Introduction
to Financial
Accounting
by
AAMIR NADEEM SHEIKH
MS (Banking & Finance),
MBA (Banking & Finance),
M.Sc. Mathematics,
LL.B,
JAIBP (Associate of Institute of Bankers of
Pakistan).
Overview
1. What is financial accounting & financial reporting ?
2. Business organization
3. Framework
4. Important accounting concepts
5. Elements of financial statements
6. Components of a set of financial statements
7. Users of financial Statements
2
Financial Accounting
It is the process of recording,
summarizing and reporting of
transactions resulting from
business operations over a
period of time
OBJECTIVE
To accurately prepare an organization’s
financial accounts for specific period
TRANSACTION
A business transaction is an event involving an
interchange of goods, money or services between
two or more parties
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Financial Reporting
Financial reporting is the process of
producing financial statements
that disclose an organization's
financial status to stakeholders,
including management, investors,
creditors and regulatory agencies.
OBJECTIVE
To provide financial information that is
financial performance and position about the
reporting entity.
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Types of Business Entity
Sole trader
Partnership
 Business owned & operated by  At least two partners
single person.
 Partners receive profits and having
 No distinction between owner unlimited liabilities
and busines.
 Partners jointly and severally liable
 Owner receives all profits and for the losses business make
having unlimited liability
 The capital structure of a
 Simple capital structure, which partnership is similar to that of
may be increase or decrease by
either introducing capital or
making drawings.
sole trader, partner’s interest in the
business is divided between capital
and current account, capital
account remains fixed whereas
current account includes the share
of profit or loss that each partner
is entitled to receive less any
drawings.
Limited liability
companies
 Separate legal entity from their owners,
through the process of incorporation.
 Owner/ Shareholders invest capital for
shareholding which entitles them for
residual interest in the company.
 Shareholders are not personally liable for
the debts of the business, in case of
insolvency of the company they don’t
have to pay debts of the company
 Managed by the board of directors, who
are elected by shareholders.
 More formalized capital structure which
entitle them for return in profits that is
dividends.
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Comparison of Companies to sole traders
& partnerships
1. Property holding
2. Transferable Shares
3. Suing & being sued
4. Security of loans
5. Taxation
6
Property Holding
The property of company belongs to company
and the change in the ownership of the share
does not effect the property of company.
In partnership form property belong to
partners directly and they can take it when
they partnership.
7
Transferable shares
Shares of the limited company can usually be
transferred without the consent of other
shareholders in the absence of agreement to
the contrary a new partner can be introduced
to the firm with the consent of all existing
partners.
8
Suing and being sued
As a separate legal person a limited company
can sue and be sued by its name, judgment
related to the company do not effect the
members personally
9
Security of Loans
A company has a greater scope of raising loans and may
secure them with the floating charges. A floating charge is a
mortgage over the constantly fluctuating assets of the
company providing security for the lenders of the money to
the company, it does not prevent the company dealing with
the assets in the ordinary course of business such a charge is
useful when company has no noncurrent assets such as land
but have large and valuable inventories.
Generally law does not permit partnerships or individuals to
secure loans with floating charges.
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Taxation
A company is legally separated from its
shareholders, it is taxed separately from its
shareholders.
Partners and sole traders are personally liable
for the income tax on the profits made by the
business.
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Disadvantages of
incorporation
1.
Registration with registrar
2.
Annual financial statements
3.
Financial documents are public
4.
Introduction & withdrawals of capital
& profits
5.
Participation in management
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Disadvantages of incorporation
1. Registration with Registrar
Companies have to register and file formal
constitution documents with the Registrar.
Registration fee and legal costs have to be
paid.
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Disadvantages of incorporation
2. Annual financial statements
It is normally requirement for a company to produce
annual financial statements that must be submitted
to registrar, it is usually the requirement that those
statements should be audited, in some countries it is
usually are requirement for large and medium size
companies cost associated with it may be high,
whereas sole traders and partnerships are not
subject to such requirements unless their
professional bodies require this.
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Disadvantages of incorporation
3. Financial documents are public
Registered companies accounts and documents are
open to public inspection whereas the accounts of
sole traders and partnerships are not open for
inspection.
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Disadvantages of incorporation
4. Introduction & withdrawals of capital
& profits
Limited companies are subject to strict rules
in connection with introduction and
withdrawals of capital and profits.
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Disadvantages of incorporation
5. Participation in management
Members of the company may not take part in
its management unless they are also
directors, whereas all partners are entitle to
share in management unless the agreement
provides otherwise.
17
“
THE
FRAMEWORK
By International Accounting Standards Board - IASB
The framework presents the main ideas, concepts and principles
upon which all International Financial Reporting Standards and
therefore financial statements are based.
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Framework
FRAMEWORK
Objective of Financial
Reporting
QUALITATIVE CHARACTERISTICS
Fundamental qualitative
characteristics
a.
Fair
Representation
a. Predictive
Relevance
b. Confirmatory
c. Cut-off point
d. Materiality
Enhancing qualitative
characteristics
a.
b.
c.
d.
Comparability
Verifiability
Timeliness
Understandability
Faithful Representation
a. Completeness
b. Neutrality
c. Free from error
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Framework
Objective of financial statements
Financial information that is useful in providing
resources.
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Framework
Fair Representation
• Compliant with relevant laws and regulations
• Compliant with the relevant financial reporting
•
framework
Qualitative characteristics of the framework have been
applied as far as possible
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Framework Qualitative Characteristics
Fundamental qualitative characteristics
Relevance
1. It is the ability to influence the economic decisions of users.
2. Is provide in time to influence the decisions.
Predictive
Confirmatory
Predictive
value
enables users to
evaluate or access
past, present & future
events.
Confirmatory
value Passed thrush hold Information is material
helps users to confirm quality test.
if its omission or
or
correct
past
misstatement
evaluations
and
influence the decision.
assessments.
Cut-off point
Materiality
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Framework Qualitative Characteristics
Fundamental qualitative characteristics
Faithful representation
Completeness
Neutrality
Free from error
Information must contain all Free from bias, financial Information must be free from
necessary descriptions and statements are not neutral if error with in the bounds of
they influence the decision/ materiality.
explanations.
judgment in order to achieve A material error can cause
predetermined outcomes.
financial statements to be
false and misleading and thus
unreliable and deficient in
terms of relevance.
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Framework Qualitative Characteristics
Enhancing qualitative characteristics
Comparability Verifiability
•
•
Comparison
overtime
Comparison
of
different entities
performance
Timeliness
Understandability
Direct Verification
Having information Understandability depends
• Counting/ direct available in time to upon:
•
The way in which
observation.
decision makers.
information is presented.
In direct Verification
•
The capability of users.
• Checking
input
It is assumed that
formulae, modeling
• Users having sufficient
knowledge.
techniques
•
Are willing to study
information with diligence.
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Important Accounting Concepts
1. Materiality
2. Substance over 3. The going concern
assumption
form
An item is material if its
omission or misstatement is If an information is to be
likely
to
change
the presented
faithfully
the
perception or understanding economic reality must be
of user of that information.
accounted for, not strict legal
Financial
statements
are
prepared on the basis that entity
will continue to trade for
foreseeable future, no intension
form – Redeemable preference to liquidate or curtail its
shares.
operations
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Important Accounting Concepts
4. The business 5. The accruals 6. Fair presentation
entity concept
basis of accounting
Financial
information
presented in the financial
statements are related to the
business entity only not to
the owners.
It means that transactions
are recorded when revenues
are earned and expenses are
incurred this pays no respect
to the timing of the cash
payment or receipt.
Fair presentation relates to
the preparation of financial
statements in accordance
with the applicable financial
reporting standards together
with relevant laws and
regulations.
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The elements of financial statements
Asset
An asset is a resource
controlled by an entity
as result of past event
from which future
economic benefits are
expected to flow to
entity. e.g. building
owned and controlled
by business.
Liability
A liability is an
obligation to transfer
economic benefit as a
result
of
past
transactions or events.
e.g. an unpaid tax
obligation is liability of
entity.
Equity
Residual interest in
the
business,
it
represents what is left
when business is
wound up, all assets
are sold and liabilities
are paid off, paid back
to
owners
(shareholders).
Income
This is recognition
of
inflow
of
economic benefit to
the entity in the
reporting
period.
e.g. sales revenue.
Expense
This is recognition
of
outflow
of
economic benefit
from the entity in
the
reporting
period.
e.g.
purchasing of goods
and services.
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The components of a set of financial
statements
The statement of financial position
The statement of profit or loss and other comprehensive income
The statement of changes in equity
The statement of cash flows
The notes to financial statements
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Statement of Financial Position
It summarizes the
assets, liabilities and
equity balances of the
business at the end of
reporting period, also
referred as balance
sheet.
29
Statement of profit or loss and other
comprehensive income
It summarizes the
revenue earned and
expenses incurred by
the business
throughout the
reporting period and
normally referred as
profit and loss account
30
Statement of Changes in Equity
It summarizes the movement in equity balances (share capital, share
premium, revaluation surplus and retained earnings) from beginning to
the end of reporting period. It applies to limited liability companies and
are not required for sole traders and partnerships.
31
The statement of cash flows
32
The notes to the financial statements
33
Users of financial statements
34
Thankyou
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