Financial & Managerial
Accounting
LECTURE 1 and 2
Chara Charalambous MBA CDA COLLEGE
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Aims of the Lecture
• What is Accounting and the purpose of
Accounting.
• The use of Financial Statements
• Users of Financial Statements
• Accounting cycle during a period
• The accounting equation
• Generally accepted accounting principles
• Forms of Organizations
Chara Charalambous MBA CDA COLLEGE
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What is Accounting?
• A service that is systematically recording and
summarizing the financial (economic) transactions of
a business and then analyzing, verifying (confirming)
and reporting the results.
• The person in charge for the execution of accounting is
known as an Accountant, and this individual is typically
required to follow a set of rules and regulations of
the IFRS (International Financial Reporting Standards).
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Purpose of Accounting
• Accounting allows a company
to analyze
the financial performance of the business and
look at statistics such as net profit. Therefore the
management is able to
make informed
judgment and better decision.
• Also Accounting aims to show the relationship of
the business with its environment which includes
its customers (debtors), suppliers (creditors),
employees, owners and lenders.
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Two fields of Accounting
 Managerial Accounting, in contrast to Financial
Accounting, is aimed to help managers inside the
organization to take decisions with the
information it provides.
Managerial Accounting also called Cost Accounting is the
procedure of identifying, measuring, analyzing and providing
information for the pursuit of an organization goals.
 Financial Accounting is aimed to provide
information to parties outside the organization
e.g. Stockholders, Banks, Creditors, investors,
Government e.t.c
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Accounting is concerned with:
1. Identification and recording of transactions:
A transaction is an economic event which affect the financial
situation of the business. A transaction could be: a sale of a product,
the purchases of raw materials , purchase of a machine, payment of
salaries or the receive of a loan. The accounting system must be
well organized so as all transactions are recognized when they take
place and then are recorded in the books of the business using the
book-keeping function.
A double-entry bookkeeping system is a set of rules for recording financial
information in a financial accounting system in which every transaction or event
affects at least two different ledger accounts. The accounting process includes the
bookkeeping function, but is just one part of the accounting process
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2. Classification and measurement of transactions after they
have been recorded. Economic events may create assets (items
which the business owns) or liabilities (what is due by the business
to others) or revenues (income from sales) or costs/expenses
(amounts incurred to make products or operate the business).
Therefore correct classification is important. Measurement
follows the classification and by this we mean: how mush of the
costs or revenues concern this year and how mush must be
carried forward to the next year.
3. Summarization and communication. Since the Accountant
has record all the transactions a summary is extracted which show
the performance of the business during a period – a month or a
year . This summary is shown through the financial statements
which they communicate information regarding the financial
position of the business to a wide range of users.
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Financial Statements
• The Accounting service is analyzing data with the
preparation of financial statements. The most widely
used financial statements are:
 The Statement of Financial Position (Balance Sheet) and
 The Income Statement (Trading and Profit & Loss
account).
To achieve its goals, an accounting system may make use of
computers and video displays as well as handwritten records and
reports printed on paper
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Financial Statements
 1. Balance Sheet: is a statement of the assets, liabilities and owners’ equities as at
a specific point in time (next day things could be different).
– Assets – are things owned by the business such as motor vehicles, machinery,
inventory (goods manufactured or purchased for resale), money owed by
debtors, balance at bank and prepaid expenses.
Assets are divided into fixed assets: A long-term tangible piece of property that a
firm owns and uses in the production of its income and is not expected to be
consumed or converted into cash any sooner than at least one year's time, and
current assets: the value of all assets that are reasonably expected to be
converted into cash within one year in the normal course of business.
.
Goodwill is an Intangible F.A.
– Liabilities – are amounts owed such as money due to
overdrafts, short term loans.
creditors, bank
– Owners’ equity – is a type of liability but this amount is due to the owner of the
business rather than to ‘outsiders’. It increases by any new capital brought in and
by the net profit made by the business and reduces by any amounts withdrawn
by the owner.
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• Goodwill typically reflects the value of intangible
assets such as a strong brand name, good customer
relations, good employee relations,innovation,new
products and favorable location. The evidence that
goodwill exists is the proven ability to earn excess
profits.
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Statement of Financial Position (Balance Sheet) as at 31st December 20YY
Fixed Assets
€
Land and Buildings
X
Furniture and Fittings
X
Motor Vechicles
X
Goodwill
Current Assets
Stock
Debtors (Accounts Receivable)
Prepayment of Expenses
Bank
Cash
X
€
Capital
Add Net Profit
Less Drawings
X
X
X
Long-term Liabilities
(repayable later than one year)
X
X
Long-term Loan
X
X
X
X
Current Liabilities
(amounts due within a year)
Creditors (Accounts Payable)
Accrued Expenses
Bank Overdraft
Short Term Loan
X
X
X
X
X
X
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X
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The Accounting Equation
• Assets = Liabilities + Capital
Or otherwise :
Capital=Assets-Liabilities
The balance sheet must always balance which means
must always satisfy the above equation, at any time
assets equals liabilities plus the capital .
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Balance Sheet as at 31 December Year 20XX
Fixed Assets
€
€
Land and Buildings
Furnitures and fittings
Motor Vehicles
Goodwil
x
x
x
x
x
x
x
x
x
Current Assets
Closing Inventory
Debtors
Prepayments
Bank
Cash
xxxxxx
Capital Account
Add Net Profit
Less Drawings
x
x
x
x
x
x
x
x
x
Long-trrm Liabilities
Long term loan
Current Liabilities
Creditors
Accruals
Bank Overdraft
Short term loan
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xxxxxx
13
 2. Income Statement:
Presents the results of operations for a period of
time. It usually covers a year of business activity in contrast to balance sheet which is
as at a specific point in time.
The income statement is prepared following the accruals
concept: the income and expenses are recorded as they
occurred regardless of whether cash has been received or
paid .
– Income – the sales revenue shows the income from goods/services
sold in the year.
– Expenses – in order to make revenues we must incur expenses: an
outflow of money to pay for an item or service e.g. wages, rents,
electricity e.t.c
The income statement is split into two parts a) the Trading
account which gives the gross profit and b) the Profit & Loss
account which gives us the Net Profit.
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Trading and Profit & Loss account
€
Opening Stock
X
Add Purchases
X
X
Less Purchases Return
Less Closing stock
X
X
X
Gross Profit c/d
Wages and Salaries
Insurance
Rent
Depreciation of motor vehicles
and Furniture's
Bad Debts
Discount allowed
Net Profit
X
X
X
X
Cost of Sales
Office Expenses
Sales
Less Sales Returns
€
X
X
X
Gross Profit b/d
Discounts Received
X
X
X
X
X
X
X
Chara Charalambous
MBA CDA COLLEGE
X
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• The above layout of the income statement is not mainly useful
but is assists the appreciation of the actual double entry
processes and the realization that the income statement is part
of the double entry.
• The modern-vertical layout is as follows:
Income statement: Trading and Profit & Loss account
Sales
x
Less Cost of Sales:
Op. Stock
x
Purchases
x
Less Closing stock
(x)
(x)
GROSS PROFIT
xx
Less Expenses
(x)
NET PROFIT
xxx
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The modern-vertical layout of Income Statement is as follows:
Income statement: Trading and Profit & Loss account
Sales
Less Cost of Sales:
Op. Stock
Purchases
Less Closing stock
GROSS PROFIT
Less Expenses:
– Wages / Salaries
Heating & Lighting
– Rent
– Insurance
– Advertising
– Bad Debts
– Depreciation
– Stationery
– Commission Paid
– Bank interest & charges
– Cleaning
– Office Expenses
NET PROFIT
x
x
x
(x)
(x)
xx
x
x
x
x
x
x
x
x
x
x
x
x
(x)
xxx
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Public Companies deduct from their Net Income the dividends paid:
•
•
•
•
•
•
•
•
•
•
•
•
•
Sales
— Variable costs
Contribution margin
— Fixed costs
Operating income
or EBIT
— Interest Expense
EBT: Earnings before taxes
— Taxes
EAT: Earnings after taxes (NET INCOME)
— Dividends of preference shares
Earnings available to common shareholders
Number of ordinary Shares
EPS: Earnings per share
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USERS
OF
FINANCIAL
STATEMENTS
The financial accounts provide a wealth of information that is
useful to various users of financial information
INVESTORS
CUSTOMERS
MANAGEMENT
OWNERS
SUPPLIERS
EMPLOYEES
USERS
LENDERS
THE PUBLIC
COMPETITORS
GOVERNMENT
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Managers:
need information on a monthly basis to control the
business, plan for the future and evaluate profitability. They prepare
budgets based on past performance and they compare it to actual
results.
Owners:
The financial Statements tell the owners just how
successful the business has been and also summarise in brief form its
present financial position
Investors:
are concerned with how secured and the profitable is
their investment in the specific company. This is shown in the income
statement.
Employees:
are interested to know if an employer can offer
secure employment, possible salary increases and retirement
benefits. They are also interested in the pay and benefits obtained by
senior management!
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Lenders:
Banks and other financial institutions who lend money
to a business require to know if they will be repaid. This is shown in
the balance sheet which displays the solvency of the firm.
Government: need to know how the economy is performing so
as to plan financial policies. Also the tax authorities evaluate the tax
witch is payable by the companies with the use of financial
statements.
Suppliers: need to know if the business is able to pay short-term
debt when it falls due.
Competitors: wish to compare
their own performance against
that of other firms that are operating in the same sector.
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Internal Users of Accounting
Information










Board of Directors
Chief Executive Officer
Chief Financial Officer
Vice Presidents
Business Unit Managers
Plant Managers
Store Managers
Line Supervisors
Business Owners
Employees
USERS OF FINANCIAL INFORMATION QUICK QUIZ
• Suppose you are the manager of a famous chain
company which sells cloths and accessories. The
company needs a bank loan in order to purchase
equipment for its stores. In evaluating the loan request,
the banker asks about the assets and liabilities of the
business. In particular, the banker wants to know the
amount of the business’s stockholders’ equity.
Requirements:
1.Is the banker considered an internal or external user of
financial information?
2.Which financial statement would provide the best
information to answer the banker’s questions?
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ANSWERS:
1.Is the banker considered an internal or external user
of financial information? The banker is an external
user.
2.Which financial statement would provide the best
information to answer the banker’s questions? The
balance sheet
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Main Types of Business Transactions
Duality Concept: Each and every transaction that the business
makes has two aspects and has a double effect on the business
and accounting equation.
B/ce Sheet
• 1. SALES OF GOODS: If with cash
If with credit
 2. PURCHASES: If with cash
If with credit

Incm Stat.
cash
debtors
cash
sales
sales
purchases
creditors
purchases
3. PURCH. OF FIXED ASSETS: If with cash
If with credit
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cash
F. A
creditors
F.A
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B/ce Sheet
• 4. PAYMENT OF EXPENSES: cash
• 5. BRING NEW CAPITAL:
cash
capital
• 6. DRAWINGS:
cash
capital
Incm Stat
expense
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Transaction
An event that affects the financial position of
the business
Can be measured reliably
Every transaction affects at least two items in
balance sheet or income statement or in both
financial statements
The accounting equation balances before and
after each transaction
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Accounting Concepts and Principles
GAAP - USA
Generally Accepted Accounting Principles
 Guidelines that govern accounting
 Based on a conceptual framework
 Goals include:
• Provide useful information for investment and lending
decisions
• Must be relevant, reliable, and comparable
IFRS – EUROPE
International Financial Reporting Standards
 Harmonize accounting across the European Union
 A common global language for business affairs so that
company accounts are understandable and comparable
across international boundaries.
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The business entity concept
 Accepted accounting principles require that a set
of financial statements describe a specific
business body, which is called business entity.
 Financial Accounting information relates only to
the activities of the business entity and not to the
activities of its owner. For e.g. if the owner buys
a car for him and his family to use personally this
transaction will not influence the balance sheet
elements at all.
 The business entity is treaded as separate from
its owners.
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Accounting Principles: Statement of
Standard Accounting Practice (SSAP)
Is concerned with the disclosure (notification , communication)
of accounting policies – the guidelines and rules that must
followed when preparing the financial statements.
The 5 fundamentals accounting concepts mentioned by the
standard are:
a.
b.
c.
d.
e.
The going-concern concept
The accruals concept
The consistency concept
The prudence concept
Cost Principle
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a. Going concern: the business for which we are
preparing the financial statements is going to continue
in operation for an undetermined period. Before the
accounts are certified as showing a true and fair view ,
the auditor must be satisfied that the company is a
going concern and that it will continue to function
successfully in the future. The auditor in order to
assume that the company is a going concern is based
on the following factors: the demand of the
company’s product in the market , if the company
have sufficient cash to respond to its liabilities in the
future and if it is profitable. Also if the company has
sound capital to face any future unexpected events
and finally if the company is competitive enough
regarding its products, its ability to acquire raw
materials and labor.
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b. The income statement for a period is prepared
following the accruals concept: the income and
expenses are recorded as they happened in the
period regardless of whether cash has been
received or paid :
Costs which are paid but they are concerning a
future period must be carried forward as a
prepayment and charged in the period they
concern not in the current profit and loss account.
The same for income: if there is an income received
but it regards a future period for e.g. next year it
will not included in the income statement of this
period but of the next and for the current year it
will consider as prepayment Expenses of the period
not yet paid and not entered in the books must be
estimated and inserted as accruals.
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The Accrual Basis of Accounting has two parts:
Principle of Revenue
Recognition:
Revenues are recognized
and recorded
in the
period earned regardless
of whether cash has been
received.
Matching Principle:
Expenses are recognized and
recorded in the period incurred
regardless of whether cash has
been paid. The timing of the
recognition of revenues and
expenses are matched and
reported
on
the
income
statement.
This
principle
measures all the expenses
incurred during a year and
matches them against the
revenues of the year.
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Chara Charalambous MBA CDA COLLEGE
c. Prudence concept: Business
transactions are
sometimes uncertain. While making judgment we
need to be careful and prudent. Prudence is a key
accounting principle which makes sure that assets
and income are not overstated and liabilities and
expenses are not understated. Accountants must not
be very optimism and overstate profits and causing
by this unrealized profits to be paid out of capital in
the form of dividends. Because there is a danger that
the profit might not finally realised since some of the
clients of the company might declared bankruptcy
and not pay. Therefore Accountants mast be strict
with profits but take in mind all possible losses.
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d. Consistency: with many accounting transactions there is more
than one method which can be used. For example the
depreciation method and policy. Accountants must use their
judgment to select the most appropriate method, but once
that choice is made the same method must be used with
consistency (stability) in forthcoming periods. Such
consistency enables users to make a useful comparison of
results over time. Thus investors can see the level of profit or
loss, comparing this year with the last year , and make their
investment decisions accordingly. The methods used should
only be changed if the new method selected improves the
true and fair value given by the accounting statements.
e. Cost Principle: Assets are recorded at purchase price not the
price that the owner might believe it deserves to the asset.
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Governing Organizations
FASB
• Financial Accounting Standards Board
• A privately funded organization, formulates accounting
standards.
SEC
• Securities and Exchange Commission
• U.S. governmental agency that oversees U.S. financial markets.
GAAP (USA)
• Generally Accepted Accounting Principles
• Main U.S. accounting rule book
IASP
• International Accounting Standards Board
• Publishes the International Financial Reporting Standards, the
international accounting rule book
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Ethics in Accounting and Business
Investors and creditors want reliable financial information
Conflict of Interest
Companies want to attract investors
THUS we have AUDIT
• SEC requires companies to have financial statements examined
by independent accountants
• Auditors will provide an opinion on financial statements
• Also created the Public Companies Accounting Oversight Board
(PCAOB) :Supervisory body of accounting profession
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Forms of business organizations
Sole Trader: Owned and operated by one person,
although there might be any number of employees.
A Sole Trader is fully and personally liable for any
losses that the business might take.
Advantages:
 It is easy and inexpensively formed but in most cases must be
licensed by the municipality in which it operates.
 Subject to few government regulations
 No corporate income taxes, it is taxed like an individual
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Limitations:
 The owner has unlimited personal liability on business debts
which can result in losses that exceed the money the owner
has invested in the company.
 Difficult to raise capital because the firm’s financial strength
is based on the financial strength of the sole traded
 Transferring ownership is difficult – selling of the business is
similar to selling a house and the proprietor has to seek out
and negotiate with a potential buyer.
 Limited life of the business equal to the life of the individual
who created it.
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 Partnership: Owed and operated by two or more people
called the ‘partners’.
Partners are ‘jointly and severally’ liable for any losses that
the business might make.
Traditionally the big accounting firms have been partnerships
 A partnership has roughly the same advantages and
limitations as a proprietorship. Also is not a legal entity
separate from its partners. And therefore each partner is
an agent of the business – a representative.
Regarding liability the partners can lose all of their
personal assets even those not invested in the business
because under partnership law all each partner is liable for
the business’ debts. Thus if any partner is unable to meet
his or her prorate claim in the event the partnership goes
bankrupt, the remaining partners must cover the
unsatisfied claims. Chara Charalambous MBA CDA COLLEGE
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 Company: Owned by many people (shareholders) and operated
by many people (thought not necessarily the same).
•
•
•
•
•
•
•
There can be one shareholder or many thousands of
shareholders.
A company is a legal entity separate from its members
Each shareholder owns part of the company.
Shareholders are not representatives of the company.
As a group, they elect the directors who run the business.
Directors often own shares in theirs companies.
Not all shareholders are directors.
Companies are limited companies (This means that the
shareholders will not be personally liable for any losses the
company incurs).
• Their liability is limited to the nominal value of the shares
that they own.
•
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 Advantages:
 Unlimited life: it can continue after its original owners are dead.
 Easy transfer of ownership: ownership can be divided into shares of
stock which in turn can be transferred far more easily than the other
two form of organizations.
 Limited liability: the loss of a shareholder in case of bankruptcy is
limited to the amount he/she initially invested
 Ease of raising capital in the financial markets for the above reasons
(sell shares e.t.c), because investors will have limited liability and since
many will invest funds can be invested in growth opportunities which
will increase the value of the firm.
There are two main disadvantages for the corporations:
 Disadvantages:
 Double taxation of earnings: the earnings of the corporation are
taxed and then the earnings paid as dividends are taxed again as
income to the stockholders
 Setting up a corporation and filing required lawyer to prepare
regulations and rules regarding the management of the company
and reports given to the government , is more complex and time
consuming the other two forms of organizations.
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Capital
For all three types of organization, the money contributed by the
individual, the partners or the shareholders is referred to as the
business capital.
In the case of a company the capital is divided into shares. And
shareholders receive dividend which is paid at the end of the year
out of the profits.
Funds raised by issuing shares in return for cash. The amount of
share capital a company has can change over time because each
time a business sells new shares to the public in exchange for cash,
and thus the amount of share capital will increase. Share capital can
be composed of both common and preferred shares.
.
Also known as "equity financing“.
capital
When a corporation issues only one class of stock: ordinary shares,
we call it Common stock also generically called capital stock. (or
capital stock).
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Stockholders’ Equity
Common stock
+ Retained earnings
+ Revenues – Expenses
– Dividend
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Non-Profit Organizations
Non-profit organizations are organizations whose activities are
directed towards completing a social target: for e.g. providing a
service, promoting worthwhile principles, raising funds for
humanitarian purposes, offering entertainment to their
members and the community in general. The main objective of
these organizations is not to make a profit. Examples are:
Social and athletic clubs, football clubs and charitable
organizations.
Non-profit organizations include churches, public schools,
public charities, public clinics and hospitals, political
organizations, legal aid societies, volunteer services
organizations, labour unions, professional associations,
research institutes, museums, and some governmental
agencies.
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Examples of Non-Profit Organizations
• England: The Wellcome Trust (double ll) was established in 1936 as
an independent charity funding research to improve human and
animal health. They do medical research to "achieve extraordinary
improvements in health.
• UNESCO United Nations Educational, Scientific and Cultural
Organization Its purpose is to contribute to peace and security by
promoting international collaboration through education, science,
and culture in order to promote universal respect for justice, the
rule of law, and human rights, along with fundamental freedom.
Projects sponsored by UNESCO include technical and teachertraining programmes; international science programmes; the
promotion of independent media and freedom of the press, the
promotion of cultural diversity, international cooperation
agreements to secure the world cultural and natural heritage (and
to preserve human rights. UNESCO’s aim is "to contribute to the
building of peace, the elimination of poverty, sustainable
development and intercultural dialogue through education, the
sciences, culture, communication and information".
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• SOS Children’s Villages the largest orphan and abandoned
children’s charity in the world they strive to create awareness
and build support for SOS Villages around the world.
• Sports Non-Profit Organizations
• However, there are also millions of smaller NPOs that provide
social services and relief efforts to people throughout the
world. There are more than 1.6 million NPOs in the United
States alone.
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THANK YOU
QUESTIONS
EXERCISES
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