Accounting
Lecture no 2
Prepared by:
Jan Hájek
OBJECTIVE OF FINANCIAL
REPORTING
•
•
The objective of financial reporting is
to provide information that is useful
for decision-making
The consistency of information
and values of the assets
and liabilities is ensured
by legislation and accounting
principles
QUALITATIVE CHARACTERISTICS
OF ACC. INFORMATION
•
The accounting alternative selected should
be one that generates the most useful
financial information for decision making.
• To be useful, information should possess
the following qualitative characteristics:
1. understandability
2. relevance
3. reliability
4. comparability and consistency
UNDERSTANDABILITY
•
•
Information must be understandable by
its users.
Users are assumed to have a
reasonable comprehension of, and
ability to study, the accounting,
business, and economic concepts
needed to understand the
information.
RELEVANCE



Accounting information is relevant if it
makes a difference in a decision.
Relevant information helps users forecast
future events (predictive value),
or it confirms or corrects prior
expectations (feedback value).
Information must be available
to decision makers before it
loses its capacity to influence
their decisions (timeliness).
RELIABILITY



Reliability of information means that the
information is free of error and bias – it
can be depended on.
To be reliable, accounting information
must be verifiable – there must be proof
that it is free of error and bias.
The information must be a faithful
representation of what it purports to be – it
must be factual.
COMPARABILITY AND
CONSISTENCY
Comparability means that the information
should be comparable with accounting
information about other enterprises.
 Consistency means that the same
accounting principles and methods should be
used from year to year within a company.

2000
2001
2003
RECOGNITION AND
MEASUREMENT CRITERIA




Recognition and measurement criteria used by accountants to
solve practical problems include assumptions, principles, and
constraints.
Assumptions provide a foundation for the accounting process.
Principles indicate how economic events should be reported
in the accounting process.
Constraints permit a company to modify generally accepted
accounting principles without reducing the usefulness of the
reported information.
Assumptions
Going concern
Monetary unit
Economic entity
Time period
Principles
Revenue
recognition
Matching
Full disclosure
Constraint
s
Cost - benefit
Materiality
GOING CONCERN
ASSUMPTION
The going concern assumption assumes that
the enterprise will continue to operate in the
foreseeable future.
Implications: capital assets are recorded at cost
instead of liquidation value, amortization is
used, items are labeled as current or noncurrent.
MONETARY UNIT ASSUMPTION
 The
monetary unit assumption states that only
transaction data capable of being expressed in
terms of money should be included in the
accounting records of the economic entity.
 Also assumes unit of measure ($) remains
sufficiently stable over time. Ignores inflationary
and deflationary effects.
Should not be
included in
accounting records
Should be included
in accounting records
Customer satisfaction
Percentage of
international employees
Salaries paid
ECONOMIC ENTITY ASSUMPTION
The economic entity assumption states
that economic events can be identified
with a particular unit of accountability.
Example: Harvey’s activities
can be distinguished from
those of other food services
such as Swiss Chalet.
TIME PERIOD ASSUMPTION
The time period assumption states that
the economic life of a business can be
divided into artificial time periods.
Example: months, quarters, and years
2000
QTR 1
QTR 2
QTR 3
QTR 4
2001
JAN
MAY
SEPT
DEC
2003
FEB
MAR APR
JUN JUL
AUG
OCT
NOV
REVENUE RECOGNITION PRINCIPLE

The revenue recognition principle says
that revenue should be recognized in the
accounting period in which it is earned.
 Production/sales essentially complete
 Revenues measurable
 Collection reasonably assured
 Expenses determinable
REVENUE RECOGNITION

Revenue can be recognized:
1.
2.
3.
4.
At point of sale
During production
At completion of production
Upon collection of cash
MATCHING PRINCIPLE
Expense recognition is traditionally tied to
revenue recognition.
 This practice – referred to as the matching
principle – dictates that expenses be
matched with revenues in the period in
which efforts are expended to generate
revenues.

MATCHING PRINCIPLE


Expired costs are costs that will generate
revenues only in the current period and
are therefore reported as operating
expenses on the income statement.
Unexpired costs are costs that will
generate revenues in future accounting
periods and are recognized as assets.
MATCHING PRINCIPLE
Unexpired costs become expenses through:
1.Cost of goods sold – Costs carried as
merchandise inventory are expensed as cost
of goods sold in the period when the sale
occurs – so there is a direct matching of
expenses with revenues.
2.Operating expenses – Unexpired costs
become operating expenses through use or
consumption or through the passageof time.
FULL DISCLOSURE PRINCIPLE
The full disclosure principle requires that
circumstances and events that make a
difference to financial statement users be
disclosed.
 Compliance with the full disclosure principle
is accomplished through
1. the data in the financial statements and
2. the notes that accompany the statements.
 A summary of significant accounting policies
is usually the first note to the financial
statements.

COST PRINCIPLE
The cost principle dictates that assets are
recorded at their historic cost.
 Cost is used because it is both relevant and
reliable.
1. Cost is relevant because it represents the
price paid, the assets sacrificed, or the
commitment made at the date of acquisition.
2.Cost is reliable because it is objectively
measurable, factual, and verifiable.

DUAL ASPECT CONVENTION

The accounting entry is always captured on
credit and debit side of the account
CONSTRAINTS IN ACCOUNTING


Constraints permit a company to modify
generally accepted accounting principles without
reducing the usefulness of the reported
information.
The constraints are cost-benefit and materiality.
1. Cost-benefit means that the value of
information should be greater than the cost of
providing it.
2. Materiality relates to an item’s impact on a
firm’s overall financial condition and operations.
CONCEPTUAL FRAMEWORK
-SUMMARY
Objectives of Financial Reporting
Qualitative
Characteristics of
Accounting
Information
Elements of
Financial Statements
Recognition and Measurement Criteria
Assumptions
Principles
Constraints
FINANCIAL STATEMENTS
After transactions are identified, recorded,
and summarized, four financial statements
are prepared from the summarized
accounting data:
1. An income statement presents the
revenues and expenses and resulting net
income or net loss of a company for a
specific period of time.
2. A statement of owner’s equity summarizes
the changes in owner’s equity for a specific
period of time.
FINANCIAL STATEMENTS
In addition to the income statement and
statement of owner’s equity, two additional
statements are prepared:
3. A balance sheet reports the assets, liabilities,
and owner’s equity of a business enterprise at a
specific date. (Statement of financial position)
4. A cash flow statement summarizes
information concerning the cash inflows
(receipts) and outflows (payments) for a specific
period of time.
The notes are an integral part of the financial
statements.
Introduction to Financial
Statements
Balance Sheet
Income Statement
Statement of Cash Flows
Describes
where the
enterprise
stands at a
specific date.
Introduction to Financial
Statements
Balance Sheet
Income Statement
Statement of Cash Flows
Depicts the
revenue and
expenses for a
designated
period of time.
Introduction to Financial
Statements
Balance Sheet
Income Statement
Statement of Cash Flows
Net income (or
net loss) is
simply the
difference
between
revenues and
expenses.
Introduction to Financial
Statements
Balance Sheet
Income Statement
Statement of Cash Flows
Depicts the
ways cash has
changed during
a designated
period of time.
The Need for Adequate
Disclosure
Balance Sheet
Income Statement
Statement of Cash Flows
Notes to the
financial
statements often
provide facts
necessary for the
proper
interpretation of
the statements.
Relationship between the statement of financial position, the income
statement and the statement of cash flows
Balance sheet
Balance sheet
Balance sheet
Income statement
Income statement
Statement of cash
flows
Statement of cash
flows
Period 1
Period 2
Time
Brie Manufacturing
Statement of financial position as at 31 December 2011
£000
ASSETS
Non-current assets
Property
45
Plant and equipment
30
Motor vans
19
94
Current assets
Inventories
23
Trade receivables
18
Cash at bank
12
53
Total assets
147
Brie Manufacturing
Statement of financial position as at 31 December 2011 (continued)
£000
EQUITY AND LIABILITIES
Equity
60
Non-current liabilities
Long-term borrowings
50
Current liabilities
Trade payables
Total equity and liabilities
37
147
Better-Price Stores
Income statement for the year ended 31 October 2011
£
Sales revenue
232,000
Cost of sales
154,000
Gross profit
78,000
Salaries and wages
(24,500)
Rent and rates
(14,200)
Heat and light
(7,500)
Telephone and postage
(1,200)
Insurance
(1,000)
Motor vehicle running expenses
(3,400)
Depreciation – fixtures and fittings
(1,000)
Depreciation – motor van
Operating profit
Interest received from investments
(600)
24,600
2,000
Interest on borrowings
(1,100)
Profit for the year
25,500
Miro plc
Statement of changes in equity for the year ended 31 Dec 2011
Share
Share
Revaluat. Translat. Retained Total
capital premium reserve
reserve earnings
£m
£m
£m
£m
£m
£m
100
_
20
40
150
310
Issue of ordinary
shares
50
20
_
_
_
70
Dividends
_
_
_
_
(27)
(27)
120
(10)
42
152
140
30
165
505
Balance as at
1 January 2011
Changes in equity
for 2011
Total
comprehensive
income for the year
Balance at
31 December 2011
-
150
-
20
Tesco plc
Summarised statement of cash flows for the year ended 26 Feb 2011
£m
Cash generated from operations
5,366
Interest paid
(614)
Corporation tax paid
(760)
Net cash from operating activities
Net cash used in investing activities
3,992
(1,859)
Cash flows from financing activities
Dividends paid to equity owners
(1,081)
Other net cash flows from financing activities
(1,955)
Net cash from financing activities
(3,036)
Net decrease in cash and cash equivalents
Source: Tesco annual review 2011, p. 35, www.tescocorporate.com.
(903)
Let’s analyze
some
transactions for
JJ’s Lawn Care
Service.
On May 1, 2003, Jill Jones and her family
invested $8,000 in JJ’s Lawn Care Service and
received 800 shares of stock.
Cash
Total
JJ's Lawn Care Service
Balance Sheet
May 1, 2003
Owners' Equity
Assets
$
$ 8,000 Capital Stock
8,000
$
8,000
$
8,000 Total
On May 2, JJ’s purchased a riding lawn
mower for $2,500 cash.
JJ's Lawn Care Service
Balance Sheet
May 2, 2003
Owners' Equity
Assets
$
$ 5,500 Capital Stock
Cash
2,500
Tools & Equipment
Total
$
8,000 Total
$
8,000
8,000
On May 8, JJ’s purchased a $15,000 truck.
JJ’s paid $2,000 down in cash and issued a note payable for the remaining
$13,000.
JJ's Lawn Care Service
Balance Sheet
May 8, 2003
Liabilities and Owners' Equity
Assets
$ 3,500 Liabilities:
Cash
$ 13,000
2,500 Notes Payable
Tools & Equipment
15,000 Owners' Equity:
Truck
8,000
Capital Stock
Total
$ 21,000 Total
$ 21,000
On May 11, JJ’s purchased some repair
parts for $300 on account.
JJ's Lawn Care Service
Balance Sheet
May 11, 2003
Liabilities and Owners' Equity
Assets
$ 3,500 Liabilities:
Cash
$ 13,000
2,800 Notes Payable
Tools & Equipment
300
15,000 Accounts Payable
Truck
$ 13,300
Total Liabilities
Owners' Equity:
8,000
Capital Stock
Total
$ 21,300 Total
$ 21,300
Jill realized she had purchased more repair parts than needed.
On May 18, JJ’s was able to sell half of the repair parts to ABC Lawns for
$150, a price equal to JJ’s cost. JJ’s will receive the cash within 30 days.
JJ's Lawn Care Service
Balance Sheet
May 18, 2003
Liabilities and Owners' Equity
Assets
$ 3,500 Liabilities:
Cash
$ 13,000
150 Notes Payable
Accounts Receivable
300
2,650 Accounts Payable
Tools & Equipment
$ 13,300
Total Liabilities
15,000
Truck
Owners' Equity:
8,000
Capital Stock
Total
$ 21,300 Total
$ 21,300
On May 25, ABC Lawns pays JJ’s $75 as a partial
settlement of its accounts receivable.
JJ's Lawn Care Service
Balance Sheet
May 25, 2003
Liabilities and Owners' Equity
Assets
$ 3,575 Liabilities:
Cash
$ 13,000
75 Notes Payable
Accounts Receivable
300
2,650 Accounts Payable
Tools & Equipment
$ 13,300
Total Liabilities
15,000
Truck
Owners' Equity:
8,000
Capital Stock
Total
$ 21,300 Total
$ 21,300
On May 28, JJ’s pays $150 of its accounts
payable.
JJ's Lawn Care Service
Balance Sheet
May 28, 2003
Liabilities and Owners' Equity
Assets
$ 3,425 Liabilities:
Cash
$ 13,000
75 Notes Payable
Accounts Receivable
150
2,650 Accounts Payable
Tools & Equipment
13,150
Total Liabilities
15,000
Truck
Owners' Equity:
8,000
Capital Stock
Total
$ 21,150 Total
$ 21,150
On May 29, JJ’s recorded lawn care services
provided during May of $750. All clients paid in
cash.
JJ's Lawn Care Service
Balance Sheet
May 29, 2003
Liabilities and Owners' Equity
Assets
$ 4,175 Liabilities:
Cash
$ 13,000
75 Notes Payable
Accounts Receivable
150
2,650 Accounts Payable
Tools & Equipment
13,150
Total Liabilities
15,000
Truck
Owners' Equity:
8,000
Capital Stock
750
Retained Earnings
$ 21,900
$ 21,900 Total
Total
On May 31, JJ’s purchased gasoline for the
lawn mower and the truck for $50 cash.
JJ's Lawn Care Service
Balance Sheet
May 31, 2003
Liabilities and Owners' Equity
Assets
$ 4,125 Liabilities:
Cash
$ 13,000
75 Notes Payable
Accounts Receivable
150
2,650 Accounts Payable
Tools & Equipment
13,150
Total Liabilities
15,000
Truck
Owners' Equity:
8,000
Capital Stock
700
Retained Earnings
$ 21,850
$ 21,850 Total
Total
Now, let’s review how JJ’s transactions
affected the accounting equation.
May 1
Balances
May 2
Balances
May 8
Balances
May 11
Balances
May 18
Balances
May 25
Balances
May 28
Balances
May 29
Balances
May 31
Balances
Cash
$ 8,000
$ 8,000
(2,500)
$ 5,500
(2,000)
$ 3,500
Assets
Accts.
Tools &
+ Rec. + Equip. +
Truck
Liabilities
+
Owners' Equity
Notes
Accts.
Capital
Retained
= Payable + Pay. + Stock + Earnings
$ 8,000
$ 8,000
$ 2,500
$ 2,500
$ 3,500
$ 3,500
75
$ 3,575
(150)
$ 3,425
750
$ 4,175
(50)
$ 4,125
=
$ 150
$ 150
(75)
$ 75
$ 75
$ 2,500
300
$ 2,800
(150)
$ 2,650
$ 8,000
$ 15,000
$ 15,000
$ 13,000
$ 13,000
$ 8,000
$ 15,000
$ 13,000
$ 300
$ 300
$ 15,000
$ 13,000
$ 300
$ 8,000
$ 2,650
$ 15,000
$ 13,000
$ 8,000
$ 2,650
$ 15,000
$ 13,000
$ 300
(150)
$ 150
$ 8,000
$ 8,000
$ 75
$ 2,650
$ 15,000
$ 13,000
$ 150
$ 8,000
$
$ 75
$ 2,650
$ 15,000
$ 13,000
$ 150
$ 8,000
$
750
750
(50)
700
Let’s prepare the Income Statement and
Statement
for JJ’s+ Lawn
Assets of Cash Flows
=
Liabilities
Owners'Care
Equity
Accts.
Tools &
Notes
Accts.
Capital
Retained
Service
for
the
month
ending
May
31,
2003.
Cash + Rec. + Equip. + Truck = Payable + Pay. + Stock + Earnings
May 1
Balances
May 2
Balances
May 8
Balances
May 11
Balances
May 18
Balances
May 25
Balances
May 28
Balances
May 29
Balances
May 31
Balances
$ 8,000
$ 8,000
(2,500)
$ 5,500
(2,000)
$ 3,500
These transactions
impact
the
$ 15,000
$ 13,000
$ 2,500Statement
$ 15,000
$ 13,000
of Cash
300
$ 300
Flows.
$ 2,800
$ 15,000
$ 13,000
$ 300
$ 2,500
$ 2,500
$ 3,500
$ 3,500
75
$ 3,575
(150)
$ 3,425
750
$ 4,175
(50)
$ 4,125
$ 8,000
$ 8,000
$ 8,000
$ 8,000
$ 8,000
$ 150
$ 150
(75)
$ 75
(150)
$ 2,650
$ 15,000
$ 13,000
$ 300
$ 8,000
$ 2,650
$ 15,000
$ 13,000
$ 8,000
$ 75
$ 2,650
$ 15,000
$ 13,000
$ 300
(150)
$ 150
$ 75
$ 2,650
$ 75
$ 2,650
These transactions
$ 15,000
$ 13,000
$ 150
impact the Income
$ 15,000
$ 13,000
$ 150
Statement.
$ 8,000
$ 8,000
$
$ 8,000
$
750
750
(50)
700
JJ's Lawn Care Service
Income Statement
For the Month Ended May 31, 2003
Sales Revenue
Operating Expense:
Gasoline Expense
Net Income
$
750
$
50
700
Investments by and payments to the owners
are not included on the Income Statement.
JJ's Lawn Care Service
Statement of Cash Flows
For the Month Ended May 31, 2003
Cash flows from operating activities:
Cash received from revenue transactions $
750
Cash paid for expenses
(50)
Net cash provided by operating activities
$
700
Cash flows from investing activities:
Purchase of lawn mower
$ (2,500)
Purchase of truck
(2,000)
Collection for sale of repair parts
75
Payment for repair parts
(150)
Net cash used by investing activities
(4,575)
Cash flows from financing activities:
Investment by owners
8,000
Increase in cash for month
$ 4,125
Cash balance, May 1, 2003
Cash balance, May 31, 2003
$ 4,125
JJ's Lawn Care Service
Statement of Cash Flows
For the Month Ended May 31, 2003
Cash flows from operating activities:
Cash received from revenue transactions $
750
Cash paid for expenses
(50)
Net cash provided by operating activities
$
700
Cash flows from investing activities:
Operating
activities include$ the
cash
Purchase
of lawn mower
(2,500)
Purchase
of truckof revenue and expense
(2,000)
effects
Collection for sale of repair parts
75
transactions.
Payment for repair parts
(150)
Net cash used by investing activities
(4,575)
Cash flows from financing activities:
Investment by owners
8,000
Increase in cash for month
$ 4,125
Cash balance, May 1, 2003
Cash balance, May 31, 2003
$ 4,125
JJ's Lawn Care Service
Statement of Cash Flows
For the Month Ended May 31, 2003
Cash flows from operating activities:
Cash received from revenue transactions $
750
Cash paid for expenses
(50)
Net cash provided by operating activities
$
700
Cash flows from investing activities:
Purchase of lawn mower
$ (2,500)
Purchase of truck
(2,000)
Collection for sale of repair parts
75
Payment for repair parts
(150)
Net cash used by investing activities
(4,575)
Cash flows from financing activities:
Investing
activities include the cash8,000
Investment
by owners
Increase
in cash for
$ 4,125
effects
ofmonth
purchasing and selling
Cash balance, May 1, 2003
assets.
Cash balance, May 31, 2003
$ 4,125
JJ's Lawn Care Service
Statement of Cash Flows
For the Month Ended May 31, 2003
Cash flows from operating activities:
Cash received from revenue transactions $
750
Cash paid for expenses
(50)
Net cash provided by operating activities
$
700
Cash flows from investing activities:
Purchase of lawn mower
$ (2,500)
Financing activities include the
cash
Purchase of truck
(2,000)
Collection
of repair parts with the owners
75
effects for
ofsale
transactions
Payment for repair parts
(150)
and
creditors.
Net cash used by investing activities
(4,575)
Cash flows from financing activities:
Investment by owners
8,000
Increase in cash for month
$ 4,125
Cash balance, May 1, 2003
Cash balance, May 31, 2003
$ 4,125