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UNIVERSITY OF THE WEST
MONA CAMPUS

Financial Accounting – ACCT 1005(MS15D)
Purpose of Accounting
Financial accounting is a system that involves recording, analysis and communication of financial
information
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In other words,
accounting is a system that is used by businesses to monitor their activities and report their performance
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Users of Financial Information
Persons outside of the business who have interest in the business, but are not involved in its day-to-day
operation (external users), as well as, persons inside the organization who are involved in its day-to-day
operations (internal users), use financial information
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Investors
Investors (both existing and potential) need information concerning the safety and
profitability of their investment and to decide whether a change of ownership interest is
warranted
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Trade and Loan Creditors
Both present and potential creditors of the business use financial information to help them in
deciding whether or not it is safe to extend credit to the business
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In other words, they are interested in the
solvency of the business i
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Can the business pay its debts when they fall due?

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Managers have a special interest in the annual financial statements, as these are
the statements popularly used by decision makers outside of the organization
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Management Accounting
Provides information
Management, Board of Directors and employees
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Certified Management Accountant (US)
An accountant, who has passed an examination offered by the IMA

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Certified Public Accountant (US)/Chartered Accountant (UK; Jamaica)
A public accountant, who has met certain educational and experience requirements and has
passed an exam prepared by the AICPA or ACCA
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The six main steps of the accounting process are:
 Analyzing
looking at events that have taken place and thinking about how
they affect the
business
 Recording
entering financial information about the events in the accounting system
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Summarizing bringing the various items of information together to determine a result
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Interpreting deciding the meaning and importance of the information in the various reports
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Types of Ownership Structures/Business Organizations
Businesses are classified according to who owns them and the specific way in which they are
organized
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 Not required by law to make any of its financial information available to the public
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 Low start-up cost
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 Owner is responsible for all the debts of the business i
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the owner’s liability is unlimited and
therefore extends to his/her personal assets
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 Any amount earned from the business is included on the personal tax return of the owner
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Partnerships
 Least common form of organization
 Owned by two or more persons e
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physicians, attorneys and accountants
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e
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e
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 Details like how much work each will do and how they will share any earnings from the business
are specified in a document called a partnership agreement
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Corporation
 Legally and financially separate from its owners
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 Ownership in a corporation is divided into amounts called shares of capital stock, each
representing ownership in a fraction of the corporation
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Stockholders are
free to sell some or all of their shares to other investors at anytime (Transferable ownership
rights)
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 Managed by a Board of Directors
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Unlike proprietorships and partnerships, corporation pays taxes on its earnings i
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an owner in a
corporation does not include the income of the corporation in his/her personal tax returns
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 The rules drawn up to govern the internal working of the company; regulate the holding
of meetings; regulate the issue of capital; define powers and duties of directors, rights of
shareholders etc
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Types of Businesses
Service
A business that provides a service e
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travel agency, catering business, computer consultant, physician,
hospital, law firm, accounting firm
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Manufacturing
Makes product to sell e
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automobile manufacturer, furniture maker, toy factory, and garment
manufacturing company
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The Financial
Accounting Standards Board (FASB), in the US has developed a set of standards referred to as
Generally Accepted Accounting Principles (GAAP)
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The standards provide the general
rules and guidelines to be followed in the accounting and reporting process i
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they determine the
amount of information to be included in the financial statements, as well as, the format of preparation
and presentation of such information
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GAAP are important in ensuring the integrity of financial
accounting information, so that financial reports for different entities can be more easily compared
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In an attempt to harmonize conflicting standards, the International
Accounting Standards Committee (IASC) was formed in 1973 to develop worldwide accounting
standards
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Since then
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the IASB has amended some IAS, has proposed to replace some IAS with new International Financial
Reporting Standards (IFRS) and has proposed certain new IFRS on topics for which no IAS previously
existed
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The accounting standards produced by the IASC are referred to as
International Accounting Standards (IASs)
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IASC standards are gaining increasing
acceptance worldwide
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S
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S GAAP
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Note
Investors and creditors need relevant and reliable information about an entity
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An
audit is a financial examination of the financial statements of an entity to determine whether these
statements give a true and fair view of the financial health of the business
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Recent scandals in the
corporate world point to the importance of ethics
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The IASB Framework
The framework describes the basic concepts by which the financial statements are prepared
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The IASB Framework
i)
defines the objective of financial statement
ii)
identifies the qualitative characteristics that make financial information useful
iii)
defines the basic elements of financial statements and the concepts for recognizing and
measuring them in financial statements

Characteristics of Accounting Information
The objective of financial reporting is to provide useful information
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 Relevance
For information to be relevant it must have the following qualities
i)
Feedback value & Predictive value i
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feedback on past events help confirm or correct
earlier expectations
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ii)

Timeliness
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Information received
after a decision is made is useless, hence for information to be relevant it must be provided to

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users within the time period in which it is most likely to influence their decisions
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Is the item large enough to influence the decision of a user
of the financial information? Information is said to be material if its omission or
misstatement could influence the decision of a user
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Reliability
Information should be relatively free from error
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The information presented
should therefore have:
i)
Verifiability i
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the data should be free from material error and bias and can be verified
by other trained accountants
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Comparability
Users must be able to compare the financial statements to a standard or benchmark such as other
firms within the industry or a prior period within the same firm
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Disclosure of accounting policies is essential
for comparability
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Benefits greater than cost
Information like any other commodity must be worth more than the cost of producing it
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1) Assets
These are economic resources owned or controlled by an entity and will provide future benefit
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Businesses may also have an asset called accounts receivable, which represents the amount of money
owed to the business by its customers as a result of making sales on account or on credit
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Current assets are assets that the business plans to convert into cash or use to generate earnings in the
next 12 months or within the business’s accounting cycle, whichever is longer
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Examples of current
assets are cash, accounts receivable, short-term investments, unsold merchandise (inventory)
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Examples of fixed assets are land, building, furniture and fixtures,
machinery
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2) Liabilities
These are debts or obligations the business has incurred to obtain the assets it has i
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liabilities are
amounts the business owes that can be paid with cash, goods or services
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An account payable is an unwritten promise to
pay a supplier for assets purchased or services received
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Like assets, liabilities can be grouped as current liabilities or non-current liabilities
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Examples of current liabilities are accounts payable, notes payable, interest
payable and short-term loans
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Mortgages, long-term loans
3) Owner’s Equity
Also referred to as Net Worth and Capital, owner’s equity represents the owner’s claim to the assets of
the business
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There are two
ways for the owners to increase their claims to the assets of the business
- By making contribution
- By earning contribution

The Accounting Equation
The relationship between the three basic accounting elements – assets, liabilities and owners equity –
can be expressed in the form of a simple equation known as the accounting equation
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Business transactions are economic events,
which have a direct impact on the business
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Examples of business transactions are buying goods and services, selling
goods and services, making loans and borrowing money
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Expanding the Accounting Equation
Revenues
These are amounts the business earns from providing goods or services to customers
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Revenues increase both assets and owners equity
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rent, salaries, supplies used
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If revenues exceed expenses, the difference is referred to as Net Income
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Withdrawals (Drawings)
Drawings are cash or other assets taken by the owner from the business for his/her personal use
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Assets = Liabilities + [Owners Equity + (Revenues – Expenses) – Drawings]

Financial Statements
Information relating to a business is usually communicated by way of financial statements
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As per IAS 1, a complete
set of financial statements include:
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The financial statements commonly prepared are the income statement, statement of owner’s equity and
balance sheet
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This heading includes:
The name of the business
The title of the statement
The time period covered or the date of the statement
The Income Statement and Statement of Owner’s Equity provide information concerning events
covering a period of time, in this case the month ended
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The Income
statement is therefore regarded as an activity statement
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There
are two (2) types of income statement:
 Single Step groups all revenues together and all expenses together
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Net income increases owner’s equity,
whereas net loss and withdrawals decrease owner’s equity
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The Balance Sheet
The balance sheet, also referred to as Statement of Financial Position or Report of Financial Condition,
describes the financial position of the business at a specific point in time
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The balance sheet reflects the accounting equation i
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Assets = Liabilities + Owner’s Equity
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The standard does not prescribe the format of the balance sheet
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Assets can be presented current then non-current or vice versa and liabilities can be presented current,
non-current then equity or vice versa
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The longterm financing approach used in the UK and elsewhere- Fixed Assets + Current Assets – Current
Liabilities = Long-term Debt + Equity, is also acceptable
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Liquidity is a measure of how easily an asset
can be converted into cash
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Users can predict the future only if they have sufficient information
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The statement of cash
flows is very important in understanding an enterprise for purposes of investment and credit decisions
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In short, the statement provides information about the nature and sources of an entity’s cash inflows and
outflows
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Operating Activities
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Financing Activities
The information contained in the statement is useful in answering questions such as:
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Were funds used for expansion; to reduce or repay outstanding debts, purchase fixed assets etc?
A clear understanding of a borrower’s cash flow is one of the most important components of financial
statements analysis in the banking sector
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Operating Activities
These are activities that are primarily related to the production and sales of goods and services, which
enter into the determination of income i
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items, which affect the income statement
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Outflows

Payment for inventory, employees' wages & salaries, taxes, interest paid and other
business expenses

Investing Activities
These are activities, which involve investment of the resources of a business
Inflows

Outflows

Receipts from sales of stock and bonds held in other businesses and from disposal of
long-term resources such as land and buildings and receipt of loan principal from
borrowers
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Financing Activities
These are activities, which provide a business with resources from either owners or creditors, i
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the
owners or creditors investing money in the business and the repayments
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Parentheses are used to denote negative cash flows i
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cash outflows
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The statements are prepared in the following order:
Income Statement → Statement of Owner’s Equity → Balance Sheet → Statement of Cash Flows
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The adequate disclosure principle means that the
financials should be accompanied by any information necessary for the proper interpretation of the
statements
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The items to be disclosed are based on a combination of official rules, tradition and
the accountant’s professional judgement
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Other items to be disclosed include: lawsuits
pending against the business; scheduled plant closings, Government investigations into the safety of the
company’s products or the legality of its pricing policies; significant events occurring after the balance
sheet date but before the financials are actually issued; specific customers that account for a large
portion of the company’s business; unusual transactions or conflict of interest between the company and
its key officers
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