Post on 28-Dec-2015
FINANCIAL ACCOUNTING
Introduction
Financial Statements
Financial Accounting - Introduction
Today we want to:
Get to know each otherDiscuss the nature of accountingRevise the financial statements
Financial Accounting - Introduction
Getting to know each other
A little bit about myself A little bit about you What is the purpose of this
course
Financial Accounting - Introduction
About myself… Italian Many interests/hobby
Professor of accounting
Financial Accounting - Introduction
About you
Why are you doing an MBA?
Financial Accounting - Introduction
About the course
You are not going to become a professional accountant!
But, I hope, you will be able to Understand accounting issues Deal with accountants and accounting
information Use accounting information to make
decisions
The book and its website
Very recent book Plenty of supplementary material http://www.mhhe.com/libby6e
Financial Accounting - Introduction
Practicalities
The PDA Store– Annual report to be handed in after session 14
Quizzes– Voluntary– They can HELP you– They can NOT HURT you
Feedback
Financial Accounting - Introduction
Financial Accounting - Introduction
A “simple” question
What is accounting?
A possible definition
Can't you see?It all makes perfect senseExpressed in dollars and cents,Pounds, shillings and pence
(by R. Waters, “Amused to death”) We wish it was true…..
Financial Accounting - Introduction
Financial Accounting - Introduction
McKinsey’s typology of jobs “Transformational”: extracting raw materials or
converting them into finished goods– traditional– declining
“Transactional”: interactions that can easily be scripted or automated
“Tacit”: complex interactions requiring a high level of judgment – Fastest increasing category
Talent: the ability to solve complex problems or invent new solutions (The Economist, October 7th 2006)– The most looked after ability for tacit jobs
Financial Accounting - Introduction
Our challenge for this course
Approach accounting as a “tacit” job Learn how to use your “talent” to make
the best use of the accounting system in business life
Accounting can be “fun”! Accounting as the transformation of raw
data into information.
Financial Accounting - Introduction
From “The Economist”
Accounting precision is an elusive goal. A company’s earnings measured under American accounting rules, for example, can be twice as high as under British rules, without any bending at at all.” (9th of March 2002, “A survey on Management”)
Financial Accounting - Introduction
Learning from the masters…
The mechanic of accounting is the double-entry system of recording transactions
Double-entry was systematized by an Italian monk: Fra Pacioli at the end of the 15th century.
Let us learn from him the basics of the system…….(video)
From the video
Which accounting issues are brought up in the video?
Double-entry mechanicsCash vs accrualValue of (intangible assets)
Financial Accounting - Introduction
Financial statements:
an introduction
Financial Accounting - Introduction
Financial statements The objective of general purpose financial
statements is to provide information about the financial position, performance and cash flows of an enterprise that is useful to a wide range of users in making economic decisions.
They provide information about and enterprise's:– Assets– Liabilities– Equity– Income and expenses– Cash flows
Financial Accounting - Introduction
Information provided by financial statements
What cash movements took place over a particular period?
Balance sheet (B/S)
Income statement (I/S)
Cash flow statement
How much wealth was generated by the enterprise over a particular period?
What is the accumulated wealth of the enterprise at the end of a particular period?
Financial Accounting - Introduction
Financial statements: ExampleFirst day
Luca decides to sell his high school books
Luca begins his enterprise with € 300 worth of books
On the first day of trading, he sells 2/3 of the books for € 250
Financial Accounting - Introduction
Example: first day
What cash movements took place on the first day of trading?
How much wealth (profit) was generated by the enterprise on the first day of trading?
What is the accumulated wealth at the end of the first day?
Financial Accounting - Introduction
Day 1: Luca’s cash flow
What cash movements took placeon the first day of trading?
Opening balance (cash introduced) € 0Proceeds from the sale of books € 250Closing balance € 250
Financial Accounting - Introduction
Day 1: Luca’s income statement
How much wealth (profit) wasgenerated by the enterprise on the
first day of trading?
Sales € 250Cost of sales (2/3 of € 300) € 200Profit € 50
Financial Accounting - Introduction
Day 1: Luca’s balance sheet
What is the accumulatedwealth at the end of the first day?
Cash (closing balance) € 250Books left for resale (i.e. inventory) € 100Total enterprise wealth € 350
Financial Accounting - Introduction
Financial statements: Examplesecond day
On the second day of trading Luca sells the rest of his high school books for € 110.
Financial Accounting - Introduction
Example 1: second day
What cash movements took place on the second day of trading?
How much wealth (profit) was generated by the enterprise on the second day of trading?
What is the accumulated wealth at the end of the second day?
Financial Accounting - Introduction
Day 2: Luca’s cash flow
What cash movements took placeon the second day of trading?
Opening balance (from day 1) € 250Proceeds from sale of books € 110Closing balance € 360
Financial Accounting - Introduction
Day 2: Luca’s income statement
How much wealth (profit) wasgenerated by the enterprise on the
second day of trading?
Sales € 110Cost of sales (1/3 of 300) € 100Profit € 10
Financial Accounting - Introduction
Day 2: Luca’s balance sheet
What is the accumulated wealthat the end of the second day?
Cash (closing balance) € 360Books left for resale € 0Total enterprise wealth € 360
Financial Accounting - Introduction
Balance sheet and income statement What is the initial wealth of the enterprise (Luca)?
All the high school books = € 300
What is the final wealth of the enterprise (Luca)?The cash accumulated = € 360
What is the wealth generated in the two days? Two ways of answering
– Final wealth – initial wealth = € 360 - € 300 = € 60– Income day 1 + Income day 2 = € 50 + € 10 = €60– They are the same!– This is not a coincidence!
Financial Accounting - Introduction
B/S, I/S and CF statement
Begin. day 1 End of day 1 End of day 2
I/S day 1Wealth
300
BalanceSheet
I/S day 1
BalanceSheet
Wealth
350
BalanceSheet
Wealth
360
Cash flow day 1
Cash flowday 2
Cash
0
Cash
250
Cash
360
Profit = 50 Profit = 10
Cash increase = 250 Cash increase = 110
Cash flow logic
Accrual logic
Different!
Financial Accounting - Introduction
Remember the accrual principle?The effects of transactions and other events are
recognised when they occur (and not as cash or its equivalent is received or paid) and they are recorded in the accounting books and reported in the financial statements of the periods to which they relate.
IASB FrameworkIn this example, cost is recognised (both in day 1 and day 2) even if no cash outflow takes place.
In accounting terms we are using inventory valued at fair value
Financial Accounting - Introduction
Cash flow vs Accrual (accounting) Accounting focuses on the economic effects
of transactions, not on the cash flow Classic examples where cash flow and
accrual logic do not coincide– Purchase of long lived pieces of equipment
(fixed assets)– Sale of goods and/or services on credit– Purchase of goods and/or services on credit
Balance sheet:
an overall view
Financial Accounting - Introduction
Purpose of a balance sheet To set out the financial position of an enterprise at
a given date, i.e. to report the ASSETS and
CLAIMS of an enterprise.
It is a status report rather than a flow report. The balance sheet has two counterbalancing
sections:– the left side lists assets which represent the resources of
an enterprise;– the right side lists liabilities and owners’ equity which
represent claims against those resources. Because the B/S shows the financial status at a
particular point in time, it is always dated.
Financial Accounting - Introduction
The balance sheet equation
Assets = Liabilities + Owners’ equity
Economic resources (future economic benefits) that are controlled by an enterprise and whose cost (or fair value) can be objectively measured
Present obligations of the enterprise arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits
Amount of finance owners have provided to the enterprise
The left and right sides of a balance sheet are always kept in balance:
Financial Accounting - Introduction
PUMA
Financial Accounting - Introduction
Luca’s balance sheetBeginning of day 1
Assets Liabilities + EquityHigh school books 300 Equity 300Total 300 Total Equity 300
When Luca start his business there is no cash movement
However he has decided to put his books on sale
This initial economic fact is registered by the accounting system in the balance sheet
Financial Accounting - Introduction
Luca’s balance sheetEnd of day 1
Assets Liabilities + EquityHigh school books 100 Equity 300Cash 250 Profit 50Total 350 Total Equity 350
Notice that Equity at the end (350) – Equity at the beginning (300) = Profit (50)
The books sold are eliminated from the B/S (300 – 200 = 100)
The cash received is included in the B/S (250) The profit gained (50) is re-invested in the business
and increases Luca’s wealth (equity)
Financial Accounting - Introduction
Luca’s balance sheetEnd of day 2Assets Liabilities + EquityHigh school books 0 Equity 300Cash 360 Profit 60Total 360 Total 360
The books sold are eliminated from the B/S (100 – 100 = 100)
Notice that Equity at the end (360) – Equity at the beginning (350) = Profit (10)
The cash received (110) is included in the B/S and added to the existing cash (250) to give the final value (360)
The profit gained (10) is re-invested in the business added to the existing (50) and increases Luca’s wealth (equity)
Financial Accounting - Introduction
Summing up Three main financial statements
– Balance sheet– Income Statement– Cash Flow statement
Accounting does not follow the cash logic, it follows the accrual logic
The balance sheet equation– Assets = Liabilities + Equity
How to prepare a very simple balance sheet