Università degli studi di Pavia Facoltà di Economia a.a. 2014-2015

1. Università degli studi di PaviaFacoltà di Economiaa.a. 2014-2015 Lesson 1 International Accounting Lelio Bigogno, Stefano Santucci

2. Introduction to the course • Lecturers presentation and CVs • Structure of the course • ow to prepare the exam • The contents of the exam • How to find out the tools for the preparation • Basic assumptions of the course • Important notice: Friday the 3rd of October there won’t be class!!

3. PART 1IAS/IFRS: a GeneralOverview

4. 1. Some definitions • A basic question: • IAS? • IAS/IFRS? • IFRS • The answer?

5. 1. Some definitions • International Accounting Standards (IASs) were issued by the IASC(International Accounting Standards Committee) from 1973 to 2000. • The IASB (international Accounting Standards Board) replaced the IASC in 2001.

6. Since then, the IASB • has amended some IASs and has proposed to amend others; • has replaced some IASs with new International Financial Reporting Standards (IFRSs); • has adopted or proposed certain new IFRSs on topics for which there was no previous IAS.

7. …….IFRSs refers to the new numbered series of pronouncements that the IASB is issuing, as distinct from the International Accounting Standards (IASs) series issued by IASC.

8. …….Broader definition IFRSs refers to the entire body of IASB pronouncements, including standards and interpretations approved by the IASB and IASs and SIC (Standing Interpretation Commission) interpretations approved by the predecessor International Accounting Standards Committee.

9. In fact, through committees, both the IASC and the IASB also have issued Interpretations of Standards

10. Interpretations of IASs and IFRSs are developed by the IFRS Interpretations Committee, whose name was changed from IFRIC (International Financial Reporting Interpretations Committee) in March 2010.

11. The IFRS Interpretations Committee replaced the former Standing Interpretations Committee (SIC) in March 2002

12. The Interpretations Committee's mission is "to interpret the application of International Accounting Standards (IASs) and International Financial Reporting Standards (IFRSs) and provide timely guidance on financial reporting issues not specifically addressed in IASs and IFRSs, in the context of the IASB Framework, and undertake other tasks at the request of the IASB".

13. 2. The advantage of International Accounting GLOBALISATION– INTERNATIONALISATION Markets Efficiency Common Accounting Rules International Accounting – Lesson 1

14. The goal of the IFRS Foundation and the IASB is to develop, in the public interest, a single set of high-quality, understandable, enforceable and globally accepted financial reporting standards based upon clearly articulated principles. International Accounting – Lesson 1

15. IAS/IFRS adoption is considered as a quality improvement for financial information produced. YES BUT, WHERE IS THE REAL IMPROVEMENT COMPARED TO ITAGAAP? International Accounting – Lesson 1

16. IAS/IFRS adoption is considered as a quality improvement, BUTsome discussions are still in place. Topics: An extremely on-going world (updating needs, uncertain rules); An assets side approach (fair value adoption problems); A complex set of rules but at the end of the day often less strict than local GAAP . International Accounting – Lesson 1

17. In July - August 2014 a set of 23 National Standards were issued after being updated. • These developments arise, on the one hand, from changes in legislation and national accounting practices and, on the other hand, from the evolution of doctrine and the international context. • Some issues are dealt with in a IFRS/IAS point of view (es: impairment of assets, fair value) • The aim was also to converge local gap to IAS/IFRS where possible (in the light of who the actual users are mainly small and medium-sized entities); International Accounting – Lesson 1

18. 3. IFRSs and European Community Standards issued by IASB must go through due process of endorsement before becoming law in EU. All the standards and interpretations are adopted in the form of Regulation. International Accounting – Lesson 1

19. Endorsement process: • IASB issues a standard • EFRAG (European Financial Reporting Advisory Group) holds consultations with interest groups • EFRAG delivers its advice to the European Commission whether the standard meets the criteria of endorsment. International Accounting – Lesson 1

20. SARG ( Standards Advice Review Group) issues its opinion whether EFRAG’S endorsement advice is well -balanced and objective. • Based on the advice of EFRAG and the opinion of SARG, the Commission prepares a draft endorsement Regulation. • ARC (Accounting Regulatory Committee) votes on the Commission proposal. International Accounting – Lesson 1

21. The European Parliament and the Council of the European Union have 3 months to oppose the adoption of the draft Regulation by the Commission • In case of favorable opinion or the 3 months elapsed without opposition, the Commission adopts the draft Regulation. • The adopted Regulation is published in the Official Journal and entersintoforce on the daylaid down in the Regulationitself. International Accounting – Lesson 1

22. 4. International Accounting Standards around the world Seeexhibit International Accounting – Lesson 1

23. PART II Basic Accounting: Sometechnicalvocabulary • Sources records and book of prime entry • Ledger accounts and double entry • Examples International Accounting – Lesson 1

24. 1. Sources records and book of prime entry Sources Documents are the source of all information recorded by a business. Documents which are used to record the business transactions in the books of account include: quotation, sales order, purchase order, goods received note, goods despatched note, statement, credit note, debit note, remittance advice, receipt, invoices. International Accounting – Lesson 1

25. Invoices: relate to a sales order or a purchase order Credit note: relates to returned goods or refunds when a customer has been overcharged (regarded as a negative invoice) Other documents: debit notes: might be issued to adjust an invoice already issued goods received notes: record a receipt of goods (most commonly in a warehouse) International Accounting – Lesson 1

26. Books of prime entry • The details of source documents need to be recorded; the records are recorded in books of prime entry,which are: • Sales day book • Purchase day book • Sales returns day book • Journal • Cash book • Petty cash book International Accounting – Lesson 1

27. Sales day book: for credit sales Purchase day book: for credit purchases Sales returns day book: for credit notes raised Purchase returns day book: for credit notes received from suppliers Journal: for transaction which are not recorded in any of the other books of prime entry International Accounting – Lesson 1

28. Cash book: for cash receipts and payments It records all transaction that go through the bank account. Reconciliation of bank statement and cash book Petty cash book: for small payments. A petty cash system is usually subject to strict controls Payments are made in respect of authorised claims All claims are supported by evidence International Accounting – Lesson 1

29. 2. Ledger accounts and double entry Why do weneedledger account ? • Ledger accounts summarise all the individual transaction listed in the books of prime entry . • Record of transaction, assets and liabilities: • in chronological order • built up in cumulative totals • The method used to summarize records is ledger accounting and double entry International Accounting – Lesson 1

30. The nominalledger • Nominal ledger is an accounting record which summarises the financial affairs of a business • The nominal ledger contains detail of: • assets • liabilities • capital • income and expenditure and • profit and loss International Accounting – Lesson 1

31. The accounting equation The accounting equation emphasises the equality between assets and liabilities ( including capital as liability) Accounting equation is: ASSETS=CAPITAL + LIABILITIES International Accounting – Lesson 1

32. The accounting equation Liabilities are trade accounts payable; A payable is a person to whom a business owes money Trade account payable are debts arising from the purchase of material,components or goods for resale Assets are trade accounts receivable International Accounting – Lesson 1

33. The accounting equation Drawings are amount of money taken out of a business by its owner International Accounting – Lesson 1

34. The accounting equation Matching convention revenue earned is matched with the expenses incurred in earning it. International Accounting – Lesson 1

35. Double entry bookkeeping Double entry bookkeeping: each transaction has an equal but opposite effect . Every accounting event must be entered in ledger accounts both as a debit and as an equal but opposite credit. Weekly or monthly, totals are transferred from books of prime entry into the nominal ledger. Every transaction has two effects (dual effect) International Accounting – Lesson 1

36. Double entry bookkeeping • A debt entry will • increase an asset • decrease a liability • increase an expense • A credit entry will • decrease an asset • increase a liability • increase income International Accounting – Lesson 1

37. Double entry bookkeeping Every financial transaction gives rise to two accounting entries (a debit and a credit) Debit entries in the nominal ledger is therefore always equal at any time to the total value of credit entries. Every transaction is recorded twice every debit is balanced by a credit International Accounting – Lesson 1

38. Double entry bookkeeping A cash payment is a credit entry in the cash account The asset is decreasing. Cash may be paid out to pay an expense or to purchase an asset . The matching debit entry is therefore made in the appropriate expense or asset account International Accounting – Lesson 1

39. Double entry bookkeeping A cash receipt is a debit entry in a cash account. The asset is increasing. Cash might be received by a retailer who makes a cash sale. The credit entry would be made in the sales account International Accounting – Lesson 1

40. The rules of double entry bookeeping In terms of 'T' accounts: ASSET LIABILITY CAPITAL DEBIT $ CREDIT $ DEBIT $ CREDIT $ DEBIT $ CREDIT $ Increase Decrease Decrease Increase Decrease Increase For income and expenses, think about profit. Profit retained in the business increases capital. Income increases profit and expenses decrease profit. INCOME EXPENSE DEBIT $ CREDIT $ DEBIT $ CREDIT $ DecreaseIncreaseIncreaseDecrease International Accounting – Lesson 1

41. Credittransaction • Not all transaction are settled immediately in cash or by cheque. • It’s possible: • purchase goods or non-current on credit terms so that the suppliers would be trade accounts payable until settlement was made in cash • grant credit terms to its customers who would be trade accounts receivable of the business International Accounting – Lesson 1

42. Examples of accounts in the nominal ledger Examples of accounts in the nominal ledger include the following: (a) Plant and machinery at cost (b) Motor vehicles at cost (c) Plant and machinery, provision for depreciation (d) Motor vehicles, provision for depreciation (e) Proprietor's capital (f) Inventories – rawmaterials (g) Inventories – finished goods (h) Total trade accounts receivable (i) Total trade accounts payable International Accounting – Lesson 1

43. Examples of accounts in the nominal ledger (j) Wages and salaries (k) Rent and local taxes (l) Advertising expenses (m) Bank charges (n) Motor expenses (o) Telephoneexpenses (p) Sales (q) Total cash or bank overdraft International Accounting – Lesson 1

44. Examples: the accounting equation Mr XY starts a business. The business begins by owning the cash that he has put into it, $2,500. The business is a separate entity in accounting terms and so it owes the money to Mr XY as capital. When Mr XY sets up his business: Capital invested = $2,500 Cash = $2,500 Capital invested is a form of liability, because it is an amount owed by the business to its owner(s). Adapting this to the idea that assets and liabilities are always equal amounts, we can state the accounting equationasfollows. As at 1 July 20X6: Assets = Capital + Liabilities $2,500 (cash) = $2,500 + $0 Mr XY purchases a market stall from Mr K, who is retiring from his fruit and vegetables business. The cost of the stall is $1,800. International Accounting – Lesson 1

45. Examples: the accounting equation He also purchases some flowers and potted plants from a trader in the wholesale market, at a cost of $650. This leaves $50 in cash, after paying for the stall and goods for resale, out of the original $2,500. The assets and liabilities of the business have now altered, and at 3 July before trading begins, the state of his business is as follows. Assets = Capital + Liabilities Stall 1,800 = $2,500 + $0 Flower and plants 650 Cash 50 2,500 The stall and the flowers and plants are physical items, but they must be given a money value. This money value is usually what they cost the business (called historical cost in accounting terms). International Accounting – Lesson 1

46. Examples: the accounting equation On 3 July Mr XY has a very successful day. He sells all of his flowers and plants for $900 cash. Since he has sold goods costing $650 to earn revenue of $900, we can say that he has earned a profit of $250 on the day's trading. Profits belong to the owners of a business. In this case, the $250 belongs to Mr XY. However, so long as the business retains the profits and does not pay anything out to its owners, the retained profits are accounted for as an addition to the proprietor's capital. Assets = Capital + Liabilities Stall 1,800 = Originalinvestment $2,500 Flower and plants 0 Retained profit Cash(50 + 900) 950 (900-650) 250 27502750+ 0 International Accounting – Lesson 1

47. Examples: the accounting equation At the beginning and end of 3 July 20X6, Mr XY’s financial position was as follows. Net assets Capital At the beginning of the day: $(2,500 – 0) = $2,500 = $2,500 (b) At the end of the day: $(2,750 – 0) = $2,750 = $2,750 There has been an increase of $250 in net assets, which is the amount of profits earned during the day. International Accounting – Lesson 1

48. Examples: the accounting equation The next market day is on 10 July and Mr XY purchases more flowers and plants for cash, at a cost of $740. He is not feeling well, because of a heavy cold, and so she decides to accept help for the day from his cousin Ethel. Ethel is to be paid a wage of $40 at the end of the day. Trading on 10 July was again very brisk, and Mr XY and Ethel sold all their goods for $1,100 cash. Mr XY paid Ethel her wage of $40 and drew out $200 for himself. Required (a) State the accounting equation before trading began on 10 July. (b) State the accounting equation at the end of 10 July, after paying Ethel: (i) but before drawings are made. (ii) after drawings have been made. International Accounting – Lesson 1

49. Examples: the accounting equation After the purchase of the goods for $740. Assets = Capital + Liabilities Stall 1,800 Goods 740 Cash (770 – 740) 30 2,570 = $ 2,570 + $0 International Accounting – Lesson 1

50. Examples: the accounting equation (b) On 10 July, all the goods are sold for $1,100 cash, and Ethel is paid $40. The profit for the dayis $320. $ $ Sales 1,100 Less cost of goods sold 740 Ethel's wage 40 780 Profit 320 International Accounting – Lesson 1