Riassunto Accounting

Chapter 1 – Accounting in action

What is accounting?

Accounting = financial information system to understand what is happening financially inside a company.

3 basic activities: it identifies, records and communicates economic events of an org. to interested users.

• Identifies: economic events relevant to its business.
• Records: the events to provide a history of companies financial activities = keeping a systematic, chronological diary of events.
• Communicates: collected information to interested users with an accounting report (=financial statements).
• Financial statement: accumulates information over a certain period of time.

When communicating economic events accountant (Buchhalter) needs to know how to analyze à and interpret the information.

It is a process of identifying, recording and communicating economic events.

Who uses accounting data?

Internal users = managers who plan, organize and run the business.

• Managerial accounting provides reports to help users make decisions about their company à.
• For marketing managers, production supervisors, finance directors etc.
• Includes: cost accounting, budgeting, performance evaluation.

External users: individuals and organizations outside a company want financial info about the company à.

• Financial accounting provides information for investors.
• Investors use accounting info to make decisions to buy, hold or sell ownership shares in a company.
• Creditors (suppliers and bankers): to evaluate the risk of granting credit or lending money.
• Tax Authorities: want to know if company complies with tax laws.
• Other Stakeholders.

Types of accounting

The building blocks of accounting

Ethics in financial reporting: an accountant follows certain standards in reporting financial information ethics in financial reporting à.

• Ethical behavior is a fundamental business concept!
• Effective financial reporting depends on ethical behavior.

Accounting standards

To ensure high quality financial reporting financial statements need to be conform to accounting standards à, like the International Financial Reporting Standards (IFRS).

In Italy: Principi contabili italiani (in the Codice Civile, set by Organismo Italiano di Contabilità (OIC).

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International Financial Reporting Standards

Primary objective of financial reporting:

• To provide information useful for making investment and lending decisions.
• For external users (investors, creditors).

Measurement principles

IFRS uses generally one of two measurement principles:

• Historical cost principle.
• Or the fair value principle (=Marktpreis).

What principle to follow depends on relevance and faithful representation. They are primary qualities that make accounting info useful for decision-making.

Relevance = that financial info is capable of making a difference in decisions.

Faithful representation = that numbers and descriptions match what really existed or happened à they are factual.

Historical cost principle = account principle that states that companies should record assets at their cost.

Issues:

• Reported at cost when purchased and also over time the asset is held.
• Cost easily verified, market value is often subjective.
• Fair value information may be more useful.

Example: company buys land at 300.000€ by end of the year it has a value of 400.000€ à.

Under this principle company continues to report the land at 300.000€ à.

Fair value principle = accounting principle stating that assets and liabilities should be reported at fair value (the price received to sell an asset or settle a liability).

Assets and liabilities are re-measured periodically to reflect changes in their value:

• Fair value provides a more timely representation of the current market value of assets and liabilities.
• It is often difficult to determine objectively.
• Used in situations where the fair value can be established with sufficient certainty.

Assumptions (= Voraussetzung)

Provide the foundation for the accounting process.

Two main assumptions:

• Monetary unit assumption.
• Economic entity assumption.

Monetary unit assumption: requires that company includes in the accounting records only transaction data that can be expressed in monetary terms.

• Enables accounting to quantify (measure) economic events in money terms.
• Important to apply historical cost principle.

Economic entity assumption: economic entity can be any organization or unit in society à requires that the activities of the entity be kept separate and distinct from activities of its owner and all other economic entities.

Forms of business ownership

Proprietorship (Eigentümerschaft): Einzelunternehmer.

• Generally owned by one person.
• Owner = manager/operator of the business.
• Often small service-type businesses.
• Usually only a small amount of money (capital) is necessary to start it.
• Owner receives any profits, suffers any losses and is personally liable for all debts.

Partnership (Partnerschaft): KG/oHG.

• Owned by two or more people associated as partners.
• Often retail and service-type businesses.
• Each partner has generally unlimited personal liability for debts.
• Partnership agreement (sets terms, duties, division of net income etc.).

Corporation (Kapitalgesellschaft): GmbH/AG.

• Ownership divided into shares (=shareholders).
• Separate legal entity organized under state corporation law.
• Limited liability.
• They are not personally liable for debts of the corporate entity.
• Shareholders can sell their shares to other investors at any time.

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Steps in the recording process

Recording a transaction:

• Analyze the transaction – accounting equation.
• Enter the transaction in a journal – journal entry.
• Transfer journal information to ledger accounts – posting.

The basic accounting equation

Provides framework for recording and summarizing economic events.

Applies to all economic entities regardless of size.

Assets = liabilities + equity.

Economic resources = sources of economic resources.

Assets must equal the sum of liabilities and equity.

Framework for recording and summarizing economic events.

Assets

Assets = resources a business owns.

• Uses them to carry out activities, like production, sales.
• Have the capacity to provide future services or benefits.
• Cash, inventory, equipment, intangible assets.

Liabilities

Liabilities: claims against assets, i.e. existing debts and obligations.

Businesses borrow money and purchase merchandise on credit à this results in payables.

• Accounts payable: when org. buys objects on credit from supplier.
• Note payable.
• Salaries and wages payable: to employees.
• Sales and taxes payable: to government.
• Creditors: people to whom the org. owes money.
• Accounts payable, notes payable, unearned revenue.

Equity

Equity = ownership claim on total assets.

= total assets – total liabilities.

What is left of assets once liabilities are paid.

Consists of:

• Share capital – ordinary.
• Retained earnings (=Rev. – Exp. – Div.).

Share capital – ordinary describes the amount paid in by shareholders for ordinary shares they purchase. Corporation may obtain funds by selling shares to investors.

Revenues = amounts received (or to be received) from customers for sales of products or services.

Lead to increase in equity resulting from business activities entered into for the purpose of earning income à.

Effect of revenues is positive.

• Increase in equity.
• Increase in asset or decrease in liabilities.

Expenses = amounts that have been paid or will be paid later for costs that have been incurred to earn revenue.

Cost of assets consumed or services used to earn revenue.

Negative effect of expenses.

• Decrease in equity.
• Decrease in assets or increase in liabilities.

Common expenses: salaries expense, rent expense, utilities expense, tax expense.

Dividends = distribution of cash or other assets to shareholders.

Net income increase in net assets must then be distributed to shareholders à à.

Reduce equity (retained earnings); aren’t expenses.

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Rules for changes in equity:

• Investment + revenues increase à.
• Expenses + dividends decrease à.

Transactions

Transactions = economic events recorded by accountants.

2 types:

• External transactions: econ. events between company and outside enterprise.
• Internal transactions: econ. events occur within the company.

External transaction example:

• Purchasing of cooking equipment from supplier.
• Payment of rent to landlord.
• Sale of pizzas to customers.

Internal transaction example:

• Use of cooking and cleaning supplies.

No business transactions:

• Hiring employees, answering telephone etc.
• But these activities can lead to business transactions à employees will earn wages.

Each transaction must have a dual effect on the accounting equation.

If assets increase there must be:

• Decrease in another asset.
• Or increase in a specific liability.
• Or increase in equity.

Transaction analysis

Expanded accounting equation:

Can better understand the impact of transactions on equity.

Can be affects:

• Share capital – ordinary affected when company issues new ordinary shares in exchange à for cash.
• Retained earnings affected when company earns revenues, incurs expenses, pays à dividends.

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Transaction analysis - Exercise

1. Investment by shareholders.

Open computer company. Invest 15.000 cash in exchange for ordinary shares à.

2. Purchase of equipment for cash.

Buy computer equipment for 7000 cash. Increase in assets; decrease in assets.

3. Purchase of supplies on credit.

Buy computer paper for 1600€ from supplier don’t pay immediately but in October à. = purchase on account. Assets increase. Liabilities increase.

4. Services provided for cash.

Company receives 1200€ from customer for provided service. = revenue-producing activity revenue increases equity à.

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5. Purchase of advertising on credit.

Company receives bill for 250€ from other company for advertising postpones payment to a later date à.

• Increase in liabilities.
• Decrease in equity (expenses).

6. Services provided for cash and credit.

Company provides 3.500€ of programming services for customers.

It receives cash of 1500€ from customer; bills balance of 2000€ on account.

• Increase in assets and equity.
• Company earns revenues when provides services.
• Increase in cash (1.500) and accounts receivable (2500) (= customer’s promise to pay in future).
• When company gets 2500€ will later have a decrease in accounts receivable (Trans. 9) à.

7. Payment of expenses.

Company pays expenses in cash: store rent 600€, salaries and wages of employees 900€; utilities 200€.

Decrease in assets and in expenses.

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8. Payment of accounts payable.

Company pays 250€ bill for advertising to other company (from transaction 5).

Payment of liability does not affect equity à.

Expense has already been recorded in Transaction 5.

9. Receipt of cash on account.

Company receives 600€ cash from customer (Transaction 6).

This transaction does not change total assets but its composition.

Increase in cash; decrease in account receivable doesn’t affect equity, because revenue has already been recorded in Transaction 6 à.

10. Dividends.

Corporation pays dividend of 1300€ in cash to the company shareholders.

Decrease in assets and equity.

Dividend reduces retained earnings.

Are not expenses!

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Summary of transactions

Financial statements

Prepared by companies.

4 different types:

• Income statement.
• Retained earnings statement.
• Statement of financial position.
• Statement of cash flows.

Income statement: lists revenues and expenses finally shows net income (or net loss) for a specific period of time à.

• Net income: revenues exceed expenses à.
• Net loss: expenses exceed revenue à.
• Does not include investments and dividends (≠ expense).
• Information: reports the success or profitability.

Retained earnings statement: summarizes changes in retained earnings for a specific period of time.

• Takes net income from income statement – dividends.
• Because they cause reduction of retained earnings decrease in equity à.
• First line: beginning retained earnings amount.
• Then net income minus dividends.
• Information: shows reasons why retained earnings increased or decreased.

Statement of financial position: reports assets, liabilities and equity of a company at a specific date.

• Lists assets at the top, then equity, then liabilities.
• Total assets must equal total equity and liabilities.
• Information: shows company’s financial condition at a specific moment in time.

Statement of cash flows: information about cash inflows (receipts) and outflows (payments) for a specific period of time.

It reports:

• Cash effects of a company’s operations.
• Investing transactions.
• Financing transactions (types of loans and amount of loans).
• Net increase in cash.
• Cash amount at the end of the period.

Reports sources, use and change in cash.

Information: answers to:

• Where did cash come from during the period?
• What was cash used during the period?
• What was the change in cash balance during the period?

Statements are interrelated!

• Net income of €2,750 on the income statement is added to the beginning balance of retained earnings in the retained earnings statement.
• Retained earnings of €1,450 at the end of the reporting period shown in the retained earnings statement is reported on the statement of financial position.
• Cash of €8,050 on the statement of financial position is reported on the statement of cash flows.

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Chapter 2 - The recording process

The account

The account = individual accounting record of increases and decreases in a specific asset, liability or equity item.

Examples: cash, account receivable, accounts payable etc.

Consists of 3 parts:

• Title.
• Left – or debit side.
• Right – or credit side.

Account can be illustrated in a T-account form à.

Debits and credits

Debit (Dr.): left side of account.

Credit (Cr.): right side.

Double-entry accounting system

History:

• Venetian merchants funders “entrusted (credere – credit) financial resources to a business à.
• This created obligation on business “to owe” (debere – debit) the money back à.
• It is a closed system, where monetary value flows FROM a source TO a destination.

Use of funds: source of funds.

• Increase in possession (= Assets) always debit à.
• Increase in Capital (= Liabilities + Equity; anything not belonging to the business) always credit à.
• And vice versa.

We have a two-sided effect of each transaction.

• Debits = Credits.
• If every transaction is recorded with equal debits and credits, the sum of all debits to the account must equal the sum of all credits.
• Each transaction must affect two or more accounts to keep the basic accounting equation in balance.
• Recording is done by debiting at least one account and crediting at least one other account.
• Debits must equal Credits.

Use them to describe where entries are made in accounts.

• If enter an amount on left side of an account = debiting à.
• If entry on right side = crediting à.

When compare totals of the two side we have:

• Debit balance: if total of debit amounts > credits.
• Credit balance: credit amounts > debits.

Example still from chapter

• Positive value receipt of cash increase in assets debit à à à.
• Negative amount payment of cash decrease of cash (=asset) credit à à à.
• In T-account record increases of cash as debits; decreases in cash as credit à.

Balance is determined by netting the two sides (subtraction).

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Example: You pay an electricity bill for 120€ by cash.

• The item exchanged is electricity.
• The expense of electricity has increased, so it’s a debit.
• Cash is the form of settlement and it must be a credit.

Debit/credit procedures for assets and liabilities

Normal balance is on the side where an increase in the account.