So Far in Corporate Financial Accounting (CFA) – Part 2

This article is a continuation of the prequel titled “So Far in Corporate Financial Accounting (CFA) – Part 1”. Where I covered how businesses go from business objectives to finance, and then to financial accounting as was taught by Dr Francis Okoye. In this second part, I will be continuing the summary of the lectures covering the accounting cycle, accounting concepts, elements of accounting, financial statements, etc.

Accounting Concepts

The following were some of the accounting concepts that we covered in some of the classes. The concepts related to financial statements are:

1. Objectivity Concept: This concept requires financial statements to be based on verifiable evidence. This means that the information presented in the financial statement must be supported by reliable sources, such as invoices, receipts, or bank statements.
2. Materiality Concept: An item is considered material if its inclusion or exclusion from a financial statement could impact the reader’s decision-making. For example, if a company is considering investing in a business and the financial statement does not disclose a significant liability, the decision to invest could be impacted.
3. Qualified and Unqualified Audit Reports: An audit report is a document prepared by an independent auditor that provides an opinion on the financial statements. An audit report may be qualified if there are issues that can mislead the reader, such as a lack of proper documentation or a material misstatement. Conversely, an unqualified report indicates that the financial statements are presented fairly, in all material respects.
4. Going Concern: This concept assumes that the business will continue to operate in the foreseeable future. When preparing financial statements, the assumption is that the business will continue to operate and generate profits.
5. Separate Entity Concept: This concept treats the business as a separate entity from its owner(s). This means that the financial statements must only reflect the financial position of the business and not include any personal assets or liabilities of the owners.
6. Periodicity Concept: This concept relates to the period covered in financial statements. Every financial statement must specify the period in question, such as a month, quarter, or year.
7. The Accrual Concept: This concept governs how revenue and expenses are accounted for in financial statements. According to the accrual concept, revenue is recognised when the service has been rendered or the product has been delivered, regardless of whether it has been paid for. Expenses are recorded when they have been incurred or when the good/service has been received, regardless of whether they have been paid for. This method provides a more accurate representation of the financial position of the business.

The Accounting Cycle

The accounting cycle is the series of steps that must be taken to produce the final financial statements. It comprises:

• Source documents – invoices, receipts, bank statements etc. used to capture transactions. The source document must contain the following information:
  • date (when)
  • amount (how much?)
  • description or justification (What)
  • who is involved (who)
  • if money moved. from where to where? (How)
• Journal – The chronological accounting record of an entity’s transactions
• Ledger – transactions recorded in the journal should be posted to the ledger or the book of accounts.
• Trial balance – is used to ensure that the total credit balance and total debit balance are equal
• Adjustments – are made to the trial balance to correct mistakes
• Closing Account and Stock Valuation
• Preparation of final account – Financial statements

We were introduced to the elements that typically make up the accounting structures of a business, such as processes, people, software, tax and compliance, and so on. During the discussion, we covered the difference between ERPs and CRMs and also mentioned different accounting software that accountants use to keep records.

Income Statement

The Income Statement, also known as the Profit and Loss Statement, summarises the revenue, expenses, and resulting net income or loss for a specific period. It provides valuable insight into a company’s financial performance and profitability. The Income Statement includes various components such as revenue, expenses, EBIT, EBITDA, profit before tax, and net income, which help assess the company’s financial health and viability.

The Typical Structure of an Income Statement

Revenue

Revenue refers to the total amount of money earned by a company from its primary business activities. It includes income generated from sales of goods or services, as well as any other sources of operating income. In the banking sector, revenue is known as Gross Earnings, while in the insurance sector, it is known as Gross Premium.

Expenses

Expenses are the costs incurred by a company to generate revenue and operate its business. They include various categories such as cost of goods sold, operating expenses, interest expenses, and taxes.

EBIT (Earnings Before Interest and Taxes)

EBIT, also known as operating income, represents a company’s profitability before taking into account interest and tax expenses. It is calculated by subtracting operating expenses, excluding interest and taxes, from the revenue.

EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortisation)

EBITDA is a measure of a company’s operating performance that excludes the effects of interest, taxes, depreciation, and amortisation. It provides a clearer picture of a company’s operating profitability by focusing on its core business operations.

Depreciation is the spread of the cost of a tangible asset over its useful life. It has nothing to do with the breakdown of the asset, while Amortisation is the spread of the cost of intangible assets over the useful life. It has nothing to do with the breakdown of the asset.

Profit Before Tax

Profit Before Tax (PBT) is the company’s profit after deducting all expenses except for income tax. It represents the company’s earnings before tax obligations are taken into account.

Net Income/Profit After Tax

Net Income, also known as net profit or net earnings, is the final profit figure after all expenses, including taxes, interest, and other deductions, have been subtracted from the revenue. It represents the company’s overall profitability and is often used as a measure of its financial performance.

Balance Sheet (Statement of Financial Position)

The Balance Sheet, also known as the Statement of Financial Position, provides a snapshot of a company’s financial position at a specific point in time. It presents the company’s assets, liabilities, and shareholders’ equity, showing how the company’s resources are financed.

Assets

Assets are economic resources owned or controlled by a company that has the potential to generate future economic benefits. They are categorised into different types based on their characteristics and timeframes.

Income-Generating Assets

Income-generating assets are assets that generate regular income for a company. These assets can include investments in stocks, bonds, rental properties, or any other assets that generate income through interest, dividends, or rental payments.

Non-Income-Generating Assets

Non-income-generating assets are assets that do not generate regular income for a company. These assets are typically used for operational purposes or held for their productive value. Examples of non-income-generating assets can include land, buildings, machinery, or vehicles.

Tangible Assets

Tangible assets are physical assets that have a physical form and can be touched or seen. They have a finite useful life and can be depreciated over time. Examples of tangible assets include cash, inventory, equipment, and buildings.

Intangible Assets

Intangible assets are non-physical assets that lack a physical form but provide value to a company. They are typically long-term assets that cannot be physically touched or seen. Examples of intangible assets include patents, trademarks, copyrights, goodwill, and intellectual property.

Current Assets

Current assets are assets that are expected to be converted into cash or used up within one year or the operating cycle of a company, whichever is longer. They include cash and cash equivalents, accounts receivable, inventory, and short-term investments.

Non-Current Assets

Non-current assets, also known as long-term assets, are assets that are not expected to be converted into cash or used up within one year or the operating cycle. They include long-term investments, property, plant and equipment, intangible assets, and other long-term assets.

These categories of assets help provide a comprehensive view of a company’s financial resources and can be used to assess its liquidity, solvency, and overall financial health.

In preparing balance sheets, companies typically present the assets in the order of liquidity, usually from the most liquid to the least, or the reverse.

In the next part of this series, I will cover the Liabilities, Equity, Financial Structure and a bit of what we covered in transaction analysis. Stay tuned!