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Management uses accounting for: finance, investment, operations and production, marketing
and sales, human relations.
Persons with direct financial interest: Investors, Banks
Persons with indirect financial interest: tax authorities, regulators, labor unions and employees
and suppliers.
Balance sheet: Set of two lists: assets on one side, and obligations to external parties on the
other side (liabilities to creditors and the residual due to shareholders or owners). It’s a
snapshot of the financial position at a given point in time.
Assets = what the enterprise owns (the resources with which it will create future value for
customers) (you can control it and benefit from it)
Liabilities and shareholders’ equity (don’t really have an obligation, because you don’t have to
pay it back) = Obligation the enterprise has towards shareholders and third parties = source of
financing of assets.
Shareholders’ equity = share capital and (retained) earnings (what you keep over the years
and don’t pay dividends.
Statement of changes in equity: Equity is a claim, right, or interest one has over some net
worth. Residual interest (of the investors) in the assets of the entity after deducting all its
liabilities.
Notes to financial statement: Notes contain info in addition to that presented in the balance
sheet, income statement, statement of changes in equity and cash flow statement. They
provide narrative descriptions or disaggregation’s of items disclosed in those statements and
info about items that do not qualify for recognition in those statements.
Income statement: Record of what happened during the period that caused the observed
income (profit or loss). Also a “film” of the business during a given period.
It has expenses and revenues. Balance = net income ◊ transferred to retained earnings.
Statement of cash flows: The cash flow statement shall report cash flows during the period
classified by operating, investing and financing activities.
Based on receipt or payment of cash:
classification:
- Operating activities: selling goods and services to customers, employing managers at
work, buying and producing goods and services, paying taxes.
- Investing activities: buying land, buildings and equipment. Purchase other resources
necessary to operate the business, selling those resources when no longer needed.
- Financing activities: Obtaining capital from creditors, securing loans, gathering funds
from owners, repaying creditors, paying returns to owners.
Cash and cash equivalents at end of the year = cash and equivalents at the beginning of the
year + operating activities + investing activities + financing activities.
Debit Credit
Expenses Liabilities
Assets Income
Dividends Capital
True view = financial statement do not falsify or dissimulate the financial situation of the
company at the end period, nor it’s profit or loss at the end of the period.
Fair view = accounts give accounting users complete and relevant info for decision makers.
1) definition
2) recognition
3) initial measurement
4) subsequent measurement: historical cost (reliable info), current (replacement) cost,
realizable (settlement or liquidation) value, present value (relevant info)
Accruals
Accrual accounting: allocating cash flows to periods (cash in/out flows don’t need to be the
same as expenses/revenues)
Matching rule: revenues assigned to the accounting period in which goods are sold, expenses
linked to those revenues.
Revenue recognition: revenues affect income statement when earned and not collected.
Net income includes revenues earned during period.
- adjustment of revenues earned but not recorded (the triggering event has not occurred
yet).
- Adjustment of revenues recorded in advance
Revenues earned, but not recorded: royalty revenue not invoiced because the department in
charge has been overworked
Expenses:
Matching principle: expenses affect income when consumed and not when paid.
Net Income includes expenses consumed during the period:
- Adjustment of expenses consumed but not recorded (the triggering event has not
occurred yet).
- Adjustment of expenses recorded in advance
1) sales of goods
Conditions satisfied:
- Transfer to significant risks and rewards of ownership of the goods.
- No managerial involvement or effective control over the goods sold
- Amount of revenue measured reliably
- Probability of economic benefits
- Costs related to the transaction measured reliably.
Research: original and planned investigation undertaken with the prospect of gaining new
scientific or technical knowledge and understanding.
Development: application of research findings or other knowledge for the production of new
or substantanially improved materials, devices, products, processes, systems or services
before the start of commercial production
Shareholders’ equity
Equity = The residual interest in the assets of the entity after deducting all its liabilities.
Equity instrument = any contract that evidences a resdiual interest in the assets of an entity
after deducting all of its liabilities.
Overall if it’s not an asset or a liability ◊ it’s equity a residual claim. Most common is an
ordinary share.
What is the return to stakeholders? Economic profit = accounting profit less cost of equity
capital.
Shareholders’ equity
Decomposition of equity:
1) share capital
2) share premium
3) treasury stock (negative value) Purchase shares on the market
4) Retained earnings (makes profit)
5) Reserves (based on earnings and dirty surplus)
revaluation reserves (dirty surplus)
- revaluation of property, plant and equipment
- foreign exchange difference
- remeasurement of available-for-sale financial assets
profit / loss brought forward (Had a loss, not reduce it by reserves, but can
also take it to the next year)
see for also appendix 11.1
Share capital
Shareholders
- influence management decision
- receive dividends and liquidation surplus
Normal or par value
- at the time of a business incorporation, it’s laws specify the face value of the share =
par value / nominal value
- capital = the number of shares * the par value
- Market value of shares generally has no relation to the par value
Outstanding ≤ Issued shares ≤authorized shares (not issued, so not on the balance sheet)
And
Subscribed capital = paid-in capital + capital receivable + uncalled capital
- Written of against equity (i.e., the total accumulated share premium in practice, when
you have a cost you reduce equity immediately)
Treasury shares, why do more than 67% of large companies purchase their own shares?
A treasury share is a share which is bought back by the issuing company, reducing the amount
of the outstanding share on the open market.
- reduce it’s capital by cancelling the repurchased shares
- use the stock for employee stock option plan, give them to the employees
- want to maintain a favorable market for their stock
- want to increase earnings per share or stock price per share (have less dividends to pay out)
- want to have additional shares of stock available for purchasing other companies
- attempt to prevent hostile takeovers
Retained earnings / reserves (up the end of the previous period) + net income (after tax) of the
year – dividends declared – transfer to reserves = retained earnings / reserves (at year end)
Annual earnings – sum of allocations to reserve accounts = earnings available for distribution
Clean surplus means that all changes in equity that do not result from transactions with
shareholders (such as dividends, share repurchases or share offerings) are reflected in the
income statement.
Dirty surplus occurs when some items - most notably foreign currency translation and certain
pension adjustments – are adjusted from shareholders’ equity, without passing through the
income statement. In order to adjust the income statement to reflect a clean surplus, an
investor can replace “net income” with “total comprehensive income”
Time value money = represents the interest one might earn on the payment received today, if
held, earning interest, until that further date.
Main principle = the fair value of option at grand date is expensed over the vesting period.
Grant date: this is the date the fair value of the option is measured:
- when the employer confers the option right to the employee, provided the vesting
conditions will be met
- if subject to an approval process (e.g. by shareholders): the date of approval
StrategicInvestments
Accounting for strategic investments (two companies) and legal mergers (one company)
Control concept
¬ ownership > one half of the voting power
¬ ownership ≤ one half of the voting power (arrangements with others to get more rights
and control)
- power > one half of the voting rights by virtue of an agreement with other
investors
- power to govern the financial and operating policies of the entity under a
statute or an agreement
- power to appoint or remove the majority of votes at meetings of the board of
directors or equivalent governing body, or
- power to cast the majority of votes at meetings of the board of directors or
equivalent governing body
Significant influence
¬ Ownership ≥ 20 % of the voting power of the investee
¬ Evidence of significant influence: look at the contract
- representation on the board of directors or equivalent governing body of the
investee
- participation in policy making processes
- Material transaction between the investor and the investee
- Interchange of managerial personnel
- Provision of essential technical information
Joint control
Business combination
Types of business combinations:
- acquisition of shares, consolidation: 2 entities parents and subsidiary
- acquisition of the shares of a company which is dissolved. Merger ◊ only one
company is left
- two companies merge to become a third entity
- acquisition of assets: buy the assets and put them on the balance sheet
multiple choice
¬ the percentage of interest reflects the interest that are controlled directly and indirectly
¬ Minority interest can be reported as a part of shareholders’ equity, long-term liabilities
¬ Associates and affiliates are often considered as synonymous
¬ Minority interest is reported with full consolidation
Some formulas
:
New shares = number of shares van merged company * ½