Introduction to Accounting

Introduction to Accounting

M B G Wimalarathna

(FCA, FCMA, MCIM, FMAAT, MCPM)(MBA–PIM/USJ)

CA BUSINESS SCHOOL

EXECUTIVE DIPLOMA IN IN BUSINESS AND ACCOUNTING STRATEGY

SEMESTER 1 : Financial Accounting and Reporting

Introduction

Accounting is a well established formal process which basically analyzes both financial & non-financial information of the particular entity/organization and present them in a formal manner in order to take (economic) decision(s).

Accounting is also treated as a structured system which entails series of activities such as identifying, measuring, recording, summarizing & presenting (communicating) the various business transactions/events.

Accounting is purely a business language which essentially communicates financial performance & position of the entity to all stakeholders (existing and prospective).

Stakeholders are the Individuals/group of people/parties who are basically interested in company’s affairs/results/position and get affected on their economic decisions accordingly.

Identify the Business

transactions

Measure the identified

transactions

Record the measured

transactions

Summarize & Present the

recorded transactions

Discussion: Every entity essentially includes an accounting system as a key component/element of its internal control system. (level of importance)

Control environment Control procedures

Accounting system

Accounting Information and Decision Making

As we have identified in above, main duty of the Accountant is to produce information for the users/stakeholders (prospective as well) to make their (economic) decisions. Types of users

Internal

Inter

External

Related

Internal - Key management/owners Inter-related - Financial Institutions (Banks) - Key customers - Key suppliers - Employees (Unions) External - Shareholders (sometimes internal) - Government - Public at large

Discussion: All of the above parties are commonly identified as “Stakeholders”.

Stakeholder Group Expected Information and Type of Decision Making

Investors

Information to determine the future profitability of the entity, to assess the

future cash flows for dividends and the possibility of capital growth of

investment.

Banks Information to determine whether entity has the ability to repay a loan along

with interests.

Suppliers Information to determine an entity’s ability to repay debt associated with

purchase.

Employees Information concerning job security, the potential to pay or awards, bonuses and

promotional opportunities down the track.

Customers Information regarding the continuity of the entity and the ability to provide the

appropriate goods and services.

Government authorities Information to determine the amount of tax that should be paid and any future

taxation liabilities or taxation assets.

Regulatory bodies Information to determine if the entity is abiding by regulations such as the

Companies act and Inland Revenue act.

Community Information to determine whether the entity is contributing positively to the

general welfare and economic growth of the local community.

Special interest groups Information to determine whether the entity has considered environmental,

social or industrial aspects during its operations.

Bookkeeper Vs. Accountant

Conceptually, there might not be any significant difference of job duties between bookkeeper and accountant.

In fact, some entities attempt to place both in a same job category. Some are use these two concepts interchangeably.

Practically, Bookkeeper is doing routine calculation (task) without using much of judgmental skills while accountant use his/her judgmental skills and analytical skills in order to present financial information more meaningful manner which are already prepared by the bookkeeper. It should be a blend of both bookkeeping and accounting function in attaining success rather than functioning either bookkeeping or accounting separately.

Calculation

Bookkeeper Input Analysis

Accountant

Relationship Between Accounting & Auditing

Auditing (external) is basically provides an assurance (reliability) on financial statement prepared by the entity. (not 100%, but true & fair view) Discussion: External Audit is not a mandatory requirement except for public corporations. But tend to conduct annually for various reasons/purposes. Discussion: Difference(s) between external & internal auditing.

Financial Accounting Vs. Management Accounting Scope of the Financial accounting defines from the view point of the external (third) party while management accounting analyzes information from the view point of the entity’s key management (internal). Management Accounting

Financial Accounting

Key Mgt./Board of Directors Investor/shareholder

Financial Accounting Management Accounting

Regulations

Bound by GAAP. GAAP are represented by accounting

standards, the Companies Act, and relevant rules of the

accounting association and other organizations such as the

SEC.

Much less formal and without any

prescribed rules. The reports are

constructed to be use of the

management.

Timeliness

Information is often outdated by the time the report is

distributed to the users. The financial reports present a

historical picture of the past operations of the entity.

Management reports can be both a

historical record and a

projections(mostly). e.g. A budget.

Level of detail

Most financial reports are of a quantitative nature. The

reports represent the entity as a whole, consolidating income

and expenses from different segments of the business.

Much more detailed and can be

tailored to suit the needs of

management. Both quantitative and

qualitative in nature.

Main users

Prepared to suit a variety of users including investors and

prospective investors, management, suppliers, consumers,

employees, banks, taxation authorities and interested

groups.

Main users are the key management

of the entity. Hence it called as

management accounting.

Limitations of Accounting Information

A particular user should consider the limitations surrounding accounting information prior to use and make decision on such information. Time lag Use historical information Subjectivity of information Potential costs - Information cost - Release information to competitors Apart from above, it is also to be noted that the profession of accounting is widely broadened with the concepts of Corporate Governance, Code of Ethics and Corporate Social Responsibility.

With rapid changes in the recent past, following new career opportunities are also emerged within the profession. Fund Accountant Internal Auditor (along with accounting function) Forensic Accountant Payroll Manager/Accountant Profession of accounting (as a whole) in each country governed by rules, regulations, acts, customs. Most of the rules & regulations are established by the government authorities. CA Sri Lanka The National Institute of Accountants Profession of accounting and some of its key attributes are evolving due to following factors. Globalization Technological change Demographic change Social impact

Environment of Accounting

Introduction The environment of accounting is the overall SCOPE within which entire accounting function/activities will be carried out by an entity/organization.

Recent episodes in corporate collapses and insider trading/dealing re-iterate the importance of having well established and strictly monitored environment to carry out accounting function smoothly.

This essentially helps to protect interest of different stakeholders along with promoting more investment avenues which in turn contributes economic growth of the country.

Hence, government itself carries more responsibility to establish strong accounting environment with the assistance of other regulatory bodies such as CA Sri Lanka. This can implement by introducing rules/regulations and other kinds of mechanisms such as introduction of code of ethics.

Key Categories

Following are the key categories which represent overall accounting environment; Statutory: this basically consists of companies act no.07 of 2007, Sri Lanka Accounting Standards and Sri Lanka Auditing Standards Professional & Technical: guide to act in line with professional code of ethics and use scares resources with 3Es Political & Economic: key macro economic factors and changes in the financial/fiscal policies of the government Social & Cultural: changes in social/cultural pattern along with the structure of the population Technological: evolution in technology (introduction of MIS/ERP)

The Companies Act of no. 07 of 2007

The companies act no. 07 of 2007 being treated as a main source of regulation to control business entities and their overall function including accounting. Act includes such sections as the definition of an entity; the accounting requirements of an entity; exemptions by act; a small business guide; the basic features of a company; registering a company; company powers; annual financial reporting to members and the appointment of an auditor; and specific offence, including false or misleading statements, and obstructing hindering regulators. Two important sections of the act are s.150, which outlines the obligation to prepare annual financial reports and director’s reports; and s. 151, which stipulates the contents & form of financial reports.

Securities & Exchange Commission (SEC) SEC provides in-depth market data and information to a variety of users. It operates as the primary Sri Lankan exchange for shares, derivatives and fixed interest securities such as debentures. SEC regulates entities through its business rules and listing rules.

Department of Inland Revenue (IRD) IRD collects taxes and responsible for overseeing all self-managed superannuation funds.

Central Bank of Sri Lanka (CBSL) CBSL is responsible for the stability of the Sri Lankan financial system and for setting monetary policy.

Sri Lanka Accounting Standards Board (SLASB)

SLASB is responsible for the development of accounting standards for the application purpose to the entities under the companies act. Functions/responsibilities of the board

Participating in IASB research projects Providing SLASB staff to the IASB to work on selected

projects Establishing and maintaining good relationships with

other standard setters.

Development of Accounting Standards

Following are the key steps involved in the event of establishing a new accounting standard.

Emerging issues are identified through submissions and other materials from interested parties. An emerging issue could be an exposure draft issued the SLASB, or by a regulatory change in Sri Lanka that has consequences for standard setting.

When an emerging issue is added to the SLASB’s work program, the SLASB usually invites people with expertise to participate in the process to investigate different opinions, current practices and viewpoints on the issue.

An early version of the standard for comment, known as an exposure draft, is prepared and sent to selected entities, user groups, individuals, academics and practitioners for comment. This original draft is reviewed and may be amended after considering the views of the different parties.

The actual exposure draft is issued, inviting comment from all interested parties over a pre determined period. This is available for downloading from the SLASB website.

The accounting standard is finalized by reviewing the submissions from the exposure draft and the final standard is then prepared.

SLASB Framework

A reporting entity is identified by reference to users who are dependent on general purpose financial reports for making and evaluating resource allocation decisions. General purpose financial reports are financial reports intended to meet the information needs common to users who are unable to command the preparation of reports tailored to suit their information needs. Hence, the financial statements prepared by the entity (external/ to publish) can be treated as general purpose financial statements.

The current SLASB framework includes following key 03 areas;

The Objective of Financial Reports The Objective of financial reports is to provide information about the financial position, financial performance & cash flows of an entity that is useful to a wide range of users in making their economic decisions. Financial statements will be used by existing and prospective internal/inter-related/external stakeholders with the aim of making economic decisions which leads to reap benefits. Hence, financial statements prepared by an entity should contain all relevant financial and non-financial information to make respective decisions.

Qualitative Characteristics

Key qualitative characteristic expected from financial statements can be identified as follows; Relevance – Information should be of value for users &

relevant in making & evaluating economic decisions. The relevant will affect by it’s nature & materiality.

Reliability – The information must be without buyers or due error & must faithfully represent transactions & events.

Comparability – The users of financial reports must be able to compare aspects of an entity at one time and over time, and between entities at one time & overtime.

Ability to Understand – The information should present in the most understandable manner to users without sacrificing their relevancy or reliabilities.

Recognizing Elements in Financial Statements

Following elements should be identified in line with the provisions available in the respective accounting standards (LKASs).

Assets – A resource control by the entity as a result of the past events & from which future economics benefits are expected to flow to the entity. E.g. PPE, Investments, Goodwill, Debtors, Inventory, Cash in hand & etc.

Liabilities – A Present obligations of the entity arising from past events & settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits. E.g. Long term & short term Loan, accrued expenses, provisions & etc.

Equity – The residual interest in the assets of the entity after

eliminating its liabilities. Equity will increase through contributions

made by owners & through the excesses of the entity’s income

over its expenditures & decrease vice versa. E.g. Share capital,

capital reserves & revenue reserves (retained earnings)

Income – Inflows or other enhancements of assets or decreases of

liabilities that result in an increase in equity during the reporting

period. E.g. Sale of goods/services, interest on investments,

dividends, service fee, grants, gain from sale of assets, discount

received and etc.

Expenses – Decrease in economic benefits in the form of outflows

or depressions of assets or incurrence of liabilities that result in a

decreasing equity during the reporting period. E.g. Cost of sales,

salaries & wages, power & electricity, rent, depreciation, interest,

bad debts, telephone and etc.

Constraints in Relevant and Reliable Information

The timelines of reports is important. A timely report is one where there is no undue delay from the reporting date and the date on which the report is made available to users. If there is a delay, the report may lose its usefulness.

A major dilemma in providing financial information is whether the costs exceed the benefits of providing certain financial information and with the possible dilution of competitive position when certain information is made public. The benefits of providing information are generally associated with more effective and efficient decision making by various users of financial information.