Financial Accounting

“The process of identifying, measuring and communicating economic

information to others so that they may make decisions on the basis of
that information and assess the stewardship of the entity’s
management”

(Institute of Chartered Accountants of England and Wales)

 Readings
• Ryan, B, Introduction to Accounting, pages
19-23 on purpose and characteristics of
accounting information.
• Annual Reports (e.g. Sainsbury)
– Familiarise yourself with the key sections

• Burberry’s Annual Report

– Resource list contains pages to be read before
the workshop
Is Sainsbury a
healthy
company?
Who wants to know?
Suppliers

Employees Customers

Managers Owners

ORGANISATION

Lenders Competitors

Government Community

Investment
Analysts
 The Financial Statements
Designed to answer the following questions:
– What does the bank balance look like?
– Who owes the business money and to whom
does the business owe money?
– How much wealth was generated by the
business’s activities?
– How much is the business worth as a whole
since it began and in what form is this wealth?
 Three Key Statements
1. Cash Flow Statement

2. Statement of Financial Position

(balance sheet)

3. Statement of Comprehensive Income

(profit & loss account or income statement)
 Recap…
I start the day with £100
I buy 100 bottles of water for £0.50 each
with cash
I sell 20 bottles for £1 each for cash
I sell 20 bottles for £1 each, pay next week

Q1: What is my cash balance?

Q2: What else do I have?
 £
Cash balance brought forward 100
Purchases (100 bottles x £0.50) -50
Sales for cash (20 bottles x £1) 20
Cash balance carried forward 70
-------------------------------------------------------------------------------------------------------------------

Sales of 20 bottles on ‘credit’ owed 20

Inventories of 60 bottles x £0.50 30
Inventories have a sales value of 60
Profit can be calculated as 20
£40 sales - £20 cost
 The Financial Statements
Statement of Financial Position Statement of Comprehensive Income

Cash 70
Inventories 30
Trade Receivables 20
Debts 0 Sales 40
Net Assets 120 Cost of sales (20)
Profit 20
Equity 100
Profit 20
Equity 120
 The Accounting Equation

Assets - Liabilities = Equity

OR

Assets = Liabilities + Equity

Characteristics of Useful Information

• Relevance
• Faithful Representation
• Comparability
• Verifiability
• Timeliness
• Understandability

Source: IFRS Conceptual Framework for Financial Reporting

 Essay objectives
• Demonstrate your understanding of TAC & ABC,
their similarities and their differences
• Develop research skills
• Structuring an academic essay
• Creating an academic argument
• Referencing sources
• Avoiding plagiarism
 Key to essay marks
Marks have been awarded to indicate a classification
• 45% Fail
• 50% Marginal Pass
• 55% Good Pass
• 60% Marginal Merit
• 65% Good Merit
• 70% Marginal Distinction
• 75% Good Distinction
• 80% Outstanding Distinction
 What you did well
• Demonstrated good understanding of the key
features of both concepts
– Principles of allocation/tracing
– Key issues such as time, accuracy
– Impact on the business

• Reference lists
• Evidence of wider reading
• Structure: similarities/differences, pros/cons
 Remember…
• Move from ‘telling’ to ‘critiquing’

• Conclusions: summarise and recommend

• Select readings carefully (integrity)
• Write with your ‘own voice’ (Turnitin % too high)
• Plan your structure:
– Try using themes
– Connect to the purpose of the discipline
– Balance breath and depth
 Exam Practice Hand-in
• Due Friday 15th November
• Learning outcome: to gauge the level of detail required for
the marks available in the exam by practicing writing
answers to exam style questions.
• Marking guide: we would normally expect to award two
marks for a point well explained, with an example where
appropriate.
• Memorised answers presented as bullet points are never
awarded high marks and we often cap them below half
marks.
• This ‘formative’ work does not contribute to your final mark
for the unit.
 Advice and Feedback Hours
FAM tutors are available to see you. Email your tutor to book
an appointment
• Tauheed: Mondays 2.30-4.30. Room 3.01, 30-32 TPR
• Charlotte: Mon & Thurs 1.30-2.30. Room 2.09, 15-19 TPR
• Ron: Mondays 9:30-10:30. Room 1.25, 15-19 TPR
• Lauren: Thursdays 11.00-12.00. Room 1.25, 15-19 TPR
• Claire: Mondays 10.30-11.30. Room 2.09, 15-19 TPR

If these times clash with your timetable email

your tutor to arrange and alternative day/time.
 efim-ptt-af@bristol.ac.uk

To find out more and to book an appointment

please visit www.ole.bris.ac.uk or efim-ptt-
man@bristol.ac.uk

Management PTT tutors:

Annalaura Marini (Senior Tutor) and Claire O’Neill
 Student Wellbeing Advisors
bristol.ac.uk/students/wellbeing/services/

Speak to your local Residential Life Advisor (24/7)

Drop-in to 12 Priory Road and speak to a Student Wellbeing

Adviser:
• Monday 9:30am – 3.00pm
• Tuesday 9:30am – 3.00pm
• Wednesday 1:30pm – 3:30pm
• Thursday 9:30am – 3.00pm

Email: wellbeing-access@bristol.ac.uk
Tel: +44 (0)117 456 9860 (9 am to 5 pm Monday to Friday)
Statement of Financial Position

Assets - Liabilities = Equity

OR

Assets = Liabilities + Equity

STATEMENT OF COMPREHENSIVE INCOME
£
Profits are
Revenue 0
opinions NOT
Cost of Sales 0 facts!
Gross Profit 0

Less: Expenses
e.g. Rent, Salaries, Depreciation 0
Total Expenses 0

Operating Profit (PBIT) 0

Net Finance Costs 0
Profit before tax (PBT or EBT) 0
Taxation 0
Profit after tax (PAT or EAT) 0
Dividends 0
Retained Profit (add to Reserves in SoFP) 0
 The Accruals concept
• It is a fundamental concept of accounting that financial
transactions are accounted for on an accruals basis and
not a cash received/paid basis.

• Income and expenses are reflected in the Statement of

Comprehensive Income statement (SOCI) in the period
in which they arose

• The corresponding asset or liability is properly reflected

in the Statement of Financial Position (SOFP)

• Income and expenditure is matched to year earned or

incurred whether or not cash has been received or paid
Recognising complex revenues
Here are the ways in which British Sky Broadcasting Group plc recognises
some of its revenues:

Pay-per-view revenues
– when the event (movie or football match) is viewed

Subscription services
– as the services are provided

Advertising revenues
– when the advertising is broadcast

Installation, hardware and service revenue

– when the goods and services are delivered

Source : Based on information in British Sky Broadcasting Group plc Annual Report and Accounts 2010, p. 65 .
 Cash vs. Profit
(for the Quarter January-March)

A company has two Revenue streams:

– Quarterly contracts paid in advance £300,000
– Project work carried out in March. The customer receives one months
credit £50,000
Costs:
– Purchases relating to the contract are paid at the end of the quarter
£150,000/qtr
– Salaries for employees working for this customer are paid monthly
£30,000/mth
– Other expenses are paid monthly £10,000/mth
– Cost of the project work is £60,000 and is paid in month the work is
carried out.
 Cash vs. Profit
For the Quarter January-March. Figures in 000’s.

CASH PROFIT/LOSS
Jan Feb Mar Total Jan Feb Mar Total
Contract 300 300 100 100 100 300
Project RECEIPTS 0 REVENUE 50 50
Total 300 0 0 300 100 100 150 350

Purchases (150) (150) (50) (50) (50) (150)

Salaries (30) (30) (30) (90) (30) (30) (30) (90)
Other expenses (10) (10) (10) (30) (10) (10) (10) (30)
Project expenses PAYMENTS (60) (60) EXPENSES (60) (60)
Total (40) (40) (250) (330) (90) (90) (150) (330)

Difference 260 (40) (250) (30) 10 10 0 20

NET RECEIPTS PROFIT/(LOSS)
 Cash vs. Profit
For the Quarter January-March. Figures in 000’s.

CASH PROFIT/LOSS
Jan Feb Mar Total Jan Feb Mar Total
Contract 300 300 100 100 100 300
Project RECEIPTS 0 REVENUE 50 50
Total 300 0 0 300 100 100 150 350

Purchases (150) (150) (50) (50) (50) (150)

Salaries (30) (30) (30) (90) (30) (30) (30) (90)
Other expenses (10) (10) (10) (30) (10) (10) (10) (30)
Project expenses PAYMENTS (60) (60) EXPENSES (60) (60)
Total (40) (40) (250) (330) (90) (90) (150) (330)

Difference 260 (40) (250) (30) 10 10 0 20

NET RECEIPTS PROFIT/(LOSS)
 The Accruals concept
• It is a fundamental concept of accounting that financial
transactions are accounted for on an accruals basis and
not a cash received/paid basis.

• Income and expenses are reflected in the Statement of

Comprehensive Income statement (SOCI) in the period
in which they arose

• The corresponding asset or liability is properly reflected

in the Statement of Financial Position (SOFP)

• Income and expenditure is matched to year earned or

incurred whether or not cash has been received or paid
 Depreciation of Assets
• Non-Current Assets are bought for long term use in the
business
• Used up or ‘worn out’ on an ongoing basis
• Their value must go down or ‘depreciate’ over time

What would the Accruals Concept tell us to do?

1. Match income with expenses that have been
used to create the income

2. Consider the value of the asset in the SOFP

 Depreciation Example
SSK Ltd buys a new car for its fleet of company cars:
• The car cost £20,000 to buy
• It will be kept by the business for 3 years
• It will then be sold for approximately £8,000

How could you spread the cost of the car across

the sales it generates?
Two ways:
1. The Straight Line Method
2. The Reducing Balance Method
 Straight Line Method
Cost of Car £20,000 - Residual Value £8,000
Useful Life 3 years

= £4,000 per annum

This is an EXPENSE in the SOCI

 Straight Line Method
What about the VALUE of the car in the SOFP?

Cost Depreciation Net Book Value

Year 1 £20,000 £ 4,000 £16,000
Year 2 £20,000 £ 8,000 £12,000
Year 3 £20,000 £12,000 £ 8,000

The value of the car is reducing in a linear fashion

Each year the depreciation amount is the same
 Reducing Balance Method
A FIXED % is applied each year on the Net Book Value

e.g. if we choose 20%

Cost/NBV Depreciation Net Book Value

Year 1 £20,000 £ 4,000 £16,000
Year 2 £16,000 £ 3,200 £12,800
Year 3 £12,800 £ 2,560 £10,240

Assets depreciate faster in the early years of their life

 When it’s time to sell a NCA
Let’s say the car is sold as expected for £8,000

If the Reducing Balance method was used:

SOFP Non-Current Asset Net Book Value £10,240
Cash received for the sale of the car £ 8,000
Loss on sale of Asset £ 2,240

• The loss represents the shortfall in depreciation

• Not enough expense has be allocated to the SOCI
• It will now be allocated as a one-off expense
• Result = A drop in profits
 Lecture examples
Example 1
Suppose that the sales staff of Homer Ltd are paid commission of 20% of sales generated
and that total sales for the period amounted to £300,000. During the period commission of
£20,000 was paid. How should the sales commissions be accounted for?

Example 2
The marketing department of Bart Ltd has launched an advertising campaign in the trade press
to cover the months of March, April and May. The total spend to cover the three months is
£300,000 and was paid in March. How is this cost reflected in the Income Statement for March
and the Statement of financial position at 31 March?

Example 3
Marge Ltd sells annual maintenance contracts to its customers. Cash sales during March
amounted to £120,000. How should these contracts be reflected in the Income Statement for
March and the Statement of financial position at 31 March?
 Lecture examples
Example 4
Burns Ltd places £10 million on deposit on 1 March at a monthly interest rate of
½%. The interest of £50,000 is credited to the company’s bank account on 1 April.
How should this interest be reflected in the Income Statement for March and the
Statement of financial position at 31 March?

Example 5
Lisa Ltd has not received an electricity invoice for the last quarter of the year. It
used (and paid for) £40,000 of electricity in each of the previous three quarters,
and has not changed its consumption habits. How will this be reflected in the
accounts?