Chapter 1: Accounting Basics and Financial Statements Overview

Lecture 1.1: Accounting Basics Part 1

 Transactions Recording Accounting

Decision Analysis and Financial Statement

Making Interpretation Analysis

 Financial Statement Analysis is what allows stakeholders to use the accounting information and make decisions about the future of the business.
 Those decisions will, in turn, be recorded by accounting thus leading to further analysis and further decisions – cyclical process.
 Owners
(Equity Investors)
Creditors
Managers
(Debt Investors)

Fiscal Authorities Company Employees

Clients and Suppliers Litigants

(...)
  Accounting information is a crucial part of
corporate information and of decision
making
Accounting Financial Markets
Information Information  It is the one that reflects the reality of the
company in a more systematic way (in a
unified language – accounting) over the last
Corporate Management
periods
Governance
Information History
 However, it is not the only source of
information and it should always be
complemented with other sources, both
Market and internal and external
Competitors
surrounding economy
 Decision making is always about the
future and accounting reflects the past!
 The accounting process includes multiple steps, from recording all transactions that take place in a
company following a set of rules, classifying them and later organizing them in the form of financial reports
 The production of these financial reports is the last step in an accounting cycle (before a new one begins)
 These reports – the financial statements – are the only thing most users get to look at.

Statement of
Balance Sheet
Equity

Income Cash Flow

Statement Statement
The sole purpose behind the existence of financial statements is to help decision makers.

It thus makes sense that the two main financial statements aim to give decision makers
their most sought out pieces of information:

How much is the result of the company (how

Income
much additional “value” the company created
Statement
or destroyed) on a given period;
How much is the company worth it (how much is
Balance
the “value” of the company), in any given
Sheet
moment?
 The income statement answers one of the biggest concerns of decision makers, which is to know how much the
company is making – what is their result!

 The result of a company will be the difference between everything the company makes (revenues and gains) and
everything it takes to make those (expenses and losses).

 What the income statement does is to showcase all of the revenues and all of the expenses so as to detail what the
result of the company is.
Examples of Revenues and Gains Examples of What Is Not Revenues

 Sales (from selling goods) Capital received from the shareholders

Services (from rendering services) Loan received from the bank
Rent Income Security deposit paid by customers
Interest Income VAT received on a sale
Dividends Earned Sale of a production machine for its
Commission Income accounting value
Royalty Income
Franchise Fees
Not income “earned” by the company
Gain on asset disposal
Etc.
Examples of Expenses and Losses Examples of What Is Not Expenses

 Cost of Sales or Cost of Goods Sold Dividends

Personnel Loan repayment
Advertising Purchase of a machine that will be used for
Utilities production during the next 5 years
Transportation Purchase of an office
Usage of assets (Depreciation/ amortization) Purchase of a laptop for a new employee
Hired Services
Rents
Interests
Etc.
  The income statement always presents 4 levels
of profitability: gross, operational, before taxes
and after taxes.
Income Statement
1 Net Sales
2 Cost of Good Sold  Other commonly calculated levels of profitability
3 Gross Result = (1) – (2) are the EBITDA or the EBIT (similar to
4 Selling, General and Administrative Expenses operational)
5 Other Operating Expenses
6 Operational Result = (3) – (4) – (5)  The income statement can be presented by
7 Financial Income and Other Gains function (medium and large enterprises) to by
8 Financial Expenses and Other Losses nature (some small firms)
9 Income Before Taxes = (6) + (7) – (8)
10 Income Taxes  When presented by function, this means that
11 Net Result = (10) – (11) costs of the same nature (e.g. depreciations) can
be allocated to different functions (e.g. cost of
goods sold, SG&A, etc.)
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1

4
 The balance sheet answers the other big concern of decision makers, which is to know the value of the company!

Goods and rights of Obligations of the

Value of the company
the company company

Assets Liabilities Shareholder’s Equity

Assets = Liabilities + Shareholder’s Equity

 Goods and rights of the company ASSETS

 Cash  Land and Buildings

Cash and Cash Property, Plant
 Bank Deposits Equivalents  Machinery and Other Equipment and Equipment
(PP&E)
 Trading Securities  Long Term Debt or Equity Investments

 Money owned by clients Accounts  Investment in Associates or Subsidiaries Long Term

Receivable Investments
 Inventories  Real Estate Investment Properties

 Costs paid but not used yet Prepaid  Patents or Copy Rights Intangible
Expenses Assets
 Etc.  Etc.

CURRENT ASSETS NON CURRENT ASSETS

 Obligations of the company LIABILITIES

 Money owned to suppliers Accounts

 Bank Loans
Payable
Debt
 Income Tax not paid yet  Bonds
 Money owned to personnel  Etc.
Accrued
 Interests owned to the bank
Liabilities
 Rents owned to landlord

 Advanced payments from Unearned or

customers Deferred
Revenue
 Etc.
CURRENT LIABILITIES NON CURRENT LIABILITIES
 According to the balance sheet, the value of the company will be the difference between all its goods and rights
(assets) and all its obligations (liabilities).

 What the balance sheet does is to showcase all of the assets and all of the liabilities so as to detail what the
residual value of the company is!

 This residual value of the company is formally called shareholders’ equity and it represents how much would be
left from the goods and right of the company after all its obligations have been fulfilled.
 Balance Sheet
Assets Liabilities
Cash and Cash Equivalents Short Term Debt
Prepaid Expenses Accounts Payable
Accounts Receivable Accrued Liabilities
Inventories Deferred Revenue
Financial Investments Provisions
Equity Investments Deferred Taxes
Long Term Debt
Deferred Taxes

Intangible Assets Shareholder’s Equity

PP&E Common Stock and Additional Paid-In Capital

Retained Earnings
 Balance Sheet
Assets Liabilities
Current Assets Current Liabilities
• Goods or rights that are expected to generate cash • Obligations that are expected to be met within a year
within a year or within the firm’s normal operating or the firm’s normal operating cycle (typically short
cycle (typically activity related receivables and term bank loans and activity related payables)
inventories)
• Cash and Cash Equivalents Non Current Liabilities
• Other obligations, that have a maturity higher than
Non Current Assets one year and that of the firm’s operating cycle
• Other goods or rights, that have a maturity higher (typically long term bank loans)
than one year and that of the firm’s operating cycle
(typically investments such as PP&E, intangibles or
Shareholders' Equity
long term financial assets)
• Assets – Liabilities (it will include capital contributions
from equity partners and non distributed results)
 Income Statement Balance Sheet
Assets Liabilities
Revenues Expenses
• Present obligation of the entity
• Arising from past events
Outflows of economic benefits • The settlement of which is expected
Inflows of economic benefits • Resource controlled by the entity
during the accounting period in to result in an outflow from the
during the accounting period in
the form of decreases in assets • Result of past events entity of resources embodying
the form of increases in assets or
or increases in liabilities that • From which future economic economic benefits
decreases in liabilities that result
result in decreases in equity, benefits are expected to flow to the
in increases in equity, other than
other than those relating to entity
those related to contributions Shareholder’s Equity
distributions to equity
from equity participants • Residual interest in the assets of
participants
the entity after deducting all of its
liabilities

Net Result = Revenues - Expenses Assets = Liabilities + Equity