FADM 1, Class 1

FADM 1 - Professor Ramana

Class 1

Accounting Environment (It consists of Standards & Relevant laws)

IFRS – International Financial Reporting Standards (Singapore FRS, All European companies follow IFRS, India and US to follow 2011 – Currently follow GAAP). Older version is International Accounting Standard (Focus shifted from accounting to reporting). Accounting is recording the transaction, but reporting is not just recording, but informing to the investor – making financial statement more relevant for user.

Investor can be equity investor / shareholder or can be a debt investor (Giving loan to company, buying bonds of company). Investor is hence a broader category.

Primarily, financial statements are for equity shareholders, who are primary investor (Letter to Shareholder – mentioned in Financial Statement). However, it has the ability to address all the stakeholders.

2 strands of processes happening

v IFRS adopted country – China (Blindly follow IFRS issued by somebody else)

v Converge with IFRS – India, Singapore (Respective countries accounting standards issued in line with IFRS)

IFRS is issued by IASB, London (International accounting standard board). Europe has followed IFRS from 2005 onwards (for all listed companies). For the change, one must change the respective local laws. 1^st office outside London is in Malaysia.

Conceptual framework (IFRS framework) for preparing financial statement (FS)

1) Preparing the FS

2) Using the FS

Accounting is the process of converting the business decisions into financial statements

1) Business decision

a. Financing Decisions (FD) – Entire CF rotates around it

i. Own Money - Equity

ii. Loan Money - Debt

b. Investing Decisions (ID)

i. Invariably results in acquisition of asset, stock, another business

c. Operating Decisions (OD)

i. Day to day activities

2) Process

a. Process is called financial accounting, governed by IFRS or respective GAAP

3) Financial statements

a. Statement of Financial position – Balance Sheet

i. It is true on a particular date

b. Statement of Comprehensive Income – Income Statement

c. Statement of changes in equity

d. Statement of Cash-flows – Cash Flow Statement

The process of converting the business decisions into financial statements can be explained with the framework of ACCOUNTING EQUATION

1) IFRS Framework

a. Economic resources & the corresponding claims (who has claim on the assets – debt holder and equity holder) – Every organization has some economic resources and these resources are not free (these resources have corresponding claims for debt & equity holders)

i. SOURCES = ASSETS (Assets of a firm must be supported by corresponding claim from equity or debt holder, somebody will have a claim)

1. Sources are classified as Debt or Equity

2. Asset: Cash or non-cash items

3. Assets = Equity + Debt (Most Important relationship in accounting). It is company’s equation as company is having the asset.

4. How a company is financing its assets – Whether by Debt or Equity

5. E = A – D (Residuary claim of a share-holder – Left over claim). It is shareholder’s equation. One can’t write D = A – E as it is wrong because first debt holder is serviced in case of any claim (say when company is liquidated) & then equity holders are serviced.

i. Equity is the book value of the firm

ii. D/E is called capital structure (Financial Restructuring). (D+E) will show size of asset or size of finance.

6. Source

a. Capital – Money contributed by the owners / shareholder

i. Owner / Shareholder gets the right to vote & right to dividend

ii. Dividend is not mandatory (May or may not be given)

b. Loan / Liability / Debt / Outsiders Money – Money contributed by the outsider

i. No voting rights, but gets interest (Interest is mandatory and given even in case company is at loss) & has first claim

c. Profit / Reserves – Excess of Sales over cost. It is a source. It is the money generated by the business.

7. Source

a. Capital + Profit (Owners money / Equity / Net Worth / Net Assets / Book Value). Infosys is equity financed company (as debt is zero & every asset is financed by company)

b. Loans

c. Sources side in BS will change only is there is a financing decision (involving equity & debt)

Acquisition of Asset will result in one of the following (Assets can financed by Capital / Loan / Profits)

v Decrease in Cash

v Increase in Liability

v Increase in Capital