On reading chapter 2 and 3 of the study guide, I was looking forward to understanding financial statements and as we had received our company at the end of week 1, I was keen to get started on my next steps of the assignment.
I read Chapter 2 which I understood talked mainly about the fact that accounting has rules, where they came from and who regulates them with the line that there is no way one person can remember all of these rules – this line had me slightly worried as I was also reading the next steps to our assignment (steps 3-6). Having not studied accounting before – the idea of understanding financial statements was rather worrying as I had not come across this in the study guide as yet and worried I would find myself out of my depth again with this subject in Week 3. However, a few cups of tea later and remembering confidence is key – I realised chapter 3 introduces us to understanding financial statements. This was a calming realisation.
The key concepts I identified from chapter 2 included the difference between financial accounting (providing accounting information to people outside the firm) and management accounting (providing accounting information to people inside a firm), the fact that financial statement requirements for listed companies in Australia are set out in the Generally Accepted Accounting Principles (GAAP) which provide the minimum standards that must be followed by any reporting entity/ company (e.g company, partnership, sole trader or government entity) that prepare and issue general purpose financial statements. Another key concept I found was that the Australian Accounting Standards Board (AASB) sets the Australian Standards in Australia, adopting the International Financial Reporting Standards (IFRS) with slight variations for our country. I found it interesting to read that the standards are set by the International Accounting Standards Board (IASB) based in London with an interesting statistic that three-quarters of the 193 countries currently in the United Nations adopt these IFRS Standards.
Another key concept I noted down from this chapter was that the Corporations Act makes the IFRS Standards legally binding in Australia.
The IASB Conceptual Framework for Financial Reporting was something I had also noted regarding its objectives towards providing financial information that would be helpful to potential or current investors as well as others who may read them for the purpose of making decisions.
This chapter also covered accrual accounting (when economic substance occurs not necessarily when cash changes hands), which from watching Martin's video regarding this, I understand deciding when the economic substances have changed hands is based on judgments and this is where people may struggle to get it right. I look forward to all the learning of this unit so that I am confident in my judgments to get it right.
I had also noted down two other definitions of concepts mentioned in the reading. The idea of the going concern assumption, the idea that a firm will continue to operate into the future when preparing financial statements and also materiality which decides if a piece of information is important to be included in financial statements if it will positively or negatively affect any decisions being made by the people reading the statements if it will then it needs to be included in the statements.
Something that I did not know was that there are no set specific rules to the way that financial statements need to be set-out or named and I was looking forward to this being in a set way, I don't know why I assumed this would be covered under "rules of accounting" with a standard set of precedent documents widely used but I hoped it would so that it would make it easier for people such as myself with limited exposure to these types of documents to locate and understand certain items as the first thing I did when I received my company was find its website and try and locate its annual report and financial statements.
My hope after reading chapter 3 is that financial statements are not as scary as I once thought. I like that four general-purpose financial statements are being the balance sheet, the income statement, statement of changes in equity and statements of cash flow.
When reviewing my company's reports, understanding these four financial statements will allow me to understand the business reality of the company better. Remembering that the Balance Sheet (produced once a year) details a firms financial position on a single day with Assets, Equity and Liabilities while the Income Statement details Revenue, Expenses and profit over a set period will help me to follow what details to look out for when identifying the information to review.
The 5 elements of accounting are represented within the balance sheet and income statement being:
Assets + Expenses + Equity + Revenue + Liabilities.
The other financial statements of Statement of Changes in Equity and Statement of Cash Flows will assist with gaining a glimpse into how equity and cash flow have changed over a set period for the firm.
The details regarding 'non – controlling interests' or 'minority interests' will be something to look out for regarding a company. I noted this key concept that if a parent company has subsidiaries, there will be footnotes to detail what they are. I noted from the reading that if there is a parent company, we are only interested in reviewing the 'consolidated accounts' which applies to all financial statements. I believe this key concept to be important in my review of the company I have been assigned in this unit.
I noted down mainly points from this chapter that would assist me with understating the financial statements of the company I have been assigned. Such as a Statement of Change in Equity shows over a period various changes in shareholder equity and various transfers with the equity investors (total equity column is most important to review). I also noted that the Statement of Cash Flows shows an opening balance at the beginning of a period and a note regarding the profit and loss account (a positive number if revenue is larger than expenses and a negative number if revenue is less than expenses).
Another important point I noted down was that profitability and liquidity were thought of as useful points to consider when reviewing firms financial statements.
I did note down the Du Pont approach and look forward to future chapter reviews on ratios to better understand this approach and how it and ratios come into accounting.
I had also noted down the following important formulas:
In relation to cash flow,
Dividends (D) = operating cash flow (C) – Capital Outlays (I) + Net Cash Flow from Debt Owners (F)
with a further note of Operating Cash Flow – Capital Outlays is called the Free Cash Flow (FCF) which is the cash being made by the firm after taking on-going capital investment into future operations into account. This unit will be focusing on cash flow meaning FCF.
Operating Cash flow is the cash made by a firm without setting aside any cash for on-going investments into the firm.
EBITDA = earnings before interest, tax, depreciation and Amortisation.
After reading both chapters and noting down my key concepts, my main questions were how do I relate my readings and concepts to the company I had received and how could I possibly find out all the details about my company that other's of the unit have about theirs, the only action to take is to dive in and start identifying each step one at a time so please be patient with me as I attempt to deepen my understanding from what I have read to practice.
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