Overview of Accounting Environment and Financial Statements EMBAACCG2005

Overview of Accounting Environment and Financial Statements EMBA-ACCG-2005 /n

Aim of the Accounting Information n n n accounting is an information system that measures, processes and communicates financial information of an economic entity to the decision makers measurable systematic financial statements and other financial reports economic entity is an economic organization that acts independently business entity is an economic entity that sells goods or provides services 2

Environment of a Business Organization General Environment of Businesses Task Environment of Businesses 3

Business Language 4

Users of Accounting Information Internal Users 1. Top management 2. Department managers n executive officers External Users 1. Users with direct financial interest 2. Users with indirect financial interest 1. 2. creditors ; investors government ; regulatory agencies ; labor unions; financial advisors; brokerage firms; auditors; lawyers; consumer groups; and academicians 5

Objective of Financial Statements n n n the objective of financial statements is to provide information to users to help them in their economic decisions the financial statements are expected to provide information about the future cash flows of an entity, its financial structure, profitability and liquidity, and its financial position and changes in financial position financial statements provide information about assets, liabilities, revenues, expenses and cash flows 6

Business Activities Investing Activities Operating Activities Financing Activities 7

Financing Activities n n n initially - funds to setup a business in later periods – funds to run operations and to grow obtaining such funds either from external or internal sources Funds obtained: from creditors Funds provided to: payment of interest repayment of debts Cash management shareholders payment of dividends 8

Investing Activities n n Spending the funds obtained effectively and efficiently involve purchase and sale of q n n buildings, machinery or other investment instruments such as government bonds, treasury bills extending loans to other companies are expected to contribute directly or indirectly to the profit maximization and solvency goals of the business 9

Operating Activities n n involve the daily activities of the entities to run the business include q q n sales and marketing of the goods sold and services provided production purchasing merchandise and inventory items managing human resources effective and efficient management of operating activities needed to achieve profitability and liquidity 10

Financial Statements n n All financial statements are interrelated because each statement provides information about a different aspect of the same entity financial statements : q q n balance sheet income statement the cash flow statement of changes in equity Notes to the financial statements: accounting policies and explanatory notes about various items 11

Financial Statements n n n balance sheet provides information about the financial position or the resources available and the claims on these resources income statement provides information about how well these resources are used to generate income in a given period cash flow statement provides information about the movement in the cash and cash equivalents in a given period both the income statement and the balance sheet are prepared on accrual basis the cash flow statement is prepared on cash basis of accounting in order to meet the objective of financial statements, certain assumptions and qualitative characteristics are defined in the framework by IASB 12

Balance Sheet n n n The main objective -to fairly disclose the financial position of a company at a certain date a balance sheet is made up of assets, liabilities and owners' equity sections IAS No. 1 requires that the balance sheets should give the name of the company, the date it is prepared for, and the monetary unit and the level of precision adopted e. g. stated in thousands of TL. 13

Balance Sheet or Statement of Financial Position n n n As of a specific date The amount of resources owned by a company in order to run business and How these resources were funded Assets Liabilities Owners’ or Shareholders’ Equity – depending on the formation of business 14

Sections of Balance Sheet EMBA-ACCG-2005 /n

Assets Current Assets: Expected to be converted into cash within the normal operating cycle or held for resale purposes q q q n Assets that are kept on hand for a short period and are expected to be converted into cash within the twelve months following the balance sheet date Assets that are held primarily for the purpose of being traded, and Unrestricted cash and cash equivalents Long-term assets: Assets that the entity expects to use longer than one year or the operating cycle; purpose of providing resources for the operations of an entity in the future 16

Assets 17

Liabilities Any liability for which the amount can reasonably be estimated and with known payment date should be disclosed in the liabilities section of the balance sheet Any liability with uncertain payment dates and amounts should be disclosed in the notes to the financial statements Liabilities to various entities or groups such as the creditors, employees and customers should be clearly labeled and disclosed Classified as short and long-term. Current liabilities include amounts with determinable amounts and payment dates that are within the next year Long-term liabilities are usually debts incurred by the entity for the purpose of financing the operations and investments 18

Shareholders’ Equity includes the amounts invested in the business by the founding owners or investors, the earnings (losses) that are retained in the business from previous years’ income (losses) current year income or loss *either separately or within retained earnings 19

Liabilities and Shareholders’ Equity 20

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Income Statement n n n summarizes the revenues and expenses of an entity for a certain period in time reveals the results of operations during a period shows whether an entity is successful in achieving the goal of profitability 22

Income Statement n n n flow statement reflecting the performance of a company in terms of utilizing the resources in a given period provides information about the revenues and the related expenses in a given period, as well as the losses incurred in the same period The bottom line figure of the income statement is the profit or income of the period 23

Sections of Income Statement n n Revenues from ordinary activities of an entity and the related expenses are reported in accordance with the matching principle q classified according to the function, such as cost of goods sold; or according to the nature of the expense q reported in a separate section that reports the results of the ordinary activities. The presentation and disclosure of discontinued operations- the post-tax income or loss of the segment until disposition and the post-tax gain or loss of disposing the segment is presented in the income statement as separate line items 24

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Cash Flow Statement n n deals with cash in-flows and out-flows company resulting from operating, financing and investing activities for a specific period presents information regarding the goal of liquidity 26

Cash Flow Statement n shows the amount of cash generated through the three main activities of any entity q q q n Financing Investing Operating a cash flow statement has also three sections that parallel the main activities. 27

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Statement of Changes in Equity n n shows the amounts invested by the owners in a given period, as well as the movements in the shareholders’ equity accounts main purpose of the statement is to present all the changes that affected the shareholders’ equity in a period movements in the reserve accounts are based on the profit appropriation of the prior period retained earnings column in the statement reflects the net of prior period income and losses 29

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Statements of a single company 31

Auditing and Auditors’ Opinion n Independent audit of financial statements: q n purpose of an independent audit is to express an opinion on the financial statementsq q n the examination of the financial statements, accounting system and internal controls, and the accounting records of a company whether they are prepared in accordance with the generally accepted accounting principles whether they fairly present the financial position of the company auditors’ report implies that the financial statements are free of material misstatements 32

Board of Directors XYZ Corporation We have audited the accompanying balance sheets of XYZ Corporation as of 31 December 2005 and 2004, and the related statements of income, shareholders’ equity and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by the management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of XYZ Corporation at 31 December 2005 and 2004, and the results of its operations and its cash flows for the years then ended, in accordance with International Financial Reporting Standards as published by the International Accounting Standards Board. Signature of the Independent Auditor Date and Place of the Report 33

Ethics in Accounting n n moral principles that an individual bases his/her behavior on should the project manager give away bribes if the competitors are also bribing? if an accountant knows that a product is environmentally hazardous although it is not illegal, should she or he report it to the authorities even if s/he knows that she might lose her job? the ethics committee is working on the professional rules of conduct 34

Quality of Earnings n 1) 2) n n Having stable and recurring basic revenue generating activities using consistent estimates and rules High: same methods of estimation and rules proximity of revenue recognition and cash collection High: when revenue recognition and cash collection are close High quality earnings are presumed to be fair representations of the economic performance of the firm Low quality earnings overstate fair earnings 35

What will affect Quality of Earnings? n Managers’ discretion in measuring and reporting earnings in: q q q Choosing among alternative accounting principles Making estimates Timing transactions in order to control recognition 36

Hypothetical Classification of Accounting Systems Exh. 11. 3 37

Regulatory Bodies n National q q n Capital Markets Board (CMB) Ministry of Finance Turkish Accounting Standards Board (TASB) TURMOB (Union of Chambers of Certified Public Accountants of Turkey) International q q International Federation of Accountants International Accounting Standards Board- International Financial Reporting Standards (IFRS) Financial Accounting Standards Board (FASB) Federation of European Accountants (FEA) 38

ACCOUNTING IN TURKEY n n n Commercial Code of 1850 was a translation of the French Commercial Code formed the first accounting regulation in Turkey second Commercial Code was enacted in 1926 code was based on the German commerce and company laws that also regulated the accounting practices accounting system has been heavily influenced by the American system or Anglo-Saxon system since the beginning of the 1960's 39

Accounting in Turkey n n The law of Istanbul Stock Exchange (ISE) in 1984, but full operations started in 1986 Foundation of the Capital Markets Board (CMB) and the Istanbul stock exchange, and the increase in foreign investments advanced the development of the accounting and auditing standards Increase in joint ventures and foreign trade led to establishment of offices of then-"Big Eight" accounting firms in Turkey As a result of these developments, large private enterprises started to report their financial statements in accordance with the International Accounting Standards in addition to national reporting requirements 40

Accounting in Turkey n n The first set of financial accounting standards for the publicly owned and/or traded companies was developed in January 1989 by the CMB to be in effect for the fiscal years that start on or after January 1, 1989 However, accounting standards used by the family-owned or small to medium sized companies was, and to some extent still is, treated as identical with tax accounting 41

Uniform Chart of Accounts n n In 1992, Ministry of Finance organized a committee to instigate the accounting principles and a uniform chart of accounts that would be used by all companies The Ministry published the committee's report in a communiqué on December 26, 1992 establishing the principles and the uniform chart of accounts to be in effect starting January 1, 1994 All companies except banks, brokerage firms, and insurance companies are required to conform Banks are subject to accounting rules set by the Central Bank of Turkey and Banking Regulation and Supervision Agency, and brokerage and insurance firms comply with the CMB rules. 42

Turkish Accounting Standards Board n n In February 1994, Turkish Accounting and Auditing Standards Board (TAASB) was formed mission to develop accounting and auditing standards As of January 1, 2002, TAASB prepared 19 accounting standards under the name of Turkish Accounting Standards (TAS) that were published by TURMOB (Union of Chambers of Certified Public Accountants of Turkey) standards were not widely applied by the Turkish companies and the Board was dissolved and re-formed as the Turkish Accounting Standards Board (TASB) under the Prime Ministry in April 2002 43

Regulatory Environment n n n the Ministry of Finance's regulation of 1992, the CMB rules, the Commercial Code and the Procedural Tax Law, Banking Regulation and Supervision Agency and the Central Bank regulations All profit oriented companies -The Commercial Code and the Procedural Tax Law ; and Uniform Chart of Accounts Listed companies and financial intermediaries: Uniform Chart of Accounts, Commercial Code and Procedural Tax Law and CMB rules 44

Current Status n n n New CMB accounting standards in effect starting 1 Jan 2005 Almost same as the IAS/IFRS Traded companies are required to comply TASB- officially translated the accounting standards Turkish Commercial Code – Expected to be in effect mid 2006 45

Underlying Assumptions of Financial Statements n n Accrual Basis of Accounting Continuity or Going Concern Assumption Periodicity or the Time Period Assumption Monetary Value or Unit-of-Measure Assumption 46

Underlying Concepts n n n n n Understandability Relevance Materiality Reliability Faithful Representation Substance over Form Neutrality (Objectivity) Prudence (Conservatism) Completeness Comparability 47

Constraints on Relevant and Reliable Information n n Timeliness Benefit and Cost 48

Underlying Principles n n Cost Concept Revenue Matching Full Disclosure 49

A fellow has been learning to be a balloonist and takes his first solo flight. Unfortunately the wind gets up, he is blown off course and is forced to land. He is in a paddock close to a road but has no idea where he is. He sees a car coming along the road and hails it. The driver gets out and the balloonist says, "G'day mate, can you tell me where I am? '. "Yes, of course", says the motorist. "You have just landed in your balloon and with this wind you have obviously been blown off course. You are in the top paddock on John Dawson's farm, 13. 5 kilometres from Canowindra. John will be ploughing the paddock next week and sowing wheat. There is a bull in the paddock. It is behind you and about to attack you. " At that moment the bull reaches the balloonist and tosses him over the fence. Luckily he is unhurt. He gets up, dusts himself off and says to the motorist, "I see you're an accountant". "Good Grief", says the other man, "you're right. How did you know that? " "I employ accountants", says the balloonist. "The information you gave me was detailed, precise and accurate. Most of it was useless and it arrived far too late to be of any help. " 50