LECTURE 1 - CHAPTER 1,2
Financial Accounting
A collection and processing of financial information to meet the decision-making needs of
parties external to the organization.
→ financial statements as a primary mean of firm communication
Financial reporting
Objective is to provide financial information about the reporting entity that is useful to
present and potential equity investors, lenders, and other creditors in making decisions
about providing resources to the entity.
Firms are global and need to communicate
→ social media → conference calls
→ public events → business press
Annual report vs Financial statements
- unregulated - regulated by GAAP
- general non-standard - must be deposited into national registers
summary of company - USUALLY include all financial statements
activities
- includes financial statements
Financial statements (FS)
- statement of financial position (aka balance sheet)
- (comprehensive) income statement (aka P&L)
- statement of cash flows
- statement of changes in shareholders’ equity
Accounting provides reliable, relevant, and timely information to managers, investors, and
creditors to allow resource allocation to the most efficient enterprises. It also provides
measurements of efficiency (profitability) and financial soundness.
Role of financial reporting
1. Scarcity of resources
Importance of efficient capital allocation decisions → capital providers’
demand for
accounting information to better understand the firm
2. Comparability
Access to international capital markets → comparability of financial
statements → single
high quality set of accounting standards
3. Economic (theory) reasoning
- Firm need economic resources (capital providers)
, - Absence of reporting = Wild Wild West! → adverse selection
- For an efficient functioning → capital providers write contracts to prevent
management
moral hazard behavior
To satisfy the need for financial reporting, governments establish a set of rules:
Generally Accepted Accounting Principles (GAAP).
→ A need for an international set of rules was obvious
→ Single set of rules established by a single-standard body which is:
- high-quality
- understandable
- enforceable
- globally accepted
-comparable
To ensure that relevant and faithful information is disclosed
→ International Financial Reporting Standards (IFRS)
Need for one set of international accounting standards:
- Multinational companies
- Mergers and acquisitions
- Adequate comparability
- Information technology
- Financial markets
IFRS is comprised of:
A. International Financial Reporting Standards
B. International Accounting Standards
C. Interpretations issued by the IFRS Interpretations Committee or SIC
Normative theory:
- IFRS conceptual framework prescribes how assets should be measured
- Accounting standards prescribed how a transaction should be reported
Positive theory:
- IFRS studies show that net income reported under IFRS contains more value
relevant
information → more useful in investors decision-making
- Net income under IFRS contains new information
- Under IFRS firms manage earnings less
- Under IFRS firms manage earnings more
- IFRS has no effect on earnings management
Controversies surrounding IFRS
1. Uniformity vs. flexibility debate
, - fair value vs. historical cost accounting → relevance vs. reliability
2. Necessity of regulation
- free-market perspective vs. pro-regulation perspective
3. Political interference & lobbying
4. (Some) reporting issues
- nonfinancial information
- accounting for innovation
- timeliness
Challenges facing financial reporting:
- IFRS in a political environment
- the expectations gap
- financial reporting issues related to keu performance measures widely used by
management, forward-looking information needed by investors and creditors, sufficient
information on a company’s intangibles, and real time financial information
- international convergence
Application of the basic principles of accounting
1. Measurement principle
IFRS requires the use of historical cost or fair value depending on the situation. Although
the historical cost principle (measurement based on acquisition price) continues to be an
important basis for valuation, recording and reporting of fair value information is
increasing.
2. Revenue recognition principle
A company generally recognizes revenue when it satisfies a performance obligation.
3. Expense recognition principle
As a general rule, companies recognize expenses when the service or the product
actually makes its contribution to revenue (matching).
4. Full disclosure principle
Companies generally provide information that is of sufficient importance to influence the
judgement and decisions of an informed user.
LECTURE 2 - CHAPTER 3,4,5
Financial reports - information to include in the most extensive reporting requirements
- Balance sheet
Information on the financial condition of a business at a certain moment
- Income Statement (or Profit & Loss or Comprehensive Income)
Information on the net income of a business during a certain period
- Statement of Cash-Flows
Information on the origin and use of cash in the company
- Statement of Shareholders’ Equity
, Presents the individual components of equity and the changes during the last year
- Notes
Information on the criteria, principles, and norms used in the financial statements
Basic steps in the accounting cycle:
1. Identifying and measuring transactions and other events
2. Journalizing
2. Posting
4. Preparing unadjusted trial balance
5. Making adjusting entries
6. Preparing an adjusted trial balance
7. Preparing financial statements
8. Closing
Balance Sheet:
- Assets: what had the company invested in?
- Liabilities & equity: where does the financing come from?
Income Statement
Provides investors and creditors with information that helps them predict the amounts, timing,
and uncertainty of future cash flows.
1. Revenues income generated through the sale of a product/service
→ recognize whenever i) it’s probable that economic benefits
will be received, ii) the amount of revenue can be measured
In general, ownership and control of the good is transferred to
the
customer
2. Expenses consumption of resources during a period
→ COGS: all costs directly incurred when producing the product
or
Service that is sold during the period (matching principle)
Cash Flow Statement
- Shows how cash (and cash equivalent items) changed during an accounting period
- Cash and cash equivalents: cash, banks, bonds about to mature (3 months or less)
→ any single item that is highly liquid
- Two ways to prepare CFS:
i) Direct method: small firms
ii) Indirect method: large firms
Statement of Stockholders’ Equity
- Shows the variation in equity accounts
- Variation generally comes from: new stock issuances, retained profit, asset revaluations etc.
Double entry principle: each transaction is recorded (at least) once on debit and credit
Financial Accounting
A collection and processing of financial information to meet the decision-making needs of
parties external to the organization.
→ financial statements as a primary mean of firm communication
Financial reporting
Objective is to provide financial information about the reporting entity that is useful to
present and potential equity investors, lenders, and other creditors in making decisions
about providing resources to the entity.
Firms are global and need to communicate
→ social media → conference calls
→ public events → business press
Annual report vs Financial statements
- unregulated - regulated by GAAP
- general non-standard - must be deposited into national registers
summary of company - USUALLY include all financial statements
activities
- includes financial statements
Financial statements (FS)
- statement of financial position (aka balance sheet)
- (comprehensive) income statement (aka P&L)
- statement of cash flows
- statement of changes in shareholders’ equity
Accounting provides reliable, relevant, and timely information to managers, investors, and
creditors to allow resource allocation to the most efficient enterprises. It also provides
measurements of efficiency (profitability) and financial soundness.
Role of financial reporting
1. Scarcity of resources
Importance of efficient capital allocation decisions → capital providers’
demand for
accounting information to better understand the firm
2. Comparability
Access to international capital markets → comparability of financial
statements → single
high quality set of accounting standards
3. Economic (theory) reasoning
- Firm need economic resources (capital providers)
, - Absence of reporting = Wild Wild West! → adverse selection
- For an efficient functioning → capital providers write contracts to prevent
management
moral hazard behavior
To satisfy the need for financial reporting, governments establish a set of rules:
Generally Accepted Accounting Principles (GAAP).
→ A need for an international set of rules was obvious
→ Single set of rules established by a single-standard body which is:
- high-quality
- understandable
- enforceable
- globally accepted
-comparable
To ensure that relevant and faithful information is disclosed
→ International Financial Reporting Standards (IFRS)
Need for one set of international accounting standards:
- Multinational companies
- Mergers and acquisitions
- Adequate comparability
- Information technology
- Financial markets
IFRS is comprised of:
A. International Financial Reporting Standards
B. International Accounting Standards
C. Interpretations issued by the IFRS Interpretations Committee or SIC
Normative theory:
- IFRS conceptual framework prescribes how assets should be measured
- Accounting standards prescribed how a transaction should be reported
Positive theory:
- IFRS studies show that net income reported under IFRS contains more value
relevant
information → more useful in investors decision-making
- Net income under IFRS contains new information
- Under IFRS firms manage earnings less
- Under IFRS firms manage earnings more
- IFRS has no effect on earnings management
Controversies surrounding IFRS
1. Uniformity vs. flexibility debate
, - fair value vs. historical cost accounting → relevance vs. reliability
2. Necessity of regulation
- free-market perspective vs. pro-regulation perspective
3. Political interference & lobbying
4. (Some) reporting issues
- nonfinancial information
- accounting for innovation
- timeliness
Challenges facing financial reporting:
- IFRS in a political environment
- the expectations gap
- financial reporting issues related to keu performance measures widely used by
management, forward-looking information needed by investors and creditors, sufficient
information on a company’s intangibles, and real time financial information
- international convergence
Application of the basic principles of accounting
1. Measurement principle
IFRS requires the use of historical cost or fair value depending on the situation. Although
the historical cost principle (measurement based on acquisition price) continues to be an
important basis for valuation, recording and reporting of fair value information is
increasing.
2. Revenue recognition principle
A company generally recognizes revenue when it satisfies a performance obligation.
3. Expense recognition principle
As a general rule, companies recognize expenses when the service or the product
actually makes its contribution to revenue (matching).
4. Full disclosure principle
Companies generally provide information that is of sufficient importance to influence the
judgement and decisions of an informed user.
LECTURE 2 - CHAPTER 3,4,5
Financial reports - information to include in the most extensive reporting requirements
- Balance sheet
Information on the financial condition of a business at a certain moment
- Income Statement (or Profit & Loss or Comprehensive Income)
Information on the net income of a business during a certain period
- Statement of Cash-Flows
Information on the origin and use of cash in the company
- Statement of Shareholders’ Equity
, Presents the individual components of equity and the changes during the last year
- Notes
Information on the criteria, principles, and norms used in the financial statements
Basic steps in the accounting cycle:
1. Identifying and measuring transactions and other events
2. Journalizing
2. Posting
4. Preparing unadjusted trial balance
5. Making adjusting entries
6. Preparing an adjusted trial balance
7. Preparing financial statements
8. Closing
Balance Sheet:
- Assets: what had the company invested in?
- Liabilities & equity: where does the financing come from?
Income Statement
Provides investors and creditors with information that helps them predict the amounts, timing,
and uncertainty of future cash flows.
1. Revenues income generated through the sale of a product/service
→ recognize whenever i) it’s probable that economic benefits
will be received, ii) the amount of revenue can be measured
In general, ownership and control of the good is transferred to
the
customer
2. Expenses consumption of resources during a period
→ COGS: all costs directly incurred when producing the product
or
Service that is sold during the period (matching principle)
Cash Flow Statement
- Shows how cash (and cash equivalent items) changed during an accounting period
- Cash and cash equivalents: cash, banks, bonds about to mature (3 months or less)
→ any single item that is highly liquid
- Two ways to prepare CFS:
i) Direct method: small firms
ii) Indirect method: large firms
Statement of Stockholders’ Equity
- Shows the variation in equity accounts
- Variation generally comes from: new stock issuances, retained profit, asset revaluations etc.
Double entry principle: each transaction is recorded (at least) once on debit and credit
