Foundations of Financial Accounting (ACC107) Lecture 1 PDF

Foundations of Financial Accounting (ACC107) Lecture 1 Financial Statements & Accounting Equation (Ch.1, 4 & 7) Learning outcomes Discuss the nature and functions of financial accounting. Outline the differences between a company, a sole trader and a partners...

Foundations of Financial Accounting (ACC107) Lecture 1 Financial Statements & Accounting Equation (Ch.1, 4 & 7) Learning outcomes Discuss the nature and functions of financial accounting. Outline the differences between a company, a sole trader and a partnership. Explain the nature of the time period concept, the going concern concept, and the entity concept. Describe the accounting equation, including how it is reflected in the statement of financial position. Explain the nature of assets, liabilities and capital. What is accounting ? Accounting is the process of recording and categorizing a company’s transactions, and then communicating these activities to users. Financial Accounting 1. Collecting, measuring, and recording an enterprise’s transactions Our (Bookkeeping system); focus 2. Reporting on the results of these transactions to external stakeholders to facilitate making economic decisions. Management Accounting Concerned with the preparation of reports for internal management purposes. What is accounting ? Accounting is not pure science. Instead, it is a business language defined by agreement among professionals. It evolves as the economy, capital markets and technologies develop. The objectives of an appropriate accounting system The recording and control of business transactions To maintain accuracy in recording Facilitate To meet the requirements of the law decision making To present final financial statements to the owners of the business To present other financial reports and analyses To facilitate the efficient allocation of resources Types of entity 1. Sole trader 2. Partnership 3. Companies Sole trader Definition One individual owns and operates a business. Characteristics The business is unincorporated, which means the business is not seen as legally separate from the individual. The individual is responsible for the debts of the business (i.e., unlimited liability). The tax expense is the individual’s, not the business’s. Partnership Definition The business is owned and operated by two or more individuals. Characteristics A partnership can be incorporated as a limited liability partnership or as an unincorporated business. If unincorporated the partners are jointly responsible for the debts of business and creditors have claim over their personal assets if the business cannot pay. The profits are split between the partners who are taxed individually on the portion of their profits. The business does not incur taxation, the partners do.  Companies Definition The business is incorporated by law as a separate legal entity. Types The two most common company forms are Public Limited Companies and Private Limited Companies。 Companies private public Shares are held privately, Listed (shares are traded usually by a family or a Unlisted in stock exchange) small group of investors Additional reading: Difference between Private Limited Company vs Unlisted Public limited Company (qapita.com) Companies Characteristics Ownership is assigned by allocation shares. The owners of shares are called shareholders or equity shareholders. Responsible for tax on any profits made. The tax is called corporation tax. Shareholders have limited liability for the company’s debt. Their liability is limited to the amount invested in the company when buying the shares. Financial statements Statement of profit or loss Other Statement reports of financial from position managers Financial statements Notes to Statement financial of cash flow statements Statement of changes in equity Statement of profit or loss Revenue (收入) Sales revenue is the gross inflow of economic benefits arising from ordinary operating activities (i.e., sales of goods and services ). When an entity has income from activities that are not its core business, such as a retailer receiving interest on its deposit account and selling a vehicle, then this is disclosed separately as ‘other income’. Expenses (费用) Expenses are running costs that a company incurs to generate revenue. *Staff wages *Electricity, heat, and light *Rent *Financial costs …  Statement of profit or loss Profit or loss (利润或损失) Profit or loss is the total income made by the entity less the total expenses incurred by the entity in the same period. Revenue Expenses Profit/Loss * Other comprehensive income will be introduced in Lecture 9 Thinking If Suzhou Ltd.’s profit is £ 100, then is this good result ? A. £ 100 for 1 month => Profit of 1 year = £ 1,200. B. £ 100 for 1 day => Profit of 1 year = £ 100* 365 days = £36,500 C. £ 100 for 1 second => Profit of 1 year = £ 100* 365 days*24hours*60mins*60sec = £3,153,600,000 * In terms of profit/loss, the time period is important! The statement of profit and loss (SPL), also known as the income statement, is a financial statement that summarizes the revenues, costs, expenses, and profits/losses of a company during a specified period. Statement of financial position Assets (资产) An asset can be defined as a tangible or intangible resource that is owned or controlled by an accounting entity as a result of past events. *Cash in hand *Money in bank accounts *Inventories *Receivables *Land and buildings *Plant and machinery *Motor vehicles … Statement of financial position Liabilities (负债) A liability can be defined as a present obligation of the entity to transfer an economic resource as a result of past events. It represents the amounts owed by the entity. *Trade payables *Bank loans *Accruals … Equity/Capital (权益) The ownership interest or claims are called owners’ equity or owners’ capital. Equity is the residual interest in the assets of the entity after deducting all its liabilities. Statement of financial position Assets Equity/Capital Liabilities Thinking If Suzhou company : A. has assets worth £ 100 million today. B. had assets worth £ 100 million at the end of 2000. C. had assets worth £ 100 million at the end of 2010. * In terms of Financial position (Assets, Liability & Equity), the point in time is important. The statement of financial position (SOFP), also known as the balance sheet, is a financial statement that reports a company's assets, liabilities, and shareholder equity at a specific point in time. Time period concept Time period concept It is also known as the time interval or periodicity concept, refers to the practice of dividing the life of an entity into periods for the purpose of preparing financial statements. The period of time, as required by company law, is usually one year. (i.e., financial year) 1st accounting period 2nd accounting period 3rd accounting period Statement of profit or Statement of profit or Statement of profit or loss for a specified loss for a specified loss for a specified period of time period of time period of time Statement of financial Statement of financial Statement of financial position at a point in position at a point in position at a point in time time time Going concern concept Going concern The going concern concept is the assumption that an entity will continue in operational existence for the foreseeable future. Negative trends that lead to no longer being a going concern include continued losses and lawsuits. If a entity is no longer a going concern, it must start reporting certain information on its financial statements. An auditor can give a going concern opinion when they have doubts about the financial longevity of a company. (see more in Lecture 12) Accounting equation Assets Capital Liabilities (A) (C) (L) What the business Who provides the owns/controls funds Assets Liabilities Capital (A) (L) (C) Owners’ interest Net resource of business in the business / Net Asset Accounting equation Liabilities Profit / Revenue Expenses (L) Loss Assets Capital Liabilities (A) (C) (L) Closing Capital (CC) = Opening Capital (OC) + New Capital (NC) – Drawings (D) + Profit / - Loss Closing Assets (CA) = Opening Capital (OC) + New Capital (NC) – Drawings (D) + Revenue (R) – Expenses (E) + Closing Liabilities (CL) Accounting equation example Liabilities (L) Working example Adam Bridgewater commenced business on the 1 July 20X8 with £20,000 in cash: Assets Capital/ Liabilities Equity Date Total C.+L. Tool Inventory Cash Total Opening Trade Capital Payables 1 July 20,000 20,000 20,000 20,000 Increase in assets Increase in capital * Check if the Accounting Equation (A=C+L) holds: ￡20,000(A) = ￡20,000 (C+L) Working example On 2 July he drew out £8,000 cash and spends it on purchasing tools: Assets Capital/ Liabilities Equity Date Total C.+L. Tool Inventory Cash Total Opening Trade Capital Payables 1 July 20,000 20,000 20,000 20,000 2 July 8,000 12,000 20,000 20,000 20,000 Increase in assets Decrease in assets * No changes in Total Asset * Check if the Accounting Equation (A=C+L) holds: ￡20,000(A) = ￡20,000 (C+L) Working example On 3 July he bought goods for resale costing £3,000 on credit: Assets Capital/ Liabilities Equity Date Total C.+L. Tool Inventory Cash Total Opening Trade Capital Payables 1 July 20,000 20,000 20,000 20,000 2 July 8,000 12,000 20,000 20,000 20,000 3 July 8,000 3,000 12,000 23,000 20,000 3,000 23,000 Increase in assets Increase in liabilities * Purchase on credit means receiving goods first and paying for goods later * Check if the Accounting Equation (A=C+L) holds: ￡23,000(A) = ￡23,000 (C+L) Working example On 4 July he paid the creditor the £3,000: Assets Capital/ Liabilities Equity Date Total C.+L. Tool Inventory Cash Total Opening Trade Capital Payables 1 July 20,000 20,000 20,000 20,000 2 July 8,000 12,000 20,000 20,000 20,000 3 July 8,000 3,000 12,000 23,000 20,000 3,000 23,000 4 July 8,000 3,000 9,000 20,000 20,000 0 20,000 Decrease in assets Decrease in liabilities * Check if the Accounting Equation (A=C+L) holds: ￡20,000(A) = ￡20,000 (C+L) Working example * On 5 July he paid the heat and light of the business £550 in cash: Assets Capital/ Liabiliti Equity es Date Total Tool Inv. Cash Total Opening - + - Trade C.+L. Capital Drawing Revenue Expense Payables 1 July 20,000 20,000 20,000 20,000 2 July 8,000 12,000 20,000 20,000 20,000 3 July 8,000 3,000 12,000 23,000 20,000 3,000 23,000 4 July 8,000 3,000 9,000 20,000 20,000 0 20,000 5 July 8,000 3,000 8,450 19,450 20,000 550 0 19,450 Decrease in assets Increase in expenses * Check if the Accounting Equation (A=C+L) holds: ￡19,450(A) = ￡19,450 (C+L) Working example * On 6 July he withdrew £400 from the business bank account to pay for the electricity of his own apartment: Assets Capital/ Liabiliti Equity es Date Total Tool Inv. Cash Total Opening - + - Trade C.+L. Capital Drawing Revenue Expense Payables 1 July 20,000 20,000 20,000 20,000 2 July 8,000 12,000 20,000 20,000 20,000 3 July 8,000 3,000 12,000 23,000 20,000 3,000 23,000 4 July 8,000 3,000 9,000 20,000 20,000 0 20,000 5 July 8,000 3,000 8,450 19,450 20,000 550 0 19,450 6 July 8,000 3,000 8,050 19,050 20,000 400 550 0 19,050 Decrease in assets Decrease in capital * Check if the Accounting Equation (A=C+L) holds: ￡19,050(A) = ￡19,050 (C+L) Accounting Entity Concept Reporting entity A reporting entity is defined in the Conceptual Framework (IASB, 2018) as ‘an entity that is required, or chooses, to prepare financial statements’. The entity concept Boundaries are created to separate out the accounting entity. Accounting for a reporting entity focuses on setting up a means of recording all accounting information in relation to that entity. Therefore, when a sole trader uses the business cheque book to buy a car for personal use, this car will not form part of the business’s assets; it will be treated as the owner withdrawing equity capital. This is called a ‘drawing’. How to calculate profits? The profit (or loss) for any given accounting period can be measured using either: A dynamic approach Profit (or Loss) = Revenue - Expenses A comparative static Recall the equation: Closing Capital (CC) = Opening Capital (OC) + New Capital (NC) – Drawings (D) + Profit / - Loss Rewrite: Profit / Loss = Closing Capital (CC) - Opening Capital (OC) - New Capital (NC) + Drawings (D) Have a try * Using the second approach – determine the profit made by ABC in the year to 31 December 20X0 – Opening capital (£20,000) – Closing capital (capital at year end) (£30,000) – Drawing (£4,000) and new capital introduced (£3,000) during the period * What is the profit for the year? – Profit = CC - OC– NC+ D = £30,000 - £20,000 - £3,000 + £4,000 = £11,000 What will we learn? Part I: transaction recording & financial Accounting statements for sole traders Adjustments Lecture 1 – Financial Lecture 5 – Depreciation Statements & Accounting (Ch. 14) Equation (Ch. 1, 4 & 7) Lecture 6 – Irrecoverable Lecture 4 Debt (Ch.15) Lecture 7 Lecture 2 – Double-entry Financial Final Bookkeeping (Ch. 9) Statement Lecture 6 – Accruals & Financial Introductory Prepayment (Ch.16) Statement Lecture 3 – Accrual Basis (Ch.13 & 2) & Trial Balance (Ch. 4 & Lecture 7 – Inventories 10) (Ch.17) Part II: Other accounting topics Lecture 8 Lecture 9 Lecture 10 Lecture 11 Bank Limited Statement of Ratio Lecture 12 Reconciliation Companies Cash Flow Analysis Audit (Ch.6) (Ch.19) (Ch.26 & 27) (Ch.28) (Ch.29) Homework Good review of the content of this lecture Attempt tutorial questions on time Thanks for your listening