Study sheet: Accounting Model and Asset Measurement

📋 Course Outline

1. Accounting as an Information System
2. Objectives and Users of Financial Information
3. GAAP and Financial Statement Quality
4. Financial Statements and Their Scope
5. Balance Sheet and Equity
6. Income, Cash Flow and Business Models
7. Double-Entry Accounting and Transactions
8. T-Accounts and Account Balances
9. Recording Transactions in Accounts
10. From Accounts to Financial Statements
11. Non-Current Asset Recognition
12. Depreciation and Impairment
13. Accounting Conventions and Write-Downs
14. Doubtful Client Impairments
15. Provision Recognition Conditions
16. Provision Examples and Accounting
17. Cut-Off Convention

📖 1. Accounting as an Information System

🔑 Key Concepts & Definitions

• Accounting information system : An information system that records a company’s business activities and transactions as figures in a database, including sales revenue, inventory and cash.

★ Must-know

📌 Management accounting or cost accounting uses highly detailed data extractions to determine partial results such as revenue generated by a product or customer, whereas financial accounting or general accounting uses less detailed extractions to determine comprehensive results such as profit or cash generation.

Further detail

• 🔄 A company’s daily transactions follow this sequence: buying goods or services, selling products, paying suppliers and salaries, collecting customer payments, repaying bank loans, storing the transactions as figures in a database

💡 Memory Hook

Management accounting gives detailed internal results, whereas financial accounting gives broader published results.

📖 2. Objectives and Users of Financial Information

★ Must-know

📌 Financial accounting information must be disclosed outside the company because external users do not have direct access to company data and need relevant information for decisions such as buying a business or granting credit.

• Financial accounting reduces information asymmetry between shareholders and management by informing shareholders about the quality of the CEO’s management, and it also supports creditors’ decisions.

📌 Net income is often the legal basis for calculating dividends and, in many countries, is the starting point for determining tax payable on profits.

Further detail

• External users include shareholders, financial analysts, journalists, rating agencies, lenders, suppliers, customers, government bodies, regulators and the public, while internal users include employees, representatives and management.

💡 Memory Hook

Separation of ownership and management → information asymmetry → financial reporting.

📖 3. GAAP and Financial Statement Quality

🔑 Key Concepts & Definitions

• GAAP : Accounting rules regulating financial accounting and financial information.

★ Must-know

• Countries may apply different national GAAPs, such as French GAAP, German GAAP and U.S. GAAP, while IFRS is an international GAAP created to provide international financial reporting standards.

📌 Financial information should be comparable over time and between companies, sufficiently objective, and reliable through external verification by an auditor.

Further detail

📌 Accounting regulations determine the information a company must publish, its presentation, the calculation of its data and its verification.

💡 Memory Hook

GAAP: Generally Accepted Accounting Principles.

📖 4. Financial Statements and Their Scope

🔑 Key Concepts & Definitions

• Balance sheet : Shows the company’s financial position on a given date, including its debt and the use made of funds collected and generated.
• Income statement : Shows the company’s performance over a given period through the profit or loss generated.

📝 Essential Points

• The main financial statements are:
  • the balance sheet
  • the income statement
  • the cash flow statement
  • the notes

📌 Individual accounts cover one company, whereas consolidated accounts cover a group of companies controlled by the same parent company.

💡 Memory Hook

Balance sheet → income statement → cash flow statement → notes.

📖 5. Balance Sheet and Equity

🔑 Key Concepts & Definitions

• Assets : Show how a company’s financing has been used at a given time and correspond to its investments and other resources.
• Share capital : A component of equity representing funds invested by shareholders in exchange for shares that provide voting rights and the possibility of receiving dividends.

★ Must-know

📐 Formula — On the balance sheet, assets always equal equity and liabilities: $\text{Assets} = \text{Equity and liabilities}$.

Further detail

📐 Formula — A company’s book value is calculated by adding non-current and current assets and subtracting non-current and current debt: $\text{Book value} = \text{Assets} - \text{Debt}$.

💡 Memory Hook

Assets show how funds are used, whereas equity and liabilities show where funds come from.

📖 6. Income, Cash Flow and Business Models

★ Must-know

📐 Formula — Net income is calculated by deducting expenses from revenues: $\text{Net income} = \text{Revenues} - \text{Expenses}$.

• In the Red Coat example, revenue was €800,000, materials and services cost €390,000, labour cost €280,000, depreciation was €38,000, interest was €2,000, income tax was €30,000 and net income was €60,000.

📌 Cash and net income are different because sales and purchases may be unpaid, some transactions affect cash without affecting income, and depreciation affects income without creating a cash outflow.

• 🔄 Cash changes are explained through:
  1. operating cash flows
  2. investing cash flows
  3. financing cash flows

Further detail

📌 Service companies typically have low tangible fixed assets, little inventory, significant accounts receivable and mainly shareholder financing, whereas industrial companies typically have substantial fixed assets and financing from both equity and debt.

💡 Memory Hook

Profit measures revenues minus expenses, whereas cash flow tracks cash inflows and outflows.

📖 7. Double-Entry Accounting and Transactions

🔑 Key Concepts & Definitions

• Double-entry accounting : Luca Pacioli, five centuries ago — Records each transaction through at least two accounts that show both the method of payment or financing and the nature of the transaction.

★ Must-know

📌 Transactions without an impact on net income affect only balance-sheet items, whereas transactions with an impact on net income affect an income-statement item and at least one balance-sheet item.

• The four balance-sheet combinations are:

  • type 1: increase in one asset and decrease in another asset
  • type 2: increase in one liability and decrease in another liability
  • type 3: increase in an asset and a liability
  • type 4: decrease in an asset and a liability

• For transactions affecting net income, type 5 increases revenue and an asset, type 6 increases an expense and a liability, and type 6a increases an expense and decreases an asset.

Further detail

• Buying 1,100 tablets at €120 each on credit increases inventory and accounts payable by €132,000 without affecting net income, while selling 1,000 tablets at €300 each increases revenue and receivables by €300,000 and records €120,000 of cost of tablets sold.

💡 Memory Hook

Identify the transaction → locate the accounts → classify the entry → assess its income impact.

📖 8. T-Accounts and Account Balances

🔑 Key Concepts & Definitions

• T-account : An account displayed as a capital T that details the movements affecting a financial-statement item and explains its ending balance.

★ Must-know

📌 Asset accounts record initial balances and increases on the left and decreases on the right, whereas liability and equity accounts record initial balances and increases on the right and decreases on the left.

📌 Revenue increases are recorded on the right side of a T-account, whereas expense increases are recorded on the left side.

Further detail

📐 Formula — An account's ending balance equals its initial balance plus increases minus decreases: $E = I + A - D$.

💡 Memory Hook

Assets increase on the left, while liabilities, equity, and revenue increase on the right.

📖 9. Recording Transactions in Accounts

★ Must-know

• Recording a transaction in double-entry bookkeeping requires entering equal amounts on the left and right sides of the affected accounts.

• The credit sale of 1,000 tablets at €300 each records €300,000 in accounts receivable and tablet sales, while the tablets' €120,000 cost is recorded as an inventory decrease and cost of tablets sold.

• The sale produces a gross margin of €180,000, equal to 60% of sales revenue, meaning that €60 of intermediary profit is generated for each €100 invoiced.

• Collecting €270,000 of receivables increases cash and decreases accounts receivable, while paying €118,000 to suppliers decreases cash and accounts payable without changing net income.

• Consuming €43,000 of services records an expense and accounts payable, the subsequent €42,000 partial payment reduces both accounts payable and cash, and paying €64,000 of personnel expenses records an expense and reduces cash.

Further detail

• The purchase of 1,100 tablets at €120 each creates a tablet-inventory asset and accounts payable of €132,000 without affecting net income because the tablets have not yet been sold.

💡 Memory Hook

Record the debit and credit, calculate each ending balance, then derive the statements.

📖 10. From Accounts to Financial Statements

★ Must-know

• At the end of the accounting period, account balances are transferred to the balance sheet and income statement, and expenses are subtracted from revenues to determine net income before it is carried to the balance sheet.

• The €3,000 bank transfer for loan repayment and interest comprises a €2,000 reduction in financial debt with no net-income effect and a €1,000 interest expense that reduces net income and cash.

Further detail

• A €6,000 loss of value on outlet fixtures is recorded as depreciation expense and reduces fixed assets, leaving the fixtures valued at €194,000.

💡 Memory Hook

General Ledger → account balances → financial statements → net income → balanced balance sheet.

📖 11. Non-Current Asset Recognition

🔑 Key Concepts & Definitions

• Non-current assets : Controlled resources resulting from past events that are expected to generate future economic benefits and have a useful life of over 12 months.

★ Must-know

• The three categories of non-current assets are:
  • intangible assets
  • tangible assets
  • financial non-current assets

📌 Acquired intangible assets are recorded on the balance sheet when they meet the asset criteria, whereas training expenditure and human capital are recorded as expenses because the company does not control them.

• The initial value of a non-current asset includes its purchase price after discounts, directly attributable acquisition costs, estimated decommissioning costs, and sometimes financing costs, but excludes training costs.

Further detail

📌 Internally generated intangible assets may be capitalized when their cost is determinable, such as software for the company's use or the cost of designing a patent to be marketed, whereas intangible production costs that cannot be measured reliably are not shown on the balance sheet.

• A production line bought for €500,000 with €20,000 installation costs and a €25,000 discount has an initial balance-sheet value of €495,000 because €12,000 of training costs are excluded.

💡 Memory Hook

Acquired or measurable intangibles can become assets, whereas training and unmeasurable internally generated costs remain expenses.

📖 12. Depreciation and Impairment

🔑 Key Concepts & Definitions

• Depreciable assets : Assets with a limited useful life because of physical wear, obsolescence, or the end of legal or contractual protection.

★ Must-know

📌 Depreciation represents an irreversible loss of value caused by consumption or use of an asset, whereas impairment represents a potentially temporary and reversible loss caused by an external event.

📐 Formula — Under straight-line depreciation, the annual depreciation rate equals $1 \div \text{useful life}$ and annual depreciation equals the depreciation base multiplied by that rate.

📌 An impairment test compares an asset's book value with the higher of its estimated net sales price and its value in use, and records the difference when book value exceeds that recoverable amount.

Further detail

📌 When an asset has components with different useful lives, each component is depreciated separately rather than depreciating the entire asset as one unit.

• A €200,000 minibus with a five-year useful life and zero residual value has annual straight-line depreciation of €40,000, a 20% rate, and a €160,000 book value after year N.

• For a machine costing €220,000 with a €20,000 residual value and 100,000 forecast production units, production of 18,000 units in year N produces €36,000 depreciation and a €184,000 net book value.

• When land costing €200,000 has a recoverable amount of €150,000 after a highway exit closes, a €50,000 impairment loss reduces the land and net income, without reducing cash.

💡 Memory Hook

Use or external loss of value → depreciation or impairment expense and a lower asset value.

📖 13. Accounting Conventions and Write-Downs

🔑 Key Concepts & Definitions

• Net realizable value : The estimated selling price of inventory less the necessary selling costs to be incurred.

★ Must-know

• The historical-cost basis values non-current assets at their original cost less losses in value, whereas the fair-value basis values them at market value.

• A company removes a sold or discarded non-current asset from its balance sheet and records a capital gain when the sales price exceeds its book value or a loss when the sales price is lower.

• The prudence principle requires probable risks and unrealized losses to be recognized through provisions or impairment expenses in the period in which the risk appears.

• Inventory must be written down when its net realizable value is lower than its cost, with inventory measured at the lower net realizable value.

• A doubtful-client impairment is estimated client by client from available information or reliable historical data and is recorded as an expense with a corresponding reduction in accounts receivable.

Further detail

• Selling land bought for €300,000 for €340,000 increases cash by €340,000, removes the €300,000 land balance, and records a €40,000 capital gain.

• For 10,000 unsold T-shirts costing €100,000 in total and expected to sell for €60,000, Distrib records a €40,000 inventory write-down expense without affecting cash.

• For a €200,000 receivable from Baddebt with a predicted 70% default risk, Distrib records a €140,000 impairment expense and reduces accounts receivable by €140,000 without affecting cash.

• If Baddebt later pays €20,000 after the €140,000 impairment, the remaining €40,000 loss is recorded as a bad-debt write-off and accounts receivable becomes zero.

💡 Memory Hook

Expected loss → expense and asset reduction before the loss is fully realized.

📖 14. Doubtful Client Impairments

★ Must-know

📌 At the closing date, the risk of default on accounts receivable must be estimated client by client using available information, or systematically using reliable historical data.

• When a client owes €200,000 and a 70% payment default is predicted, an impairment loss for doubtful clients of €140,000 is recorded as an income-statement expense with a corresponding decrease in accounts receivable.

• When the doubtful client later pays €20,000 after the €140,000 impairment, the company records a further €40,000 bad debt write-off, reducing accounts receivable to zero and reducing N+1 net income by €40,000.

📌 When a doubtful client pays the full €200,000 in N+1, the receivable disappears, cash increases by €200,000, and a €140,000 reversal of impairment is recognized as income.

Further detail

📌 Impairments and write-downs can be reversed, unlike depreciations and amortizations.

💡 Memory Hook

Impairment anticipates a loss; reversal restores income when the risk disappears.

📖 15. Provision Recognition Conditions

★ Must-know

• A provision requires four conditions:
  • an obligation toward a third party exists at closing
  • the obligation results from a past event
  • a cash outflow is highly probable
  • the probable outflow can be reliably estimated

📌 In practice, a provision is recorded only when the probability of cash outflow is over 50%.

Further detail

• The four recognition conditions are intended to prevent companies from influencing net income through unjustified provisions.

💡 Memory Hook

O-P-P-R: obligation, past event, probable outflow, reliable estimate.

📖 16. Provision Examples and Accounting

★ Must-know

• A manufacturer providing a two-year warranty must record a provision when historical statistics allow the expected repair obligation and cost to be estimated.

📌 When a fire destroys a warehouse and the company merely intends to rebuild it, no provision is recorded because there is no commitment to a third party; instead, the warehouse is impaired by €20,000 to reduce its book value to zero.

📌 A provision is recorded as an income-statement expense and a balance-sheet liability, classified as current if expected within one year and non-current if expected after one year.

• When a €40,000 provision is settled for €30,000 in N+1, the company records a €30,000 cash outflow and a €10,000 increase in N+1 net income through the reversal of the unused provision.

Further detail

• A provision must be recorded when a dismissed employee takes legal action and the company lawyer considers it highly probable that the company will pay six months of salary as damages.

• Common provisions include:

  • provisions for litigation
  • provisions for warranties
  • provisions for post-employment benefits

💡 Memory Hook

Past obligation plus probable, estimable outflow → expense and liability.

📖 17. Cut-Off Convention

🔑 Key Concepts & Definitions

• Cut-off convention : requires all revenues and expenses generated in a period to be recorded in that period and revenues and expenses generated in other periods to be excluded

★ Must-know

📌 A sale of goods is recorded in the accounting period when delivery occurs, regardless of the invoicing date.

📌 A service sale is recognized when the service has been provided.

• When Speedfly receives €100,000 in December N for flights provided in January or February N+1, the amount is excluded from N revenue and recognized as a balance-sheet liability until the transportation service is provided.

Further detail

• Because the €20,000 marketing study for Publi was fully provided by 31 December N although invoicing occurred in January N+1, an expense of €20,000 and a corresponding accounts payable are recognized in N without a cash impact.

📌 The cut-off convention prevents income-smoothing strategies and ensures that reported net income reflects transactions of the current period.

💡 Memory Hook

Cash or invoicing date is not the recognition date; delivery or service completion determines the period.

📊 Synthesis Tables

Main Financial Statements

Statement	Main information	Time reference
Balance sheet	Financial position, assets, equity and liabilities	Given date
Income statement	Revenues, expenses and profit or loss	Given period
Cash flow statement	Operating, investing and financing cash changes	Given period
Notes	Explanations of reported figures	Related reporting period

Non-Current Asset Losses

Notion	Cause	Accounting effect
Depreciation	Irreversible use, wear, or obsolescence	Expense and reduction in asset value
Impairment	Potentially reversible external or internal indication	Expense and reduction in asset value
Capital loss	Sale price below book value	Loss recorded on disposal