accounting basics

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Introduction to Financial Accounting

Prof. Jijo Lukose P.J., IIM Kozhikode

Topics Discussion of Accounting

Economic Consequences of Accounting Introduction to Financial Accounting Why do we need Accounting

An overview of financial statements

2Financial Accounting S1

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What Accounting Does?

Financial Accounting S13

Accounting is a system that provides information on: Amounts of resources. How resources were financed. Results achieved by using resources.

For either: Parties inside and outside of the organization. Profit and nonprofit organizations.

Hindustan Unilever Limited

Financial Accounting S1 4

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Hindustan Unilever Limited

The Process of . Raising cash from investors

Investments in real assets

Using cash to purchase inputs

Changing those inputs into products, and

Providing the product or service to customers and eventually getting cash back


Procedural Scheme of a firm

Equit

y Cap

ital

Divide

nds

CashCashCOMPANY

(MANAGERS)

Customers

Suppliers

EmployeesCommunity

Government

Creditors/Debt Holders

Shareholders


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Financial Accounting


Financial accounting formal system for communicating financial information to interested users

Financial Statements, along with the notes, report a companys past performance and its financial condition.

Financial statements provide information about an entitys a. Assets. b. Liabilities. c. Equity. d. Income and expenses, including gains and losses. e. Cash flows

The Financial Statements: Stock vs. Flow Stock/ resources and obligations at a point in time:

Balance sheet : Assets=liabilities +owners equity Flow/ activity over a period of time:

Income Statement- performance over a given period Revenue - Expenses = Net Income

Revenues -a measure of economic benefits generated by the sale of products or providing of services over a period of time

Expenses -a measure of economic sacrifices incurred to earn the revenues of a given period.

Statement of cash flows Operating, Investing and Financing activities

Notes, Auditors Report, Directors Report and Management Discussion and Analysis


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Balance Sheet Assets = Liabilities + Shareholders Equity

Resources and Claims View Sources and Uses of Funds View

Asset is: a resource controlled by the enterprise as a result of past events and from which future economic benefits are expected to flow to the enterprise.

Liability: Present obligation as a result of past events and settlement is expected to result in an outflow of resources (payment)

Provision: A liability of uncertain timing or amount. Current assets: Cash and other assets that are reasonably

expected to be realized in cash or consumed during the normal operating cycle of the business or within one year, whichever is longer.


Stockholders Equity Equivalently net assets (i.e. = A -L). Two sources of OE:

Amounts provided directly by equity investors (Paid-in-capital). Amounts retained from earnings, i.e. profits (Retained

Earnings).

Want more Equity (owners equity)?Youll need to..Raise More capital Increases the Contributed Capital portion

of Equity Earn More Running a successful business increases the

Retained Earnings portion of Equity


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But the BS doesnt tell the whole story. The Balance Sheet describes what we have But not how we got it!

The Income Statement tells how the companys performance changed the net assets.

Revenues are transactions which resulted in an inflow of net assets The Amount Earned from Sales or Services

Expenses are transactions which resulted in an outflow of net assets The Costs incurred to generate Revenues


The Articulation of the Financial Statements

RevenuesExpensesNet Profit

Profit and Loss Account

RE + Net Profit- DividendsChange in owners equity

Cash from operationsCash from investingCash from financing

Net change in cash

Cash Flow Statement

Cash+ Other Assets

Total Assets- LiabilitiesOwners equity

Beg Balance SheetCash+ Other Assets

Total Assets- Liabilities

Owners equity

Endg Balance Sheet


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Income Statement Net Revenue

-Operating Expenses other than Depreciation

= EBITDA (Margin)-Depreciation

= Operating Income before Taxes (EBIT)-Interest Expense (I)

= Income Before Taxes (EAIBT or PBT)-Income Taxes (T)

= Net Income Beg. RE + NI - Div = End. RE RE = net income - dividends


Cash Flow Statement Categorizes Cash Inflows and Outflows during a

specific period of time into three categories: Operating

Cash receipts and cash disbursements as a result of day-to-day operation of the business

Investing Cash used to buy long-term assets and investments Cash obtained by selling long-term assets and investments

Financing Cash receipts and cash disbursements from the companys funding

sources its long-term creditors and stockholders Cash dividends paid, or payments to retire long-term debt


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Financial Accounting S1

Why do We Need Financial Accounting?

Financial accounting promotes the exchange of resources

CompanyOutsiders-Investors-Suppliers-Creditors

Resources Today

Resources Tomorrow

Information(Financial Statements)

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Financial Statements


Provides information primarily to people outside the company Provides information that would be helpful in attracting capital

Equity and debt (useful in debt contracts) Credit from suppliers

Non-financial Stakeholders: Customers, Employees, suppliers Others: Governments and their agencies., Public

Provides information helpful in monitoring and evaluating management performance in assessing the amount, timing, and uncertainty of future cash

flows. Common rules used so investors can compare with other

companies financial statements.

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Approaches to Study Accounting


Viewpoint of accountant (preparer). Collecting, summarizing and reporting accounting information.

Viewpoint of user. Understanding, analyzing, and interpreting accounting reports

to make decisions.

We emphasize perspective of current and potential future users, recognizing need for some knowledge of how accounting reports are prepared.

Sophisticated Financial Statement User


Understand the rules and managements discretion

Understand what explains the rules and the type of management discretion Incentives

Understand how events affect firm value

Economic Events

Rules&

Management Choice

Financial Statements

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Understanding the rules & Incentives


Demand for independence: Accounting enters objective, verifiable information into accounting records Outside investors demand independently audited financial

information In the process, accounting misses out on forward-looking

information that might be valuable, but lacks objective evidence Asymmetry

Asymmetric treatment of good and bad news Why?

Demand for bad news: Creditors with no upside, but all the downside

Investors believe bad news disclosed by management, but skeptical of good news

Management incentives affect believability of their disclosures

Terminology


US India Income Statement Profit and Loss Account Accounts Receivable Trade Receivable/

Sundry Debtors PPE Gross Block Common Stock (Equity) Capital Additional Paid-in Capital Securities Premium

Documents

accounting basics