ACCT2111: Introductory Financial Accounting

Conceptual Frameworks
and Financial Statements
Prof. Matthew Bonnett
CUHK 2013
 Reading

Course textbook:

 Financial Accounting: International Financial Reporting

Standards, 9th Edition, by Harrison, Horngren,
Thomas and Suwardy. Chapter 1 pp 1-29.

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Accounting
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Types of Accounting
Financial Accounting Managerial Accounting
Provides information for Provides information for
external users internal users – managers
– Investors Includes:
– Creditors – Budgets
– Government – Forecasts
– The public
– Customers
– Employees

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Forms of Business Organisation
Proprietorship Partnership Corporation

Owner(s) Proprietor – One owner Partners – two or Shareholders –

more owners generally many
owners

Personal liability of Proprietor is personally General partners are Shareholders are

owner(s) for liable personally liable; NOT personally liable
business debts limited partners are (“Limited Liability”)
not

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Proprietorship
• Single owner

• Common business form for small retails stores and

professional service providers

• Proprietor personally liable for business debts

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Partnerships
• Not a taxpaying entity
– Income passes through to partners

• Governed by an agreement

• Mutual agency
– Each partner can act on behalf of the entity

• Unlimited liability

• Involve risk
– Limited liability partnerships lessen risk (LLP)

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Corporations
• Formed under state law
– Legally distinct from its owners

• Double taxation
– Corporate income is taxed
– Shareholders taxed on distributions of earnings
(dividends)

• Shareholders elect Board of Directors

– Set policy and appoint officers

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International Financial
Reporting Standards (IFRS)
• Historically, different countries use their own
accounting standards.
– Difficult for investors to compare companies that
operate in different countries

• The IASB has developed international standards

(IFRS)
– In the past, U.S. considered its GAAP to be the
strongest set of standards

• In November 2008, the SEC announced it will require

all U.S. public companies to adopt IFRS

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Conceptual Framework of Accounting

Divider Page
 Hong Kong Conceptual Framework
http://app1.hkicpa.org.hk/ebook/HKSA_Members_Handbook_Master/volumeII/framework.pdf

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Users of Accounting Information

Employee
Investors
s

Suppliers and
Creditors trade creditors

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Qualitative Characteristics -
Fundamental

Faithful
Relevance representation

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Qualitative Characteristics -
Enhancing

Comparab Verifiabilit
ility y

Understan
Timeliness
dability
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Constraints in providing
information
• Benefits vs Costs

• Cost: Cost of data collection, processing,

verifying and disseminating information

• Will benefits>cost?

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Assumptions

Accrual Accounting

• Transactions and other events are recognized when they occur

Going- concern assumption

• Entity will continue to exist indefinitely

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Accounting Equation Elements

Assets
•Economic resources
•Produce future benefits

Liabilities
•Present obligations
•Result in an outflow of economic benefits

Equity
•Represents shareholders’ residual claim to the entity’s
assets

Income
•Increases in economic benefits during an accounting
period

Expenses
•Decreases in economic benefits during an accounting
period

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Accounting Equation

• How do the elements in the Accounting

Equation fit together?

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Assets = Liabilities + Equity

Liabilities
$600
Assets
$1,000
Equity
$400

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Total Revenue and Gain – Total
Expenses and Losses = Net
Income (or Loss)

Total Revenue Total Net Income

and Gains Expenses and (or Loss)
Losses
$500 $200
$300

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Components of Retained Earnings
Revenues for
the period

minus

Expenses for
the period

equals
Plus
Beginning or
minus Net Income (or minus equals Ending Balance
Balance of Dividends for
Net Loss) for of Retained
Retained the period
the period Earnings
Earnings

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The Financial Statements

Income Statement of
Changes in
Statement Equity

Balance Statement of
Sheet Cash Flows
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The Income Statement

• Reports two main categories

– Revenues and gains
– Expenses and losses

• Shows the “bottom line”

– Net income or net loss for the period

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 ABC Corporation
Income Statement
Financial Year Ended December 31
Net sales $$,$$$
Other income $$,$$$
Total income $$,$$$
Cost of sales $$,$$$
Gross margin $$,$$$
Selling, general and administrative expenses $$,$$$
Depreciation, amortization and provisions $$,$$$
Non-recurring income and expenses $$,$$$
Earnings before interest and tax $$,$$$
Finance costs $$,$$$
Income tax $$,$$$
Other income items $$,$$$
Net Income $$,$$$
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Statement of Changes in Equity

• The Statement of Changes in Equity shows a

company’s transactions with its owners.

• Net income (or net loss) flows from the Income

Statement to the Statement of Changes in
Equity.

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 ABC Corporation
Statement of Changes in Equity
For the year ending December 31, 20X6

Shareholder equity as of December 31, 20X5 $$,$$$

Plus: Net income $$,$$$
Less: Dividends $$,$$$
Reclassifications and other reserves $$,$$$
Shareholder equity as of December 31, 20X6 $$,$$$

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The Balance Sheet
• Also called the Statement of Financial Position

• Reports
– Assets
– Liabilities
– Shareholders’ equity

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Assets on the Balance Sheet
Current Non-current
• Expected to be converted to • Will be held longer than one
cash, sold or consumed in the year
next 12 months or within the
business’ operating cycle • Include
• Include – Property, plant and
– Cash equipment
– Short-term investments • Land
– Receivables (or debtors) • Buildings
– Inventory • Computers
– Prepaid expenses
• Equipment
– Intangibles
– Long-term investments

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Liabilities on the Balance Sheet
Current Non-current

• Obligations or debts payable in • Debts payable more than one

the one year or within the year from balance sheet date
business’s operating cycle • Include
• Include – Long-term notes payable
– Accounts payable – Bonds payable
– Taxes payable
– Short-term notes payable
– Salaries/wages payable

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Shareholders’ Equity on the
Balance Sheet
• Represents shareholders’ ownership of the
business assets

• Consists of:
– Paid-in capital (sometimes labeled Share
Capital or simply, Capital)
– Additional paid-in capital (sometimes labeled
Share Premium, depends on jurisdictions)
– Retained earnings

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The Statement of Cash Flows
• Measures cash receipts and cash payments

• Fourth required financial statement

• Categorizes into three types of activities:

– Operating
– Investing
– Financing

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Relationships between
financial statements
Income Statement
For the year ended December 31, 20X6
Revenues $$$,$$$
Expenses ($$,$$$)
Net income $$,$$$
Statement of Changes in Equity
For the year ended December 31, 20X6
Beginning equity $$$,$$$
Net income $$,$$$
Cash dividends ($$,$$$)
Ending equity $$,$$$

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 Statement of Changes in Equity
For the year ended December 31, 20X6
Beginning equity $$$,$$$
Net income $$,$$$
Cash dividends ($$,$$$)
Ending equity $$,$$$
Balance Sheet
December 31, 20X6
Assets $$$,$$$
Liabilities $$$,$$$
Shareholders’ equity:
Share capital $$$,$$$
Retained earnings $$$,$$$
Total liabilities and equity $$$,$$$
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 Balance Sheet
December 31, 20X6
Assets $$$,$$$
Cash from
Liabilities $$$,$$$ the Asset
Shareholders’ equity: section of
Share capital $$$,$$$ the
Retained earnings $$$,$$$ Balance
Total liabilities and equity $$$,$$$ Sheet
Statement of Cash Flows equals
For the year ended December 31, 20X6 ending
Cash flows from operating activities $$$,$$$ Cash on
Cash flows from investing activities $$,$$$ the
Cash flows from financing activities $$,$$$ Statement
Net cash flows $$,$$$ of Cash
Cash balance, December 31, 2009 $$,$$$
Flows
Cash balance, December 31, 2010 $$,$$$

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Evaluating a Company
Question/Decision
Can the company sell its products or Sale revenue
services?
What are the main income
measures to watch for trends?
What percentage of sales revenue
ends up as profit?
Can the company collects its
receivables?
Can the company pay its liabilities?
Where is the company’s cash
coming from?
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What to look for
Increasing or Decreasing?
Gross profit
Operating income and Net income
Divide net income by sales revenue
Compare change in receivables to
change in sales
Compare assets to liabilities
Observe the line items on the cash
flow statement
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 Ethics in Business and
Accounting Decisions
• Which options are most honest, open, and truthful?

• Which options are most kind, compassionate, and build a sense

of community?

• Which options create the greatest good for the greatest number
of stakeholders?

• Which options result in treating others as I would want to be

treated?

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Exercise 1-20A
(a) Share capital (h) Revenue
(b) Income tax payable (I) Cash spent to acquire the
building
(c) Dividends (j) Selling, general &
administrative expenses
(d) Income tax expense (k) Adjustments to reconcile net
income to net cash by
operations
(e) Ending balance of retained (l) Ending cash balance
earnings
(f) Total assets (m) Current liabilities
(g) Long-term debt (n) Net income

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 Exercise 1-20A
(a) Balance sheet (h) Income statement
(b) Balance sheet (I) Statement of cash flows
(c) Statement of changes in equity; (j) Income statement
Statement of cash flows
(d) Income statement (k) Statement of cash flows
(e) Statement of changes in equity; (l) Balance sheet;
Balance sheet Statement of cash flows
(f) Balance sheet (m) Balance sheet
(g) Balance sheet (n) Income statement;
Statement of changes in equity;
Statement of cash flows

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Homework Assignments
• S1-14

• E1-17A

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