Business Economics - Appunti per Esame

Income Statement and Balance Sheet

received in advance: there is an increase in liabilities (i.e. an obligation to provide the service in the next reporting period), not in the income statement

- Borrowed money from a bank

This doesn't satisfy the income definition. There's an increase in economic benefits through an increase in asset (cash), but no increase in equity; but the increase in assets results in the increase of liabilities (bank loan).

- Sale of goods on credit

This satisfies the income definition. There's an increase in entity's assets (not cash but trade receivable) that increases equity and does not relate to contributions from equity participants.

- Purchase of inventory

This satisfies the expense definition only if inventory has been used. Otherwise we have a decrease of cash and corresponding increase in inventories in the assets reported in the balance sheet.

- Owner contributed $20,000 to fund a new product line

This doesn't satisfy the income definition. There's an increase in

Economic benefits through an increase in asset (cash), that increases equity, but the $20,000 relates to contributions from equity participants.

VI. RECORDING BUSINESS TRANSACTIONS

Business transactions are occurrences that affect the assets, liabilities, and equity items in an entity. They are an exchange of goods, services, cash, and/or obligations that occur between the entity and an outside entity. They are related to economic events.

Expanded accounting equation:

ASSETS = LIABILITIES + EQUITY + INCOME - EXPENSES

ASSET + EXPENSES = LIABILITIES + EQUITY + INCOME

Assets: resources controlled by the entity

Liabilities: external sources of funds

Equity: internal sources of funds, from owner

Liabilities and equity represent the claims of owners and external providers of capital against an entity's assets.

Income produces an increase in equity.

Expenses result in decreases in equity. They must be compensated by increasing or decreasing assets.

Duality is a key point. The accounting equation must be kept in

Equity and Income

Each transaction must be recorded at least twice, once in debits and once in credits.

The sum of debits must be equal to the sum of credits.

Massimiliano Guerini, Dipartimento di Ingegneria Gestionale

The Trial Balance

It's a list of ledger accounts that is prepared at the end of the period.

Purpose:

• To assist in the preparation of the financial statements
• To check the accuracy of the ledger or journal entries

Accounting worksheet

It summarises the duality associated with each business transaction.

All business transaction of the entity are entered into the worksheet.

Then the individual columns of the worksheet can be totalled and used as the basis for preparing financial statements.

Journal

It's an accounting record in which transactions are initially recorded in chronological order.

The journal entry will consist of:

• The transaction date
• The name of the accounts affected by the transaction
• Whether each account is debited or credited

The final approach is

• The entity's income and expenses generated by business transactions
• The change in cash position from one point in time to another
• The cash flows associated with that change
• The entity's ability to generate cash flows from the operating cycle
• The entity's ability to meet financial obligations
• The entity's ability to make long-term investments
• The entity's ability to obtain external finance

• Profitability: ability to make profit, for example the ability to sell and make revenues (income statement).
• Liquidity: ability of a entity to meet its short term debt obligations (statement of cash flows).
• Solvency: Ability of a business entity to survive in the long term.
• Operating cycle: Amount of time an entity takes in realizing its inventories in cash. This characterized manufactory industry or business entities that operated in services.
• Cash inflows and outflows are classified into 3 main sections, reflecting major cash flow activities:
1. Operating activities: Activities related to provision of goods and services and other activities that are neither investing or financing activities. Activities that include receipts and payments.
2. Investing activities: Activities related to the acquisition and/or disposal of non-current assets.

Format of the statement of cash flows: These items allow users to analyse the future direction of the entity by studying major asset.

Main sections:

examples and link to other statements acquisitions and disposals. (ex: increase/reduction of production capacity).

III. Financing activities (you are asking for extra money for ex, it’s depends if it’s positive or not):

• Cash inflows and outflows that are associated to change in the size and/or composition of the financial structure of the entity.

Main steps Direct Method

1. Determine cash flows from operating activities;
2. Determine cash flows from investing activities;
3. Determine cash flows from financing activities;

Massimiliano Guerini, Dipartimento di Ingegneria Gestionale

IV. Calculate net cash flows + ending cash balance for the year;

Step 5

V. Reconcile cash from operating activities with profit Indirect Method.

Example !

The statement of cash flows must show

• (Increase)/decrease in current assets - Net cash flow from operating activities;
• (Increase)/decrease in inventory (3,000) - Net cash flows from investing activities;
• (Increase)/decrease

In trade receivables 5,000 (Increase)/decrease in prepaid expenses 2,000 - Net cash flows from financing activities;- Total net cash flow;Increase/(decrease) in current liabilities - Beginning cash balance;Increase/(decrease) in trade payables (29,000) - Ending cash balance.Increase/(decrease) in tax payables 8,000Increase/(decrease) in other payables 2,000Net cash flow from operating activities $ 51,000

Massimiliano Guerini, Dipartimento di Ingegneria Gestionale

Warning signals- Cash receipts from customers are less than cash payments to suppliers and employees;- Net cash from operating activities is low