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Institut für Betriebswirtschaftslehre

Welcome to

Advanced Financial Accounting

Prof. Dr. Hui Chen

Introduction Advanced Financial Acounting, H. Chen 1

Institut für BetriebswirtschaftslehreImportance of financial accounting

Big Picture: Why is financial accounting important?• Efficient economic resource allocation

Why is there a demand for financial accounting?• To provide financial information that is useful to

capital providers • To assist potential investors and creditors in valuing

the firm• To monitor the actions of management


Institut für BetriebswirtschaftslehreObjectives of financial accounting

To provide information that is:• Useful in investment and credit decisions • Useful in assessing future cash flows • Useful in assessing enterprise resources, claims to

resources and associated changes

“Accounting is the language of business.”


Institut für BetriebswirtschaftslehreAn example – Nestle

Nestle 2017 annual report was just released:https://www.nestle.com/investors/publications/2017

Who prepared the results?Who audited the results?

Who read the results (and attended the conference call and asked many questions)?

How did Nestle do in 2017?What happened to their stock price?

etc…


Institut für BetriebswirtschaftslehreWhat will you learn in AFA class?

Advanced topics in financial accounting:• accounting for corporate investment and business

combination• equity and cost methods of accounting for

investments• how to prepare consolidated financial statements• accounting for foreign currency transactions and

translations• international accounting diversity and regimes• etc.


Institut für BetriebswirtschaftslehreWho needs to know these?

If you work in:• finance & accounting in larger corporations• investment • auditing• financial regulation• etc.


Institut für BetriebswirtschaftslehreWhen you finish…

You should be able to:• understand accounting for investments and business

combination• prepare consolidated accounting statements• feel comfortable in reading and using the information

presented in companies’ financial reports • analyze and evaluate firms’ accounting activities +

choices and their implications• understand the similarities/differences among different

accounting regimes• comment on the current events related to these topics


Institut für BetriebswirtschaftslehreWhat accounting rules does Switzerland use?

As of Jan. 2015:


Institut für BetriebswirtschaftslehreSwiss GAAP FER vs. IFRS vs. U.S. GAAP


• In general, Swiss GAAP FER deals with simple accounting issues for smaller companies

• Advantages: easy to apply, simple to understand, stable over time

• Disadvantages: too simple, doesn’t cover complex transactions and advanced problems

• By nature of the topic, AFA class mainly focuses on IFRS -- because many advanced accounting topics are not covered by Swiss GAAP FER

• Consolidation is however largely the same for all accounting standards

Institut für BetriebswirtschaftslehreWhat if the rules change?


• Accounting is a living/changing/growing institution• IFRS is especially changing constantly• Some of the methods we learn in this class will

change (eg. foreign currency hedging)• However, the fundamental concepts will remain• Keep yourselves informed with future changes

Institut für BetriebswirtschaftslehreTextbook

Advanced Accounting, 13th Edition. Hoyle, Schaefer, Doupnik. McGraw-Hill Publishing, 2017. Official websiteConnet website:http://connect.mheducation.com/class/uzh-spring-2018


Institut für BetriebswirtschaftslehreTextbook Cont.


• The textbook is written mainly for U.S. GAAP users, and discusses IFRS implication in every chapter

• In advanced accounting topics, IFRS and U.S. GAAP are 99% the same (rules are jointly issued)

• Additionally, we will discuss differences in Swiss GAAP FER wherever necessary

Institut für BetriebswirtschaftslehreSupplementary materials


• Consolidated Financial Statements (Meyer, 2009)• Intermediate Accounting (Keiso, Weygandt, and

Warfield, 2014)• Intermediate Accounting, IFRS Edition (Keiso,

Weygandt, and Warfield, 2014)

• Annual reports and 10K filings• Press & research publications

You don’t have to buy any of these above!

Institut für BetriebswirtschaftslehreHow will we learn?


• Lectures• Exercises• Homework• Mini-cases• Real life examples• Guest speakers• Etc.

Institut für BetriebswirtschaftslehreExam and Grading


Final exam • Comprehensive • Written• 90 minutes• Tuesday June 19


Questions?


Institut für BetriebswirtschaftslehreReview of basics

Advanced Financial Acounting, H. Chen 17

• An account shows the effect of transactions on a given asset, liability, equity, revenue, or expense account.

• Double-entry accounting system (two-sided effect).

• Recording done by debiting at least one account and crediting another.

• DEBITS must equal CREDITS.

Accounting cycle

Institut für BetriebswirtschaftslehreThe five fundamental reporting elements


• Assets

• Liabilities

• Shareholders’ equity

• Revenues

• Expenses

Accounting cycle

Institut für BetriebswirtschaftslehreDebits and credits


Chapter 3-23

AssetsAssetsDebit / Dr. Credit / Cr.

Normal BalanceNormal Balance

Chapter 3-27

Debit / Dr. Credit / Cr.


ExpenseExpense

Chapter 3-24

LiabilitiesDebit / Dr. Credit / Cr.

Normal Balance

Chapter 3-25


Normal Balance

Stockholders’ Equity

Chapter 3-26



RevenueRevenue

Normal Balance Credit

Normal Balance Debit

Accounting cycle

Institut für BetriebswirtschaftslehreThe accounting equation


Relationship among the assets, liabilities and stockholders’ equity of a business:

The equation must be in balance after every transaction. For every Debit there must be a Credit.

Accounting cycle

Institut für BetriebswirtschaftslehreThe accounting cycle


Transactions

1. Journalization

6. Financial Statements

7. Closing entries

8. Post-closing trail balance

9. Reversing entries

3. Trial balance

2. Posting

5. Adjusted trial balance

4. AdjustmentsWork Sheet

Accounting cycle

Institut für BetriebswirtschaftslehreTransactions and events


What to record?

“transactions and other events and circumstances that affect a business enterprise.”

Types of Events:• External – between a business and its environment.

• Internal – event occurring entirely within a business.

Accounting cycle


Accounting cycle

Example – Rod’s chocolate factory


Rod started a chocolate factory: Jan. 3. Rod invested 100,000 CHF of his own money into the business.

Jan. 10. Rod borrowed 150,000 CHF from Zürcher Kantonalbank to finance his purchase of a factory building (12% annual interest, payable every half year).

Jan. 15. Rod purchased 60,000 CHF worth of production materials (cocoa powder, milk, sugar, etc.) on account.

Jan. 15. Rod hired Limmat Werbeagentur for advertising service.

Jan. 20. Rod sold his first batch of chocolate products to Coop on account for 75,000 CHF, which costed 30,000 CHF to produce.

Jan. 25. Rod hired an accountant to take care of his financial matters starting to work on February 1st.

Jan. 29. Coop paid Rod 40,000 CHF.

Institut für BetriebswirtschaftslehreCharter of accounts


Acct. No. Account100 Cash105 Accounts receivable110 Inventory130 Building200 Accounts payable220 Note payable300 Common stock330 Retained earnings400 Sales500 Cost of goods sold

…

Chart of Accounts

Accounting cycle

Assets

Liabilities

Equity

Revenues

Expenses


Account Title Ref. Debit CreditDate

1. Journalizing


General Journal – a chronological record of transactions. Journal Entries are recorded in the journal.

General Journal

Accounting cycle

Institut für Betriebswirtschaftslehre1. Journalizing cont.


Date Account Title Ref. Debit CreditJan. 3 Cash 100 100'000

Common stock 300 100'000

10 Building 130 150'000 Note payable 220 150'000

15 Inventory 110 60'000 Accounts payable 200 60'000

20 Accounts receivable 105 75'000 Sales 400 75'000

20 Cost of goods sold 500 30'000 Inventory 110 30'000

29 Cash 100 40'000 Accounts receivable 105 40'000

Accounting cycle

Institut für Betriebswirtschaftslehre2. Posting


Posting – the process of transferring amounts from the journal to the ledger accounts.

Cash Acct. No. 100Date Explanation Ref. Debit Credit Balance

General Ledger

Account Title Ref. Debit CreditJan. 3 Cash 100,000

Common stock 100,000

Date

General Journal

Jan. 3 Sale of stock GJ1 100,000 100,000

100

GJ1

Accounting cycle

Institut für Betriebswirtschaftslehre2. Posting cont.


Cash Acct. No. 100Date Explanation Ref. Debit Credit BalanceJan. 3 Sale of common stock GJ 100'000 100'000

20 GJ 40'000 140'000

Accounts Receivable Acct. No. 105Date Explanation Ref. Debit Credit BalanceJan. 20 GJ 75'000 75'000

GJ 40'000 35'000

Inventory Acct. No. 110Date Explanation Ref. Debit Credit BalanceJan. 15 GJ 60'000 60'000

20 GJ 30'000 30'000

Building Acct. No. 130Date Explanation Ref. Debit Credit BalanceJan. 10 GJ 150'000 150'000

Accounting cycle


Accounting cycle

2. Posting cont.


Accounts payable Acct. No. 200Date Explanation Ref. Debit Credit BalanceJan. 15 GJ 60'000 (60'000)

Notes payable Acct. No. 220Date Explanation Ref. Debit Credit BalanceJan. 10 GJ 150'000 (150'000)

Common stock Acct. No. 300Date Explanation Ref. Debit Credit BalanceJan. 3 Sale for cash GJ 100'000 (100'000)

Retained Earnings Acct. No. 330Date Explanation Ref. Debit Credit Balance

-

Sales Acct. No. 400Date Explanation Ref. Debit Credit BalanceJan. 20 GJ 75'000 (75'000)

Cost of Goods Sold Acct. No. 500Date Explanation Ref. Debit Credit BalanceJan. 20 GJ 30'000 30'000

Institut für BetriebswirtschaftslehreDouble check with the accounting equation

Advanced Financial Acounting, H. Chen 30Accounting cycle

= +Accounts Accounts Notes Common Retained Cost of

Cash Receivable Inventory Building Payable Payable Stock Earnings Sales Goods Sold1. 100'000 100'000 2. 150'000 150'000 3. 60'000 60'000 4. 75'000 (30'000) 75'000 30'000 5 40'000 (40'000)

140'000 35'000 30'000 150'000 = 60'000 150'000 + 100'000 - 75'000 30'000

Assets Liabilities Equity= +Accounts Accounts Notes Common Retained Cost of

Cash Receivable Inventory Building Payable Payable Stock Earnings Sales Goods Sold1. 100'000 100'000 2. 150'000 150'000 3. 60'000 60'000 4. 75'000 (30'000) 75'000 30'000 5 40'000 (40'000)

140'000 35'000 30'000 150'000 = 60'000 150'000 + 100'000 - 75'000 30'000

Assets Liabilities Equity

Institut für Betriebswirtschaftslehre3. Trial balance


Trial Balance – a list of each account and its balance; used to prove equality of debit and credit balances.

Acct. No. Account Debit Credit100 Cash 140'000CHF 105 Accounts receivable 35'000 110 Inventory 30'000 130 Building 150'000 200 Accounts payable 60'000.00CHF 220 Note payable 150'000 300 Common stock 100'000 330 Retained earnings400 Sales 75'000 500 Cost of goods sold 30'000

385'000.00CHF 385'000.00CHF

Accounting cycle

Institut für Betriebswirtschaftslehre4. Adjusting Entries


• Revenues - recorded in the period in which they are earned.

• Expenses - recognized in the period in which they are incurred.

• Adjusting entries - needed to ensure that the revenue recognition and matching principles are followed.

Accounting cycle

Institut für Betriebswirtschaftslehre4. Adjusting Entries – types of adjustment


1. Prepaid Expenses.Expenses paid in cash and recorded as assets before they are used or consumed.

Prepayments3. Accrued Revenues.

Revenues earned but not yet received in cash or recorded.

4. Accrued Expenses.Expenses incurred but not yet paid in cash or recorded.

2. Unearned Revenues.Revenues received in cash and recorded as liabilities before they are earned.

Accruals

Accounting cycle



Rod owes Zürcher Kantonalbank for monthly interest of CHF 1,500.

Accrued interest expense 1,500Interest expense 1,500Jan. 31

Debit CreditInterest Expense

1,500 1,500

Debit CreditAccrued Interest Expense

Example -- adjusting unpaid expenses

Accounting cycle



Rod’s factory building has a 10 year useable life, with salvage value of CHF 30,000. It has depreciated by CHF 1,000.

Accumulated depreciation 1,000Depreciation expense 1,000Jan. 31

Debit CreditDepreciation expense

1,000 1,000

Debit CreditAccumulated depreciation

Example -- adjusting for depreciation

Accounting cycle



Rod also decides to withdraw CHF 2,000 as dividend for himself.

Cash 2,000Dividend 2,000Jan. 31

Debit CreditDividend

2,000 2,000

Debit CreditCash

Dividend declared and paid

Accounting cycle

Institut für Betriebswirtschaftslehre5. Adjusted Trial Balance


Adjusted Trial Balance Debit CreditCash CHF 138'000Accounts receivable 35'000 Inventory 30'000 Building 149'000 Accounts payable 60'000 Note payable 150'000Accrued interest payment 1'500Common stock 100'000 Retained earnings -Dividends 2'000 Sales 75'000 Cost of goods sold 30'000 Interest expense 1'500 Depreciation expense 1'000

386'500.00CHF 386'500.00CHF

Accounting cycle

Institut für Betriebswirtschaftslehre6. Preparing financial statements


Financial Statements are prepared directly from the Adjusted Trial Balance.

Balance Sheet

Income Statement

Statement of Cash Flows

Statement of Retained Earnings

Accounting cycle

* We assume Rod’s company at this stage is still a private firm.



Income StatementAdjusted Trial Balance

Exercise – preparing financial statements


386'500.00CHF 386'500.00CHF

Income StatementRevenues:

Sales 75'000CHF Expenses:

Cost of goods sold 30'000 Interest expense 1'500 Depreciation expense 1'000

Total expenses 32'500 Net income 42'500$

Accounting cycle




Adjusted Trial Balance



386'500.00CHF 386'500.00CHF


Beginning balance CHF -+ Net income 42'500 - Dividends (2'000) Ending balance 40'500

Accounting cycle



Balance SheetAdjusted Trial Balance



386'500.00CHF 386'500.00CHF

AssetsCash 138'000.00CHF Accounts receivable 35'000 Inventory 30'000 Building 149'000

Total assets 352'000CHF LiabilitiesAccount payable 60'000.00CHF

Note payable 150'000 Accrued interest payment 1'500

Stockholders' equityCommon stock 100'000 Retained earnings 40'500

Total liab. & equity 352'000CHF

Accounting cycle

Institut für Betriebswirtschaftslehre7. Closing entries


• To reduce the balance of the income statement (revenue and expense) accounts to zero.

• To transfer net income or net loss to owner’s equity.

• Balance sheet (asset, liability, and equity) accounts are not closed.

• Dividends are closed directly to the Retained Earnings account.

Accounting cycle


Accounting cycle Advanced Financial Acounting, H. Chen


386'500.00CHF 386'500.00CHF

7. Closing entries

43

Prepare the Closing journal entry from the adjusted trial balance on the previous slide.

Balances should be zero close to Income

Summary

Close to R/E

Which accounts need to be closed?

Institut für BetriebswirtschaftslehreExercise -- closing entries


Prepare the Closing journal entry from the adjusted trial balance on the previous slide.

Sales 75,000Income summary 75,000

Income summary 32,500Cost of goods sold 30,000Interest expense 1,500Depreciation expense 1,000

Income summary 42,500Retained earnings 42,500

Retained earnings 2,000Dividends declared 2,000

Accounting cycle

Institut für Betriebswirtschaftslehre8. Post-closing trial balance


Adjusted Trial Balance Debit CreditCash CHF 138'000Accounts receivable 35'000 Inventory 30'000 Building 149'000 Accounts payable CHF 60'000Note payable 150'000Accrued interest payment 1'500Common stock 100'000 Retained earnings 40'500 Dividends -Sales -Cost of goods sold -Interest expense -Depreciation expense -

CHF 352'000 352'000CHF

Accounting cycle



Statement of cash flows

Accounting cycle

Operating activitiesNet income 42'500CHF Deduct increase in accounts receivable 35'000 Deduct increase in inventory 30'000 Add increase in accounts payable 60'000 Add accrued interest payment 1'500 Add depreciation expense 1'000

Cash provided in operating activities 40'000CHF Investing activities Pruchase of building 150'000CHF

Cash used by investing activities 150'000CHF Financing activities Equity investment 100'000CHF Deduct divident payment 2'000

Bank loan 150'000 Cash provided by financing activities 248'000CHF Net increase in cash 138'000CHF Cash at beginning of the period -Cash at end of the period 138'000CHF

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