INTRODUCTION TO ACCOUNTING

M B G WIMALARATHNA

[FCA, FCMA, MCIM, CPFA , FMAAT, MCPM] [FINALIST – ICAEW] [MBA–PIM/USJ]

CA BUSINESS SCHOOL

EXECUTIVE DIPLOMA IN BUSINESS AND ACCOUNTING STRATEGY

SEMESTER 1 : Financial Accounting and Reporting

INTRODUCTION

Accounting is a well established formal process which basicallyanalyzes both financial & non-financial information of theparticular entity/organization and present them in a formalmanner in order to take (economic) decision(s).

Accounting is a structured system which entails series ofactivities including identifying, measuring, recording,summarizing & presenting (communicating) the various businesstransactions/events.

Accounting is a business language which essentiallycommunicates financial performance & position of an entity toall stakeholders (existing and prospective).

Accounting is a dynamic scope which evolve rapidly around theglobe in recent past

Identify the Business

transactions

Measure the identified

transactions

Record the measured

transactions

Summarize & Present the

recorded transactions

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

Control environment Control procedures

Accounting system

ACCOUNTING INFORMATION AND DECISION MAKING

As we have already identified, main duty of an Accountant is toproduce information for the existing & prospectiveusers/stakeholders 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” and Stakeholders arethe Individuals/group of people/parties who are basically interested in company’saffairs/results/position and get affected on their economic decisions accordingly.

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 the

investment.

BanksInformation to determine whether an entity has the ability to repay its loan along

with interests.

SuppliersInformation to determine the entity’s ability to repay debt associated with

purchases.

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

promotional opportunities down the track.

CustomersInformation regarding the continuity of the entity and the ability to provide the

appropriate goods and services.

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

tax liabilities or tax assets.

Regulatory bodiesInformation to determine the conformity of an entity to regulations such as the

Companies act and Inland Revenue act.

CommunityInformation to determine whether an entity contributes positively to the general

welfare and economic growth of the local community.

Special interest groupsInformation to determine whether the entity has considered environmental,

social or industrial aspects during its business operations.

BOOKKEEPER VS. ACCOUNTANT Conceptually, no significant difference of job duties between

bookkeeper and accountant.

Some entities attempt to place both bookkeeper and accountantin a same job category and some organization use these twointerchangeably.

Practically, Bookkeeper is doing routine calculation (task) withoutusing much of judgmental skills while accountant use his/herjudgmental skills and analytical skills in order to present financialinformation more meaningful manner which are alreadyprepared by the bookkeeper.

Organization must use blend of both bookkeeping andaccounting function in attaining success rather than functioningseparately.

Calculation

Bookkeeper Input Analysis

Accountant

RELATIONSHIP BETWEEN ACCOUNTING & AUDITING

Auditing (external) is basically provides an assurance (reliability) onfinancial statement prepared by the entity. (not 100%, but true & fairview)

Discussion: External Audit is not a mandatory requirement exceptfor public corporations. But tend to conduct annually for variousreasons/purposes.

Discussion: Difference(s) between external & internal auditing.

FINANCIAL ACCOUNTING VS. MANAGEMENT ACCOUNTINGScope of the Financial accounting defines from the view point of the external (third) party whilemanagement 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, 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 internal

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

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 the

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 surroundingaccounting information prior to use and make decision on suchinformation.

Time lag Use of historical information Subjectivity of information Potential costs - Information compilation cost

- Release information to competitors

Apart from above, the profession of accounting is widely broadenedwith the concepts of Corporate Governance, Code of Ethics andCorporate Social Responsibility.

With rapid changes in the recent past, following new career opportunities are alsoemerged 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 thegovernment authorities.

CA Sri Lanka

Profession of accounting and some of its key attributes are evolving due tofollowing factors.

Globalization Technological changes Demographic changes Social impact

ENVIRONMENT OF ACCOUNTING

INTRODUCTION The environment of accounting is the overall SCOPE within

which the entire accounting function/activities will be carriedout by an entity/organization.

Recent episodes in corporate collapses and insidertrading/dealing re-iterate the importance of having wellestablished and strictly monitored environment to carry outaccounting function smoothly.

Strictly monitored environment is essentially help to protectinterest of different stakeholders along with promoting moreinvestment avenues which in turn contributes economic growthof the country.

Government itself carries more responsibility to establish strongaccounting environment with the assistance of other regulatorybodies such as CA Sri Lanka. This can be implemented byintroducing rules/regulations and other kinds of mechanismssuch as introduction of code of ethics.

KEY CATEGORIES

Following are the key categories represents overall accountingenvironment;

Statutory: this basically consists of companies act no.07 of 2007, SriLanka Accounting Standards and Sri Lanka Auditing Standards

Professional & Technical: guide to act in line with professional code ofethics and use scares resources with 3Es

Political & Economic: key macro economic factors and changes in thefinancial/fiscal policies of the government

Social & Cultural: changes in social/cultural pattern along with thestructure 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 ofregulation to control business entities and their overall functionincluding accounting.

Act includes such sections as the definition of an entity; theaccounting requirements of an entity; exemptions by act; a smallbusiness guide; the basic features of a company; registering acompany; company powers; annual financial reporting to membersand the appointment of an auditor; and specific offence, includingfalse or misleading statements, and obstructing hindering regulators.Two important sections of the act are s.150, which outlines theobligation 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. Itoperates as the primary Sri Lankan exchange for shares, derivatives and fixedinterest securities such as debentures. SEC regulates entities through itsbusiness rules and listing rules.

DEPARTMENT OF INLAND REVENUE (IRD)IRD collects taxes and responsible for overseeing business operations ofcorporates in tax aspects

CENTRAL BANK OF SRI LANKA (CBSL)CBSL is responsible for the stability of the Sri Lankan financial system and forsetting monetary policy.

SRI LANKA ACCOUNTING STANDARDS BOARD (SLASB)

SLASB is responsible for the development of accountingstandards for the application purpose to the entities under thecompanies 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 otherstandard setters.

DEVELOPMENT OF ACCOUNTING STANDARDS

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

Emerging issues are identified through submissions and othermaterials from interested parties. An emerging issue could be anexposure draft issued the SLASB, or by a regulatory change in SriLanka 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 inthe process to investigate different opinions, current practicesand viewpoints on the issue.

An early version of the standard for comment, known as anexposure draft, is prepared and sent to selected entities, usergroups, individuals, academics and practitioners for comment. Thisoriginal draft is reviewed and may be amended after consideringthe views of the different parties.

The actual exposure draft is issued, inviting comment from allinterested parties over a pre determined period. This is available fordownloading from the SLASB website.

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

SLASB FRAMEWORK

A reporting entity is identified by reference to users who aredependent on general purpose financial reports for making andevaluating resource allocation decisions.

General purpose financial reports are financial reports intended tomeet the information needs common to users who are unable tocommand the preparation of reports tailored to suit their informationneeds.

Hence, the financial statements prepared by the entity (external/ topublish) 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 thefinancial position, financial performance & cash flows of an entity thatis useful to a wide range of users in making their economic decisions.

Financial statements will be used by existing and prospectiveinternal/inter-related/external stakeholders with the aim of makingeconomic decisions which leads to reap economic benefits.

Hence, financial statements prepared by an entity should contain allrelevant financial and non-financial information to make respectivedecisions.

QUALITATIVE CHARACTERISTICS

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

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

Reliability/Faithful Representation – The information must bewithout buyers or due error & must faithfully representtransactions & events.

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

Ability to Understand – The information should present in themost understandable manner to users without sacrificing theirrelevancy or reliabilities.

Verifiability – The users of financial statements must be able toverify the material items independently

Timeliness – The users shall receive the financial statements ontime in order to take economic decisions.

RECOGNIZING ELEMENTS IN FINANCIAL STATEMENTS

Following elements should be identified in line with the provisions available inthe 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.

A present economic resource controlled by an entity as a result of past events. Economic resource is aright that has the potential to produce economic benefits.

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

A present obligation of an entity to transfer an economic resource as a result of past events. Anobligation is a duty or responsibility that the entity has no practical ability to avoid.

Equity – The residual interest in the assets of the entity after eliminating itsliabilities. Equity will increase through contributions made by owners & throughthe 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 thatresult in an increase in equity during the reporting period. E.g. Sale ofgoods/services, interest on investments, dividends, service fee, grants, gain fromsale of assets, discount received and etc.

Increases in assets or decreases in liabilities that result in increase in equity other than thoserelating to contributions from holders of equity claims.

Expenses – Decrease in economic benefits in the form of outflows or depressionsof assets or incurrence of liabilities that result in a decreasing equity during thereporting period. E.g. Cost of sales, salaries & wages, power & electricity, rent,depreciation, interest, bad debts, telephone and etc.

Decreases in assets or increases in liabilities that result in decreases in equity other than thoserelating to distributions to holders of equity claims.

CONSTRAINTS IN RELEVANT AND RELIABLE INFORMATION

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

A major dilemma in providing financial information is whether thecosts exceed the benefits of providing certain financial informationand with the possible dilution of competitive position whencertain information is made public. The benefits of providinginformation are generally associated with more effective andefficient decision making by various users of financial information.