Financial Management Chapter 1- Introduction to Accounting & Finance Session Number N1

 Nature and role of accounting and finance  Accounting and user needs  The major financial statements  The Concept of “True and Fair” view  Fundamental accounting concepts  Accounting skills: accounting concepts and conventions

 Accounting is a service activity.  Its function is to provide quantitative information about economic entities.  The information is primarily financial in nature and is intended to be useful in making economic decisions.

 If the entity for which the information is provided is a business, for example, the information is used by its management in answering questions such as:  What are the resources of the business?  What debt does it owe?  Does it have earnings?  Are expenses too large in relation to sales?  Are amounts owed by customers being collected rapidly?

 In addition, grantors of credit such as banks, wholesale houses, and manufacturers use accounting information in answering questions such as: Are the customer’s earning prospects good? What is its debt-paying ability? Has it paid its debts promptly in the past? Should it be granted additional credit?

Likewise, governmental units use accounting information in regulating businesses and collecting taxes. Labour unions use it in negotiating working conditions and wage agreements, and investors make wide use of accounting data in investment decisions.

Work of an accountant: Public Auditing Management advisory services Tax services Private General accounting Cost accounting Budgeting Internal auditing

Information for use in answering questions like the ones listed earlier is conveyed in accounting reports. If a person is to use these reports effectively, he or she must  have some understanding of how their data were gathered and the figures were put together.  he or she must appreciate and understand accounting terms and concepts.

 Accounting statements are the end product of the accounting process, but a good place to begin the study of accounting.  Picture of profitability Income statement / Trading and profit and loss Account  Picture of financial position Balance Sheet  Accounting equation Asset = Capital + Liability

 Companies Act 1985: 'true and fair view' requirement:  Another foundation of the authority of ASB standards is the requirement in Sections Companies Act 1985 (as amended) that accounts must give a 'true and fair view' of the state of affairs of the company and, if appropriate, the group of which it is part.

True and fair view is a correct statement of company’s financial position as shown in its accounts and confirmed by its auditors.

Fundamental concepts Four fundamental concepts normally form the corner-stones of the "true and fair view". These are:  the "going concern" concept used for valuing assets and liabilities on the basis that activities will continue uncurtailed for the foreseeable future ~(in particular, the following year) and that there is therefore no need to use liquidation valuation principles;

 the "accruals" concept, which subject to prudence, brings the relevant transactions into the same period of account, without regard to the actual dates of receipt and payment;  the "consistency" concept of treating like items alike within the accounts and from one year to the next; and

 the "prudence" concept of making provision for all actual and probable liabilities, but only including assets as incoming resources when they are definitely realisable. Online MBA Program. All rights reserved. Copyright © 2012 World Wide Science.

It is assumed that accounts intended to show a "true and fair view" are based on compliance with these four concepts unless the "accounting policies" declared in the Notes to the accounts specifically exclude one or other of them.

Accounting skills Accounting Concepts and Conventions Session Number N1

 Separate Entity  Going Concern  Monetary Unit  Accounting Period  Principle of Historical Cost  Principle of Income Recognition  Principle of Matching  Principle of Full Disclosure

 Accounting concepts and conventions provide a good understanding and justification for the any accounting treatment and adjustments.  The accounts prepared can be used for comparisons between years or company (consistent).

Separate Entity  For the purpose of accounting, an entity is assumed to be separate from its owner and also other entities.  Example 1: Assume that you own a business, your personal economic activities must be kept separate from the business’ economic activities.

Assumption of Going Concern  According to this assumption, an entity is assumed to continue to exist and in operation in the future.

Assumption of Monetary Unit  According to this assumption, all economic activities are measured and valued in currency unit. weaknesses,  It restricts the scope of accounting. Only transactions that can be measured in monetary terms will be taken into account,  It assumes that the value of currency is constantly stable, whereas we know that the currency value is always changing.

Accounting Period  lifetime of the entity is divided into a certain period for the purpose of reporting its economic activities. Example Starting Date Ending Date 1 January December July June March February 2014

Principle of Historical Cost  According to this principle, all business resources will be recorded based on historical cost, which is the original cost at time of purchase.

Principle of Income Recognition  The three conditions that must be complied with before income is recognised are: The seller had performed the necessary actions to obtain the income Income can be measured objectively The income can be collected

Principle of Matching  This principle matches the expense (effort) with the revenue (benefit obtained from the effort). (i) First Step Recognition of the revenue for a specific period. (ii) Second Step Recognition of all the expenses involved in ascertaining the revenue.

Principle of Full Disclosure  The principle stresses for the full disclosure of all relevant information and material in the financial statement whether in the statement itself or in the notes to the accounts.

Materiality  Materiality refers to the effect of an item towards the overall operation of the entity.  An item is considered immaterial if it does not affect the decision that will be made.

Q & A

Chapter 2 MEASURING AND REPORTING FINANCIAL POSITION