Financial Reporting M20: Tutorial

Tutorial
Financial Reporting M20

October 14, 2019
Tutorial
Financial Accounting
October 14, 2019
Content
1 Summary of Content
• Accounting Basics
• Introduction to Bookkeeping
• Basic Financial Statements
• Introduction to Consolidated Financial Statements
• Interpreting Financial Statements
3 Financial Reporting - Tutorial October 14, 2019

Accounting Basics
_ Financial Reporting Environment

 Characteristics of accounting are:
a) Identification, measurement, and communication of financial information about
b) Economic entities to
c) Interested parties
 Objective of financial reporting:

 Provide financial information about the reporting entity that is useful to present and
potential equity investors, lenders, and other creditors in making decisions about
providing resources to the entity
 Investors are interested in assessing
a) The company´s ability to generate net cash inflows and
b) Management´s ability to protect and enhance the capital provider´s investments

Accounting Basics
_ Regulatory Framework
International Financial Reporting Standards - IFRS
IASB IOSCO
IFRS - IAS
IFRIC - SIC
Conceptual Framework

Accounting Basics
_ Basic Accounting Principles

Provide financial information about the reporting entity that is useful to
Basic objective present and potential equity investors, lenders, and other creditors in making
decisions about providing resources to the entity.
Fundamental Enhancing
Qualitative Relevance Comparability

predictive & confirmatory value, materiality Verifiability
characteristics Timeliness
Faithful presentation Understandability
completeness, neutrality, free from error
Basic elements Asset – Liability – Equity – Income - Expense
Economic entity – Going concern – Monetary unit – Periodicity –

Assumptions Accrual basis for accounting
Measurement – historical cost, fair value

Principles Revenue & expense recognition
Full disclosure
Cost constraint Benefits must exceed the costs

Introduction to Bookkeeping
_ Basic Terminology
 Event and transaction, (real/nominal) account, (general) ledger, journal and posting, trial
balance, adjusting/closing entries, financial statements
 Double-entry accounting:
Assets Equity and Liabilities

Debit Credit Debit Credit
Increase Decrease Decrease Increase
Expense Income
Increase Increase

_ Record and Summarize Basic Transactions

 Following analysis:
Journal Posting
Basic Equation Debit-Credit
Transaction (Book)
Analysis Analysis Analysis (T-Account)
Entry
On 14th September Assets = Liabilities + Equity Account Debit Credit
2018, company E sells Accounts Receivable 900

A/R = + Revenue
150 units for 22 EUR Cash 900
each on account. 3,300 = + 3,300
Accounts Receivable
Debit Credit
• Asset Accounts Receivable • Debits increase assets: debit Revenue 3,300
increases 3,300 EUR A/R 3,300 EUR
Revenue
• Income Revenue increases • Credits increase Revenues:
3,300 EUR credit revenue 3,300 EUR Debit Credit
3,300 A/R

_ Adjusting Entries
Prepaid Accrued Unearned Accrued

Expenses Expenses Revenues Revenues
(e.g. insurance, rent, (e.g. rent, taxes, interest, (e.g. rent, magazine (e.g. rent, interest, services
supplies, advertising, salaries) subscriptions, airline performed)
building and equipment) tickets, customer deposits,
tuition)
Asset Liability Liability Asset

_ Preparing Financial Statements
Adjusted  Consists of all real accounts (assets, liabilities, equity) and nominal accounts
(income, expense)
Trial Balance
 Consists of all nominal accounts (income, expense) coming from the adjusted
Income trial balance and leads to the net income
Statement
 Consists of a beginning balance, net income from income statement, and

Retained dividends payable
Earnings
 Consists of all real accounts (assets, liabilities, equity) including the

Balance
ending balance of retained earnings
Sheet

Basic Financial Statements
_ Income Statement
Usefulness • Past performance evaluation

• Future performance prediction
• Assessing the risk or uncertainty of achieving future cash flows
Limitations • Omission of items that cannot be measured reliably

• Income numbers are affected by different accounting methods
• Income measurement involves judgment
Elements • Income as inflows/enhancements of assets or decreases of liabilities that result in

increases in equity (revenues and gains)
• Expense as outflows of assets or incurrences of liabilities that result in decreases
in equity (expenses and losses)
Sections • Gross profit

• Income from Operations (nature and function classification)
• Income before Income Tax
• Net Income
Retained Earnings • Net income/loss

• Dividends
• Change in accounting principles and prior period adjustments

_ Balance Sheet
Usefulness • Computing rates of return

• Capital structure evaluating (financial flexibility, solvency)
• Risk and future cash flow assessment (liquidity)
Limitations • Assets and liabilities usually measured at historical cost

• Judgements and estimates are used
• Omission of many items of financial value
Elements • Assets are resources controlled by the entity, that results of past events and
future economic benefits are expected to flow to the entity
 current (inventories, receivables, cash/equivalents, prepaid expenses)
 non-current (long-term investments, PPE, intangibles)
• Liabilities are present obligations of the entity, that arises from past events and
settlement is expected to result in an outflow of resources embodying economic
benefits
 current (within accounting cycle or one year, e.g. accounts payable)
 long-term (notes payable, bonds payable)
• Equity is the residual interest in the assets of the entity after deducting all its
liabilities (share capital, share premium, retained earnings, treasury shares)
Forms • Account form (assets left, equity and liabilities right)

• Report form (sections one above the other)

_ Cash Flow Statement
Purpose • Provide relevant information about cash receipts/payments during a period

• Where did cash came from?
• What was the cash used for?
• What was the change in the cash balance?
Content • Operating activities – transactions that enter into the determination of net
income
• Investing activities – making and collecting loans and acquiring and disposing of
investments and PPE
• Financing activities – transactions involving liability and equity items
Preparation • Sources of information

 Comparative statements of financial position
 Current income statement
 Selected transaction data
• Determine net cash (operating, investing, financing) and the change in cash during
the period to reconcile the change in cash with the beginning and the ending cash
balance

_ Balance Sheet Items – Cash
• Most liquid asset (current asset)

Characteristics • Standard medium for exchange
• Basis for measuring and accounting for all other items
• Cash equivalents
Special issues • Restricted cash
• Bank overdrafts
Account Debit Credit
Cash Increase
Book entries
Cash Decrease
and
Cash
Posting Debit Credit
Increase Decrease

_ Balance Sheet Items – Receivables
• Claims held against customers and others for money, goods, or services
Characteristics
• Accounts receivables and notes receivables
• As part of revenue arrangement when it satisfies its performance

Recognition
obligation by transferring the good or service to customer
• Transaction price
• Discounts and returns/allowances
Measurement
• Uncollectable accounts receivables – bad debt expenses
• Allowance method and write off
Accounts Receivable Increase

Book entries Accounts Receivable Decrease
Discounts/Returns/Bad Debt Expenses (-) Increase

and
Discounts/Returns/Bad Debt
Accounts Receivable Expenses (-)
Posting Debit Credit Debit Credit
Increase Decrease Increase

_ Balance Sheet Items – Inventories
• Items held for sale in the ordinary course of business or goods to be

Characteristics used in the production of goods to be sold (raw materials, work in
progress, finished goods)
• Inventory cost flow (beginning inventory + cost of goods purchased =

Special issues cost of goods available = cost of goods sold + ending inventory)
• Perpetual and periodic system and inventory control
• At time the company controls the asset (passage of title)

Recognition
• goods in transit, consigned goods, repurchase agreement, right of return
• Product costs (purchase price, import duties/taxes, transportation costs,

handling costs )
• Purchase discounts as reduction from cost of inventories
Measurement • Cost flow assumptions – specific identification, FiFo, average cost
• Lower-of-Cost-or-Net Realizable Value (LCNRV)
• NRV as selling price less estimated costs to complete/sell
• Use of allowance and recovery of inventory loss

_ Balance Sheet Items – Inventories
Inventories Increase
Inventories Decrease
Costs of Goods Sold (-) Increase
Loss Due to Decline of Inventory to NRV (-) Increase
Recovery of Inventory Loss (+) Increase

Book entries
and Inventories Costs of Goods Sold (-)

Posting Increase Decrease Increase
Loss Due to Decline of Inventory to

NRV (-) Recovery of Inventory Loss (+)
Increase Increase

_ Balance Sheet Items – Property, Plants, and Equipment
• Assets of a durable nature (plant assets, fixed assets)

• Used in operations, long-term in nature, and possess physical
Characteristics
substance
• e.g. offices, factories, warehouses, machinery, furniture, tools, cars)
• Historical cost (purchase price, import duties, trade discounts, rebates,

costs attributable to brining asset to location and condition necessary to
Initial cost be used)
• Costs subsequent to acquisition (additions, improvements/replacements,
rearrangement/reorganization, repairs)
• Depreciation as allocation of cost of tangible assets to expense in a

systematic/rational manner to those periods expected to benefit from use
of asset Different methods (activity, straight-line, sum-of-the-years-digits,
declining-balance)
Valuation • Impairment of asset when no recover of asset´s carrying amount
through using/selling (annually review for indicators)
• Impairment test – carrying amount compared to recoverable amount (the
higher of FV less costs to sell and value-in-use)
• Use of accumulated depreciation and recovery of impairment loss

_ Balance Sheet Items – Property, Plants, and Equipment
PPE Increase
PPE Decrease
Depreciation Expense (-) Increase
Impairment Loss (-) Increase
Recovery of Impairment Loss (+) Increase

Book entries
and PPE Depreciation Expense (-)

Impairment Loss (-) Recovery of Impairment Loss (+)

Increase Increase

_ Balance Sheet Items – Intangibles
• Identifiable, lack physical existence, and no monetary asset

• Different types (marketing, contract, customer, technology, artistic)
Characteristics
• Goodwill as future economic benefits arising from other assets acquired
in a business combination that are not individual identifiable
• Historical cost (purchase price, acquisition costs, expenses to readiness

for intended use)
Initial cost • Internally created intangibles include certain capitalized development
costs (see special issues)
• Goodwill – excess of cost over FV of identifiable net assets acquired
• Limited life – amortization by systematic charge to expense over useful

life as reflection of consumption or use up of the asset and impairment
equal to PPE
Valuation • Indefinite-life – no amortization, annual impairment test
• Goodwill – no amortization, annual impairment test is conducted based
on the cash-generating unit (division) to which goodwill is assigned,
reversals are not permitted
• Research costs must be expensed as incurred

Special issues
• Development costs expensed or capitalized (economically viable)

_ Balance Sheet Items – Intangibles
Intangibles Increase
Intangibles Decrease
Amortization Expense (-) Increase
Impairment Loss (-) Increase
Recovery of Impairment Loss (+) Increase

Book entries
and Intangibles Amortization Expense (-)

Impairment Loss (-) Recovery of Impairment Loss (+)

Increase Increase

_ Balance Sheet Items – Current Liabilities
• Present obligation
• Arises from past events
• Results in outflow of resources such as cash, goods, services
Characteristics • Is expected to be settled within normal operating cycle or within 12
months
• E.g. accounts/notes/dividends/income taxes/VAT payable, unearned
revenues etc.
Book entries Accounts Payable Decrease
Accounts Payable Increase
and
Accounts Payable
Posting
Debit Credit
Decrease Increase

_ Balance Sheet Items – Provisions
• Liability of uncertain timing or amount

Characteristics • Current or non-current liability
• E.g. litigation, warrantees, business restructurings, environmental
• Present obligation as a result of past event

Recognition • Probable outflow required to settle obligation
• Reliable estimation can be made
• Estimation based on judgement (past transactions, experts, other

Measurement
pertinent information
Provision Decrease
Book entries
Provision Increase
Provision Expense/Loss (-) Increase

and
Provision Provision Expense/Loss (-)
Decrease Increase Increase

_ Balance Sheet Items – Long-term Liabilities
• Non-current liabilities
• Expected outflow of resources arising from present obligation
Characteristics
• Not payable within 1 year or operating cycle (which is longer)
• E.g. Bonds/notes/mortgages payable, pension/lease liabilities
• Stated/coupon/nominal rate vs. market rate/effective yield

• Premium or par value or discount
• Effective-interest method – periodic interest expense equal to a
constant percentage of the carrying value
• Interest payment = stated rate x face value
Valuation
• Interest expense = market rate x carrying value
• Calculation of discount:
• Maturity value, less
• Present value of liability (single sum), less
• Present value of interest payable (ordinary annuity)

_ Balance Sheet Items – Long-term Liabilities
Long-term Liability decrease
Long-term Liability increase
Interest Expense (-) increase

Book entries
and
Posting
Long-term Liability Interest Expense (-)
Decrease Increase Increase

_ Balance Sheet Items – Equity
• Assets – Liabilities = Equity

• Contributed capital and retained earnings as source
• Typical categories:
Characteristics • Share capital (ordinary, preference)
• Share premium (ordinary, preference, treasury)
• Retained earnings
• Treasury shares
• Ordinary shares – residual corporate interest

• Preference shares – sacrifice rights in return for other rights
Issuance of Shares
• Par vs. no-par value shares
• Proportional and incremental allocation method
• Purchase of treasury shares

Reacquisition of
• Reduction of equity
Shares • Cost vs par value method
• Cash/property/liquidating/share dividends
Dividend Policy • Reduce total equity
• share splits as reduction of market value of shares

_ Balance Sheet Items – Equity
Share Capital/Premium decrease
Retained Earnings decrease
Treasury Shares increase
Share Capital/Premium increase
Retained Earnings increase

Book entries
Treasury Shares decrease
and
Share Capital/Premium Retained Earnings
Decrease Increase Decrease Increase
Treasury Shares
Debit Credit
Increase Decrease

Introduction to Consolidated Financial Statements
_ Basics of CFS
 Individual FS vs. consolidated FS
 Definition and relevance of groups
 Reasons for and importance of group accounting
 Consolidation techniques
a) Capital consolidation
b) Debt consolidation
c) Income and expense consolidation
d) Elimination of intermediate results
 CFS accounting theories

_ Purposes and Principles of CFS

 Purposes
a) Conceptual framework for financial reporting (fundamental and enhancing qualitative
characteristics of financial information)
b) Objective of general purpose of financial reporting
c) General purpose of financial reporting
 Concept of consolidation
Treatment Asset
No significant influence Cost or FV Financial instrument
Significant influence Equity method Joint ventures and associated entities
Significant influence or control Proportional consolidation Joint operations
Control Full consoldation Subsidiary

_ Purposes and Principles of CFS
Uniformity
Reporting Dates Currency Translation Accounting Policies
Reporting Exchange Translation Translation

Currency Rate Date Method
Functional Currency
Temporal Principle
Spot Rate Method
Histortical Rate
Average Rate
Average Rate
Spot Rate
Ask Rate
Bid Rate
Method
Method
_ Interpreting Financial Statements

 Financial analysis as part of business analysis
Industry Analysis
Comparative Analysis
Prospective
Strategy Analysis Financial Analysis Cash Flow Analysis
Analysis
Ratio Analysis
Accounting Analysis
 Ratio analysis – Growth and profitability

a) Product market strategies
 Operating management (managing revenue and expenses)
 Investment management (managing working capital and fixed assets)
b) Financial market strategies
 Financing decisions (managing liabilities and equity)
 Dividend policy (managing payouts)


 Ratio analysis
Category Name of Ratio Equation

𝑛𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡
Return on Equity 𝑅𝑂𝐸 =
𝑒𝑞𝑢𝑖𝑡𝑦
Return on Assets 𝑅𝑂𝐴 =
𝑎𝑠𝑠𝑒𝑡𝑠
Profitability Financial Leverage 𝐹𝐿 =
𝑒𝑞𝑢𝑖𝑡𝑦
Return on Sales 𝑅𝑂𝑆 =
𝑠𝑎𝑙𝑒𝑠
Asset Turnover 𝐴𝑇 =


 Ratio analysis

Net profit
+/- Tax expense/income
= Earnings befot taxes (EBT)
+/- Net interest income/expense
- Foreign currency result
EBT, EBIT, EBITDA = Earnings before interest and taxes
(EBIT)
+ depreciation expense
= Earnings before interest, taxes,
depreciation and amortization
(EBITDA)
Operating Management
𝐸𝐵𝑇/𝐸𝐵𝐼𝑇/𝐸𝐵𝐼𝑇𝐷𝐴
EBT/EBIT/EBITDA Margin =
Gross Profit 𝐺𝑃 = 𝑠𝑎𝑙𝑒𝑠 − 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑠𝑎𝑙𝑒𝑠
𝐺𝑃
Gross Profit Margin 𝐺𝑃𝑀 =


 Ratio analysis

𝑊𝐶
Working Capital = 𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑠𝑠𝑒𝑡𝑠
− 𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑒𝑠
𝑊𝐶
WC to Sales Ration 𝑊𝐶𝑅 =
WC Turnnover 𝑊𝐶𝑇 =
Investment Management 𝑊𝐶
Trade Receivables Turnover 𝑇𝑅𝑇 =
ø 𝑡𝑟𝑎𝑑𝑒 𝑟𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠
𝑐𝑜𝑠𝑡 𝑜𝑓 𝑠𝑎𝑙𝑒𝑠/𝑚𝑎𝑡𝑒𝑟𝑖𝑎𝑙𝑠
Inventories Turnover 𝐼𝑇 =
ø 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑖𝑒𝑠
𝑐𝑜𝑠𝑡 𝑜𝑓 𝑠𝑎𝑙𝑒𝑠/𝑚𝑎𝑡𝑒𝑟𝑖𝑎𝑙𝑠
Trade Payables Turnover 𝑇𝑃𝑇 =
ø 𝑡𝑟𝑎𝑑𝑒 𝑝𝑎𝑦𝑎𝑏𝑙𝑒𝑠


 Ratio analysis

ø 𝑡𝑟𝑎𝑑𝑒 𝑟𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠
Days Sales Outstanding 𝐷𝑆𝑂 =
𝑠𝑎𝑙𝑒𝑠/365
ø 𝑡𝑟𝑎𝑑𝑒 𝑝𝑎𝑦𝑎𝑏𝑙𝑒𝑠
Investment Management Days Payables Outstanding 𝐷𝑃𝑂 =
𝑐𝑜𝑠𝑡 𝑜𝑓 𝑠𝑎𝑙𝑒𝑠/365
ø 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑖𝑒𝑠
Dasy Inventories Outstanding 𝐷𝑃𝑂 =
𝑐𝑜𝑠𝑡 𝑜𝑓 𝑠𝑎𝑙𝑒𝑠/365
Sustainable Growth Rate 𝑆𝐺𝑅 = 𝑅𝑂𝐸 𝑥 (1 − 𝐷𝑃𝑅)

Growth
𝑐𝑎𝑠ℎ 𝑑𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠 𝑝𝑎𝑖𝑑
Dividend Payout Ratio 𝐷𝑃𝑅 =


 Ratio analysis

𝑐𝑎𝑠ℎ 𝑎𝑛𝑑 𝑚𝑎𝑟𝑘𝑒𝑡𝑎𝑏𝑙𝑒 𝑠𝑒𝑐𝑢𝑟𝑖𝑡𝑖𝑒𝑠
Cash Ratio =
𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
" + 𝑡𝑟𝑎𝑑𝑒 𝑟𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠
Quick Ratio =
𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑠𝑠𝑒𝑡𝑠
Current Ratio =
Financial Management
𝑡𝑜𝑡𝑎𝑙 𝑒𝑞𝑢𝑖𝑡𝑦
Equity Ratio =
𝑡𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠
𝑡𝑜𝑡𝑎𝑙 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
Total Liabilities to Total Assets =
𝑡𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠
𝑡𝑜𝑡𝑎𝑙 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
Total Liabilities to Total Equity =
𝑡𝑜𝑡𝑎𝑙 𝑒𝑞𝑢𝑖𝑡𝑦

End of Tutorial

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Tutorial

Financial Reporting M20

3 Financial Reporting - Tutorial October 14, 2019

_ Financial Reporting Environment

 Objective of financial reporting:

4 Financial Reporting - Tutorial October 14, 2019

International Financial Reporting Standards - IFRS

5 Financial Reporting - Tutorial October 14, 2019

_ Basic Accounting Principles

Qualitative Relevance Comparability

Basic elements Asset – Liability – Equity – Income - Expense

Economic entity – Going concern – Monetary unit – Periodicity –

Measurement – historical cost, fair value

Cost constraint Benefits must exceed the costs

6 Financial Reporting - Tutorial October 14, 2019

Assets Equity and Liabilities

Increase Decrease Decrease Increase

7 Financial Reporting - Tutorial October 14, 2019

_ Record and Summarize Basic Transactions

On 14th September Assets = Liabilities + Equity Account Debit Credit

2018, company E sells Accounts Receivable 900

8 Financial Reporting - Tutorial October 14, 2019

Prepaid Accrued Unearned Accrued

Asset Liability Liability Asset

9 Financial Reporting - Tutorial October 14, 2019

_ Preparing Financial Statements

 Consists of a beginning balance, net income from income statement, and

 Consists of all real accounts (assets, liabilities, equity) including the

10 Financial Reporting - Tutorial October 14, 2019

Usefulness • Past performance evaluation

Limitations • Omission of items that cannot be measured reliably

Elements • Income as inflows/enhancements of assets or decreases of liabilities that result in

Sections • Gross profit

Retained Earnings • Net income/loss

11 Financial Reporting - Tutorial October 14, 2019

Usefulness • Computing rates of return

Limitations • Assets and liabilities usually measured at historical cost

Forms • Account form (assets left, equity and liabilities right)

12 Financial Reporting - Tutorial October 14, 2019

_ Cash Flow Statement

Purpose • Provide relevant information about cash receipts/payments during a period

Preparation • Sources of information

13 Financial Reporting - Tutorial October 14, 2019

_ Balance Sheet Items – Cash

• Most liquid asset (current asset)

Account Debit Credit

14 Financial Reporting - Tutorial October 14, 2019

_ Balance Sheet Items – Receivables

• As part of revenue arrangement when it satisfies its performance

Account Debit Credit

Accounts Receivable Increase

Discounts/Returns/Bad Debt Expenses (-) Increase

Increase Decrease Increase

15 Financial Reporting - Tutorial October 14, 2019

_ Balance Sheet Items – Inventories

• Items held for sale in the ordinary course of business or goods to be

• Inventory cost flow (beginning inventory + cost of goods purchased =

• At time the company controls the asset (passage of title)

• Product costs (purchase price, import duties/taxes, transportation costs,

16 Financial Reporting - Tutorial October 14, 2019

_ Balance Sheet Items – Inventories

Account Debit Credit