Reading Control 1.

BASIC/FUNDAMENTAL ACCOUNTING PRINCIPLES

FINANCIAL STATEMENTS / ESTADOS FINANCIEROS
WHY DO WE HAVE FINANCIAL STATEMENTS?
o Management of any business requires a flow of information to make informed,
intelligent decisions affecting the success or failure of its operations.
o Investors need statements to analyze investment potential.
o Banks require financial statements to decide whether or not to loan money.
o Companies need statements to assess the risk involved when doing business with
their customers and suppliers.
1. DEFINITION
Financial statements are written records of a business' financial situation. They include
standard reports such as:
1. Balance Sheet (estado de situacion financiera)
2. Income or Profit and Loss Statement (estados de resultados)
3. Cash Flow Statement
4. Statement of changes in owners' equity or stockholders' equity.
Financial statements are a summary of the financial position of an entity at a given
point in time. They are designed to meet the needs of many diverse users, owners and
creditors. Financial statements condense data which is primarily obtained from a
company's accounting system
2. OBJECTIVES
The objective of financial statements is to provide information about the performance
and changes in financial position of an enterprise that is useful to financial users when
making economic decisions.
Financial statements should be understandable, relevant, reliable and comparable.
Reported assets, liabilities, equity, income and expenses are directly related to an
organization's financial position.
Financial statements must be understandable by readers who have a reasonable
knowledge of business, economic activities and accounting.
3. FINANCIAL STATEMENT PRINCIPLES
To ensure uniformity and comparability between financial statements prepared by different
companies, a set of guidelines and rules are used.
Generally Accepted Accounting Principles (GAAP)
International Accounting Standards Board ("IASB").
International Financial Reporting (IFR).
4. FINANCIAL STATEMENT PRINCIPLES PERU
Peruvian accounting principles are contained in the Normas Internacionales de
Contabilidad (NIC or IFR) which have been written by the Consejo Normativo de
Contabilidad (CNC).
Peruvian companies business operations are registered according to this standard and
these principles, alongside the rules established by the Ley General de Sociedades
regulate the companies financial statements.
Resolucin de CONASEV N 103-99EF/94 Reglamento de informacin financiera y Manual
para la preparacin de la informacin Financiera.

5. FINANCIAL STATEMENT DEFINITION (41 CURRENT NICS EN EL CEL)

The NIC or IFR are the general guidelines that govern accounting. The main objective of
these rules is to standardize the information when preparing financial statements.
This standardization enables the investors, financial analysts, and general public to use
financial statements, knowing that there is a uniform, worldwide system.
6. BASIC/FUNDAMENTAL ACCOUNTING PRINCIPLES FOR THE PREPARATION OF
FINANCIAL STATEMENTS
Accounting principles serve as bases for preparing, presenting and interpreting
financial statements:
ACCRUAL CONCEPT: DEVENGADO
o Under accrual basis revenues and expenses are recognized when they
occur regardless of when the amounts are received or paid.
o Income and expenses are registered in book of accounting and then they are
reported in the financial stament of the due period.
For example, ABC Mining Company sells cupper to a client on December 9th,
2013 (USD 2m). The client will paid in 30 days January 9th, 2014. When
should the income be recognized?
On the date it is considered earned (when the revenue has been fully
rendered). Hence, the revenue and income should be recognized on
December 9, 2013 even if it has not yet been collected on that date.

GOING CONCERN PRINCIPLE: EMPRESA EN MARCHA

o It is known as continuing concern concept, and means that a business entity will
continue to operate indefinitely, or at least for another twelve months.
o Financial statements are prepared with the assumption that the entity will
continue to exist in the future, unless otherwise stated

ACCOUNTING ENTITY: ENTIDAD CONTABLE

o it means that a company is legally independent from its owners or anyone else.
Personal transactions of the owners, managers, and employees must not be
mixed with transactions of the company.
o The companys aim is to generate value for the shareholders and there is no
intention to reduce or liquidate significantly the running of the business.
o When Financial statements are prepared, managers and board members will
evaluate the capability of the enterprise to continue or maintain its commercial
activities . The business will not be interrupted.
o When a company is in an insolvency process, the Accountant has to prepare the
financial reports according to the compans value of liquidation.

CONSISTENCY CONCEPT: CONSISTENCIA

o The concept of consistency means that once accounting methods are adopted
they must be applied consistently in the future. Furthermore the same methods
and techniques must be used for all other similar situations.
o It implies that a business must not change its accounting policy unless there is
reasonable justification. If for any valid reason the accounting policy is changed,
a business must disclose the nature of the change, the reasons for the change
and its effects on the financial statements.
o
Company B is a retailer dealing in shoes. It used FIFO method of inventory valuation in
respect of shoes at Branch X, and weighted average inventory valuation method in
respect of similar shoes at Branch Y. Here, the auditors must investigate if there are
any valid reasons for the different treatment of similar inventory located at different

locations. If not, they must direct the company to use any one of the valuation method
uniformly for the whole class of inventory.

MONETARY UNIT ASSUMPTION:

It has two characteristics: Quantifiability and Stability of the currency.
Quantifiability means that records should be stated in terms of money, usually
in the currency of the country where the financial statements are prepared.
Stability of the Sol, dollar, euro, peso, etc. means that the purchasing
power of the said currency is stable or constant and it does not have any
significant effect on financial statements.

RELEVANCE AND GROUPING: IMPORTANCIA RELATIVA Y AGRUPACION

Information should be relevant to the decision making needs of the user. Information is
relevant if it helps users of the financial statements in predicting future trends of the
business (Predictive Value) or confirming or correcting any past predictions they have
made (Confirmatory Value). The same information can assist users to confirm their
past predictions which may also be helpful when forecasting.

COMPENSATION: COMPENSACION
This principle states that full details of the financial info should be shown without
expecting any compensation of debt by an asset, revenue by an expense, except if it
will be required by a specific case.

COMPARATIVE INFORMATION: INFORMACION COMPARATIVA

o Present comparative information, except for specific cases that do not require it.
o Apply the comparative information to previous financial periods.
o Reclassify the financial statements comparative items by amendments.
o Reveal items when it is not possible to reclassify .

FINANCIAL STATEMENT USERS

1. STAKEHOLDERS: TODOS LOS AFECTADOS POR UNA EMPRESA (11)
a) Shareholders: use Financial Statements to assess the risk and return on,
company investments. In addition they also use them to make investment
decisions.
b) Investors: need Financial Statements to assess the viability of investing in
a company. They may predict future dividends based on the profits
disclosed in the Financial Statements (even though the risks are
associated with the investment) , Example: Fluctuating profits indicate
higher risk.
c) Financial Institutions (BANKS): use Financial Statements to decide
whether to grant a loan or credit to a business. Financial institutions
assess the financial health of a business to determine the risk of the
loan.
Any decision to lend must be supported by a sufficient asset
base and liquidity.
d) Competitors: compare their performance with rival companies to learn
and develop strategies to improve their competitiveness.
e) Governmemnt: require Financial Statements to determine if the correct
tax has been declared. The Government also keeps track of economic
progress by analyzing businesses Financial Statements from different
sectors of the economy.
f) Managers/Board Members: require Financial Statements to evaluate the
companys position, its financial performance and to make important
business decisions.

g) Suppliers: need Financial Statements to assess the credit worthiness of a

business and to ascertain whether they can supply goods on credit.
Terms
of credit are set according to their customers' financial state.
h) Clients: use Financial Statements to assess whether a supplier has the
resources to ensure the steady supply of goods in the future. This is
especially important where a customer is dependent on a supplier for a
specialized component.
i) Auditors
j) Employees: use Financial Statements to assess the company's profitability
and any possible effect it may have on future remuneration and job
security.
k) GENERAL PUBLIC: May be interested in the effects of a company on the
economy, environment and the local community.
2. CONCERNS:
Do all the users have the same analysis and interest in a companys financial
statement?
Does the company have the appropriate mixed assets for the users?
How do we measure the companys profitability and value creation?
Is the profitability optimal for the company?
How can we improve the Cash Flow of the company?
What is the companys value?
Is the leverage appropriate for the company and industry ?
What is the cost of capital?
How long does the company take to pay its suppliers?
How long does the company take to clear their receivables accounts?
How can inflation and foreign exchange affect the company business?
Is the financial statement analysis done monthly, dayly, anually ?
3. QUALITATIVE CHARACTERISTICS: These atributes provided by Financial Statements make
the information ... to users
a) Useful
b) Relevance
c) Reliability
d) Comparability
e) Materiality test
4. BASIC FINANCIAL STATEMENTS (5)
4.1
BALANCE SHEET
4.2
INCOME STATEMENT
4.3
STATEMENT OF CHANGES IN OWNERS OR STOCKHOLDERS EQUITY
4.4
CASH FLOW STATEMENT (NO ESTA)
4.5
EXPLANATORY NOTES (NO ESTA)
4.1 BALANCE SHEET / ESTADO DE SITUACION FINANCIERA (FOTO EN EL CEL)
The purpose of the balance sheet (Statement of Financial Position) reports the amount of
assets, liabilities, and stockholders' equity of an accounting entity at a given point in time. It
can be prepared monthly, quarterly, twice yearly or annually, based on the companys needs.
o

BS POSITION (FOTO)

BS ELEMENTS (FOTO)
ASSETS: These are the economic resources owned by the company (goods,
securities and rights.

Current Assets:
- These are made up of cash, and other resources that are expected
to turn into cash within one year of the balance sheet date.
- Current assets are presented in the order of liquidity, i.e., cash,
temporary investments, accounts receivable, inventory.
Non Current Assets:
- These assets are the company's long-term investments and the full
value will not be convert into cash within one accounting year.
- Depending on the type of asset, it may depreciate, amortize or
deplete, but these are all just technical terms for allocation.
- Examples of non-current assets include investments in another
company, capital expenditure and intangible assets such as
goodwill, brand recognition and intellectual property.
DATO ASSETS: The assets are listed in order by the length of time it would normally
take a firm with ongoing operations to convert them into cash. Clearly, cash is much
more liquid than property, plant, and equipment
LIABLILITY
It is the company's legal debts or obligations that arise during the course
of business operations. Liabilities are settled over time through the
transfer of money, goods or services to name a few.
Liabilities include loans, accounts payable, mortgages, deferred revenues
and accrued expenses.
Liabilities are a vital aspect of a company's operations because they are
used to finance projects and pay for future investment.
They can make transactions between businesses more efficient. For
example, the outstanding money that a company owes to its suppliers
would be considered a liability.
Current Liabilities
- Current liabilities are outstanding debts owed to creditors and
suppliers that must be paid within one year.
- Current liabilities include short term debt (overdrafts, promisory
notes, trade finance, etc) accounts payable, employees salaries,
accrued tax, accrued dividends, CTS, and other debts.
- Normally, companies withdraw cash from current assets in order to
pay their current liabilities.
Long Term Liabilities:
- They are outstanding debts owed to creditors and suppliers that
have a long term repayment plan of more than one year.
Long-term liabilities include items like debentures, loans, deferred
tax liabilities and pension obligations.
- The portions of long-term liabilities that come within the next 12
months are listed under current liabilities, as current portion of
long-term debt .
- Separating liabilities into current and long-term liabilities allows
analysts to have a clearer view of the company's current liquidity
position.
- Typically an analyst would want to see that a company has most of
the assets needed to pay for current liabilities in cash or cash
equivalent accounts. On the other hand, the assets needed to
satisfy long-term liabilities could be expected to be derived from
future earnings or future financing transactions.
EQUITY
It is the funds contributed by the owners (the stockholders) plus/minus the
retained earnings/losses.

The investment of cash and other assets in the business by the owners is
called contributed capital. The amount of earnings (profits) reinvested in
the business (and thus not distributed to stockholders in the form of
dividends) is called retained earnings.
Owner's equity is sometimes referred to as the book of value of a
company. This is because owner's equity is equal to the reported asset
amounts minus the reported liability amounts.
-

Equity or Stockholders' equity : "Owner's Equity" are the words

used on the balance sheet when the company is a sole
proprietorship. If the company is a corporation, the words
Stockholders' Equity are used instead of Owner's Equity.

An example of an owner's equity account is Patty Cancino Capital

(where Patty Cancino is the owner of the sole proprietorship).

DATO STOCKHOLDERS EQUITY INCLUDE:

Common Stock:
Shares of common stock provide evidence of ownership in a corporation.
Holders of common stock elect the corporation's directors and receive a share of
the companys profits via dividends.
If the corporation were to liquidate, the secured lenders would be paid first,
followed by unsecured lenders, preferred stockholders (if any), and lastly the
common stockholders.
Preferred Stock: A class of corporation stock that provides the preferential delivery of
dividends: preferred stockholders will be paid before the common stockholders receive their
dividends. In exchange for the preferential treatment of dividends, preferred shareholders
usually do not share in the corporation's earnings and instead only receive their fixed
dividend.
Retained Earnings: This is the cumulative net income of a corporation from its creation.

Legal reserve:

Reserve is a percentage of the profit achieved that is held back by the business to help when
times are hard. The most common examples are:
Legal reserve fund - it is required by many legislations and it must be
paid as a percentage of share capital.
share premium - amount paid by shareholders for shares in excess of
their nominal value
However, profits may be distributed also to other types of reserves,
Remuneration reserve - will be used later to pay bonuses to employees
or management.
Translation reserve: arises during consolidation of entities with different
reporting currencies
DATO BS: When analyzing a balance sheet, the Finance Manager should be aware of three
concerns:
1. Liquidity
2. Debt versus equity
3. Value versus cost
4.2

INCOME STATEMENT

o
o

A financial statement that measures a company's net profit or loss incurred over
a specific accounting period, typically a fiscal quarter or year.
In the context of corporate financial reporting, the income statement
summarizes a company's revenues (sales) and expenses, this is commonly a
quarterly and annually statement. The final net figure, along with other key
amounts are of major interest to the investment community.
It is the companys main financial tool to analyze profitability/return. Many
professionals still use the term "P&L," which stands for profit and loss statement.

FOTO DEL INCOME STATEMENT

o The result obtained, called Net Income, can be positive; which means that the
Revenues > expenses. If the net Income is negative, the revenues originated <
expenses
o The income statement accounts/items are settled or canceled from year to year.
NON CASH ITEMS:
Depreciation is the most apparent. No firm ever writes a check for depreciation.
Another non-cash item is deferred taxes, which does not represent a cash flow.
Thus, net income is not cash.
CLASSIFYING THE REVENUES ITEMS
1. Revenue:
This is income earned from the principal activities of an entity (the companys
BAU). For example, for a manufacturer of electronic appliances, revenue will be
comprised of the sales from electronic appliances and services provided. If the
manufacturer earns interest from its cash account , this will not be classified as
revenue, but as other income.
These revenues are netted from discounts and price reductions offered to clients.
2. Diverse Incomes:
They are operational incomes that are not very important to the companys BAU
but they can be significant in specific financial periods.
3. Other Income
Other income consists of income earned from activities that are not related to the
entity's main business. For example, other income of an entity that manufactures
electronic appliances may include:
Gain on disposal of fixed assets (sell of fixed assets, taxes recovered, insurance
against loss, etc).
4. Financial Income:
Interest income on bank deposits.
Exchange gain on foreign currency transfer.
Costs and Expenses classification.
1. Cost of Sales:
It represents the cost of goods sold (or services), the pending inventory for the production (as
raw material, final goods, products in process) incurred during an accounting period .
For a retailer, cost of sales will be the sum of inventory at the start of the period and
purchases made during the period minus any closing inventory.
In the case of a manufacturer, cost of sales will also include production costs
incurred in the manufacturing process such as the cost of direct labor, direct
material consumption, depreciation of plant and machinery and factory overheads,
etc during a period of analysis.
2. Selling Expenses:
Selling expenses are part of the operating expenses (along with administrative
expenses).

Selling expenses include sales commissions, advertising, promotional materials

distributed, rent of the sales showroom, rent of the sales offices, salaries and fringe
benefits of sales personnel, utilities and telephone usage in the sales department, etc.
Under the accrual basis of accounting, selling expenses appear on the income
statement in the period in which they occurred (not the period in which they were
paid).

3. Administrative Expenses
This considers the costs related to the management and support functions that are not
directly involved in the production and supply of goods and services offered by the entity.
Examples:
Salary cost of executive management
Legal and professional charges
Depreciation of head office building
Rent expense of offices used for administration and management purposes Cost of
functions / departments not directly involved in production such as finance department,
HR department and administration department, etc
4. Finance Charges
This make reference to the interest expense of loans and debentures.
The effect of present value adjustments of discounted provisions are also included in
finance charges (e.g. unwinding of discount on provision for decommissioning cost).
5. Expenses classification
The income statement also includes gains and losses, which result in an increase
(gains) or decrease (losses) of economic benefits. Profit/Gains and losses may or may
not result from ordinary business activities. For example,
a firm might sell surplus equipment used in its manufacturing operation that is no
longer needed. The difference between the sales price and book value is reported as a
gain or loss on the income statement.
Summarizing, net income is equal to income (revenues + gains) minus expenses
(including losses).
4.3

STATEMENT OF CHANGES IN OWNERSS EQUITY OR STOCKHOLDER EQUITY

Statement of Changes in Equity, often referred to as Statement of Retained Earnings in U.S.

GAAP, details the change in owners' equity over an accounting period by presenting the
movement in reserves comprising the shareholders' equity.
Movement in shareholders' equity over an accounting period comprises the following elements:
1. Net profit or loss during the accounting period attributable to shareholders.
2. Increase or decrease in share capital reserves
3. Dividend payments to shareholders
4. Gains and losses recognized directly in equity
5. Effect of changes in accounting policies
6. Effect of correction of prior period error
4.4
4.5

Cash Flow Statement (NO ESTAN EN LAS DIAPOS)

Explanatory Notes (NO ESTAN EN LAS DIAPOS)