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Exam Prep Accounting

Making boring things more boring

1. Accounting consists of two parts:
   • Financial Accounting:
     • Recording financial transactions:
       • The Income statement
       • The Statement of financial position
       • The statement of financial cashflow
     • Keeping track of the company's performance and financial position
     • Needed for investors and partners
     • Have to be prepared according to financial standards:
       • International Financial Accounting Standards (World)
       • US General Accepted Accounting Rules (US)
     • Standards are:
       • Report on business entity
       • Use monetary measures
       • Historical costs, report over some fixed period of time
       • Do not report liquidation (only ongoing concerns)
       • Consistent on period duration and period times
     • Have to be verified by the external auditor
     • Outcome: Financial statements
     • Outcome: Produced for external entities
     • Slow
   • Management Accounting:
     • Decision support analysis to help managers in making financial decisions
     • Produced for consumption within the company
     • Quick
2. Regulatory Framework: (Groupon example)
   • Gross Profit - best proxy for the value they are creating
   • Free Cash Flow - no better metric for long-term financial stability
   • Adjusted CSOI (Consolidated Segment Operation Income):
     • Consolidated segment operated income before new subscriber acquisition costs and non-cash charges -- operating profitability
3. Regulatory Framework:
   • Directors prepare this account
   • Verified and proofread by auditors
   • Sent to shareholders
   • Companies Act
   • Financial Reporting Standards: (UK)
     • IFRS (International Financial Reporting Standards)
     • Others
4. Annual Report and business entity:
   • Purpose of the annual report: -- Refers to a group of companies
     • Investor information (to encourage investment)
     • Managerial support (decision making)
     • Compliance (Have to follow certain rules)
     • Marketing (Flashy, glossy, image of th company)
   • Structure:
     • Statement of Financial Position
     • Income Statement
     • Statement of Cash Flows
     • Statement of changes in Equity
5. Concept of control:
   • Voting rights == shares (most of the times)
   • All subsidiaries that are controlled by a company are part of the group
   • Control == Relative majority
   • All companies in the group are aggregated into a single annual report
   • In the statements there will be a line that specifies what percentage is owned by non-controlling entities
   • Non-controlling interest != minority (15% could still be controlling if everyone else is lower)

Double-entry bookkeeping

• Assets = liabilities + equity Resources = Claims on resource by Outsiders + owners
• Equity = Capital + Retained Earnings Retained Earnings = Prior Retained Earnings + Net Income - Dividends Net Income = Revenues - Expenses
• Assets = Liabilities + capital + Prior Retained Earnings + Revenues - Expenses - Dividends
• Every transaction must have at least one debit and one credit. They must be equal.

Steps:

1. Recording transactions:
   • Journal entry format Debit (Always first) Credit (Always second, indented)
   • T-account is simply a poorly formatted table that has debit on the left and credit on the right
2. Balancing off:
   • Sum up T-accounts and subtract the smaller side from the bigger.
   • Post the balance at the bottom side of the highest amount
3. Prepare the trial balance:
   • All T accounts with the debits and credits
   • Check if the transactions were recorded correctly
   • BALANCE
4. Adjusting entries: (Recognise expenses incurred)
   • Inventory (after inventory counts):
     • Items on hand
     • Debit cost of goods sold if the inventory is lacking something
   • Accruals (interest):
     • From loans, etc
   • Depreciation:
     • Equipment used and its value depreciation
   • Prepayments (e.g Rent, Advertising):
     • Things paid for in advance but only partially used to date
   • Bad and Doubtful Debt (Accounts):
     • Matched in the same period against the revenues
     • The estimate of the amount of revenue

1. Assets always equal the liabilities + equity
2. The sum of debits = the sum of credits
3. The beginning balance + the increases - the decreases = ending balance

Always start with the Income statement (Net Profit goes into the balance sheet) Income statement:

• Revenue
• Cost of goods sold Gross Margin
• Administrative Costs & Operating Expenses
• Deprecation and Amortization Operating Profit
• Interest (Net interest -- paid and received) Earnings Before Taxes
• Taxes Net Profit/Loss -- Capitalised (added) to the retained earnings balance

Balance Sheet: (A snapshot that captures a financial position of a company at a given time) Total Assets == Total Liabilities & Equity

• Total assets on one hand:
  • Short-term (Current) assets (< 1 year)
  • Long-term (Non-Current) assets (> 1 year)
• Total Liabilities and Equity:
  • Current liability
  • Non-Current Liability Total Liability
  • Equity (Shareholders equity)
  • Reserves
  • Retained Earnings Total Equity == Net Assets (Total Assets - Total Liabilities)

Inflow an outflow of cash

1. Cash - money that company has in the bank
2. Profit - earnings over a period of time
3. Closing balance of the cash flow statement has the same value as the cash field in the balance sheet
4. Cash flows examples:
   • Operating Activities:
     • In:
     • Collections from customers
     • Out:
     • Payments of interest
     • Payments to suppliers
     • Payments to employees
     • Payments of tax
     • Other operating disbursements
   • Investing Activities:
     • In:
     • Receipts of interest and dividends
     • Sale of PPE and intangibles
     • Sale of investments
     • Divestitures of businesses
     • Out:
     • Acquisition of businesses
     • Acquisition of PPEs and intangibles
     • Purchase of investments
   • Financing Activities:
     • In:
     • Issue new shares
     • Reissue treasury shares
     • Borrow money
     • Out:
     • Payments of dividends
     • Payments of treasury shares
     • Payments of principal on debt
5. Statement preparation methods:
   • Direct:
     • All cash flows from bank (operating, investing, financing)
     • Prepare statement
   • Indirect:
     • Net income (Starting with Net income) -- Adjust for non-cash items
     • Adjust operating profit to operating cash flow by:
       • Adjusting for changes in working capital
       • Non-cash items (deprecation)
     • Prepare statement

1. Audited Part:
   • Audited by external auditors and therefore is more credible
   • Main Statements:
     • Income
     • Financial Position
     • Cash Flows
   • Subsidiary statements:
     • Changes in Equity
     • Note on reconciliation of net cash flow to movement in net debt
     • Note on historical costs, profits and losses
   • Explanatory:
     • Accounting Policies
     • Notes to Accountants
     • Principal subsidiaries
2. Unaudited Part:
   • Narrative:
     • Directors report (how the company operated and future plans)
   • Non-Narrative

Accounting. 3rd edition. John Wiley. Pages 248-258 of Chapter 9 and pages 335-369 of Chapter 12

1. Profitability Ratios:
   • Return on Capital Employed (ROCE):
     • Retun on Sales
     • The value that the market recognises in the company product
   • Gross Profit:
     • Gross Profit -> \( for every \) of revenue
   • Net Profit
2. Efficiency Ratios:
   • Debtors (Trades Receivable) --> Collection Period
   • Creditors (Trade Payable) --> Collection Period
   • Stock (Inventory) --> Turnover
   • Asset Turnover
3. Liquidity Ratios:
   • Current Ratio
   • Quick Ratio
4. Gearing:
   • Something?
5. Cash Flow:
   • Something?
6. Investment:
   • Dividend Yield
   • Dividend Cover
   • Earnings per Share
   • Price/Earnings
   • Interest Cover