Financial accounting for IBA

Lecture 2

Transaction analysis T-accounts

To understand amounts that appear on a company’s balance sheet we need to answer these
questions:

1. What business activities cause changes in the balance sheet

2. How do specific activities affect each balance?
3. How do companies keep track of balance sheet amounts?

How do companies record the transactions that eventually become part of the financial statements?

Requirements: faithful representation: the information should be complete, neutral and free from
error
Assumptions: going concern: states that business are assumed to continue to operate into the
foreseeable future

Transactions

Transaction = any activity that impacts the financial position of a business that can be measured
reliably

Every transactions has 2 sides:

1. Business gives something

2. Business receives something

Accounting records both sides of a transaction

 each transaction affects at least 2 accounts

= DOUBLE-ENTRY ACCOUNTING

Note: A = L + SE
How do companies keep track of balance sheet amounts?
T-accounts

For each asset, liability and element of stockholders’ equity

 use a record called an account

Accounts records all changes in a particular assets, liability or equity during a period

Debit and credit are neutral terms (not good and bad)
means either a decrease or an increase depending on the type of account

Every transaction has both a debit and a credit.

The journal entry

Chronological record of the transactions = journal (general journal)

Three steps to book transactions:

1. Specify each account + identify type of account (A, L, SE)

2. Increase or decrease? Debit or credit?
3. Record in the journal  making the journal entry
= journalising the transaction
Income statement = profit & loss account

Building blocks
- focus = financial performance (i.e. profit/loss) over a certain period
- comprises revenues and expenses

Major components

REVENUES: operating revenues + financial revenues (income from investments. Intrest income…)

EXPENSES: cost of merchandise sold (cost of goods sold, cost of sales) + general & administrative
expenses (other expenses) + financial expenses

TAXES: income taxes

Income statement: an example

“revenue from the sale of goods is recognized when significant risks and rewards of ownership have
been transferred to external parties, normally when the goods are delivered to the customer”

Recognising revenues (accrual accounting versus cash accounting)

Revenue arising from sale of goods on provision of service

 can be recognised at variant points

Cash is not revenues (recognized before cash is received)

Main criteria for revenue recognition (IFRS 15 + ASC 605 FASB):

- Services had been rendered

- Ownership and control of the item should pass to the buyer
- Amount of revenue can be measured reliably
- It is probable that the economic benefit will be received

Recognition when ‘realized’

Accrual based <-> cash based

Income statement is not equal to the cash flow statement

Accrual basis accounting

= revenues and expenses are recognized when the transaction that causes them occurs (not
necessary when cash is received or paid

- Revenues are recognized when they are earned --> Revenue principle
- Expenses are recognized when they are incurred  matching principle

Cash basis accounting

= records revenues when cash is received and expenses when cash is ….
Total asset turnover ratio

How effective is management in generating sales from assets (resources)?

TOTAL ASSETS TURNOVER RATIO =

Sales (or operating revenues)/average total assets

Average total assets = (beginning balance + ending balance)/2

How to draw conclusions from this ratio?

- compare over time
- compare with competitors