Financial Accounting I. Unit 2 PDF

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FINANCIAL ACCOUNTING

UNIT 2. THEORY OF PATRIMONY 2.1. The patrimony of the company 2.2. The accounting identity: economic and financial structure 2.3. Patrimony positions 2 4 Analysis 2.4. A l i off the th economic i structure t t and d th the fi financial i l structure t t 2.4.1. The asset or economic structure 2.4.2. The financial structure 2.5. The balance sheet 2.6. The operating cycle

This subject of Financial Accounting I received financial support from the Unidad de Innovación of the Universidad de Murcia (Resolución del Rectorado (R-702/2010) de fecha 2 de diciembre

Dr. Marcos Anton Renart

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2.1. THE PATRIMONY OF A COMPANY

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 Patrimony (latin “patrimonium”): an inheritance from one’s father or other ancestor.  Colloquially, people believe that it is referred to the goods that a person or a firm owns. Nevertheless, from an accounting point of view, this is not exact. DEFINITION OF PATRIMONY The collection of: -

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goods (tangible or intangible) which are used by a firm to develop an specific purpose in its activity. These goods belong to (or are controlled by) the owner of a firm (or the shareholders) The liabilities that the owner of a firm or shareholders have not paid yet.

These goods and liabilities must be correctly valued. Dr. Marcos Anton Renart

2.1. THE PATRIMONY OF A COMPANY

Therefore, it is possible to set up a first group of accounts which show: GOODS: those assets that the firm uses to develop its main activity (or other complementary activities). In some cases, these goods are used in the production process (ex. Machinery, buildings, furniture, …). In other cases, the firm buys or produces them in order to sell them later. (ex. Merchandises, raw material, packages). RIGHTS: those RIGHTS th assets t which hi h show h th privilege the i il off a firm fi tto ask k for f the th complying of any agreement with other agents related to a firm (ex. Accounts receivable; computer programs; …). LIABILITIES: those debts with other agents related to the firm. The origin of these debts is in development of the “activity” of the firm. These debts will have to be paid with the goods and rights (ex. Accounts payable; bank debts; debts with the Tax agencies; …). Dr. Marcos Anton Renart

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2.1. THE PATRIMONY OF A COMPANY

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• The difference between goods, rights and liabilities will show us the Owners’ equity:

Goods + rights – liabilities = Owner’s equity Presenting this equation from another point of view: Goods + Rights

=

Owner’s equity

+

Liabilities

In accounting it is called “Accounting equation” and is: ASSETS

=

Dr. Marcos Anton Renart

EQUITY

+ LIABILITIES

2.1. THE PATRIMONY OF A COMPANY

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ASSET: “Goods, rights and other resources controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the company”. For example: buildings, merchandises, computers, furniture, vehicles, money, accounts receivable; … LIABILITY: “A liability is a present obligation of the entity arising from past events, the h settlement l off which hi h iis expected d to result l iin an outflow fl ffrom the h entity i of resources embodying economic benefits”. For example: debts with a bank; debt with a supplier, … EQUITY: “Equity is the residual interest in the assets of the entity after deducting all its liabilities.”. For example: the money that the shareholders put from their own patrimony to the patrimony of the firm; reserves; … Dr. Marcos Anton Renart

2.2. The accounting identity: economic and financial structure

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• The patrimony is studied in Accounting from a double perspective: economic and financial. a) Economic Structure: it consists of the assets of a firm necessary to develop its activity. ASSETS b) Financial Structure: it consists of the financing funds of the firm. They represent the origin of the funds of the firm or the financing funds necessary to purchase the assets. (EQUITY AND LIABILITIES). b.1. EQUITY. Own resources. It is the money that the owner or shareholders of a firm put from their own patrimony to the patrimony of a firm (capital) or also those retained earnings not given to the shareholders (reserves). b.2. LIABILITIES. Borrowed funds. Any debt of the firm (debts with a bank; with suppliers; with the employees; …).

Dr. Marcos Anton Renart

2.2. The accounting identity: economic and financial structure

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 Obviously, the firm will not be able to invest in assets more than the existing funds (own resources or borrowed funds).  Therefore, as it was seen in the Accounting Equation, there will be a identity between the total sum of the value of the Economic Structure or Assets (en euros) with the total sum of the Financial Structure (Equity and Liabilities):

ASSETS = EQUITY + LIABILITIES

Goods, rights or other assets controlled = are financed with own resources and/or by the firm borrowed funds.

Dr. Marcos Anton Renart

2.2. The accounting identity: economic and financial structure

For example:

ASSETS

EQUITY AND LIABILITIES

Building…………….160,000 Vehicles……………….3,000 Money…………………7,000 Accounts receivable…2,000 Computers……………5,000 Machinery…………...10,000 Inventories……………1,000 Furniture…………….12,000

Capital………………….60,000 Reserves………………35,000 Debts with banks….......40,000 Debts with suppliers…..30,000 Debts with employees.. 35,000

Total Assets……..…200,000

Total E and L…………200,000

Economic Structure Dr. Marcos Anton Renart

=

Financial Structure

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2.3. PATRIMONY POSITIONS

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IASB CF and Glossary: Financial position: The relationship of the assets, liabilities and equity of an entity, as reported in the balance sheet [statement of financial position]. The financial position of an entity is affected by the economic resources it controls, its financial structure, its liquidity and solvency, and its capacity to adapt to changes in the environment in which it operates. Information about the economic resources controlled by the entity and its capacity in the past to modify these resources is useful in predicting the ability of the entity to generate cash and cash equivalents in the future. Information about financial structure is useful in predicting future borrowing needs and how future profits and cash flows will be distributed among those with an interest in the entity; it is also useful in predicting how successful the entity is likely to be in raising further finance. Information about liquidity and solvency is useful in predicting the ability of the entity to meet its financial commitments as they fall due. Liquidity refers to the availability of cash in the near future after taking account of financial commitments over this period. Solvency refers to the availability of cash over the longer term to meet financial commitments as they fall due.

2.3. PATRIMONY POSITIONS

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IASB CF: Information concerning changes in the financial position of an entity is useful in order to assess its investing, financing and operating activities during the reporting period. NOTES: • The equilibrium of the patrimony will come from the position of the total Assets (A), Liabilities (L) and Equity (E) in a particular moment. • In this sense, we must point out that there will always be a quantitative equilibrium between A, L and E because of the A=E+L. • But, from an financial point of view we may find three basic positions in a firm situation: 1.- Maximum stability: A=E 2.- Financial stability: A=E+L and CA>CL 3.- Financial Instability: A=E+L and CA...