Basic accounting principles
Table of Contents
Basic accounting principles .............................................................................................. 1
Session 1: Overview Accounting, Financial Reporting, Income Statement and Balance sheet ...... 2
Session 2: Preparing Financial Statements ................................................................................ 6
The Balance Sheet Equation (The Accounting Equation) ...............................................................6
Three Fundamentals of double entry bookkeeping .......................................................................7
T-Accounts.......................................................................................................................................7
Analysing transactions ....................................................................................................................8
Session 3: The cash flow statement .......................................................................................... 9
Cash flow .........................................................................................................................................9
Structure Statement of Cash Flows (IFRS) ......................................................................................9
Preparation of Statement of Cash Flows ..................................................................................... 10
Session 4: Annual Report and Ratio Analysis ........................................................................... 12
Annual Report Analysis ............................................................................................................... 12
Ratio Analyses .............................................................................................................................. 14
Session 5: Managerial Accounting .......................................................................................... 16
Introduction to Management Accounting ................................................................................... 16
Different types of costs ................................................................................................................ 17
Cost behaviour: Variable and fixed costs ..................................................................................... 18
Cost Volume Profit analysis: Contribution margin ...................................................................... 19
Break even analysis / Safety margin calculations ........................................................................ 19
Target profit calculations ............................................................................................................. 20
Sales mix decisions ....................................................................................................................... 20
Session 7: Balanced Score Card, Budgeting ............................................................................. 20
Introduction ................................................................................................................................. 20
Balanced Scorecard ...................................................................................................................... 20
Budgeting ..................................................................................................................................... 22
Session 8: Limiting factors and Accounting for overheads // activity based costing .................. 24
Short term decision making: Limiting Factors ............................................................................. 24
Costing: Accounting for overhead ............................................................................................... 24
1. Absorption costing ................................................................................................................... 24
2. Activity based costing .............................................................................................................. 25
Session 9: Variance Analysis ................................................................................................... 26
Standard Costing .......................................................................................................................... 26
Variance analysis .......................................................................................................................... 26
Session 10: Capital Investment Appraisal ................................................................................ 29
Capital Investment Appraisal ....................................................................................................... 29
Payback period ............................................................................................................................. 30
Net present value ......................................................................................................................... 30
Internal rate of return .................................................................................................................. 31
,Session 1: Overview Accounting, Financial Reporting, Income Statement and Balance
sheet
What is accounting?
• Accounting is all about recording and interpreting business transactions and
providing financial information to users so they can make decisions
• Accounting provides information to a number of key stakeholders, both internally and
external.
• Its goal is to identify, measure and communicate financial information such that key
stakeholders can take informed decisions and companies can be compared.
• We distinct between financial accounting and management accounting
• Financial Accounting provides financial information on a business’s recent financial
performance targeted at external users, such as shareholders
•Backward-looking
•Double-entry bookkeeping
•Income statement, Statement of Financial Position and Statement of Cash
Flows
• Management Accounting primarily serves the internal needs of the organisation.
• Internal needs of business
• Unlike financial accounting, not required by law
• Management accounting supports short and long term decision-making
More on Financial Accounting
Regulatory framework
• The regulatory framework is the set of rules and regulations which govern
accounting practice ensuring that financial statements give a true and fair view of
the financial position and performance of the reporting entity.
o In the United Kingdom, there are two main sources of regulations
▪ Companies Acts and Financial Reporting Standards
o At international level, the International Accounting Standard Board (IASB)
provides a broad regulatory framework
▪ International Financial Reporting Standards (IFRS). These apply to all
European listed companies, including the UK
Accounting Principles
• We have these to provide transparency and accountability
• Accounting Conventions
1. Entity.
2. Monetary Measurement.
3. Historical Cost.
4. Periodicity.
• Accounting Concepts
1. Going Concern.
a. Going concern: not if we liquidate, but if the company continue running
2. Matching (accruals).
a. revenue generated and the cost to generate that revenue
, 3. Consistency.
a. one item should be treated the same way in all years: or not you will have to
explain why not (this is again, to compare)
4. Prudence.
a. be conservative: If we know something is coming (like restructuring costs) we
should use those costs, however, if there is revenue that might happen, we
should not include it.
Financial accounting major statements
- Statement of financial position (Balance sheet): Financial position (listing of assets
and liabilities) on a specific date
o 31.12 or in march
Balance sheet (limited company)
Assets
Noncurrent assets
• Tangible assets (PPE)
• Intangible assets
Current assets (benefits within next year)
• Cash
• Trade Receivable
• Inventory
• Prepaid Assets
Liabilities
Non-current liabilities (obligations after a year)
• Bank borrowings and bonds
• Other types of liabilities (deferred taxes, pensions)
Current liabilities (obligations within next year)
• Bank borrowings
• Trade payable and other payables
• Deferred revenues and other noncash liabilities
Stockholders’ Equity
Stockholders’ equity
• Issues share capital
• Share premium Account
• Retained earnings
Balance sheet equation:
Assets = Liabilities + Stockholders equity
Net assets = SH equity = assets - liabilities
• Stockholders equity is:
▪ Contributed capital (sale of shares)
▪ Common stock (par value)
, ▪ Share premium account (excess over par value)
▪ Treasury Stock (stock repurchased by company)
• Retained earnings (arises from operations)
▪ Accumulation of Net income (Revenue – Expenses) – Dividends
▪ Dividends are distributions of retained earnings to
shareholders. Dividends are not an expense. They are
recorded as a reduction of retained earnings on the
declaration date (creates a liability until payment date)
• An asset is a resource that is expected to provide future economic benefits
(i.e. generate future cash inflows or reduce future cash outflows)
▪ An asset is recognized when:
▪ It is acquired in a past transaction or exchange (already
happened)
▪ The value of its future benefits can be measured with a
reasonable degree of precision (can be measured in future)
• A liability is a claim on assets by “creditors” (non-owners) that represents an
obligation to make future payment of cash, goods, or services
▪ A liability is recognized when:
▪ The obligation is based on benefits or services received
currently or in the past (already happened)
▪ The amount and timing of payment is reasonably certain (can
be measured in future)
- Income statement (Profit and Loss account): Results of operations over a period of
time using accrual accounting (i.e., recognition income and expenses tied to business
activities)
Income statement (limited company)
Revenue (or Sales)
-/- Cost of Goods Sold
Gross Profit
-/- Operating Expenses
Operating Income
-/- Interest, Gains and Losses
Pre-tax Income
-/- Income Tax Expense
Net Income
Income statement equations:
Net Income = Revenue – Expenses
Net income is also called “earnings” or
“net profit”
• The income statement reports increase in shareholders’ equity due to operations over a
period of time (net income is added to retained earnings)
• All income statement items are based on Accrual Accounting principles
▪ Recognition of revenues and expenses are based on business activities, not cash
flows
▪ Net income ≠ Net cash flow
▪ Revenue is recognized when goods or services are provided (revenue recognition
principle).
▪ Revenues ≠ Cash inflows
Table of Contents
Basic accounting principles .............................................................................................. 1
Session 1: Overview Accounting, Financial Reporting, Income Statement and Balance sheet ...... 2
Session 2: Preparing Financial Statements ................................................................................ 6
The Balance Sheet Equation (The Accounting Equation) ...............................................................6
Three Fundamentals of double entry bookkeeping .......................................................................7
T-Accounts.......................................................................................................................................7
Analysing transactions ....................................................................................................................8
Session 3: The cash flow statement .......................................................................................... 9
Cash flow .........................................................................................................................................9
Structure Statement of Cash Flows (IFRS) ......................................................................................9
Preparation of Statement of Cash Flows ..................................................................................... 10
Session 4: Annual Report and Ratio Analysis ........................................................................... 12
Annual Report Analysis ............................................................................................................... 12
Ratio Analyses .............................................................................................................................. 14
Session 5: Managerial Accounting .......................................................................................... 16
Introduction to Management Accounting ................................................................................... 16
Different types of costs ................................................................................................................ 17
Cost behaviour: Variable and fixed costs ..................................................................................... 18
Cost Volume Profit analysis: Contribution margin ...................................................................... 19
Break even analysis / Safety margin calculations ........................................................................ 19
Target profit calculations ............................................................................................................. 20
Sales mix decisions ....................................................................................................................... 20
Session 7: Balanced Score Card, Budgeting ............................................................................. 20
Introduction ................................................................................................................................. 20
Balanced Scorecard ...................................................................................................................... 20
Budgeting ..................................................................................................................................... 22
Session 8: Limiting factors and Accounting for overheads // activity based costing .................. 24
Short term decision making: Limiting Factors ............................................................................. 24
Costing: Accounting for overhead ............................................................................................... 24
1. Absorption costing ................................................................................................................... 24
2. Activity based costing .............................................................................................................. 25
Session 9: Variance Analysis ................................................................................................... 26
Standard Costing .......................................................................................................................... 26
Variance analysis .......................................................................................................................... 26
Session 10: Capital Investment Appraisal ................................................................................ 29
Capital Investment Appraisal ....................................................................................................... 29
Payback period ............................................................................................................................. 30
Net present value ......................................................................................................................... 30
Internal rate of return .................................................................................................................. 31
,Session 1: Overview Accounting, Financial Reporting, Income Statement and Balance
sheet
What is accounting?
• Accounting is all about recording and interpreting business transactions and
providing financial information to users so they can make decisions
• Accounting provides information to a number of key stakeholders, both internally and
external.
• Its goal is to identify, measure and communicate financial information such that key
stakeholders can take informed decisions and companies can be compared.
• We distinct between financial accounting and management accounting
• Financial Accounting provides financial information on a business’s recent financial
performance targeted at external users, such as shareholders
•Backward-looking
•Double-entry bookkeeping
•Income statement, Statement of Financial Position and Statement of Cash
Flows
• Management Accounting primarily serves the internal needs of the organisation.
• Internal needs of business
• Unlike financial accounting, not required by law
• Management accounting supports short and long term decision-making
More on Financial Accounting
Regulatory framework
• The regulatory framework is the set of rules and regulations which govern
accounting practice ensuring that financial statements give a true and fair view of
the financial position and performance of the reporting entity.
o In the United Kingdom, there are two main sources of regulations
▪ Companies Acts and Financial Reporting Standards
o At international level, the International Accounting Standard Board (IASB)
provides a broad regulatory framework
▪ International Financial Reporting Standards (IFRS). These apply to all
European listed companies, including the UK
Accounting Principles
• We have these to provide transparency and accountability
• Accounting Conventions
1. Entity.
2. Monetary Measurement.
3. Historical Cost.
4. Periodicity.
• Accounting Concepts
1. Going Concern.
a. Going concern: not if we liquidate, but if the company continue running
2. Matching (accruals).
a. revenue generated and the cost to generate that revenue
, 3. Consistency.
a. one item should be treated the same way in all years: or not you will have to
explain why not (this is again, to compare)
4. Prudence.
a. be conservative: If we know something is coming (like restructuring costs) we
should use those costs, however, if there is revenue that might happen, we
should not include it.
Financial accounting major statements
- Statement of financial position (Balance sheet): Financial position (listing of assets
and liabilities) on a specific date
o 31.12 or in march
Balance sheet (limited company)
Assets
Noncurrent assets
• Tangible assets (PPE)
• Intangible assets
Current assets (benefits within next year)
• Cash
• Trade Receivable
• Inventory
• Prepaid Assets
Liabilities
Non-current liabilities (obligations after a year)
• Bank borrowings and bonds
• Other types of liabilities (deferred taxes, pensions)
Current liabilities (obligations within next year)
• Bank borrowings
• Trade payable and other payables
• Deferred revenues and other noncash liabilities
Stockholders’ Equity
Stockholders’ equity
• Issues share capital
• Share premium Account
• Retained earnings
Balance sheet equation:
Assets = Liabilities + Stockholders equity
Net assets = SH equity = assets - liabilities
• Stockholders equity is:
▪ Contributed capital (sale of shares)
▪ Common stock (par value)
, ▪ Share premium account (excess over par value)
▪ Treasury Stock (stock repurchased by company)
• Retained earnings (arises from operations)
▪ Accumulation of Net income (Revenue – Expenses) – Dividends
▪ Dividends are distributions of retained earnings to
shareholders. Dividends are not an expense. They are
recorded as a reduction of retained earnings on the
declaration date (creates a liability until payment date)
• An asset is a resource that is expected to provide future economic benefits
(i.e. generate future cash inflows or reduce future cash outflows)
▪ An asset is recognized when:
▪ It is acquired in a past transaction or exchange (already
happened)
▪ The value of its future benefits can be measured with a
reasonable degree of precision (can be measured in future)
• A liability is a claim on assets by “creditors” (non-owners) that represents an
obligation to make future payment of cash, goods, or services
▪ A liability is recognized when:
▪ The obligation is based on benefits or services received
currently or in the past (already happened)
▪ The amount and timing of payment is reasonably certain (can
be measured in future)
- Income statement (Profit and Loss account): Results of operations over a period of
time using accrual accounting (i.e., recognition income and expenses tied to business
activities)
Income statement (limited company)
Revenue (or Sales)
-/- Cost of Goods Sold
Gross Profit
-/- Operating Expenses
Operating Income
-/- Interest, Gains and Losses
Pre-tax Income
-/- Income Tax Expense
Net Income
Income statement equations:
Net Income = Revenue – Expenses
Net income is also called “earnings” or
“net profit”
• The income statement reports increase in shareholders’ equity due to operations over a
period of time (net income is added to retained earnings)
• All income statement items are based on Accrual Accounting principles
▪ Recognition of revenues and expenses are based on business activities, not cash
flows
▪ Net income ≠ Net cash flow
▪ Revenue is recognized when goods or services are provided (revenue recognition
principle).
▪ Revenues ≠ Cash inflows
