Introduction to Accounting Flashcards
Company (def)
- Functional term : a company is deemed to exist if a legal or natural person is entrepreneurially planning and operating
- Institutional term : a company requires a commercial activity in the economy and a minimum level of institutional means
Different types of companies
1) Private companies : industrial (producing goods), capital/consumer goods industry, service, disposal (waste management), etc
2) Public companies : public authorities & administrations (manage and oversee public resources, infrastructure and services)
3) Inputs & resources : labour (workforce), natural resources (used by industries like agriculture, mining and energy), capital
3 Purposes of Accounting
1) Valuation Role : provides information about the ex-ante prospects of a company.
-> e.g.: assessing market performance
2) Stewardship Role : holds managers accountable by reporting the ex-post performance of the company.
-> e.g.: identifies reasons for success or insolvency (bad accounting or financial mismanagement
3) Contracting role : provides a basis for contracts and agreements between companies, managers, and stakeholders
-> e.g.: royalty contracts, performance-based compensation agreements.
Central Definitions (balances)
- Cash-inflow + Cash-outflow = Payment balance
- Receipts + Expenditures = Financial balance
- Income + Expenses = Profit
- Performance + Costs = Operating result
Key processes in accounting
1) Standard processes
1. Purchase-to-pay: handles payments
2. Order-to-cash (sales) : manages sales
3. Fixed asset accounting: manages company assets
4. General ledger: main repository of all transaction
5. Master data management: ensures accurate data
2) Order-to-cash processes:
— step 1: order intake (receive, process and confirm customer order + check stock availability)
— step 2: invoice creation (generate invoices + update inventory + record in general ledger)
— step 3: payment receipt (record payments + integrate data into ledgers and accounts)
Earnings management
- Def : intentionally influencing financial reporting to achieve private gain + mislead stakeholders about a firm’s underlying performance (NOT ILLEGAL under GAAP)
1) Incentives : — performance-based compensation
— raising capital: presenting attractive financials for IPOs or equity offering
— meeting/beating targets: analyst forecasts,
— avoiding debt covenant violations: maintaining 30% equity ratio threshold
3) Income smoothing: reducing volatility in reported earnings to present consistent growth over time
Countermeasures against earnings management
- Supervisory boards & audit committees: have to approve financial statements (transparency)
- Financial auditors: independent verification of compliance with accounting rules/standards
- Enforcement bodies: DPR/BaFin (De), SEC (USA)
- Corporate governance mechanisms: internal audits and other safeguards
Types of Accounting
1) External (financial) accounting : provides information for stakeholders (bookkeeping, inventory, financial statement)
-> Governed by legal rules (GAAP, IFRS)
2) Internal (management) accounting : provides information for internal decision-makers
-> Governed by company specific rules
Central Definitions (Liabilities Side)
- Cash outflow : cash spent within a period, reducing cash balance (e.g.: company pays 1,000 to its supplier for raw materials purchased this month)
- Expenditure : monetary value of acquired goods, regardless of cash outflow timing (e.g.: company buys office equipment worth 2,000 in January but plans to pay the supplier in February. 2,000 is an expenditure in January)
- Expense : periodized consumption of goods/services affecting net income (e.g.: a company uses 3,000 worth of electricity during January. This is recorded as an expense for January even if the payment is made later) -> depreciation and accruals are expenses
- Cost : monetary assessment of goods/services consumed during production (e.g.: company uses raw materials worth 8,000 to produce 500 units of its product. The 8,000 are the cost of production)
Central Definitions (Asset Side)
- Cash inflow : cash received within a period, increasing cash balance (e.g.: customer pays 5,000 to the company for goods delivered last week)
- Receipts : monetary value of delivered goods, regardless of cash inflow timing (e.g.: company delivers products worth 15,000 to a customer in march, but customer will pay in April. 15,000 is recorded as receipts in march)
- Income : periodized value increase affecting net income (e.g.: company provides services worth 20,000 in April which is recognized as income in
April even if the payment is in march) -> after tax, income becomes earnings - Performance : monetary assessment of value increase through goods/services provided (e.g.: company sells 500 units worth 15,000. This 15,000 represents the performance, showing the monetary value created by the sale)
Broad Accounting principles
1) Framework Principles (relating to bookkeeping):
- Completeness (all relevant data included)
- Accuracy/Neutrality (precise and unbiased)
- Transparency and Understandability
2) Accrual Principles (relating to inventory-taking) -> also known as Prudence Principles
- Accrual : revenues recognised when they occur
- Realisation : revenues recognised when earned
- Imparity : losses recorded when identified
3) Complementary Principles (financial statements)
- Prudence
- Consistency
- Going concern (business can continue to operate)
- Single-asset valuation (assets valued individually)
Components of Financial Statements (for capital market oriented companies)
1) Balance Sheet : balance of assets and liabilities on the balance sheet date (point of time related)
2) Income Statement : balance of revenues and all incurred expenses (statement of profit/loss) -> presents period-related figures
3) Cash Flow Statement : presentation of cash balance (cash flows over a period)
4) Statement of changes in equity (self explanatory)
5) Notes : for the completion/ correction / interpretation of the info on B.S. and I.S.
6) Segment Reporting : financial information on individual sub-sectors of the company
Annual closing process
1) Board of directors : makes decisions regarding business transactions -> transactions are posted
2) Auditor : prepares audit report based on financial statements -> ensures accuracy and compliance
3) Supervisory board : receives the audit report and oversees corrections if needed
4) Board : finalises financial statements for disclosure
5) General assembly : decides on profit distribution based on disclosed financial statements
