Week 2 the Accounting Equation and Analysis of Transactions

8/9/2019 Week 2 the Accounting Equation and Analysis of Transactions

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The accounting equation and the

analysis of transactionsBEA1007 Accounting II

Dr Petros Vourvachis

[email protected]

Ofice !"# 1.$%& hours'

(ri)a*s 11+1


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2

About today

Overview of the regulatory frameworkin the UK and of the development ofinternational accounting standards

Discussion of the accounting equation,with particular objectives to

! define the elements and theirrecognition requirements in financial

statements, and,! consider the effects of transactions onthe accounting equation


3/42

Many national dierences in

FA Reasonsfor differences in financial reporting include"but are not limited to#! $he character of the national legal "and ta%# system

! $he way in which industries are financed, which affects the

&relevance' of the provided information! $he e%istence of a strong accounting profession

! &(ccidents' of historye)g) scandals surrounding corporatefailures, colonisation, memberships of organisations such as*U

! +anguage $hese have considerable costsfor "particularly

international# companies

-eed for global standards ".U$ harmonisation vs)

standardisation/# 3


4/42

0egulatory framework is a key element to ensurerelevant and reliable financial reporting "i)e) meet userneeds#

1((2 includes all the rules, from whichever source,that govern accounting! +ocal or national legislation

! "3nter#national accounting standards

! 4tatutory requirementsin other countries "e)g) 4O5#

! 4tock e%change requirements! UK 1((2 vs) i1((2/

6ithout agreed regulatory body "i)e) 3(4.# andframework of principles "i)e) the 78# there is no way toenforce 1((2 compliance !room forcreativeaccounting!

Need for regulation

4


5/42

3t has been defined as9use:abuse of accountingtechniques:principles toachieve financial results

which, intentionally, donot provide a true andfair view;

&True and fair view' has

no official definitionmanagers should followthe rules to show fairlythe financial position andperformance

Creative accounting

5


6/42

( number of motivationsboost profits for personal

gain, manage gearing,

smooth profits, reduce ta%,

create reserves to be used inthe future, etc)

$here is a long history of

accounting scandals, which

have initiated a series of

accounting standard setting

bodies' responses

Creative accounting

6


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1*7:(*3 < 2ergamon 2ressscandals forced the professionin =>?>, via 37*(6, toannounce that there was apressing need for the formation

of a standard setting body)4ubsequently, (447 "=>@A#,

(47 "=>@?#, 44(2s etc) *nron and 6orld7om initiated

U4 4arbanesBO%ley (ct "CAAC#

! greater power to 4*7, andchanges to the 807, revisionson the 7ombined 7ode forcorporate governance etc)

6ays out accounting ethics/2rinciples vs) rules/

Creative accounting

7


8/42

8

Accounting scandals

are also evident in the natural world

! http::athensvoice)gr:article:videoBgallery:fun:E78

EFAE7*E.>E7*E.GE7*E.(E7*E.8E78EFHE7*E(8E7*E.DE7*E.8E78EFCBE7*

E.(E7*E..E7*E.HE78EF?E78EFIE78

EF=E78EF7E7*E.DE7*E.>


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Principles vs. rules

9

( principles-based system"such as theone adopted by 3(4.# works with acertain set of established principles! $he 78 provides the background of principles

within which standards can be developed, withthe aim to eliminate conflict

! (ny departure can be judged based on whetherit is consistent with 78 principles

( rules-based system"such as that of8(4.# regulates for issues as an whenthey arise ! uses many detailed standards

(dvantages and disadvantages in both
http://archive.iasb.org.uk/index.asphttp://archive.iasb.org.uk/index.asp


10/42

2rincipleBbased system have beenwith us for a while) 2rincipleBbased3804s are running ahead of 78

0ulesBbased system deals withissues that arise between reviews! the use of precise standardshowever makes it relatively easierto get around them

3(4. and 8(4. are working on ajoint 78 combining the twoapproaches! (im is 78 to be principlesBbased

and internationally converged

Principles vs. rules

10


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3ndependent, privatelyBfunded standard setting body"based in +ondon#

IASC Foundationis parent company of 3(4. "based inU4#

3(47 was established in =>@G and 3(4. assumedstandard setting responsibility from it in CAA=

Standards Advisory Council"now called 3804 advisorycouncil! http::www)ifrs)org:$heJorganisation:(dvisoryJbodies:$heJ4(7:

4tandardsJ(dvisoryJ7ouncil)htm# International Financial Reporting Interpretations

Committeereviews issues that could receive divergenttreatment! http::www)ifrs)org:owJweJdevelopJ3nterpretations:owJweJd

evelopJ3nterpretations)htm

history

11


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structure

12


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$he 3(47 issued 4 IASsas on = (pril CAA=

$heir successor, the 3(4. has issued IFRS

to date! http::www)iasb)org:3804s:3804)htm

Other current projectsinclude consolidation, fair

value measurement, emissions trading schemes

etc

! http::www)ifrs)org:7urrentJ2rojects:3(4.J2r

ojects:3(4.J6orkJ2lan)htm

and current standards

13


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=) ( needfor new standard is identified

C) 3(4. publishes discussion document

G) 7ommentand reviewprocess follows

I) 3(4. publishes e%posure draft "*D# -ational standard setters also publish *Ds and can vote on

3(4.'s preferred solution

H) 3(4. issues 3804

"http::www)ifrs)org:owJweJdevelopJstandards:owJweJde

velopJstandards)htm# ! could take a long time

setting

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4tandards reduce variations

2rovide focal point for debate

Obligedisclosure

+ess rigidthan legislation

Organisations disclose moreinformationthan they would otherwise

have done e)g) 3(4GG *24

pros

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= set of rules may be inappropriate !what if it has a fundamental flaw/

+obbyingstill e%istent) *)g) 8(4=> oiland gas was suspended

4ome national standards are not basedon 78) 3804 are! but how about developing 3804 and 78 at

the same time/

Lore rigidity less fle%ibility

cons

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ow do we get international consensus/! *)g) developing countriesbelieve 3(4. is dominated

by U4

UK:U4 model focuses on investor reporting,*uropean model of ta%

*urope still issues relevant directivesand U4and Mapan have been reluctantto accept 3804s,although joint projects with 3(4. have beenlaunched to achieve convergence! once convergence is achieved, who's going to be

responsible for issuing global accounting standards/17

political problems


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"#issue a number of relevantdirectives "e)g) I,@,F#

! (ll listed entities in *U states must use

3804 in their consolidated accounts from

=:=:CAAH) UK +tds may chose to adopt3804 or UK 804

#$7ommission and 7entre on

$ransnational 0eporting 7orporations

gather info re activities and reporting ofLultiBnational 7ompanies "L-7s#

"http::unctc)unctad)org:asp%:commissi

on$itle)asp%#

18

ther organisational in!uences


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International Federation of Accountants"38(7# is a private sector body establishedin =>@@ with over =AA professional bodies"www)ifac)org:#! (im is to issue international standards on

auditing, management accounting, ethics,education and training, e)g) 38(7 Code of Ethicsfor Professional Accountants"**@, p) =?H#

%"C&"www)O*7D)org# was established in=>?= and 9provides a setting wheregovernments compare policy e%periences,

seek answers to common problems,identify good practice and coordinatedomestic and international policies;)! (im is to achieve the highest sustainable

economic growth and employmentand a risingstandard of living in member countries whilemaintaining financial stability and, thus, to

contribute to world economy 19

ther organisational in!uences
http://www.oecd.org/home/0,3305,en_2649_201185_1_1_1_1_1,00.htmlhttp://www.ifac.org/http://www.ifac.org/


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Channel Setting Instructions

=) 2ress the 97h; or &1o' button

C) *nter the channel number

G) 2ress the 97h; or &1o' button

I) 2ress and release the N=:(N button)

$he light should flash amber to confirm)

20


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"et#s chec$ if it %or$s&

' (o you recognise this man)

*. +es

,. No"another not particularly interestingquestion 2etros#

21


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-n the /0 the level of disclosure in 1nancial statements

is primarily in!uenced by a combination of2

a3 accounting standardsb3 Financial 4ervices Authority listing rulesc3 employers# desires to give additional information to

their employeesd3 legislation0 such as the Companies Act *567

=) a#, b# and c#

C) a#, b# and d#

G) a# and b#

I) b# and d#


23/42

Arguments in favour of international accountingstandards include to2

a3 improve comparabilityb3 increase o%ners# interestc3 increase competition amongst auditorsd3 improve user con1dence in 1nancial information

=) a#, b# and c#

C) a#, b# and d#

G) b# and c#

I) a# and d#


24/42

8hich of the follo%ing bodies no% issue -nternational

Financial 9eporting 4tandards 2

a3 the -nternational Accounting 4tandards :oard ;-A4:3b3 the -nternational Accounting 4tandards Committee;-A4C3

c3 The -nternational Federation of Accountants ;-FAC3d3 The rganisation for


25/42

8hich of the follo%ing is a correct

statement of the accounting equation)

=) (ssets equals liability equals equity

C) (ssets equals liabilities minus equity

G) (ssets minus liabilities equals equity

I) (ssets plus liabilities equals equity


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26

The accounting equation is&

3t can be reBarranged so that Assets ' (iabilities )"*uity)$his highlights the fact that equity represents the residualinterest of the owners after deducting all liabilities of thebusiness)

(nd can further be e%panded when you distinguish acrosstypes of these elements "as reflected on the .alance sheet# $on current assets + current assets ' current liabilities ' non

current liabilities ) e*uity


27/42

8hich of the follo%ing does the -A4: regard as the

essential features of an asset)

a3 the item is acquired at a cost %hich can be reliablymeasuredb3 rights to future economic bene1ts from the item

must be legally enforceablec3 rights to future economic bene1ts from the itemmust be controlled by the entity

=) a# and c#

C) b# only

G) a#, b# and c#

I) b# and c#


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Assets2 de1nition and recognition

&a resource controlledby the entity as a result of pasteventsand from which future economic benefitsare

e%pected to flow to the entity'

! 7an we restrict access/! as an agreement or event taken place that has resulted in

the organisation obtaining control of the item/

! 6ill cash be generated in the future/

0ecognised if

! 3t is probablethat the future economic benefits will flow to the

entity, and,

! $he asset has a cost or value that can be measured reliably

7an be current or nonBcurrent)


29/42

8hich of the follo%ing possible descriptions of items

that appear in balance sheets are correct)

a3 Cash0 described as current assetb3 -nventory0 described as non'current assetc3


30/42

(lso termed Fi,ed assets, these are assets eld for

continuing usewithin the business, -O$ held for

immediate resale) $hey include

20O2*0$, 2+(-$ < *PU32L*-$ : $(-13.+* 835*D

(44*$4"e)g) land, buildings, machinery, equipment,

computers, fi%tures < fittings, motor vehicles#

835*D (44*$ 3-Q*4$L*-$4! a holding in the

securities of another organisation that is intended tocontinue rather than be sold

3-$(-13.+* 835*D (44*$4B "e)g) goodwill, brands,

research and development#

./

30

Non'current assets


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Assets not eld for continuing use, normally realised

within one year of the balance sheet date) $hey include

3-Q*-$O03*4 : 4$O7K4e)g) goods for resale, workin progress, raw materials

$0(D* 0*7*3Q(.+*4 : D*.$O04"amounts owing

from customers#

O$*0 0*7*3Q(.+*4 : 20*2(L*-$4"e%penses

already paid for the following period#

7(4 < 7(4 *PU3Q(+*-$4"held in bank accounts

< notes < coins# ! a slide on asset recognition

.

31

Current assets


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8hich of the follo%ing does the -A4: regard as the

essential features of a liability)

a3 the amount of obligation must be certainb3 the obligation must be legally enforceablec3 settlement of the obligation must involve an out!o%

of cashd3 the obligation must arise from past events

=) a# and b#

C) d# only

G) a# and d# only

I) c# and d#


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33

"iabilities2 de1nition andrecognition

&a present obligationof the entity arising from pastevents, the settlement of which is e%pected to result inan outflow from te entityof resources embodyingeconomic benefits'

! 3s there a legal obligation or any other as a result ofcommercial practice/

! 6ill cash or other resource leave the business/

0ecognised if

! 3t is probablethat an outflow of resources embodyingeconomic benefits will result from the settlement of a presentobligation, and,

! $he amount at which the settlement will take place can bemeasured reliably

7an be current or nonBcurrent)


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(lso termed Creditors0 amounts falling due witin one

year, and include

.(-K OQ*0D0(8$4

$0(D* 2((.+*4 : $0(D* 70*D3$O04B owing to

suppliers

O$*0 2((.+*4 : (770U*D *52*-4*4B not yet

invoiced

$(5 2((.+*

D3Q3D*-D4"declared but not yet paid to shareholders#20OQ343O-4"estimates of uncertain liabilities that are

thought likely to be paid#

.4

Current liabilities

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(lso termed Creditors0 amounts falling due in

more tan one year, and include

+O(-4B that are repayable in more than one yearfrom the balance sheet date

20OQ343O-4B for uncertain liabilities that are likely

to be paid in more than one year from the balance

sheet date

.1

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Non'currentliabilities


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(lso termed &Capital and reserves' or &%wnersip

interest') 4ometimes it includes nonBequity shares e)g)

preference shares, in addition to

4(0* 7(23$(+B the -OL3-(+ Q(+U* of shares

issued by the company since its formation

4(0* 20*L3ULB the amount received by a

company when issuing shares above nominal value

0*Q(+U($3O- 0*4*0Q*B arises when fi%edassets

are revalued to replacement cost or market value

0*$(3-*D *(0-3-14! accumulated profits

.2

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4ome e=amples of transactions

&and their eect on accounting equation2

Owner invests fundsin the business ("Jcash# R + J *"Jcapital#

.usiness borrows fundsfrom lender ( "Jcash# R + "Jloans# J *

.usiness buys inventory for cash ("J inventory ! cash# R + J *

.usiness buys inventory on credit

("J inventory# R +"J creditors# J * .usiness receives cashfrom a customer

("Jcash ! debtors# R + J *

Owner withdraws fundsfrom the business

("B cash# R + J *"B capital#


38/42

4unrise +td is set up in 4eptember CA=A, "=#raises 3////

from its shareholders and puts the money into a new bank

account) During the month it

56 #sesS?,AAA of its bank account to buy a delivery van

.6 7uysinventory for SG,AAA on credit agreeing to pay thesuppliers in October

46 Ta8es outa loan from the bank for S?,AAA to be repaid in

CA=H

16 Sellsgoods costing S=,AAA for SC,AAA on credit

26 7uysa computer for SHAA, paying by cheque

0equired

Demonstrate the effect of these transactions on accounting

equation and prepare a .alance 4heet as at GA:A>:CA=A)

.9

A simple e=ercise

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.

The accounting equation

No. Total Assets = Total Liabilities + Equity

Non-current

Assets

CurrentAssets

Non-current

liabilities

CurrentLiabiliti

es

Capital Prot

!. + !"#"""

$ban%&

+!"#""

"

'. +(#"""

$)an&

- (#"""

$ban%&*. +*#"""

$in)entory&

+*#"""

$creito

r&

,. +(#"""

$ban%&

+(#"""

$loan&

. -!#"""$in)entory&

+'#"""

$ebtor&

+!#"""

(. +""

$coput

er&

-"" $ban%&

Tota ( "" !* "" ( """ * """ !" """ ! """

39

h l h ; 3


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4/

The :alance 4heet ;-3

Sunrise Lt

/alance sheet as at *" Septeber '"!">

Non-current assetsProperty0 Plant and


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4

The :alance 4heet ;--3

Current liabilities

Trade and other payables $*#"""&

Current ta= payable $-&

Total current liabilities $*#"""&

Non-current liabilities

"ong'term borro%ings $(#"""&ther provisions $-&

Total non-current liabilities $(#"""&

Total liabilities $0#"""&

Net assets !!#"""

Equity

4hare capital !"#"""

9etained earnings !#"""

Total Equity !!#""" 41


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-ndependent study for ne=t%ee$

2art of chapter C "not all#,

2ages

(ttempt self assessment question

C)= "on p) HA ! answer is on p) I@C#

7hapter = from Lelvile "on *+*#

omework essay

94tandardisation is the only way forward

for 8inancial 0eporting;) Discuss this

statement in the light of efforts that have

been made to harmonise company law

and financial accounting in *urope)

.2 49

Week 2 the Accounting Equation and Analysis of Transactions

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Transcript of Week 2 the Accounting Equation and Analysis of Transactions