Review of Accounting

Financial Accounting

 Conceptual foundations

 What is Accounting

 “A process of 3 activities: identifying, recording and communicating the

economic event of an organization”

 Assumptions in Financial Reporting

 Monetary Unit Assumption: “Only those numbers being reported in money are
included in accounting records”

 Economic Entity Assumption: “Every economic entity can be separately

identified and accounted for”

 Time Period Assumption: “The life of a business can be divided into artificial
time periods and that useful reports covering those periods can be prepared for
the business.”

 Going Concern Assumption: “The business will remain in operation for the
foreseeable future”

 Principles

 Cost Principle: “Assets are recorded at their cost”

 Full Disclosure Principle: “Requires that all circumstances and events that would
make a difference to financial statement users should be disclosed”

 Income statement

 Helpful in determining both past and future performance

 Limitations

 Important information used in predicting future performance may not be

measurable limiting predictability

 Accounting Methods are not considered in preparing an income statement

 Parts

 Revenues

 Expenses
 Balance Sheet

 Assets = Liabilities + Shareholders’ Equity

 Consists of 3 parts

 Assets (right-side)

 Current Assets

 Cash

 Inventory

 Accounts Receivable

 Long-term investments

 Property, Plant and equipment

 Intangible Assets

 Patents

 Copyrights

 Brands

 Liabilities (left-top)

 Current

 Accounts Payable

 Salaries

 Interest

 Notes

 Long-Term

 Mortgage

 Notes

 Shareholders’ equity(left-bottom)

 Common Stock
  Retained Earnings

 Based on a given date rather than a period of time

 Statement of cash flows

 Shows both the incoming and outgoing cash flow

 3 Sections

 Cash Flows from operating Activities

 Transactions that create revenues or expenses

 Apply to the net income

 Cash Flows from investing Activities

 Purchasing and disposing of investments and productive long-lived

assets using cash

 Lending money and collecting the loans

 Cash Flows from financing Activities

 Obtaining cash from issuing debt and repaying the amounts borrowed

 Obtaining cash from stockholders and paying dividends

 “The cash flow statement has been adopted as a standard financial statement
because it eliminates allocations which might be derived from different
accounting methods, such as various timeframes for depreciating fixed assets.”

Managerial Accounting

 Cost concepts

 Cost: a sacrifice of resources

 Cost driver: Any factor whose change “causes” a change in the total cost of a related
cost object. Note: Cost drivers can be factors other than volume

 Direct costs: Costs that can be traced to a given cost object (product, department, etc.)
in an economically feasible way.

 Indirect costs: Costs that cannot be traced to a given cost object in an economically
feasible way. These costs are also known as “overhead”.
  Cost assignment: Direct costs are traced to a cost object. Indirect costs are allocated or
assigned to a cost object.

 Product costing systems

 Product costs: Costs that “attach” to the units that are produced (i.e., manufacturing
costs) and are not reported expenses until the goods are sold.

 LIFO vs. FIFO-how do you handle your merchandise?

 LIFO-recording the last units purchased as the first goods sold

 In times of inflation, LIFO results in higher reported cost of goods sold

and thus lower income and retained earnings

 This leads to lower taxes, which results in higher net income

 Results in lower reported assets and equity

 In the case of LIFO, the business will appear less well off

 FIFO-recording the oldest units will be first to be sold

 In times of inflation, FIFO results in lower reported cost of goods sold

and thus higher income and higher retained earnings

 This leads to higher taxes, which results in lower net income

 Results in higher reported assets and equity

 Business will appear better off than in LIFO

 Activities-based costing

 An overhead cost allocation system that allocates overhead to multiple activity cost
pools

 Assigns the activity cost pools to products or services by means of a cost driver that
represents the activity used

 Activity: an event, action, transaction, or work sequence that causes a cost to be

incurred in producing a product or providing a service

 Activity cost pool: a distinct type of activity. ie ordering materials

 Cost driver: any factors or activities that have a direct cause and effect
relationship with the resources consumed
  “Products consume activities and activities consume resources”

 Basis of the ABC system

 Identify activities

 Trace the cost of resources to the activities consumed

 Identify activity measures by which the costs of the process vary most directly

 Trace activity costs to the cost objects

 Typical activity cost drivers

 Units produced

 Number of receipts for materials/parts

 Direct labor hours

 Set-up hours

 Number of customer complaints

 Cost, volume, and profit analysis

 A financial decision making aid used to determine the level of output used to achieve
any target profit level or the financial impact of basic business activities like changes in
costs or pricing.

 Two main tools used for CVP analysis:

 Break-even analysis

 Contribution margin analysis which compares profitability of production lines

 There are several assumptions made:

 Behavior of cost and revenue is linear throughout the relevant range of the
activity index

 All costs can be classified as variable or fixed

 Changes in activity are the only factors that affect costs

 All units produced are sold

 Sales mix is constant with more than one type of product

  Helpful for producing a flexible budget and determining pricing decisions that should be
made for the product

 Budgeting

 Budget: a formal written statement of management’s plans for a specific future time
period, expressed in financial terms

 Primary way to communicate agreed upon objectives to all parts of the

company

 Promotes efficiency

 Control device-important basis for performance evaluation once adopted

 Essentials of Effective Budgeting:

 Depends on a sound organizational structure with authority and responsibility

for all phases of operations clearly defined

 Based on research and analysis with realistic goals

 Accepted by all levels of management

 Benefits of Budgeting:

 Requires all levels of management to plan ahead and formalize goals on a

recurring basis

 Provides definite objectives for evaluating performance

 Creates an early warning system for potential problems

 Facilitates coordination of activities within the business

 Results in greater management awareness

 Motivates personnel throughout organization to meet planned objectives

 Budgeting Process:

 Base budget goals on past performance

 Collect data from organizational units

 Develop budget within the framework of a sales forecast

  Shows potential industry sales

 Shows company’s expected share

 Usually informal in small companies; assigned to a budgetary

committee in larger companies

 Standard Costing

 A system of cost accounting which is designed to find out how much should be the cost
of a product under the existing conditions

 Rather than assigning the actual costs of direct material, direct labor, and manufacturing
overhead to a product, many manufacturers assign the expected or standard cost

 The actual cost can be found only when production is undertaken

 The predetermined cost is compared to the actual cost and a variance between
the two enables the management to take necessary corrective measures

 May lead to variances

 Favorable-standard costs are greater than actual costs

 Unfavorable-actual costs are greater than standard costs

 Advantages of Standard Costing

 Efficiency Measurement

 Finding of variance

 Management by exception

 Cost control

 Right decisions

 Eliminating inefficiencies

 Limitations of Standard Costing

 Products must be homogenous

 The process of setting a standard is a difficult task requiring technical skills

 With the change of circumstances, if the standards are not revised, they become
impractical
  Non-routine decision making

 Short-term, nonrecurring decision such as the following:

 To accept or reject a special order

 To make or buy a certain part

 To sell or process further

 To keep or drop a certain product line or division

 In these types of decisions, a choice is typically made considering the

Relevant Costs and Contribution Margin

International Accounting

 International Accounting Standards Committee was founded in June

1973 in London and replaced by the International Accounting Standards
Board on April 1, 2001. It was responsible for developing the
International Accounting Standards and promoting the use and
application of these standards.

 The IASC was founded as a result of an agreement between

accountancy bodies in the following countries:

 Australia, Pakistan, Canada, France, Germany, Japan, Mexico,

the Netherlands, the United Kingdom and Ireland, the United
States of America

 The IASC had about 140 member bodies from 104 countries.

 International Financial Reporting Standards (IFRS) are standards and

interpretations adopted by the International Accounting Standards
Board (IASB).

 Many of the standards forming part of IFRS are known by the

older name of International Accounting Standards (IAS). IAS
were issued between 1973 and 2001 by the board of the
International Accounting Standards Committee (IASC). In April
2001 the IASB adopted all IAS and continued their development,
calling the new standards IFRS.
 2001 International Financial Reporting Interpretations Committee
(IFRIC).

 IFRIC Members

 14 Members plus non-voting Chairman

 US member? :Philip D Ameen: (Vice Pres and Comptroller of the

GE Company)

 United States and convergence with US GAAP

 In 2002 at a meeting at Norwalk, Connecticut, the IASB and the

US Financial Accounting Standards Board agreed to harmonise
their agenda and work towards reducing differences between
IFRS and US GAAP (the Norwalk Agreement). In February 2006
FASB and IASB issued a Memorandum of Understanding
including a programme of topics on which the two bodies will
seek to achieve convergence by 2008.

 US companies registered with the United States Securities and

Exchange Commission must file financial statements prepared
in accordance with US GAAP. Until 2007, foreign private issuers
were required to file financial statements prepared either (a)
under US GAAP or (b) in accordance with local accounting
principles or IFRS with a footnote reconciling from local
principles or IFRS to US GAAP. This reconciliation imposed extra
expense on companies which are listed on exchanges both in
the US and another country. From 2008, foreign private issuers
are additionally permitted to file financial statements in
accordance with IFRS as issued by the IASB without
reconciliation to US GAAP.[

 SECURITIES AND EXCHANGE COMMISSION 8/7/07

 Proposal to allow US companies to start using IFRS standards in

the US!

 IFRS 1 First-time Adoption of International Financial Reporting

Standards

 Example of one of the current IFRS statements

 …financial statements, contain high quality information

that:
 (a) is transparent for users and comparable
over all periods presented;

 (b) provides a suitable starting point for

accounting under International Financial
Reporting Standards (IFRSs); and

 (c) can be generated at a cost that does not

exceed the benefits to users.