Overview of Financial Reports

There are 3 main minds of financial reports or statements

1. Balance Sheet

 Balance sheet also called statement of financial position

 It is report of organization’s financial situation at a particular point of time
 It lists entities such as assets, liabilities, and owner’s equity
 It is called balance sheet because it reports balances of assets, liabilities, and owner’s
equity.
2. Income Statement

 The income statement shoes the entity’s operating performance during a specific period
 That period is known as accounting period. It is displayed at the top of the statement.
3. Statement cash Flows

 It shows the sources and uses of cash by an entity over a period.

 It is organized by type of business activity i.e., operating, investing, and financing.

Introduction to Concepts
Financial accounting system lays the foundation on which accounting systems and reports are
built.
Accounting concepts provide guidance to resolve accounting issues.
There are 5 main accounting concepts names entity, money measurement, going concern,
consistency, and materiality.
1. Entity Concept

 It is the most basic accounting concept.

 It states, “accounts are kept for an entity as distinct from the people who own, run or
do business with the entity”.
 It allows accountant to draw a virtual boundary around the entity and hence limit the
activities that need to be tracked and recorded.
 Example, Global Grocer is an accounting entity, and only it’s accounting transactions will
be recorded. If I get a salary from Global Grocer, it will be recorded in the book. But if I
buy something from that salary, that transaction will not be recorded.
 A boundary is kept between Global Grocer transactions and my personal transactions.
2. Money Measurement Concept

 It states, “financial accounting deals only with the things that can be represented in
monetary terms”.
 This concept is very basic and is usually taken for granted.
 Example, If Global Grocer buys merchandise, it will be recorded in the balance sheet as
it has a monetary value. But to be successful, we require valuable employee, but this
can not be recorded in the balance sheet as value of an employee cannot be recorded
into monetary value.
3. Going Concern Concept

 Going Concern says that “an entity is expected to remain in operation for an indefinite
future”
 Going Concern concept allows accountants to make this assumption in absence of
contrary evidence.
 Example, If Global Grocer has open bin items such as cheese, olives, and fruits. If Global
Grocer decides to shut down then realistically, these open bin items will be thrown
away and hence should be recorded as loss. But Going Concern allows accountant to
record the value of these items as assets as if Global Grocer were going to sell those
items.
4. Consistency Concept

 Consistency Concept states that “an entity should use the same accounting methods
and procedures from period to period unless they have a sound reason to change the
methods”.
 Consistency concept reduces the likelihood of random and sudden changes in
accounting procedures by an entity.
 Consistency Concept does not forbid a switch in accounting procedures.
 In the context of accounting concepts, consistency means consistency over time
5. Materiality Concept

 Materiality Concept states that, “Proper accounting is only required for the items that
are materials”.
 Materials are those items that are significant to potential users of the financial
statement.
 A general rule in accounting is “An item is material if it’s disclosure would impact the
decision of the users of account statement”.
 This concept allows accountant to be practical in choosing the appropriate degree of
precision in the accounts.
 Whether an item is material or not is subjective, and hence, can differ from accountant
to accountant.
Quality Attributes
In any financial accounting system, decision must be made whether to record a transaction or
not. If it is to be recorded, then when to record it and how to record it. There must be a criteria
or guidelines to help make those decisions. We will discuss the quality attributes of a
transaction, and the guidelines that come with it, required for it to be recorded.
Relevance
Relevance refers to timeliness and usefulness of the information to its users
Reliability
Reliability refers to the objectivity and verifiability of the information
Note
While recording a transaction where both attributes i.e., relevance and reliability cannot be
determined together. Reliability is generally given precedence over relevance.

Example
Global Grocers bought a property worth 70,000 USD. Whereas some real estate brokers valued
the property to be of 75,000 USD.
Relevance criterions says, Global Grocers owns a property that is valued 75,000 USD to some of
the real estate agents. Hence it should be recorded as 75,000 USD.
Reliability Criterion says, to record the transaction of 70,000 USD, as this was the original price
for which the property was bought.
The figure 70,000 USD is a verifiable amount and hence reliable, compared to 75,000 USD,
which is relevant but can vary from agent to agent. In such case reliability is favored upon
relevance

Accrual Accounting
 Accrual accounting is important in finding relevance in accounting reports.
 This method provides information about company’s assets, liabilities and owner’s equity
that cannot be obtained by cash receipts and outlays
 Accrual accounting focusses on economic characteristics of transactions rather than
cash flows
 Accrual accounting records the transaction when it is maid rather than when the cash of
said transaction is received or paid.
  Example, If Global Grocer buys a van of 10,000 USD with the promise to pay cash after a
month, transaction will be recorded today, rather than when the cash will be paid.
 Example, if a customer buys merchandise of 100 USD, paying 25 USD at the spot and
promise to pay 75 USD after a month, accrual accounting would record the transaction
of whole 100 USD with 25 USD in cash and 75 USD in receivables. In cash-based
accounting only 25 USD would be recorded.

GAAP
 Generally accepted accounting principles are guidelines for accountants, managers, and
auditors, which they must follow while preparing and auditing accounting information
for external use, i.e., making financial statement.
 These principles are more numerous than accounting concepts.
 These are explicit rules used to improve reliability and comparability of financial reports.
 Financial Accounting Standard Board (FASB) determines GAAP in United States.
 There is also International Accounting Standards Board (IASB), which has taken efforts to
harmonize accounting standards around the world.

IFRS
The international Accounting Standard Board (IASB) publishes International Financial Reporting
Standards (IFRS).

Principles Based versus Rules Based

 IFRS tends to be stated in the form of broad principles.
 GAAP tends to be explicit bright line rules.
 As GAAP and IFRS converge, it is anticipated that GAAP will become more principle
based.

The Balance Sheet

In this chapter, you will learn

 How a balance sheet is organized and about its main organizing principle
 The accounting equation
 Two concepts that are important for the preparation of the balance sheet
 Dual aspect
 Historical cost will be explained.
They will be used to record the operating, investing, and financing activities you have
undertaken to get Global Grocer ready for business. Finally, two financial ratios that can be
computed from the balance sheet--current ratio and total debt to equity ratio--will be
discussed.