1. Financial Accounting
Lecture 1
Chara Charalambous

2. Aims of Lesson What is Accounting and the purpose of Accounting.
Explain the use of Financial Statements
Identify the users of Financial Statements
Identify and explain simple accounting terms
The accounting equation
Accounting cycle during a period
Generally accepted accounting principles

3. What is Bookkeeping?
A great deal of efforts goes into gathering and processing information about a concern before the facts end up in an accounting report. Much of the work required is clerical in nature and can be performed by office workers, machine and computers. The functions of  Bookkeeping is to properly record the financial transactions in the books of account.

4. What is Accounting?
A service that is systematically recording and summarizing the financial (economic) transactions of a business and then analyzing, verifying (confirming) and reporting the results.
The person in charge for the execution of accounting is known as an Accountant, and this individual is typically required to follow a set of rules and regulations of the IFRS (International Financial Reporting Standards).

5. Bookkeeping VS. Accounting?
Bookkeeping is confined to recording aspect of accounting. It is a small and simplest part of accounting. Both represent two different phases of the main subject "accountancy". Bookkeeping is the first stage, while accounting is the final stage, that is why, it is said that accounting starts where bookkeeping ends. The function of bookkeeping ends with the recording of transactions in the books of accounts. But the function of accounting is to classify the recorded transactions, summarize them, interpret them, and collect and communicate necessary information to the management and other interested persons.

6. Purpose of Accounting
Accounting allows a company to analyze the financial performance of the business and look at statistics such as net profit. Therefore the management is able to make informed judgment and better decision.
Also Accounting aims to show the relationship of the business with its environment which includes its customers (debtors), suppliers (creditors), employees owners and lenders.

7. Accounting is concerned with:
Identification and recording of transactions:
A transaction is an economic event which affect the financial situation of the business. A transaction could be: a sale of a product, the purchases of raw materials , purchase of a machine, payment of salaries or the receive of a loan. The accounting system must be well organized so as all transactions are recognized when they take place and then are recorded in the books of the business using the book-keeping function.
A double-entry bookkeeping system is a set of rules for recording financial information in a financial accounting system in which every transaction or event affects at least two different nominal ledger accounts. The accounting process includes the bookkeeping function, but is just one part of the accounting process

8. Classification and measurement of transactions after they have been recorded. Economic events may create assets (items which the business owns) or liabilities (what is due by the business to others) or revenues (income from sales) or costs/expenses (amounts incurred to make products or operate the business). Therefore correct classification is important. Measurement follows the classification and by this we mean: how much of the costs or revenues concern this year and how much must be carried forward to the next year.
Summarization and communication. Since the Accountant has record all the transactions a summary is extracted which show the performance of the business during a period – a month or a year . This summary is shown through the financial statements which they communicate information regarding the financial position of the business to a wide range of users.

9. Financial Statements
The Accounting service is analyzing data with the preparation of financial statements. The most widely used financial statements are:
The Statement of Financial Position (Balance Sheet) and
The Income Statement (Trading and Profit & Loss account).
To achieve its goals, an accounting system may make use of computers and video displays as well as handwritten records and reports printed on paper

10. USERS OF FINANCIAL STATEMENTS The financial accounts provide a wealth of information that is useful to various users of financial information
INVESTORS
CUSTOMERS
MANAGEMENT
OWNERS
SUPPLIERS
EMPLOYEES
USERS
LENDERS
THE PUBLIC
COMPETITORS
GOVERNMENT

11. Managers: need information on a monthly basis to control the business, plan for the future and evaluate profitability. They prepare budgets based on past performance and they compare it to actual results.
Owners: The financial Statements tell the owners just how successful the business has been and also summarise in brief form its present financial position
Investors: are concerned with how secured and the profitable is their investment in the specific company. This is shown in the income statement.
Employees: are interested to know if an employer can offer secure employment, possible salary increases and retirement benefits. They are also interested in the pay and benefits obtained by senior management!

12. Lenders: Banks and other financial institutions who lend money to a business require to know if they will be repaid. This is shown in the balance sheet which displays the solvency of the firm.
Government: need to know how the economy is performing so as to plan financial policies. Also the tax authorities evaluate the tax witch is payable by the companies with the use of financial statements.
Suppliers: need to know if the business is able to pay short-term debt when it falls due.
Competitors: wish to compare their own performance against that of other firms that are operating in the same sector.

13. Accounting Terms
1. Balance Sheet: is a statement of the assets, liabilities and capital/owners’ equities as at a specific point in time (next day things could be different).
Assets – are things owned by the business such as motor vehicles, machinery, inventory (goods manufactured or purchased for resale), money owed by debtors, balance at bank and prepaid expenses.
Assets are divided into fixed assets: A long-term tangible  piece of property that a firm owns and uses in the production of its income and is not expected to be consumed or converted into cash any sooner than at least one year's time, and current assets: the value of all assets that are reasonably expected to be converted into cash within one year in the normal course of business Goodwill is an Intangible F.A.
Liabilities – are amounts owed such as money due to creditors, bank overdrafts, short term loans.
Capital/Owners’ equity – is a type of liability but this amount is due to the owner of the business rather than to ‘outsiders’. It increases by any new capital brought in and by the net profit made by the business and reduces by any amounts withdrawn by the owner. It is use to start the business.

14. Accounting Terms
Turnover –Turnover is an accounting term that calculates how quickly a business collects cash from accounts receivable or how fast the company sells its inventory.
Profit –  Profit, also called net income, is the amount of earnings that exceed expenses for the period. In other words, it’s the amount of income left over after all the necessary and matched expenses are subtracted for the period. Notice I didn’t say all the expenses that were paid during the period.
Debit – A debit is an accounting entry that results in either an increase in assets or a decrease in liabilities and capital on a company's balance sheet.
Credit- A credit is an accounting entry that either increases a liability or capital/equity account, or decreases an asset or expense account. It is positioned to the right in an accounting entry.

15. The duality concept and double entry bookkeeping
ACCOUNTS
INCREASES
DECREASES
Asset Account
Debited
Credited
Liability Account
Capital Account

16. Exercises Give one word that bookkeeping does
Give one action of accounting
List two (2) users of accounting information
Define, only in your own words, the following terms: * Asset * Liability * Capital * Turnover * Debit & Credit

17. The Accounting Equation
Assets = Liabilities + Capital
Or otherwise : Capital=Assets-Liabilities
The balance sheet must always balance which means
must always satisfy the above equation, at any time
assets equals liabilities plus the capital .

18. Statement of Financial Position (Balance Sheet) as at 31st December 20YY€ €
Fixed Assets
Capital X X
Land and Buildings
Add Net Profit X X
Furniture and Fittings
Less Drawings X X
Motor Vechicles X
Long-term Liabilities
(repayable later than one year) X X
Goodwill
Long-term Loan
Current Assets X
Current Liabilities
(amounts due within a year)
Stock X X
Debtors
Creditors X
Accrued Expenses X
Prepayment of Expenses X
Bank Overdraft X
Bank
Short Term Loan X X
Cash X X

19. Balance Sheet as at 31 December Year 20XX
Fixed Assets €
Land and Buildings
Furniture and fittings x
Motor Vehicles
Goodwil
Current Assets
Closing Inventory
Debtors
Prepayments
Bank
Cash
xxxxxx
Capital Account
Add Net Profit
Less Drawings
Long-trrm Liabilities
Long term loan
Current Liabilities
Creditors
Accruals
Bank Overdraft
Short term loan X
Chara Charalambous

20. 2. Income Statement: Presents the results of operations for a period of time. It usually covers a year of business activity in contrast to balance sheet which is as at a specific point in time.
The income statement is prepared following the accruals
concept: the income and expenses are recorded as they
occurred regardless of whether cash has been received or
paid .
Income – the sales revenue shows the income from goods/services sold in the year.
Expenses – in order to make revenues we must incur expenses: an outflow of money to pay for an item or service e.g. wages, rents, electricity e.t.c
The income statement is split into two parts a) the Trading
account which gives the gross profit and b) the Profit & Loss
account which gives us the Net Profit.

21. Trading and Profit & Loss account€ € X X
Sales
Opening Stock
Less Sales Returns X X X
Add Purchases X
Less Purchases Return X
Less Closing stock
Cost of Sales X
Gross Profit c/d X X X X
Gross Profit b/d
Wages and Salaries X
Discounts Received X
Insurance X
Rent X
Depreciation of motor vehicles
and Furniture's X
Bad Debts X
Office Expenses
Discount allowed X X
Net Profit X

22. The modern-vertical layout is as follows:
The above layout of the income statement is not mainly useful but is assists the appreciation of the actual double entry processes and the realization that the income statement is part of the double entry.
The modern-vertical layout is as follows:
Income statement: Trading and Profit & Loss account
Sales x
Less Cost of Sales:
Op. Stock x
Purchases x
Less Closing stock (x) (x)
GROSS PROFIT xx
Less Expenses (x)
NET PROFIT xxx
Chara Charalambous

23. The modern-vertical layout of Income Statement is as follows:
Income statement: Trading and Profit & Loss account
Net Sales x
Less Cost of Sales:
Op. Stock x
Purchases x
Less Closing stock (x) (x)
GROSS PROFIT xx
Plus Other income xx
Less Operating Expenses:
Wages / Salaries x
Heating & Lighting x
Rent x
Insurance x
Advertising x
Bad Debts x
Depreciation x
Stationery x
Commission Paid x
Bank interest & charges x
Cleaning x
Office Expenses x (x)
NET PROFIT xxx

24. Accounting Cycle During Period
Also known as “bookkeeping cycle ”, is the process of recording and processing the accounting events of a company. The series of steps begin when a transaction occurs and end with its inclusion in the financial statements.
The main steps of the accounting cycle are:  
Collecting and analyzing data from transactions and events.
Posting entries to the general ledger.
Adjusting entries appropriately.
Preparing an adjusted trial balance.
Organizing the accounts into the financial statements.
Closing the books.
Preparing a post-closing trial balance to check the accounts. . 

25. Main Types of Business Transactions
Duality Concept: Each and every transaction that the business makes has two aspects and has a double effect on the business and accounting equation.
B/ce Sheet Incm Stat.
1. SALES OF GOODS: If with cash cash sales
If with credit debtors sales
2. PURCHASES: If with cash cash stock
If with credit creditors stock
3. PURCH. OF FIXED ASSETS: If with cash cash F. A
If with credit creditors F.A

26. B/ce Sheet Incm Stat
4. PAYMENT OF EXPENSES: cash expense
5. BRING NEW CAPITAL: cash capital
6. DRAWINGS: cash capital

27. The business entity concept
Accepted accounting principles require that a set of financial statements describe a specific business body, which is called business entity.
Financial Accounting information relates only to the activities of the business entity and not to the activities of its owner. For e.g. if the owner buys a car for him and his family to use personally this transaction will not influence the balance sheet elements at all.
The business entity is treaded as separate from its owners.

28. Forms of business organizations
Sole Trader: Owned and operated by one person, although there might be any number of employees. A Sole Trader is fully and personally liable for any losses that the business might take.
Partnership: Owed and operated by two or more people called the ‘partners’.
Partners are ‘jointly and severally’ liable for any losses that the business might make.
Traditionally the big accounting firms have been partnerships

29. Company: Owned by many people (shareholders) and operated by many people (thought not necessarily the same).
There can be one shareholder or many thousands of shareholders.
Each shareholder owns part of the company.
As a group, they elect the directors who run the business.
Directors often own shares in theirs companies.
Not all shareholders are directors.
Companies are almost always limited companies (This means that the shareholders will not be personally liable for any losses the company incurs).
Their liability is limited to the nominal value of the shares that they own.

30. Capital
For all three types of organization, the money contributed by the individual, the partners or the shareholders is referred to as the business capital.
In the case of a company the capital is divided into shares.

31. Statement of Standard Accounting Practice (SSAP)
Is concerned with the disclosure (notification , communication) of accounting policies – the guidelines and rules that must followed when preparing the financial statements.
The 4 fundamentals accounting concepts mentioned by the standard are:
The going-concern concept
The accruals concept
The consistency concept
The prudence concept

32. Going concern: the business for which we are preparing the financial statements is going to continue in operation for an undetermined period. Before the accounts are certified as showing a true and fair view , the auditor must be satisfied that the company is a going concern and that it will continue to function successfully in the future. The auditor in order to assume that the company is a going concern is based on the following factors: the demand of the company’s product in the market , if the company have sufficient cash to respond to its liabilities in the future and if it is profitable. Also if the company has sound capital to face any future unexpected events and finally if the company is competive enough regarding its products, its ability to acquire raw materials and labor.

33. The income statement for a period is prepared following the accruals concept: the income and expenses are recorded as they happened in the period regardless of whether cash has been received or paid :
Costs which are paid but they are concerning a future period must be carried forward as a prepayment and charged in the period they concern not in the current profit and loss account. The same for income: if there is an income received but it regards a future period for e.g. next year it will not included in the income statement of this period but of the next and for the current year it will consider as prepayment Expenses of the period not yet paid and not entered in the books must be estimated and inserted as accruals.
Chara Charalambous

34. Prudence concept: Business transactions are sometimes uncertain
Prudence concept: Business transactions are sometimes uncertain. While making judgment we need to be careful and prudent. Prudence is a key accounting principle which makes sure that assets and income are not overstated and liabilities and expenses are not understated. Accountants must not be very optimism and overstate profits and causing by this unrealized profits to be paid out of capital in the form of dividends. Because there is a danger that the profit might not finally realised since some of the clients of the company might declared bankruptcy and not pay. Therefore Accountants must be strict with profits but take in mind all possible losses.
Chara Charalambous

35. Consistency: with many accounting transactions there is more than one method which can be used. For example the depreciation method and policy. Accountants must use their judgment to select the most appropriate method, but once that choice is made the same method must be used with consistency (stability) in forthcoming periods. Such consistency enables users to make a useful comparison of results over time. Thus investors can see the level of profit or loss, comparing this year with the last year , and make their investment decisions accordingly. The methods used should only be changed if the new method selected improves the true and fair value given by the accounting statements.
Chara Charalambous

36. Exercises of the handout
Chara Charalambous