option for all

When measuring and measuring, there a number of factors including

• Value of PPE
• Cost
• Expected value

The last case the asset at disposal after measuring Straight = (Cost - reasidualy) / useful life

Units Production Cos - Reasidualy

• --- over the term

Double Declining Balance A decreasing balnce method, where all can get less or near zero And all can get more revenue, but less in later years.

• Must know residual value