FINANCIAL

ACCOUNTING
W E E K S 2 & 3 : C O N C E P T UA L F R A M E WO R K A N D
THE ACCOUNTING PROCESS
 CONCEPTUAL FRAMEWORK

The Conceptual Framework defines:

• The objective of financial reporting

• Underlying assumptions and basis
• The qualitative characteristics of useful financial information
• The definition, recognition and measurement of the elements from which
financial statements are constructed
• Concepts of capital and capital maintenance.

It describes the basic concepts for preparing financial statements and it is a guide to
resolving accounting issues.
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 CONCEPTUAL FRAMEWORK

The Conceptual Framework defines:

• The objective of financial reporting

• Underlying assumptions and basis
• The qualitative characteristics of useful financial information
• The definition, recognition and measurement of the elements from which
financial statements are constructed
• Concepts of capital and capital maintenance.

It describes the basic concepts for preparing financial statements and it is a guide to
resolving accounting issues.
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 CONCEPTUAL FRAMEWORK

The financial statements are normally prepared on

the assumption that an entity is a going concern
Going concern and will continue in operation for the foreseeable
assumption future. Hence, it is assumed that the entity has neither
the intention nor the need to liquidate or curtail
materially the scale of its operations.

Under this basis, the effects of transactions and

other events are recognised when they occur (and
not as cash and its equivalent is received or paid)
Accrual basis
and they are recorded in the accounting records and
reported in the financial statements of the periods to
which they relate.

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 CONCEPTUAL FRAMEWORK

The Conceptual Framework defines:

• The objective of financial reporting

• Underlying assumptions and basis
• The qualitative characteristics of useful financial information
• The definition, recognition and measurement of the elements from which
financial statements are constructed
• Concepts of capital and capital maintenance.

It describes the basic concepts for preparing financial statements and it is a guide to
resolving accounting issues.
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 CONCEPTUAL FRAMEWORK

Source: Maynard, 2016

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 CONCEPTUAL FRAMEWORK

• Relevance: relevant information is capable of making a difference in the

decisions made by users. Materiality is an entity-specific aspect of relevance.

• Faithfull representation: to be useful, financial information must not only be

relevant, but also represent faithfully the entity: complete, neutral (no bias)
and free from error.

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 CONCEPTUAL FRAMEWORK

Source: Maynard, 2016

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 CONCEPTUAL FRAMEWORK

• Comparability: information about a reporting entity is more useful if it can be

compared with a similar information about other entities and with the same entity
over time (identify trends).
• Verifiability: means that different knowledgeable and independent observers would
agree that the information presented represents faithfully the economic phenomena.
• Timeliness: means that the information is available to decision-makers in time to be
capable of influencing their decisions.
• Understandability: means that the information is clear and understandable by
users who have a reasonable knowledge of business and economic activities.

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 CONCEPTUAL FRAMEWORK

The Conceptual Framework defines:

• The objective of financial reporting

• Underlying assumptions and basis
• The qualitative characteristics of useful financial information
• The definition, recognition and measurement of the elements from which
financial statements are constructed
• Concepts of capital and capital maintenance.

It describes the basic concepts for preparing financial statements and it is a guide to
resolving accounting issues.
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 FINANCIAL STATEMENT ELEMENTS

Asset – e.g. Liability – e.g. Capital – e.g.

property, plant and bank overdraft, Share capital, share
equipment, motor payables, loans premium, retained
vehicles, inventory, profits and losses
receivables, bank

Income – e.g. Expense – e.g.

Sales, rent receivable, Salaries, heat & light,
interest receivable telephone, insurance,
motor expenses,
interest

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 THE FINANCIAL STATEMENTS

Balance Sheet Income

Cash Flow
Statement
Statement
Assets Liabilities Revenue
Operating
Cash Accounts payable Operating expenses
Investing
Accounts Bank loan Operating profit
Financing receivable
Financing expenses
Change in Cash
Inventory
Profit before tax
Intangible assets Tax
Property, plant Profit after tax
and equipment Capital
Share capital
Retained earnings

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 STATEMENT OF FINANCIAL POSITION/BAL ANCE SHEET

The statement of the financial position (aka balance sheet) is a financial

statement that reports the value of a company’s assets, liabilities and equity
at a specific point in time.

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 BALANCE SHEET PRESENTATION
The statement of financial position should provide totals for the following items
Assets
(a) property, plant and equipment
(b) investment property
(c) intangible assets
(d) financial assets
(e) investments accounted for using the equity method
(f) biological assets
(g) inventories
(h) trade and other receivables
(i) cash and cash equivalents
(j) assets held for sale
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 BALANCE SHEET PRESENTATION

Asset
A present economic resource controlled by the entity
as a result of past events.

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 BALANCE SHEET PRESENTATION

Liabilities
(k) trade and other payables
(l) provisions
(m) financial liabilities
(n) current tax liabilities and current tax assets
(o) deferred tax liabilities and deferred tax assets
(p) liabilities included in disposal groups

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 BALANCE SHEET PRESENTATION

Liability
A present obligation of the entity to transfer an economic resource
as a result of past events.

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 BALANCE SHEET PRESENTATION

Capital
(q) non-controlling interests, presented within equity
(r) issued capital and reserves attributable to owners of the parent.

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 BALANCE SHEET PRESENTATION

Capital/Equity
The residual interest in the assets of the entity after
deducting all its liabilities

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 BALANCE SHEET PRESENTATION: ASSETS

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

• Prepaid expenses • Long-term investments

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 BALANCE SHEET PRESENTATION: LIABILITIES

Current Non-current
Obligations or debts payable in the one Debts payable more than one year
year or within the business’s from balance sheet date
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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 BALANCE SHEET PRESENTATION
STAT E ME N T OF F I N A N CI A L POSI T I ON / BA L A N CE SH E ET 3 1 . 1 2. 20 1 9

ASSETS EQUITY
Non-current Assets: Equity
Tangible fixed assets Capital
Retained earnings
Intangible fixed assets SE
Total Equity
Investments in subsidiaries and associates
Other financial investments LIABILITIES
Current Assets:
Non-current Liabilities:
Inventories
Loans
Clients and other debtors Provisions
Cash and cash equivalents Current Liabilities:
Other current assets Suppliers
Accruals and deferrals Loans
Provisions
Accruals and deferrals
Total liabilities L
Total assets A Total Equity and liabilities SE + L
always: A = SE + L 22
 EX AMPLE: GP BROADCASTING

A thorough review of GP Broadcasting assets and liabilities at the end of December 31, 2018
resulted in the following information:
• Cash on hand and cash at bank $483,000
• Fixed term deposits with banks $140,000 (matures July 1, 2020)
• Interest-free loan from a shareholder, totaling $400,000, payable in eight equal quarterly
instalments, first payment due on March 1, 2019
• Inventories totaling $304,000
• Investment in associate companies using equity method at $45,000
• Loans to employees of $100,000, 30% of which is due by end of 2019
• Note payable of $260,000 due July 1, 2020
• PPE with a net value of $137,000
• Provision for employee benefit of $140,000 (first employee retirement expected in 2022)
• Short-term investment in publicly traded shares of listed companies at $12,000
• Trade payable of $307,000
• Trade receivables totaling $249,000
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 INCOME STATEMENT
Income Statement or Statement of Profit and Loss: provides information
about a company’s profitability over a period of time.

NET PROFIT = INCOME – EXPENSES

Income
Increases in assets or decreases in liabilities that result in increases in equity,
other than those relating to contributions from holders of equity claims.

Expenses
Decreases in assets or increases in liabilities that result in decreases in
equity, other than those relating to distributions to holders of equity claims.
 INCOME STATEMENT

Net Profit: is a measure of the increase in the “wealth” of an entity over a period of
time (coming from other sources than contributions from equity participants).

The accrual basis: Revenue is recognized as the company earns it, and expenses are
recognized as the company incurs them and not when cash is received or paid.

The matching principle: Income and expenses that result directly and jointly from
the same transactions or other events should be recognised simultaneously.
 INCOME STATEMENT

INCOME = REVENUES + GAINS

Revenue arises in the course of the ordinary activities of an entity and is

referred to by a variety of different names including sales, fees, interest,
dividends, royalties and rent. Gains represent other items that meet the definition
of income and may, or may not, arise in the course of the ordinary activities of an
entity.
 INCOME STATEMENT

According to IAS 1, an entity can prepare two alternative Income Statement

presentations:
1. The expenses are classified according to its nature.
2. The expenses are classified according to its function within the entity.
 INCOME STATEMENT
INCOME STATEMENT BY NATURE 2018

Operating revenue and income:

Sales
Services rendered
Other operating income
Total operating income
Operating expenses:
Cost of inventory
Supplies and services
Staff costs
Depreciation and amortization
Provisions and impairement losses
Other operating expenses
Total operating expenses
Operating profit (EBIT)

Profit/(Loss) related to financial investments

Interest expense
Proft/(Loss) before income tax
Income tax
Net profit
 INCOME STATEMENT
INCOME STATEMENT BY FUNCTION 2018
Operating revenues:
Sales
Services rendered
Other operating income
Total operating income
Operating expenses:
Production expenses/ Cost of sales
Distribution expenses
Adminitrative expenses
Other operating expenses
Total operating expenses
Operating profit
Profit/(Loss) related to financial investments
Interest expense
Proft/(Loss) before income tax
Income tax
Net profit
 INCOME STATEMENT

The entity should choose the presentation that provides more relevant and
reliable information.

The Income statement by function can provide more relevant information to

users than the classification of expenses by nature but allocating costs to
functions may require arbitrary allocations and involve considerable judgment.
 STATEMENT OF OTHER COMPREHENSIVE INCOME

Not all expenses or all income is recognised in the income statement!

Examples of income/expenses not recognised in the income statement include:

o revaluation gains and losses
o remeasurements of defined benefit plans
o gains and losses arising from translating financial statements of a foreign
operation
o for particular liabilities designated as at fair value through profit and loss, the
amount of the change in fair value that is attributable to changes in the
liability’s credit risk
o items relating to hedging instruments
 STATEMENT OF CHANGES IN EQUITY
STATEMENT OF CHANGES IN EQUITY

Equity, at the begining of the year

+ Net profit for the year
+ Other comprehensive income
+ Other transactions with owners (capital issue, treasury
shares)
- Dividends declared
Equity, at the end of the year
THE FLOW OF ACCOUNTING INFORMATION

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 THE RULES OF BOOKKEEPING

Source: Maynard, 2016

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 THE RULES OF BOOKKEEPING

Debit Credit
Increase in an asset • Decrease in an asset
Decrease in a liability
• Increase in a liability
Decrease in equity
q (Expense/Loss) • Increase in equity
q (Income/Profit)

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 EX AMPLES: TRANSACTIONS
Transaction Accounts increased or Resulting double-
decreased entry
1. The owner of a business pays
£10,000 into the business
bank account
2. The business purchases a
motor vehicle on credit
3. The business buys
merchandise on credit
4. The business pays a supplier
from whom goods had been
purchased on credit
5. The business receives a loan
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 EX AMPLES: TRANSACTIONS
Transaction Accounts increased or Resulting double-
decreased entry
1. The business sells goods on
credit
2. The business pays wages

3. The business buys

merchandise on credit
4. The business pays interest on
its loan
5. The business pays dividend
to shareholders
 CASH FLOW STATEMENT

The statement of cash flows analyses changes in cash and cash equivalents
during a period.

Cash and cash equivalents comprise cash on hand and demand deposits,
together with short-term, highly liquid investments that are readily convertible
to a known amount of cash, and that are subject to an insignificant risk of
changes in value.
 CASH FLOW STATEMENT

Although profitability is important, so is the ability to generate positive cash

flows:
- Cash is needed to pay employees, suppliers, and others to continue as a going
concern;
- Cash is needed to fund investments and take advantages of attractive
business oportunities;
- Cash is the source of returns to providers of capital.
 CASH FLOW STATEMENT

Operating Activities
• Cash receipts and payments from the main revenue-producing activities

Investing Activities
• Purchasing & selling long-term assets

Financing Activities
• Issuing stock and borrowing

Net Changes in Cash and cash equivalents

 SUMMARY

üDiscuss the concepts and principles that underpin international financial

reporting standards.
üIntroduce the elements of the financial statements and learn how to account
for changes due to transactions.
üUnderstand the elements and presentation of the statement of financial
position.
üUnderstand the elements and presentation of the income statement.
üConstruct financial statements from transaction data.

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 HOMEWORK

• Read chapter 2.
• Prepare Case 3 for your practical class.

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