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PRINCIPLES OF ACCOUNTING Lecturer: Maja Zaman Groff, PhD

PRINCIPLES OF ACCOUNTING Lecturer: Maja Zaman Groff, PhD. Lecture 2 : March 4 , 201 1 1. The accounting profession (continued) 2. Accounting concepts and principles 3. Balance sheet and t he accounting equation 4. Assets, liabilities and owner’s equity

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PRINCIPLES OF ACCOUNTING Lecturer: Maja Zaman Groff, PhD

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  1. PRINCIPLES OF ACCOUNTINGLecturer: Maja Zaman Groff, PhD Lecture 2: March 4, 2011 1. The accounting profession (continued) 2. Accounting concepts and principles 3. Balance sheet and the accounting equation 4. Assets, liabilities and owner’s equity 5. Accounting for business transactions – an extended example 6. Accounting for business transactions – a team work assignment © Maja Zaman Groff PhD, Faculty of Economics, Ljubljana, January 2010

  2. THE ACCOUNTING PROFESSION Accounting-related careers: • Financial accounting • Management accounting (& Cost accounting) • Auditing • Internal Auditing • Tax consulting • Management consulting © Maja Zaman Groff PhD, Faculty of Economics, Ljubljana, March 2011

  3. THE ACCOUNTING PROFESSION THE ROLE OF AUDITORS Investors and creditors need relevant and reliable information about companies. Companies want to look good to attract investors therefore, a conflict of interest arises. To provide reliable information, companies need to have their financial statements audited by independent accountants. An audit is a financial examination and the independent auditors (statutory auditors, CPAs) provide their independent opinion on whether or not the financial statements give a fair presentation of the company’s financial position. CODES OF ETHICS: IFAC Code of Ethics for Professional Accountants http://web.ifac.org/publications/international-ethics-standards-board-for-accountants/code-of-ethics AICPA Code of Professional Conduct for Accountants http://www.aicpa.org/Research/Standards/CodeofConduct/Pages/default.aspx © Maja Zaman Groff PhD, Faculty of Economics, Ljubljana, March 2011

  4. ACCOUNTING CONCEPTS AND PRINCIPLES The principle objective of financial reporting is to provide useful information for decision-making. To be useful, information must be relevant, reliable and comparable. • THE ENTITY CONCEPT The ENTITY CONCEPT holds that an organization must be viewed as a unit that is separated and apart from its owners and from other firms. This assumption requires individual sets of financial records for each business enterprise. © Maja Zaman Groff PhD, Faculty of Economics, Ljubljana, March 2011

  5. ACCOUNTING CONCEPTS AND PRINCIPLES 2. THE RELIABILITY (OBJECTIVITY) PRINCIPLE RELIABILITY (OBJECTIVITY) PRINCIPLE holds that accounting measurements must be verifiable. Also, the accounting records must present “true and fair “ view of financial condition. What do you consider verifiable value of shares that were purchased today at 50 EUR? What do you consider verifiable value of the same shares in 5 years when preparing financial statements for external financial reporting? © Maja Zaman Groff PhD, Faculty of Economics, Ljubljana, March 2011

  6. ACCOUNTING CONCEPTS AND PRINCIPLES • THE COST PRINCIPLE The COST PRINCIPLE holds that purchases of assets and services are entered in the accounting records at their actual cost (also: historical cost). Example: if we buy 100 shares at the stock exchange at the price 50 EUR per share, we will enter the initial total value of 5.000 EUR in accounting records . THE COST PRINCIPLE AND FAIR VALUE ACCOUNTING Continuing usage of historicalcost can create severe accounting problems and can result in misstatement of financial condition and profitability. This problem has been solved by a contemporary concept of FAIR VALUE ACCOUNTING (IFRS, US GAAP). © Maja Zaman Groff PhD, Faculty of Economics, Ljubljana, March 2011

  7. ACCOUNTING CONCEPTS AND PRINCIPLES THE COST PRINCIPLE AND FAIR VALUE ACCOUNTING (continued) http://www.uic.edu/classes/actg/actg593/Readings/Fair-Value/Fair%20value%20accounting%20-%20Understanding%20the%20issues%20Ryan.pdf Discuss the advantages and drawbacks of fair value accounting. How are these related to current conditions in world economy? © Maja Zaman Groff PhD, Faculty of Economics, Ljubljana, March 2011

  8. ACCOUNTING CONCEPTS AND PRINCIPLES 4. THE GOING-CONCERN CONCEPT The GOING-CONCERN CONCEPT assumes that the entity will remain in operation for the forseeable future. The accountants assume that the business will remain in operation long enough to use existing assets for their intended purpose. How (at what value, historical or fair) would you measure the equipment under the going-concern concept? Consider the alternative. How would you measure the same equipment if the company is to go out of business? © Maja Zaman Groff PhD, Faculty of Economics, Ljubljana, March 2011

  9. ACCOUNTING CONCEPTS AND PRINCIPLES 5.THE STABLE MONETARY UNIT CONCEPT Accountants assume that the purchasing power of the currency, in which the financial statements are prepared, is stable. This assumption is the basis of the stable monetary unit concept. © Maja Zaman Groff PhD, Faculty of Economics, Ljubljana, March 2011

  10. BUSINESS EVENT ORIGINAL DOCUMENTS receivables, payables, cash receipts, loan contracts… ACCOUNTING RECORDS ledger, diary FINANCIAL STATEMENTS balance sheet, income statement, cash flow statement, statement of owner’s equity THE ACCOUNTING PROCESS © Maja Zaman Groff PhD, Faculty of Economics, Ljubljana, March 2011

  11. ASSETS LIABILITIES AND OWNER’S EQUITY BALANCE ASSETS OWNER’S EQUITY LIABILITIES THE ACCOUNTING EQUATION TOTAL ASSETS = TOTAL LIABILITIES + OWNER’S EQUITY BALANCE SHEET(BASIC SCHEME) NO SINGLE EVENT CAN RESULT IN ONLY ONE CHANGE IN THE BALANCE SHEET. TWO CHANGES (AT LEAST) ARE REQUIRED TO PRESERVE THE “BALANCE” . © Maja Zaman Groff PhD, Faculty of Economics, Ljubljana, March 2011

  12. BALANCE SHEET(STATEMENT OF FINANCIAL POSITION) RESOURCES OWNED BY THE FIRM: ASSETS OWNER’S CLAIM AGAINST THE RESOURCES: OWNER’S EQUITY CREDITORS’ CLAIMS AGAINST THE RESOURCES: LIABILITIES Balance sheet reveals the financial position of a company as it reveals the resources owned by the busines and the claims on those resources by specified parties at a particular point in time. Liabilities represent creditor claims against an entity’s resources. © Maja Zaman Groff PhD, Faculty of Economics, Ljubljana, March 2011

  13. BALANCE SHEET • Take a look at the Annual report of Krka d.d. for year 2009 and check its balance sheet (“statement of financial position”) • What are the main categories of assets, liabilities and owner’s equity? • Check the notes of some of the categories in the balance sheet – what do these notes reveal? © Maja Zaman Groff PhD, Faculty of Economics, Ljubljana, March 2011

  14. THE ACCOUNTING EQUATION The basic tool of accounting is the accounting equation. Accounting equation measures resources of a business and claims to those resources: • Assets are economic resources that are expected to benefit the business in the future. • Claims to the assets composed of: • Liabilities (debts payable to outsiders – creditors) • The owner’s claims are known as owner’s equity (owner’s equity is created when an owner invests money in the business) • The accounting equation shows how assets, liabilities and owner’s equity are related and the two sides MUST ALWAYS BE EQUAL. © Maja Zaman Groff PhD, Faculty of Economics, Ljubljana, March 2011

  15. ASSETS ASSETS are economic resources owned by a company, for example: 1. 2. 3. 4. 5. Try to list different types of assets possessed by a company!!! © Maja Zaman Groff PhD, Faculty of Economics, Ljubljana, March 2011

  16. LIABILITIES LIABILITIES are the economic obligations of an entity that are owed to creditors, for example: • Accounts payable • Loans payable • Salaries payable • Interest payable • Taxes payable © Maja Zaman Groff PhD, Faculty of Economics, Ljubljana, March 2011

  17. OWNER’S EQUITY (CAPITAL) OWNER’S EQUITY (CAPITAL) represents the owner’s stake in the business. It equals the company’s net assets: ASSETS – LIABILITIES = OWNER’S EQUITY Any transaction that affects both assets and liabilities by an equal amount has no impact on owner’s equity. Same holds when only assets or only liabilities are affected. © Maja Zaman Groff PhD, Faculty of Economics, Ljubljana, March 2011

  18. TYPES OF BUSINESS ORGANIZATIONS © Maja Zaman Groff PhD, Faculty of Economics, Ljubljana, March 2011

  19. OWNER’S EQUITY OF A PROPRIETORSHIP • The owner’s equity of a proprietorship is called capital. Capital is the amount invested in the business by its owners and is increased by earnings, if these are not withdrawn from the business. • Capital is increased by revenues: • Sales revenues • Service revenues • Interest revenues • Dividend revenues • Capital is decreased by expenses: • Rent expenses • Salary expenses • Advertising, utilities expenses (water, electricity, gas) • Insurance expenses, expenses for supplies used up • Interest expenses, tax expenses, etc. © Maja Zaman Groff PhD, Faculty of Economics, Ljubljana, March 2011

  20. OWNER’S EQUITY OF A PROPRIETORSHIP • Capital is increased with further investments of the owner. • Capital is decreased by withdrawals (distributions to the owner of assets – usually in cash). • Revenues > Expenses → NET INCOME • Revenues < Expenses → NET LOSS © Maja Zaman Groff PhD, Faculty of Economics, Ljubljana, March 2011

  21. OWNER’S EQUITY OF A PROPRIETORSHIP Owner’s equity changes as a consequence of four factors: 1. Investments by the owner 2. Withdrawal by the owner 3. Revenues 4. Expenses © Maja Zaman Groff PhD, Faculty of Economics, Ljubljana, March 2011

  22. OWNER’S EQUITY OF A CORPORATION • The equity of corporations is different from the owner’s equity as they separate the share capital from other components of equity (such as “reserves” and “retained earnings”) • As an example take the balance sheet of Krka: © Maja Zaman Groff PhD, Faculty of Economics, Ljubljana, March 2011

  23. THE ACCOUNTING EQUATIONTEAM WORK ASSIGNMENT Set up the accounting equation: ASSETS = LIABILITIES + OWNER’S EQUITY a) b) c) d) By using “+” and “-” signs, indicate the effect of the following transactions (note that revenues increase owner’s equity and expenses decrease owner’s equity)! • Processed a 5.000 EUR cash withdrawal for the owner. • Recorded the receipt of May’s utility bill, to be paid in June. • Provided services to customers on account. • Paid the current month’s advertising charges. © Maja Zaman Groff PhD, Faculty of Economics, Ljubljana, March 2011

  24. ACCOUNTING FOR BUSINESS TRANSACTIONS(AN EXTENDED EXAMPLE) • Company: Vista Transit • Small company, engaged with transportation services • Established on Jan 2 of current year Show the impact of the following 9 business events on the accounting equation! © Maja Zaman Groff PhD, Faculty of Economics, Ljubljana, March 2011

  25. 1. The owner invests EUR 40.000 in the firm. ACCOUNTING FOR BUSINESS TRANSACTIONS(AN EXTENDED EXAMPLE) © Maja Zaman Groff PhD, Faculty of Economics, Ljubljana, March 2011

  26. 2. Two vans were bought at a total price of 34.000 EUR for cash. 40.000 ACCOUNTING FOR BUSINESS TRANSACTIONS(AN EXTENDED EXAMPLE) 40.000 © Maja Zaman Groff PhD, Faculty of Economics, Ljubljana, March 2011

  27. 3. Two charter trips were completed and clients were billed for 1.700 EUR (on account). 41.700 ACCOUNTING FOR BUSINESS TRANSACTIONS(AN EXTENDED EXAMPLE) 41.700 © Maja Zaman Groff PhD, Faculty of Economics, Ljubljana, March 2011

  28. 4. Repairs for the two vans amounted to 750 EUR and will be paid (on account) in 30 days. 41.700 ACCOUNTING FOR BUSINESS TRANSACTIONS(AN EXTENDED EXAMPLE) 41.700 © Maja Zaman Groff PhD, Faculty of Economics, Ljubljana, March 2011

  29. 5. A 600 EUR check from one of the clients (see transaction 3) was received. 41.700 ACCOUNTING FOR BUSINESS TRANSACTIONS(AN EXTENDED EXAMPLE) 41.700 © Maja Zaman Groff PhD, Faculty of Economics, Ljubljana, March 2011

  30. 6. The comapny paid 400 EUR as partial payment for the van repairs (see trans. 4). 41.300 ACCOUNTING FOR BUSINESS TRANSACTIONS(AN EXTENDED EXAMPLE) 41.300 © Maja Zaman Groff PhD, Faculty of Economics, Ljubljana, March 2011

  31. 7. The company paid 500 EUR (wages 400 EUR and 100 refund for advertising). 40.800 ACCOUNTING FOR BUSINESS TRANSACTIONS(AN EXTENDED EXAMPLE) 40.800 © Maja Zaman Groff PhD, Faculty of Economics, Ljubljana, March 2011

  32. 8. The company sold one van (that was purchased for 14.000 EUR) for the same amount. The buyer paid 10.000 EUR, the balance is due in 2 weeks. 40.800 ACCOUNTING FOR BUSINESS TRANSACTIONS(AN EXTENDED EXAMPLE) 40.800 © Maja Zaman Groff PhD, Faculty of Economics, Ljubljana, March 2011

  33. 9. The owner withdrew 250 EUR from the company. 40.550 ACCOUNTING FOR BUSINESS TRANSACTIONS(AN EXTENDED EXAMPLE) 40.550 © Maja Zaman Groff PhD, Faculty of Economics, Ljubljana, March 2011

  34. ACCOUNTING FOR BUSINESS TRANSACTIONSTEAM WORK ASSIGNMENT Continue the Vista Transit case. Show the impact of the following 4 business events on the accounting equation! • The company invested 2.000 EUR in trading securities and paid with cash. • All trading securities were sold for a total of 2.300 EUR. • An invoice for 200 EUR issued by the cleaning service was received (payment in 10 days). • An invoice for a charter transportation for 700 EUR was issued by the company (400 EUR were received in cash and 300 EUR to be paid in 14 days). © Maja Zaman Groff PhD, Faculty of Economics, Ljubljana, March 2011

  35. Use the following scheme to complete the assignment! If necessary, add new assets / liabilities categories! ACCOUNTING FOR BUSINESS TRANSACTIONSTEAM WORK ASSIGNMENT © Maja Zaman Groff PhD, Faculty of Economics, Ljubljana, March 2011

  36. End of Lecture 2 QUESTIONS??? Have a nice weekend!!! © Maja Zaman Groff PhD, Faculty of Economics, Ljubljana, March 2011

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