Accounting Awareness

7/31/2019 Accounting Awareness

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Finance for non-Finance Executives

The Concept of Responsibility Centres

Functional Classification

1. Investment centers

2. Cost centers

3. Revenue centers

4. Profit centers

The Principles for Responsible Investment will contribute to improved corporate

performance on environmental, social and governance issues.

Financial Responsibility

1. Become knowledgeable of, and follow, applicable financial standards andrequirements.

2. Apply sound financial practices and ensure transparency in financial dealings.

3. Actively promote and practice responsible financial behavior throughout thesupply chain.

Financial Statements

Financial statements provide information of value to company officials as well as to

various outsiders, such as investors and lenders of funds. Publicly owned companies are

required to periodically publish general-purpose financial statements that include a

balance sheet, an income statement, and a statement of cash flows. Some companies

also issue a statement of stockholders' equity and a statement of comprehensive income,

which provide additional detail on changes in the equity section of the balance sheet.

Financial statements provide an overview of a business' financial condition in both short

and long term. There are four basic financial statements :

1. Balance sheet : also referred to as statement of financial position or condition,reports on a company's assets, liabilities and net equity as of a given point intime.

2. Income statement : also referred to as Profit and Loss statement (or a "P&L"),

reports on a company's results of operations over a period of time.3. Statement of retained earnings : explains the changes in a company's retained

earnings over the reporting period.

4. Statement of cash flows : reports on a company's cash flow activities, particularlyits operating, investing and financing activities.

For large corporations, these statements are often complex and may include an extensive

set of notes to the financial statements and management discussion and analysis. The


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notes typically describe each item on the balance sheet, income statement and cash flow

statement in further detail. Notes to financial statements are considered an integral part

of the financial statements.

Purpose of financial statements

"The objective of financial statements is to provide information about the financial

strength, performance and changes in financial position of an enterprise that is useful to

a wide range of users in making economic decisions." [2] Financial statements should be

understandable, relevant, reliable and comparable. Reported assets, liabilities and equity

are directly related to an organization's financial position. Reported income and expenses

are directly related to an organization's financial performance.

Financial statements are intended to be understandable by readers who have "a

reasonable knowledge of business and economic activities and accounting and who arewilling to study the information diligently."

1. Owners and Managers require financial statements to make important business

decisions that affect its continued operations. Financial analysis are then performed on

these statements to provide management with a more detailed understanding of the

figures. These statements are also used as part of management's report to its

stockholders, as it form part of its Annual Report.

2. Employees also need these reports in making collective bargaining agreements (CBA)

with the management, in the case of labor unions or for individuals in discussing their

compensation, promotion and rankings.

3. External Users are potential investors, banks, government agencies and other parties

who are outside the business but need financial information about the business for a

diverse number of reasons. Prospective Investors make use of financial statements to

assess the viability of investing in a business. Financial analyses are often used by

investors and is prepared by professionals (financial analysts), thus providing them with

the basis in making investment decisions.

4. Financial Institutions (banks and other lending companies) use them todecidewhether to grant a company with fresh working capital or extend debt securities

(such as a long-term bank loan or debentures) to finance expansion and other

significant expenditures.

5. Government Entities (tax authorities) need financial statements toascertain the


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propriety and accuracy of taxes and other duties declared and paid by a company.

6. Media and the General Public are also interested in financial statements fora

variety of reasons.

Financial statements include notes, which are considered an integral part of the

statements. The notes contain required disclosures of additional data, assumptions and

methodologies employed, and other information deemed useful to users.

The financial statements of publicly owned companies also include an auditor's report,

indicating that the statements have been audited by independent auditors. The auditor's

opinion is related to fair presentation in conformity with GAAP.

The external financial statements required for not-for-profit organizations are similar to

those for business enterprises, except that there is no ownership component (equity) and

no income. Not-for-profit organizations present a statement of financial position, a

statement of activities, and a statement of cash flows. The financial statements must

classify the organization's net assets and its revenues, expenses, gains, and losses based

on the existence or absence of donor-imposed restrictions.

Each of three classes of net assetspermanently restricted, temporarily restricted, and

unrestrictedmust be displayed in the statement of financial position, and the amounts

of change in each of those classes of net assets must be displayed in the statement of

activities. Governmental bodies, which are guided by the Governmental Accounting

Standards Board (GASB), present general-purpose external financial statements that are

similar to those of other not-for-profit organizations, but they classify their financial

statements according to fund entities.

Government financial statements

The rules for the recording, measurement and presentation of government financial

statements may be different from those required for business and even for non-profitorganizations. They may use either of two accounting methods: accrual accounting, or

cash accounting, or a combination of the two. A complete set of chart of accounts is also

used that is substantially different from the chart of a profit-oriented business.

1. Audit and legal implications


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Although the legal statutes may differ from country to country, an audit of financial

statements are usually, but not exclusively required for investment, financing, and tax

purposes. These are usually performed by independent accountants or auditing firms.

Results of the audit are summarized in an audit report that either provide an unqualified

opinion on the financial statements or qualifications as to its fairness and accuracy. The

audit opinion on the financial statements is usually included in the annual report.

There has been much legal debate over who an auditor is liable to. Since audit reports

tend to be addressed to the current shareholders, it is commonly thought that they owe a

legal duty of care to them. But this may not be the case as determined by common law

precedent. In Canada, auditors are liable only to investors using a prospectus to buy

shares in the primary market. In the United Kingdom, they have been held liable to

potential investors when the auditor was aware of the potential investor and how they

would use the information in the financial statements. Nowadays auditors tend to includein their report liability restricting language, discouraging anyone other than the

addressees of their report from relying on it. Liability is an important issue: in the UK, for

example, auditors have unlimited liability.

In the United States, especially in the post-Enron era there has been substantial concern

about the accuracy of financial statements. Corporate officers (the chief executive officer

(CEO) and chief financial officer (CFO)) are personally liable for attesting that financial

statements "do not contain any untrue statement of a material fact or omit to state a

material fact necessary to make the statements made, in light of the circumstances under

which such statements were made, not misleading with respect to the period covered by

th[e] report". Making or certifying misleading financial statements exposes the people

involved to substantial civil and criminal liability. For example Bernie Ebbers (former CEO

of WorldCom) was sentenced to 25 years in federal prison for allowing WorldCom's

revenues to be overstated by `11 billion over five years.

2. Standards and regulations

Different countries have developed their own accounting principles over time, making

international comparisons of companies difficult. To ensure uniformity and comparability

between financial statements prepared by different companies, a set of guidelines and

rules are used. Commonly referred to as Generally Accepted Accounting Principles

(GAAP), these set of guidelines provide the basis in the preparation of financial

statements.

Recently there has been a push towards standardizing accounting rules made by the


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International Accounting Standards Board ("IASB"). IASB develops International Financial

Reporting Standards that have been adopted by Australia, Canada and the European

Union (for publicly quoted companies only), are under consideration in South Africa and

other countries. The United States Federal Accounting Standards Board has made a

commitment to converge the U.S. GAAP and IFRS over time.

3. Inclusion in annual reports

To entice new investors, most public companies assemble their financial statements on

fine paper with pleasing graphics and photos in an annual report to shareholders,

attempting to capture the excitement and culture of the organization in a "marketing

brochure" of sorts. Usually the company's chief executive will write a letter to

shareholders, describing management's performance and the company's financial

highlights.

In the United States, prior to the advent of the internet, the annual report is considered

the most effective way for corporations to communicate with individual shareholders. Blue

chip companies went to great expense to produce and mail out attractive annual reports

to every shareholder. The annual report was often prepared in the style of a coffee table

book.

The Balance Sheet

The balance sheet, also known as the statement of financial position or condition,

presents the assets, liabilities, and owners' equity of the company at a specific point in

time.

The assets are the firm's resources, financial or nonfinancial, such as cash, receivables,

inventories, properties, and equipment. The total assets equal (balance) the sources of

funding for those resources: liabilities (external borrowings) and equity (owners'

contributions and earnings from firm operations).

The balance sheet is used by investors, creditors, and other decision makers to assess

the overall composition of resources, the constriction of external obligations, and the

firm's flexibility and ability to change to meet new requirements.

Firms frequently issue a separate statement of stockholders' equity to present certain


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changes in equity, rather than showing them on the face of the balance sheet. The

statement of stockholders' equity itemizes the changes in equity over the period covered,

including investments by owners and other capital contributions, earnings for the period,

and distributions to owners of earnings (dividends) or other capital.

Sometimes companies present a statement of changes in retained earnings rather than a

statement of stockholders' equity. The statement of changes in retained earnings, also

known as the statement of earned surplus, details only the changes in earned capital: the

net income and the dividends for the period. Then the changes in contributed capital

(stock issued, stock options, etc.) must be detailed on the balance sheet or in the notes

to the financial statements.

In financial accounting, a balance sheet or statement of financial position is a summary of

a persons or organization's assets, liabilities and Ownership equity on a specific date,

such as the end of its financial year. A balance sheet is often described as a snapshot of a

company's financial condition. Of the four basic financial statements, the balance sheet is

the only statement which applies to a single point in time.

A company balance sheet has three parts: assets, liabilities and shareholders' equity. The

main categories of assets are usually listed first and are followed by the liabilities. The

difference between the assets and the liabilities is known as the net assets or the net

worth of the company. According to the accounting equation, net worth must equal assets

minus liabilities.

Records of the values of each account or line in the balance sheet are usually maintained

using a system of accounting known as the double-entry bookkeeping system.

A business operating entirely in cash can measure its profits by withdrawing the entire

bank balance at the end of the period, plus any cash in hand. However, real businesses

are not paid immediately; they build up inventories of goods and they acquire buildings

and equipment. In other words: businesses have assets and so they can not, even if they

want to, immediately turn these into cash at the end of each period. Real businesses owe

money to suppliers and to tax authorities, and the proprietors do not withdraw all their

original capital and profits at the end of each period. In other words businesses also haveliabilities.

Types of balance sheets


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A balance sheet summarizes an organization or individual's asset, equity and liabilities at

a specific point in time. Individuals and small businesses tend to have simple balance

sheets. Larger businesses tend to have more complex balance sheets, and these are

presented in the organization's annual report. Large businesses also may prepare

balance sheets for segments of their businesses. A balance sheet is often presented

alongside one for a different point in time (typically the previous year) for comparison.

1. Personal balance sheet

A personal balance sheet lists current assets such as cash in checking accounts and

savings accounts, long-term assets such as common stock and real estate, current

liabilities such as loan debt and mortgage debt due or overdue, and long-term liabilities

such as mortgage and other loan debt. Securities and real estate values are listed at

market value rather than at historical cost or cost basis. Personal net worth is the

difference between an individual's total assets and total liabilities.

2. Small business balance sheet

Sample Small Business Balance SheetAssets Liabilities and Owners' Equity

Cash 16,600 Liabilities

Accounts Receivable 1,200 Notes Payable 30,000

Land 52,000 Accounts Payable 7,000

Building 36,000 Total liabilities 37,000

Tools and equipment 12,000 Owners' equity

Capital Stock 80,000

Retained Earnings 800

Total owners' equity 80,800

Total 117,800 Total 117,800

A small business balance sheet lists current assets such as cash, accounts receivable,

and inventory, fixed assets such as land, buildings, and equipment, intangible assets

such as patents, and liabilities such as accounts payable, accrued expenses, and long-

term debt. Contingent liabilities such as warranties are noted in the footnotes to the

balance sheet. The small business's equity is the difference between total assets and

total liabilities.

3. Corporate balance sheet structure

Guidelines for corporate balance sheets are given by the International Accounting

Standards Committee and numerous country-specific organizations. Balance sheet


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account names and usage depend on the organization's country and the type of

organization. Government organizations do not generally follow standards established for

individuals or businesses. If applicable to the business, summary values for the following

items should be included on the balance sheet.

Assets

Current Assets

1. inventories

2. accounts receivable

3. cash and cash equivalents

Long-term Assets

1. property, plant and equipment

2. investment property, such as real estate held for investment purposes

3. intangible assets

4. financial assets (excluding investments accounted for using the equitymethod, accounts receivables, and cash and cash equivalents)

5. investments accounted for using the equity method

6. biological assets , which are living plants or animals. Bearer biological assetsare plants or animals which bear agricultural produce for harvest, such asapple trees grown to produce apples and sheep raised to produce wool.

Liabilities

1. accounts payable2. provisions for warranties or court decisions

3. financial liabilities (excluding provisions and accounts payable), such aspromissory notes and corporate bonds

4. liabilities and assets for current tax

5. deferred tax liabilities and deferred tax assets

6. minority interest in equity

7. issued capital and reserves attributable to equity holders of the parentcompany

8. Equity

The net assets shown by the balance sheet equals the third part of the balance sheet,

which is known as the shareholders' equity. Formally, shareholders' equity is part of the

company's liabilities: they are funds "owing" to shareholders (after payment of all other

liabilities); usually, however, "liabilities" is used in the more restrictive sense of liabilities

excluding shareholders' equity. The balance of assets and liabilities (including

shareholders' equity) is not a coincidence. Records of the values of each account in the


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balance sheet are maintained using a system of accounting known as double-entry

bookkeeping. In this sense, shareholders' equity by construction must equal assets minus

liabilities, and are a residual.

1. numbers of shares authorised, issued and fully paid, issued but not fully paid

2. par value of shares

3. reconciliation of shares outstanding at the beginning and end of period

4. description of rights, preferences, and restrictions of shares

5. treasury shares , including shares held by subsidiaries and associates

6. shares reserved for issuance under options and contracts

7. a description of the nature and purpose of each reserve within owners' equity

In accounting, a current asset is an asset on the balance sheet which is expected to be

sold or otherwise used up in the near future, usually within one year, or one business

cycle - whichever is longer. Typical current assets include cash, cash equivalents,

accounts receivable, inventory, the portion of prepaid accounts which will be used within

a year, and short-term investments.

On the balance sheet, assets will typically be classified into current assets and long-term

assets.

The current ratio is calculated by dividing total current assets by total current liabilities. It

is frequently used as an indicator of a company's liquidity, its ability to meet short-term

obligations.

A Sample Balance Sheet Structure

The following balance sheet structure is just an example. It does not show all possible

kinds of assets, equity and liabilities, but it shows the most usual ones. Because it shows

goodwill, it could be a consolidated balance sheet. Monetary values are not shown,

summary (total) rows are missing as well.

Balance Sheet of XYZ, Ltd. as of 31 December 2006

ASSETS

Current Assets

1. Cash and cash equivalents

2. Accounts receivable (debtors)

3. Inventories


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4. Prepaid Expenses

5. Investments held for trading

6. Other current assets

Fixed Assets (Non-Current Assets)

1. Property, plant and equipment2. Less : Accumulated Depreciation

3. Goodwill

4. Other intangible fixed assets

5. Investments in associates

6. Deferred tax assets

LIABILITIES and EQUITY

Creditors: amounts falling due within one year (Current Liabilities)

1. Accounts payable

2. Current income tax liabilities

3. Current portion of bank loans payable

4. Short-term provisions

5. Other current liabilities

Creditors: amounts falling due after one year (Long-Term Liabilities)

1. Bank loans

2. Issued debt securities

3. Deferred tax liability

4. Provisions

5. Minority interest

Equity

1. Share capital

2. Capital reserves

3. Revaluation reserve

4. Translation reserve

5. Retained profit


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Constructing a balance sheet

Case Study

1.1 A new business starts up as a limited liability company called Sunrise Ltd by raising

`10,000 from the owners i.e. share holders. The money is put into a new bank account.

What would the assets, liabilities and equity be?

Assets :Bank Balance 10,000

Equity & Liabilities:Share Capital 10,000

1.2 They then use 6,000 of its bank account to buy a delivery van. Assets and liabilities

after this transaction:

Assets :Bank Balance 4,000Delivery Van 6,000

Equity & Liabilities :Share Capital 10,000

1.3

Sunrise Ltd then buys some inventory at 3,000 on credit. Assets and liabilities after thistransaction:

Assets :Bank Balance 4,000

Delivery Van 6,000Inventory 3,000

Liabilities:Accounts Payable 3,000 (to be paid to creditors)

Equity:Share Capital 10,000

Total assets must always equal total liabilities (and equity). This is inevitable, as liabilities(and equity) provide the funds that are spent on these assets.


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1.4

Shortly afterwards, after selling 1,000 of inventory for 2,500, payment of 2,600 of theaccounts payable and the purchase of 2,200 of machinery financed by a 2,200 bank loan,the assets and liabilities change to the following:

SunriseLtd.

Balance Sheet

As of December 31, 2005

Assets

Current assets

Bank balance 1,400

Inventory 2,000

Accounts receivable 2,500Total current assets 5,900

Fixed assetsDelivery van 6,000

Machinery 2,200Total fixed assets 8,200

Total assets 14,100

Liabilities and stockholders' equity

Current liabilities

Accounts payable 400

Long-term liabilities

Loans payable 2,200

Total liabilities 2,600

Stockholders' equity

Share capital 10,000

Retained earnings 1,500

Total stockholders' equity (Net worth) 11,500

Total liabilities and stockholders' equity 14,100

Points to note:

Must be headed with the name of the reporting entity (e.g., Sunrise Ltd.) and thedate.

The van has not been depreciated and there are no other trading expenses.

The terms 'Current Liability' and 'Long-Term Liability' are the traditional namespossibly used by sole traders or partnerships. Limited companies may use thephrases 'Liabilities: Amounts falling due within 1 year' and 'Liabilities: Amountsfalling due after 1 year'.

The Total Equity may also be called the 'Net Worth'.

The Net Worth is in principle what the company is worth; it shows the monetaryamount that would effectively be left if all assets were sold and all liabilities paidoff.


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Accounts receivable

Accounts receivable is one of a series of accounting transactions dealing with the billing of

customers who owe money to a person, company or organization for goods and services

that have been provided to the customer. In most business entities this is typically done

by generating an invoice and mailing or electronically delivering it to the customer, who

in turn must pay it within an established timeframe called credit or payment terms.

An example of a common payment term is Net30, meaning payment is due in the amount

of the invoice 30 days from the date of invoice. Other common payment terms include

Net45 & Net60 but could in reality be for any time period agreed upon by the vendor and

client.

While booking a receivable is accomplished by a simple accounting transaction, theprocess of maintaining and collecting payments on the accounts receivable subsidiary

account balances can be a full time proposition. Depending on the industry in practice,

accounts receivable payments can be received up to 10 - 15 days after the due date has

been reached. These types of payment practices are sometimes developed by industry

standards, corporate policy, or because of the financial condition of the client.

On a company's balance sheet, accounts receivable is the amount that customers owe to

that company. Sometimes called trade receivables, they are classified as current assets.To record a journal entry for a sale on account, one must debit a receivable and credit a

revenue account. When the customer pays off their accounts, one debits cash and credits

the receivable in the journal entry. The ending balance on the trial balance sheet for

accounts receivable is always debit.

Business organizations which have become too large to perform such tasks by hand (or

small ones that could but prefer not to do them by hand) will generally use accounting

software on a computer to perform this task.

Associated accounting issues include recognizing accounts receivable, valuing accounts

receivable, and disposing of accounts receivable.

Accounts receivable departments use the sales ledger.

Other types of accounting transactions include accounts payable, payroll, and trial

balance.


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Since not all customer debts will be collected, businesses typically record an allowance for

bad debts which is subtracted from total accounts receivable. When accounts receivable

are not paid, some companies turn them over to third party collection agencies or

collection attorneys who will attempt to recover the debt via negotiating payment plans,

settlement offers or legal action.

Outstanding advances are part of accounts receivables : If a company gets an order from

its customers with advance agreed in payment terms. Since no billing is being done to

claim the advances several times this area of collectible is not reflected in Accounts

Receivables.

Ideally, since advance payment is mutually agreed term, it is the responsibility of the

accounts department to take out periodically the statement showing advance collectible

and should be provided to sales & marketing for collection of advances. The payment of

accounts receivable can be protected either by a letter of credit or by Trade Credit

Insurance.

Companies can use their accounts receivable as collateral when obtaining a loan (Asset-

based lending) or sell them through Factoring (finance). Pools or portfolios of accounts

receivable can be sold in the capital markets through a Securitization.

Cash and cash equivalents are the most liquid assets found within the asset portion of a

company's balance sheet. Cash equivalents are assets that are readily convertible intocash, such as money market holdings, short-term government bonds or Treasury bills,

marketable securities and commercial paper. Cash equivalents are distinguished from

other investments through their short-term existence; they mature within 3 months

whereas short-term investments are 12 months or less, and long-term investments are

any investments that mature in excess of 12 months.

"Cash and cash equivalents", when used in the context of payments and payments

transactions refer to currency, coins, money orders, paper checks, and stored value

poducts such as gift certificates and gift cards.


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Income Statement or Profit and Loss Statement (P&L)

An Income Statement, also called a Profit and Loss Statement (P&L), is a financial

statement for companies that indicates how Revenue (money received from the sale of

products and services before expenses are taken out, also known as the "top line") is

transformed into net income (the result after all revenues and expenses have been

accounted for, also known as the "bottom line"). The purpose of the income statement is

to show managers and investors whether the company made or lost money during the

period being reported.

Charitable organizations that are required to publish financial statements do not produce

an income statement. Instead, they produce a similar statement that reflects the fact

that the charity is not operating to make a profit.

Revenue - Cash inflows or other enhancements of assets of an entity duringa

period from delivering or producing goods, rendering services, or other activities

that constitute the entity's ongoing major operations. Usually presented as sales

minus sales discounts, returns, and allowances.

Expenses - Cash outflows or other using-up of assets or incurrence of liabilities

during a period from delivering or producing goods, rendering services, or

carrying out other activities that constitute the entity's ongoing

major operations.

o General and administrative expenses (G & A) - represent expenses to manage thebusiness (officer salaries, legal and professional fees, utilities, insurance,

depreciation of office building and equipment, stationery, supplies)

o Selling expenses - represent expenses needed to sell products (e.g., sales salaries

and commissions, advertising, freight, shipping, depreciation of sales

equipment)

o R & D expenses - represent expenses included in research and development

o Depreciation- is the charge for a specific period (i.e. year, accountingperiod) with

respect to fixed assets that have been capitalised on the balance sheet.


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Non-operating section

Other revenues or gains - revenues and gains from other than primary business

activities (e.g. rent, patents). It also includes unusual gains and losses that are either

unusual or infrequent, but not both (e.g. sale of securities or fixed assets).

Other expenses or losses - expenses or losses not related to primarybusiness

operations.

Irregular items

They are reported separately because this way users can better predict future cash flows

- irregular items most likely won't happen next year. These are reported net of taxes.

Discontinued operations is the most common type of irregular items. Shifting

business location, stopping production temporarily, or changes due to technological

improvement do not qualify as discontinued operations.

Extraordinary items are both unusual (abnormal) and infrequent, for example,

unexpected nature disaster, expropriation, prohibitions under new regulations. Note:

natural disaster might not qualify depending on location (e.g. frost damage would not

qualify in Canada but would in the tropics).

Changes in accounting principle is, for example, deciding to depreciate an

investment property that has previously not been depreciated. However, changes in

estimates (e.g. estimated useful life of a fixed asset) do not qualify.

Earnings per share

Because of its importance, earnings per share (EPS) are required to be disclosed on the

face of the income statement. A company which reports any of the irregular items must

also report EPS for these items either in the statement or in the notes. There are two

forms of EPS reported:

Basic: in this case "weighted average of shares outstanding" includes only actualstocks outstanding.

Diluted: in this case "weighted average of shares outstanding" is calculated as if

all stock options, warrants, convertible bonds, and other securities that could be

transformed into shares are transformed. This increases the number of shares

and so EPS decreases. Diluted EPS is considered to be a more reliable way to

measure EPS.


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- INCOME STATEMENT BOND LLC - For the year ended DECEMBER 31 2007

Revenues: Rs.

GROSS PROFIT (including rental income)496,397

--------

Expenses:

ADVERTISING 6,300

INSURANCE 750

LEGAL & PROFESSIONAL SERVICES 1,575

RENT 13,000

UTILITIES 491

PRINTING, POSTAGE & STATIONERY 320

ENTERTAINMENT 5,550

LICENSES 632

BANK & CREDIT CARD FEES 144

BOOKKEEPING 3,350

EMPLOYEES 88,000

RENTAL MORTGAGES AND FEES 74,400

--------

TOTAL EXPENSES (194,512)

--------

NET INCOME 301,885

========


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Factoring is a word often misused synonymously with accounts receivable financing.

Factoring is afinancial transactionwhereby a business sells itsaccounts receivable (i.e.,

invoices) at a discount. Factoring differs from a bank loan in three main ways. First, the

emphasis is on the value of the receivables, not the firms credit worthiness. Secondly,

factoring is not a loan it is the purchase of an asset (the receivable). Finally, a bank

loan involves two parties whereas factoring involves three.

The three parties directly involved are: the seller, debtor, and the factor. The seller is

owed money (usually for work performed or goods sold) by the second party, the debtor.

The seller then sells one or more of its invoices at a discount to the third party, the

specialized financial organization (aka the factor) to obtain cash. The debtor then directly

pays the factor the full value of the invoice

Depreciation

Depreciation - is the charge for a specific period (i.e. year, accounting period) with

respect to fixed assets that have been capitalised on the balance sheet

Depreciation is simply put to be the expense generated by the use of an asset. It is the

wear and tear of an asset or diminution in the historical value owing to usage. Further to

this; it is the cost of the asset less any salvage value over its estimated useful life. It is

an expense because it is matched against the revenue generated through the use of the

same asset. Depreciation is usually spread over the economic useful life of an asset

because it is regarded as the cost of an asset absorbed over its useful life. Invariably the

depreciation expense is charged against the revenue generated through the use of the

asset. The method of depreciation to be adopted is best left for the management to

decide in consideration to the peculiarity of the business, prevailing economic condition of

the assets and existing accounting guideline and principles as implied in the

organizational policies.

The primary objective of a business entity is to make profit and increase the wealth of itsowners. In the attainment of this objective it is required that the management will

exercise due care and diligence in applying the basic accounting concept of Matching

Concept. Matching concept is simply matching the expenses of a period against the

revenues of the same period.

Generally, the use of assets in the generation of revenue is usually more than a year-


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that is long term. It is therefore obligatory that in order to accurately determine the net

income or profit for a period depreciation is charged on the total value of asset that

contributed to the revenue for the period in consideration and charge against the same

revenue of the same period. This is essential in the prudent reporting of the net revenue

for the entity in the period.

Net book value of an asset is basically the difference between the historical cost of that

asset and it associated depreciation. From the foregoing, it is apparent that in order to

report a true and fair position of the financial jurisprudence of an entity it is relatable to

record and report the value of fixed assets at its net book value. Apart from the fact that

it is enshrined in Standard Accounting Statement (SAS) 3 and IAS 16 that value of asset

should be carry at the net book value, it is the best way of consciously presenting the

value of assets to the owners of the business and potential investor.

Equity method

Equity method in accounting is the process of treating equity investments, usually 20

50%, in associate companies. The investor keeps such equities as an asset. Proportional

part of associate company's net income increases the investment, and payment of

dividends decreases it. The ownership of more than 50% of voting stock creates a

subsidiary. Its financial statements consolidate into the parents' ones.

Another type of account is the cost method, which keeps the value of the investment insubsidiary account at historic book value.


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Cash flow statement

Statement of Cash Flow - Simple Example

for the period 12/31/2005 to 12/31/2006

Cash flow from operations 4,000

Cash flow from investing 1,000

Cash flow from financing 2,000

Net increase (decrease) in cash 1,000

In financial accounting, a cash flow statement or statement of cash flows is a

financial statement that shows a company's incoming and outgoing money (sources and

uses of cash) during a time period (often monthly or quarterly). The statement shows

how changes in balance sheet and income accounts affected cash and cash equivalents,

and breaks the analysis down according to operating, investing, and financing

activities. As an analytical tool thestatement of cash flows is useful in determining the

short-term viability of a company, particularly its ability to pay bills. International

Accounting Standard 7 (IAS 7), is the International Accounting Standard that deals with

cash flow statements.

People and groups interested in cash flow statements include

accounting personnel, who need to know whether the organization will be able to

cover payroll and other immediate expenses

potential lenders or creditors, who want a clear picture of a company's ability to

repay

potential investors, who need to judge whether the company is financially

sound

potential employees or contractors, who need to know whether the company will

be able to afford compensation


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Purpose

The cash flow statement was previously known as the statement of changes in financial

position or flow of funds statement. The cash flow statement reflects a firm's liquidity or

solvency.

The balance sheet is a snapshot of a firm's financial resources and obligations at a single

point in time, and the income statement summarizes a firm's financial transactions over

an interval of time. These two financial statements reflect the accrual basis accounting

used by firms to match revenues with the expenses associated with generating those

revenues.

The cash flow statement includes only inflows and outflows of cash and cash equivalents;

it excludes transactions that do not directly affect cash receipts and payments. These

noncash transactions include depreciation and write-offs on bad debts. The cash flow

statement is a cash basis report on three types of financial activities: operating activities,

investing activities, and financing activities. Noncash activities are usually reported in

footnotes.

The cash flow statement is intended to

1. provide information on a firm's liquidity and solvency and its ability to change

cash flows in future circumstances

2. provide additional information for evaluating changes in assets, liabilities and

equity

3. improve the comparability of different firms' operating performance by eliminating

the effects of different accounting methods

4. indicate the amount, timing and probability of future cash flows

The cash flow statement has been adopted as a standard financial statement because it

eliminates allocations which might be derived from different accounting methods, such as

various timeframes for depreciating fixed assets.


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History and variations

Cash basis financial statements were common before accrual basis financial statements.

The "flow of funds" statements of the past were cash flow statements.

The Financial Accounting Standards Board (FASB) defined rules that made it mandatory

under Generally Accepted Accounting Principles (US GAAP) to report sources and uses of

funds, but the definition of "funds" was not clear.

"Net working capital" might be cash or might be the difference between current liabilities

and current assets. From the late 1970 to the mid-1980s, the FASB discussed the

usefulness of predicting future cash flows. In 1987, FASB Statement No. 95 (FAS 95)

mandated that firms provide cash flow statements.

In 1992, the International Accounting Standards Board issued International Accounting

Standard 7 (IAS 7), Cash Flow Statements, which became effective in 1994, mandating

that firms provide cash flow statements.

Cash flow activities

The cash flow statement is partitioned into cash flow resulting from operating activities,

cash flow resulting from investing activities, and cash flow resulting from financingactivities.

Operating activities

Operating activities include the production, sales and delivery of the company's product

as well as collecting payment from its customers. This could include purchasing raw

materials, building inventory, advertising and shipping the product.

Under IAS 7, operating cash flows include

receipts from the sale of goods or services

receipts for the sale of loans, debt or equity instruments in a trading portfolio

interest received on loans

dividends received on equity securities

payments to suppliers for goods and services


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payments to employees or on behalf of employees

tax payments

interest payments (alternatively, this can be reported under financing activities in

IAS 7, but not in GAAP)

payments for the sale of loans, debt or equity instruments in a trading portfolio

Items which are added back to the net income figure (which is found on the Income

Statement) to arrive at cash flows from operations generally include:

Depreciation (loss of tangible asset value over time)

Deferred tax

Amortization (loss of intangible asset value over time)

Any gains or losses associated with an asset sale (unrealized gains/losses are also

added back from the income statement)

Investing activities

Investing activities focus on the purchase of the long-term assets a company needs in

order to make and sell its products, and the selling of any long-term assets.

Under IAS 7, investing cash flows include

collections on loan principal and sales of other firms' debt instruments

investment returns from other firms' equity instruments, including sale of those

instruments

receipts from sale of plant and equipment

expenditure for purchase of plant and equipment

loans made and acquisition of other firms' debt instruments

expenditure for purchase of other firms' equity instruments (unless held for

trading or considered cash equivalents)

Items under investing activities include:

Capital expenditures, which include purchases (and sales) of property, plant and

equipment


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Investments

Financing activities

Financing activities include the inflow of cash from investors such as banks and

shareholders, as well as the outflow of cash to shareholders as dividends as the company

generates income. Other activities which impact the long-term liabilities and equity of the

company are also listed in the financing activities section of the cash flow statement.

Under IAS 7, financing cash flows include

proceeds from issuing shares

proceeds from issuing short-term or long-term debt

payments of dividends

payments for repurchase of company shares

repayment of debt principal, including capital leases

for non-profit organizations, receipts of donor-restricted cash that is limited to long-

term purposes

Items under the financing activities section include:

Dividends paid

Sale or repurchase of the company's stock

Net borrowings

Disclosure of noncash activities

Under IAS 7, noncash investing and financing activities are disclosed in footnotes to the

financial statements. Under GAAP, noncash activities may be disclosed in a footnote or

within the cash flow statement itself. Noncash financing activities may include

leasing to purchase an asset

converting debt to equity

exchanging noncash assets or liabilities for other noncash assets or liabilities

issuing shares in exchange for assets

Preparation methods


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The direct method of preparing a cash flow statement results in a more easily understood

report. The indirect method is almost universally used, because FAS 95 requires a

supplementary report similar to the indirect method if a company chooses to use the

direct method.

Direct method

The direct method for creating a cash flow statement reports major classes of gross cash

receipts and payments. Under IAS 7, dividends received may be reported under operating

activities or under investing activities. If taxes paid are directly linked to operating

activities, they are reported under operating activities; if the taxes are directly linked to

investing activities or financing activities, they are reported under investing or financing

activities.


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Sample cash flow statement using the direct method

Cash flows from operating activities

Cash receipts from customers 27,500`

Cash paid to suppliers and employees (20,000)

Cash generated from operations (sum) 7,500

Interest paid (2,000)

Income taxes paid (2,000)

Net cash flows from operating activities 3,500`

Cash flows from investing activities

Proceeds from the sale of equipment 7,500

Dividends received 3,000

Net cash flows from investing activities 10,500

Cash flows from financing activities

Dividends paid (12,000)

Net cash flows used in financing activities (12,000)

.


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Net increase in cash and cash equivalents

2,000

Cash and cash equivalents, beginning of year 1,000

Cash and cash equivalents, end of year 3,000

`

Indirect method

The indirect method uses net-income as a starting point, makes adjustments for all

transactions for non-cash items, then adjusts for all cash-based transactions. An increase

in an asset account is subtracted from net income, and an increase in a liability account is

added back to net income. This method converts accrual-basis net income (loss) into

cash flow by using a series of additions and deductions.

Rules

The following rules are used to make adjustments for changes in current assets and

liabilities, operating items not providing or using cash and nonoperating items.

Decrease in noncash current assets are added to net income

Increase in noncash current asset are subtracted from net income

Increase in current liabilities are added to net income

Decrease in current liabilitiesare subtracted from net income

Expenses with no cash outflows are added back to net income

Revenues with no cash inflows are subtracted from net income (depreciation

expense is the only operating item that has no effect on cash flows in the period)

Nonoperating losses are added back to net income

Nonoperating gains are subtracted from net income


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Citigroup Incorporated cash flow example:

Citigroup Cash Flow Statement

(all numbers in thousands)

Period ending 12/31/2006 12/31/2005 12/31/2004

Net income 21,538,000 24,589,000 17,046,000

Operating activities, cash flows provided by or used in:

Depreciation and amortization 2,790,000 2,592,000 2,747,000

Adjustments to net income 4,617,000 621,000 2,910,000

Decrease (increase) in accounts receivable 12,503,000 17,236,000 --

Increase (decrease) in liabilities (A/P, taxes 131,622,000 19,822,000 37,856,000

payable)

Decrease (increase) in inventories -- -- --

Increase (decrease) in other operating activities (173,057,000) (33,061,000) (62,963,000)

Net cash flow from operating activities 13,000 31,799,000 (2,404,000)

Investing activities, cash flows provided by or used in:

Capital expenditures (4,035,000) (3,724,000) (3,011,000)

Investments (201,777,000) (71,710,000) (75,649,000)

Other cash flows from investing activities 1,606,000 17,009,000 (571,000)


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Net cash flows from investing activities(204,206,000) (58,425,000) (79,231,000)

Financing activities, cash flows provided by or used in:

Dividends paid (9,826,000) (9,188,000) (8,375,000)

Sale (repurchase) of stock (5,327,000) (12,090,000) 133,000

Increase (decrease) in debt 101,122,000 26,651,000 21,204,000

Other cash flows from financing activities 120,461,000 27,910,000 70,349,000

Net cash flows from financing activities 206,430,000 33,283,000 83,311,000

Effect of exchange rate changes 645,000 (1,840,000) 731,000

Net increase (decrease) in cash and cash 2,882,000 4,817,000 2,407,000

equivalents ` ` `


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Cost-Volume-Profit (CVP) Analysis

Analysis that deals with how profits and costs change with a change in volume. More

specifically, it looks at the effects on profits of changes in such factors as variable costs,

fixed costs, selling prices, volume, and mix of products sold. By studying the relationships

of costs, sales, and net income, management is better able to cope with many planning

decisions. For example, CVP analysis attempts to answer the following questions:

1) What sales volume is required to break even?

2) What sales volume is necessary in order to earn a desired (target) profit?

3) What profit can be expected on a given sales volume?

4) How would changes in selling price, variable costs, fixed costs, and output affect

profits?

5) How would a change in the mix of products sold affect the break-even and target

volume and profit potential?

Cost-volume-profit analysis (CVP), or break-even analysis, is used to compute the

volume level at which total revenues are equal to total costs. When total costs and total

revenues are equal, the business organization is said to be "breaking even." The analysis

is based on a set of linear equations for a straight line and the separation of variable and

fixed costs.

Total variable costs are considered to be those costs that vary as the production volume

changes. In a factory, production volume is considered to be the number of units

produced, but in a governmental organization with no assembly process, the units

produced might refer, for example, to the number of welfare cases processed.

There are a number of costs that vary or change, but if the variation is not due to volume

changes, it is not considered to be a variable cost. Examples of variable costs are direct

materials and direct labor. Total fixed costs do not vary as volume levels change within

the relevant range. Examples of fixed costs are straight-line depreciation and annual

insurance charges. Total variable costs can be viewed as a 45 line and total fixed costs as

a straight line. In the break-even chart shown in Figure 1, the upward slope of line DFC

represents the change in variable costs. Variable costs sit on top of fixed costs, line DE.


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Point F representsthe breakeven point. This is where the total cost (costs below the line

DFC) crosses and is equal to total revenues (line AFB).

All the lines in the chart are straight lines: Linearity is an underlying assumption of CVP

analysis. Although no one can be certain that costs are linear over the entire range of

output or production, this is an assumption of CVP. To help alleviate the limitations of this

assumption, it is also assumed that the linear relationships hold only within the relevant

range of production. The relevant range is represented by the high and low output points

that have been previously reached with past production. CVP analysis is best viewed

within the relevant range, that is, within our previous actual experience. Outside of that

range, costs may vary in a nonlinear manner. The straight-line equation for total cost is:

Total cost = total fixed cost + total variable cost

Total variable cost is calculated by multiplying the cost of a unit, which remains constant

on a per-unit basis, by the number of units produced. Therefore the total cost equation

could be expanded as:

Total cost = total fixed cost + (variable cost per unit number of units)

Total fixed costs do not change.

A final version of the equation is:

Y = a + bx

where a is the fixed cost, b is the variable cost per unit, x is the level of activity, and Y is

the total cost. Assume that the fixed costs are `5,000, the volume of units produced is

1,000, and the per-unit variable cost is `2. In that case the total cost would be computed

as follows:

Y = `5,000 + (`2 1,000) Y = `7,000

It can be seen that it is important to separate variable and fixed costs. Another reason it

is important to separate these costs is because variable costs are used to determine the

contribution margin, and the contribution margin is used to determine the break-even

point. The contribution margin is the difference between the per-unit variable cost and

the selling price per unit.

Accounting Awareness

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