Overview of Accounting Environment and Financial Statements

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Overview of Accounting Environment and Financial
Statements
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Aim of the Accounting Information

• accounting is an information system that
  measures, processes and communicates financial
  information of an economic entity to the decision
  makers
• measurable
• systematic
• financial statements and other financial reports
• economic entity is an economic organization that
  acts independently
• business entity is an economic entity that sells
  goods or provides services

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Environment of a Business Organization
General Environment of Businesses
Task Environment of Businesses
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Business Language
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Users of Accounting Information
Internal Users Top management Department managers External Users Users with direct financial interest Users with indirect financial interest

1. creditors investors
2. government regulatory agencies labor unions
   financial advisors brokerage firms auditors
   lawyers consumer groups and academicians

• executive officers

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Objective of Financial Statements

• the objective of financial statements is to
  provide information to users to help them in
  their economic decisions
• the financial statements are expected to provide
  information about the future cash flows of an
  entity, its financial structure, profitability
  and liquidity, and its financial position and
  changes in financial position
• financial statements provide information about
  assets, liabilities, revenues, expenses and cash
  flows

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Business Activities
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Financing Activities

• initially - funds to setup a business
• in later periods funds to run operations and to
  grow
• obtaining such funds either from external or
  internal sources

Funds obtained from creditors
shareholders Funds provided to payment of
payment of
interest dividends
repayment
of debts Cash management
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Investing Activities

• Spending the funds obtained effectively and
  efficiently
• involve purchase and sale of
• buildings, machinery or other investment
  instruments such as government bonds, treasury
  bills
• extending loans to other companies
• are expected to contribute directly or indirectly
  to the profit maximization and solvency goals of
  the business

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Operating Activities

• involve the daily activities of the entities to
  run the business
• include
• sales and marketing of the goods sold and
  services provided
• production
• purchasing merchandise and inventory items
• managing human resources
• effective and efficient management of operating
  activities needed to achieve profitability and
  liquidity

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Financial Statements

• All financial statements are interrelated because
  each statement provides information about a
  different aspect of the same entity
• financial statements
• balance sheet
• income statement
• the cash flow statement
• statement of changes in equity
• Notes to the financial statements accounting
  policies and explanatory notes about various items

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Financial Statements

• balance sheet provides information about the
  financial position or the resources available and
  the claims on these resources
• income statement provides information about how
  well these resources are used to generate income
  in a given period
• cash flow statement provides information about
  the movement in the cash and cash equivalents in
  a given period
• both the income statement and the balance sheet
  are prepared on accrual basis
• the cash flow statement is prepared on cash basis
  of accounting
• in order to meet the objective of financial
  statements, certain assumptions and qualitative
  characteristics are defined in the framework by
  IASB

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Balance Sheet

• The main objective -to fairly disclose the
  financial position of a company at a certain date
• a balance sheet is made up of assets, liabilities
  and owners' equity sections
• IAS No.1 requires that the balance sheets should
  give the name of the company, the date it is
  prepared for, and the monetary unit and the level
  of precision adopted e.g. stated in thousands of
  TL.

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Balance Sheet or Statement of Financial Position

• As of a specific date
• The amount of resources owned by a company in
  order to run business and
• How these resources were funded
• Assets
• Liabilities
• Owners or Shareholders Equity depending on
  the formation of business

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Sections of Balance Sheet
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Assets

• Current AssetsExpected to be converted into cash
  within the normal operating cycle or held for
  resale purposes
• Assets that are kept on hand for a short period
  and are expected to be converted into cash within
  the twelve months following the balance sheet
  date
• Assets that are held primarily for the purpose of
  being traded, and
• Unrestricted cash and cash equivalents
• Long-term assets Assets that the entity expects
  to use longer than one year or the operating
  cycle purpose of providing resources for the
  operations of an entity in the future

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Assets
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Liabilities
Any liability for which the amount can reasonably
be estimated and with known payment date should
be disclosed in the liabilities section of the
balance sheet Any liability with uncertain
payment dates and amounts should be disclosed in
the notes to the financial statements Liabilities
to various entities or groups such as the
creditors, employees and customers should be
clearly labeled and disclosed Classified as short
and long-term- Current liabilities include
amounts with determinable amounts and payment
dates that are within the next year Long-term
liabilities are usually debts incurred by the
entity for the purpose of financing the
operations and investments
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Shareholders Equity
includes the amounts invested in the business by
the founding owners or investors, the earnings
(losses) that are retained in the business from
previous years income (losses) current year
income or loss either separately or within
retained earnings
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Liabilities and Shareholders Equity
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Income Statement

• summarizes the revenues and expenses of an entity
  for a certain period in time
• reveals the results of operations during a period
  
• shows whether an entity is successful in
  achieving the goal of profitability

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Income Statement

• flow statement reflecting the performance of a
  company in terms of utilizing the resources in a
  given period
• provides information about the revenues and the
  related expenses in a given period, as well as
  the losses incurred in the same period
• The bottom line figure of the income statement is
  the profit or income of the period

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Sections of Income Statement

• Revenues from ordinary activities of an entity
  and the related expenses are reported in
  accordance with the matching principle
• classified according to the function, such as
  cost of goods sold or according to the nature of
  the expense
• reported in a separate section that reports the
  results of the ordinary activities.
• The presentation and disclosure of discontinued
  operations- the post-tax income or loss of the
  segment until disposition and the post-tax gain
  or loss of disposing the segment is presented in
  the income statement as separate line items

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Cash Flow Statement

• deals with cash in-flows and out-flows company
  resulting from operating, financing and investing
  activities for a specific period
• presents information regarding the goal of
  liquidity

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Cash Flow Statement

• shows the amount of cash generated through the
  three main activities of any entity
• Financing
• Investing
• Operating
• a cash flow statement has also three sections
  that parallel the main activities.

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Statement of Changes in Equity

• shows the amounts invested by the owners in a
  given period, as well as the movements in the
  shareholders equity accounts
• main purpose of the statement is to present all
  the changes that affected the shareholders
  equity in a period
• movements in the reserve accounts are based on
  the profit appropriation of the prior period
• retained earnings column in the statement
  reflects the net of prior period income and
  losses

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Statements of a single company
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Auditing and Auditors Opinion

• Independent audit of financial statements
• the examination of the financial statements,
  accounting system and internal controls, and the
  accounting records of a company
• purpose of an independent audit is to express an
  opinion on the financial statements-
• whether they are prepared in accordance with the
  generally accepted accounting principles
• whether they fairly present the financial
  position of the company
• auditors report implies that the financial
  statements are free of material misstatements

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Board of Directors XYZ Corporation We have
audited the accompanying balance sheets of XYZ
Corporation as of 31 December 2005 and 2004, and
the related statements of income, shareholders
equity and cash flows for the years then ended.
These financial statements are the responsibility
of the Companys management. Our responsibility
is to express an opinion on these financial
statements based on our audits. We conducted our
audits in accordance with generally accepted
auditing standards. Those standards require that
we plan and perform the audit to obtain
reasonable assurance about whether the financial
statements are free of material misstatement. An
audit includes examining, on a test basis,
evidence supporting the amounts and disclosures
in the financial statements. An audit also
includes assessing the accounting principles used
and significant estimates made by the management,
as well as evaluating the overall financial
statement presentation. We believe that our
audits provide a reasonable basis for our
opinion. In our opinion, the financial
statements referred to above present fairly, in
all material respects, the financial position of
XYZ Corporation at 31 December 2005 and 2004, and
the results of its operations and its cash flows
for the years then ended, in accordance with
International Financial Reporting Standards as
published by the International Accounting
Standards Board. Signature of the Independent
Auditor Date and Place of the Report
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Ethics in Accounting

• moral principles that an individual bases his/her
  behavior on
• should the project manager give away bribes if
  the competitors are also bribing?
• if an accountant knows that a product is
  environmentally hazardous although it is not
  illegal, should she or he report it to the
  authorities even if s/he knows that she might
  lose her job?
• the ethics committee is working on the
  professional rules of conduct

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Quality of Earnings

• Having stable and recurring basic revenue
  generating activities
• using consistent estimates and rules High same
  methods of estimation and rules
• proximity of revenue recognition and cash
  collection
• High when revenue recognition and cash
  collection are close
• High quality earnings are presumed to be fair
  representations of the economic performance of
  the firm
• Low quality earnings overstate fair earnings

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What will affect Quality of Earnings?

• Managers discretion in measuring and reporting
  earnings in
• Choosing among alternative accounting principles
• Making estimates
• Timing transactions in order to control
  recognition

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Hypothetical Classification of Accounting Systems
Exh. 11.3
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Regulatory Bodies

• National
• Capital Markets Board (CMB)
• Ministry of Finance
• Turkish Accounting Standards Board (TASB)
• TURMOB (Union of Chambers of Certified Public
  Accountants of Turkey)
• International
• International Federation of Accountants
• International Accounting Standards Board-
  International Financial Reporting Standards
  (IFRS)
• Financial Accounting Standards Board (FASB)
• Federation of European Accountants (FEA)

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ACCOUNTING IN TURKEY

• Commercial Code of 1850 was a translation of the
  French Commercial Code
• formed the first accounting regulation in Turkey
• second Commercial Code was enacted in 1926
• code was based on the German commerce and company
  laws that also regulated the accounting practices
  
• accounting system has been heavily influenced by
  the American system or Anglo-Saxon system since
  the beginning of the 1960's

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Accounting in Turkey

• The law of Istanbul Stock Exchange (ISE) in
  1984, but full operations started in 1986
• Foundation of the Capital Markets Board (CMB)
  and the Istanbul stock exchange, and the increase
  in foreign investments advanced the development
  of the accounting and auditing standards
• Increase in joint ventures and foreign trade led
  to establishment of offices of the then-"Big
  Eight" accounting firms in Turkey
• As a result of these developments, large private
  enterprises started to report their financial
  statements in accordance with the International
  Accounting Standards in addition to national
  reporting requirements

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Accounting in Turkey

• The first set of financial accounting standards
  for the publicly owned and/or traded companies
  was developed in January 1989 by the CMB to be in
  effect for the fiscal years that start on or
  after January 1, 1989
• However, accounting standards used by the
  family-owned or small to medium sized companies
  was, and to some extent still is, treated as
  identical with tax accounting

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Uniform Chart of Accounts

• In 1992, Ministry of Finance organized a
  committee to instigate the accounting principles
  and a uniform chart of accounts that would be
  used by all companies
• The Ministry published the committee's report in
  a communiqué on December 26, 1992 establishing
  the principles and the uniform chart of accounts
  to be in effect starting January 1,1994
• All companies except banks, brokerage firms, and
  insurance companies are required to conform
• Banks are subject to accounting rules set by the
  Central Bank of Turkey and Banking Regulation and
  Supervision Agency, and brokerage and insurance
  firms comply with the CMB rules.

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Turkish Accounting Standards Board

• In February 1994, Turkish Accounting and Auditing
  Standards Board (TAASB) was formed
• mission to develop accounting and auditing
  standards
• As of January 1, 2002, TAASB prepared 19
  accounting standards under the name of Turkish
  Accounting Standards (TAS) that were published by
  TURMOB (Union of Chambers of Certified Public
  Accountants of Turkey)
• standards were not widely applied by the Turkish
  companies and the Board was dissolved and
  re-formed as the Turkish Accounting Standards
  Board (TASB) under the Prime Ministry in April
  2002

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Regulatory Environment

• the Ministry of Finance's regulation of 1992, the
  CMB rules, the Commercial Code and the Procedural
  Tax Law, Banking Regulation and Supervision
  Agency and the Central Bank regulations
• All profit oriented companies -The Commercial
  Code and the Procedural Tax Law and Uniform
  Chart of Accounts
• Listed companies and financial intermediaries
  Uniform Chart of Accounts, Commercial Code and
  Procedural Tax Law and CMB rules

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Current Status

• New CMB accounting standards in effect starting 1
  Jan 2005
• Almost same as the IAS/IFRS
• Traded companies are required to comply
• TASB- officially translated the accounting
  standards
• Turkish Commercial Code Expected to be in
  effect mid 2006

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Underlying Assumptions of Financial Statements

• Accrual Basis of Accounting
• Continuity or Going Concern Assumption
• Periodicity or the Time Period Assumption
• Monetary Value or Unit-of-Measure Assumption

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Underlying Concepts

• Understandability
• Relevance
• Materiality
• Reliability
• Faithful Representation
• Substance over Form
• Neutrality (Objectivity)
• Prudence (Conservatism)
• Completeness
• Comparability

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Constraints on Relevant and Reliable Information

• Timeliness
• Benefit and Cost

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Underlying Principles

• Cost Concept
• Revenue
• Matching
• Full Disclosure

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A fellow has been learning to be a balloonist and
takes his first solo flight. Unfortunately the
wind gets up, he is blown off course and is
forced to land. He is in a paddock close to a
road but has no idea where he is. He sees a car
coming along the road and hails it. The driver
gets out and the balloonist says, "G'day mate,
can you tell me where I am?'. "Yes, of course",
says the motorist. "You have just landed in your
balloon and with this wind you have obviously
been blown off course. You are in the top paddock
on John Dawson's farm, 13.5 kilometres from
Canowindra. John will be ploughing the paddock
next week and sowing wheat. There is a bull in
the paddock. It is behind you and about to attack
you." At that moment the bull reaches the
balloonist and tosses him over the fence. Luckily
he is unhurt. He gets up, dusts himself off and
says to the motorist, "I see you're an
accountant". "Good Grief", says the other man,
"you're right. How did you know that?" "I employ
accountants", says the balloonist. "The
information you gave me was detailed, precise and
accurate. Most of it was useless and it arrived
far too late to be of any help."