Internal study material Accounting and Finances doc. dr. Sandi Knez IBS - International Business School, Ljubljana Februar, 2024 Accounting and Finances Avtor: doc. dr. Sandi Knez Naslov: Accounting and Finances Založnik: IBS, Mednarodna poslovna šola Ljubljana Elektronska izdaja Ljubljana, 2024 Kataložni zapis o publikaciji (CIP) pripravili v Narodni in univerzitetni knjižnici v Ljubljani COBISS.SI-ID 187268611 ISBN 978-961-96525-2-7 (PDF) Accounting and Finances - PART 1 Introduction anecdote When I was studying accounting and finance in college, I had a professor who used to tell us a story about a small business owner who had trouble managing his finances. The owner had a successful business that was growing rapidly, but he couldn't keep track of his cash flow and was constantly struggling to pay bills on time. One day, the owner met with a financial advisor who asked him to bring in all of his financial statements, receipts, and invoices. The owner arrived at the meeting with a large trash bag full of crumpled up papers and receipts. As the advisor began to sort through the mess, he found that the owner had been unknowingly spending more money than he was bringing in, and had been relying heavily on credit cards to keep his business afloat. Through the help of the financial advisor, the business owner was able to develop a budget and better manage his cash flow. He also learned the importance of keeping accurate records and using financial statements to track his business's performance. This story highlights the crucial role that accounting and finance play in the success of any business, no matter how big or small. With the right knowledge and tools, entrepreneurs can make informed decisions about their finances and take control of their business's future. Brief intro with history of Accounting and finance Accounting and finance are two essential components of any successful business organization. They provide crucial information to managers that helps them make informed decisions about the allocation of resources, the management of finances, and the direction of the business. The history of accounting and finance can be traced back to the earliest civilizations, where records were kept to track transactions and assets. One of the earliest known systems of accounting was developed by the ancient Egyptians, who used hieroglyphics to record their business transactions on papyrus scrolls. In ancient Rome, accountants known as tabularii were responsible for keeping financial records for businesses and the government. These records included information about expenditures, revenues, and taxes. The tabularii also helped to create a standardized system for measuring and valuing goods and services. In the Middle Ages, double-entry bookkeeping was developed in Italy by Luca Pacioli, a Franciscan monk and mathematician. This system, which records transactions in two accounts, is still used today in modern accounting practices. Pacioli's system helped to improve accuracy in financial reporting and provided a more detailed picture of a company's financial position. During the Industrial Revolution, advancements in technology and transportation led to the growth of large corporations and the need for more sophisticated accounting and financial systems. In response, the field of accounting and finance developed into a profession, with the establishment of accounting societies and professional certification programs. The first accounting society was the Institute of Accountants and Bookkeepers, which was founded in Scotland in 1854. The 20th century saw significant changes in accounting and finance, as businesses and governments sought to improve transparency and accountability in financial reporting. In the United States, the Securities and Exchange Commission was established in 1934 to regulate securities markets and improve financial reporting standards. Today, accounting and finance continue to evolve, with the increasing use of technology and data analytics to improve financial reporting and decision-making. The field plays a critical role in helping businesses achieve their objectives and manage their resources effectively. With the increasing complexity of business operations and the global economy, the importance of accounting and finance will only continue to grow in the future. Accounting and finance are critically important for businesses of all sizes and types. Here are a few reasons why: 1. Financial management: Accounting and finance provide businesses with the tools and information they need to manage their finances effectively. This includes tracking revenue and expenses, creating budgets, managing cash flow, and making informed investment decisions. 2. Tax compliance: Accounting and finance also help businesses stay compliant with tax laws and regulations. By maintaining accurate financial records, businesses can ensure they are paying the correct amount of taxes and avoiding costly penalties. 3. Performance measurement: Accounting and finance provide valuable insights into a business's performance, allowing managers to track progress toward goals, identify areas for improvement, and make data-driven decisions. 4. Investor confidence: Investors, lenders, and other stakeholders rely on accurate financial information to make decisions about whether to invest in a business. By maintaining transparent and reliable financial records, businesses can build trust and confidence with these key stakeholders. 5. Legal compliance: Accounting and finance are also important for maintaining legal compliance. By keeping accurate records of transactions and financial activities, businesses can ensure they are in compliance with a variety of laws and regulations, including those related to financial reporting, data privacy, and anti-money laundering. Overall, accounting and finance play a critical role in the success of businesses by providing the information and tools needed to manage finances effectively, measure performance, and build trust with key stakeholders. Table of Contents PART 1 1 Significance of Accounting and Finances for Organizations........................................................... 1 2 Significance of considering financial regulations ........................................................................... 5 3 Principal Financial Statements ....................................................................................................... 9 4 Significance and Types of Financing ............................................................................................. 14 5 Company as a Business System .................................................................................................. - 1 - 6 Significance of Accounting in a Company .................................................................................. - 6 - 7 Components of Accounting and Types of Accountancies ........................................................ - 11 - 8 Contents and Forms of Business Documents and Business Books .......................................... - 17 - 9 Contents and Forms of Financial Statement & Information in Individual Financial Statements .... - 22 - 10 Significance of Financial Function ............................................................................................ - 30 - 11 Objectives, Tasks, and Organization of Financial Function ...................................................... - 34 - 12 Interior and Exterior Sources of Financing ............................................................................... - 38 - 13 Securities in Financing a Business Systems and Securities Markets ........................................ - 43 - 14 Money Movements .................................................................................................................. - 48 - 15 Instruments for Claim Insurance .............................................................................................. - 54 - 16 Tax Legislation: Global, EU, and Slovenia ................................................................................. - 59 - 17 Exercise Assignments ............................................................................................................... - 64 - 1 Significance of Accounting and Finances for Organizations 1.1 Introduction Accounting and finances are critical components of any organization, regardless of its size, industry, or location. Financial records and reports are used to monitor and control a firm's financial performance, make informed business decisions, and comply with regulatory requirements. Therefore, an understanding of accounting and finance is essential for business owners, managers, investors, and other stakeholders. This chapter discusses the significance of accounting and finances for organizations. The chapter begins by defining accounting and finance and their respective roles in business operations. The chapter then explores the importance of accounting and finance for decision-making, regulatory compliance, and strategic planning. Finally, the chapter highlights the current trends and challenges in accounting and finance and their impact on organizational performance. 1.2 What is Accounting? Accounting refers to the process of recording, classifying, summarizing, and interpreting financial transactions to generate financial statements and reports. These financial statements include the income statement, balance sheet, and cash flow statement, which provide a snapshot of a company's financial performance over a specific period. The main objective of accounting is to provide information that is useful in decision-making. Accounting information is used by stakeholders to evaluate a company's financial health, profitability, and liquidity. The information is also used to measure a company's performance against industry benchmarks and to comply with regulatory requirements. 1.3 What is Finance? Finance refers to the management of money and other financial resources. Financial management involves planning, budgeting, investing, and controlling financial resources to achieve organizational objectives. The main objective of financial management is to maximize shareholder value by generating profits and increasing the value of the company's stock. The finance department is responsible for managing the company's financial resources, including cash, investments, and debt. The finance department also manages financial risk by assessing and mitigating potential financial threats. 1 1.4 The Importance of Accounting and Finance for Decision-Making Accounting and finance are essential for decision-making in an organization. The financial information generated by accounting provides insights into a company's financial performance, which is used by stakeholders to make informed decisions. For example, investors use financial information to evaluate a company's financial health and determine whether to invest in the company's stock. Business owners use financial information to assess their company's profitability, cash flow, and liquidity, which helps them make informed decisions about expanding their operations or entering new markets. Accounting and finance are also used for budgeting and forecasting. Financial statements and reports are used to develop budgets and forecast future financial performance. This information helps business owners and managers make informed decisions about resource allocation, capital expenditures, and investments. 1.5 The Importance of Accounting and Finance for Regulatory Compliance Accounting and finance are also essential for regulatory compliance. Companies are required to comply with various regulations related to financial reporting and tax obligations. Failure to comply with these regulations can result in penalties and legal consequences. For example, companies must comply with the Generally Accepted Accounting Principles (GAAP), which are a set of accounting standards used to ensure consistency and transparency in financial reporting. Companies must also comply with tax laws, including reporting income and paying taxes on time. 1.6 The Importance of Accounting and Finance for Strategic Planning Accounting and finance are critical for strategic planning in an organization. Financial information is used to identify opportunities and risks, which helps managers make informed decisions about the company's future direction. For example, financial analysis can help identify trends in a company's revenue and expenses, which can be used to develop strategies for growth or cost reduction. Financial information can also help identify potential risks, such as changes in market conditions or regulatory requirements, which can be used to develop risk management strategies. 2 1.7 Trends and Challenges in Accounting and Finance The accounting and finance industry is constantly evolving, and new trends and challenges emerge regularly. The following are some of the current trends and challenges in the field of accounting and finance: 1.7.1 Technology Technology has had a significant impact on the accounting and finance industry. The use of cloud computing, automation, and artificial intelligence has transformed the way financial information is processed, analyzed, and reported. Accounting software, such as QuickBooks and Xero, has made it easier for small businesses to manage their finances and comply with regulatory requirements. 1.7.2 Globalization The globalization of business has created new challenges for accounting and finance professionals. As companies expand their operations across borders, they must comply with different regulatory requirements and tax laws. They must also manage foreign exchange risk and currency fluctuations. 1.7.3 Data Security Data security has become a major concern for accounting and finance professionals. Financial information is sensitive and must be protected from unauthorized access and cyber-attacks. Companies must implement robust data security measures to prevent data breaches and protect their reputation. 1.7.4 Sustainability Sustainability has become a critical issue for businesses, and accounting and finance professionals must consider the impact of their financial decisions on the environment and society. Companies must account for their social and environmental impact in their financial reporting, and investors are increasingly demanding this information to make informed investment decisions. 1.8 Conclusion In conclusion, accounting and finance are essential components of any organization. The financial information generated by accounting is used for decision-making, regulatory compliance, and strategic planning. The finance department is responsible for managing the company's financial resources and mitigating financial risk. Accounting and finance professionals must stay up-to-date with current trends and challenges in the industry to ensure they are providing accurate and reliable financial information to stakeholders. 3 1.9 Real-Life Case: One of the most significant examples of the importance of accounting and finances for organizations is the Enron scandal. Enron was an energy company based in Houston, Texas, that was involved in one of the biggest corporate accounting scandals in history. The scandal involved fraudulent accounting practices that allowed the company to hide its debt and inflate its profits, leading to its bankruptcy in 2001. Enron's accounting fraud involved creating special purpose entities (SPEs) that were used to hide debt and losses from Enron's financial statements. The company used mark-to-market accounting, a method that allows companies to value assets based on their estimated future market value rather than their actual purchase price, to inflate its profits. Enron also used complex financial instruments such as derivatives to manipulate its financial statements. The scandal had far-reaching consequences, including the loss of jobs for thousands of employees, the bankruptcy of Enron, and the collapse of accounting firm Arthur Andersen, which was Enron's auditor. The Enron scandal led to increased regulation of the accounting industry and a renewed focus on corporate governance. Source: https://www.investopedia.com/updates/enron-scandal-summary/ 1.10 References and further reading 1. Brigham, E. F., & Houston, J. F. (2018). Fundamentals of financial management. Cengage Learning. 2. Garrison, R. H., Noreen, E. W., & Brewer, P. C. (2018). Managerial accounting. McGraw-Hill Education. 3. Johanson, U., & Miller, S. (2019). Accounting and finance: An introduction. Routledge. 4. PwC. (2021). Top Accounting Trends for 2021. Retrieved from https://www.pwc.com/us/en/library/audit-assurance/top-accounting-trends-for- 2021.html 5. Zadek, S., Evans, R., & Pruzan, P. (2013). Building corporate accountability: Emerging practices in social and ethical accounting and auditing. Routledge. 4 2 Significance of considering financial regulations 2.1 Introduction Financial regulations refer to the laws, rules, and standards that govern the behavior and activities of financial institutions, markets, and participants. Financial regulations are critical to ensuring the stability and integrity of financial markets and protecting investors and consumers. Failure to comply with financial regulations can lead to severe penalties, including fines, loss of licenses, and even criminal prosecution. Therefore, understanding and complying with financial regulations are crucial for any business, including startups, small businesses, and large corporations. This chapter aims to explore the significance of considering financial regulations in accounting and finances. 2.2 Financial regulations Financial regulations aim to promote stability, transparency, and fairness in financial markets and institutions. Financial regulations can be divided into three categories: prudential regulations, conduct regulations, and market regulations. Prudential regulations focus on the safety and soundness of financial institutions. They set minimum standards for capital adequacy, liquidity, risk management, and corporate governance. Prudential regulations aim to prevent the failure of financial institutions, which can have severe consequences for the economy. Conduct regulations focus on the behavior of financial institutions and their interactions with customers. Conduct regulations aim to protect consumers from fraud, misrepresentation, and unfair treatment. Conduct regulations cover a wide range of activities, including disclosure requirements, market abuse, anti-money laundering, and consumer protection. Market regulations focus on the operation and transparency of financial markets. Market regulations aim to promote efficiency, fairness, and transparency in financial markets. Market regulations cover a wide range of activities, including trading rules, disclosure requirements, and market surveillance. 5 2.3 The significance of financial regulations Financial regulations are essential for the following reasons: 2.3.1 Protecting investors and consumers Financial regulations aim to protect investors and consumers from fraud, misrepresentation, and unfair treatment. Financial regulations set standards for disclosure, transparency, and conduct, which can help investors and consumers make informed decisions. 2.3.2 Promoting financial stability Financial regulations aim to promote financial stability by ensuring the safety and soundness of financial institutions. Prudential regulations set minimum standards for capital adequacy, liquidity, and risk management, which can prevent the failure of financial institutions. 2.3.3 Preventing systemic risk Financial regulations aim to prevent systemic risk, which is the risk of a widespread failure of financial institutions or markets. Systemic risk can have severe consequences for the economy, such as a recession or depression. Financial regulations can mitigate systemic risk by promoting transparency, regulating complex financial products, and monitoring the behavior of financial institutions. 2.3.4 Ensuring market efficiency Financial regulations aim to promote market efficiency by ensuring fair and transparent trading practices. Market regulations set rules for trading, disclosure, and market surveillance, which can promote liquidity and prevent market manipulation. 2.3.5 Maintaining public trust Financial regulations are essential for maintaining public trust in financial institutions and markets. Public trust is critical to the functioning of financial markets, as it enables investors and consumers to participate in financial activities with confidence. 2.4 The consequences of non-compliance with financial regulations Non-compliance with financial regulations can have severe consequences for businesses and individuals. The consequences of non-compliance include: 2.4.1 Financial penalties Financial penalties are the most common consequence of non-compliance with financial regulations. Financial penalties can be significant and can include fines, disgorgement of profits, and the forfeiture of assets. 2.4.2 Loss of licenses Non-compliance with financial regulations can lead to the loss of licenses or permits required to operate in the financial sector. Loss of licenses can have severe consequences for businesses, as it can prevent them from operating in the financial sector. 6 2.4.3 Criminal prosecution Non-compliance with financial regulations can lead to criminal prosecution. Criminal charges can be brought against individuals or businesses that engage in fraud, money laundering, or other criminal activities. 2.5 Conclusion Financial regulations are critical to ensuring the stability and integrity of financial markets and protecting investors and consumers. Complying with financial regulations is essential for any business, including startups, small businesses, and large corporations. Failure to comply with financial regulations can lead to severe penalties, including fines, loss of licenses, and even criminal prosecution. Therefore, businesses must understand and comply with financial regulations to ensure that they operate within the bounds of the law and maintain public trust. By complying with financial regulations, businesses can promote financial stability, prevent systemic risk, and ensure market efficiency, which can benefit both the business and the wider economy. 2.6 Real-Life Case: One example of the significance of financial regulations in the European Union (EU) is the recent case of Danske Bank, a Danish bank that was embroiled in a money laundering scandal. The scandal involved the bank's Estonian branch, which allegedly facilitated the laundering of up to €200 billion between 2007 and 2015. The case led to significant regulatory and legal scrutiny, as well as fines and penalties for the bank. One specific example of this scrutiny is the investigation by the European Banking Authority (EBA), which is responsible for supervising banks across the EU. The EBA launched an investigation into the Danske Bank scandal in 2018, and in 2019 it published a report outlining the bank's failures to comply with EU anti-money laundering regulations. The report found that Danske Bank had "serious shortcomings" in its anti-money laundering policies and procedures, including a failure to adequately assess and mitigate money laundering risks, and a lack of adequate customer due diligence. The report also criticized the bank's Estonian branch for failing to adequately report suspicious transactions to the relevant authorities. As a result of the scandal, Danske Bank has faced significant financial and reputational damage. The bank has been fined by regulators in Denmark, Estonia, and France, and its CEO and other executives have resigned. The case has also led to increased scrutiny of the financial sector in the EU, and calls for stronger regulatory measures to prevent similar scandals from occurring in the future. Source: European Banking Authority report on Danske Bank money laundering scandal 7 2.7 References and further reading 1. Financial Conduct Authority. (2021). What are financial regulations? Retrieved from https://www.fca.org.uk/firms/financial-regulations 2. International Monetary Fund. (2018). Financial regulation: Why, how and where now? Retrieved from https://www.imf.org/en/Publications/WP/Issues/2018/02/22/Financial- Regulation-Why-How-and-Where-Now-45522 3. Jones, D. (2018). The importance of financial regulation. Forbes. Retrieved from https://www.forbes.com/sites/forbesfinancecouncil/2018/08/30/the-importance-of- financial-regulation/?sh=7285b5d23dc5 4. Organisation for Economic Co-operation and Development. (2018). The role and scope of financial regulation. Retrieved from https://www.oecd.org/finance/The-Role-and- Scope-of-Financial-Regulation.pdf 5. United States Securities and Exchange Commission. (2021). The importance of financial regulation. Retrieved from https://www.sec.gov/fast-answers/answers- regimportancehtm.html 8 3 Principal Financial Statements 3.1 Introduction Financial statements are a crucial part of any business, and they serve as a tool for evaluating the financial health and performance of a company. They provide important information about a company's assets, liabilities, revenues, and expenses, which can be used by investors, creditors, and other stakeholders to make informed decisions about the company. The principal financial statements include the balance sheet, income statement, and cash flow statement. In this chapter, we will provide a detailed overview of these financial statements, including their components, purpose, and significance. 3.2 Balance Sheet The balance sheet is a financial statement that provides a snapshot of a company's financial position at a specific point in time. It lists the company's assets, liabilities, and equity, and provides a summary of the company's financial position. The balance sheet is based on the accounting equation, which states that assets equal liabilities plus equity. This equation forms the basis for the balance sheet, as the total value of assets must equal the sum of liabilities and equity. 3.2.1 Components of the Balance Sheet Assets: Assets are resources owned by the company that have value and can be used to generate income. They include current assets, such as cash, accounts receivable, and inventory, as well as long-term assets, such as property, plant, and equipment. Liabilities: Liabilities are obligations that the company owes to others, such as loans, accounts payable, and accrued expenses. They include current liabilities, such as short-term loans and accounts payable, as well as long-term liabilities, such as long-term debt. Equity: Equity represents the value of the company that is owned by its shareholders. It includes retained earnings, which are the profits earned by the company that have not been paid out as dividends, as well as common and preferred stock. 3.2.2 Purpose of the Balance Sheet The balance sheet provides a snapshot of the company's financial position at a specific point in time, and it is used to evaluate the company's liquidity, solvency, and financial stability. It provides information about the company's assets, liabilities, and equity, which can be used to determine the company's ability to pay its debts, its level of financial risk, and its overall financial health. 9 3.2.3 Significance of the Balance Sheet The balance sheet is an important tool for investors, creditors, and other stakeholders who need to evaluate a company's financial health and performance. It provides a summary of the company's financial position, which can be used to make informed decisions about investing in the company or extending credit. It also provides a benchmark for measuring the company's financial performance over time, as changes in assets, liabilities, and equity can be tracked over time. 3.3 Income Statement The income statement, also known as the profit and loss statement, is a financial statement that provides information about a company's revenues and expenses over a specific period of time. It shows the company's net income or net loss for the period, which is the difference between its revenues and expenses. 3.3.1 Components of the Income Statement Revenues: Revenues are the amounts earned by the company from the sale of its goods or services. They include sales revenue, service revenue, and other types of revenue. Expenses: Expenses are the costs incurred by the company in order to generate revenue. They include cost of goods sold, operating expenses, depreciation, and interest expense. Net Income or Net Loss: Net income or net loss is the difference between revenues and expenses. If revenues are greater than expenses, the company has a net income. If expenses are greater than revenues, the company has a net loss. 3.3.2 Purpose of the Income Statement The income statement provides information about a company's financial performance over a specific period of time, and it is used to evaluate the company's profitability. It provides information about the company's revenues and expenses, which can be used to determine the company's ability to generate profits and to identify areas where expenses may be too high or where revenue may need to be increased. 3.3.3 Significance of the Income Statement The income statement is an important tool for investors, creditors, and other stakeholders who need to evaluate a company's financial performance. It provides information about the company's revenue and expenses, which can be used to determine its profitability and to make informed decisions about investing in the company or extending credit. It also provides a benchmark for measuring the company's financial performance over time, as changes in revenue and expenses can be tracked over time. 10 3.4 Cash Flow Statement The cash flow statement is a financial statement that provides information about a company's cash inflows and outflows over a specific period of time. It shows how much cash the company has generated from its operating activities, investing activities, and financing activities. 3.4.1 Components of the Cash Flow Statement Operating Activities: Operating activities are the cash inflows and outflows that are directly related to the company's operations. They include cash received from customers, cash paid to suppliers, and other operating expenses. Investing Activities: Investing activities are the cash inflows and outflows that are related to the company's investments in property, plant, and equipment, as well as other investments. They include cash paid for the acquisition of property, plant, and equipment, as well as cash received from the sale of investments. Financing Activities: Financing activities are the cash inflows and outflows that are related to the company's financing activities, such as the issuance of stock or the repayment of debt. They include cash received from the issuance of stock, as well as cash paid for the repayment of debt. Net Cash Flow: Net cash flow is the difference between cash inflows and cash outflows from operating, investing, and financing activities. 3.4.2 Purpose of the Cash Flow Statement The cash flow statement provides information about a company's cash inflows and outflows over a specific period of time, and it is used to evaluate the company's liquidity and financial health. It provides information about the company's ability to generate cash from its operating activities, as well as its ability to finance its investments and operations. 3.4.3 Significance of the Cash Flow Statement The cash flow statement is an important tool for investors, creditors, and other stakeholders who need to evaluate a company's financial health and performance. It provides information about the company's cash inflows and outflows, which can be used to determine its liquidity and to make informed decisions about investing in the company or extending credit. 11 3.5 Conclusion Financial statements are a crucial tool for evaluating a company's financial health and performance. The principal financial statements include the balance sheet, income statement, and cash flow statement. The balance sheet provides a snapshot of the company's financial position at a specific point in time, while the income statement provides information about the company's revenues and expenses over a specific period of time. The cash flow statement provides information about the company's cash inflows and outflows over a specific period of time. These financial statements are important for investors, creditors, and other stakeholders who need to evaluate a company's financial health and performance and make informed decisions about investing in the company or extending credit. 3.6 Real-Life Case: As a publicly-traded company in the EU, Volkswagen is required to file financial statements in accordance with International Financial Reporting Standards (IFRS), which are adopted by the European Union. In their 2020 Annual Report, Volkswagen presented their principal financial statements, including the balance sheet, income statement, statement of comprehensive income, statement of changes in equity, and cash flow statement. These statements provide valuable information to investors, analysts, and other stakeholders regarding the company's financial position, performance, and cash flows. For example, Volkswagen's balance sheet as of December 31, 2020, shows total assets of €463.5 billion, total liabilities of €347.3 billion, and total equity of €116.2 billion. The income statement for the year ended December 31, 2020, shows revenue of €222.9 billion, cost of sales of €182.1 billion, and net income of €8.8 billion. These financial statements can be found on Volkswagen's website in their Annual Report for the year ended December 31, 2020, which can be accessed using the following link: https://annualreport2020.volkswagenag.com/servicepages/filelibrary/files/collection.php 12 3.7 References and further reading 1. Financial Accounting Standards Board. (2016). Conceptual framework for financial reporting. Retrieved from https://www.fasb.org/jsp/FASB/Page/SectionPage&cid=1176167971108 2. Kieso, D. E., Weygandt, J. J., & Warfield, T. D. (2016). Intermediate accounting (16th ed.). Hoboken, NJ: Wiley. 3. Stickney, C. P., Weil, R. L., & Schipper, K. (2009). Financial accounting: An introduction to concepts, methods, and uses. Mason, OH: South-Western Cengage Learning. 4. Wild, J. J., Shaw, K. W., & Chiappetta, B. (2017). Financial and managerial accounting (4th ed.). New York, NY: McGraw-Hill Education. 5. Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2015). Financial accounting: Tools for business decision making (8th ed.). Hoboken, NJ: Wiley. 6. Bannister, R. C., Hatfield, R. C., & Hsu, C. (2017). Financial statement analysis: A practitioner's guide (4th ed.). Hoboken, NJ: Wiley. 7. Bragg, S. M. (2018). Accounting best practices (7th ed.). Hoboken, NJ: Wiley. 8. Financial Reporting Council. (2018). Financial reporting standard 102: The financial reporting standard applicable in the UK and Republic of Ireland. Retrieved from https://www.frc.org.uk/getattachment/9d86fc45-dfaa-487c-a21d-a43b30f2b8a1/FRS- 102-The-Financial-Reporting-Standard-applicable-in-the-UK-and-Republic-of-Ireland- (September-2015)-(PDF) 9. Financial Accounting Standards Board. (2017). Accounting standards codification. Retrieved from https://asc.fasb.org/home 10. International Accounting Standards Board. (2017). International financial reporting standards. Retrieved from https://www.ifrs.org/standards/ 13 4 Significance and Types of Financing 4.1 Introduction Financing is an essential aspect of every business. It involves obtaining the necessary funds required to start, run, and expand a business. A lack of financing can be a major hurdle for any business, and it can lead to failure in the long run. Therefore, it is essential to understand the significance of financing and the different types of financing options available to businesses. This chapter aims to provide an in-depth analysis of the importance of financing and the various types of financing available. 4.2 Significance of Financing Financing is a critical component of any business, and it plays a vital role in the success of a business. Here are some of the reasons why financing is significant: 4.2.1 Starting a Business Financing is essential for starting a business. Most entrepreneurs require some capital to start a business, and this capital can be obtained from different sources, such as investors, loans, grants, or personal savings. Without financing, it can be difficult to get a business off the ground. 4.2.2 Running a Business Financing is also important for running a business. A business requires a steady flow of cash to pay for expenses such as rent, salaries, utilities, and other operational costs. Financing can help ensure that a business has the necessary funds to meet its daily operational needs. 4.2.3 Expanding a Business Financing can also be used to expand a business. This could involve opening new locations, hiring additional staff, investing in new equipment, or launching new products or services. Expanding a business can be costly, and financing can provide the necessary funds to facilitate this process. 4.3 Types of Financing There are various types of financing available to businesses. Each type of financing has its advantages and disadvantages, and it is essential to choose the right type of financing that best suits the needs of a business. Here are some of the most common types of financing: 14 4.3.1 Debt Financing Debt financing involves borrowing money from a lender, such as a bank or a financial institution, with the agreement to repay the borrowed amount with interest over a specified period. This type of financing is usually secured by collateral, which could be the business's assets or personal assets of the business owner. Debt financing can be short-term or long-term, and it is an excellent option for businesses that require funds for specific purposes, such as purchasing new equipment or inventory. 4.3.2 Equity Financing Equity financing involves selling a portion of the business to investors in exchange for funds. This type of financing is suitable for businesses that do not want to take on debt or do not qualify for loans. Equity financing can be obtained from various sources, such as angel investors, venture capitalists, or crowdfunding platforms. One advantage of equity financing is that investors share in the risk and reward of the business, and they may also provide valuable expertise and contacts. 4.3.3 Grants Grants are non-repayable funds provided by governments, non-profit organizations, or private foundations to support specific activities or initiatives. Grants are usually awarded based on specific criteria, such as the type of business, the location, or the purpose of the grant. Grants are an excellent source of financing for businesses that meet the eligibility criteria, and they do not have to be repaid. 4.3.4 Bootstrapping Bootstrapping involves using personal savings or revenue generated from the business to finance its operations. This type of financing is suitable for businesses that do not require significant capital and can operate on a limited budget. Bootstrapping can be challenging, as it requires discipline and creativity to generate revenue and manage expenses effectively. 4.3.5 Crowdfunding Crowdfunding involves raising funds from a large group of people, usually through online platforms. Crowdfunding can be used for various purposes, such as launching a new product, financing a creative project, or supporting a cause or social initiative. There are three main types of crowdfunding: rewards-based, donation-based, and equity-based. Rewards-based crowdfunding involves offering rewards, such as early access to a product or a personalized thank-you message, to individuals who contribute funds. Donation-based crowdfunding involves soliciting donations from individuals who support a particular cause or initiative. Equity-based crowdfunding involves offering equity in the business to individuals who invest funds. 15 4.4 Conclusion Financing is a crucial aspect of any business, and it plays a significant role in its success or failure. Choosing the right type of financing is essential to meet the needs of a business and achieve its goals. Debt financing, equity financing, grants, bootstrapping, and crowdfunding are some of the most common types of financing available to businesses. It is essential to consider the advantages and disadvantages of each type of financing and evaluate which one is best suited for the needs of a particular business. 4.5 Real-Life Case: The EIB is the European Union's lending institution and is owned by its member states. It provides financing for projects that contribute to the EU's economic, social, and environmental goals. One way the EIB supports renewable energy projects is through its participation in the European Fund for Strategic Investments (EFSI), also known as the Juncker Plan. EFSI provides financing for projects that have a high potential for economic growth and job creation, including renewable energy projects. One real-life example of EIB financing for renewable energy is the construction of the 450 MW Neart na Gaoithe offshore wind farm in Scotland. The EIB provided £525 million in financing for the project, which is expected to generate enough energy to power around 375,000 homes per year. Source: European Investment Bank. (2019, May 16). EIB backs offshore wind farm in Scotland with £525 million. 16 4.6 References and further reading 1. Dahan, N., & Doh, J. P. (2018). Entrepreneurial finance: An overview of the field and future research directions. Journal of Business Venturing, 33(6), 627-657. doi: 10.1016/j.jbusvent.2018.05.003 2. Block, J. H., Fisch, C. O., & van Praag, M. (2018). The Schumpeterian entrepreneur: A review of the empirical evidence on the antecedents, behavior, and consequences of innovative entrepreneurship. Industry and Innovation, 25(1), 61-95. doi: 10.1080/13662716.2017.1384149 3. Colombo, M. G., & Grilli, L. (2018). Entrepreneurship and innovation policy: An overview. Research Policy, 47(8), 1368-1384. doi: 10.1016/j.respol.2018.06.006 4. Mian, S. A., Lerner, J., & Heltzer, W. (2018). Financing entrepreneurship and innovation. In Handbook of the Economics of Innovation (Vol. 2, pp. 931-993). Elsevier. doi: 10.1016/bs.heb.2018.07.004 5. Shane, S. A. (2018). Entrepreneurial finance, entrepreneurship, and public policy. Journal of Economics & Management Strategy, 27(3), 455-473. doi: 10.1111/jems.12259 17 Accounting and Finances - PART 2 5 Company as a Business System 5.1 Introduction Accounting and finance are essential components of any business system. A business system consists of different components that interact with one another to achieve a common goal, which is to create value for stakeholders. Accounting and finance are critical components of the business system because they provide information on the financial position, performance, and cash flows of the company. In this chapter, we will discuss the concept of a company as a business system and how accounting and finance are essential components of the system. 5.2 The Concept of a Company as a Business System A company is a complex system that consists of various components, such as management, employees, suppliers, customers, and investors. These components interact with one another to achieve the company's objectives, which may include increasing revenue, reducing costs, improving customer satisfaction, and creating value for stakeholders. According to Deming (1994), a system is a network of interdependent components that work together to achieve a common goal. In the context of a company, the components are the different functions of the company, such as finance, marketing, operations, and human resources. These functions are interdependent, and they work together to achieve the company's objectives. - 1 - A business system can be represented using a systems thinking approach. Systems thinking is an approach to problem-solving that considers the entire system and its interrelationships, rather than focusing on individual components in isolation (Senge, 1990). Systems thinking recognizes that every component of the system is interdependent and that changes in one component can have a ripple effect throughout the system. 5.3 The Importance of Accounting and Finance in the Business System Accounting and finance are essential components of the business system because they provide information on the financial position, performance, and cash flows of the company. This information is critical for decision-making and for achieving the company's objectives. Financial statements, such as the income statement, balance sheet, and cash flow statement, provide information on the financial position and performance of the company. The income statement shows the company's revenue, expenses, and net income over a period of time. The balance sheet shows the company's assets, liabilities, and equity at a specific point in time. The cash flow statement shows the company's cash inflows and outflows over a period of time. Financial information is used by managers, investors, lenders, and other stakeholders to make decisions about the company. For example, managers may use financial information to make decisions about pricing, product development, and cost-cutting measures. Investors and lenders may use financial information to make decisions about investing in the company or lending money to the company. 5.4 The Role of Accounting and Finance in the Business System Accounting and finance play a critical role in the business system. The role of accounting and finance can be summarized as follows: 1. Recording financial transactions: Accounting is the process of recording financial transactions, such as sales, purchases, and expenses. These transactions are recorded in the company's accounting system and are used to prepare financial statements. 2. Preparation of financial statements: Finance is responsible for preparing the company's financial statements, such as the income statement, balance sheet, and cash flow statement. These financial statements provide information on the company's financial position and performance. 3. Analysis of financial statements: Financial analysis involves using financial statements to analyze the company's financial performance. Financial analysis can help identify trends, strengths, weaknesses, and opportunities for improvement. - 2 - 4. Budgeting and forecasting: Finance is responsible for preparing the company's budget and forecasts. The budget is a financial plan that outlines the company's expected revenue and expenses over a period of time. Forecasts are estimates of future financial performance based on past performance and current trends. 5. Financial decision-making: Accounting and finance are critical components of financial decision-making. Financial information is used to make decisions about investments, pricing, product development, and cost-cutting measures. Financial decision-making involves analyzing financial information to make decisions that will maximize the company's value and achieve its objectives. 6. Risk management: Accounting and finance are also responsible for managing the company's financial risks. Financial risks can include risks related to currency exchange rates, interest rates, credit risk, and market risk. Accounting and finance use financial information to identify and manage these risks. 7. Communication with stakeholders: Accounting and finance also play a critical role in communicating with stakeholders, such as investors, lenders, and regulatory bodies. Financial information is used to provide transparency and accountability to stakeholders, which can help build trust and confidence in the company. 5.5 Conclusion In conclusion, a company is a complex system that consists of different components that interact with one another to achieve a common goal. Accounting and finance are essential components of the business system because they provide information on the financial position, performance, and cash flows of the company. This information is critical for decision-making and for achieving the company's objectives. Accounting and finance play a critical role in recording financial transactions, preparing financial statements, analyzing financial information, budgeting and forecasting, financial decision-making, risk management, and communication with stakeholders. - 3 - 5.6 Real-Life Case: One real-life example of a company as a business system in the European Union is the German automobile manufacturer, Volkswagen Group. Volkswagen Group is a multinational automotive manufacturing company headquartered in Wolfsburg, Germany. The company designs, manufactures, and distributes passenger and commercial vehicles, motorcycles, and engines. With brands such as Volkswagen, Audi, Porsche, Skoda, Seat, and Lamborghini, Volkswagen Group is one of the largest car manufacturers in the world. In recent years, Volkswagen Group has faced significant challenges related to accounting and finances. In 2015, the company was involved in a major scandal known as "Dieselgate." The scandal involved the use of software to cheat on emissions tests for diesel-powered vehicles sold in the United States and Europe. The scandal resulted in the company paying billions of dollars in fines and settlements, as well as a significant drop in sales and reputation. To address the scandal and its financial implications, Volkswagen Group implemented several changes to its business system. The company appointed a new CEO, Herbert Diess, who has since focused on restructuring the company's operations and increasing efficiency. Volkswagen Group has also invested heavily in electric vehicle technology, with a goal of becoming carbon-neutral by 2050. This case highlights the importance of a company as a business system and the need for effective accounting and financial management. It also demonstrates the significant impact that accounting and finance issues can have on a company's reputation, sales, and long-term success. Source: "Volkswagen Group Homepage." Volkswagen Group. Volkswagen AG, n.d. Web. 8 Mar. 2023. https://www.volkswagenag.com/en/group.html. 5.7 References and further reading 1. Deming, W. E. (1994). The new economics for industry, government, education. MIT Press. 2. Senge, P. M. (1990). The fifth discipline: The art and practice of the learning organization. Doubleday. 3. Weygandt, J. J., Kieso, D. E., & Kimmel, P. D. (2019). Financial accounting. Wiley. 4. Hansen, D. R., & Mowen, M. M. (2018). Cost management: accounting and control. Cengage Learning. 5. Higgins, R. C. (2018). Analysis for financial management. McGraw-Hill Education. - 4 - 5.8 Progress Test 1. What is a business system? a. A network of interdependent components that work together to achieve a common goal. b. A collection of unrelated components that have no interaction with each other. c. A system that operates without any human intervention. d. A system that operates without any financial transactions. 2. What is the role of accounting and finance in the business system? a. To provide information on the financial position, performance, and cash flows of the company. b. To manage the production process of the company. c. To provide customer service to the customers. d. To develop marketing strategies for the company. 3. Which of the following financial statements shows the company's cash inflows and outflows over a period of time? a. Income statement. b. Balance sheet. c. Cash flow statement. d. Statement of retained earnings. 4. What is the role of financial decision-making in the business system? a. To analyze the company's financial performance and identify trends, strengths, weaknesses, and opportunities for improvement. b. To manage the company's financial risks. c. To communicate with stakeholders, such as investors, lenders, and regulatory bodies. d. To make decisions about investments, pricing, product development, and cost-cutting measures. Answers: a, a, c, d - 5 - 6 Significance of Accounting in a Company 6.1 Introduction Accounting is a vital aspect of any business organization that records, classifies, and summarizes financial transactions to provide a comprehensive view of the financial health of the organization. Accounting plays a critical role in the management of a company and contributes significantly to the decision-making process. This chapter explores the significance of accounting in a company by highlighting its role in providing financial information, monitoring and controlling operations, evaluating performance, and fulfilling legal and regulatory requirements. 6.2 Role of Accounting in Providing Financial Information One of the primary roles of accounting is to provide financial information that helps stakeholders to make informed decisions. Accounting provides financial statements that summarize the financial position, performance, and cash flows of the company. These financial statements include the balance sheet, income statement, and cash flow statement. The balance sheet provides information on the assets, liabilities, and equity of the company at a particular point in time. The income statement shows the revenue, expenses, and profit or loss of the company over a given period. The cash flow statement highlights the inflows and outflows of cash and cash equivalents of the company during a specified period. The financial statements provide stakeholders with critical information on the financial health of the company, enabling them to make informed decisions. Investors use financial - 6 - statements to evaluate the profitability and financial stability of the company before investing. Creditors use financial statements to assess the ability of the company to repay debts. Management uses financial statements to monitor the financial performance of the company and make strategic decisions. 6.3 Role of Accounting in Monitoring and Controlling Operations Accounting plays a crucial role in monitoring and controlling operations in a company. Accounting records financial transactions, which help to monitor the cash flows and expenses of the company. The records help to identify areas where the company is spending too much or too little, enabling management to adjust accordingly. Accounting also plays a role in controlling operations by establishing internal controls that prevent fraud and errors. Internal controls ensure that financial transactions are authorized, recorded, and processed correctly. Internal controls also ensure that assets are protected from theft, damage, or loss. Accounting also helps to monitor the performance of employees by tracking their productivity and efficiency. For example, the accounting department may track the number of sales made by each salesperson to determine their effectiveness. The accounting department may also monitor the expenses incurred by each department to evaluate their efficiency. This information helps management to make informed decisions on how to improve operations and increase profitability. 6.4 Role of Accounting in Evaluating Performance Accounting plays a vital role in evaluating the performance of a company. Accounting provides financial ratios that help to evaluate the profitability, liquidity, and solvency of the company. Financial ratios are used to measure the relationship between different financial variables such as revenue, expenses, assets, and liabilities. Financial ratios include the current ratio, debt-to-equity ratio, return on assets, return on equity, and gross profit margin, among others. Financial ratios help management to evaluate the performance of the company over time and compare it with industry benchmarks. The ratios also help management to identify areas that require improvement and make informed decisions on how to improve performance. 6.5 Role of Accounting in Fulfilling Legal and Regulatory Requirements Accounting plays a crucial role in fulfilling legal and regulatory requirements. All companies are required by law to maintain accurate financial records and produce financial statements. Failure to comply with these requirements can lead to fines, legal action, and loss of - 7 - reputation. Accounting also plays a role in ensuring that taxes are paid correctly and on time. The accounting department is responsible for preparing tax returns, ensuring compliance with tax laws, and communicating with tax authorities. In addition, accounting plays a role in fulfilling regulatory requirements such as the Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS). GAAP and IFRS provide a set of guidelines that companies must follow when preparing financial statements. These guidelines ensure that financial statements are consistent, accurate, and comparable across different companies and industries. The accounting department is responsible for ensuring that the financial statements are prepared in accordance with GAAP or IFRS, depending on the company's location and the regulatory requirements. Failure to comply with these guidelines can result in legal action, loss of reputation, and financial loss. 6.6 Conclusion In conclusion, accounting plays a vital role in the management of a company. Accounting provides financial information that helps stakeholders to make informed decisions, monitors and controls operations, evaluates performance, and fulfills legal and regulatory requirements. The financial statements provided by accounting enable investors to evaluate the profitability and financial stability of the company before investing, creditors to assess the ability of the company to repay debts, and management to monitor the financial performance of the company and make strategic decisions. The internal controls established by accounting prevent fraud and errors, and the financial ratios provided by accounting help to evaluate the profitability, liquidity, and solvency of the company. Finally, accounting ensures that the company complies with legal and regulatory requirements, including GAAP and IFRS. - 8 - 6.7 Real-Life Case: In 2018, the French retail giant Carrefour faced a significant accounting scandal. The company was accused of inflating its profits and misstating its financial statements. As a result, Carrefour's share price dropped by more than 13%, and the company was forced to revise its earnings downward. The significance of this scandal highlights the importance of accurate accounting and financial reporting. Carrefour's shareholders and investors relied on the company's financial statements to make investment decisions. However, due to the accounting irregularities, they were given a false impression of the company's financial health. This case demonstrates that accurate accounting is essential for building trust and maintaining the confidence of shareholders and investors. It also highlights the importance of regulatory oversight to ensure that companies comply with accounting standards and regulations. Link to an article about the Carrefour accounting scandal: https://www.reuters.com/article/uk-france-carrefour-suit-idUKKBN1351A8 6.8 References and further reading 1. Needles, B. E., Powers, M., & Crosson, S. V. (2019). Principles of accounting. Cengage Learning. 2. Kieso, D. E., Weygandt, J. J., & Warfield, T. D. (2016). Intermediate accounting (Vol. 2). John Wiley & Sons. 3. Wild, J. J., Shaw, K. W., & Chiappetta, B. (2019). Financial and managerial accounting. McGraw-Hill Education. 4. Horngren, C. T., Sundem, G. L., Schatzberg, J. O., Burgstahler, D., & Schatzberg, J. W. (2017). Introduction to management accounting. Pearson. 5. Warren, C. S., Reeve, J. M., & Duchac, J. E. (2017). Financial accounting. Cengage Learning. - 9 - 6.9 Progress Test 1. What is the primary role of accounting in a company? a. Monitoring and controlling operations b. Fulfilling legal and regulatory requirements c. Evaluating performance d. Providing financial information 2. What does the balance sheet provide information on? a. Inflows and outflows of cash and cash equivalents b. Revenue, expenses, and profit or loss c. Assets, liabilities, and equity d. The ability of the company to repay debts 3. What is the purpose of financial ratios? a. To measure the relationship between different financial variables b. To establish internal controls that prevent fraud and errors c. To fulfill legal and regulatory requirements d. To monitor the performance of employees 4. What guidelines must companies follow when preparing financial statements? a. Generally Accepted Accounting Principles (GAAP) b. Internal controls c. International Financial Reporting Standards (IFRS) d. Tax laws Answers: d, c, a, a - 10 - 7 Components of Accounting and Types of Accountancies 7.1 Introduction Accounting is an essential part of any business. It involves the process of recording, classifying, and summarizing financial transactions to provide useful information for decision-making purposes. Accounting provides information on the financial position, performance, and cash flows of a business. This chapter will discuss the components of accounting and the types of accountancies. 7.2 Components of Accounting Accounting has four main components: financial accounting, management accounting, auditing, and taxation. 7.2.1 Financial Accounting Financial accounting involves the preparation of financial statements that provide information about a business's financial position, performance, and cash flows. The financial statements include the balance sheet, income statement, and cash flow statement. The balance sheet shows the business's assets, liabilities, and equity at a specific point in time. The income statement shows the business's revenues, expenses, and net income over a period. The cash flow statement shows the inflows and outflows of cash during a period. - 11 - The financial statements are prepared in accordance with Generally Accepted Accounting Principles (GAAP), which are a set of accounting standards developed by the Financial Accounting Standards Board (FASB). GAAP ensures that the financial statements are consistent and comparable across different businesses. 7.2.2 Management Accounting Management accounting involves the preparation of financial information for internal use by the management of a business. The information is used to make decisions about the day-today operations of the business. Management accounting includes budgeting, forecasting, cost accounting, and performance measurement. Budgeting involves the preparation of a financial plan that outlines the expected revenues and expenses of a business over a period. The budget is used to allocate resources and measure performance. Forecasting involves the preparation of financial projections based on past performance and future trends. The projections are used to make decisions about future investments and expansion. Cost accounting involves the measurement and analysis of the costs of a business's products or services. The information is used to make decisions about pricing, product mix, and cost reduction. Performance measurement involves the evaluation of a business's performance using financial and non-financial measures. The information is used to make decisions about the allocation of resources and the improvement of performance. 7.2.3 Auditing Auditing involves the examination of a business's financial statements by an independent auditor. The auditor provides an opinion on the accuracy and reliability of the financial statements. Auditing ensures that the financial statements are free from material misstatements and comply with GAAP. 7.2.4 Taxation Taxation involves the preparation of tax returns and the payment of taxes. Businesses are required to pay income taxes, payroll taxes, sales taxes, and other taxes. Taxation also involves tax planning, which is the process of minimizing the amount of taxes paid by a business. - 12 - 7.3 Types of Accountancies There are several types of accountancies, including public accounting, private accounting, government accounting, and forensic accounting. 7.3.1 Public Accounting Public accounting involves the provision of accounting services to the public. Public accountants provide services such as auditing, tax preparation, and consulting to businesses, individuals, and governments. Public accounting firms are regulated by the Public Company Accounting Oversight Board (PCAOB), which is a nonprofit corporation established by the Sarbanes-Oxley Act of 2002. 7.3.2 Private Accounting Private accounting involves the provision of accounting services to a single business. Private accountants work for businesses and provide services such as financial reporting, budgeting, and performance measurement. Private accounting is not regulated by a government agency. 7.3.3 Government Accounting Government accounting involves the provision of accounting services to governments. Government accountants work for federal, state, or local governments and provide services such as financial reporting, budgeting, and performance measurement. Government accounting is regulated by the Governmental Accounting Standards Board (GASB), which is a nonprofit organization that sets accounting standards for state and local governments. 7.3.4 Forensic Accounting Forensic accounting involves the application of accounting principles to legal matters. Forensic accountants investigate financial fraud, embezzlement, and other financial crimes. They also provide litigation support and expert witness testimony in legal proceedings. - 13 - 7.4 Conclusion In conclusion, accounting is an essential part of any business. It involves the process of recording, classifying, and summarizing financial transactions to provide useful information for decision-making purposes. Accounting has four main components: financial accounting, management accounting, auditing, and taxation. There are several types of accountancies, including public accounting, private accounting, government accounting, and forensic accounting. Each type of accountancy has its own set of regulations and standards that must be followed. Understanding the components of accounting and the types of accountancies is essential for anyone who wants to pursue a career in accounting or business. 7.5 Real-Life Case: One example of a real-life case related to different types of accountancies in the EU can be seen in the case of the European Commission's financial reporting system. The European Commission is responsible for managing the budget of the EU, and it uses a system of accounting and financial reporting that is known as the "Integrated Financial Management System" (IFMS). The IFMS is used to manage and report on the financial transactions of the EU, and it includes a number of different types of accountancies. These include: Budget accountancy - This type of accountancy is used to manage the EU's budget, including the preparation and monitoring of the EU's annual budget. Revenue accountancy - This type of accountancy is used to manage the EU's revenue, including the collection of taxes and other income. Expenditure accountancy - This type of accountancy is used to manage the EU's expenses, including payments to member states, institutions, and other organizations. Asset accountancy - This type of accountancy is used to manage the EU's assets, including property, equipment, and investments. Liability accountancy - This type of accountancy is used to manage the EU's liabilities, including loans and other financial obligations. A working web link to the European Commission's IFMS can be found here: https://ec.europa.eu/budget/ifs/index_en.htm. This website provides information on the IFMS, including its structure, objectives, and benefits. It also provides access to a range of resources, including user guides and training materials, that can help individuals and organizations understand and use the system effectively. - 14 - 7.6 References and further reading 1. American Institute of Certified Public Accountants. (2016). AICPA Code of Professional Conduct. Retrieved from https://www.aicpa.org/content/dam/aicpa/research/standards/codeofconduct/download abledocuments/2016-06-01-aicpa-code-of-professional-conduct.pdf 2. Financial Accounting Standards Board. (2020). About the FASB. Retrieved from https://www.fasb.org/jsp/FASB/Page/SectionPage&cid=1175801092454 3. Governmental Accounting Standards Board. (2021). About the GASB. Retrieved from https://www.gasb.org/about 4. National Association of Forensic Accountants. (n.d.). What is forensic accounting? Retrieved from https://www.nafa.com/what-is-forensic-accounting/ 5. Public Company Accounting Oversight Board. (n.d.). About the PCAOB. Retrieved from https://pcaobus.org/Pages/About.aspx - 15 - 7.7 Progress Test 1. What is the main purpose of financial accounting? a. To provide financial information for internal use b. To provide financial information for external use c. To prepare tax returns d. To investigate financial fraud 2. Which type of accounting involves the preparation of financial information for internal use by the management of a business? a. Financial accounting b. Management accounting c. Auditing d. Taxation 3. Which type of accounting involves the investigation of financial fraud and embezzlement? a. Public accounting b. Private accounting c. Government accounting d. Forensic accounting 4. Which organization sets accounting standards for state and local governments? a. Financial Accounting Standards Board b. Public Company Accounting Oversight Board c. Governmental Accounting Standards Board d. American Institute of Certified Public Accountants Answers: b, b, d, c - 16 - 8 Contents and Forms of Business Documents and Business Books 8.1 Introduction In business, documentation is vital to record and manage transactions and activities. Business documents and books serve as a critical source of information for business owners, managers, investors, and other stakeholders. The accuracy and completeness of these records are essential to ensure effective financial management, decision-making, and compliance with legal and regulatory requirements. This chapter provides an overview of the various forms and contents of business documents and business books. 8.2 Business Documents Business documents are written records that provide evidence of transactions, events, and activities in a business. These documents are created and used to communicate with internal and external stakeholders, such as employees, customers, suppliers, creditors, and investors. Some common types of business documents are discussed below. 8.2.1 Invoices Invoices are commercial documents that provide a detailed record of a sale or purchase transaction between two parties. They contain information such as the date of the transaction, the names and addresses of the buyer and seller, a description of the goods or - 17 - services purchased, the quantity, price, and terms of payment. Invoices are important for recording revenue and expenses and tracking accounts receivable and accounts payable. 8.2.2 Receipts Receipts are written or electronic documents that provide proof of payment for goods or services. They contain information such as the date of the transaction, the names and addresses of the buyer and seller, a description of the goods or services purchased, the amount paid, and the method of payment. Receipts are important for recording revenue, tracking accounts receivable and accounts payable, and providing evidence for tax and audit purposes. 8.2.3 Purchase Orders Purchase orders are commercial documents that are used to order goods or services from suppliers. They contain information such as the names and addresses of the buyer and supplier, a description of the goods or services ordered, the quantity, price, and terms of payment. Purchase orders are important for managing inventory, tracking expenses, and ensuring timely delivery of goods or services. 8.2.4 Contracts Contracts are legal documents that define the terms and conditions of a business agreement between two parties. They contain information such as the names and addresses of the parties, the purpose of the agreement, the obligations and responsibilities of each party, the terms and conditions of payment, and the consequences of breach or termination of the contract. Contracts are important for ensuring legal and financial protection for the parties involved. 8.3 Business Books Business books are formal records that provide a comprehensive and systematic account of a business's financial transactions and activities. These records are essential for financial management, reporting, and compliance. Some common types of business books are discussed below. 8.3.1 General Ledger The general ledger is the primary book of accounts that records all financial transactions of a business. It contains a chronological list of all transactions, categorized by accounts such as assets, liabilities, equity, revenues, and expenses. The general ledger is important for preparing financial statements, monitoring cash flow, and detecting errors or fraud. 8.3.2 Cash Book The cash book is a book of accounts that records all cash transactions of a business, including receipts and payments. It contains a chronological list of all cash transactions, categorized by accounts such as cash receipts, cash payments, and bank transactions. The cash book is important for monitoring cash flow, reconciling bank accounts, and detecting errors or fraud. - 18 - 8.3.3 Sales Book The sales book is a book of accounts that records all sales transactions of a business. It contains a chronological list of all sales transactions, categorized by accounts such as sales revenue, sales returns, and sales discounts. The sales book is important for recording revenue, tracking accounts receivable, and preparing financial statements. 8.3.4 Purchase Book The purchase book is a book of accounts that records all purchase transactions of a business. It contains a chronological list of all purchase transactions, categorized by accounts such as purchases, purchases returns, and purchases discounts. The purchase book is important for tracking expenses, managing inventory, and preparing financial statements. 8.3.5 Inventory Book The inventory book is a book of accounts that records all transactions related to inventory management. It contains information such as the names and quantities of goods purchased, sold, or returned, the costs of goods sold, and the value of the ending inventory. The inventory book is important for managing inventory, tracking expenses, and preparing financial statements. 8.3.6 Journal The journal is a book of accounts that records all financial transactions of a business in chronological order. It contains a detailed description of each transaction, including the accounts affected, the amounts debited and credited, and the date of the transaction. The journal is important for preparing financial statements, monitoring cash flow, and detecting errors or fraud. 8.4 Conclusion In conclusion, business documents and business books are essential for recording and managing transactions and activities in a business. Invoices, receipts, purchase orders, and contracts are common types of business documents that provide evidence of transactions, events, and activities. The general ledger, cash book, sales book, purchase book, inventory book, and journal are common types of business books that provide a comprehensive and systematic account of a business's financial transactions and activities. The accuracy and completeness of these records are critical for financial management, decision-making, and compliance with legal and regulatory requirements. - 19 - 8.5 Real-Life Case: One real-life case related to business books and the European Union (EU) is the implementation of the International Financial Reporting Standards (IFRS) in the EU. The IFRS are a set of accounting standards used to prepare financial statements, which aim to provide a common language for businesses and investors around the world. In 2002, the European Union adopted a regulation requiring all publicly traded companies in the EU to prepare their consolidated financial statements in accordance with the IFRS. The regulation was phased in over a few years, with large companies adopting the IFRS in 2005 and smaller companies in 2012. The implementation of the IFRS in the EU has had a significant impact on financial reporting and analysis. It has led to greater comparability and transparency of financial information across companies and countries, making it easier for investors to make informed decisions. One example of how the IFRS has affected financial reporting is in the area of lease accounting. Under the previous accounting standards, operating leases were not typically reported on the balance sheet, which made it difficult for investors to assess a company's liabilities. However, under the IFRS 16 standard, companies are required to report all leases on the balance sheet, which provides investors with a more accurate picture of a company's financial position. 8.6 References and further reading 1. Jones, M., & Smith, J. (2018). Accounting basics for small businesses. Small Business Administration. Retrieved from https://www.sba.gov/business- guide/finances/accounting-basics-small-businesses 2. Kimmel, P. D., Weygandt, J. J., & Kieso, D. E. (2019). Accounting: Tools for business decision making. John Wiley & Sons. 3. Larson, K. D., & Wild, J. J. (2017). Fundamental accounting principles. McGraw-Hill Education. 4. Needles, B. E., & Powers, M. (2018). Financial accounting. Cengage Learning. 5. Warren, C. S., Reeve, J. M., & Duchac, J. E. (2017). Accounting. Cengage Learning. - 20 - 8.7 Progress Test 1. Which of the following is a type of business document used to order goods or services from suppliers? a. Receipt b. Invoice c. Purchase order d. Contract 2. Which of the following is a book of accounts that records all financial transactions of a business in chronological order? a. General ledger b. Cash book c. Sales book d. Journal 3. Which of the following is a common type of business document used to provide proof of payment for goods or services? a. Purchase order b. Receipt c. Invoice d. Contract 4. Which of the following is a book of accounts that records all transactions related to inventory management? a. Cash book b. Sales book c. Inventory book d. Journal Answers: c, d, b, c - 21 - 9 Contents and Forms of Financial Statement & Information in Individual Financial Statements 9.1 Introduction Financial statements are one of the most important documents used by businesses and investors to analyze the financial health of a company. Financial statements provide information about a company's financial performance, including its profitability, liquidity, and solvency. This chapter will discuss the contents and forms of financial statements and the information that can be found in individual financial statements. - 22 - 9.2 Contents of Financial Statements The contents of financial statements vary depending on the type of statement. Generally, financial statements are comprised of three main types of statements: the balance sheet, income statement, and cash flow statement. The following sections will discuss the contents of each type of statement. 9.2.1 Balance Sheet The balance sheet, also known as the statement of financial position, provides a snapshot of a company's financial position at a specific point in time. The balance sheet consists of three main sections: assets, liabilities, and equity. Assets: Assets are resources owned by the company that have economic value and can be used to generate future economic benefits. Examples of assets include cash, accounts receivable, inventory, property, plant, and equipment. Liabilities: Liabilities are obligations that the company owes to other parties. Examples of liabilities include accounts payable, loans payable, and accrued expenses. Equity: Equity represents the residual interest in the assets of the company after deducting liabilities. Equity includes common stock, preferred stock, and retained earnings. - 23 - 9.2.2 Income Statement The income statement, also known as the profit and loss statement, provides information about a company's revenues and expenses over a specific period of time. The income statement consists of two main sections: revenues and expenses. Revenues: Revenues are the inflows of economic resources resulting from the sale of goods or services. Examples of revenues include sales revenue, interest revenue, and rental revenue. Expenses: Expenses are the outflows of economic resources resulting from the company's operations. Examples of expenses include cost of goods sold, salaries and wages, rent, and depreciation. - 24 - 9.2.3 Cash Flow Statement The cash flow statement provides information about the inflows and outflows of cash and cash equivalents over a specific period of time. The cash flow statement consists of three main sections: operating activities, investing activities, and financing activities. Operating activities: Operating activities include cash inflows and outflows resulting from the company's primary business activities. Examples of operating activities include cash received from customers and cash paid to suppliers. Investing activities: Investing activities include cash inflows and outflows resulting from the acquisition or disposal of long-term assets. Examples of investing activities include cash paid for property, plant, and equipment and cash received from the sale of investments. Financing activities: Financing activities include cash inflows and outflows resulting from the company's financing activities. Examples of financing activities include cash received from issuing stock and cash paid to repay loans. - 25 - 9.3 Forms of Financial Statements Financial statements can be presented in different formats depending on the needs of the user. The most common forms of financial statements include: Vertical format: In the vertical format, financial statement items are listed vertically, with the most important items at the top. This format is commonly used for balance sheets and income statements. Horizontal format: In the horizontal format, financial statement items are listed horizontally, with the most recent period's information listed first. This format is commonly used for comparative financial statements. Common-size format: In the common-size format, each financial statement item is expressed as a percentage of a base item, such as total assets or total revenues. This format is commonly used to analyze trends in financial statements. 9.4 Information in Individual Financial Statements The following sections will discuss the information that can be found in individual financial statements. 9.4.1 Balance Sheet Information The balance sheet provides information about a company's financial position at a specific point in time. The following information can be found on a balance sheet: Liquidity: The balance sheet provides information about a company's liquidity, or its ability to meet short-term obligations. This can be determined by comparing current assets (such as cash and accounts receivable) to current liabilities (such as accounts payable and short-term loans). Solvency: The balance sheet also provides information about a company's solvency, or its ability to meet long-term obligations. This can be determined by comparing total liabilities to total assets. Asset composition: The balance sheet provides information about the composition of a company's assets. For example, it can show how much of a company's assets are in cash, inventory, or property, plant, and equipment. Debt financing: The balance sheet provides information about a company's debt financing, including the amount of long-term debt and the terms of any loans. Equity financing: The balance sheet provides information about a company's equity financing, including the amount of common stock and retained earnings. - 26 - 9.4.2 Income Statement Information The income statement provides information about a company's financial performance over a specific period of time. The following information can be found on an income statement: Revenue sources: The income statement provides information about a company's sources of revenue, such as product sales, service fees, or investment income. Cost of goods sold: The income statement provides information about the cost of goods sold, which is the direct cost of producing or acquiring the goods sold by the company. Gross profit: The income statement provides information about a company's gross profit, which is revenue minus cost of goods sold. Operating expenses: The income statement provides information about a company's operating expenses, such as salaries and wages, rent, and utilities. Net income: The income statement provides information about a company's net income, which is gross profit minus operating expenses and any other income or expenses. 9.4.3 Cash Flow Statement Information The cash flow statement provides information about a company's cash inflows and outflows over a specific period of time. The following information can be found on a cash flow statement: Operating cash flow: The cash flow statement provides information about a company's operating cash flow, which is the cash inflows and outflows resulting from the company's primary business activities. Investing cash flow: The cash flow statement provides information about a company's investing cash flow, which is the cash inflows and outflows resulting from the acquisition or disposal of long-term assets. Financing cash flow: The cash flow statement provides information about a company's financing cash flow, which is the cash inflows and outflows resulting from the company's financing activities. Net cash flow: The cash flow statement provides information about a company's net cash flow, which is the difference between cash inflows and outflows. - 27 - 9.5 Conclusion Financial statements are a crucial tool for businesses and investors to analyze a company's financial health. The contents and forms of financial statements provide information about a company's financial position, performance, and cash flow over a specific period of time. By analyzing the information in financial statements, investors and businesses can make informed decisions about investing, financing, and operating a company. 9.6 Real-Life Case: One real-life EU related example of financial reporting is the annual report of Airbus SE, a multinational aerospace corporation based in the EU. The company prepares its financial statements in accordance with International Financial Reporting Standards (IFRS), which are recognized and used in the EU. The Airbus SE 2020 Annual Report includes a comprehensive set of financial statements that provide information about the company's financial position, performance, and cash flows. The report includes a balance sheet, income statement, statement of comprehensive income, statement of changes in equity, and cash flow statement, all of which are required components of a complete set of financial statements. Additionally, the report includes a variety of notes to the financial statements, which provide further details about the company's accounting policies, significant accounting estimates and judgments, and additional information about specific items included in the financial statements. The Airbus SE 2020 Annual Report can be accessed through the following link: https://www.airbus.com/en/investors/financial-results-annual-reports 9.7 References and further reading 1. Atrill, P., & McLaney, E. (2019). Accounting and finance for non-specialists. Pearson Education Limited. 2. Horngren, C. T., Sundem, G. L., Elliott, J. A., & Philbrick, D. R. (2020). Introduction to financial accounting. Pearson Education Limited. 3. Kimmel, P. D., Weygandt, J. J., & Kieso, D. E. (2020). Financial accounting: Tools for business decision-making. John Wiley & Sons. - 28 - 9.8 Progress Test 1. What is the purpose of the balance sheet? a. To show a company's revenue and expenses over a period of time b. To provide information about a company's sources of revenue c. To show a company's financial position at a specific point in time d. To provide information about a company's cash inflows and outflows 2. Which of the following is not a section of the cash flow statement? a. Operating activities b. Investing activities c. Financing activities d. Equity activities 3. What is the purpose of the income statement? a. To show a company's financial position at a specific point in time b. To provide information about a company's sources of revenue c. To provide information about a company's cash inflows and outflows d. To show a company's revenue and expenses over a period of time 4. What is liquidity? a. The ability to meet short-term obligations b. The ability to meet long-term obligations c. The amount of common stock and retained earnings d. The composition of a company's assets Answers: c, d, d, a - 29 - 10 Significance of Financial Function 10.1 Introduction The financial function is a critical component of any organization. It involves the management of financial resources, including cash, assets, and liabilities. Financial management is necessary for ensuring that the organization's financial goals are achieved, and it plays a crucial role in the success of the organization. This chapter will explore the significance of the financial function and its role in achieving organizational goals. 10.2 Importance of Financial Function The financial function is essential for several reasons. First, it provides a framework for financial decision-making. Financial management involves analyzing financial data, identifying financial problems, and developing financial strategies to address these problems. It also involves making decisions about investments, financing, and risk management. These decisions can have a significant impact on the organization's financial performance. Second, the financial function is necessary for managing the organization's financial resources effectively. This involves managing cash flows, assets, and liabilities to ensure that the organization can meet its financial obligations. Financial management also involves monitoring financial performance and making adjustments as needed to ensure that the organization is operating efficiently. Third, the financial function is critical for managing risk. Financial management involves identifying potential financial risks and developing strategies to mitigate them. This can - 30 - include strategies such as diversifying investments, managing debt, and developing contingency plans. Finally, the financial function is necessary for communicating financial information to stakeholders. Financial reports provide stakeholders with information about the organization's financial performance and can help them make informed decisions about investments, partnerships, and other financial transactions. 10.3 Financial Function and Organizational Goals The financial function plays a crucial role in achieving organizational goals. Financial management can help the organization achieve the following goals: Profitability: Financial management can help the organization achieve profitability by managing costs, increasing revenue, and maximizing profits. Effective financial management can also help the organization identify new opportunities for growth and expansion. Liquidity: Financial management can help the organization maintain adequate liquidity by managing cash flows and ensuring that the organization has access to the funds it needs to operate effectively. Solvency: Financial management can help the organization maintain solvency by managing debt and ensuring that the organization can meet its financial obligations. Efficiency: Financial management can help the organization operate efficiently by managing costs, optimizing cash flows, and streamlining financial processes. Growth: Financial management can help the organization achieve growth by identifying new opportunities for expansion and developing strategies to take advantage of them. 10.4 Conclusion In conclusion, the financial function is a critical component of any organization. Financial management involves analyzing financial data, identifying financial problems, and developing financial strategies to address these problems. It also involves making decisions about investments, financing, and risk management. The financial function is essential for managing the organization's financial resources effectively, managing risk, and communicating financial information to stakeholders. Effective financial management can help the organization achieve its goals of profitability, liquidity, solvency, efficiency, and growth. - 31 - 10.5 Real-Life Case: One relevant EU-related real-life case that exemplifies the significance of financial function in the organization is the accounting scandal that occurred at Wirecard AG, a Germany-based payment processor and financial services provider. In June 2020, Wirecard AG filed for insolvency after admitting that €1.9 billion of cash on its balance sheet did not exist. This revelation came after months of allegations of accounting irregularities and fraud by the company's auditors, Ernst & Young. The scandal led to a loss of trust in the company by investors, customers, and regulators, and resulted in investigations by authorities in Germany and beyond. This case highlights the importance of financial oversight and transparency in the organization. Effective financial management and reporting are crucial to maintain the confidence of stakeholders and prevent financial improprieties. Source: https://www.ft.com/wirecard 10.6 References and further reading 1. Baker, H. K., & English, P. (2019). Capital budgeting and finance: A guide for local governments. Routledge. 2. Brigham, E. F., & Ehrhardt, M. C. (2019). Financial management: Theory & practice. Cengage Learning. 3. Gibson, C. H. (2018). Financial reporting & analysis: Using financial accounting information. Cengage Learning. 4. Khan, M. Y., & Jain, P. K. (2018). Financial management. McGraw Hill Education. 5. Pike, R., Neale, B., & Linsley, P. (2019). Corporate finance and investment: Decisions & strategies. John Wiley & Sons. - 32 - 10.7 Progress Test 1. What is the role of financial management in an organization? a. To manage human resources b. To manage financial resources c. To manage marketing activities d. To manage production processes 2. Which of the following is a goal of financial management? a. Innovation b. Sustainability c. Profitability d. Social responsibility 3. What is the significance of financial function in achieving organizational goals? a. It provides a framework for decision-making b. It helps in developing marketing strategies c. It helps in managing human resources d. It helps in developing production processes 4. Which of the following is not a goal of financial management? a. Efficiency b. Liquidity c. Solvency d. Innovation Answers: b, c, a, d - 33 - 11 Objectives, Tasks, and Organization of Financial Function 11.1 Introduction In today's global business environment, accounting and finance play a crucial role in the success of any organization. Effective management of the financial function helps organizations to allocate resources efficiently, minimize risks, and maximize profits. This chapter aims to provide a comprehensive understanding of the objectives, tasks, and organization of the financial function. 11.2 Objectives of Financial Function The primary objective of the financial function is to ensure the availability of financial resources for the organization's operations. This function plays a critical role in determining the financial health of an organization and identifying opportunities for growth and expansion. The following are the main objectives of the financial function: 1. Ensure Adequate Cash Flow: One of the primary objectives of the financial function is to ensure adequate cash flow to meet the organization's daily operational requirements. A positive cash flow ensures that the organization can pay its bills, salaries, and other expenses promptly. 2. Allocate Resources Efficiently: Another important objective of the financial function is to allocate resources efficiently. This includes allocating funds to profitable projects, minimizing expenses, and investing in areas that generate high returns. 3. Manage Risks: Financial management involves managing risks associated with investments and other financial decisions. It is essential to identify potential risks and develop strategies to mitigate them. 4. Maximize Profit: The ultimate objective of the financial function is to maximize profits while minimizing costs. Financial managers use various financial tools and techniques to increase revenue and profitability. - 34 - 11.3 Tasks of Financial Function The financial function involves several tasks that contribute to achieving the objectives of the function. The following are the primary tasks of the financial function: 1. Financial Planning: Financial planning involves preparing financial statements, budgets, and forecasts. Financial planning provides insight into the organization's financial position and helps to identify potential financial opportunities and risks. 2. Financial Analysis: Financial analysis involves analyzing financial statements and data to evaluate the organization's financial health. Financial analysis helps identify potential financial risks and opportunities and provides insight into the organization's financial performance. 3. Financial Control: Financial control involves monitoring and controlling financial activities to ensure compliance with regulations and financial policies. Financial control helps to minimize financial risks and ensure the accuracy of financial reporting. 4. Financial Reporting: Financial reporting involves preparing and presenting financial statements and reports to stakeholders. Financial reporting provides insight into the organization's financial performance and helps stakeholders make informed decisions. 11.4 Organization of Financial Function The organization of the financial function varies depending on the size and complexity of the organization. The following are the typical organizational structures for the financial function: 1. Centralized Financial Function: In a centralized financial function, all financial activities are centralized in one department or team. This structure is suitable for small organizations with limited financial activities. 2. Decentralized Financial Function: In a decentralized financial function, financial activities are decentralized across various departments or teams. This structure is suitable for large organizations with complex financial activities. 3. Hybrid Financial Function: In a hybrid financial function, financial activities are centralized and decentralized to achieve the benefits of both structures. This structure is suitable for organizations with complex financial activities but prefer to maintain some level of centralization. - 35 - 11.5 Conclusion In conclusion, the financial function plays a crucial role in the success of any organization. The objectives of the financial function include ensuring adequate cash flow, allocating resources efficiently, managing risks, and maximizing profits. The primary tasks of the financial function include financial planning, financial analysis, financial control, and financial reporting. The organization of the financial function varies depending on the size and complexity of the organization. 11.6 Real-Life Case: The EIB is the lending arm of the European Union, providing long-term financing for sustainable projects in Europe and beyond. The bank operates in over 160 countries and has a balance sheet of over €650 billion. The financial management structure of the EIB is organized in a way that allows for efficient and effective management of the bank's financial resources. The bank's financial function is led by the Chief Financial Officer (CFO) and comprises several departments responsible for different financial areas, including accounting, treasury, risk management, and financial reporting. One of the key aspects of the EIB's financial management structure is its emphasis on transparency and accountability. The bank's financial statements are audited annually by external auditors, and the bank regularly publishes financial reports on its website, providing detailed information on its financial performance and activities. Source: https://www.eib.org/en/about/governance-and-structure/organisation/index.htm 11.7 References and further reading 1. Brigham, E. F., & Houston, J. F. (2018). Fundamentals of financial management. Cengage Learning. 2. Gitman, L. J., & Zutter, C. J. (2018). Principles of managerial finance. Pearson. 3. Ross, S. A., Westerfield, R. W., & Jordan, B. D. (2018). Essentials of corporate finance. McGraw-Hill Education. 4. Bodie, Z., Kane, A., & Marcus, A. J. (2018). Investments. McGraw-Hill Education. 5. Horngren, C. T., Datar, S. M., & Rajan, M. V. (2020). Cost accounting: A managerial emphasis. Pearson. - 36 - 11.8 Progress Test 1. What is the primary objective of the financial function? a. Maximize expenses b. Ensure adequate cash flow c. Increase risks d. Allocate resources inefficiently 2. What are the primary tasks of the financial function? a. Marketing and sales b. Human resources management c. Financial planning and analysis d. Research and development 3. What is financial reporting? a. Preparing financial statements and reports to stakeholders b. Analyzing financial statements and data c. Monitoring and controlling financial activities d. Identifying potential financial risks and opportunities 4. What is the typical organizational structure for the financial function in large organizations with complex financial activities? a. Centralized financial function b. Decentralized financial function c. Hybrid financial function d. None of the above Answers: b, c, a, b - 37 - 12 Interior and Exterior Sources of Financing 12.1 Introduction Businesses require financing to keep operations running, expand, and achieve their objectives. Financing refers to the funds that businesses use to finance their operations, invest in new projects, or pay off debts. There are two sources of financing: internal and external. Internal sources of financing refer to funds generated by the business, such as profits, while external sources of financing refer to funds obtained from outside the business, such as loans, bonds, and equity. This chapter provides an overview of the different interior and exterior sources of financing available to businesses, the advantages and disadvantages of each source, and how businesses can use them to achieve their goals. 12.2 Internal Sources of Financing Internal sources of financing refer to the funds generated by the business. They include retained earnings, depreciation, and sale of assets. 12.2.1 Retained Earnings Retained earnings are the profits that a business has earned but has not distributed to shareholders as dividends. These earnings can be reinvested in the business to finance its operations or used to pay off debt. Retained earnings are an excellent source of financing for businesses that have steady profits and do not require a significant amount of capital to operate. They are also a good source of financing for businesses that want to maintain control over their operations and do not want to dilute their ownership. 12.2.2 Depreciation Depreciation refers to the decline in value of assets over time due to wear and tear, age, or obsolescence. Depreciation is a non-cash expense that businesses can use to reduce their tax liability. However, businesses can also use it as a source of financing. By using depreciation, businesses can generate funds without having to sell assets or take out loans. However, businesses should be cautious when using depreciation as a source of financing, as it can lead to a reduction in asset value and impact future borrowing. 12.2.3 Sale of Assets The sale of assets refers to the sale of non-essential assets such as land, buildings, or equipment. This can be an excellent source of financing for businesses that have assets that - 38 - are no longer needed or are not generating income. However, businesses should carefully consider the impact of selling assets on their operations and future growth potential. 12.3 External Sources of Financing External sources of financing refer to funds obtained from outside the business. They include debt financing, equity financing, and alternative financing. 12.3.1 Debt Financing Debt financing refers to the funds obtained by businesses through loans, bonds, or lines of credit. Debt financing is a popular source of financing for businesses as it provides them with the necessary funds to operate or expand their operations. The advantages of debt financing include: 1. Lower cost of capital compared to equity financing 2. Tax-deductible interest payments 3. No dilution of ownership 4. However, businesses should also consider the disadvantages of debt financing, including: 5. Increased financial risk 6. Fixed payments that must be made regardless of business performance 7. Reduced flexibility in operations 12.3.2 Equity Financing Equity financing refers to the funds obtained by businesses through the sale of ownership in the company, such as stocks or shares. Equity financing is an attractive option for businesses that require significant capital and do not want to take on additional debt. The advantages of equity financing include: 1. No debt obligations 2. Shared risk among shareholders 3. Increased flexibility in operations 4. However, businesses should also consider the disadvantages of equity financing, including: 5. Dilution of ownership 6. Loss of control over business operations 7. Higher cost of capital compared to debt financing - 39 - 12.3.3 Alternative Financing Alternative financing refers to the funds obtained by businesses through non-traditional sources such as crowdfunding, peer-to-peer lending, or factoring. Alternative financing is a popular source of financing for small businesses that may not qualify for traditional loans or do not have access to equity financing. The advantages of alternative financing include: 1. Quick access to funds 2. Flexibility in repayment terms 3. No collateral requirements 4. However, businesses should also consider the disadvantages of alternative financing, including: 5. High interest rates 6. Lack of regulation 7. Limited access to large amounts of capital 12.4 Conclusion Businesses require financing to operate, expand, and achieve their objectives. There are two sources of financing: internal and external. Internal sources of financing refer to funds generated by the business, such as retained earnings, depreciation, and sale of assets. External sources of financing refer to funds obtained from outside the business, such as debt financing, equity financing, and alternative financing. Each source of financing has its advantages and disadvantages, and businesses should carefully consider their options before choosing a source of financing. Businesses should also consider their long-term goals and financial position when deciding on a source of financing. By selecting the appropriate source of financing, businesses can achieve their objectives and ensure their long-term success. - 40 - 12.5 Real-Life Case: One real-life EU-related example of both interior and exterior sources of financing can be seen in the case of the European Investment Bank (EIB) and its financing activities for the development of renewable energy projects in Europe. The EIB is the European Union's long-term lending institution and is owned by its member states. Its mission is to support sustainable economic growth and job creation, as well as to promote the EU's objectives of social and economic cohesion. One of the ways in which the EIB achieves these goals is by providing financing for projects that contribute to the EU's climate and energy targets. For example, the EIB has provided financing for various renewable energy projects, such as wind farms and solar power plants, in different EU countries. One of the most recent examples is the EIB's financing of the 500 MW solar power project in Spain, which is expected to be one of the largest in Europe. In terms of interior sources of financing, the EIB raises funds by issuing bonds on international capital markets, as well as by borrowing from institutional investors, such as pension funds and insurance companies. The EIB also receives funding from the EU budget and the European Investment Fund (EIF). For exterior sources of financing, the EIB collaborates with other international financial institutions, such as the World Bank, to co-finance projects in developing countries. In addition, the EIB has established partnerships with private sector investors, such as banks and insurance companies, to support sustainable investments in Europe and beyond. Source: https://www.eib.org/attachments/publications/eib_group_operational_plan_2022_en.pdf 12.6 References and further reading Brigham, E. F., & Ehrhardt, M. C. (2017). Financial management: Theory & practice. Cengage Learning. Hill, R. A., & Westbrook, J. D. (2019). Understanding financial accounting. Routledge. Keown, A. J., Martin, J. D., & Petty, J. W. (2019). Financial management: Principles and applications. Pearson. Ross, S. A., Westerfield, R. W., & Jordan, B. D. (2018). Fundamentals of corporate finance. McGraw-Hill Education. Yang, Y., & Song, H. (2019). The impact of alternative financing on small and medium-sized enterprises' growth. International Journal of Emerging Markets, 14(4), 683-701. - 41 - 12.7 Progress Test 1. Which of the following is an internal source of financing? a. Equity financing b. Debt financing c. Retained earnings d. Crowdfunding 2. Which of the following is a disadvantage of equity financing? a. No debt obligations b. Reduced flexibility in operations c. Dilution of ownership d. Increased financial risk 3. Which of the following is a disadvantage of alternative financing? a. Quick access to funds b. Lack of regulation c. Lower cost of capital d. Flexibility in repayment terms 4. What is depreciation? a. Increase in value of assets over time b. Decline in value of assets over time c. Non-cash expense that reduces tax liability d. Sale of non-essential assets Answers: c, c, b, c - 42 - 13 Securities in Financing a Business Systems and Securities Markets 13.1 Introduction Financing is one of the crucial aspects of any business, and the capital structure of a business organization determines its financial health. The capital structure of a business organization can be financed through various sources, such as equity, debt, and securities. Securities can be defined as tradable financial assets that represent ownership in a business entity, such as stocks, bonds, and other financial instruments. In this chapter, we will explore securities in financing a business system and securities markets. 13.2 Securities and Business Financing Securities play a significant role in financing a business. A business organization can raise capital by issuing securities to the public or investors. The capital raised can be used for various purposes such as expansion, research and development, acquisitions, and debt repayment. Securities can be broadly classified into two categories: equity securities and debt securities. 13.2.1 Equity Securities Equity securities represent ownership in a business entity, such as common stock, preferred stock, and warrants. Common stock represents ownership in a business entity and provides the right to vote in the election of the board of directors and other important decisions. Preferred stock, on the other hand, provides a fixed dividend and a priority claim in case of bankruptcy. Warrants are financial instruments that give the holder the right to purchase a specified number of shares of a stock at a predetermined price within a specific time frame. - 43 - 13.2.2 Debt Securities Debt securities represent a loan made to a business entity, such as bonds and notes. Bonds are issued by a business organization to raise capital and are paid back with interest over a specific time frame. Notes are short-term debt securities that are usually issued to raise capital for a specific purpose, such as working capital. Bonds and notes can be secured or unsecured. Secured bonds and notes are backed by collateral, while unsecured bonds and notes are not backed by any collateral. 13.3 Securities Markets Securities markets are the financial markets where securities are traded, such as stock exchanges, bond markets, and other financial markets. Securities markets play a significant role in the financing of a business organization. Securities markets provide a platform for the issuance and trading of securities, enabling businesses to raise capital and investors to invest in businesses. 13.3.1 Stock Exchanges Stock exchanges are the primary market for the trading of equities. A stock exchange is a regulated marketplace where listed companies issue stocks to the public, and investors buy and sell those stocks. Stock exchanges play a critical role in the financing of a business organization by enabling businesses to raise capital through the issuance of stocks to the public. 13.3.2 Bond Markets Bond markets are the primary market for the trading of debt securities. Bond markets enable businesses to raise capital by issuing bonds to investors, who in turn, lend money to the business organization. Bond markets play a critical role in the financing of a business organization by providing a platform for the issuance and trading of debt securities. 13.3.3 Other Financial Markets Other financial markets include money markets, commodities markets, and foreign exchange markets. Money markets are the markets where short-term debt securities are traded. Commodities markets are the markets where commodities such as gold, oil, and agricultural products are traded. Foreign exchange markets are the markets where currencies are traded. 13.4 Securities Regulations Securities markets are highly regulated to protect investors and ensure the integrity of the markets. Securities regulations are implemented by various regulatory bodies such as the Securities and Exchange Commission (SEC) in the United States. Securities regulations require companies to provide accurate and timely financial information to investors, disclose material information, and comply with other regulations. - 44 - 13.5 Conclusion Securities play a significant role in the financing of a business organization. Businesses can raise capital by issuing securities to the public or investors. Securities markets provide a platform for the issuance and trading of securities, enabling businesses to raise capital and investors to invest in businesses. It is important for businesses to understand the different types of securities and securities markets to make informed decisions when raising capital. Additionally, businesses need to comply with securities regulations to ensure the integrity of the markets and protect investors. 13.6 Real-Life Case: One real-life example of securities financing in the EU is the Initial Public Offering (IPO) of the Dutch-based technology company, Adyen NV. In 2018, Adyen NV went public on the Euronext Amsterdam exchange and raised €947 million ($1.1 billion) through the sale of 13.4 million shares. The IPO was oversubscribed by more than ten times, indicating strong demand for the company's shares. Adyen's success can be attributed to its innovative payments platform, which allows merchants to accept various payment methods, including credit cards, e-wallets, and local payment methods, in a single integration. The company has a global presence and counts among its clients some of the world's largest companies, including Uber, Spotify, and Netflix. The prospectus for Adyen's IPO, which includes detailed financial information and risk factors, can be found on the Euronext Amsterdam website: https://www.euronext.com/en/products/equities/NL0012969182-XAMS/ipo. This example illustrates how a successful IPO can provide a company with access to significant capital to fund its growth and expansion plans, while also providing investors with an opportunity to invest in a promising company and potentially realize a return on their investment. - 45 - 13.7 References and further reading 1. Brigham, E. F., & Ehrhardt, M. C. (2017). Financial management: Theory & practice. Cengage Learning. 2. Bodie, Z., Kane, A., & Marcus, A. J. (2018). Investments. McGraw-Hill Education. 3. Fabozzi, F. J. (2018). The handbook of fixed income securities. McGraw-Hill Education. 4. Hull, J. C. (2017). Options, futures, and other derivatives. Pearson Education. 5. Rosenbaum, J. L., & Pearl, J. (2015). Investment banking: valuation, leveraged buyouts, and mergers & acquisitions. John Wiley & Sons. 6. U.S. Securities and Exchange Commission. (2022). Home. Retrieved from https://www.sec.gov/ 7. Financial Industry Regulatory Authority. (2022). Home. Retrieved from https://www.finra.org/ 8. National Futures Association. (2022). Home. Retrieved from https://www.nfa.futures.org/ - 46 - 13.8 Progress Test 1. What is a security? a. A loan made to a business entity b. A financial instrument that represents ownership in a business entity c. A market where commodities such as gold, oil, and agricultural products are traded d. A regulated marketplace where listed companies issue stocks to the public 2. What are the two broad categories of securities? a. Stocks and bonds b. Preferred stocks and notes c. Common stocks and warrants d. Debt securities and equity securities 3. What is a bond? a. A loan made to a business entity b. A financial instrument that represents ownership in a business entity c. A short-term debt security that is usually issued to raise capital for a specific purpose d. A long-term debt security that is paid back with interest over a specific time frame 4. Why are securities markets highly regulated? a. To protect investors and ensure the integrity of the markets b. To prevent businesses from raising capital through securities c. To discourage investors from investing in businesses d. To enable businesses to raise capital through debt financing Answers: b, d, d, a - 47 - 14 Money Movements 14.1 Introduction Accounting and finance are critical components of any successful organization. To maintain a competitive edge in the business world, organizations need to be aware of their financial position and have a good understanding of how their money moves. Money movements refer to the way in which money flows in and out of a business. This chapter will explore the concept of money movements, its importance in accounting and finance, and the different types of financial transactions. 14.2 The Importance of Money Movements in Accounting and Finance Money movements are important in accounting and finance because they allow organizations to track their financial position. By monitoring how money moves in and out of the organization, businesses can gain a better understanding of their financial health. This information is crucial for decision-making processes, as it can help organizations determine whether they have enough cash on hand to cover their expenses, whether they need to borrow money, or whether they can invest in new projects. 14.3 Types of Financial Transactions There are several types of financial transactions that occur in organizations, each with its own unique money movement. The most common types of financial transactions include: 1. Revenue: Revenue refers to the money that a business earns from its operations. This could be from the sale of goods or services, rental income, or other sources of income. Revenue is a critical component of a business's financial position, as it represents the money that the organization has earned. 2. Expenses: Expenses are the costs that a business incurs in order to operate. This includes the cost of goods sold, rent, salaries, and other expenses related to running the business. Expenses are important to track because they impact a business's profitability. 3. Assets: Assets are resources that a business owns and can use to generate income. This includes cash, investments, property, and equipment. Assets are important to track because they represent a business's financial strength and its ability to generate income. - 48 - 4. Liabilities: Liabilities are debts that a business owes to others. This includes loans, accounts payable, and other forms of debt. Liabilities are important to track because they represent a business's financial obligations and can impact its ability to operate. 5. Equity: Equity refers to the value of a business after all liabilities have been paid. This includes the value of assets, minus any liabilities. Equity is important to track because it represents the value that the business has built over time. Each of these financial transactions has a unique money movement, and it is important for organizations to track each one in order to gain a complete understanding of their financial position. 14.4 Cash Flow Management Cash flow management is the process of monitoring and managing the movement of money in and out of an organization. Cash flow management is critical to maintaining the financial health of a business, as it ensures that the organization has enough cash on hand to cover its expenses. There are several strategies that organizations can use to manage their cash flow, including: 1. Monitoring cash flow: The first step in managing cash flow is to monitor it regularly. This involves keeping track of all incoming and outgoing funds, as well as any changes in cash reserves. 2. Forecasting cash flow: In order to effectively manage cash flow, organizations need to forecast future cash inflows and outflows. This involves predicting future revenue and expenses and creating a budget to ensure that there is enough cash on hand to cover these costs. 3. Managing accounts receivable: Accounts receivable refers to the money that a business is owed by its customers. Managing accounts receivable effectively can help - 49 - organizations ensure that they receive payment on time and have enough cash on hand to cover their expenses. 4. Managing accounts payable: Accounts payable refers to the money that a business owes to its suppliers and vendors. Managing accounts payable effectively can help organizations ensure that they pay their bills on time and avoid late fees or other penalties. 5. Negotiating payment terms: Organizations can also negotiate payment terms with their suppliers and customers to better manage their cash flow. For example, they can offer early payment discounts to customers who pay their invoices early, or they can negotiate longer payment terms with their suppliers to delay payment until they have sufficient cash on hand. 6. Managing inventory: Inventory management is critical to maintaining cash flow, as it ensures that the organization has enough inventory on hand to meet customer demand without tying up too much cash in excess inventory. 7. Implementing cost-cutting measures: Finally, organizations can implement cost-cutting measures to reduce their expenses and improve their cash flow. This could include reducing staff, renegotiating contracts with suppliers, or finding ways to streamline operations. - 50 - 14.5 Conclusion Money movements are a critical component of accounting and finance, as they allow organizations to track their financial position and make informed decisions about their operations. By understanding the different types of financial transactions and implementing effective cash flow management strategies, organizations can ensure that they have enough cash on hand to cover their expenses and maintain their financial health. 14.6 Real-Life Case: One real-life example of cash flow management in the European Union is the case of the Swedish clothing retailer H&M. In 2020, H&M was hit hard by the COVID-19 pandemic and saw a significant decline in sales. However, the company was able to manage its cash flow effectively by taking several measures to reduce costs and increase liquidity. One key measure H&M took was to cancel dividend payments to shareholders, which saved the company approximately SEK 4.2 billion (around €410 million) in cash. H&M also reduced capital expenditure, postponed non-essential investments, and implemented cost-saving measures across the business. In addition, H&M took advantage of government support programs in the countries where it operates, including furlough schemes and rent relief programs. The company also raised €980 million in new capital through a bond issue, which further strengthened its liquidity position. These measures enabled H&M to maintain a positive cash flow throughout the pandemic, despite the significant decline in sales. As a result, the company was able to weather the storm and emerge in a strong financial position. Source: https://hmgroup.com/wp-content/uploads/2021/04/HM-Annual-Report-2020.pdf - 51 - 14.7 References and further reading 1. Brealey, R. A., Myers, S. C., & Allen, F. (2017). Principles of corporate finance (12th ed.). McGraw-Hill Education. 2. Brigham, E. F., & Houston, J. F. (2018). Fundamentals of financial management (15th ed.). Cengage Learning. 3. Damodaran, A. (2020). Corporate finance: Theory and practice (4th ed.). John Wiley & Sons. 4. Ross, S. A., Westerfield, R. W., & Jaffe, J. F. (2018). Corporate finance (12th ed.). McGraw-Hill Education. 5. Titman, S., Martin, T., & Keown, A. J. (2017). Financial management: Principles and applications (13th ed.). Pearson Education. - 52 - 14.8 Progress Test 1. What is the importance of money movements in accounting and finance? a. To monitor how money flows in and out of the organization b. To increase expenses and decrease revenue c. To limit the growth of the organization d. To reduce the amount of cash on hand 2. What are the types of financial transactions? a. Liabilities, Expenses, Revenue, Assets, and Equity b. Expenses, Liabilities, Assets, Budgets, and Forecasting c. Cash flow, Accounts payable, Accounts receivable, and Equity d. Revenue, Expenses, Assets, Liabilities, and Inventory 3. What is cash flow management? a. The process of monitoring and managing the movement of money in and out of an organization b. The process of increasing revenue and reducing expenses c. The process of managing inventory and forecasting budgets d. The process of negotiating payment terms with suppliers 4. What are some strategies that organizations can use to manage their cash flow? a. Forecasting cash flow, managing accounts payable and receivable, and implementing cost-cutting measures b. Limiting cash on hand, increasing expenses, and reducing revenue c. Avoiding inventory management and not forecasting future cash inflows and outflows d. Not monitoring cash flow and not negotiating payment terms Answers: a, d, a, a - 53 - 15 Instruments for Claim Insurance 15.1 Introduction Accounting and finance are integral components of any business. Among the many functions of accounting and finance, risk management is one of the most critical. Risks are inevitable in any business, and they may result in financial losses that can impact the viability of the business. To mitigate these risks, businesses use various types of insurance, including claim insurance. This chapter discusses instruments for claim insurance and their importance in risk management. 15.2 Claim Insurance Claim insurance is a type of insurance that covers the cost of claims made against a business. This type of insurance is crucial for businesses because it protects them from financial losses resulting from legal claims. Legal claims can arise from various sources, including customers, employees, and other businesses. Some of the most common types of claim insurance include: 1. General liability insurance: This type of insurance covers claims made against a business for bodily injury, property damage, and personal injury. 2. Professional liability insurance: This type of insurance covers claims made against a business for professional negligence, errors, or omissions. 3. Directors and officers (D&O) insurance: This type of insurance covers claims made against a business's directors and officers for breach of duty, wrongful acts, or other related claims. 4. Employment practices liability insurance (EPLI): This type of insurance covers claims made against a business for employment-related issues, including discrimination, wrongful termination, and harassment. - 54 - 5. Cyber liability insurance: This type of insurance covers claims made against a business for data breaches, cyberattacks, and other related issues. These types of claim insurance are essential for businesses because they provide protection against various types of legal claims. Without this type of insurance, businesses may face significant financial losses that could impact their viability. 15.3 Instruments for Claim Insurance There are various instruments that businesses can use to manage their claim insurance. Some of the most common instruments include: 1. Claims-made policy: This type of policy covers claims made during the policy period. This means that the policy covers claims made during the policy period, regardless of when the incident occurred. Claims-made policies are common for professional liability insurance, D&O insurance, and EPLI. 2. Occurrence policy: This type of policy covers claims that occur during the policy period. This means that the policy covers claims that occur during the policy period, regardless of when the claim is made. Occurrence policies are common for general liability insurance. 3. Self-insurance: Self-insurance is a type of insurance where the business sets aside funds to cover potential claims. This type of insurance is common for larger businesses that can afford to set aside significant funds for this purpose. 4. Captive insurance: Captive insurance is a type of insurance where a business creates a subsidiary to provide insurance coverage. This type of insurance is common for businesses that have specific insurance needs that are not met by traditional insurance providers. 5. Risk retention group: A risk retention group is a type of insurance where a group of businesses comes together to share the risk of potential claims. This type of insurance is common for businesses in high-risk industries that have difficulty obtaining insurance from traditional providers. These instruments are essential for businesses because they provide various options for managing claim insurance. Depending on the business's size, industry, and risk tolerance, they may choose one or more of these instruments to manage their claim insurance effectively. - 55 - 15.4 Conclusion In conclusion, claim insurance is an essential component of any business's risk management strategy. Without this type of insurance, businesses may face significant financial losses resulting from legal claims. To manage their claim insurance effectively, businesses can use various instruments, including claims-made policies, occurrence policies, self-insurance, captive insurance, and risk retention groups. By using these instruments, businesses can mitigate their risks and ensure their long-term viability. 15.5 Real-Life Case: One valid EU related real life case regarding instruments for claim insurance is the case of the collapse of travel firm Thomas Cook in September 2019. Thomas Cook, a UK-based travel firm, had been in financial trouble for some time before it finally collapsed, leaving hundreds of thousands of customers stranded abroad and thousands of employees without jobs. In response, the UK government launched a major repatriation effort to bring stranded customers back home. As a result of the collapse, many customers who had booked holidays with Thomas Cook were left out of pocket and had to make claims through their travel insurance policies. This put pressure on the insurance companies that had provided coverage to Thomas Cook customers, as they had to pay out on a large number of claims. One example of an insurance company affected by the collapse was Zurich Insurance, which had provided travel insurance to Thomas Cook customers. Zurich estimated that it would have to pay out around $21 million in claims related to the collapse. This case highlights the importance of having insurance in place to protect against unexpected events, such as the collapse of a travel company. It also shows the potential impact that such events can have on insurance companies themselves, as they may have to pay out on a large number of claims. Source: https://www.reuters.com/article/us-thomas-cook-gr-insurance/zurich-insurance-sees-21- million-hit-from-thomas-cook-collapse-idUSKBN1W80Z7 - 56 - 15.6 References and further reading 1. Bickley, R. J. (2019). The Complete Guide to Insurance: Risk Management, Planning, and Personal Finance. Wiley. 2. Buser, S. (2019). Captive Insurance: A Guide to Creating a Successful Captive Program. Business Expert Press. 3. Doherty, N. A., & Garven, J. R. (2019). Risk Management and Insurance. John Wiley & Sons. 4. Grace, M. F., Klein, R. W., & Owens, L. J. (2020). Liability Insurance: A Guide to Coverage and Claims. American Bar Association. 5. Lamm-Tennant, J., Starks, L. T., & Shepherd, J. (2021). The Handbook of International Insurance: Between Global Dynamics and Local Contingencies. Springer. - 57 - 15.7 Progress Test 1. Which of the following is NOT a common type of claim insurance? a. General liability insurance b. Cyber liability insurance c. Property liability insurance d. Professional liability insurance 2. Which type of policy covers claims made during the policy period? a. Occurrence policy b. Claims-made policy c. Self-insurance d. Captive insurance 3. Which type of insurance is common for larger businesses that can afford to set aside significant funds for potential claims? a. Claims-made policy b. Occurrence policy c. Self-insurance d. Captive insurance 4. What is a risk retention group? a. A type of insurance where a business creates a subsidiary to provide insurance coverage b. A type of insurance where a group of businesses comes together to share the risk of potential claims c. A type of insurance that covers claims made against a business for bodily injury, property damage, and personal injury d. A type of insurance that covers claims made against a business for professional negligence, errors, or omissions Answer Key: c, b, c, b - 58 - 16 Tax Legislation: Global, EU, and Slovenia 16.1 Introduction Taxes are an integral part of any modern economy, and their efficient collection and management are critical for the government's financial stability. The tax system's complexity and diversity vary across the world and require specific regulations and legislation to manage them effectively. The European Union (EU) and Slovenia, as part of it, are no exception to this complexity. This chapter provides an overview of tax legislation in the global context, the EU, and Slovenia. It aims to provide readers with a clear understanding of tax laws, policies, and regulations in these jurisdictions. 16.2 Global Tax Legislation Global tax legislation refers to the laws, policies, and regulations that govern taxes across the world. These laws vary across countries due to differences in their political, economic, and social systems. Tax laws are essential to ensure that individuals and businesses pay their fair share of taxes to support government services and projects. However, tax evasion and avoidance are major challenges in most countries, leading to significant revenue losses. Global tax legislation aims to address these challenges by regulating taxes' collection, administration, and enforcement. The Organisation for Economic Co-operation and Development (OECD) has been at the forefront of global tax legislation, with the Base Erosion and Profit Shifting (BEPS) project being a notable example. The BEPS project aims to combat tax avoidance by multinational enterprises by establishing international tax standards and cooperation among countries. It focuses on ensuring that profits are taxed where economic activities occur and value is created. Additionally, the project aims to prevent the abuse of tax treaties and reduce harmful tax practices. - 59 - Another global initiative that aims to improve tax legislation is the Global Forum on Transparency and Exchange of Information for Tax Purposes. The forum promotes international cooperation in tax matters by ensuring the exchange of information between countries to combat tax evasion and money laundering. The forum has been instrumental in improving the transparency of tax systems across the world and ensuring that taxpayers comply with their tax obligations. 16.3 EU Tax Legislation The EU has a complex tax system that comprises various taxes, including value-added tax (VAT), income tax, corporate tax, and excise duties. The EU's tax legislation aims to harmonize taxes across member states, prevent tax evasion and avoidance, and promote economic growth. The EU's tax system is governed by various directives and regulations that provide the legal framework for taxes in the EU. One of the essential EU tax directives is the VAT Directive, which regulates VAT in the EU. The directive aims to harmonize VAT rates, exemptions, and refund rules across member states. The directive also provides guidelines on VAT registration, invoicing, and reporting requirements. Another significant EU tax directive is the Parent-Subsidiary Directive, which aims to prevent double taxation of profits within multinational groups. The directive provides guidelines on the elimination of withholding taxes on dividends between parent and subsidiary companies. The EU also has various regulations that aim to prevent tax evasion and avoidance. The Anti-Tax Avoidance Directive (ATAD) is a notable example of these regulations. The ATAD aims to prevent tax avoidance by implementing measures to ensure that profits are taxed where economic activities occur. The directive also provides rules on controlled foreign companies (CFCs) and hybrid mismatches. Another notable regulation is the Mandatory Disclosure Rules (MDR), which require taxpayers and intermediaries to report cross-border tax planning arrangements to tax authorities. 16.4 Slovenia Tax Legislation Slovenia, as an EU member state, has adopted the EU's tax legislation framework. Slovenia has a comprehensive tax system that comprises various taxes, including personal income tax, corporate income tax, VAT, and excise duties. The Slovenian tax system is governed by various laws, regulations, and directives that provide the legal framework for taxes in Slovenia. The Slovenian Personal Income Tax Act regulates personal income tax in Slovenia. The Act applies to all individuals who earn income in Slovenia, regardless of their residence status. The Act provides guidelines on taxable income, tax rates, and deductions. The standard tax - 60 - rate for personal income tax in Slovenia is 25%, but there are various deductions and exemptions that taxpayers can claim. The Slovenian Corporate Income Tax Act regulates corporate income tax in Slovenia. The Act applies to all legal entities that conduct business in Slovenia, regardless of their country of origin. The Act provides guidelines on taxable income, tax rates, and deductions. The standard tax rate for corporate income tax in Slovenia is 19%, but there are various deductions and exemptions that taxpayers can claim. The Slovenian VAT Act regulates VAT in Slovenia. The Act applies to all businesses that sell goods and services in Slovenia, regardless of their country of origin. The Act provides guidelines on VAT rates, exemptions, and refund rules. The standard VAT rate in Slovenia is 22%, but there are reduced rates for certain goods and services. The Slovenian tax legislation also includes various regulations and directives that aim to prevent tax evasion and avoidance. The Slovenian Tax Procedure Act regulates the procedures for tax collection, administration, and enforcement. The Act provides guidelines on tax audits, assessments, and appeals. Another notable regulation is the Slovenian Transfer Pricing Documentation Rules, which require companies to provide detailed documentation on their transfer pricing transactions to tax authorities. 16.5 Conclusion Tax legislation is a critical component of any modern economy, and its effective management is vital for the government's financial stability. The complexity and diversity of tax systems across the world require specific regulations and legislation to manage them efficiently. The OECD and the EU have been at the forefront of global tax legislation, establishing international tax standards and cooperation among countries. Slovenia, as an EU member state, has adopted the EU's tax legislation framework, providing a comprehensive legal framework for taxes in Slovenia. Tax legislation, combined with effective tax administration and enforcement, can ensure that individuals and businesses pay their fair share of taxes and contribute to the government's financial stability. - 61 - 16.6 Real-Life Case: One relevant example of EU tax legislation is the case of Apple and Ireland's tax arrangement, which the European Commission deemed to be illegal state aid. In 2016, the European Commission ordered Apple to pay €13 billion in back taxes to Ireland, stating that the country had given the tech giant an unfair advantage by allowing it to pay an effective tax rate of 1% on its European profits. The commission argued that this constituted a violation of EU state aid rules. Apple and the Irish government both disputed the ruling and appealed it, but in 2020, the EU General Court upheld the commission's decision. Apple and Ireland are currently appealing the case to the European Court of Justice. This case highlights the EU's efforts to crack down on illegal tax arrangements that give certain companies an unfair advantage over others. It also underscores the importance of complying with EU tax laws and regulations. Here is a working web link to the European Commission's page on the Apple-Ireland case: https://ec.europa.eu/commission/presscorner/detail/en/IP_16_2923 16.7 References and further reading 1. European Commission. (2020). Taxation and customs union: Taxation. Retrieved from https://ec.europa.eu/taxation_customs/business/index_en.htm 2. Government of Slovenia. (2020). Taxes. Retrieved from https://www.gov.si/en/topics/taxes/ 3. Organisation for Economic Co-operation and Development. (2021). Base erosion and profit shifting (BEPS). Retrieved from https://www.oecd.org/tax/beps/ 4. Slovenian Tax Administration. (2020). Tax legislation. Retrieved from https://www.fu.gov.si/en/taxes_and_duties/tax_legislation/ 5. Tax Justice Network. (2020). Global tax legislation. Retrieved from https://taxjustice.net/topic/global-tax-legislation/ - 62 - 16.8 Progress Test 1. What is the aim of the OECD's Base Erosion and Profit Shifting (BEPS) project? a. To reduce taxes for multinational enterprises. b. To increase taxes for small businesses. c. To establish international tax standards and cooperation among countries. d. To prevent countries from exchanging tax information. 2. What is the standard corporate income tax rate in Slovenia? a. 25% b. 19% c. 22% d. It varies depending on the business type. 3. What is the Anti-Tax Avoidance Directive (ATAD)? a. A directive that aims to prevent tax evasion and avoidance in the EU. b. A directive that establishes international tax standards and cooperation among countries. c. A directive that provides guidelines on VAT registration, invoicing, and reporting requirements. d. A directive that regulates personal income tax in the EU. 4. What is the aim of the Mandatory Disclosure Rules (MDR)? a. To prevent tax evasion and avoidance in the EU. b. To establish international tax standards and cooperation among countries. c. To provide guidelines on VAT registration, invoicing, and reporting requirements. d. To reduce taxes for small businesses. Answers: c, b, a, a - 63 - 17 Exercise Assignments EXERCISE ASSIGNMENT – 1: COMPANY AS A BUSINESS SYSTEM Analyze a company of your choice by examining its core components—such as its business model, organizational structure, value chain, and financial health—to understand how it operates as a cohesive business system. Present your findings in a detailed report, highlighting how these components interact to drive the company's success. EXERCISE ASSIGNMENT – 2: SIGNIFICANCE OF ACCOUNTING IN A COMPANY Analyze and detail how accounting practices impact a company's operational efficiency, decision-making processes, and strategic planning, emphasizing its role in financial management and regulatory compliance. EXERCISE ASSIGNMENT – 3: COMPONENTS OF ACCOUNTING AND TYPES OF ACCOUNTANCIES Explore and detail the primary components of accounting—assets, liabilities, equity, revenue, and expenses—and analyze the different types of accountancies, including financial, managerial, cost, and tax accounting, highlighting their key features and applications. EXERCISE ASSIGNMENT – 4: CONTENTS AND FORMS OF BUSINESS DOCUMENTS AND BOOKS Analyze various business documents and books, noting their specific contents and forms, and prepare a report detailing how each is used in business operations, including examples of invoices, receipts, ledgers, and journals EXERCISE ASSIGNMENT – 5: CONTENTS AND FORMS OF FINANCIAL STATEMENTS AND INFORMATION IN INDIVIDUAL STATEMENTS analyze the contents and forms of the Balance Sheet, Income Statement, and Cash Flow Statement. Identify and discuss the key information each statement provides, including assets, liabilities, equity, revenue, expenses, and cash flows. Highlight how these elements contribute to the overall financial health and operational performance of a business. Use real or hypothetical examples to illustrate your points. EXERCISE ASSIGNMENT – 6: SIGNIFICANCE OF FINANCIAL FUNCTION Analyze the significance of the financial function within a business by outlining its role in resource allocation, investment decisions, and strategic planning, and discuss how it impacts overall business performance. EXERCISE ASSIGNMENT – 7: OBJECTIVES, TASKS AND ORGANIZATION OF FINANCIAL FUNCTION For your exercise assignment on the objectives, tasks, and organization of the financial function, please complete the following steps: Define the Objectives: Summarize the main goals of the financial function within a business, including ensuring financial health, supporting growth, and maximizing shareholder value. Outline the Tasks: List and describe the key tasks performed by the finance department, such as budgeting, forecasting, managing cash flow, and securing funding. - 64 - Discuss the Organization: Analyze how the financial function is typically organized within a company, considering roles like CFO, financial analysts, and accountants, and how these positions collaborate to achieve the financial objectives. EXERCISE ASSIGNMENT – 8: INTERIOR AND EXTERIOR SOURCES OF FINANCING For your assignment on interior and exterior sources of financing, research and compare internal financing methods, such as retained earnings and depreciation funds, against external financing options, including bank loans, equity capital, and bond issuance. Analyze their advantages, disadvantages, and suitability for different business scenarios, presenting your findings in a detailed report with examples. EXERCISE ASSIGNMENT – 9: SECURITIES IN FINANCING A BUSINESS SYSTEM AND SECURITIES MARKETS Analyze the role of securities in financing a business system and their impact on securities markets, focusing on types of securities (such as stocks and bonds), how they are used to raise capital, and their influence on market dynamics. Include examples of their application and implications for investors and companies alike. EXERCISE ASSIGNMENT – 10: MONEY MOVEMENT Analyze and report on the flow of money within a selected company or industry, focusing on income, expenses, investments, and financial transactions over a specific period. EXERCISE ASSIGNMENT – 11: INSTRUMENTS FOR CLAIM INSURANCE Research and prepare a brief report on the various instruments used for filing insurance claims, detailing their purposes, requirements, and the process for submission. EXERCISE ASSIGNMENT – 12: TAX LEGISLATION: GLOBAL, EU, SLOVENIA Research and analyze the tax legislation at three levels: global (focusing on international tax principles and agreements), European Union (examining EU tax directives and policies), and Slovenia (detailing national tax laws and how they align with global and EU regulations). Compare their similarities and differences, and discuss the impact on businesses and individuals. Present your findings in a report, including references to specific laws and real-world examples. - 65 -