Introduction to Accounting
1. Who is responsible for Financial Statements?
- BOD (Board of Management): preparation
- Supervisory Board and Audit Committee: audit and approval
- Auditors: assists supervisory board with external audit
- Enforcement: additional audit by governmental agency
2. Differences between Single and Consolidated Financial Statement:
Single Consolidated
- One company - Parent company and all subsidiaries
- Individual performance - Overall performance
3. A set of accounting principles, standards and procedures:
- Germany: HGB
- US: GAAP
- Vietnam: VAS
4. Why international standards?
- More comparability: IFRS is intended to be a uniform accounting language.
- Saving cost: Investors do not need time, money and effort to reconcile financial information.
Chapter 1| Accounting in Action
Accounting Activities and Users
*Accounting: consists of 3 basic activities: it identifies, records, and communicates the economic
events of an organization to interested users
Three Activities:
- Identify: the starting point of accounting process
- Record: Recording consists of keeping a systematic, chronological diary of events, measures
in monetary units.
- Communicate: Collected information is communicated via financial reports, with the most
common type being financial statements (data is reported in the aggregate)
- Accounting process includes the bookkeeping function. Bookkeeping involves only the
recording of economic events.
Users of Accounting Data:
1. Internal Users:
- The managers of the business
- Type of financial reports used: Management/ Managerial/ Cost accounting.
2. External Users:
- Outside the company
- 2 common types:
+ Investors (owners): whether to buy, hold or sell the ownership shares of a company.
+ Creditors (suppliers or bankers): evaluate the risks of granting credit or lending money.
- Type of financial reports used: Financial accounting.
- Types of information needed vary:
+ Taxing authorities: whether the company complies with tax laws.
+ Regulatory agencies: whether the company is operating within prescribed rules.
+ Labor unions: whether the companies have the ability to pay wages and benefits to union
employees.
The Building Blocks of Accounting
Accountants muss follow certain standards in reporting financial information.
Ethics in Financial Reporting:
- Ethics: accounting actions are judged as right or wrong, honest or dishonest, fair or not fair.
Accounting Standards:
- 2 accounting standard-setting bodies:
+ IASB (International Accounting Standards Board): issues IFRS (International Financial
Reporting Standards) used by >130 countries.
+ FASB (Financial Accounting Standards Board): issues GAAP (Generally Accepted
Accounting Principles) used by most US companies.
Measurement Principles:
- 2 measurement principles:
+ Historical Cost Principle
+ Fair Value Principle
- The selection between these 2 methods based on the trade-offs between Relevance and
Faithful representation:
+ Relevance: financial information is capable of making a difference in a decision.
+ Faithful representation: the numbers and descriptions match what really existed or
happened.
Historical Cost Principle:
- Companies record their assets at their cost.
- It is true at the time the asset is purchases and over the time the asset is held.
Fair Value Principle:
- Assets and liabilities should be reported at fair value (the price received to sell an asset or
settle a liability)
Assumptions:
- 2 main assumptions:
+ Monetary Unit Assumption
+ Economic Entity Assumption
Monetary Unit Assumption:
- Requirement: Companies include in the accounting records only transaction data can be
expressed in money terms.
- Prevents: can not include some relevant information, such as: health of a company’s owners,
quality of service, morale of employees, …
Economic Entity Assumption:
- An economic entity can be any organization or unit in society.
- Requirement: The activities of the entity muss be kept separate and distinct from the activities
of its owner and all other economic entities.
+ Proprietorship: A business owned by one person.
+ Partnership: A business owned by two or more people.
+ Corporation: A business organized as a separate legal entity under jurisdiction corporation
law and having ownership divided into transferable shares.
The Accounting Equation
Analyzing Business Transactions
*Accounting information system: the system of collecting and processing transaction data and
communicating financial information to decision-makers
Accounting Transactions:
*Transaction: business’s events recorded by accountants.
- Each transaction must have a dual effect on accounting equation.
Transaction Analysis:
(1) Investment by Shareholders:
(2) Purchase of Equipment for Cash:
(3) Purchase of Supplies on Credit:
(4) Service Performed for Cash:
(5) Purchase of Advertising on Credit:
(6) Services Performed for Cash and Credit:
(7) Payment of Expenses:
(8) Payment of Accounts Payable:
(9) Receipt of Cash on Account:
(10) Dividends:
Financial Statements
- 5 important financial statements:
(1) Income Statement: Revenues, Expenses -> Net Income/ Loss.
(2) Retained Earnings Statement: Retained earnings, Net income/ loss -> Retained
earnings.
(3) Statement of Financial Position: Assets, Liabilities, Equity
(4) Statement of Cash Flows: cash inflows, outflows
(5) Comprehensive Income Statement: other comprehensive income items not included in
the determination of net income.
Chapter 2| The Recording Process
Accounts, Debits, and Credits
The Account
*Account: is an individual accounting period of increases and decreases in a specific asset, liability,
or equity item
Debits and Credits
- The terms debit and credit describe where entries are made in accounts.
Debit and Credit Procedure
- Each transaction must affect 2 or more accounts to keep the basic accounting equation in
balance.
Equity Relationships
The Journal
The Recording Process
(1) Analyze transaction.
(2) Enter transaction in journal.
(3) Transfer journal information to ledger accounts.
The Journal
- The most basic form is General Journal.
- Transactions are recorded in chronological order.
- Structure: (1) dates; (2) account titles; (3) explanations; (4) references; (5) two amount
columns
- Pros:
+ It discloses in one place the complete effects of a transaction.
+ It provides a chronological record of transactions.
+ It helps to prevent and locate errors.
Journalizing
Simple and Compound Entries
- Simple entry: involve only 2 accounts, 1 credit and 1 debit.
- Compound entry: involve more than 2 accounts.
The Ledger and Posting
The Ledger
*Ledger: the entire group of accounts maintained by a company
- The ledger provides the balance in each of the accounts as well as keeps track of changes in these
balances.
- The most common type of ledger is General Ledger.
Standard Form of Account
- Beside the simple T-account, the standard format is three-column form of account.
- The balance is determined after each transaction.
Posting
*Posting: the procedure of transferring journal entries to the ledger.
- Posting should be performed in chronological order.
Chart of Accounts
- Chart of accounts lists the accounts and the account numbers (code) that identify their
location in the ledger.
101-199 Assets
200-299 Liabilities
301-350 Equity
400-499 Revenues
601-799 Expenses
800-899 Other revenues
900-999 Other expenses
- Companies leave gaps to permit the insertion of new accounts.
The Recording Process Illustrated
(1) Investment of cash by shareholders
(2) Purchase of office equipment
(3) Receipt of cash for future service
(4) Payment of monthly rent
(5) Payment for insurance
(6) Purchase if supplies on credit:
(7) Hiring employees
(8) Declaration and payment of dividend
(9) Payment of salaries
(10) Receipt of cash for services provided
The Trial Balance
*Trial balance: is a list of accounts and their balances at a given time.
- Trial balance is often prepared at the end of an accounting period.
Limitations of a Trial Balance
- The trial balance may balance even when:
+ A transaction is not journalized.
+ A correct journal entry is not posted.
+ A journal entry is posted twice.
+ Incorrect accounts are used in journalizing or posting.
+ Offsetting errors are made in recording the amount of a transaction.
- The trial balance does not prove that the company has recorded all transactions or that ledger
is correct.
Chapter 3| Adjusting the Accounts
Accrual-Basis Accounting and Adjusting Entries
*Time period assumption: accountants divide economic life of a business into artificial time
periods. (Also called: periodicity assumption)
Fiscal and Calendar Years
- Accounting time periods are generally a month, a quarter, or a year.
- Interim periods: monthly and quarterly time periods.
- Fiscal year: one year in length.
Accrual- versus Cash-Basis Accounting
- Accrual-basis accounting: companies record transactions that change a company’s financial
statement in the periods in which the events occur. => In accordance with IFRS.
- Cash-basis accounting: companies record revenue at the time they receive cash, and they
record expense when they pay out cash. (More suitable for individual and small companies)
Recognizing Revenues and Expenses
- Performance obligation: when a company agrees to perform a service or sell a product to a
customer.
- Revenue recognition principle: companies recognize revenue in the accounting period in
which the performance obligation is satisfied.
Expense Recognition Principle
- Expense recognition is tied to revenue recognition.
- Expense recognition principle: companies recognize expenses in the period in which they
make efforts to generate revenue.
The Need for Adjusting Entries
- Adjusting entries ensure that the revenue recognition and expense recognition principles are
followed.
- Adjusting entries are required every time a company prepares financial statements.
- Every adjusting entry will include one income statement account and one statement of
financial position account.
Types of Adjusting Entries
- 2 types:
+ Deferrals:
(1) Prepaid expenses: expenses paid in cash before they are uses or consumed.
(2) Unearned revenues: cash received before services are performed.
+ Accruals:
(1) Accrued revenues: revenues for services performed but not yet received in cash or
recorded.
(2) Accrued expenses: expenses incurred but not yet paid in cash or recorded.
Adjusting Entries for Deferrals
Prepaid Expenses/ Prepayment
- Examples: insurance, supplies, advertising, and rent.
- Prepaid expenses are costs that expire either with the passage of time or through use.
Supplies
- At the end of accounting period, the company counts the remaining supplies or supplies on
hand.
Insurance
- Insurance must be paid in advance, often for multiple months.
Depreciation
- Assets like buildings, equipment, and motor vehicles have useful life.
- According to historical cost principle, such assets are recorded at their costs.
- Depreciation is the process of allocating the cost of an asset to expense over its useful life.
- Instead of crediting the asset account directly, we credit Accumulated Depreciation
account, which is called a contra asset account.
- Book value: is the difference between the cost of any depreciable asset and its related
accumulated depreciation.
Unearned Revenue
- Record under a liability account called unearned revenue.
Adjusting Entries for Accruals
Accrued Revenues
Accrued Expenses
- Examples: interest, taxes, salaries.
Accrued Interest
Accrued Salaries and Wages
Summary
Adjusted Trial Balance and Financial Statements
Alternative Treatment of Deferrals
Prepaid Expenses
- If at the time of purchase the company expects consume the supplies before the next financial
statement date, it may choose to debit an expenses account rather than an asset account.
Unearned Revenues
- Unearned revenues are recognized as revenue at the time services are performed and the
company may credit a revenue account rather than a liability account when they receive cash
for future services. If the company performs the services before the financial statement date,
no adjustment is needed at the end of the period.
Financial Reporting Concepts
Qualities of Useful Information
- Relevance: accounting information has relevance if it would make a difference in a business
decision.
- Faithful representation: information accurately depicts what really happened.
Enhancing Qualities
- Beside relevance and faithful representation, there should be also:
(1) Comparability: different companies use the same accounting principles.
(2) Consistency: a company uses the sane accounting principles and methods from year to
year.
(3) Verifiability: information is verifiable if independent observers obtain the same results.
(4) Timeliness: information must be available to decision-makers before it loses its capacity
to influence decisions.
Assumptions in Financial Reporting
Principles in Financial Reporting
Measurement Principles
(1) Historical Cost Principle: companies record their assets at their costs. This is true not only
at the time the asset is purchased but also over the time the asset is held.
(2) Fair Value Principle: assets and liabilities should be reported at fair value.
Most assets follow the historical cost principle, only in situations where assets are actively
traded, is the fair value principle applied.
Revenue Recognition Principle
Expense recognition Principle
Full Disclosure Principle
Chapter 4| Completing the Accounting Cycle
The Worksheet
Closing the Books
- Temporary accounts: relate only to a given accounting period. The companies close all
temporary accounts at the end of the period.
- Permanent accounts: relate to one or more future accounting periods. They are not closed
from period to period.
Preparing Closing Entries
- At the end of the accounting period, the company transfers temporary account balances to the
permanent equity account – Retained Earnings – by means of closing entries.
- Closing entries recognize in the ledger the transfer of net income/ loss and dividends to
Retained Earnings.
- Companies generally journalize and post closing entries only at the end of the annual
accounting period.
Classified Statement of Financial Position
Intangible Assets
- Long-lived assets that do not have physical substance.
- Goodwill:
Company A Company B
A: 100 E: 20 Cash: 1000 E: 900
L: 80 L: 100
100 100 1000 1000
Company B purchases for 100% shares
of company A with 150.
Single FS Consolidated FS
Company B Company B
Cash: 850 E: 900 Cash: 850 E: 900
Fin. Ass: 150 L: 100 A: 100 L: 180
1000 1000 G.w: 130
1080 1080
- Goodwill = purchase price – (assets acquired – liabilities acquired) = 150 – (100 – 80) = 130
Property, Plants and Equipment
- Alternative terminology: fixed assets or plant assets.
- Depreciation is the practice of allocating the cost of asset to a number of years. (Accumulated
depreciation)
Long-term Investment
(1) Investments in shares and bonds
(2) Non-current assets such as land or buildings
(3) Long-term notes receivable
Current Assets
- Assets that a company expects to convert to cash or use up within one year or its operating
cycle.
- The operating cycle of a company is the average time that it takes to purchase inventory, sell
it on account, and then collect cash from customers.
- Common types: cash, investments, receivables, inventories, prepaid expenses.
Equity
- Corporations often divide equity into 2 accounts: Share Capital-Ordinary and Retained
Earnings.
Non-current Liabilities
- Common types: bonds payable, mortgages payable, long-term notes payable, lease liabilities,
pension liabilities, …
Current Liabilities
- Obligations that the company is to pay within the coming year or its operating cycle.
- Common types: accounts payable, salaries & wages payable, interest payable, income taxes
payable.
- Liquidity: the relationship between current assets and current liabilities.
Reversing Entries
- Companies make a reversing entry at the beginning if the next accounting period.
- Each reversing entry is exact opposite of the adjusting entry made in the previous period.
- Purpose: to simplify the recording of a subsequent transaction related to an adjusting entry.
Chapter 6| Inventories
Classifying and Determining Inventory
Classifying Inventory
- Regardless of the classification, companies report all inventories under Current Assets.
- In a merchandising company: inventories have only 2 common characteristics: (1) they are
owned by the company; (2) the are in a form ready for sale => Only 1 inventory classification:
merchandise inventory.
- In manufacturing company: some inventory may not yet be ready for sale => 3 categories:
(1) Finishes goods.
(2) Work in process.
(3) Raw materials.
- By considering the levels of these types of inventories, we can gain insight into production
plans:
+ Low levels of raw materials and high levels of finished goods => enough inventories on
hand, production will be slowing down.
+ High levels of raw materials and low levels of finished goods => step up production.
- Just-in-time (JIT) inventory: companies manufacture or purchase goods only when
needed. The success of JIT system depends on reliable suppliers.
Determining Inventory Quantities
- Companies with perpetual system take a physical inventory to:
+ Check the accuracy of their perpetual inventory records.
+ Determine the amount of inventory lost due to wasted raw materials, shoplifting, or
employee theft.
- Companies with periodic system take a physical inventory to:
+ Determine the inventory on hand.
+ Determine the cost of goods sold (COGS).
- Determining inventory quantities involves 2 steps:
(1) Taking a physical inventory of goods on hand.
(2) Determining the ownership of goods.
Taking a Physical Inventory
- Counting, weighing and measuring.
Determining Ownership of Goods
(1) Goods in Transit:
(2) Consigned Goods:
- Hold the goods of other parties and try to sell the goods for them for a fee, but without taking
ownership of the goods.
- Purpose: keep their inventory costs down and avoid the risk of purchasing an item that they
will not be able to sell (keep their inventory levels low).
Inventory Methods and Financial Effects
- Inventory is accounted for at cost. Cost includes all expenditures necessary to acquire goods
and place them in a condition ready for sale.
- Freight costs incurred to acquire inventory -> cost of inventory; but cost of shipping goods ->
selling expense.
Specific Identification
Cost Flow Assumptions
- 2 common methods:
(1) First-in, first-out (FIFO)
(2) Average-cost
- Cost of Goof Sold:
First-in, first-out
Average-cost
Financial Statement and Tax Effects of Cost Flow Methods
Income Statement Effects
- In the period of rising prices, FIFO reports higher Net Income.
- In the period of falling prices, Average-cost reports higher Net Income.
- To management, higher net income is advantage as it attracts external users.
Tax Effects
- In periods of rising prices, some companies use Average-cost method as it results in lower
income taxes.
Effects of Inventory Errors
Inventory Statement Presentation and Analysis
Presentation
- Current Assets
Lower-of-Cost-or-Net Realizable Value
- When the value of inventory is lower than its cost, companies must write down the inventory
to its net realizable value.
Analysis
(1) Inventory Turnover: measures the number of times on average the inventory is sold during
the period.
- Formula:
(2) Days in Inventory measures the average number of days inventory is held.
- Formula: 365/ Inventory Turnover.
Estimating Inventories
Gross Profit Method
- Gross profit rate to net sales.
Retail Inventory Method
Chapter 9| Plant Assets, Natural Resources, and Intangible Assets
Plant Asset Expenditures
- Plant assets: (1) have physical substance; (2) are used in the operations of a business; (3)
are not intended for sale to customers.
Depreciation Methods
- Depreciation: process of allocating to expense the cost of a plant asset over its useful life in a
rational and systematic manner.
- Do not apply to land.
Factors in Computing Depreciation
Depreciation Methods
- 3 methods:
Straight-line Method
Units-of-Activity Method
Declining-Balance Method
Statement Presentation and Analysis
Analysis
- Asset Turnover: analyzes the productivity of a company’s assets.
Asset assumption rate = Accumulated Depreciation-Equipment / Historical cost
Quick ratio = Current Assets/ Current Liabilities
Goodwill = Purchase price – (Assets acquired – Liabilities acquired)
IAS 38: Intangible Assets
IAS 16: Tangible Assets
IFRS 15/ IAS 18: Revenue
IAS 1: Representation of Financial Statements
IAS 7: Cash Flows
IAS 40: Long-term Investments
IFRS 9: Financial Instruments (Recognition and Measurement)
