CHAPTER 1

CONCEPTUAL FRAMEWORK
AND FINANCIAL
STATEMENTS
 Learning Objectives

 Understand the Role of Accounting in Communicating

Financial Information
 Understand the Underlying Accounting Concepts in the
IFRS Conceptual Framework
 Obtain insights into Business Operations through
Financial Statements Identify
 Financial Statements and their Interrelationships
 Understand the role of Ethics in Accounting
 ACCOUNTING CAREERS: MUCH MORE
THAN COUNTING THINGS
• Public Practice
– Specialize in areas such as audit, tax, consulting and serve as an external
accountant.
• Managerial Accounting
– Role is to analyze the financial information and communicate to managers for
making strategic decisions.
• Government and Not-for-Profit Entities
– As an accountant, you can serve the government in the areas of auditing,
financial reporting and management accounting.
– You can also serve in the non profit sector like Colleges, Universities, schools,
hospitals and charitable organization
• Education
– You can serve the schools and colleges through teaching theory of accounting
and you might develop new ways of categorizing financial data .
 Financial Statements
These are the business documents that the companies use to
report their activities to various groups which include managers,
investors, creditors and regulatory agencies.

• The core of financial statements

– The statement of Comprehensive Income (Income

Statement)
– Statement of Financial Position (Balance Sheet)
– Statement of Cash Flows
– Statement of Changes in Equity.
Role of Accounting in Communicating
Financial Information
• Business Decisions
– The shareholders and the potential investors make use of the financial
information to decide when to buy, hold or sell their investment.

• Accounting is the language of Business

– Accounting basically records and measures the business activities,
processes data into information and communicates to the decision
makers.
Two Perspective of Accounting

• Financial Accounting
– Provides information to decision makers outside the reporting
entity.

• Management Accounting
– Provides information to the managers of the company like
budgets, forecasts and projections
 Accounting is used in every type of
business
Proprietorship Partnership Corporation

Owners Proprietor, Partners, Shareholders,

One owner Two or more Generally many
owners owners

Personal liability Proprietor, Partners Generally are not

liable
 Role of Accounting Standards
• Accounting Standards plays a crucial role in the for each company and helps
for making comparisons among different companies.

• Each country will their own accounting standards which is commonly referred
as Generally Accepted Accounting Policies (GAAP)

• There was a discrepancies among different countries accounting standards,

International Accounting Standards Board (IASB) has framed International
Financial Reporting Standards(IFRS) with the objective of developing single
set of high-quality, understandable, and enforceable accounting
standards.
 BENEFITS OF IFRS
• One common set of standards instead of
multiple versions.
• Financial statements are more comparable.
• Easier for investors to evaluate the information
of various companies across the globe.
• Global use will reduce the costs of doing
business.
 THE UNDERLYING
ACCOUNTING CONCEPTS IN
THE IFRS FRAMEWORK

The focus is on general purpose financial

statements which are directed towards the
common interest of wide range of financial
statement users.
 Is Financial Reporting important?
• In order to assess the financial health of the entity.

• In order to discover the entity’s strengths and

weaknesses.

• In order to take decisions whether or not to make

additional investment, providing credit and financing.

• In order to assess the management’s efficiency

effectiveness in the use of entity’s resources.
 Who will be using Financial Reports?
 Investors - Adequate returns
 Employees - Job security, salary increments,
compensation benefits.
 Creditors - Provisions for additional loans for
expansion plans and ability for
repayment.
 Suppliers and trade creditor- Ability to pay
invoices
 Government -Tax collection, provision of grants and
subsidies.
 Users of Financial Reports

PRIMARY USERS
 Existing investors
 Potential investors
 Lenders
 Creditors

NON-PRIMARY USERS
 Government regulators
 Consumers
What makes Financial Information
Useful?

Relevance Materiality of information

Faithful
Economic phenomenon
Representation

Trends in Financial position and

Comparability
performance
 Continued…

The depiction of financial statements should

Verifiability
be same

Timeliness Timely availability of information to users

The financial information must be

Understandability classified, characterized and presented
clear and concise
 Constraints in Providing
Information
• Cost
– Cost of data collection, data processing, verifying and disseminating
the information.

• Lower returns
– Naturally higher costs will result in lower returns
 Assumptions in Financial Reporting

Accrual basis of accounting

• Going concern concept
• Information about financial position is
provided in Balance Sheet.
• The information about financial performance
is primarily provided in an Income
Statement.
What exactly are we Accounting for?
• Assets
– Are the economic resources controlled by the entity which are
expected to produce a benefit in the future.

• Liabilities
– Are the present obligations of the entity which are expected to result
in an outflow of economic benefits from the entity

• Equity
– Represents the residual claim to the entity’s assets (assets after
deducting the liabilities).
– Share Capital and Retained Earnings
 Continued…
• Income
– Refers to increases in economic benefits during an accounting period.
– Distinguished into revenue and gain
– Revenue arise from ordinary course of business (sales revenue)
– Gains are typically outside the ordinary course of business (gain on disposal of
subsidiary)
• Expenses
– Are decreases in the economic benefits during an accounting period.
– Distinguished into expenses and losses
– Expenses are incurred in the ordinary course of business (salaries and wages)
– Losses may or may not be in the ordinary course of business (loss on disposal of
long-term assets)
 Accounting Equation (1)

• Assets = Liabilities + Equity

Accounting Equation (2)
Components of Retained Earnings
Solution!
 Flow of Financial Information

Statement of
Income Statement of Balance Statement of
Income Changes in Balance Statement of
Statements Changes in Sheet Cash Flows
Statements equity Sheet Cash Flows
equity
Income Statement
 Income Statement shows a
Company’s Financial Performance
• Reports revenues and expenses for the period.
• The bottom line is the net income or net loss
for the period.
• Consolidated Statements implies that Alibaba is
actually made up of several corporations that
are owned by common group of shareholders
Sales – cost of sales – operating expenses = operating profit
Statement of Changes in Equity
Statement of Financial Position
Components of balance sheet

Assets Current assets

Non – current assets

Current liabilities
Liabilities Non current liabilities
 Continued…

Share Paid in Capital

holders Retained Earning
equity Other equity items
 Analysis

Current Cash, short term investments, receivables, inventory and

assets prepaid expenses
Non-
Property Plant and Equipment, long term investments and
current
intangibles like patents, trademarks and goodwill
assets

Current Accounts payable, taxes payable and other short-term

liability notes payable salaries/ wages payable
 Analysis continued

Non- current
Long term loans, bank loans, debentures.
liability

Shareholders Paid in capital = equity and preferred stock

equity Retained Earnings = earnings of equity– dividends
paid
Other equity – reserves and non controlling interest
Statement of Cash Flows
3 basic activities of cash flow statement

Financing
Financing
activities
activities

Operating
Operating
activities
activities

Investing
Investing
activities
activities
Inter-relationship of Financial Statement
• Income Statement
– Reports total income and expenses and the resultant net profit or
net loss.

• Statement of Changes in Equity

– Begins with equity from previous financial reports
– Adds net income directly from Income Statement

• Balance Sheet
– Reports total equity which comes from Statement of Changes in
Equity

• Statement of Cash Flows

 Role of Ethics in Accounting

• 1 Economic factor
• 2 Legal factor
• 3 Ethical factor
Code of Ethics for Professional Accountants

• Code provided by International Ethics

Standard Board for Accountants (IESBA)

• Provides guidance to all members in the

performance of their professional duties.
Principles of Professional Ethics

 Integrity
 Objectivity
 Professional Competence and Due Care
 Confidentiality
 Professional Behavior
 Question
1. Which of the following is not included under
the head Current Assets?

A) Debtors B) Inventory
C) Land D) Cash & Cash
equivalent
 Solution
C) Land

Land is categorized as Property Plant and Equipment and the return on

which is for a longer period of time.
 Question
2. ___________ includes in Retained Earnings.

A) Equity Share Capital B) Surplus

C) Debentures D) Creditors
 Solution
B) Surplus

Surplus includes the profits and income left over

after declaration of dividend.
 Question
3. Ethics are the set of codes which provides
__________ to accounting professional.

A) Guidance B) Rules
C) Principles D) Suggestion
 Solution
A) Guidance

– Ethics provides guidance in order to undertake the activities

professionally.
END OF CHAPTER