ACT B861F

Accounting for
corporations
Lecture 1
ACT B861

Renfred WONG
Email: rwlwong@ouhk.edu.hk
CIMA, CPA Australia

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ACT B861

? Success ?
Read, understand, practise

I am here only to facilitate your learning

You are responsible for your own learning
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ACT B861

If you want to send me an email…

Please include your full name
Submitting assignments thro’ OLE:
• Please DO NOT zip files
• Follow requirements in “assignment file section” in study pack
• All assignments must be WORD PROCESSED (i.e. MS WORD) and
are to be submitted via the OLE. Assignments prepared by MS
EXCEL are NOT accepted
• Make sure you are submitting the final version of your work
• Avoid the last minute rush; OLE acknowledges your submission
• Only highlights in lectures and tutorials; you are expected to
read thro’ learning materials in your own time 4
ACT B861

Assignment Due Dates

Assignment: 26th November 2021

Presentation: 13th December 2021

(Exam: details to be announced in due course)

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ACT B861

Reminder
• Whatever you do, please do not copy and paste
• Academic integrity is key
• Need to understand academic referencing
thoroughly
• Assignment: there is NO need to copy the
assignment questions in your response or
submission
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ACT B861

You may wish to know…

Teaching in this course –
• Based on International Accounting Standards / HK Accounting
Standards, NOT American or PRC accounting standards.
• Some US based textbooks should be used for reference only.
Good in explaining certain concepts, but not everything is
applicable in HK, e.g. LIFO and certain depreciation methods.
Lectures/Tutorials
• Attendance/ participation has positive correlation with success
Discussion Board – general communication and announcements
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ACT B861

Worth thinking about…

• Reflect on the relevance of accounting to you, and how
studying accounting may help you in the future
• Safe environment – this course and OU in general; it is
OK to make mistakes
• A problem may be an enduring problem until you try to
solve it
• You should question your own preconceptions of
accounting – is it really just about numbers?

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ACT B861

Poll 1

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ACT B861

ACT B861
• Don’t worry
• Start from the basics
• Exercises/ practice questions on OLE
• During lectures/ tutorials: getting immediate
feedback

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 Contents
Unit Topic
1 An overview of financial accounting
2 Operating Activities
3 Financing Activities
4 Investing Activities
5 Other issues in financial reporting
Revision

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Unit 1
An overview of
financial accounting
ACT B861

Learning outcomes
• Understand the conceptual framework and
the objective of financial reporting
• Understand the major components of the
following financial statements:
• Statement of financial position (balance sheet)
• Statement of profit or loss (income statement)
• Statement of cash flow (cash flow statement)
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ACT B861

Session 1
Conceptual framework

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ACT B861

The conceptual framework and objective of

financial reporting

Theoretical Foundation Entity Theory

Historical cost

Conceptual Framework
Preface to HKFRS
Conceptual Framework
Accounting Standards
Legal
requirement HKAS
Financial Reporting HKFRS

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ACT B861

Question

Why do we need accounting (or

accounting information)?

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ACT B861

A user oriented approach

• Shareholder: to see how an investee firm is doing
financially and its future plans
• Potential investor: to see if a firm is worth investing in
• Banker (or other creditors): to see if a loan should be
provided to a company asking for a loan
• Prospective employee: look at a company’s \financial
statements to see what line(s) of business the company
is in and if it is financially healthy
• Competitor: to see how a rival has been doing e.g.
Prada and Gucci
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 LO1-1
Primary Focus of Financial Accounting
• Providing financial information to various external
users (but mainly capital providers):
Investors Creditors Other external users
Investors Use different kinds  To predict future
and of information risk and potential
creditors Financial information, return of
conveyed through investments or
financial statements and loans
disclosures notes, is a key  Before supplying
component of that capital to
information set. businesses 18
 LO1-1
The Investment-Credit Decision
Why do investors and creditors provide capital?
• They want to earn a fair return on the resources
they provide.
• Shareholders receive cash from:
– sale of the ownership shares
– periodic dividends
Accounting information should help investors
evaluate the amount, timing, and uncertainty of
the enterprise’s future cash flows. 19
ACT B861

Some conceptual underpinning of accounting

The entity concept
• the entity (the company, the firm…) is viewed as having
separate existence from the capital providers; e.g. owner’s
own expenses (buying cosmetics) cannot be counted as a
legitimate business expense
• Simply put, the company rather than the owners/
shareholders is the centre of accounting interest
• The company owns the resources of the enterprises and is
liable to both the claims of the owners and the claims of
the creditors
• Asset = Liability + Equity (basic equation of accounting)
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ACT B861

How to prepare Financial Statements?

Conceptual Framework for Financial Reporting 2018 deals with:
a) the objective of financial reporting;
b) the qualitative characteristics of useful financial information;
c) financial statements and the reporting entity;
d) the definition, recognition, measurement, presentation and
disclosure of the elements from which financial statements
are constructed; and
e) concepts of capital and capital maintenance.

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ACT B861

Financial Statements: HKAS 1 (Revised):

• Financial statements are a structured representation of the
financial position and financial performance of an entity.
• The objective of financial statements is to provide
information about the financial position, financial
performance and cash flows of an entity that is useful to a
wide range of users in making economic decisions.
• Financial statements also show the results of the
management’s stewardship of the resources entrusted to it
[para. 9].
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 LO1-6
Qualitative Characteristics of
Financial Reporting Information

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ACT B861

Conceptual Framework for Financial Reporting 2018

Qualitative characteristics
If financial information is to be useful for decision making, it
must be relevant and must faithfully represent what it purports
to depict.
[Fundamental qualitative characteristics are relevance and
faithful representation]
• The usefulness of financial information is enhanced if it is
comparable, verifiable, timely and understandable.
[Enhancing qualitative characteristics are comparability,
verifiability, timeliness and understandability]
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ACT B861

Conceptual Framework for Financial Reporting 2018

Fundamental qualitative characteristics
• Relevance: information is relevant if it has an impact on decisions
• Financial information that is capable to make a difference in decisions if it
has predictive value, confirmatory value or both.
• Predictive value: able to predict future outcomes; e.g. using current
profitability to predict future stock price movements
• Confirmatory value: provides feedback to previous predictions
• Information is material if omitting it or misstating it could influence the
decisions made by users
• Materiality is an entity-specific concept based on the nature and magnitude
of the items related to the financial statements.
• E.g. CK Hutchison’s 2018 Profit after tax was HK46,580 million; if it should
have been HK46,580.05 million, would the error be a material error?
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ACT B861

Conceptual Framework for Financial Reporting 2018

Fundamental qualitative characteristics
• Faithful representation
Financial information should faithfully represent relevant
phenomena; 3 characteristics to help achieve faithful
representation: completeness, neutrality and freedom from error
Completeness means that all information necessary for a user to
understand the phenomenon should be included.
Neutrality means without bias in the selection or presentation of
financial information.
Free from error means that there are no errors or omissions in the
presentation and the process used to produce the information.
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ACT B861

Conceptual Framework for Financial Reporting 2018

Enhancing qualitative characteristics
• Comparability: Financial information is more useful if it can be
compared over time, or if information from different companies
can be compared.
• To facilitate comparability, it is important that companies use
their accounting policies consistently. Furthermore, accounting
policies used should be disclosed in the financial statements.
• If there is a change in any of these polices, the change and the
effect of the change should also be disclosed.

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ACT B861

Conceptual Framework for Financial Reporting 2018

Enhancing qualitative characteristics
• Verifiability: different knowledgeable and
independent observers could reach consensus,
although not necessarily complete agreement, that a
particular depiction is a faithful representation.
• Timeliness: having information available to decision-
makers in time to be capable of influencing their
decisions.
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ACT B861

Conceptual Framework for Financial Reporting 2018

Enhancing qualitative characteristics
• Understandability: Financial statements should be prepared
for users who have a reasonable level of knowledge about
business, economic activity and accounting.
• These users are expected to spend a reasonable amount of
time reading the financial statements with care.
• Preparers should not omit information from the financial
statements based on the complex nature of the information.

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ACT B861

Financial Statements: HKAS 1 (Revised):

True and fair view and compliance with HKFRSs
• Financial statements shall present a true and fair view (TFV) of the
financial position, financial performance and cash flows of an entity.
• True and fair view requires the faithful representation of the effects
of transactions, other events and conditions in accordance with the
definitions and recognition criteria for assets, liabilities, income and
expenses set out in the Conceptual Framework.
• The application of HKFRSs, with additional disclosure when
necessary, is presumed to result in financial statements that achieve
a TFV; True and fair view =/= 100% accuracy (c.f. materiality)
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ACT B861

Financial Statements: HKAS 1 (Revised):

True and fair view and compliance with HKFRSs
• In the extremely rare circumstances in which management
concludes that compliance with a requirement in a HKFRS
would be so misleading that it would conflict with the
objective of financial statements set out in the Conceptual
Framework
• the entity shall depart from that requirement and make
necessary disclosure, if the relevant regulatory framework
requires, or otherwise does not prohibit, such a departure.
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ACT B861

Financial Statements: HKAS 1 (Revised):

• Underlying assumption for presentation
• Going concern
• When preparing financial statements,
management shall make an assessment of an
entity’s ability to continue as a going concern.
• i.e. the company should continue to exist as a
viable business in the near future (e.g. next 12
months)
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MGT B240
Other underlying assumptions (continue)
Economic Entity: It states that the recorded activities of a business
entity will be kept separate from the recorded activities of its owner(s)
and any other business entities.
Arm’s Length Transaction: A transaction between two related or
affiliated parties that is conducted as if they were unrelated, so that
there is no question of a conflict of interest. It is the basis of
determining fair market value.
Periodicity: The period covered by the financial statements. For
example, it may be a period of month, a quarter, 6 months or 12
months.
Stable Monetary Unit: It assumes that the value of the dollar is stable
over time. This concept essentially allows accountants to disregard
the effect of inflation -- a decrease, in terms of real goods, of what a
dollar can purchase.
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ACT B861

Financial Statements: HKAS 1 (Revised):

Accrual-basis accounting: governs the measurement of profit or loss
(Revenue – expenses = Profit/ Loss)
Revenues are recognised in the period when they are ‘earned’ and become
‘measurable’, not necessarily when cash is received. Expenses are
recognised when incurred, not necessarily when they are settled in cash.
In general, accrual accounting revenues do not correspond with cash
receipts for the period, and expenses do not correspond with cash outlays
for the period. E.g. monthly rent is $1,000; it says so far the company has
paid $11,000 for rent in cash. Does that mean only $11,000 should be
recorded as “rent expense” for a 12-month period?
Obviously not. The one month unpaid rent should also be recognised as
“rent expense”; the unpaid rent should be recognised as a liability on B/S
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 LO1-2
Cash Basis Example
• Carter company paid $60,000 for 3 years’ rent at the
beginning of year 1.
– Under cash basis accounting, the rent payment is
shown when paid.
Year 1 Year 2 Year 3 Total
Sales (on credit) $100,000 $100,000 $100,000 $300,000
Net Operating Cash Flows
Cash receipts from customers $ 50,000 $125,000 $125,000 $300,000
Cash disbursements:
Prepayment of three years’ rent (60,000) –0– –0– (60,000)
Salaries to employees (50,000) (50,000) (50,000) (150,000)
Utilities (5,000) (15,000) (10,000) (30,000)
Net operating cash flow $(65,000) $ 60,000 $ 65,000 $ 60,000

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 LO1-2
Accrual Basis Example
Carter company paid $60,000 for three years’ rent at the beginning of
year 1.
• Under accrual basis accounting, rent is recognized as an
expense in all three years even though it was paid in year 1.
CARTER COMPANY
Statements of Profit or Loss
Year 1 Year 2 Year 3 Total

Revenues $100,000 $100,000 $100,000 $300,000

Expenses:
Rent 20,000 20,000 20,000 60,000
Salaries 50,000 50,000 50,000 150,000
Utilities 10,000 10,000 10,000 30,000
Total expenses 80,000 80,000 80,000 240,000
Net profit $ 20,000 $ 20,000 $ 20,000 $ 60,000

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ACT B861

Financial Statements: HKAS 1 (Revised):

• Frequency of reporting
An entity shall present a complete set of financial
statements (including comparative information) at least
once every 12 months.
• Consistency of presentation
An entity shall retain the presentation and classification of
items in the financial statements from one period to the
next … (comparability)

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 LO1-4
A Move Away from Rules-Based Standards?
Principles-based vs. Rules-based

Objectives-oriented
• A principles-based approach to standard-setting that stresses
professional judgment to apply broad principles to various
situations, as opposed to following a list of rules.
• Regardless, poor ethical values on the part of management
are at the heart of accounting abuses and scandals.
• Also see additional notes on this topic on OLE
• Relevant to your Assignment 1.
ACT B861

Statement of financial
position

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ACT B861

Statement of Financial Position (Balance Sheet)

• Can be considered as a snapshot or picture of a company’s
assets, liabilities and owners’ equity as of a specific date
• Assets: is the monetary value of a resource that is owned or
controlled by an entity (separate from the owner(s))
– A resource must be:
• Identifiable
• Separable
• valuable
– Current assets
– Non-current assets
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ACT B861

Statement of Financial Position (Balance Sheet)

Current assets
• Generally defined as economic resources that will be converted
into cash within one year or the operating cycle, whichever is
longer.
• Within current assets, cash is the first line item and inventories are
the last line item or vice versa (because of liquidity priority).
• Includes: cash, prepayment, accounts receivables, inventories

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ACT B861

Statement of Financial Position (Balance Sheet)

Non-current assets
• Assets that do not fit into the category of current
assets; i.e. intended to be held for longer than 12
months
• Non-current assets (long-term assets) include
tangible (e.g. property, plant & equipment (PPE)),
intangible (e.g. Goodwill) and financial assets (e.g.
Investments in equity instruments) of a long-term
nature.
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ACT B861

Statement of Financial Position

• Liabilities
– Are claims (by others, e.g. a loan provider) to an
entity’s assets
– A liability is a present obligation (i.e. includes legal,
moral, social and implied commitments) of an
entity to consume or transfer assets
– Current liabilities, and
– Non-current liabilities
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ACT B861

Statement of Financial Position

Current liabilities
• Current liabilities are economic outflows that are expected
to be settled within the normal operating cycle or one year
from the statement of financial position date
• Include accounts payable, accrued expenses, liabilities held
primarily for purpose of trading, current portions of debt
and others.

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ACT B861

Statement of Financial Position

Non-current liabilities
• Non-current liabilities are generally defined as economic
outflows not expected to be paid within one year.
• Non-current liabilities (long-term liabilities) include notes
payable that are not due within one year, bonds payable,
lease obligations, deferred tax liabilities, pension liabilities
and others.

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ACT B861

Statement of Financial Position

Equity
• Equity, i.e. the ownership interest, is one of the elements in the
statement of financial position.
• Owners’ equity can be interpreted as the difference between
assets and liabilities. Do you recall the accounting equation?
• Thus also known as residual interest, in the sense that in a
winding up of the undertaking, after all creditors are settled and
all debts paid, the remaining assets go to the equity interests.
• Owners’ equity generally includes share capital (ordinary and
preference shares), capital reserve, retained profit etc.

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ACT B861

Income statement

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ACT B861

Statement of profit or loss and other

comprehensive income (or Income statement)
It measures the revenues and expenses incurred by a firm over
the accounting period. The difference between revenues (also
called sales or turnover or income) and expenses is called profit
or loss.
The statement of comprehensive income shall present:
(a) profit or loss (of the normal business operations);
(b) other comprehensive income (or loss);
(c) comprehensive income for the period, being the total of profit
or loss and other comprehensive income.
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ACT B861

Statement of profit or loss and other comprehensive income

• Revenue: Inflows or other enhancements of assets of
an entity or settlements of its liabilities from delivering or
producing goods, rendering services, or other activities
that constitute the entity’s ongoing, major, or central
operations
• Expense: Outflows or other using up of assets or
incurrence of liabilities from delivering or producing
goods, rendering services, or carrying out other activities
that constitute the entity’s ongoing, major, or central
operations
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ACT B861

Simplified Income Statement

ACT B861

Statement of profit or loss and other

comprehensive income
• Gain: Increase in equity resulting from a certain kind of
transactions that are not directly related to the selling of products
or provision of service that is seen as a core activity of the
company. E.g. money that McDonald’s has made by selling
equipment or other operating assets but not by selling hamburgers.
• Loss: Decrease in equity resulting from a certain kind of
transactions that are not directly related to the selling of products
or provision of service that is seen as a core activity of the
company.
• Recognition: The process of formally recording or incorporating
an item in the financial statements of an entity
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MGT B240
Relationship between the income statement and the
statement of financial position

+ Profit
Assets = Equity
(−) (Loss)
+ Liabilities

The above equation can be extended to:

Expenses
Assets = Equity +
Sales
revenue
− + Liabilities
ACT B861

Statement of Changes in Equity

Shows the changes in owners’ equity over a period of time, includes:
• The total comprehensive income for the period, showing separately the
total amounts attributable to owners of the parent and non-controlling
interests.
• For each component of equity, the effects of retrospective application or
retrospective restatement recognized in accordance with HKAS 8
• For each component of equity, a reconciliation between the carrying
amount at the beginning and the end of the period, separately disclosing
changes resulting from
– Profit or loss
– Other Comprehensive Income (OCI) and
– Transaction with owners
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ACT B861

Statement of cash flow

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ACT B861

Statement of Cash Flows HKAS 7 [revised July 2019]

• Objective
Information about the cash flows of an entity is useful in providing users of
financial statements with a basis to assess the ability of the entity to
generate cash and cash equivalents and the needs of the entity to utilize
those cash flows.
The economic decisions that are taken by users require an evaluation of
the ability of an entity to generate cash and cash equivalents and the
timing and certainty of their generation.
The objective of this Standard is to require the provision of information
about the historical changes in cash and cash equivalents of an entity by
means of a statement of cash flows which classifies cash flows during the
period from operating, investing and financing activities.

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ACT B861

Statement of Cash Flows HKAS 7 [revised July 2019]

Definition of Cash and Cash Equivalents
Cash comprises cash on hand and demand deposits.
Cash equivalents are short-term, highly liquid investments that are readily
convertible to known amounts of cash and which are subject to an
insignificant risk of changes in value.

Cash equivalents are held for the purpose of meeting short-term cash
commitments rather than for investment or other purposes. For an
investment to qualify as a cash equivalent it must be readily convertible to
a known amount of cash and be subject to an insignificant risk of changes
in value. Therefore, an investment normally qualifies as a cash equivalent
only when it has a short maturity of, say, three months or less from the
date of acquisition.
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ACT B861

Current Assets

Trade
Self test question: Receiva Cash Trade
-bles Payables
Which one of them
is the most liquid? Invento-
ries
ACT B861

Statement of Cash Flows HKAS 7 [revised July 2019]

Cash receipts and disbursement (into 3 activities during the accounting period)
Operating activities: the principal revenue-producing activities of the entity
and other activities that are not investing or financing activities (e.g.
payments to suppliers for goods and services).
Investing activities: the acquisition and disposal of long-term assets and other
investments not included in cash equivalents activities (e.g. payments to
acquire property, plant and equipment, intangibles and other long-term
assets).
Financing activities: activities that result in changes in the size and
composition of the contributed equity and borrowings of the entity activities
(e.g. receipts from issuing shares; money obtained from loans).
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ACT B861

Statement of Cash Flows

Most companies use the indirect method; the direct
method is used very infrequently.
According to the AICPA, US GAAP Financial
Statements – Best Practices in Presentation and
Disclosure – 2013, a survey of 500 companies showed
that 495 companies chose to use the indirect method,
and only 5 chose to use the direct method.
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ACT B861

Statement of Cash Flows

Reporting cash flows from operating activities
The direct method
• The direct approach presents only cash receipts and cash
disbursements. The direct method determines cash flows
from operating activities by calculating how much cash was
collected from customers and how much cash was paid for
operations during the accounting period.
• The result, cash flow from operating activities, is always the
same for both the direct and indirect methods.
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ACT B861

Statement of Cash Flows

Reporting cash flows from operating activities
• The indirect method
– The indirect (reconciliation) method reports the same amount
for net cash flow from operating activities as the direct method.
This is accomplished by adjusting net income to reconcile to net
cash flow.
Profit before interest and tax
+ depreciation / amortization expense
+ loss on sales of assets
+ decrease in receivables, decrease in inventory,
increase in payables
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ACT B861

(Mock up Income statement for comparison)

Cash flow from operation activities: Million ($)
Sales revenue 15
Cost of goods sold (6)
Gross profit 9
Depreciation expense (3)
Operating profit 6
Other income (expenses):
Gain on sale of land 8
Loss on sale of equipment (2)
Net profit 12 62
ACT B861

Indirect method - adjustments

Cash flow from operation activities: Million ($) Remarks
Net profit 12
Adjustments for non-cash effects:
Gain on sale of land (8) Take it off to neutralise
Depreciation expense 3 Add it back to neutralise
Loss on sale of equipment 2 Add it back to neutralise
Changes in operating assets and liabilities:
Increase in accounts receivable (2) Need 2 consecutive
years’ information to
Decrease in inventory 4 work this out
Increase in accounts payable 6 (see next slide)
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…
ACT B861

Extract of statements of financial position

of a company
2019 2020
Current asset $M Current asset $M
Inventory 6.8 Inventory 2.8
Accounts receivable 9 Accounts receivable 11
… …
Current liability Current liability
Accounts payable 12 Accounts payable 18
Hint: when you are working on cash flow statements, always think of current asset as a pie
(3 slices: cash, AR and inventory) and ask yourself which slice you like the best
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ACT B861

Professional Ethics

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ACT B861

The accountancy profession and professional ethics

The HKICPA’s Code of Ethics for Professional Accountants [revised February
2018]:
• Part A establishes the fundamental principles of professional ethics for
professional accountants and provides a conceptual framework for
applying the principles. The fundamental principles are integrity,
objectivity, professional competence and due care, confidentiality and
professional behavior.
• Part B, C and D illustrate how the conceptual framework is applied in
specific situations. Part B applies to professional accountants in public
practice. Part C applies to professional accountants in business. Part D sets
out additional ethical requirements in specific areas.

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Double entry bookkeeping
Double Entry (Debit and Credit) Accounting System

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The Basic Accounting Equation

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 The Expanded Accounting Equation

The equation must be in balance after every transaction.

For every Debit there must be a Credit.
Note: the above are called T-accounts
They are NOT journal entries.
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 Transactions for Perez Inc.
Transaction 1

An example of a pair of journal entries:

Dr Cash $40,000
Cr Equity (Owner’s capital) $40,000
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Transactions for Perez Inc.
Transaction 2

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Transactions for Perez Inc.
Transaction 3

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Transactions for Perez Inc.
Transaction 4

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Transactions for Perez Inc.
Transaction 5

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Transactions for Perez Inc.
Transaction 6

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Transactions for Perez Inc.
Transaction 7

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 Transactions for Perez Inc.
Transaction 8

Note that the accounting equation equality is

maintained after recording each transaction.
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ACT B861

Re-cap
• Accountant’s ethics: hot topic
• Accounting/ audit failures
• Do you recall the most important qualitative
characteristics of information?
• Do you recall the main purpose of each
financial statement?

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ACT B861

Self Test
Column I Column II
1. Statement of financial position
2. Statement of profit or loss and other
comprehensive income
3. Statement of cash flow
a. Income
b. Accrued rent
c. Decrease in inventory
d. Shareholder’s capital
e. Accounts receivable
Can you match items in Column I with items in Column II?
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