COURSES 1 & 2

Accounting is an information and measurement system that identifies, records and communicates relevant information about the activities of an organization. The primary objective of accounting is to provide useful information for making decisions, such as assessing opportunities, products, investments, social and community responsibilities. Another important objective is related to stewardship, that is, accounting reports how managers (stewards) have used the resources entrusted to them by the owners. To achieve its objectives, accounting includes activities such as: identifying, measuring, reporting and analyzing business events and transactions (i.e., exchanges between entities). Accounting also involves interpreting information and designing information systems to provide useful reports that monitor and control an organizations activities. The accounting department designs a system of internal controls for the organizations use in order to promote efficiency and prevent the unauthorized use of the companys resources. Accounting provides information only about transactions and events that can be expressed in monetary terms. The consequence is that important information like the capabilities of the management team or the imminence of a strike, although essential, cannot be translated into accounting language. Despite its limits, accounting offers to interested parties information that is synthetic and unique about an organisation. 1.1. Business entities A very broad classification of organizations distinguishes them as for profit and not-for-profit. In the United States two thirds of the active workforce is involved in for-profit or business enterprises. Business enterprises may be: sole proprietorships (sole trader), partnerships or companies (corporations). A sole proprietorship is an unincorporated business owned by one person who is often the manager too. This small-size business is not legally separated from its owner, and its duration expires when the owner decides to terminate it or dies. A partnership involves several people jointly owning and running a business. Some of those entities are large in size (international accounting firms, such as PriceWaterhouseCoopers, Ernst&Young, KPMG, Deloitte Touche Tohmatsu). A partnership is not legally separate from its owners and each partner is responsible for the debts of the business (unlimited liability). A partnerships life expires by choice or withdrawal of partners. Partners shares cannot be sold without the agreement of other partners. When this happens, a new partnership is formed. In the Anglo-Saxon world, partnerships were created to allow the provision of professional services by lawyers, doctors, architects and accountants. In Romania, the best equivalent for partnerships is societate civil, which is mainly used by lawyers. A company (corporation in the United States) can emerge with the contribution of many individuals, each bringing in a fraction of the capital needed to operate the business (shares of capital are usually bought and sold frequently). These contributors are called shareholders, stockholders or members (owners). Although the shareholders own the company, it is often the case that they do not participate in daily management. The Shareholders Assembly Meeting is generally called once a year, after the accounting year has ended. It may approve or reject the financial statements prepared by management, extend or withdraw the mandate of managers and auditors and debate other issues concerning the companys activity. 1

With very few exceptions, most companies are formed as limited companies, that is, the liability of the shareholders for the obligations assumed by the company is limited to the amount invested into the business. Creditors can claim the assets of the Company but cannot get the personal assets of the shareholders. As opposed to a proprietorship or a partnership, a companys life is indefinite. Companies may be private or public. A private company has got few members, most of which are directors. Generally, this is a small company, where shares are not freely transferable. A shareholder wishing to sell his shares can do this only with the agreement of the other shareholders. The Romanian equivalent is societate cu rspundere limitat S.R.L. A public company is usually bigger than a private company and its shares are freely transferable. Most public companies are quoted (listed) on the Stock Exchange. In the United Kingdom, the words public limited company (plc) are stated at the end of a companys name. In most European countries public is equivalent with owned by the state, which is not the case in the Anglo-Saxon world (shares of public companies may be bought by anyone: individuals, companies, including state-owned companies). The Romanian equivalent of a public company is societate pe aciuni S.A.. Romanian company law includes other less common types of companies: the unlimited company (societate n nume colectiv) and two other: societate n comandit simpl and societate n comandit pe aciuni1. The unlimited company is a legal entity where owners have unlimited responsibility for the companys obligations. The two other companies combine attributes of unlimited and limited companies. Members in charge of management have unlimited responsibility for the companys obligations, whereas other members obligations are limited to the amount of capital contributed. The shares of the latter are not freely transferable in societatea n comandit simpl, but they can be exchanged without restrictions in societatea n comandit pe aciuni. 1.2.Availability of accounting information

In the Anglo-Saxon world the financial statements of sole traders and partnerships are completely private and are not seen by others than the trader or partners concerned, unless they choose to show them to third parties (e.g. to a banker for the approval of loans). The financial statements of all companies (both private and public) should be published. A copy of the financial statements is sent to the Registrar of Companies where they are released to the public for a small fee. In the developed world the financial statements of listed companies are available to the public via the internet. Romanian company law requires that public and private companies should file their audited and approved2 financial statements with the Registrar of Companies (Registrul Comerului), where the public has access to them. Accounting Regulations also provide for the possibility that any member of the public may obtain the annual report (financial statements, directors report and auditors report) from the companys headquarters, for an amount not exceeding its administrative cost. However, the Regulations are not clear on this point, apparently allowing the presentation of a shortened version of the financial statements. 1.3.Financial accounting and managerial accounting

Financial accounting provides information to decision makers not involved in the day-to-day operations of an enterprise. Financial accounting is concerned with the production of general purpose 2

financial statements for users such as investors (present and potential), lenders, government agencies, employees, suppliers and customers and the general public. Financial statements should present fairly (give a true and fair view of) an enterprises financial position, performance and cash flows for the past year. A complete set of financial statements includes: the balance sheet, the profit and loss account, the statement of changes in equity, the cash flow statement and accounting policies and explanatory notes. The responsibility for issuing the financial statements belongs to management. Managerial accounting is an integral part of management which provides information that is used by management to formulate strategies, plan, coordinate and control the activity, make decisions, optimise the use of resources and safeguard assets3. For example, by reporting variances from planned costs, managerial accounting enables managers to control costs and take corrective action. The following table shows the main differences between financial and managerial accounting: Financial Accounting Managerial Accounting o regulated; o not regulated; o mainly concerned with past o mainly concerned with performance; predictions, includes future expectations of the management team; o historical financial o a budget system based on statements (past events), disclosed at historical information but also on year end; predictions, frequent reporting, not disclosed; o prudence is enforced: o relevance is enforced: providing for all potential losses, but revaluations, changes of depreciation recording revenues only when they rates (flexibility in working with are earned. historical records). 1.4. The regulation of accounting in Romania The accounting regulator in Romania is the Ministry of Public Finance. In the rule setting process, professional accounting bodies have an advisory role, but their influence is limited. Two main laws underlie the regulation of accounting in Romania:
o o

Company Law no. 31/1990 as subsequently amended and Accounting Law no. 82/1991 as subsequently amended.

The actual regulation of accounting is given by OMFP 3055 / 2009, which is completed by OMFP 2869 / 2010. Companies that control other companies (their subsidiaries) are required to prepare group (consolidated) accounts if they meet certain size criteria or if the group includes one or more listed companies. The consolidation procedures are found in the Ministerial Order 772/2000 for the Approval of Consolidation Regulations. The national securities regulator, CNVM4, requires businesses with publicly traded securities to file the balance sheet and profit and loss account at 30 June, along with an audit review report. 3

2.1.

ACCOUNTING AND BOOKKEEPING

WHAT IS ACCOUNTING? Accounting is the process of recording, classifying and summarizing financial information collected by bookkeepers for analysis and interpretation. It provides guidance in making business decisions and provides useful economic information to interested parties and users who depend on these results. WHAT IS BOOKKEEPING? Bookkeeping is the detailed and accurate recording of all transactions which take place in a business. It is necessary to record the date, nature and value (in money terms) of the transaction. Bookkeeping records provide the information from which financial accounts are prepared. Role of the bookkeeper Source documents arise as a result of transactions. It is the task of the bookkeeper to convert financial data gathered from source documents into useful economic information. This is done by: identifying source documents resulting from the transactions recording and summarizing details in journals classifying the information from the journals in the ledger. Once the information has been collected, recorded and arranged in a meaningful way by the bookkeeper, it is used by the accountant to prepare accounting reports. These reports assist management in planning for and controlling an organization and are also communicated to outside users such as shareholders and potential investors to assist with economic decision - making. Objectives of bookkeeping Bookkeeping is the process of maintaining a clear, concise and permanent record of all transactions as they occur, to assist the owner/s of the business to ascertain: amounts owing to the business by debtors amounts owed to creditors amounts of losses and gains in a particular accounting period and the reasons for these flow of cash and goods, both into and out of the business nature and amount of what the business owns or what is owed to the business (assets) nature and amount of what the business owes (liabilities) the amount of owners equity (capital, proprietorship) that the owner has invested in the business the overall financial standing of the business at a given date. FUNCTION OF ACCOUNTING People need economic information to help them taking decisions and judgments about businesses. Managers are interested in Accounting information. Accounting information should help them with their decisions. Accounting is concerned with the collection, analysis and communication of economic information. Accounting information is useful to those who need to make decisions and plans about business and for those who need to control those businesses. Managers working within a particular business are likely to be significant users of accounting information. But managers there are not the only people to use accounting information about that particular business. The fact is that accounting exists for some particular purposes, such as: to help users of accounting information make informed decisions; to prepare financial reports on a regular basis; to influence the decisions of users of the information produced. Accounting seeks to satisfy the needs of a wide range of users. In relation to a particular business, there may be various groups who are likely to have an interest in its financial health.

Accounting is concerned with the economic activities of a business. Accounting involves gathering information, processing it and reporting on it to management and other interested users. This information is used to evaluate past economic events, control current economic activities and make economic decisions and plans for the future.

2.2.Users of financial information

Financial statements are prepared for the purpose of providing useful information to a large range of rational decision-makers: investors, employees, lenders, suppliers and other trade creditors, customers, governments and their agencies and the public. Financial information is thus meant for decision makers who have different interests. In its Framework IASB points out seven groups of users of financial information and what they are looking for in a businesss financial statements:

investors employees lenders suppliers customers governments the public

Investors want information concerning their investments risks and rewards. Information about future cash flows associated to an investment is vital, but not available. A companys financial position and performance are the best substitutes and can be found in the annual financial statements. Would it be possible to mislead investors through the financial statements? The answer is yes, as some companies may manipulate the profit figure using alternative accounting policies and methods to suit managements interests (e.g. the choice of stock valuation and depreciation methods). This is why financial statements are certified by an independent auditor. At the same time financial analysts perform adjustments to data contained in the financial statements to enable comparisons between companies. Employees and employee organisations are interested in assessing employment stability and if a fair share of the value added by the company has been allocated to them. Lenders are interested if the repayment of the loans granted, as well as their related interest, will be made on time. Suppliers need information concerning the short-term liquidity of their debtors, while customers take a longer term view of an enterprise, as they look forward to securing inputs. Government agencies that do not rely on specific reporting, aggregate data from the financial statements of individual businesses to obtain sector or macroeconomic indicators. The public needs information regarding the impact of an enterprises activity on the local economy and environment. Financial statements cannot meet all the information needs of the users, but it is assumed that if they meet investors needs, then most of these information needs are met. The preparation and the presentation of financial statements is the responsibility of the management. Its own information needs are satisfied through different reports which are prepared much more frequently and are more detailed than the financial statements. 5

2.3. The objective of financial statements As pointed out before, information on future cash flows generated by an enterprise, in terms of their amount, certainty and timing, is vital but unavailable. Users make their own predictions by adjusting data disclosed in the financial statements over a period of time. Therefore, the objective of financial statements is to provide decision-makers with useful information about the financial position, performance and changes in financial position of an enterprise. All three aspects relate to the generation of cash in the future. The financial position of an enterprise is characterized by several aspects: the resources controlled its financial structure, liquidity and solvency. The relevant information on these topics is primarily found in the balance sheet (bilanin romanian), with details presented in the explanatory notes. The balance sheet lists, in money terms, all assets owned and controlled by an enterprise and all liabilities owed, along with shareholders interest (equity) in the business at a particular date. It is a snapshot of the financial position of the business at a point in time. Companies operating in different industries control different resources and have different financial structures. The resources of a mining company consist mostly of equipment, while the most important resources of a retailer are commercial buildings. A mining company relies heavier on bank loans, while a retailer uses payment facilities from its suppliers. Liquidity measures how quickly an enterprises economic resources can be converted into cash to meet its current obligations towards suppliers, employees or government. Solvency takes a longer term view. It answers questions such as: can the company repay its long-term loans when they fall due? Information on performance reflects the enterprises ability to obtain profit, in other words, to obtain revenues that exceed expenses incurred. Information about performance is contained mainly in the profit and loss account (contul de profit i pierdere in romanian) and the related explanatory notes. The profit and loss account is a record of revenues generated and expenses incurred over a given period. The statement of changes in equity brings in additional information about the performance of the enterprise as some gains and losses are sometimes included directly in equity without passing through the profit and loss account first. After all, the change in equity between two separate moments in time shows the increase (or decrease) of wealth during that period5. Information regarding changes in financial position discloses the enterprises ability to generate cash - the ultimate condition to continue the activity in the future - and the use of this cash for operating, investment and financing activities. Information on this topic is typically found in the statement of cash flows (Rom. situaia fluxurilor de numerar) and in the explanatory notes to this statement. ACCOUNTING CONCEPTUAL FRAMEWORK GENERAL ACCEPTED ACCOUNTING PRINCIPLES (GAAP) Over the years, the accounting profession evolved without a defined set of guiding principles. Confusion often arose as different firms used varying methods to correct similar problems. This made comparison of financial reports between companies and over time difficult, as information was interpreted in different ways by different people. For these reason, c conceptual framework, in the form of a number of concept statement, is being developed to provide a set of guiding principles for the accounting profession. Accountants themselves have developed traditional ways of doing things. This is reflected in the Accounting Conventions, which are generally accepted accounting principles which have been used for many years. These conventions (or accepted practices) include those described below. 6

The entity concept (business entity concept). Under the business entity concept, for accounting purposes, every business is conceived to be and is treated as a separate entity, separate and distinct from its owner or owners and from every other business. Businesses are so conceived and treated because, in as far as a specific business is concerned, the purpose of accounting is to record its financial position and profitability. Consequently, the records and periodically report its financial position and should not include either the transactions or assets of another business or the personal assets and transactions of its owner or owners. To include either distorts the financial position and profitability of the business. For example, the personally owed automobile of a business owner should not be included among the assets of the owner's business. Likewise, its gas, oil and repairs should not be treated as an expense of the business, for to do so distort the reported financial position and profitability of the business. It should be also made a clear distinction between accounting and legal entities. In some cases the two coincide. For example, corporations, trusts and governmental agencies are both accounting and legal entities. The proprietorship is an accounting entity, as indicated by the fact that all assets and liabilities of the business unit are included in its financial statements. The business proprietorship is not a legal entity (is not legally separated from its proprietor). He is legally liable both for his personal obligations and for those incurred in his business. For accounting purposes, the proprietor as an individual and his business enterprise are separate entities. A corporation is a legal entity (the shareholders are not responsible from the legal point of view for the company's debts or obligation), separate from the persons who own it. As a general rule, we may say that any legal or economic unit which controls economic resources and is accountable for those resources is an accounting entity. The substance over form principle When assets are recorded, it is respected first the economic financial point of view and after this, the juridical interfierence. The going concern assumption (continuity of activity convention). An underlying assumption in accounting is that an accounting entity will continue in operation for a period of time sufficient to carry out its existing commitments. The assumption of continuity leads to the concept of the going concern. In general, the going concern assumption justifies ignoring immediate liquidating values in presenting assets and liabilities in the balance sheet. The going concern principle assumes an indefinite life for most accounting entities. Accrual convention (the independence of financial year principle). This principle states that any transaction should be registrated in the moment when it happens and not in the moment of paying or receiving the money. For example, a company sells merchandises in its total value of $400, on January, the 2nd 2002 and will receive the money later on a certain maturity date, which is March, 3 rd 2003. The accrual convention says that the company should registrate the transaction in the moment it was generated (on January, the 2 nd 2002) and not in the moment it will receive the money (Accounts Receivable) which is March, 3rd 2003. Consistency. The same procedures used to collect accounting information should be used each fiscal period; in the absence of this standard it is not possible to make decisions and comparisons. Periodicity (the time period principle). Statements of the operation's financial condition must be reported periodically. So, this principle assures the requirement to measure operating progress and changes in economic position at relatively short time intervals during the indefinite life of the business entity. The intervals are called "accounting period of time" or just "accounting year". 7

In each accounting period (usually a year, but the reports may be made quarterly or even often) it is necessary to present the beginning financial position (though the beginning balance sheet) and a final financial position (determined at the end of the period) though the ended balance sheet. Dividing the life of the enterprise into time segments and measuring changes in financial position for these short periods is a difficult process. The tentative nature of periodic measurements of net income should be understood by those who rely on periodic accounting information. The need for frequent measurements creates many of the accounting most serious problems. The most common reporting is the financial year, which in our country and in Europe could be the same with the calendaristic year (Jan 1st Dec 31st) and in UK lasts from April the 1st to March 31st . Prudence (conservatism). This standard requires that all losses are to be shown in financial records if there is a reasonable change that such problems will occur; gains and related financial benefits, however should not be reflected in records until really occur. Further on, in accounting will registrate elements for the minimum value between book value and inventory value. This principle is important since many accounting decisions do not have a single right answer. Therefore, a choise between alternative assumptions is necessary. This concept guides the accountant faced with alternate measurement to select the option with the least favorable impact upon the net income and financial position within the current accounting period. The money measurement concept. This principle means that money is used as the basic measuring unit for financial reporting. Money is the common denominator in which accounting measurements are made and summarized. The USD, or any other monetary unit (ROL) represents a unit of value. Implicit in the use of money as a measuring unit is the assumption that the USD (ROL) is not a stable unit of value. The prices of goods and services in economy changes over time. When the general price level (the average of all prices) increases, the value of money (that is, its ability to command goods and services) decreases. According to the stable USD (ROL) concept, subsequent changes in the purchasing power of money do not affect the amount used for the evaluation of the event when it was recorded in the accounts. The cost (historical cost) concept. A fundamental concept of accounting, closely related to the going concern principle, is that an asset is commonly entered in the accounting records at the price paid to acquire it. This price is called acquisition cost because it means resources used in order to bring the assets in the patrimony. This cost is the basis for all subsequent accounting records related to the asset aquired. For example, if a business pays $50,000 for land to be used in carrying on its operations, the purchase should be recorded at $50,000. It makes no difference if the buyer and several competent outside appraisers think the land worth at least $60,000. Its cost $50,000 should appear on the balance sheet at that amount. Furthermore, if five years later, due to the booming real estate prices, the lands market value has doubled, this makes no difference either. The land cost $50,000 and should continue to appear on the balance sheet at $50,000 even though its estimated market value is twice that. The real value of an asset may change in time, during the revaluation procedure. The accounting records do not necessarily reflect all the changes in the asset value. In accounting assets are initially recorded at their cost. This is also referred to as an assets historical cost. This amount is ordinarily unaffected by subsequent changes in the value of the asset. In ordinary usage by contrast, the value of an asset usually means the amount for which it currently be sold. Thus, the amounts at which assets are shown in an entitys account do not indicate the sale values of the assets. If the asset is sold at a price above or below historical cost, in the accounting books must be recorded three types of information: 1) the historical cost written off from the books; 2) the market value or the price obtained by selling the asset; 3) the proceeds (differences) between historical cost and market value as an increase in revenues or expenses. 8

The most common mistake made by persons who read accounting reports is that of believing there is a close correspondence between the amounts at which an asset appears in these reports and the actual value of the asset. To emphasize the distinction between the accounting concept and the ordinary measuring of value, the term book value is used for the historical cost amounts as shown in the accounting records and the term market value for the actual value of the asset as reflected in the market place. Double entry. This principle is based on the fundamental accounting equation: ASSETS = LIABILITIES + OWNERS EQUITY Each transaction supposes at the same time at least two changes in the patrimony substance. That means that minimum two accounts are going to be used in connection, in order to reflect a business transaction (because for each item is used one account to reflect its existence and its changes). The accounts used should be affected in different ways, because they reflect two images of the same patrimony (assets and equity or assets and liabilities etc.). Double entry applied for the accounts, used as a concept, can be summarized in the correspondence existing between: DEBIT ---------------------------------- CREDIT Anyway, each phenomenon that occurs should be first analyzed from two points of view : what is it? and where does it come from? And then registered with the inherent changes that produces on the fundamental accounting equation. Materiality. The term materiality refers to the relative importance of an item or event. Disclosure of relevant information is closely related to the concept of materiality; what is material is likely to be relevant. We must recognize that the materiality of an item is a relative matter, what is materiality of an item is a relative matter, what is material for one business may not be material for another. Materiality of an item may depend not only on its amount but also on its nature. In summary, it can be stated the following rule: an item is material if there is a reasonable expectation that knowledge of it would influence the decision of prudent users of financial statements. The full disclosure principle. Adequate disclosure means that all materials and relevant facts concerning financial position and the results of operations are communicated to the users. This can be accomplished either in the financial statements or in the notes accompanying the statements. Such disclosure should make the financial statements more useful and less subject to misinterpretation. The following information generally should be disclosed: 1. terms of major borrowing arrangements and existence of large contingent liabilities. 2. contractual provisions relating to leasing arrangements, employee pension and major proposed asset acquisition. 3. accounting methods used in preparing the financial statements. 4. changes in accounting methods made during the latest period. 5. other significant events affecting financial position, including major new contracts for sale of goods or services, laborer strikes, shortages of raw materials. The matching principle. This is a fundamental principle for determining the net income of a company and preparing an income statement. Revenue, the gross increase in net assets resulting from the production or sale of goods and services, is offset by expenses incurred in bringing the firms output to the point of sale. So, incurred expenses must be matched with, and deducted from, revenues generated. The recognition of revenue, accordingly to the realization principle is made 9

when it is earned. In a manufacturing business, the earning process involves: (a) acquisition of raw materials, (b) production of finished goods, (c) sale of the finished goods and (d) collection of cash from credit customers. In cash accounting revenue is considered realized only when cash is collected from customers. In accrual accounting revenue should be recognized at the time of the sale of the goods or the rendering of services. The measurement of expenses occurs in two stages: 1) measuring the cost of goods and services that will be consumed or expire in generating revenue and 2) determining when the goods and services acquired, have contributed to revenue and their cost thus become an expense. The second aspect of the measurement process is often referred to as matching costs and revenues and is fundamental to the accrual basis of accounting. Costs are matched with revenues in two major ways: 1. In relation to the product sold or service rendered. If goods and services can be related to the product or service that constitutes the output of the enterprise, its costs become an expense when the product is sold or the service rendered to customers. The cost of goods sold in merchandising firms is a good example of this type of expense. 2. In relation to the time period during which revenue is earned. Some costs incurred by business cannot be directly related to the product or service output of the firm. These period costs are considered expense in that period when they contribute to revenue. The realization principle (recognition principle). The realization principle is the accounting rule that defines a revenue as an inflow of assets, not necessarily cash, in the exchange for goods and services and requires the revenue to be recognized at the same time, but not before it is earned. The principle also requires that the amount of revenue recognized be measured by the cash received plus the cash equivalent (fair value) of any other asset or assets received. The objectivity principle. This principle is the accounting rule that wherever possible the amounts used in recording transactions be based on objective evidence rather than on subjective judgments. The objectivity principle supplies the reason transactions are recorded at cost, since it requires that transaction amounts be objectively established. Whims and fancies plus, for example, something like an opinion of management that an asset is worth more than it cost have no place in accounting. To be fully useful, accounting information must be based on objective data. As a rule, costs are objective, since they normally are established by buyers and sellers, each striking the best possible bargain for himself or herself. Considering its procedures or instruments used in the accounting practice, the method of accounting science represents an assembly of general, common and specific procedures. Some of the general procedures are: observation, classification, analysis and synthesizing. Common procedures are: documentation, evaluation, calculus and physical counts for inventory, while the specific procedures are: balance sheet, account and trial balance. The accounting information processing cycle includes these procedures with their interaction. 10

B A L A N C E S H E E T

I N C O M E S T A T E M E N T T

CROSSWORDS:

1. 2. 3. 4. 5. 6. 7.

FINANCIAL STATEMENT WHICH SHOWS THE ECONOMIC POSITION ECONOMIC RESOURCE GENERATING FUTURE PROFITS THE MOST LIQUID ITEM OF A COMPANY THE POSITIVE PART OF THE PROFIT AND LOSS FINANCIAL STATEMENT WHICH SHOWS THE FINANCIAL PERFORMANCE TOTAL OF A LIST OF ITEMS A SORT OF OBLIGATION

11