Finance and Managerial Accounting Note

Finance and Managerial Accounting
(MBA 521)
Chapter One
Uses of Accounting Information and
the Financial Statement
Instructor: Habtamu B. Abera [PhD]

Learning Objectives
• After studying this chapter, you should be able to:
– Explain what accounting is and describe its role in making
informed decisions
– Identify the users and uses of accounting
– Identify business goals and activities
– Explain, briefly, the difference between Financial
Accounting and Managerial Accounting
– Define financial position and the accounting equation
– Identify the four basic financial statements

Accounting as an information system
• Accounting is an information system that measures,
processes, and communicates financial information
about an economic entity.
• What is an economic entity?
• Accounting is a link between business activities and
decision makers.
– Accounting measures economic or business activities by
recording data about them for future use
– The data are stored until needed and then processed to
become useful information
– The information is communicated through reports to decision
makers.

Accounting
information
The
accounting
process
Decision
makers
Economic
or Business
activities
Actions
(decisions)
Accounting “links”
decision makers
with economic
activities ¾ and
with the results of
their decisions.
Reports
Results of
Actions
(decisions)

Management
There are two broad groups
of users of financial
information: internal users
and external users.
Human
Resources
Researchers
Labor
Unions
AABE
Marketing
Finance
Investors
Creditors
Customers
Internal Users
External
Users
Users and Uses of Accounting Information

Users and Uses of Accounting Information
Primary
Users

Common Questions Asked User
1. Can we afford to give our
employees a pay raise?
Human Resources
2. Did the company earn a
satisfactory income?
3. Should any product lines be
eliminated?
4. Is cash sufficient to pay dividends
to stockholders?
5. What price for our product will
maximize net income?
LO 2
6. Will the company be able to pay
its debts as they become due?
Investors
Management
Finance
Marketing
Trade Creditors
Uses and Users of Accounting Information

Exercise
• What does the term ‘accounting’ mean?
a) The act of reporting
b) The act of collecting, organizing, and interpreting
financial data
c) The act of filing receipts from transactions
d) The act of recording financial data to be used later
e) The act of writing checks in a check register

Exercise
• Why is accounting important to business?
a) It lets a business owner know how much money
s/he is making
b) It lets a business owner know how much money
s/he spending.
c) It provides the information that a business needs to
file taxes with ERCA
d) It lets a business owner know what her/his assets
are worth
e) All of the answers are correct

Information
Users
 Managers
 Investors
 Creditors
 Owners
 Customers
 Employees
 Regulatory
agencies
 General
Public
Decision
Supported
 CVP analysis
 Performance
evaluation
 Ratio analysis
 Incremental analysis
 Budgeting
 Capital allocation
Accounting Information System
Financial information provided
Cost & Revenue Determination
 Job costing
 Process costing
 ABC
 Sales
Assets, Liabilities & Equity
 Cash, Receivables, inventory
 Plant, Property and equipment
 ST Payables, Loans &
 Equity
Cash Flows
 From operations
 From financing
 From investing

Issues Discussed
• Defining Accounting
• Identifying users and uses of
accounting information
• Financial Information provided and
decisions supported

Business Goals and Activities
• A business is an economic entity that aims to sell goods and
services to customers at prices that will provide an adequate
return to its owners.
• E.g. You name three businesses /entities you know! [1 min.]
• Do you think all the businesses /entities you named have similar
goals and activities? Y or N , Why? [1 min]
• Despite their differences, all businesses have similar goals and
engage in similar activities.
• Business Goals:
– Profitability
– Liquidity
• Business Activities:
– Operating
– Investing
– Financing

Exercise
 Which of these transactions would not be an example of the
operating activities?
a) credit purchase of inventory
b) sales of product, for cash
c) cash paid for purchase of equipment
d) salary payments to employees
 Which of these transactions would be part of the financing
activities?
a) Land purchased for cash
b) cash paid as a repayment of bank loan
c) sales of product, on account
d) dividend payments to shareholders, paid in cash

Financial Accounting Vs Managerial Accounting
• Financial Accounting:
– The day-to-day processing of an organisation’s
financial transactions and the summarising of
those transactions to satisfy the information needs
of the primary and other user groups shown
previously.
– It is sometimes referred to as meeting the external
accounting needs of the organisation.
– Subject to many rules and regulations (a
regulatory framework) imposed by company
legislation, stock exchange regulations and
financial reporting standards.

Financial Accounting Vs Managerial Accounting
• Managerial Accounting:
– Sometimes referred to as meeting the internal
accounting needs of the organisation, as it is
designed to help managers with decision-making
and planning.
– Unlike financial accounting, it often involves
estimates and forecasts.
– It is not subject to the same regulatory
framework as financial accounting.

Externally
Reported
Information
Features
A means
to an End
Broader
than FS
Historical
in Nature
Results from
Inexact and
Approximate
Measures
Based on
General-
Purpose
Assumption
Usefulness
Enhanced via
Explanation

Features
of MAI
A means
to an End
Importance
of
Timeliness
Identity of
Decision
maker
Oriented
towards the
future
Measures of
Efficiency
& Effectiveness

Financial Position and the Accounting Equation
• Financial position:
– refers to a company’s economic resources, such as cash,
inventory, and buildings, and the claims against those
resources at a time.
• Claims are also called equities
• Economic Resources = Creditors’ Equities + Owners’ Equities
• In accounting, economic resources are called ASSETS, and
creditors’ equities are called LIABILITIES
• ASSETS = LIABILITIES + OWNERS’ EQUITY

• The accounting equation can also be expressed as:
• ASSETS – LIABILITIES = OWNERSHIP INTEREST
• The ownership interest is the residual claim after
liabilities to third parties have been satisfied. The
equation expressed above emphasizes this aspect.
Assets Minus Liabilities Equals Ownership Interest (OI)

• In a corporate business or entity, the accounting equation
can be read as:
• ASSETS = LIABILITIES + SHAREHOLDERS’ EQUITY
• Or
• ASSETS – LIABILITIES = SHAREHOLDERS’ EQUITY
• The shareholders’ equity has two parts:
– contributed capital and
– retained earnings
• Contributed capital:
– is the amount that shareholders invest in the business which is
represented by shares of capital stock
– Is divided between par value and additional paid in capital

• Example:
– Ato Birru bought 10,000 shares of GENZEB S. Co at Br. 2500 each
where the par value of the share of the Company is Br. 1000 a share.
a. Compute the total investment made by Ato Birru
b. What is the value of the additional paid in capital (PIC)?
• Soln.
a. Investment value Br. 2500/share x 10,000 shares = Br. 25,000,000
b. The value at par = Br. 1000/share x 10,000 shares = Br. 10,000,000.
Then, the additional Paid In Capital is Br. 15,000,000
i.e. Br. 25,000,000 – Br. 10,000,000.
• Retained Earnings:
– Represent shareholders’ equity that has been generated by the
business’s income producing activities and kept for use in the
business.

Exercises
1. The assets of ABC Co. are Br. 240,000, and the liabilities
are Br. 90,000. What is the amount of the stockholders’
equity?
2. The liabilities of PS Co. equal one-fifth of the total assets.
The stockholders’ equity is Br. 40,000. What is the amount
of the liabilities?

Exercises
3. At the beginning of the fiscal year of 2019, ENAT Bank S.
Company’s assets were Br. 6.5 Billion and its shareholders’ equity
was Br. 1.2 Billion. During the fiscal year, assets increased by Br. 2.7
Billion and liabilities increased by Br. 2.4 Billion. What was the
shareholders’ equity at the end of the fiscal year 2019?
4. In CK Corp. liabilities of Br. 50,000 and stockholders’ equity of Br.
96,000 was reported at the beginning of year II. In year II, if assets
increased by Br. 40,000 and liabilities decreased by Br. 30,000,
what was the stockholders’ equity at the end of year II?

Effects of Business Transactions on the accounting
equation
• Assume, Ato Ahmed started his own consulting business
on Meskerem 1, 2012. Some of the transactions of the
same month are indicated below.
• Mes. 3 He transferred Br. 500,000 cash to the business.
• Mes. 5 Purchased office equipment Br. 20,000 cash
• Mes. 15 Received cash from customers Br. 45,000 cash
• Mes. 19 Purchased Office supplies Br. 12,000 on credit
• Mes. 20 Provided Br. 25,000 services to customers on
account.
• Mes. 30 Received Br. 10,000 in partial collection from
customers.

Financial Statements
a financial statement is simply a
declaration of what is believed to be true
about an entity, communicated in terms of
a monetary unit, such as the Birr.
a financial statement includes:
- Balance sheet
- Income statement
- Statement of cash flows
- Statement of changes in equity

Balance Sheet
/Statement of Financial
Position/

Statement of Financial Position
• Statement of financial position or balance
sheet lists all resources, obligations /claims/
and net worth of an economic entity on a
specific date, usually at the last date of the
fiscal period.
• Resources are ASSETS
• Obligations are LIABILITIES or CLAIMS
• Net worth are EQUITIES or OWNERS’
INTEREST

Uses of the statement of financial position
Can provide a basis for assessing the value of the
business
To assess the relationships between assets and
claims
Shows how the business is financed and how funds
are deployed
Performance can be better assessed

Defining Basic Terms of the Balance Sheet
• Assets: an asset is defined as
– a resource controlled by the entity as a result of past
events and from which future economic benefits are
expected to flow to the entity.

Features of an asset
• A probable future benefit must exist
– Evidence of existence or happening
• The business must have the right to control the
resources
• The benefit must arise from some past transaction
or event
• The asset must be capable of measurement in
monetary terms
• Note:
• All four of these conditions must apply. If one of them is
missing, the item will not be treated as an asset for accounting
purposes

Exercise
• Indicate which of the following items could appear as an asset
on the statement of financial position of a business. Explain
your reasoning in each case.
a) Br. 1,000 owed to the business by a customer who is unable
to pay.
b) A patent, bought from an inventor, that gives the business the
right to produce a new product. Production of the new
product is expected to increase profits over the period during
which the patent is held.
c) A new marketing director, whom the business had recently
hired, who is confidently expected to increase profits by over
30 per cent during the next three years.
d) A recently purchased machine that will save the business Br.
10,000 each year. It is already being used by the business but
it has been acquired on credit and is not yet paid for.

Categories of ASSETS
• An entity’s assets can be categorized into two as:
• Current assets and
• Long-term assets
• Current assets bring short-term benefits to an entity which will
be consumed or converted into cash within one accounting
period.
• Long-term assets will give long term benefit and which cannot
be converted into cash easily within a year (i.e. more than one
accounting period).

• Liabilities: a liability is as
– a present obligation of an entity arising from past events,
the settlement of which is expected to result in an outflow
from the entity of resources embodying economic
benefits
– Present obligation: a legal obligation is evidence that a
liability exists because there is another person or entity
having a legal claim to payment. (either by contract or
statute law).
– Past events: … finding some reasonably objective way
of confirming existence of a liability.
– Outflow of economic benefits: when the resource of
cash is the economic benefit transferable in respect of
most obligations.

The classification of Liabilities
Current liabilities
Non-current liabilities

 Owners’ Equity:
– represents the owners’ claims on the assets of the
business. Because liabilities or creditors’ claims have
legal priority over those of the owners, owners’ equity
is a residual amount.
– Owners’ equity does not represent a specific claim to
cash or any other particular asset. Rather, it is the
owners’ overall financial interest in the entire
company
• Owners’ Equity: consists of
– Contributed Capital or PIC (cash raised from the issuance of
shares)
– Earned Capital (retained earnings). Which is updated each
period as follows:

Examples of Equity Accounts
• Common stock — par value received from the
original sale of common stock to investors.
• Preferred stock— value received from the original
sale of preferred stock to investors; preferred stock
has fewer ownership rights compared to common
stock.
• Additional paid-in capital — amounts received from
the original sale of stock to investors in addition to
the par value of common stock.
• Treasury stock — amount the company paid to
reacquire its common stock from shareholders.
• Retained earnings — accumulated net income
(profit) that has not been distributed to stockholders
as dividends.

Exercise
• Use the following accounts and balances to prepare
a balance sheet with the accounts in proper order
for Global Company at June 30, 2020.
– Accounts Receivable Br. 1,600
– Bonds Payable 10,000
– Wages Payable 700
– Retained Earnings 4,700
– Common Stock 14,000
– Building 22,000
– Cash ?

Main Issues Discussed in the previous sessions
• Defining Accounting
• Identifying users and uses of accounting information
• Businesses Goals and Activities
• Distinction between Financial Accounting and Managerial
Accounting
• Financial Position and the Accounting Equation
– FP = Company’s economic resource with claims against them on a
particular date
- Accounting Equation => A = L +E or A – L = E
• Balance sheet
– Assets can be Current & Non-current
– Liabilities Can be current & non-current
– Equity Include contributed Cap. & RE
• Why we don’t have Current & non-current classification in
Equity ? [bonus 3 marks]

• Reports on an entity’s revenues, expenses and
the net change in revenue over a given period
of time.
• Hence, shows a company’s profit or loss over a
given period of time
Income Statement

When are Revenues and Expenses Recognized?
• Revenue Recognition Principle—recognize
revenues when earned
• Matching Principle—recognize expenses
when incurred.

Profit vs. Cash
• Net Income does not necessarily correspond to a net cash
flow. A firm could have “good income” but “poor cash flow”
or vice versa (i.e., there are two dimensions to consider).

Operating vs. Nonoperating
• Operating expenses are the usual and
customary costs that a company incurs to
support its main business activities.
• Non-operating expenses relate to the
company’s financing and investing activities

Statement of
Shareholders’ Equity

Statement of Stockholders’ Equity
• Statement of Equity is a reconciliation of
the beginning and ending balances of
stockholders’ equity accounts.
• Main equity categories are:
– Contributed capital
– Retained earnings
– Treasury stock

Articulation of Financial Statements
• Financial statements are linked within and
across time – they articulate.
• Balance sheet and income statement are
linked via retained earnings.

Statement of Cash Flows
• Statement of cash flows (SCF) reports cash inflows and
outflows
• Cash flows are reported based on the three business
activities of a company:
– Cash flows from operating activities - Cash flows from the
company’s transactions and events that relate to its
operations.
– Cash flows from investing activities - Cash flows from
acquisitions and divestitures of investments and long-term
assets.
– Cash flows from financing activities- Cash flows from
issuances of and payments toward borrowings and equity.

Relationships among Financial Statements

Exercise
• TS Corporation engaged in activities during the first year of its
operations that resulted in the following: service revenue, Br.
4,800.00; total expenses, Br. 2,450.00 (24% of which are non-
operating); and dividends, 10% of profit after tax
• In addition, the year-end balances of selected accounts were as
follows:
• Cash, Br. 1,405.00; Accounts receivable, Br. 480.00; Prepaid
Expenses, Br. 360.00; Other current Assets, Br. 640.00; Building,
Br. 1,234.00; Machinery, Br. 911.50; Accounts Payable, Br. 820.00;
Accrued Liabilities; Br. 340.00; long-term liabilities; Br. 1,330.00,
Common Stock, Br. 800.00; Paid in Capital; Br. 260.00 If the
balance of retained earnings at the beginning of the year was
zero and profit tax is 30% , prepare the income statement,
statement of Retained Earnings and balance sheet for TS Corp.
(assume the year ends on December 31, 2019).

Solution
• Revenue……………………….……………….……….. Br. 4,800
• Less: Expenses:
• Operating Exp. ... Br. 1,862
• Non-operating …. 588
• Total Expenses……………………… 2,450
• Profit Before Tax …………………………..….. Br. 2,350
• Less: Profit Tax (30%)………………..…… 705
• Net Income or profit after tax……… Br. 1,645
TS Corp.
Income Statement
For the Year Ended Dec. 31, 2019

Solution
• Beginning Balance, Jan. 1, 2019 ….……….. Br. 0
• Add: Net Income or Profit after tax…. 1,645.00
• Sub-total ……………………………………… Br. 1,645.00
• Less: Dividend (10% of Profit after Tax) ……. 164.50
• Ending Balance, Dec. 31, 2019……….… Br. 1,480.50
TS Corp.
Statement of Retained Earnings
For the Year Ended Dec. 31, 2019

Solution TS Corp.
Statement of Financial Position
Dec. 31, 2019
ASSETS LIABILITIES AND EQUITY
Current Asset Current Liabilities
Cash …………………………………… Br. 1,405.00 A/Payable …………….……... Br. 820.00
Accounts Receivable……………… 480.00 Accrued Liab. ……………….. 340.00
Prepaid expenses ………………… 360.00 Total Current Lia. …... Br. 1,160.00
Other Current Assets …………. 640.00 Long-term Liab. ……………. 1,330.00
Total Current Assets ……. Br. 2,885.00 Total Liab. …………………… Br. 2,490.00
Non-current Assets Equity
Machinery …………………………… Br. 911.50 Common Stock……………... Br. 800.00
Building ……………………………… 1,234.00 Paid – in – Capital…..…… 260.00
Total Non-current Assets . Br. 2,145.50 Retained earnings….. ….. 1,480.50
Total Equity…………………. . Br. 2,540.50
Total Assets …………………………. Br. 5030.50 Total Lia. & Equity ………... Br. 5,030.50

Find the missing figures (assume no new investments by shareholders)
Income Statement
Revenues Br. 2,775.00
Less: Expenses [a]
Net Income [b]
Statement of Retained Earnings
Beg. Balance Br. 7,250.00
Add:Net Income [c]
Less: Divdends 500.00
Ending Balance 7,500.00
Balance Sheet
Total Assets [d]
Liabilities 4,000.00
Shareholders' Equity
Common Stock 5,000.00
Retained Earnings [e]
Total Liab. & Shareholders' Equity [f]
b =c = Br. 750.00
a=Br. 2,025.00
e= Br. 7,500.00 and d= Br. 8,500
Exercise

End of Chapter One
Managerial Accounting
(MGT 5160)

Finance and Managerial Accounting Note

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