Appunti financial accounting

Financial management accounting

Cultural organisations: profit vs non-profit

Cultural organisations might be profit or not for profit. Profit is the difference between revenues and expenses that result from activity and entity during the period. NPOs mean that revenues must be reinvested due to differences in the aim of organisation. Profit organisations have an investment for the capital. The profit organisation must remunerate the capital. This is very simplified, the ultimate scope of profit organisations.

The production of tables is not the mean of the organisation but it is the mean for the organisation. The capital put in the investment is used to reinvest the productive factor and those goods and services are sold in a free market. The sum of the prices contributes to create revenues. The difference between revenue and expenses will be used to cover initial expenditures.

In a NPO, an organisation is not established to make money and invest capital, but indeed, you collect interest and social aims. From a juridical point of view, there is not an “owner” but the mission is to serve public interest as a whole. You must produce goods and services. Also, the economic process is different. Revenues come from different sources: associate membership, public grants, donations, volunteers contributions. You might look for public funds, etc. These revenues are used to cover goods and services; thus, the public aim is the interest. The final scope is not having profit and remunerating the capital. In both cases, it is important to have enough resources.

What do profit and non-profit organisations have in common?

• Operate with limited resources.
• Must use resources in an effective and efficient way to pursue its aims and survive in the long run.
• Effectiveness: results equal aims.
• Efficiency: max results – minimum resources.
• Need to adequately plan, manage, and control the use of resources.
• Need to be accountable: transparency and responsibility on the revenues collected.

Develop accounting tools. In recent years, the need to be accountable has highly increased. Every organisation shall use accounting principles. This is why it is important to know how tools are developed and how to use advantages to have economic and financial organisations might tell.

What is accounting?

Accounting is the process of identifying, measuring, communicating economic and financial information about an entity for decisions and informed judgements. It's a useful tool to elaborate on this in documents to help people make decisions. Who are the people interested in accounting information? Stakeholders, investors, government, the advisory board, consumers, etc.

There are different typologies of accounting, we mentioned two different accounting typologies: financial and management accounting with different professional roles. Some will perform financial accounting, others managerial accounting.

Financial accounting

Financial accounting is mainly addressed to external users. Indeed it is used by managers, but the manager has much more information about the company rather than those written in the report. Financial statements are a group of documents with specific information. The past activity of the entity is not future-oriented. Budgets are based also on previous years, but the budget is not included in financial accounting. The aim is to communicate financial position, cash flows for a specific time period. To prepare the financial statement, we use bookkeeping and accounting procedures, used to register economic transactions and to register the effect of each transaction into each transaction. It’s done by a financial accountant. It has a specific format and standards.

Financial accounting has a macro focus and it can be done frequently, but usually, it is done yearly for the fiscal year. Financial accounting reports are reviewed by a third party, the auditors: they issue an opinion if they’re correctly done or not. Internal auditing is used for many retail companies. We need to have an internal audit for the single companies. It’s done by internal auditors that can be also external.

Managerial accounting

Managerial accounting requires internal users: it addresses managers to take decisions. We use economic and financial information to evaluate cost and benefits to direct the activity and controlling it while the activity is done. It’s future-oriented because it helps in decision making. In the case of control, you control to inform judgement and decisions for the future. The main tool is the budget and preparation of the budget. Managerial accounting has specific professions (managerial accountants with specific certification to perform this work). Since it has an internal orientation, it is not compulsory and has not a standard format.

Also, there is governmental and not-for-profit accounting. For government, we have the same accounting functions with similar but not the same procedures. Over-governmental organisations. The basic concepts and functions are the same. To understand also accounting.

Focus on financial accounting

Financial accounting is the process that starts with transactions to register and identifying transactions culminate into financial statements. Accounting is not an exact science, not a mechanical procedure! It's not mechanical. There might be different ways to account. Thus, the picture can be very confusing due to different criteria used. Each country developed different accounting principles (i.e., Accounting Bodies in the US).

At the international level, the need to compare financial statements has emerged. The body is charged with promoting harmonisation between countries around the world.

Financial accounting is the process that starts with connections coordinating preparation of financial statements. Transactions are economic interchanges. What does it mean? Something of value has given in exchange for something with the same value. Transactions occur every day and they’re summarised in accounts. Accounts are folders used to organise similar transactions. Not every transaction affects cash, and they’re reported in the cash folder. Every account affects inventory, and it’s recorded in a folder which has an account name. At the end of the period, you will have the balance of the account; every income will give the total balance for the cash account. This balance will be used to prepare financial statements.

Financial statements

Financial statements include:

• Balance sheets (financial positions of the company)
• Cash flow (inflows and outflows of cash)
• Income statement (earnings or profits during the period – profit and losses statement)
• Statement of changes in owners’ equity (investment and distribution to owners)

These are the four financial statements included in the financial report that includes also several explanatory notes where management and accountants describe numbers included in financial reports. Looking to real financial statements, you will see that the four financial statements are brief, whereas the explanatory notes can be very long. The overall document is the annual financial report which includes four financial statements and explanatory notes.

The balance sheet

The balance sheet summarises the financial position of an organisation at one point in time (end of the fiscal period, usually December 31^st). It includes:

• Assets: resources of the company. Resources controlled by the company as a result of past events from which future economic benefits are expected to flow to the entity.
• Liabilities: obligations to other entities. Resources not owned by the entity but owned by others. For instance loans, debts (both short term and long term).
• Owners’ equity: Owners’ rights on the resources. The residual interest in the assets of the entity after deducting all its liabilities (A - L -> OE).

Assets

• Cash
• Account receivable (amount due to customers)
• Merchandise inventory (the cost of merchandise acquired to be sold)
• Plant and equipment (the cost of equipment and plant used in business like the cost of the building the shops)
• Accumulated depreciation: the portion of the cost of equipment that is estimated to be used up. Depreciation means spreading the cost of the asset during its whole life. Decreases the value of the assets in the years.
• Current assets are those assets that are likely to be converted into cash or used to benefit within one year (cash, account receivable, merchandise).

Liabilities

• Short-term debt (amounts borrowed that will be repaid within one year of the balance sheet date: all the debts that the company has to repay)
• Accounts payable (amounts due to suppliers to purchase. Debts due to suppliers for material on credit)
• Other accrued liabilities (amounts owed to other creditors i.e., wages not paid the current month but the next)
• Long-term debts (amounts borrowed from banks not paid within one year from the balance sheet date). Why underlining dates? We want to understand current assets – current liabilities.
• Current liabilities are those liabilities that are likely to be paid within one year (short term debt, accounts payable, accrued liabilities).

The balance sheet is always in balance. Total assets equal total liabilities and owners’ equity. Whatever transaction will affect the balance sheet but keep the balance sheet in balance.

ASSETS = LIABILITIES + OES

ASSETS – LIABILITIES = OES

NET ASSETS + EQUITY

The timeline model is used to see how financial statements equal at the end of the year. The balance sheet at the end of one period is the balance sheet at the beginning of the period.

The income statement

The income statement shows the incomes (profit or losses) for the period under consideration. Here is the difference with the balance sheet, which refers to a point in time. Income is referred to a period like earnings produced during one year. Define the time period to which the income statement refers to. It would be very different considering the different periods.

This is like a movie on the operation of activity while the balance sheet takes a picture. How is profit and loss composed? Define it as all revenues produced in a period minus all the expenses (gain and losses). Revenues result from the entity operating activity. For example, what company earns from the sale of merchandise constitutes the positive part of the income statement. Expenses are costs incurred in generating revenues. The difference between these two is called income.

Before understanding the real statement, we must understand that activities are three:

1. Operating activities: the core activity of the entity. For instance, we are a publishing house; thus, our core activity will be publishing books. Revenues come from the revenues of the book. The company might need a building or equipment to print the books.
2. Financing activities: invest money to generate a positive inflow: they generate interest expenses and interest income.
3. Investing activities: can generate gain and losses.

Depending on these activities, we distinguish different kinds of costs:

• Operating costs: are related to the core activity of the entity. Are necessary to operate and they differentiate into:
• Manufacturing costs: are those costs that actually manufacture the product. Usually, they are raw materials, direct labour, manufacturing overhead (indirect costs necessary to manufacture the product like the salary of the supervisor).
• Non-manufacturing costs: cost of acquiring the product (like in retail companies) these costs are product costs directly assigned to a single unit of product. And product costs in the financial statement are called “cost of goods sold” in the income statement and “Inventory” in the balance sheet. Other are selling, general and administrative expenses. For the retail store, the cost of electricity for the shop, administration, and so on, are not manufacturing costs but still operating costs.