Financial Accounting

1. Introductory Course Session 1 Financial Accounting

2. Dr. Clive Vlieland-Boddy FCA FCCA MBA 2009 What is Financial Accounting

3. The Purpose of Accounting To provide accurate financial information on the performance of a firm. Managers need this to enable them to make their planning and control. Outsiders need this to be able to evaluate the firms position and whether they will or will not trade with it. Shareholders and investors need to see that their investment is good.

4. Cash Inventory Notes Payable Equipment Accounts An organized format used by companies to accumulate the dollar effects of transactions.

5. Nature of Business Transactions External events: exchanges of assets and liabilities between the business and one or more other parties. Borrow cash from the bank

6. Nature of Business Transactions Internal events: not an exchange between the business and other parties, but have a direct effect on the accounting entity. Loss due to fire damage.

7. PRINCIPLES OF AN EFFICIENTAND EFFECTIVE ACCOUNTING INFORMATION SYSTEM

8. PHASES IN THE DEVELOPMENT OF AN ACCOUNTING SYSTEM Analysis Planning and identifying information needs and sources Follow-up Design Monitoring and correcting any weaknesses Creating forms, documents, procedures, job descriptions, and reports Implementation Installing the system, training personnel, and making the system wholly operational

9. Transaction Occurs Source Documents Prepared Transaction Analysed Transaction entered in Day Book & Posted to Ledger Flow of Accounting Data

10. Duality of Effects Most transactions with external parties involve an exchangewhere the business entity both gives upsomething and receives something in return.

11. The Basics Businesses buy and sell products and incur expenses, known as overheads, with the objective of making a profit. Transactions can be either Cash or Credit

12. Cash v Credit Transactions Most shoppers who go into a sweet shop or a snack bar will pay for their purchases in Cash. The sweet shop and the snack bar will usually order supplied from a wholesaler who will often deliver them directly to them. Usually the supplier will invoice the sweet shop or snack bar and some days later, they will receive payment for that invoice.

13. Cash and Credit Accounting Cash will normally be put in a till and once a day taken to the bank. Cheques are often written out days after the invoice is received and then sent to the supplier. The cash transaction is therefore completed as it takes place, whilst the credit transaction is only completed when the cheque is received by the supplier and banked by them.

14. Accounting Methods for Measuring Performance Strict cash basis of accounting. Revenues are recorded when cash is received and expenses are recorded when cash is paid. Accrual basis of accounting. Revenues and expenses are recorded on an economic basis independently of the actual flow of cash.

15. Cash V Accrual Basis of Accounting Cash Basis Accrual Basis Easy to understand. Theoretically difficult. Provides a reliable picture of the the change in cash and the firm’s liquidity. Provides a more reliable picture of the economic changes in wealth. Revenues and expenses are recorded according to cash inflows and outflows. Revenues and expenses are recorded according to economic change in wealth (the rules are discussed later on in this clinic). Can be manipulated by changing the cash flows timing. Can be manipulated by the changing the recognition rules.

16. What is the issue…. Whilst a cash transaction is completed immediately, we need to appreciate that with a Credit transaction, that there is an outstanding responsibility of the sweet shop or the snack bar to pay for the supplies they have received. We therefore need to record the fact that the Credit transaction is not completed. It is outstanding until paid.

17. Basic Books of Accounts Cash Book Petty Cash Book Sales Day Book Purchased Day Book Sales or Accounts Receivable Ledger Purchase or Accounts Payable Ledger General or Nominal Ledger

19. The Cash Book This is an item by item summary of the enterprise's bank account. This shows Money Banked or other bank receipts and Cheques and other payments out of the bank. The Receipts are shown on the left and the payments on the right. The balance can be reconciled to the balance on the bank statement.

20. The Petty Cash Book Most enterprises keep a small amount of cash in a tin to meet sundry daily expenses which are paid in cash. Milk and coffee. A taxi fare. A rail fare for a member of staff. The tin is normally replenished with cash drawn from the bank. The left side of the book shows the reimbursements from the bank and the right the expenses paid out. This book is of minor importance.

21. Sales Day Book or Journal This is a summary of the sales made. Normally individually. The date, the amount and the name of the customer. It is what the name says. Sales Day Book.

22. Sales Day Book Date Customer Name Reference Amount Parts Service 2 July 2008 JJ Manufacturing SI1 2500 2500 29 July 2008 ABC Products AI2 3200 3200 ------- ------- ------- Total 5700 2500 3200 ==== ==== ====

23. Purchase Day Book or Journal This is a summary of the daily purchases so as to record what the enterprise has incurred by way of supplies and expenses.

24. Purchase Day Book Date Supplier Name Reference Amount Electricity Widgets 10 July 2006 Electricity Company PI1 1000 1000 12 July 2006 Widget Company PI2 1600 1600 ------- ------- ------- Total 2600 1000 1600 ==== ==== ====

25. Sales or Accounts Receivable Ledger This records all Credit sales that have been made to customers. Normally a page is for each customer. It shows the sales made and the payments that the customer has made. The balance on a customers account represents the amount that the customer owes the enterprise. This money which will be received is called Accounts Receivable

26. Accounts Receivable Ledger

27. Posting from a Sales Journal To a Cash Receipts Ledger

28. QUESTION: What is an accounts receivable ledger? ANSWER: An accounts receivable ledger is a subsidiary ledger that contains a separate account for each customer.

29. Purchase or Accounts Payable Ledger. This records all Credit purchases from suppliers. Normally a page for each supplier. It shows the goods or serviced received and the payments that have been made. The balance on an account represents the amount that the enterprise owes the supplier. This money which will be paid is called Accounts Payable.

30. The Accounts Payable Ledger NAME International Apparel Shop TERMS n/30 ADDRESS 1718 Sherry Lane, New Town DATE DESCRIPTION POST. DEBIT CREDIT BALANCE REF. 20-- JAN. 1 Balance 1,600.00 23 Invoice 7985, 01/23/-- P1 5,120.00 6,720.00 • The accounts payable ledger has three money columns. • The Balance column is presumed to contain credit amounts.

31. QUESTION: What is an accounts payable ledger? ANSWER: An accounts payable ledger is a subsidiary ledger that contains a separate account for each creditor.

32. Posting Payments to Suppliers

33. When cash is paid to a supplier for an outstanding invoice, the transaction is first recorded in a Bank Payments Book. Bank Payments

34. NAME International Apparel Shop TERMS n/30 ADDRESS 1718 Sherry Lane, Dallas, New Town DATE DESCRIPTION POST. DEBIT CREDIT BALANCE REF. 20-- Jan. 1 Balance  1,600.00 23 Invoice 7985, 01/22/-- P1 5,120.00 6,720.00 27 BP1 2,400.00 4,320.00 The cash payment is then posted to the individual creditor’s account in the accounts payable ledger. Posted from page 1 of the Bank Payments Book

35. RELATIONSHIP OF GENERAL LEDGERS AND SUBSIDIARY ACCOUNTS

36. RELATIONSHIP BETWEEN LEDGERS The subsidiary ledger is separatefrom the general ledger. Accounts Receivable is a control account.

38. 4 Fundamental Accounting Concepts Going Concern - That the business will continue and not be liquidated. Accruals (or Matching) - That income is matched with expenditure. You match the sale with the cost of that sale. Consistency - What you did last year you do this. Otherwise figures would be meaningless. Prudence - Caution is essential. Note “Prudence must prevail”

39. Types of Enterprises Sole Traders - where the firm is owner occupied. It is owned and run by one person. The owner is personally responsible for all the liabilities. Partnerships - Where two or more people get together and form an enterprise without the structure of a formal limited liability company. Essentially a group of sole traders. Limited Liability Companies - Incorporated enterprises to take advantage of limited liability.

40. The Structure of Accounts There are essentially three sets of figures as well as notes and additional explanations. The Balance Sheet The Income Statement The Cash Statement Notes to the Accounts Other statements in published accounts.

41. Financial Performance Aims to make money for its owners. Invests the company funds to achieve a higher return than the owners could personally do elsewhere. Profit represents the excess income over expenditure. Loss is the converse.

42. Management's Stewardship Management are accountable to the shareholders who have invested their funds into the business. The shareholders evaluate management's stewardship through the reports and accounts. These accounts therefore enable shareholders to judge how well management has carried out their stewardship responsibility.

43. Stakeholders .

44. The Basic Financial Statements • Balance Sheet • Income Statement

45. The Balance Sheet • A picture of the business. • Like a Milometer. It says what is the current position.

46. Income Statement • Like a movie picture. • Shows how fast or slow the business is. Like a speedometer.

47. Cash v Credit Transactions • Most shoppers who go into a sweet shop or a snack bar will pay for their purchases in Cash. • The sweet shop and the snack bar will usually order supplied from a wholesaler who will often deliver them directly to them. • Usually the supplier will invoice the sweet shop or snack bar and some days later, they will receive payment for that invoice.

48. Cash and Credit Accounting • Cash will normally be put in a till and once a day taken to the bank. • Cheques are often written out days after the invoice is received and then sent to the supplier. • The cash transaction is therefore completed as it takes place, whilst the credit transaction is only completed when the cheque is received by the supplier and banked by them.

49. Accounting Methods for Measuring Performance • Strict cash basis of accounting. • Revenues are recorded when cash is received and expenses are recorded when cash is paid. • Accrual basis of accounting. • Revenues and expenses are recorded on an economic basis independently of the actual flow of cash.

50. Cash Basis Accrual Basis Easy to understand. Theoretically difficult. Provides a reliable picture of the the change in cash and the firm’s liquidity. Provides a more reliable picture of the economic changes in wealth. Revenues and expenses are recorded according to cash inflows and outflows. Revenues and expenses are recorded according to economic change in wealth (the rules are discussed later on in this clinic). Can be manipulated by changing the cash flows timing. Can be manipulated by the changing the recognition rules. Cash V Accrual Basis of Accounting