1.   Components of Financial Statements

 

      As explained before, the outputs of financial accounting are the financial statements. Financial statements contain information about the financial position of the business, results of its economic activities (its performance), cash flows, and the change in its financial position. Basic components of the financial statements are: assets, liabilities, shareholders’ equity, revenues, and expenses. These components are explained below:

 

      a.   Assets: Assets are resources that are owned and controlled by the firm and that are expected to provide economic benefit to the firm in the future. Assets are objects, claims, and rights of the firm. Objects are cash, inventories, land, buildings, vehicles, etc. that are owned by the business. Claims are cash, services or goods that other businesses, individuals or government owe to the firm. Rights are controlled by the firm and permit the firm to engage in an activity in a certain area, use a trade mark or a name, publish a book, manufacture a certain good, etc.

 

      b. Liabilities: Liabilities are cash, services or goods that the firm owes to other businesses, individuals or government. Liabilities are fulfilled by paying cash, or by providing service, or by delivering goods, or giving equity.

 

      c.   Shareholders’ equity: Shareholders’ equity is the difference between the value of the assets and the value of the liabilities. Shareholders’ equity is the amount invested by the owners into the firm.

 

      We can say that; assets are what the firm owns, liabilities are what the firm owes, and shareholders’ equity is what belongs to the owners.

     

 

      Financial statements are prepared through a process called the financial accounting process or simply the accounting process. Here we present the steps of this process in general; each step will be examined in detail later. Steps of the accounting process are as follows:

 

a.    Opening entries are made,

      b.   Transactions occur,

      c.   Accounting records to the accounting slips based on source documents are made as the transactions occur,

      d.   Journal entries are made (general journal),

      e.   Amounts in the journal entries are posted to the accounts (general ledger),

      f.    Unadjusted trial balance is prepared,

      g.   Inventory is taken and the adjusting entries are made,

      h.   Adjusted trial balance is prepared,

      i.    Financial statements are prepared,

      j.    Closing entries are made.

 

      There are three official books that must be kept by law. One of the books is general journal. General journal contains the journal entries in a chronological order. Another book is the general ledger. General ledger contains the accounts. The third official book is the inventory book. After taking the inventory at the end of the accounting period, the results of the inventory is recorded in this book. Today, all books are kept electronically. But, at the end of the accounting period, hard copies must be taken and must be kept in a binned form. Accounting slip is a piece of paper that records every individual transaction. Accounting slips are also prepared and kept electronically. Journal entries are prepared and listed in the general journal from the records on the accounting slips.

 

 

      Account is the basic device to record the transactions. In fact, the term accounting comes from the concept of account. When a transaction occurs an accounting record must be made. So, it is in order now to define what a transaction is from an accounting perspective. A transaction is any economic event that causes an increase or decrease in assets, liabilities or shareholders’ equity or any economic event that creates revenue or expense. Monetary values of the increases or decreases in assets, liabilities and shareholders’ equity, and monetary values of the revenues and expenses are recorded into the accounts. Accounts are also asset, liability, shareholders’ equity, revenue, and expense items. In order to make accounting records a firm must create the accounts. The list of the accounts that a firm uses is called the chart of accounts. In Turkey there is a uniform chart of accounts that was prepared by the ministry of finance. Every firm in Turkey must use this uniform chart of accounts. But this is not the case in most other countries. Firms operating in a country that does not have a uniform chart of accounts must prepare its own chart of accounts and use it. We use the Turkish uniform chart of accounts throughout this book.

 

      There is a hierarchy of accounts in the chart of accounts. This hierarchy is presented below:

 

      a.   Account class

      b.   Account group

      c.   Account

      d.   Subsidiary account

 

      Items in the hierarchy are numbered. Account classes are denoted by single digit numbers (example: 1, 2, 3…..), account groups are denoted by double digit number (example: 10, 11, 20, 32……), accounts are denoted by three-digit numbers (example: 100, 101, 121, 257,…..). Numbering system of the subsidiary accounts will be examined later.  

 

      a.   Account classes, account groups, accounts, and subsidiary accounts

            Account classes are listed below. Numbers in parentheses are the account class number.

 

            (1) Current assets

            (2) Fixed (non-current) assets

            (3) Short-term liabilities

            (4) Long-term liabilities

            (5) Shareholders’ equity

            (6) Revenues and expenses

            (7) Cost accounts

 

            Cost accounts are used in cost accounting. Account groups under each account class and the accounts under each account group are explained below: Numbers in parentheses are account group numbers and account numbers.

 

            Current asset:  Current assets are the assets that are cash, or expected to be converted into cash or benefited within a year. Economic benefits of the current assets last within a year. Account groups and accounts under current assets are as follows:

 

                  Cash and cash equivalents (10)

                        Cash (100): Cash in local currency or the local currency equivalent of the foreign currency held by the firm in its vaults.   

 

                        Checks received (101): Checks received by the firm that have not been cashed yet (does not include forward-dated checks).

 

                        Bank accounts (102): Cash in local currency or the local currency equivalent of the foreign currency held by the firm in its bank accounts.

 

                        Outstanding checks and payment orders (-) (103): Checks given by the firm that have not been cashed by the other party (does not include forward-dated checks) or payment orders that have not been executed yet.                   

 

                        Minus in parentheses represents that the amount of the account decreases the amount of the group. These types of accounts in assets are called contra-asset accounts. Amount of the cash and cash equivalents is reduced by the amount of outstanding checks and payment orders. Since the check has not been cashed or the payment order has not been executed yet, the amount is included in the bank accounts. But the firm cannot use this amount because it belongs to the other party. Although the amount is included in the bank accounts, the firm does not technically own this amount.

 

                  Marketable securities (11): Marketable securities is short-term investments in stocks, treasury notes, government bonds, mutual funds, etc. for the purpose of generating extra return from idle cash.

 

                  Trade receivables: (12): Trade receivables arise from the operating activities (sale of goods and services) of the firm.

 

                        Accounts receivable (120): They are the trade receivables that are not backed by a note or a forward-dated check. They are also called open accounts.

 

                        Notes receivable (121): They are the trade receivables that are backed by a note or a forward-dated check. In other words, the firm delivers the goods or provides the service but does not receive the payment for them. Instead, the firm receives a note or a forward-dated check showing the amount due and the payment date. On the other hand, in accounts receivable the firm does not receive a note or a forward-dated check.

                            

                             Credit card receivables (123): Credit card receivables from the bank.

 

                     Deposits and guarantees extended (126): Deposits and guarantees extended in cash to the other parties related to the operating activities. For example, a guarantee payment of a retailer to its distributor.

 

                        Allowance for uncollectibles (-) (129): It is a contra-asset account. It is an allowance made for over due (haven’t been paid at maturity) accounts receivable or notes receivable.

 

                  Other receivables (13): Receivables that do not arise from the operating activities (sale of goods or services). The accounts under this group are: receivables from shareholders (owners), receivables from personnel, miscellaneous other receivables, etc.)

  

                  Inventories (15):

 

                        Materials inventory (150): Materials (raw materials or components) that will be used in manufacturing and materials that will be used in providing service or carrying out other business activities.

 

                        Work-in process inventory (151): Goods that are unfinished and still in production process.

 

                        Finished goods inventory (152): Goods that are finished but have not been delivered to the customers yet.

 

                        Merchandise inventory (153): Goods that are purchased manufactured for resale.

 

                        Advance payments (159): Advance payments made to the suppliers for the inventory items (materials or merchandise) that will be received later.

 

                  Prepaid expenses and accrued revenues (18)

                        Prepaid expenses (180): Payment made before receiving the benefit (before receiving the service or before using something).

 

                        Accrued revenues (181): Revenues (other than sale of goods or services) like interest or rent accrued in this period but will be received in the next period.

 

                  Other current assets (19):

                       

                        VAT (value added tax) carried forward (190)

                        VAT deductible (191): VAT paid or due to the supplier when goods or services are bought.

 

      Fixed (non-current assets): Assets that are expected to be converted into cash more than a year or assets that are expected to be used more than a year.

 

            Trade receivables (22): Receivables that arise from the operating activities (sale of goods and services) of the firm, which are due more than a year. (Accounts receivable, notes receivable, deposit and guarantees extended)

     

            Other receivables (23): Receivables that do not arise from the operating activities (sale of goods or services), which are due more than a year.

 

            Financial fixed-assets (24): Long-term equity investments of the firm to the other businesses. The purpose of the firm is to control the other firm.

 

                  Long-term financial investments (240): Voting right in the other business is less than 10%.

 

                  Affiliates (242): Voting right in the other business is between 10 % (inclusive) and 50 % (inclusive).

 

                  Subsidiaries (245): Voting right in the other business is more than 50%.

 

            Tangible assets (25):

 

                  Land (250): Empty land that belongs to the firm.

                  Land improvements (251): Road, bridge, pier, tank, etc.

 

                  Buildings (252): Buildings owned by the firm such as factory building, administrative building, apartment flat, store, warehouse, etc.

                  Machinery and equipment (253): Any type of machinery and equipment used in business activities such as CNC machines, oven, conveyors, MR equipments, tools, X-ray equipment, etc.

 

                  Vehicles (254): Any type of land, rail, air, and sea vehicles such as automobiles, trucks, buses, mini buses, planes, ships, etc. that belong to the firm.

           

                  Furniture and fixtures (255): Desks, chairs, tables, beds, counters, other store and office equipments, etc.

                  Accumulated depreciation (-) (257): Contra-asset account that reduces the value of the tangible assets.

 

                  Advance payments (259): Advance payments made to the suppliers for the tangible assets that will be received later.

 

            Intangible assets (26): Assets such as rights, patents, licenses, franchise, software, copyright, etc. that does not have physical form, but that will provide economic benefits to the firm more than a year. The firm must obtain tangible assets by paying money.

 

      Short-term liabilities: Liabilities that are due within a year (liabilities whose maturities are at most one year).

 

            Financial liabilities (30):

 

                  Bank loans (300): Bank loans that are due within a year.

 

                  Lease liabilities (301): Financial lease payments that are due within a year.

 

            Trade payables (31): Payables that arise from the operating activities of the firm.

 

                  Accounts payable (320): They are the trade payables that are not backed by a note or a forward-dated check. They are also called open accounts.

 

                  Notes payable (321): They are the trade payables that are backed by a note or a forward-dated check. In other words, the firm receives the goods and the services but does not make the payment for them. Instead, the firm gives a note or a forward-dated check showing the amount due and the payment date. On the other hand, in accounts payable the firm does not give a note or a forward-dated check.

 

                  Deposits and guarantees received (326): Deposits and guarantees received in cash from the other parties related to the operating activities. For example, a guarantee payment received from the retailer.

 

            Other payables (33): Payables that do not arise from the operating activities. The accounts under this group are: payables to shareholders (owners), payables to personnel, miscellaneous other payables, etc.)

 

            Advance payments received (340): Advance payments received from the customers for the deliveries that will be made later.

 

            Taxes and other duties payable (36): Payables to the government authorities that are accrued.

 

                  Taxes payable (360): Accrued taxes that will be paid later.

 

                  Social security premiums payable (361): Accrued social security premiums of the employees that will be paid later.

 

                  Unemployment insurance premiums payable: Accrued social unemployment insurance premiums of the employees that will be paid later.

 

            Debt provisions (37):

 

                  Provision for corporate tax (371): Provision for the corporate tax on the period income that is calculated, which will be accrued and paid later.

 

            Unearned revenue and accrued expenses (38):

 

                  Unearned revenue (380): Payment received before providing a service. It is also called deferred income or deferred revenue.

 

                  Accrued expenses (381): Expenses like wages, salaries, interest or rent accrued in this period but will be paid in the next period.

 

            Other short-term liabilities (39):

 

                  VAT payable (391): VAT received or due from the customer when a sale is made.

 

      Long-term liabilities: Liabilities that are due more than a year (liabilities whose maturities are more than one year).

 

            Financial liabilities (40):

 

                  Bank loans (400): Bank loans that are due more than a year.

 

                  Lease liabilities (401): Financial lease payments that are due more than a year.

 

            Trade payables (42): Payables that arise from the operating activities of the firm, which are due more than a year (accounts payable, notes payable, deposit and guarantees received).

 

            Other payables (43): Payables that do not arise from the operating activities, which are due more than a year. The accounts under this group are: payables to shareholders (owners), payables to personnel, miscellaneous other payables, etc.).

 

      Shareholders’ equity:

            Paid-in capital (50): Capital paid by the owners as cash or in-kind.

 

                  Capital (500): Capital that is stated in the articles of association and registered to the trade registry.

 

                  Unpaid capital (-) (501): Capital that is committed by the owners but has not been paid yet. It is a contra account that reduces the value of the shareholders’ equity.

 

            Previous years’ losses (-) 580: Cumulative amount of the previous years’ losses that have not been offset. The loss of each year must be stated separately (2005 loss, 2006 loss, etc.). It is a contra account that reduces the value of the shareholders’ equity.

 

            Net period income (590): Net period income of the year that has just ended.

 

            Period loss (-) (591): Period loss of the year that has just ended. Period loss reduces the value of the shareholders’ equity.

      Revenues and expenses:

 

            Gross sales (60): Total amount accrued (received or that will be received) from the sale of goods or services.

 

                  Domestic sales (600): Total amount accrued from the sales made in Turkey (sales made to the customers inside Turkey).

 

                  Foreign sales (601):  Total amount accrued from the exports (sales made to the customers outside Turkey).

 

            Sales deductions (-) (61): This group is contra-revenue account and reduces the amount of the sales. Gross sales – sales deductions = net sales.

 

                  Sales returns (610): Monetary amount of the returned goods that have been previously delivered. Goods must be returned physically.

 

                  Sales discounts (611): Any cash discount granted to the buyer (early payment discount or amount discount) after the invoice is prepared and given to the customer.   

 

            Cost of sales (-) (62): Cost of merchandise, finished goods, and service delivered or provided to the customers. Cost of sales includes the production (for both goods and services) costs and acquiring costs (for merchandise).

                  Cost of goods sold (620):  All manufacturing costs of the finished goods sold.

 

                  Cost of merchandise sold (621): All acquiring costs of the merchandise inventory sold.   

 

                  Cost of service sold (622): Production cost of services provided (sold).

 

            Operating expenses (-) (63):

 

                  Research and development expenses (630): Expenses related to the research and development activities.

 

                  Selling, marketing and delivery expenses (631): Expenses related to the selling, marketing and delivery activities.

 

                  General administrative expenses (632): Expenses related to the general administrative activities.

 

            Other revenues and gains (64): Revenues and gains that are not related to the sale of goods or services. The most important other revenues and gains are listed below:

                 

                  Interest revenue (642)

            Other expenses and losses (-) (65): Expenses and losses that are not related to the operating activities. The most important other expenses and losses are listed below:

 

                  Commission expense (653)

            Finance expenses (-) (66): All expenses such as interest, foreign exchange difference, tax, commission, etc. related to the funds acquired from the financial institutions or capital markets.

 

                  Short-term finance expenses (660)

                  Long-term finance expenses (661)

            Period net income or loss (69):

                  Period income or period loss (690):

                  Provision for corporate tax (-) (691):

                  Period net income or loss (692): 

 

 Cost accounts: As will be explained later, according to the Turkish Uniform Accounting System cost accounting and financial accounting records are made seperately. That is why there are seperate cost accounting accounts. These accounts are listed below.

 

        710 Direct Materials Cost

         730  Manufacturing Overhead

        770 General Administrative Expenses

 

 You may notice one thing. 630 is research and development expenses, 631 is selling, marketing and delivery expenses, 632 is general administrative expenses. Likewise, 750 is research and development expenses, 760 is selling, marketing and delivery expenses, 770 is general administrative expenses. They may seem to be the same, but they are different. Since Turkish Uniform accounting System requires that financial accounting and cost accounting records be made seperately, different accounts must be used for financial accounting and cost accounting. 630, 631, and 632 are financial accounting accounts; 750, 760, and 770 are cost accounting accounts. Although their names are the same, their account numbers are different. This subject will be covered in detail later in this chapter.

 

Subsidiary accounts are numbered as shown below:

 

102 is bank acconts. This account shows all the money in bank accounts. Subsidiary accounts af this account may be:

 

  102.00 TL demand deposits

    102.00.00 Demand deposit in bank....... branch .......

     102.00.01 Demand deposit in bank ....... branch .......

     102.00.02 Demand deposit in bank ....... branch ......

   102.01 TL time deposits

      102.01.00 Time deposit in bank ...... branch .....

       102.01.01 Time deposit in bank ..... branch .....

   102.02 USD demand deposits

       102.02.00 Demand deposit in bank .... branch

       102.02.01 Demand deposit in bank ...... branch

 

 

      As explained above when a transaction occurs an accounting record is made into the accounts. We learned the basic accounts. Now, it is time to learn how an accounting record is made into the accounts. Shape of the account is shown below:

 

Account Name

Debit                                                                          Credit