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Accounting and finance: an introduction. Summary chapter 1 until 13.
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A summery of chapter 1 until 13 of the book "Accounting and finance: an introduction".
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Financial management & accounting - Accounting and Finance
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Accounting and finance: an introductionChapter 1: Introduction to accounting and finance
Accounting = collecting, analysing and communicating financial information.
The aim is that the users of the information is able to make more informed decisions.
Finance (or financial management) = the way in which funds for businesses are raised and invested
The accountant must know for what the information is being used and who it uses. (like customers,
employees, government and so on)
Sometimes the interests of the various user groups might collide.
Other sources of information about the business is not reliable, like meetings, newspaper or
websites.
Shares = portions of ownership of a business.
Accounting information can lead to different prices of shares or volume of shares traded.
Accounting information must be:
- Relevance: it must help to predict future events (such as predicting next year’s profit) or help
to confirm past events (such as establishing last year’s profit)
Materiality = information is considered material or significant if its omission(verzuim) or
misstatement would alter the decision that users make.
If information is not material it should not be part of the accounting report.
- Faithful representation: information should be complete, neutral and free from error
These qualities can enhance its usefulness:
- Comparability: accounting system treats items in the same way and where policies for
measuring and presenting accounting information are made clear (so they can compare items
to maybe previous years )
- Verifiability: accounting information is verifiable where different, independent experts would
be able to agree that it provides a faithful portrayal. There must be evidence.
- Timeliness: it should be produces in time for users to make their decisions.
- Understandability: it should be understood by those at whom the information is aimed.
In theory a particular item of accounting information should only be produced if the costs of
providing it are less than the benefits, or the value, to be derived from its use. (so it can be relevant
and faithfully represented, but it is to expansive, you won’t produce the information)
(see costs value graphic)
Accounting information system
- Identifying and capturing relevant information (in this case financial information)
- Recording, in a systematic way, the information collected
- Analysing and interpreting the information collected
- Reporting the information in a manner that suits the needs of the user
Management accounting = which seeks to meet the accounting needs of managers (internal use)
Financial accounting = which seeks to meet those of all of the users identified earlier in the chapter,
except for managers (general purpose)
Differences are (see figure 1.5):
- Nature of reports produced (specific-purpose reports vs general purpose)
- Level of detail (considerable detail vs broad overview)
, - Regulation (designed to meet the needs vs regulations imposed by the law and accounting
rule makers)
- Reporting interval (as frequently as needed vs mostly annually)
- Time orientation (future performance as well as past vs backward looking)
- Range and quality of information (can contain information of a non-financial nature vs can be
quantified in monetary terms)
Because of internationalisation and rapid technology changes and so on. There has been increasing
harmonisation of accounting rules across national frontiers. So investors can compare easier and
harmonisation can lead to saving costs to produce accounting reports for every nation.
Financial reports are now more comparable and transparent and provide a more faithful portrayal of
economic reality.
Management accounting has become more outward looking.
Customer driven = concerned with satisfying customer needs
Kinds of private-sector businesses:
- Sole proprietorship: an individual is the sole owner, mostly small, no formal procedures are
required, must produce mostly only for the taxation authorities, Unlimited liability
- Partnership: two or more individuals, mostly small, no formal procedures are required,
unlimited liability
- Limited company: number of individuals may be unlimited, can be quite small to very large,
certain obligations, limited liability, audited
The owners (shareholders) are mostly not involved in the daily running of the business. They appoint
a board of directors, they have 3 main tasks:
- Setting the overall direction and strategy for the business
- Monitoring and controlling the activities of the business
- Communicating with shareholders and others connected with the business
Each board has a chairman, elected by the directors. This is in many companies also the chief
executive officer (CEO) who is responsible for running the business on a day-to-day basis.
This may be a way a business is organized.
Board of directors finance, human resources, marketing, operations
Strategic management = setting the long-term direction of the business, focussing on doing things
differently rather than simply doing things better.
A business is normally created to enhance the wealth of its owner. But the needs of other groups
seems more and more important. Like the satisfaction of employees and customers and so on.
Wealth creation is concerned with the longer term.
Risk and return influence each other. More risk means more return. But you never know what
happens in the future. You must find a balance.
The way in which individual businesses operate in terms of the honesty, fairness and transparency
with which they treat their stakeholders (costumers suppliers and so on) has become key issue.
,Chapter 2: Measuring and reporting financial position
The major financial statements:
- Statement of cash flows
- Income statement (also known as the profit and loss account)
- Statement of financial position (also known as the balance sheet)
Assets = business recourses (things of value to the business), including cash and inventories
Equity = investment, or stake of the owner
Cash is a vital resource that is necessary for any business to function effectively. It is required to meet
debts that become due and to acquire other resources (such as inventories)
The equity of most businesses will similarly be made up of injections of funds by the owner plus any
accumulated profits.
Income statement and cash flows measuring flows during a particular period. The financial position
statement is concerned with a particular moment of time.
The three financial statements discussed are often referred to as the final accounts of the business.
The statement of financial position
Assets on one hand and the claims on the other.
Assets:
- A probable future economic benefit must exist.
- The benefit must arise from past transaction event.
- The business must have the right to control the resource.
- The asset must be capable of measurement in monetary terms.
Sorts of items that often appear as assets: property, plant and equipment, fixtures and fittings,
patents and trademarks, trade receivables (debtors), investments outside the business.
An asset does not have to be a physical item, it may be a non-physical one that gives a right to certain
benefits.
Tangible assets = have a physical substance and can be touched (like inventories)
Intangible assets = have no physical substance but which provide expected future benefits (like
patents)
Claims
- Equity = the claim of the owner against the business. Also known as owner’s capital.
- Liability = represents the claims of all individuals and organisations, apart from the owner.
Accounting equation: Assets = equity + liability
(there must always be a balance)
Trade payable is a liability, it is a good being bought on credit.
Reporting period = the period over which businesses measure their financial results. (sometimes
called accounting or financial period)
, The length of the period is determent by weighing up the costs of producing the information against
the perceived benefits of having that information for decision making purposes.
Assets (at the end of the period) = equity (amount at the start of the period) + profit (or – loss for the
period) + liabilities (at the end of the period.
Assets
- Current assets (short term, most common are inventories, trade receivables and cash)
o Held for sale or consumption during the business’s normal operating cycle
o Expected to be sold within a year after the date of the relevant statement of financial
position
o Held principally for trading
o Are cash, or near cash such as easily marketable, short-term investments
- Non-current assets (or fixed assets) (long term)
o Tangible non-current assets (property, plant and equipment)
o intangible non-current assets
liabilities
- current liabilities (short term, like trade payables)
o expected to be settled within the business’s normal operating cycle
o exist principally as a result of trading
o due to be settled within a year after the date of the relevant statement of financial
position
o there is no right to defer settlement beyond a year after the date of de relevant
statement of financial position
- Non-current liabilities (long term, like long-term borrowings)
It is quite common for non-current liabilities to become current liabilities. For example, borrowings to
be paid 18 months after the date of a particular statement of financial position.
Assets – liabilities = equity
Accounting conventions
- Business entity (eenheid) convention
o Distinguished from the legal position that may exist between businesses and their
owners.
- Historic cost convention
o The value of assets shown on the statement of financial position should be based on
their historic costs.
The key problem is that even quite early in the life of some assets, historic costs may
become outdated (like a vehicle)
Instead of historic costs you can use current replacements costs or current realisable value (selling
price). But it can be defined in different ways.
Where the current values of assets are based on the opinion of managers of the business, there is a
greater risk that they will lack credibility. Some form of independent valuation, or verification, may
therefore be required to reassure users.
- Prudence convention
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