Financial Accounting

for

BBA Emphasis/Honors

Kathmandu University School of

Management (KUSOM)

nisha@kusom.edu.np
 What is Business?

to provide with
members goods
Activities of an and
economic services
system

nisha@kusom.edu.np
Classification of business by type of activity
• Product companies - provide goods or product
• Suppliers - supply raw materials needed to make the
product
• Manufacturers/Producers - transform the raw materials
obtained from the suppliers into a finished product
• Distributors - sell the finished product to others
– Wholesalers - sell to retail outlets
– Retailers - sell to consumers

• Service companies - provide a service. Service

providers are becoming increasingly important
in today’s economy.

nisha@kusom.edu.np
 Non-business Entities

Government Entities Private Organizations

Federal, State, and

Local Governments Hospitals, Universities,
Cooperatives
 Non-business Entities
– Exist to serve the needs of various segments of
society
– Lack of identifiable owner
– Even though there is a lack of a profit motive in
non-business entities, still need information
provided by an accounting system
– Hospitals, municipal government, colleges, are
non-business entities
 Forms of Organization

Sole Proprietorship One owner

Partnership Two or more owners

Corporation
Entity organized under
laws of a particular state
 Sole proprietorship

• A business organization with a single owner

• Many small businesses are sole proprietorships
• Economic entity concept: the affairs of the
business and the owners must be kept separate. A
single, identifiable unit must be accounted for in all
situations.
• Economic entity concept is an accounting concept,
not a legal concept. Therefore, a sole
proprietorship is not a taxable entity
• Any profits earned are included on the tax return
of the owner.
 Partnership

• A business owned by two or more individuals

• Partnership agreement - determines how
profits will be divided and how much each
partner will contribute. Can be oral or written
• Public accounting firms, law firms are often
partnerships
• Not a taxable entity: Any profits earned are
taxed on the return of the owners
 Corporations

• Business organized under the laws of a particular state

• Articles of incorporation must be filed with the state.

Once approved, a corporate charter is issued and
corporation can sell stock

• Stock certificate - evidence of ownership in a

corporation

• Stocks can be sold on organized stock exchanges

(NEPSE)
 Advantages/Disadvantages of Sole Proprietorships
Advantages Disadvantages
Freedom Unlimited Liability
Ease of Formation Lack of Continuity

Difficulty
Low Start-up Costs
Raising Money

Single Taxation Reliance On

One Person

dvantages/Disadvantages of General Partnersh

Advantages Disadvantages
Larger Talent Pool Unlimited Liability

Larger Money Pool Lack of Continuity

Ownership
Ease of Formation Transfer Difficult

Possibility of
Single Taxation Conflict
 Advantages/Disadvantages of
Corporations
Advantages Disadvantages
Limited Liability Stockholder Revolts
Continuity
High Start-up cost
Greater likelihood of
professional Management
High Cost of Regulatio
Easier Access to Money
Double Taxation
 The Nature of Business Activity
Financing Investing Operating
Activities Activities Activities
Examples:
•Borrowing •Purchase and Sale •Sale of
•Sale of stock of assets
products/services
•Payment of • Costs incurred
Dividends to operate
business
 Financing activities
• How a business obtains money (capital) for its needs

• Accounting is called the “language of business” and has its

own unique terminology

• Includes the sale of stock or borrowing to finance operations

• Liabilities: an obligation of a business. Notes payable,

bonds payable, accounts payable

• Capital stock: - the dollar amount of stock sold to the public.

Indicates the owners’ contributions to a corporation

• Stockholder (shareholder) provides permanent form of

financing and need not be repaid

• Creditor (lender) expects repayment of the amount loaned

plus interest
 Investing activities

• Once the funds are generated from

financing activities, the money is now
available to invest

• Includes the purchase of assets for the

business

• Assets: a future economic benefit to the

business. Accounts receivable, patents,
cash are examples
– Not all assets are tangible in nature
 Operating activities

• Once investments are made in assets, company

can begin operations
• Includes the sale of products or services and the
costs incurred to operate the business
• Revenues are the inflow of assets resulting from
the sale of goods and services. Represents the
dollar amount of sales of products and services for
a specific period of time
• Expenses are the outflow of assets resulting from
the sale of goods and services. They are the costs
incurred in operating a business
 What is Accounting?

Accounting is not just a procedural record-keeping

activity done by people “Who are good at math”.
In fact, Accounting is “the process of identifying,
measuring and communicating economic
information to permit informed judgments and
decisions by users of the information”

American Accounting Association

 What is Accounting?

Identifying

Economic to
Measuring
Information various
users

Communicating
 Characteristics of Accounting
Economic Entity Financial Statements Additional Information

Financial Balance Sheet President’s letter

Information
Income Statement Prospectuses,
Accounting?
Statement of Cash SEC Reporting
Identifies Flows News releases
and Statement of Forecasts
Measures Owners’ or
Stockholders’ Environmental
and Reports
Equity
Communicat Note Disclosures Etc.
es
 Internal and External
Users of Accounting Information

Bankers
Existing
and Creditors
Potential
Investors
Internal
Users –
Management Financial
Analysts
Researchers

Government
Suppliers
Agencies
 Why
Why do
do we
we need
need to
to Understand
Understand Accounting?
Accounting?

Common Questions Asked? Users &Decisions related

with
1. Can we afford to give our
employees a pay raise? Human Resources
2. Did the company earn a
satisfactory income? Investors
3. Which product line is most
profitable? For the Management
decision
4. Is cash sufficient to pay dividends to making!
the stockholders? Finance
5. What price for our product will
maximize net income? Marketing
6. Will the company be able to pay
its short-term debts? Creditors
Decisions Made with Financial Information

Add new
Invest?? product line??

Borrow $$??
Build new plant??
Extend credit $$?? Loan $$??

Start new business?? Sell stocks or bonds??

 Users of Accounting Information

Internal Users
External Users

•Lenders •Consumer Groups •Managers •Sales Staff

•Shareholders •External Auditors •Officers •Budget Officers
•Governments •Customers •Internal Auditors •Controllers

1-26
 Users of Accounting
Information

External Users Internal Users

Financial accounting provides Managerial accounting provides

external users with financial information needs for internal decision
statements (shareholders, lenders, makers (officers, managers, etc.).
etc.).
1-27
 Financial and Management
Accounting
• The major distinction between financial and
management accounting is the users of the
information.
– Financial accounting serves external users.
– Management accounting serves internal users,
such as top executives, management,
and administrators within
organizations.
Financial and Management Accounting
The primary questions about an organization’s
success that decision makers want to know are:

What is the financial picture of the organization

on a given day?
How well did the organization do during a given
period?
Financial and Management Accounting
Accountants answer these primary questions
with three major financial statements.
• Balance Sheet - financial picture on a given day
• Income Statement - performance over a given
period
• Statement of Cash Flows - performance over a
given period
 Financial and Managerial
Accounting: Seven Key Differences
Financial Accounting Managerial Accounting
1. Users External persons who Managers who plan for
make financial decisions and control an organization

2. Time focus Historical perspective Future emphasis

3. Verifiability Emphasis on Emphasis on
versus relevance objectivity and verifiability relevance
4. Precision versus Emphasis on Emphasis on
timeliness precision timeliness

5. Subject Primary focus is on Focus on

companywide reports segment reports

6. Rules Must follow GAAP / IFRS Not bound by GAAP / IFRS

and prescribed formats or any prescribed format
7. Requirement Mandatory for Not
external reports Mandatory
05/03/2025 31
Financial and Management Accounting
• Annual report - a document prepared by
management and distributed to current and
potential investors to inform them about the
company’s past performance and future
prospects.
– The annual report is one of the most common
sources of financial information used by investors
and managers.
 Financial and Management Accounting
• The annual report usually includes:
– a letter from corporate management
– a discussion and analysis of recent economic events
by management
– footnotes that explain many elements of the financial
statements in more detail
– the report of the independent auditors
– a statement of management’s responsibility for
preparation of the financial statements
– other corporate information
 The Accounting Equation
Assets = Liabilities + Owners’ Equity
(or Stockholders’
Equity)

Economic Creditors’ Owners’

resources
= claims + claims
to assets to assets
Examples:
Cash Accounts payable Capital stock
Accounts receivable Notes payable Retained earnings
Land
 Balance Sheet
(snapshot of financial position)

Assets = Liabilities
+
Owners’ Equity
(or Stockholders’ Equity)
 Top of the World
Balance Sheet
June 30, 2022

A A = L + SE
Current assets:
Cash $ 200
Accounts receivable 600
Land 4,000
Lodge, lifts and equipment 2,500
Total assets $7,300
 Top of the World A = L + SE
Balance Sheet
June 30, 2022
Liabilities and Stockholders’ Equity
Liabilities:
=L
Accounts payable $ 700
Salaries and wages payable 400
Notes payable 3,000
Total liabilities $4,100

Stockholders’ equity:
+ SE
Capital stock $2,000
Retained earnings 1,200
Total stockholders’ equity
$3,200
Total Liabilities and Stockholders’ Equity $7,300
 Income Statement
(for a period of time)

Revenues $$
Less: Expenses ($$)
Net income $$
 Top of the World
Income Statement
For the Year Ended June 30, 2022
Revenues – Expenses = Net Income
Revenues:
Lift tickets $5,800
Equipment rentals Revenues 2,200
Total revenues
$8,000

Expenses:
Salaries and wages $2,000
Depreciation 100 Expenses
Water, gas, and electricity 1,500
Insurance 1,100
Interest 300
Income taxes Net Income 1,000
Total expenses $6,000
Net income $2,000
 Statement of Retained Earnings
(for a period of time)

Beginning retained earnings $$$

Add: Net income for the period $$$
Deduct: Dividends for the period ($$$)
Ending retained earnings $$$
 Top of the World
Statement of Retained Earnings
For the Year Ended June 30, 2022

Retained earnings, beginning of the year $ 0

Add: Net income for the year
2,000
Deduct: Dividends for the year (800)
Retained earnings, end of the year $ 1,200
 Top of the World
Statement of Cash Flows
For the Year ended June 30, 2022

Cash flows from operating activities:

Cash collected from customers $ 7,400
Cash payments for:
Salaries and wages $ 1,600
Water, gas, and electricity 1,500
Insurance 400
Interest 300
Income taxes 1,000
Total cash payments 4,800
Net cash provided by operating activities $ 2,600
 Top of the World
Statement of Cash Flows
For the Year ended June 30, 2022

Cash flows from investing activities:

Purchase of land $(4,000)
Purchase of lodge, lift and equipment (2,600)
Net cash flows from investing activities $(6,600)
Cash flows from financing activities:
Proceeds from issuance of long term note $ 3,000
Proceeds from issuance of capital stock 2,000
Dividends declared and paid (800)
Net cash flows from financing activities 4,200
Net increase in cash $ 200
Cash at beginning of year 0
Cash at the end of the year $ 200
 Relationship among Financial Statements
Top of the World Example
Income Statement for Year ended June 30, 2022
Revenues $ 8,000
Less: Expenses ( 6,000)
Net income $ 2,000

Statement of Retained Earnings for Year ended June 30, 2022

Beginning balance, retained earnings $ 0
Add: Net income 2,000
Deduct: Cash dividends (800)
Ending balance, retained earnings $ 1,200

Balance Sheets
June 30, 2022 July 1, 2021
Total assets $7,300 $ 0
Liabilities 4,100 0
Capital stock 2,000 0
Retained earnings 1,200 0
Total liabilities and stockholders’ equity $7,300 $ 0
 The Conceptual Framework:
Foundation for Financial Statements

Aids accountants in their role as

interpreters and communicators of
relevant information
Acts as a foundation for the specific
principles and standards needed by
the profession
Financial Statement Assumptions

Economic
Entity Cost
Concept Principle
Time
Period
Assumption
Going Monetary
Concern Unit
 Economic Entity Concept
Each entity has its own books,
records, and financial statements
that are separate from owners
No intermingling of personal and
business assets and liabilities or
income and expenses
 Cost Principle
Record assets at cost paid to
acquire them
Continue to value assets at
historical cost until sold
More objective than market value
 Going Concern
Assume business will
continue indefinitely into the
future
Justifies use of historical cost
 Monetary Unit
 How we measure amounts in the financial
statements (e.g., U.S. dollar, Japanese yen,
Mexican peso, etc.)

 Assumes economic measure is relatively

stable; no adjustment for inflation made in
financial statements
 Time Period
• Under the time period assumption,
accountants assume that it is possible to
prepare an income statement that accurately
reflects net income or earnings for a specific
time period.
 Generally Accepted
Accounting Principles(GAAP)
The various methods, rules, practices
and other procedures that have
evolved over time that regulates the
preparation of financial statements
 The Rules of the Game
 The rules Þ GAAP
 The rule makers Þ FASB
 The rule enforcers Þ SEC
 The CPA regulators Þ AICPA
 International
Accounting Standards
International Accounting Standards
Board was created in 2001
There may be significant differences
between U.S. and international
standards
 Auditing
Financial statements are prepared by
and are the responsibility of the
company’s management
External auditors performs tests and
procedures to render an opinion as to
the financial statements are fairly
presented
 Corporate Governance

• Definition:
– “The system by which business corporations are directed
and controlled. The corporate governance structure
specifies the distribution of rights and responsibilities
among different participants in the corporation, such as,
the board, managers, shareholders and other
stakeholders, and spells out the rules and procedures for
making decisions on corporate affairs.”
OECD, April 1999
 Corporate Governance and Capital Markets

• Investment is an act of faith

• Poor governance
– Undermines integrity of corporations and discourages the use of public
markets as a means to intermediate savings
– Particularly the areas of transparency and disclosure have been a major factor
behind instability in the financial markets across the globe
• Good corporate governance
– Essential pre-requisite for the integrity and credibility of capital market players
– Contributes to the development of a vibrant economy and robust capital
markets
• Recent events have repeatedly proven the importance of corporate
governance standards, including the collapse of large global corporations
 Corporate Governance and Capital
Markets
• Equity investment requires good corporate
governance.
• Good corporate governance requires credible
disclosure by the issuer.
• Disclosure Requirements, Good Accounting
Standards, Independent Auditors and Effective
Enforcement helps in Capital Markets.
 Ethics—A Key Concept

Ethics

Beliefs that
Accepted
distinguish right
standards of
from wrong
good and bad
behavior
Financial
Financial accounting
accountingpractice
practiceisisgoverned
governedby
by
concepts
conceptsandandrules
rulesknown
knownas as generally
generallyaccepted
accepted
accounting
accountingprinciples
principles(GAAP).
(GAAP).

Relevant
Relevant Affects
Affectsthethedecision
decisionof
of
Information
Information its
itsusers.
users.

Reliable
Reliable Information
Information Is
Istrusted
trustedby
by
users.
users.

Comparable
Comparable Used
Usedin
incomparisons
comparisons
Information across
acrossyears
years&&companies.
companies.
Information
 Guidelines for Ethical Decisions

1. Identify ethical  Analyze  Make ethical

concerns options decision

Use personal ethics Consider all good Choose best option

to recognize an and bad after weighing all
ethical concern. consequences. consequences.
 Ethics in Accounting

1. Identify the ethical dilemma

2. Analyze key elements
3. Determine the alternatives
4. Resolve by selecting ethical
alternative
 Ethics in Business
Whistle-blowing
Whistle-blowing happens when an
employee informs officials or the public
about an illegal or ethical violation.

63
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Business Ethics and
Social Responsibility

What Happens When People Do Not Behave Ethically?

When an individual acts unethically, his or her behaviour will most likely
harm others. The individual could also be sent to jail for his or her
actions. Major ethical issues include fraud, accounting scandals, and
insider trading.

Fraud
Fraud is a crime of lying or pretending. Some businesses mislead
consumers and trick them to buy their products or services. The
Competition Act 2002 bans such fraud and deceptive business
practices and defines these as
• false or misleading advertising
• “bait and switch” selling
• double ticketing items for sale
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Business Ethics and Social Responsibility

Accounting Scandals
An accounting scandal occurs when accountants or senior executives
alter accounting records for personal benefit.

Accounting information is used inside and outside of the business to

make decisions. When accounting irregularities are uncovered, a
forensic accountant investigates legal and financial documents to find
evidence of tampering.

Embezzlement,
A type of accounting fraud, happens when an accountant or senior
executive creates false accounts and redirects money into them for
personal gain.

Business owners rely on outside accountants, auditors, to check and

report on the validity of financial records.
66
Business Ethics and Social Responsibility

Insider Trading
Insider trading is buying or selling shares of a
company based on confidential information. This type
of trading is illegal.

Included in Nepal Law Commission, Chapter-9,

Offenses Relating to Insider Trading in Securities and
Transactions of Securities and Punishment

67
Business Ethics and Social Responsibility

A business exhibits Corporate Social Responsibility (CSR) through

their values, ethics, and the contributions it makes to communities.
CSR is driven by a desire to protect customers and to treat employees
and shareholders fairly.

CSR Principles
Businesses that practice CSR principles support their employees and
consumers by
• providing a safe and healthy work environment
• adopting fair labor polices
• protecting the environment
• being truthful in advertising
• avoiding price discrimination
• donating to charity

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Ethics and Corporate Social Responsibility

Duty to Report
Corporations and their employees have a duty to report, which means
they must disclose all important information to shareholders, partners,
lenders, insurers, communities, regulators, consumers, employees, and
investors.

Laws that Govern Corporate Ethics

Workplace Safety
Government of Nepal has enforced concept of Organization Safety and
Health (OSH) through its Labor Act 1992. It has highlighted provisions
and few issues on physical infrastructure setup, working hours, annual
medical check-up, provision on safety measures, etc.
These regulations were put in place to remind companies that it is not
only important to focus on making profits, but also equally imperative to
look after the safety and health their workers.
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Ethics and Corporate Social Responsibility

Antidiscrimination Issues
Discrimination is denying a qualified individual an interview, job,
or promotion based on his or her religion, gender, sexual
orientation, or physical disabilities.

Gender discrimination is treating an employee differently based

on their gender (male or female).

The glass ceiling refers to invisible barriers that may affect the
career path of senior leaders in corporate positions.
Harassment
Many businesses have policies and procedures for dealing with
harassment: behavior that is threatening, disturbing, or makes
others feel uncomfortable.
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Ethics and Corporate Social Responsibility

Accessibility Issues
The duty to accommodate refers to an employer’s obligation to ensure
accessibility for all employees. The Canadian Human Rights Act, Sections
2 and 15, states that employees with disabilities must be accommodated
by business as long as undue hardship does not occur to the business.
Environmental Responsibility
Environmental concerns for business include the Earth’s air, land, and
water. These issues affect Canadian businesses and others in the world

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 Relevant cases
Case 1
• Suppose one guest come to your hotel take
the service. The hotel policy is to have all bills
settle in cash. You know the guests very well.
While making payment, his/her card did not
work and he/she has no cash. Now, he/she
asks you if s/he can pay tomorrow so as an
outlet manager will you accept his/her
request? What will you do?
 Case 2
• Auditing practice says you should have VAT
bills for every expense greater that Rs. 50,000.
Suppose in your finance department you
receive bill of Rs. 70,000 of crockery items
which was not VAT bill.
What will you do?
• Suppose the bill received was VAT bill but the
bill name was Shiva musical store. So as an
Accountant what will you do?
The Changing Face of the Accounting Profession
A “financial reporting crisis” caused by:
 Enron: the omission of entities from the
financial statements
 WorldCom: treating costs as assets rather
than expenses causing higher net income
Any Questions???
Thank You
