Foundations of accounting

© Lakatos

What is accounting?

The systematic recording, reporting, and analysis of quantitative financial

transactions of a business in a way that is useful for the decision making.

“The provision of information about the financial position, performance

and changes in the financial position of an enterprise that is useful to a
wide range of potential users in making economic decisions” (IASB, FASB)

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The activities of accounting

Planning what to gather Substantive

Gathering the information

„Technical”

Processing the information

Providing the information

Substantive
Explaining the information

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Activities of accounting

Recording Book-keeping
Accounting

Balance sheet
(SPF)
Income statment
(SOCI)
Financial Statement of
Summarizing
statements changes in equity
Statement of cash
flows

Notes
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Types of businesses

SOLE TRADER AND SIMILAR COMPANIES

PARTNERSHIPS
Owned and managed by one individual Owned by the shareholders (can be 1
Owned and managed by more than one
(there might be employees). to infinitive) - each shareholder owns a
individual (usually under 10).
Owner takes all the profit. "piece" of the company.
Profit is divided between the partners.
Easy to make decisions. Managed by the board of directors
Decision making becomes more (these people are elected).
Responsible for fulfilling all the debts complicated (owners must agree).
personally. Companies have limited liability.
Responsibility - ? - depends on the legal
The legal requirements are easy to Lots of compliance requirements.
system of country it was incorporated
fulfill, not too many compliance issues Completely separate from its owners
Relatively easy rules of compliance.
(expect of taxes). (legal entity).
Exit is very limited.
Exit means closing the business. Exit is easy.

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The separate entity concept

Type Transfer IN Transfer OUT

Business and personal Sole trader,

partnership
Introduction of capital Drawings
wealth is separated Companies Share issue proceeds Dividend,...

There are limited means of

transfer between personal
and business wealth.

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Who needs accounting information? The stakeholders

Investors Creditors Employees Management

Government Suppliers Customers Competitors

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Types of accounting

Accounting

Financial Management
accounting accounting
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Financial vs. management accounting

Financial accounting Management accounting

Governed by Law, standards Needs of managers

Users External Internal

Time Past and present Present and future

Period Usually one year As appropriate

Coverage Whole company of group Divisions and subgroups

Emphasis Accuracy Speed

Criteria Objective, consistent Relevance

Nature of information Precise and regulated For use by non-accountants

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Nature of the regulation and need for enforcement

Different
„Stop”
possibility for
interpretations
influence

Enforcement
No cherry-
to make
picking
people follow
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How to proceed further from principles

What do I
Information Financial
want to
need statements
see?

What makes the Create the rules

First: underlying financial statements for the financial
principles good? statements

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Underlying principles

Going Accrual
concern basis

Underlying
principles

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Qualitative characteristics
Qualitative characteristics Relevance
Both must be
Fundamentals true!
Faithful
representation
IMP
Comparability

Verifiability
Enhancing
Timeliness

Understandability 13
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In a bit more details…

Fundamental
Aim Content
requirements

Predictive
value
Relevance
Confirmatory
value
To be useful
Complete

Fair
Neutral
presentation

Free from
errors

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Financial statements Financial

statements

Position Performance

Accounting equation Assets Income

Liabilities Expenses

Equity
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Definitions

Asset
• An asset is a present economic resource controlled by the entity as a result of past events.
• An economic resource is a right that has the potential to prduce economic benefits
Liability
• A liability is a present obligation of the entity to transfer an economic resource as a result of past
events.
• An obligation is a duty or responsibility that an entity has no practical ability to avoid.
Equity
• The residual interest in the assets of the entity after deducting all its liability.

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The structure of the balance sheet

Statement of financial position, 31st December 20X1

Non current assets Owners' equity
Tangible assets Capital
Intangible assets Reserves

Current assets Liabilities

Inventory Long term liabilities
Receivables Short term liabilities
Cash and cash equivalents

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Few things to note… current asset and liability

Current liability
Current asset

Expected to be realized in, or is held Expected to be settled in the

for sale or consumption in, the normal normal course of the entity's
course of the entity's operating cycle operating cycle

is held primarily for trading purposes

or for the short term and expected to It is due to settle within twelve
be realized within twelve months of months
the date of the SFP

The entity does not have a right

cash or cash equivalent asset (not
restricted) to delay the payment with twelve
more than twelve months.

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Equity

Issued capital
Contributed
Additional paid in
Equity
captial

Retained earnings
Generated
…

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The dual aspect of accounting

Every asset must have been financed, acquired somehow, either

by own or other (borrowed) resources. Which means that:

Assets = Owners' equity + Liabilities

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