Financial Accounting PDF

BASIC ACCOUNTING MODEL - UNITS 1-7 UNIT 1. ENTERPRISES AND ACCOUNTING INFORMATION THE ECONOMIC ACTIVITY, ITS AGENTS AND ENTERPRISES An enterprise is a company organised for commercial purposes, that is, a business firm, which operates in the economic system, in which goods and services are exchange...

BASIC ACCOUNTING MODEL - UNITS 1-7 UNIT 1. ENTERPRISES AND ACCOUNTING INFORMATION THE ECONOMIC ACTIVITY, ITS AGENTS AND ENTERPRISES An enterprise is a company organised for commercial purposes, that is, a business firm, which operates in the economic system, in which goods and services are exchanged for money. Every business requires some productive resources: land, plant and equipment, inputs and raw materials, labour, capital and management. By using productive resources an enterprise makes, trades and sells goods and services in order to obtain profit. Clients of every enterprise can be both individual (customers) and other enterprises, organisations, public authorities… Types of enterprises: Enterprises can be classified depending on different items: a) Depending on the type of good or service that they offer: A service business provides services to its customers. Common types of service business are law firms, fiscal and accounting firms, physical therapy offices, painting companies, automotive repair companies… A merchandise business sells physical goods or products to its customers. Common types of merchandise businesses are grocery stores, automobile dealerships, sporting goods stores. A merchandise business may be either a wholesale business or a retail business. Manufacturing business produces goods that they sell to their customers such as automobile manufacturers, the makers of clothing, etc… b) Depending on the legal form that they adopt: A sole proprietorship. It’s a business with a single owner. Most often, the owner is also the manager. Therefore, sole proprietorships tend to be small retail establishments and individual professional business. A partnership is an organisation that joins two or more individuals who act as co-owners and work together to provide services. Corporations are business organisations created under state laws. The owners of a corporation have limited liability, which means that corporate creditors ordinarily have claims against the corporate assets only, not against the personal assets of the owners. In contrast, owners in sole proprietorships and partnerships are usually personally liable for any obligation of the business. Corporations tend to be medium a large enterprises that hire professional managers. In Spain the two usual forms of corporation are Limited Society and Anonymous Society. c) Depending on the non-profit making: Profit-making Enterprises. Non-profit Making Entities: foundations, associations, non-governmental organisations… d) Depending on the ownership of the enterprises: Private enterprises. The owners are corporations, enterprises or individuals. State enterprises. They are enterprises owned by public authorities. e) Depending on the size: Large enterprises. Small and medium enterprises (SMEs). Micro enterprises. 1 Enterprises qualify as micro, SMEs if they fulfil the criteria laid down in Spanish mercantile legislation which are summarised in the table below. In addition to the staff ceiling, an enterprise qualifies as an SME if it meets either the turnover ceiling or the balance sheet ceiling, but not necessarily both. Enterprise category Staff Turnover (or) Balance sheet total Small and Medium < 50 ≤ €5.7 million ≤ €2.85 million Micro < 10 ≤ €2 million ≤ €1 million ECONOMIC AND ACCOUNTING INFORMATION Economic and financial reporting should offer useful information about the financial position of the company and the results of its management. The core information provided by companies, consist of the Financial Statements that are prepared and presented for external users by many entities around the World. Accounting is a process of identifying, analysing, measuring, recording and summarising economic information and reporting it to decision makers. Accounting information can thus reduce uncertainty in decision making in an environment characterised by risk, uncertainty and competition among private companies. The users of accounting information The objective of financial reporting is to provide financial information about the reporting entity that is useful to two types of users in making decisions: 1. Internal users: managers 2. External users: investors, lenders, creditors, suppliers, clients, debtors, employees, regulators, etc. Nearly all users are making economic decisions, for example: to decide when to buy, hold or sell an equity investment (investors). to assess the management of the company and make internal decisions (managers). to assess the ability of the entity to pay (suppliers, employees and other creditors). to assess the security for amounts lent to the entity (banks and others creditors). to determine taxation policies, to prepare national income statistics and to regulate the activities of entities (regulators). to determine distributable profits and dividends (managers and shareholders). 2 Requirements of accounting information If financial information is to be useful, it must be relevant and faithfully represent what it purports to represent. The usefulness of financial information is enhanced if it is relevant, objective and comparable, verifiable, timely and understandable. The fundamental qualitative characteristics are relevance, objectiveness, verifiability, timeliness and understandability. Relevance (materiality and completeness) Relevant financial information is useful and capable of making a difference in the decisions made by users. Financial information is capable of making a difference in decisions if it has predictive value, confirmatory value or both. Information must be material, that is, if omitting it or misstating it could influence decisions that users make. In other words, materiality is an entity-specific aspect of relevance. To be a perfectly faithful representation, a depiction would have an additional characteristic: It would be complete. Completeness means including all information necessary for a user to understand the phenomenon being depicted, including all necessary descriptions and explanations. Objectiveness or reliability (neutrality, free from errors and comparability) A neutral depiction is without bias in the selection or presentation of financial information. That implies reliability. Free from error means there are no errors or omissions in the description of the phenomenon, and the process used to produce the reported information has been selected and applied with no errors in the process. Information about a reporting entity is more useful if it can be compared with similar information about other entities and with similar information about the same entity for another period or another date. Comparability is the qualitative characteristic that enables users to identify and understand similarities in, and differences among, items. Verifiability Verifiability helps assure users that information faithfully represents the economic phenomena it purports to represent. Verifiability means that different knowledgeable and independent observers (auditors) could reach consensus, although not necessarily complete agreement, that a particular depiction is a faithful representation. Timeliness Timeliness means having information available to decision-makers in time to be capable of influencing their decisions. Generally, the older the information is the less useful it is. The financial statements are prepared and published once a year, at the end of the financial period. Understandability Classifying, characterising and presenting information clearly and concisely makes it understandable. Financial reports are prepared for users who have a reasonable knowledge of business and economic activities and who review and analyse the information diligently. 3 UNIT 2. ACCOUNTING HISTORY 1. TECHNICAL PERIOD – From 3.000 B.C – 1.840 A.D. Accounting was considered a technique of recording economic transactions In a primitive way Records of quantities of goods The growth of the economic and monetary system implied a more sophisticated method, measuring items in monetary terms. From 1.202 the double entry system was developed, because of the need of information. In 1.494 the first book of the double-entry system was published by Luca Paccioli Development of bookkeeping and double-entry system until the end of the XIX Centur 2. SCIENTIFIC PERIOD – From 1.840 – Nowadays. Accounting is considered a science which uses a specific method (double-entry system) to its scientific purpose: provide information about the economic and financial position of enterprises. Many theories were developed depending on the consideration of the objectives and users of accounting information: different systems for different purposes. Development of capital markets. Increase in accounting regulation and harmonisation worldwide. Useful information approach UNIT 3. ACCOUNTING: CONCEPT, CLASSIFICATION AND METHOD CONCEPT OF FINANCIAL ACCOUNTING Accounting is a process of identifying, analysing, measuring, recording and summarising economic information and reporting it to decision makers. Financial accounting focuses on the specific needs of decision-makers external to the organisations, such as stockholders, employees, suppliers, creditors, debtors, banks, and government agencies. These stakeholders can use this information in deciding how, when, what to buy, sell, invest… Accounting also helps predict the future effects of decisions. Accounting organises and summarises economic information so that decision makers can use it. Accountants present this information in reports called Financial Statements. To prepare these statements, accountants analyse, quantify and measure, record and summarise economic events and their financial effect on the organisation. ACCOUNTING METHOD A company’s accounting system is the series of the following steps, called the accounting method: Identifying and analysing how economic events have an effect on the financial and economic position of the company. Quantifying and measuring economics events. That implies valuing the accounting facts that have an effect on the financial position of entities. Recording economic events. Bookkeepers and computers then perform the routine tasks of collecting economic information. Summarising periodically information in Financial Statements that presents the financial position of the company for a given period of time. EVENTS -- ANALYSIS -- MEASUREMENT -- RECORDING -- FINANCIAL STATEMENTS -- USERS 4 In order to carry out the steps of the accounting method, accountants count on the following instruments: 1. To analyse economic events, the Dual Aspect Convention is used. It’s necessary to make discrimination between the events you are interested in capturing or not, on the basis of whether they are useful in providing information about the economic and financial situation. The Dual Aspect Convention is an accounting convention according to which transactions are treated as having two aspects or two parts. This leads to double- entry system according to which transactions are recognised simultaneously as debit and credit items. Each accounting fact has to be analysed in order to determine what accounts are impacted and how they are impacted (increasing or decreasing). Each transaction will have two aspects: investment (use o resources) and funding or financing (origin of resources). It’s the basis of the double-entry system. 2. To quantify and measure economic events accountants use the General Accounting Accepted Principles and Criteria of Recognition and Measurement. They are conventions, rules and procedures that define and dictate accepted accounting measurement practice. The concept includes not only broad guidelines but also detailed rules. 3. To record economics events accountants use the accounts and accounting records. Accounts represent financial and economic elements of the company. Accounting records are used to record economics transactions in. The Journal (or Day Book) and the Ledger, are two main records of accounting bookkeeping. 4. Financial Statements summarise accounting information periodically. The major financial statements are: Balance Sheet, Income Statement (Profit and Loss Account), Annual Report (Notes to the Accounts), Cash Flow Statement and Statement of Changes in Equity. ACCOUNTING DISCIPLINES Accountants often distinguish different types of accounting referred to companies: 1. Financial Accounting focuses on the specific needs of decision-makers external to the organisations and provides information about the economic relationship between the company and its surroundings. The financial accounting information provided for these users is disclosed in the annual accounts and the financial statements, as we have stated when we have defined the term “accounting”. 2. Cost and Management Accounting is that part of the cost management system that measures cost for the purpose of management decision and financial reporting to managers. Cost accounting involves budgeting, breaking down of costs and revenues by product. 3. Auditing. It consists of the examination of a company’s transactions and the resulting financial statement by an auditor. An auditor is a person who examines the information used by managers to prepare the financial statements and attests to the credibility of those statements in a report describing the scope and results of an audit process. Companies include the opinion with the financial statements in their annuals reports. 4. Accounting analysis or financial statement analysis is defined as the process of identifying financial strengths and weaknesses of the firm by properly establishing relationship between the items of the balance sheet and the income statement. There are various methods or techniques that are used in analysing financial statements, such as comparative statements, common size percentages, funds analysis, trend analysis, and ratios analysis. 5. Consolidation is the preparation of consolidated financial statements by holdings groups (parent company and its subsidiaries) 5 UNIT 4. WEALTH AND INCOME WEALTH AND INCOME. CONCEPTS AND RELATIONSHIP “Wealth” is the difference between ASSETS (property, goods, legal rights, debtors or entitlements), and LIABILITIES (economic obligations) of an entity in a particular instant in time. The accounting concept for wealth is “Equity” or “Owner’s Equity”. The term “Income” is used to refer the difference between the two economic mainstreams of companies’ activities. In general, the amount by which the selling price (revenues) exceeds expenses during a particular period of time, is called profit or net income. Wealth and income are linked: If a company obtains a positive income (profit) for the financial period (usually a year), its wealth or equity increases. If a negative income is obtained, that loss implies a decrease in the equity of the entity. WEALTH COMPONENTS AND BALANCE SHEET “Wealth”: difference between ASSETS & LIABILITIES, as above. The accounting concept: “(Owners) Equity” Wealth or Equity = Assets - Liabilities Assets = Liabilities + Equity (Fundamental Accounting Equation) Balance Sheet ASSETS EQUITY AND LIABILITIES Property and goods (plant, equipment, land, Equity (Owner’/ Shareholder’s equity) cash…) Rights (accounts receivable) Liabilities (economic obligations) ASSETS LIABILITIES EQUITY Goods, rights and other economic Economics obligations and Is the owner’s claim on the resources that the company amounts owed to outsiders organisation’s assets. It’s equal to expects to help generate future relating to loans, debts to the assets minus the liabilities. cash inflows, such as land, suppliers, etc. buildings, equipment, accounts receivable, cash, inventories and even intangible assets such as patents and software. ❗ EXERCISE 1 ❗ 6 ELEMENTS AND ACCOUNTS OF BALANCE SHEET ASSETS Fixed assets or long-lived assets, are assets, like property and legal rights, that are intended for permanent ownership or use by the Enterprise for a period of more than one year. For instance, land, buildings, plant and equipment, furniture, vehicles, machines, computers as tangible assets. A fixed asset may be an intangible asset as well (such as patents, software) and fixed investments (shares, loans to outsiders, loans to employees, to other enterprises) that will be settled o realised in, within more than one year. Accumulated Amortisation. It’s the total amortisation charges recognised since the acquisition of an asset. Amortisation is the systematic allocation of the acquisition cost of long-lived assets to the expense accounts of particular periods. Tangible and intangible assets are used in the operating cycle of a company and it gradually implies depreciation in their cost. Land, some intangible assets and financial assets are not subject to this type of depreciation. Short-term trade debtors. Amounts due from clients, customers and other debtors due to the provision of goods and services that will be paid within a period of one year. Another term used is trade receivable. Short-term financial debtors. Investments or financial receivables such as shares on other companies, loans to outsiders, loans to employees, to other enterprises that will be settled or realised in, within a period of one year. Cash. Deposits in current or checking bank accounts and cash in hand. LIABILITIES Long-term creditors/payables. Debts due to suppliers, various creditors, banks, etc., that represents amounts that fall due after more than one year. Short-term trade creditors/payables. Debts with goods and services suppliers, debts with employees, with other trade creditors… They must be settled in a period of one year. Short-term financial creditors/payables. Debts such as debenture loans, bank loans and other financial instruments, which amount fall due in a year. EQUITY (owners’ equity, shareholders’ equity or stockholders’ equity) Capital: the fund provided for the long-term financing of an enterprise by its owners. Investors become the owners of the company and that ownership interest is represented by shares that can be transferred to others. Net Income / Profit or Loss. Earnings for the accounting period of a company. The retained earnings not distributed to shareholders are called reserves. ➣ Exercise 1 ASSETS EQUITY AND LIABILITIES NON-CURRENT ASSETS EQUITY Fixed assets or long-lived assets Capital resources - Accumulated Amortisation - Capital - Net Income/Profit or Loss NON-CURRENT LIABILITIES - Long-term creditors/payables CURRENT ASSETS - Short-term trade debtors CURRENT LIABILITIES - Short-term financial debtors - Short-term trade creditors/payables - Cash - Short-term financial creditors/payables 7 COMPOSITION OF NET INCOME AND INCOME STATEMENT (PROFIT AND LOSS ACCOUNT) Net Income is the surplus of the production process during an exercise. During the operating cycle, the company uses cash to acquire goods and services, which in turn it sells to customers. The customers in turn pay for their purchases with cash. The amount by which the selling price exceeds expenses is profit or net income. Expenses are defined as the economic valuation of the consumption of goods and services in the operating process, directly or indirectly, during the financial year. The valuation of goods sold and services rendered, directly or indirectly, in the production process during a financial year, is called Revenues (and Sales). The company when carrying out their activities may incur loss of assets without compensation or may obtain extraordinary resources. These can be considered Losses (extraordinary expenses) and Gains (extraordinary income). Income for an accounting period is equal to Revenues + Gains – Expenses – Losses. I1 = R, G1 - E, L1 Initial Balance Sheet Final Balance Sheet Assets (i) Equity (i) Assets (f) Equity (i) Equity Net Income Liabilities (i) Liabilities Income Statement (account model) Expenses and Losses Revenues and Gains Net Income (Profit if positive) Net Income (Loss if negative) Income Statement (list model) + Revenues and Gains - Expenses and Losses Net Income (Profit or Loss) ELEMENTS AND ACCOUNTS OF INCOME STATEMENT (PROFIT AND LOSS ACCOUNT) EXPENSES AND LOSSES ACCOUNTS: Service Expenses: Services outsourced by the company. It includes among others: rent, repairs, maintenance, independent professional services, insurances, banking services (no interest), advertising, public relations, supplies (water, electricity, gas, telephone, fax, etc...) and others. Personnel Expenses. Staff expenses like wages and salaries, social security costs and pension costs. Amortisation Expenses. It represents the depreciation of fixed assets in one year due to its use in the production process. Other Operating Expenses. Other expenses related to the operating cycle, not included in accounts above, like taxes. Financial Expenses. Accrued interest on loans during the accounting period. Extraordinary Expenses. Involuntary sacrifices of assets without compensation or come upon of liabilities that occur in unusual ways. 8 REVENUES AND GAINS ACCOUNTS: Service Revenues. Economic valuation of the services provided to customers arising on the core operating activities. Other Operating Income. Income and other revenues involved in secondary operating activities. Financial Income. Returns on own financial resources invested by the company (interest loans, dividends). Extraordinary Income. Increases in assets and decreases in liabilities, without compensation occurred in extraordinary events Income Statement or Profit and Loss Account (account model) Operating Expenses Operating Revenues and Incomes Service Expenses Service Revenues Personnel Expenses Other Operating Income Extraordinary Income Other Operating Expenses Amortisation Expenses Extraordinary Expenses Financial Expenses Financial Income Financial Expenses Financial Income Profit for the period Loss for the period Income Statement or Profit and Loss Account (list model) + Service Revenues + Other Operating Income + Extraordinary Income - Service Expenses - Personnel Expenses - Other Operating Expenses - Amortisation Expenses - Extraordinary Expenses 1. Operating Profit or Loss + Financial Income - Financial Expenses 2. Financial Profit or Loss 3. Net Income (profit or Loss) for the period (1+2) ❗ EXERCISE 1 ❗ 9 UNIT 5. THE DUAL ASPECT CONVENTION Accounting captures, analyses, measures and records economic events. The aim of this unit is to understand: 1. The identification of accounting events. 2. The analysis of the origin and application of resources of accounting events. 3. The identification of revenues, expenses, increases and decreases in assets, liabilities and equity elements. Accounting facts or events are: Economic transactions that have an effect in the components of the Balance Sheet and the Income Statement. Events happening in a company may cause changes in its financial status or affect its generation of its incomes. The accounting collects those facts that may cause modifications in assets, liabilities, equity, revenues or expenses. It’s necessary to make discrimination between the events you are interested in capturing or not, on the basis of whether they are useful in providing information about the economic and financial situation. These facts are called accounting events. The Dual Aspect Convention is an accounting convention according to which transactions are treated as having two aspects or two parts. This leads to double-entry system according to which transactions are recognised simultaneously as debit and credit items. Every accounting fact has to be analysed in order to determine which accounts are impacted and how they are impacted (by increasing or decreasing). Every transaction will have two aspects: investment (use of resources) and funding or financing (origin of resources). As for the elements of the Balance Sheet the origin of resources implies obtaining funds from increases in liabilities and equity and from decreases in assets. The application of resources implies increases in assets and decreases in liabilities and equity. On the other hand, revenues are considered origin of resources by means the operating cycle of the company and expenses are considered application of resources. For each transaction we will have: (Slides) Σ uses of resources = Σ origin of resources Σ (△A, ▽L, △Eq, Ex = Σ (△L, △Eq, ▽A, R) 10 UNIT 6. ACCOUNTING REGISTRATION In Spain, the main records (books) to register economic transactions in financial accounting are: Daybook or Journal (MANDATORY) Ledger Inventories and Annual Accounts (MANDATORY) ACCOUNTING RECORDS: Daybook or Journal The Daybook is just a log book that contains a chronological listing of a company’s events. Specifically, an entry indicates the accounts involved in two parts. On the left side, called debit, we must record the accounts that imply a use or application of resources (increases in assets, decreases in liabilities and equity, and expenses). On the right side called credit, we record the accounts that imply an origin of resources (decreases in assets, increases in liabilities and equity, and revenues). Number of entry DEBIT Date CREDIT ACCOUNT ACCOUNT AMOUNT AMOUNT △Assets, △ Equity, ▽ Equity, △ Liabilities, ▽ Liabilities, Expenses ▽ Assets, Revenues → Example: Accounting records ACCOUNTING RECORDS: LEDGER The General Ledger is the collection of accounts that accumulate the amounts reported in the financial statements. It includes the ledger accounts, called T-accounts. The vertical line in the T divides the account into the left and the right sides for recording increases and decreases in the account. Account title: horizontal line. Each T-account summarises the changes in a particular asset, liability, equity, revenues and expenses. The term debit is used to denote an entry on the left side of the Ledger, credit denotes an entry on the right side. A balance is the difference between the total left-side (debit) amounts and the right-side (credit) amounts. Assets and Expenses accounts have left-side (debit) balances, because entries on the left increase assets/ expenses accounts and entries on the right side decrease them. So they are debit accounts. This process is exactly reversed for liabilities, equity and revenues. Entries on the right side increase them and entries on the left decrease them, so they are credit accounts with credit balances. 11 ACCOUNTING RECORDS: LEDGER – T-ACCOUNTS Dr (Assets) Cr ASSETS: DEBIT ACCOUNTS (Debit > Credit) Increases (+) Decreases (-) Dr (Equity and Liabilities) Cr EQUITY AND LIABILITIES: CREDIT ACCOUNTS Decreases (-) Increases (+) (Debit < Credit) Dr (Expenses) Cr EXPENSES: DEBIT ACCOUNTS (Debit > Credit) Increases (+) Dr (Revenues) Cr REVENUES: CREDIT ACCOUNTS (Debit < Credit) Increases (+) We have to transfer amounts from the Daybook to the appropriate accounts in the Ledger (T-accounts). Posting is strictly a mechanical process of moving amounts from the Daybook to the Ledger. → Exercise GUIA (T-accounts (Ledger), Financial Statements UNIT 7. PREPARATION OF ANNUAL ACCOUNTS INVENTORIES AND ANNUAL ACCOUNTS BOOK This record, mandatory in Spain, includes: 1. An initial inventory of assets and liabilities, which is a list of all the property, assets (long-term assets and current assets) and long-term and short-term liabilities. It’s a statement prepared outside the double entry system, counting assets and liabilities from their source documents and from a physical count. 2. Four quarterly Trial Balances. A Trial Balance is a list of all accounts with their debit and credit amounts and with their balances by difference. They are used as a test or check and the purpose is twofold: to help check on the accuracy of postings by proving whether the total debits equal the total credits and to establish a convenient summary of the balances in all accounts for the preparation of financial statements. → Guida Accounts Debit amounts Credit amounts Debit Balances Credit Balances 3. Annual Accounts. The Balance Sheet The Income Statement (Profit and Loss Account) The Annual Report (Notes to the accounts) The Statement of Changes in Equity The Cash Flow Statement 12 ACCOUNTING CYCLE The sequence of the steps in recording and reporting transactions, that is, the accounting cycle is as follows: Economic Transactions - Daybook - Ledger - Trial Balances – Annual Accounts Source documents (Inventories and Annual Accounts Book) Economic Transactions Daybook → Ledger → Trial Balance → Annual Accounts Some adjustments at 31-12 Inventories and Annual Accounts Book END-OF-THE-PERIOD ADJUSTMENTS Accrual Adjustments involve recording accrued revenues and expenses to a particular period. These adjustments arise from expenses paid in advance or revenues received in advance. Recording Inventory Differences, consists of correcting any quantitative differences found when preparing the final inventory by contrasting it with the accounting information of T-accounts. Reclassification of accounts, implies reviewing the maturity of the accounts that represent rights or obligations, readjusting their name when moving from long-term to short-term, because of the passage of time. Correcting entries have to be made where errors are detected. Such corrections should be recorded at any time of the financial year, when the error is detected. Value adjustments. At the end of a financial year events or circumstances may cause depreciation in assets which comes from two situations: 1. Economic causes. The value of asset items has been depreciated because their fair market value (the value by which a company could sell the asset) has decreased. In that respect, the book value is inferior to the fair market value and a value adjustment must be recorded. Such depreciation is called impairment. In general, we adjust impairment losses of assets, but if the fair market value is superior to the book value (which means a potential gain) we can not record that gain, due to the fact that is not a real gain. 2. Technical causes. The value of tangible and intangible assets decreases due to their use over time. Fixed- assets wear out and become depreciated because they are used in a production process, they become obsolete or simply because of the passage of time. Amortisation is the cost allocation of assets over their useful life. END-OF-THE-PERIOD ADJUSTMENTS: AMORTISATION Some intangible assets and tangible assets usually wear out, except for land. Land doesn’t wear out or become obsolete, so we don’t depreciate it. As a company uses fixed-assets over time, accountants convert their cost to expense. The allocation of costs over time is called amortisation or depreciation. Accounting for fixed-assets begins with its purchase at the acquisition cost. At least at the end of the financial year, companies must calculate the depreciation (based on their cost) of the fixed-assets and record it in Daybook. So, firstly we need to know how to calculate amortisation and secondly how to record it. 13 The amount of the annual amortisation depends on some concepts: Acquisition cost of the fixed-asset. Useful life of the assets: is the estimated life (years) of a specific asset, depending on its nature and how it is used in the production process (it could be different from the asset’s physical life). Depreciation and useful life could be based on physical units (service units, production units, hours, kilometres…) instead of time units. Residual value: is the amount a company expects to receive from selling the asset at the end of its useful life. Depreciable value: is the cost that must be allocated, that is, the difference between the total acquisition cost and the estimated residual value. Annual amortisation, namely amortisation expense, calculation: (Acquisition c. – Residual value ) / l. Years Accumulated amortisation is the total (cumulative) amount of the depreciation at a specific period of time. Net book value: is the difference between acquisition cost and accumulated amortisation. → Exercise RETIREMENT AND SALES (DISPOSAL) OF FIXED ASSETS Companies sometimes sell or retire an asset before the end of its useful life. When they sell assets gain or losses (extraordinary income or expenses) are inevitable. We measure these gains or losses by the difference between the proceeds received and the net book value of the asset being sold. → Exercise PREPARATION OF FINANCIAL STATEMENTS AND CLOSING ACCOUNTS After preparing annuals accounts (Balance Sheet & Income Statement), accountants must close the books at the end of the financial year (31/12), which prepares the Ledger accounts to record the next period’s transactions. To do this, we have to make closing entries into the Daybook & the Ledger. Closing entries consists of 2 steps: 1. Reducing the amount of revenues and expenses accounts to zero (in T-accounts). They will be ready to record transactions for the next period and at the same time we transfer the difference between revenues and expenses in the Income account for the period. Revenues and Expenses account balances are “reset” to zero and the net Income generated comes up into a corresponding T-account. To reset Revenues accounts we must debit their balances. To reset Expenses accounts we must credit their balances. DEBIT 31-12 CREDIT AMOUNTS REVENUES EXPENSES AMOUNTS PROFIT AND LOSS DIFFERENCE 2. Once Revenues and Expenses are closed, the next step is to close Assets, Liabilities and Equity accounts. This is a formal closing entry and it doesn’t mean that the balances of those accounts must be zero. Assets, liabilities and Equity accounts are closed (balanced to zero) at the end of the financial year and then they must be opened at the beginning of the next period (01/01). This is called the opening entry. The closing entry for assets, liabilities and equity is as follows. To close Liabilities and Equity accounts we must debit their balances. To close Assets accounts we must credit their balances DEBIT 31-12 CREDIT BALANCES Capital Fixes Assets BALANCES Profit and Loss Cash Long-term creditors Short-term trade debtors Short-term trade creditors Short-term financial debtors short-term financial creditors 14 The opening on January 1st would be: DEBIT 01-01 CREDIT BALANCES AT Fixes Assets Capital BALANCES AT 12-31 Cash Retained Earnings (P/L of 12-31 Short-term trade debtors previous period) Short-term financial debtors Long-term creditors Short-term trade creditors Short-term financial creditors → Exercise According to the steps studied in 2. and by adding previous operations before annual closing entries, the complete accounting cycle is the following: GENERAL ACCOUNTING PLAN - UNITS 8-12 UNIT 8. GENERAL ACCOUNTING LEGISLATION INTRODUCTION: ACCOUNTING LEGISLATION AND STANDARIZATION IN SPAIN - Accounting Formal Aspects: Commercial, Civil and Fiscal Legislation This legislation develops matters concerning accounting books, accounting information (financial statements) and auditing: Code of Commerce, RLD on Capital Companies (among others). - Accounting Content and Valuation Aspects PUBLIC LEGISLATION: Spanish General Accounting Plan 2007 (Plan General de Contabilidad), its sectoral adaptations, the determinations of the Instituto de Contabilidad y Auditoría de Cuentas (ICAC), and rules regarding consolidated annual accounts and auditing. PRIVATE STANDARDS In Spain – rules and papers of Asociación Española de Contabilidad y Administración de Empresas (AECA) International – standards of the International Accounting Standard Board (IASB), called the International Financial Reporting Standards (IFRS). 15