ACCOUNTING - CFAB

Lecturer: Ms.Nguyen Thi Thanh Mai

[email protected]

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 Accounting – CFAB ICAEW

 Exam
 Duration: 90 mins
 Pass rate: 55 marks
 CBE
 Specification grid:
Contents Weighting
Maintaining financial records 30%
Adjustments to accounting records and financial statements 35%
Preparing financial statements 35%
100%

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 Chapter 1:
Introduction to Accounting

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 Introduction to accounting

Qualitative
The regulation
The purpose of The main characteristics Accounting
of accounting Capital and
accounting financial of useful concepts and
and ethical revenue items
information statements accounting conventions
considerations
information

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 The
Accounting
Process

Accounting links
decision makers with
economic activities Accounting
Economic  and with the Information
Activities
results of their
decisions.

Reported
Decision Results of
Actions Makers Actions
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 What is Accounting?

Accounting consists of following basic activities—it

 identifies,

 records, and

 Analyses and posts to the ledgers

 Summarises in the financial statements

the economic transactions and events of an organization to

interested users.

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 What is Accounting?
Illustration 1-1

Three Activities The activities of the

accounting process

The accounting process includes

the bookkeeping function.

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 Types of business entity

Sole traders Limited liability

Partnerships
(Proprietorship) companies
 Generally owned  Owned by two or  Ownership
by one person. more persons. divided into
 Often small shares of stock
 Often retail and
service-type service-type  Separate legal
businesses businesses entity organized
 Owner receives under state
 Generally
any profits, corporation law
unlimited
suffers any personal liability  Limited liability
losses, and is
 Partnership
personally liable
agreement
for all debts.
Not legally a separate entity from its owners Owners (shareholders)
1-8 are legally separated
 Advantages & Disadvantages

Sole traders Partnerships Limited liability companies

Advantages
 Limited paperwork-  Additional capital can  Raising finance
save cost be raised easier
 Owner complete  Division of roles and  Investment less risky
control business responsibilities,  Separate legal
 Owner is entitled to increased skill set identity from
profit and ownership  Sharing of risk and shareholders
of assets losses between more  Easy to transfer
 No law requirement people shares from one
to financial account  No law requirement to owner to another
 Highly flexible financial account unless  Tax advantages
Limited liability
partnership
 No company tax

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 Advantages & Disadvantages
Sole traders Partnerships Limited liability companies
Disadvantages
 Owner is personally  Partners are liable for  Have to publish
liable for all debts all debts unless LLP annual financial
(unlimited liability)  Costly when setting statements
 Personal property up partnership  FSs have to comply
may be vulnerable agreement with legal and
 Large capital are  Slower decision accounting
less available making requirements
 May lead less  When one partner  F/S have to be
benefit for leaves, the audited
employees partnership is  Share issues are
 Continuity of automatically regulated by law
business in the dissolved and another
event of death or agreement is required
illness of the owner  Continuity of business
in the event of death
or illness of the owner

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 Who Uses Accounting Data?

HM Revenue &
Management Customs
(HMRC)
Trade Owners
contacts

Bodies
Finance
provider Common Questions
Financial
analysts &
Employees advisers
Government
The public agencies

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 Who Uses Accounting Data

Internal
Users

Illustration 1-2
Questions that internal
users ask

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 Who Uses Accounting Data

External
Users

Illustration 1-3
Questions that external
users ask
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 Purpose of financial statements

The objective of financial statements is:

 To provide information about the financial
position, performance, cash flows and changes
in financial position of an entity that is useful to a
wide range of users in making economic
decision.
 To show the results of management’s
stewardship of the resources entrusted to it;
 To predict the entity’s future cash flows and, in
particular, their timing and certainty.

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 Objectives of External Financial
Reporting

Provide specific information about economic

resources, claims to resources, and changes in
resources and claims.

Provide information useful in assessing amount,

timing and uncertainty of future cash flows.

Provide general information useful in making

investment and credit decisions.
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 The main financial statements
The primary financial
Statement of statements.
Statement of
financial position Profit or Loss
(Balance Sheet) (Income Statement)
Statement of
A statement Cash Flows
of changes in
equity
Notes to Financial
Statements

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 Objectives of Financial Reporting

Statement of Profit or Loss

Statement of financial position
The primary
Statement of Cash Flows financial
Statement of Changes in equitystatements.

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 The main financial statements
Statement of Statement of
financial positition Profit or Loss
Definition: A list of all the assets Definition: A statement
controlled and all the liabilities displaying items of income and
owed by a business as at a expense in a reporting period
particular date: it is snapshot of the
as components of profit or loss
financial position of the business at
for the period. The statement
a particular moment. Monetary
amounts are attributed to assets shows whether the business
and liabilities. It also quantifies the has had more income than
amount of the owners’ interest in expense (a profit for the period)
the company: equity. or vice versa (a loss for the
Equity: the amount invested in a period)
buisness by the owners.

The link between the statement of financial position and the

statement of profit or loss is provided by the statement of cash
flows and the statement of changes in equity
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 The regulation of accounting
and ethical considerations

legislation

Accounting
Accounting concepts &
standards individual
Code judgement

of
ethics
True & fair Generally
accepted
View/fair accounting
presentation practice
(GAAP)

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 The regulation of Ethical considerations

Ethics In Financial Reporting

Regulators and lawmakers were very concerned that the
economy would suffer if investors lost confidence in corporate
accounting because of unethical financial reporting.

 Recent financial scandals include: Enron, WorldCom,

HealthSouth, AIG, and others.

 Effective financial reporting depends on sound ethical

behavior.

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 Code of ethics

Integrity

Professional
behaviour Objectivity

Professional
Confidentiality competence
and due care

Five fundamental principles of professional ethics

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 The fundamental principles
INTEGRITY A professional accountant should be straightforward and honest in all
business and professional relationships
OBJECTIVITY A professional accountant should not allow bias, conflict of interest or
undue influence of others to override professional or business
judgements
PROFESSIONAL A professional accountant have a continuing duty to maintain
COMPETENCE AND professional knowledge or skill at a level required to ensure that a
DUE CARE client or employer receives competent professional service based on
current developments in practice, legislation and techniques. A
professional accountant should act diligently and in accordance with
applicable technical and professional standards when providing
professional services

CONFIDENTIALITY A professional accountant should respect the confidentiality of

information acquired as a result of professional and business
relationships and should not disclose any such information to third
parties without proper or specific authority or unless there is a legal
or professional right or duty to disclose.

PROFESSIONAL A professional accountant should comply with relevant laws and

BEHAVIOUR regulations and should avoid any action that discredits the profession
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 Principles based system

Advantages of a principles based over a rules based system of ethics

A principles based system places the onus on the individual to actively

consider independence for every given situation, rather than just agreeing a
checklist of forbidden items. Even if something is not expressly stated in the
guidance, professional accountants are required to follow the spirit as well as
the letter of the guidance.
A principles based system prevents individuals interpreting legalistic
requirements narrowly to get around the ethical requirements. There is an
extent to which rules engender deception, whereas principles encourage
compliance.
A principles based system allows for the variations that are found in every
individual situation. Each situation is likely to be different.
A principles based system can accommodate a rapidly changing environment,
such as the one that professional accountants regularly face.
A principles based system can contain prohibitions where these are necessary
as safeguards are not feasible.
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 Accounting Standards

At international level At a UK level

 Developed by International  Developed by Accounting
Accounting Standard Boads Standards Boards (ASB), an
(IASB) operating body of the
 The standards & Financial Reporting Council
interpretations comprise: (FRC), now Accounting
 International Financial
Council of FRC
Reporting Standards
(IFRS)
 International Accounting
Standards (IAS)
 IFRIC interpretations
 SIC interpretations

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 Generally Accepted Accounting Practice (GAAP)

Financial Statements
Various users  Balance Sheet
need financial  Income Statement
 Statement of Stockholders’ Equity
information  Statement of Cash Flows
 Note Disclosure

The accounting profession

has attempted to develop a
Generally Accepted
set of standards that are
Accounting
generally accepted and Principles (GAAP)
universally practiced.

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 GAAP

UK GAAP rules derive from:

 The Companies Act 2006
 UK & international accounting & financial reporting
standards (IFRS)
 Statutory requirements in other countries
(particularly the US)
 Stock exchange listing requirements

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 Qualitative Characteristics of financial
information
Qualitative characteristics are the attributes that make the
information provided in financial statements useful to users.

Fundamental qualitative Enhancing qualitative

characteristics characteristics

Relevance Comparability

Faithful
representation Verifiability

Timeliness

Understandability

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 Qualitative Characteristics
of financial information
Only relevant information can be useful to
Relevance the decision making needs of users
(making a difference in decisions if
information has predictive value,
confirmation value or both)

Predictive value: help users to predict future events.

Confirmatory value: able to help decision makers evaluate past
decisions.
The relevance of information is affected by its
nature and materiality
Materiality: Information is material if its
Materiality omission or misstatement could influence the
economic decisions of users taken on the basis
of the financial statements
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 Qualitative Characteristics
of financial information
Faithful To be a faithful representation information must
representation/ be complete, neutral and free bias/from
error
reliability

-Complete: all information necessary for a user to understand the phenomenon

being depicted, including all necessary descriptions and explanations.
-Neutral: without bias in the selection or presentation of financial information.
-Free from error: there are no errors or omissions in the description of the
phenomenon and no errors made in the process by which the information was
produced.
=> But this does not mean accurate in all respect. The nature and limitations
of the estimating process are explained, and no errors have been made in
selecting and applying an appropriate process for developing the estimate.

Faithful representation of a transaction is only possible if it is accounted for

according to its substance and economic reality and not merely their legal
form : substance over form
Exp: financial leasing agreement
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 Qualitative Characteristics of financial
information
Information about a reporting entity is more useful if it
Comparability can be compared with similar information about other
entities and with similar information about the same
entity for another period or date:
- Through time to identify trends
- With other entity’s statements
• Need to disclosure accounting policies
• Comparability is not the same as uniformity

An entity shall retain the presentation and

Consistency classification of items in the financial
statements from one period to the next.
The use of the same methods for the same
items from period to period.

Consistency related to comparability, but not the same.

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 Qualitative Characteristics
of financial information

The different knowledgeable and independent

Verifiability observers could reach consensus that a
particular depiction is a faithful representation.

Information available to decision-makers

Timeliness in time to be capable of influencing their
decisions. Generally, the older information is
the less useful..

Classifying, characterizing and presenting

Understandability information clearly and concisely makes it
understandable.
Users: have reasonable knowledge of business
and economic activities and who review and
analyse the information diligently.
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 Qualitative characteristics
FUNDEMENTAL

Relevance Faithful Representation

Materiality Freedom Neutrality Completeness

from error

ENHANCING

Comparability Verifiability Timeliness Understandability

Consistency Reasonable knowledge

of users

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 Fair presentation

 Most importantly, financial statements should

present fairly the financial position, financial
performance and cash flows of an entity
 Fair presentation: The faithful representation of
the effects of transactions, other events and
conditions in accordance with the Conceptial
framework

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 Fair presentation

Fair presentation: IAS 1 stated what is required for a fair

presentation:
 Selection and application of accounting policies
 Presentation of information in a manner which
provides relevant, reliable, comparable &
understandable information
 Additional disclosures where required to enable
users to understand the impact of particular
transactions, events and conditions on the entity’s
financial position and performance.

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 Accounting concepts & conventions

Accounting Principles
Accounting Concepts Accounting Conventions
• Accounting entity assumption • Convention of Disclosure
• Going concern assumption • Convention of Materiality
• Accounting period assumption • Convention of Consistency
• Money measurement • Convention of Conservatism
• Accrual basis
• Dual aspect or Double entry
• Matching concept
• Cost concept (historical cost)

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 ASSUMPTIONS FOR FS
is the underlying
assumption for financial
framework
GOING
CONCERN

BASIS FOR
PREPARING
FS

ACCRUAL
BASIS

is not an underlying
assumption, but FS should be
prepared on an accrual
basis.
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 GOING CONCERN ASSUMPTION

Concept assumes  The entity is

reviewed as continuing in operation for Preparing a
the foreseeable future. It is assumed that normal set of
the entity has neither the intention nor the accounts
necessity of liquidation or ceasing to trade

Unless:

(i) the entity is being liquidated or

has ceased trading, or BREAK-UP
(ii) the directors either intend to
liquidate the entity or to cease BASIS
trading
(iii) Scale down operations in a
material way.
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 GOING CONCERN ASSUMPTION

GOING-
BREAK-UP
CONCERN
BASIS
ASSUMPTION

Assets: Net book value Assets: Scrap Value

Provisions for future
No provisions for operating loss
future operating loss

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 Going concern assumption

If the going concern assumption is not

followed, that fact must be disclosed,
together with the following information:
 The basis on which the financial statements
have been prepared;
 The reasons why the entity is not considered
to be a going concern.

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 ACCRUALS BASIS

The effects of transactions and other events are recognized when they occur
(and not as cash or its equivalent is received or paid) and they are recorded in
the accounting records and reported in the FSs of the periods to which they
relate.

Entities  record when revenues or expenses are earned or incurred in the

accounting period, to which they relate, not as the cash is paid or received

Accrual assumption  profit/revenue earned must be matched against the

expenditure incurred in earning it. This is the matching convention

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 The Accrual Basis of Accounting

Current Future
Accounting Accounting
Period Period
Jan. 1, 2015 Dec. 1, 2015 Jan. 1, 2016 Dec. 1, 2016

The income statement

Cash is received or But . . . reports revenue or
paid here
expense here

OR

The income statement

reports revenue or
But . . . Cash is received or
paid here
expenses here
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 ACCRUALS BASIS

ACCRUAL CASH
BASIS BASIS

Occur  Record Cash receipt or

disbursed  Record

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 Cash basis

 Cash accounting basis of accounting: a

company records customer receipts in the
period that they are received, and expenses in
the period in which they are paid.
 It is easier to use and can be useful for a
smaller company, especially for tax purposes
where cash flow may be an issue.
 Under the accruals basis, a company may have
to pay tax on profits before the cash is actually
received by the business.

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 The Matching Principle: When To Record Revenue

Matching Principle
Revenue should be
recognized at the time
goods are sold and
services are rendered.

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 The Matching Principle: When To Record Expenses

Matching Principle
Expenses should be
recorded in the period
in which they are used
up.

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 ACCRUALS BASIS
Example:

Tom prints 20 T-shirts in his first month of trading (May) at a cost of $5 each. He
then sells all of them for $10 each.

Tom has therefore made a profit of $100, by matching the revenue ($200) earned
against the cost ($100) of acquiring them.

If Tom only sells 18 T-shirts  incorrect to charge her income statement with the
cost of 20 T-shirts, as she still has two T-shirts in inventory.

If he sells them in June, he is likely to make a profit on the sale. Therefore, only
the purchase cost of 18 T-shirts ($90) should be matched with her sales revenue
($180), leaving her with a profit of $90.

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 Accounting concepts

Assumptions
Monetary Unit Assumption requires that companies
include in the accounting records only transaction data that can be
expressed in terms of money.

The business entity concept requires that activities of the

entity be kept separate and distinct from the activities of its owner
and all other economic entities.
 Proprietorship.
Forms of Business
 Partnership.
Ownership
 Corporation.
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 The period assumption

 There are some statutory requirements for entity

to determine periodic profit figures, such as for
taxation. This division of the life of the entity into
equal time intervals is know as the period
assumption.
 As a result of this assumption, profit
determination involves a process of recognizing
the income for a period and deducting the
expenses incurred for that same period.

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 Historical cost

 Historical cost: Transactions are recorded at

their cost when they incurred.
=> A basic principle of accounting is that the
monetary amount at which items are normally
measured in financial statements is at historical
cost, ie at the amount which the business paid to
acquire them. There is usually a source
document to prove the amount paid to
purchase an asset or pay an expense

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 Materiality and aggregation (IAS 1)

 Material: Omissions or misstatements of items

are material if they could, individually or
collectively, influence the economic decisions of
users taken on the basis of the financial
statements.
 Materiality depends on the size and nature of
the omission or misstatement judged in the
surrounding circumstances. The size or the
nature of an item, or a combination of both,
could be the determining factor

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 Practices

 Question Banks
 Self-test

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