Financial Accounting Tutorial 1:
1.
The income statement of a company details the firm’s earned revenues and net
income. What is the meaning of these accounting terms?
Solution:
Revenues are increases in net income (and therefore also in retained earnings) from
delivering goods and services to customers or clients. Net income is the difference
between the revenues earned during the accounting period and the expenses incurred
to earn the revenues.
2.
Who are investors and what information does a potential investor need from a
company?
Solution:
Investors (along with creditors) provide money to finance the operations of a
company. They need relevant and reliable information regarding the amount they can
expect to earn from their investment in a company.
3.
Briefly discuss the difference between accounting and bookkeeping. How does
bookkeeping fit into accounting?
Solution:
Accounting is the information system that measures business activities, processes data
into reports, and communicates results to people. Bookkeeping is only a part of
accounting. Bookkeeping is related to accounting as arithmetic is related to
mathematics.
4.
Consider Microsoft Corporation, the world's largest software company. Please classify
the following items as an asset (A), a Liability (L), or an Owners' Equity (E).
Solution:
a. Accounts receivable A
g.
Accounts payable L
b. Long-term debt
h.
Common stock E
c. Merchandise inventory A
i.
Supplies A
d. Notes payable
L
j.
Retained earnings E
e. Expenses payable
L
k.
Land
l.
Prepaid expenses A
f. Equipment
5.
L
A
A
Suppose you are analyzing the financial statement of Nestlé. Identify each item with
its appropriate financial statement, using the following abbreviations: Income
statement (IS), Statement of retained earnings (SRE), Balance Sheet (BS), and
Statement of cash flows (SCF). Three items appear on two financial statements, and
one item shows up on three statements.
a.
b.
c.
d.
e.
f.
g.
h.
i.
j.
k.
l.
m.
n.
6.
Solution:
Cash BS, SCF
Net cash used for financing activities
SCF
Accounts payable
BS
Common stock
BS
Interest revenue
IS
Long-term debt
BS
Increase or decrease in cash
SCF
Dividends
SRE, SCF
Salary expense
IS
Inventory
BS
Sales revenue
IS
Retained earnings
SRE, BS
Net cash provided by operating activities SCF
Net income (or net loss)
IS, SRE, SCF
Amounts of the assets and liabilities of Wells Fargo & Company, a banking chain, as
of December 31, 2003, are adopted as follows. Also included are revenue and expense
figures for the year ended on that date (amounts in billions CHF):
Total revenue
Receivables
Current liabilities
Common stock
Interest expense
Salary and other employee expense
Other assets
32
253
290
12
3
9
43
Property and equipment, net
Investment assets
Long-term liabilities
Other expenses
Cash
Retained earnings, beginning
Retained earnings, ending
4
72
64
14
16
19
?
Prepare the balance sheet and income statement of Wells Fargo & Company at
December 31, 2003.
Solution:
Wells Fargo & Company
Balance Sheet (Adapted; Amounts in billions)
December 31, 2003
ASSETS
LIABILITIES
Cash
16 Current liabilities
Receivable
253 Long-term liabilities
Investment assets
72 Total liabilities
Property and
equipment, net
4 STOCKHOLDERS’
Other assets
43 EQUITY
Common stock
Retained earnings
Total stockholders’ equity
Total liabilities and
Total assets
388
stockholders’ equity
*Computation of retained earnings:
Total assets (388) – Total liabilities (354) – Common stock (12) = 22
290
64
354
12
22*
34
388
Wells Fargo & Company
Income Statement (Adapted)
Year Ended December 31, 2003
Billions
Total revenue
Expenses:
Interest expense
Salary and other employee expenses
Other expenses
Total expenses
Net income
32
3
9
14
26
6
QUESTIONS ON IAS/IFRS
(answers for 1 to 6 can be found on slides 36,37,47 session 1 eMBA):
1. How is an asset defined according to the IFRS Framework?
Resource controlled by the entity as result of past events, from which future
benefits are expected.
2. How is a liability defined according to the IFRS Framework?
Present obligation arising from past events, settlement of which is expected to
result in an outflow of resources embodying economic benefits.
3. What is the definition of equity according to the IFRS Framework?
Residual interest in the assets after deducting liabilities.
4. What is the definition of income?
Increases in economic benefits in form of inflows or enhancements of assets or
decreases of liabilities that result in increases in equity, other than those relating
to distributions from equity participants.
5. What is the definition of expense?
Decreases in economic benefits in the form of outflows or depletions of assets of
incurrences of liabilities that result in decreases in equity, other than those
relating to distributions to equity participants.
6. Which are the conditions for recognizing an item in financial statements (recognition
criteria)?
general criteria: probable (> 50%) that future economic benefit will flow to or
from the entity; cost or value can be measured reliably; specific recognition
criteria for special items.
7. Do the following transactions constitute an asset or a liability? Should they be
recognised according to IFRS? If a recognition is required, please state also the
amount. (I added comments on open questions starting with "Note:" in brackets).
a. Acquisition of a van for 200'000 CHF. Future economic benefit is expected
between 220'000 CHF (probability 80%) and 180'000 CHF (probability 20%). The
van can be sold at any time.
b. Acquisition of a specialised machine for 300'000 CHF. The products that are
manufactured on the machine can not be distributed due to legal restrictions.
Another usage is impossible. Expected future economic benefit is expected
between minus 50'000 CHF (probability 80%) and 30'000 CHF (probability 20%).
A sale of the machine is possible at any time.
c. Expenses for a broadcast: 50,000 CHF in 20X1. The commercial is succesful so
that clients react. Expected future economic benefit: 150,000 (probability = 0.7);
80,000 (probability = 0.3).
d. A company with the financial year as of December 31 pays the yearly rent for its
office building of 12,000 CHF in advance at the beginning of December.
According to the rental agreement, payments in advance should be paid back in the
case of a termination of the rental contract. (Note: Last sentence is not important).
e. The company faces a lawsuit. The management expects a fine of 300,000 CHF
with a probability of 50 %, and a fine of 100,000 CHF with the same probability.
f. The company faces another lawsuit expecting a fine of 500,000 CHF with a
probability of 50 % and expecting to win with a probability of as well 50 %.
g. On fiscal year's 20X4 sales of 400,000,000 CHF, management estimates warranty
expense of 2 %; One year ago, at June 30, 20X3, estimated warranty liability stood
at 3,000,000 CHF. Warranty payments were 9,000,000 CHF during the year ended
June 30, 20X4. (Note: Fiscal year 2004 is from June 30, 2003, to June 30, 2004).
h. A firm has several machines that they usually maintain on a regular basis. The
yearly amount for maintenance is 100,000 CHF. Due to a financial shortage the
management decides to postpone 50 % of the maintenance to the following
financial year.
Solution:
Item Asset/Liability according to IFRS?
a.
Asset, all criteria fullfilled, control and future
benefit > 50 %, reliably measurable
b.
No, future economic benefit unlikely (< 50 %)
c.
No, future economic benefit probable but cannot be
reliably measured and allocated to expense
d.
Asset (prepaid expense), all criteria fulfilled, past
event, future benefit > 50 % (either payback or less
expense), reliably measurable
e.
Liability (provision), past event, future outflow
probable, reliably measurable
f.
No, only contingent liability, future outflow not
probable
g.
Liability, past event, probable, reliably measurable
h.
No, no claims from third parties
Recognised amount
Acquisition cost:
200,000 CHF
Not recognised
Not recognised
11,000 CHF
200,000 CHF (or even
300,000 CHF)
Not recognised
2,000,000 CHF
(3,000,000 + 400,000,000
X 0.02 - 9,000,000 CHF)
Not recognised
TRUE/FALSE QUESTIONS
1.
Relevant and reliable accounting information is required to convince an investor to
invest money in a particular company. (true)
2.
Accounting is an information system that measures business activities, processes data
into reports and communicates results to decision makers. (true)
3.
All business owners are personally liable for the debts of their businesses. (false)
4.
Generally accepted accounting principles, like IAS/IFRS, are the rules and procedures
established by the International Accounting Standards Board (IASB). (true)
5.
The International Accounting Standards Board is a commission of the European
Parliament. (false)
6.
The acceptance of rules (IFRSs) developed by the International Accounting Standards
Board and integration into EU legislation is called Endorsement. (true)
7.
IFRS are accepted at US capital markets since January 2005 because of a
memorandum which was signed in February 2004. (false)
8.
The Users of financial information rely on credible, transparent and comparable
financial information. That is one reason why accounting harmonisation is important.
(true)
9.
The balance sheet and cash flow statement of a company are the only sources of
information for investors provided by companies. (false)
10.
The objectivity principle states that assets and services should be recorded at their
actual cost, since cost is a reliable measure to use in financial accounting. (false)
11.
The accounting equation expresses the idea that Resources = Outsider claims + Insider
claims. (true)
12.
The accounting equation must always be in balance. (true)
13.
Stockholders’ equity is often referred to as "net assets" and represents the residual
amount of business assets which can be claimed by the owners. (true)