Accounting

Financial Accounting

-Basis for communication between organisations using publically available information -governed by rules, but professional judgement is important -mainly relying on historical information e.g. the performance of a firm in an accounting period

Management Accounting

-Basis for communication within an organisation, using confidential information -information used to plan and control the business and to make internal financial decisiongs -no rules prescriped (as it is internal info) -mostly information for forward looking e.g. estimating future costs

4 sources of accounting regulation

-Companies Acts requirements -UK and International Financial Reporting Standards -Stock Exchange requirements -International Financial Reporting Standards (IFRS), issued by IASB

comprehensive income statement

-IASB issued the IAS 1 Presentation of Financial Statements composed of: 1) income statement (trading and other realised transactions) 2) info on OCI, Other Comprehensive Income (unrealised gains e.g. on revaluation on land) -the sum of net profit and OCI gives the total comprehensive income

purpose of the statement of financial position

-List of the assets, liability and capital of a business at the end of a given account year -it provides information about the resources and debts of the reporting entity -this enables users to evaluate its financial position, specifically whether a business will likely to be able to pay its debt

the accounting entity

-a construct that defines the boundaries of the unit which is the object of the particular accounting process, and thus determines those transactions to be recorded -it can be legally defined e.g. as a company, club, uni etc -or be a notional part of a natural person's activies e.g. sole trader. in such caes, needs to distinguish private from business transcations

format of the statement of financial position

-a list of balances in the ledger after the profit and loss account has been prepared. 2 formats: -Account/Horizontal (US) -Vertical form (UK/internation)

debit note

-additional invoice to rectify any undercharge on the original invoice -i.e. informs additional amount owed to seller

revenue expenditure

-all the expediture expect those to purchase and improve non-current assets -expense

Investments in subsidiaries/associates

-also investments in paper shares -however, the intention is to retain these as part of the entity's normal activities -non-current asset

errors not detected in a trial balance

-arithmetic errors: an incorrect addition on one side of an account and/or calculation of a balance -posting errors: 1) a transaction has only been entered on one side of the ledger 2) a transaction has been entered twice on the same side 3) the wrong amount has been entered on one side

tangible assets

-assets that can be seen and touched -also referred to as property, plant and equipment -non current asset

intangible assets

-assets that cannot be seen or touched -e.g. intellectual property -non-current asset

Double entries for CoS

-at the end of the period, income and expense account balances are transferred to the profit/loss account. -this is the same for CoS, which can be seen as an expense, and it will have a Dr balance Dr: CoS A+ B Cr Opening Inventory A Dr: CoS Cr: Purchases B Dr closing Inventory C Cr: CoS C

Statement of financial position

-balance sheet -capital (equity) = asset - liabilities

Recording Cash transactions

-cash transaction: when g/s are paid for in cash/cheque when they are received or delivered Receipts -Dr: cash -Cr: relevant income account (e.g. revenue) Payments -Dr: relevant expense account (e.g. purchases) -Cr: cash -if cash is represented by bank deposits, then "bank" account may be used -if the transaction involves buying inventory, the "purchases" account should be used

Valuation of closing inventory

-closing inventory is valued at the lower of historical cost and net realisable value (IAS2) -application of the prudence concept and covers situations where inventory is obsolete or damaged -may be difficult to value homogenous inventory when prices are changing -stock flow assumption is required 1) First in first out 2) average cost note: last in first out is not allowed

expenses

-costs attributable to the period being reported on -e.g. cost of goods sold, employment costs, rent etc

cost of sales

-costs most directly connected with purchasing/producing the g/s sold

Recording credit transations

-credit transaction: when payment is made or received some time after delivery Earned income -Dr: trade receivables -Cr: relevant income account incurred expense -Dr: relevant expense account -Cr: trade payables Receipts from customers -Dr: cash -Cr: trade receivables Payments to suppliers -Dr: trade payables -Cr: cash Sales return Dr: Returns in Cr trade receivables Purchase returns Dr: trade payables Cr: Returns out

returning goods to suppliers before payments (returns out)

-decrease in trade payables (liability, debit)

the nature of depreciation

-depreciation is the allocation of the cost of a non-current asset over the accounting periods that comprise its useful economic life -done as non-current assets generate revenue over a number of years. To comply with the matching principle, the cost of a non-current asset should be set against the revenue it generates -the depreciation part of cost is charged to P/L according to how much is "used up" or "consumed" in each period

Fair value

-difference in the amount a tangible, non-current asset can be exchanged between knowledgeable, willing parties in an arm's length transaction

Trade discounts

-discount given by one trade to another -deducted on the invoice indication that the buyer is charged for the goods -reduces the purchase price (and the VAT charged)

linking the income statement with financial position statement

-income and expense accounts are posted to profit and loss for the period -retained profit: profit - drawings -retained profit is a part of capital in the statement of financial position

Available-for-sale assets

-investments that are denominated in money or paper -entity holds for financial gain -will be sold by the entity in the future -non-current asset

International Financial Reporting Standards

-issued by the International Accounting Standards Board (IASB) -all companies whose shares are listed in the EU are required to prepare their consolidated financial statements in accordance with IFRSs

drawings

-money taken out of the business by owners -decreases in capital

historical cost accounting

-non-current assets are valued at their cost minus the aggregate/accumulated deprecation from the date of acquisition to the date of the statement of financial position -this value is known as the net book value (NBV) or net carrying amount -assets are reported in the statement of financial position at the NBV

Liabilities

-present obligation of an entity -arising from past events -the settlement of which is expected to result in an outflow of resources that embody economic beneift -presented in the financial statements according to the length of time an entity expects the liability to be outstanding

Income statements

-profit and loss account -profit/loss = income - expenses

capital expenditure

-purchase of a non-current asset (including the cost of getting it operational at the outset) and the cost of imrpovements -asset

Books of prime entry: Sales day book

-recording the sale on credit of those goods bought specifically for resale -written up from copies of the sales invoices retained by the seller

Basic Principles of double entry bookkeeping

-records an enterprise's transactions in the "general ledger" -each page of the ledger is split in halves -left side= debit side -right side= credit side -ledger divided into sections called accounts -each account normally starts on a new page -money value of each transaction is recorded once on both sides (debit of one account, and credit of the other account) -debit = credit

Books of prime entry: the journal

-records any transactions not included in the other books of prime entry -e.g. purchases and sales of non-current assets on credit, the correction of errors in the ledger etc -it is usually written up from a copy of the invoice

Books of prime entry: petty cash book

-records cash received and paid -written up from copies of receipts given and received, respectively

Books of prime entry: purchase returns day book

-records goods purchased on credit that have been returned to the supplier -written up from credit notes received from supplier

Books of prime entry: Purchase day book

-records the purchase on credit of those goods intended for resale. -written up from the invoices of suppliers

the journal

-records transaction not included in the other books of prime entry e.g. purchase and sale of non-current assets on credit, the correction of errors in the ledger etc. -usually written up from a copy of the invoice

Cash Discounts

-reduction in the amount that the customer has to pay provided payment is given in a certain amount of time -stipulated by the seller at the time of sale -does not reduce the amount paid (e.g. shown as an expense "discounts allowed" or as "discounts received" with other incomes) -still reduces the VAT charged

occurence: incurred

-refers to expenses -g/s are deemed to have been purchased on the date they are received, and not when the payment is made

Occurence: earned

-refers to income -a sale is deemed to have taken place at that point in time at which the g/s is delivered/provided, and not when the proceeds of sale are received

income

-represents increases in economic benefits during the accounting period -inflow/enhancement of assets -decreases in liabilities -increases in equity, other than those relating to contributions from equity participants -revenue is the income earned in the period from normal trading acitivities

Companies Acts requirements

-requirements are often not specific -therefore there is increased importance of professional judgement

assets

-resources controlled by the entity -are a result of past events -expect future economic benefits

Straight line method

-same amount of depreciation charged on the income statement in resepect of an asset each year through its useful economic life -depreciation p.a.= (cost-residual value)/useful economic life -can apply to parts of a year depending on the accounting policy

Net Realised Value

-selling price minus any costs required to bring the inventory up to saleable condition

Purpose of the income statement

-summary of the results of a business' trading activities during a given period -shows profit and loss -does not show drawings or dividends (which are found in the statement of cash flow) -enables users to evaluate the financial performance of a business

The matching principle

-the assumption that when measuring profit, costs should be set against the income they generate (i.e. during period when income arises)

Books of prime entry

-transactions are recorded here before it is recorded in the ledger

Functions of the double entry system

-two equal and opposite entries, balance is maintained across the accounts -by following rules as to what accounts are involved, and what debits and credits signify, ledger balances reflect values of individual accounts -therefore they show amounts of each type of income/expenditure and values of assets/liabilities/equity- for preparing financial statements

cash

-type of current asset

inventory

-type of current asset -goods purchased or internally produced for resale or to manufacture other goods (not yet sold)

short term borrowing

-type of current liability -e.g. overdraft, commerical paper

trade payables

-type of current liability -money owed by the entity to a supplier who provided goods on credit

Debit balance

-when total amount of money on the debit side is greater than that of the credit side. -increases assets and expenses are added to the debit side

Essential data to compute depreciation

1) Historical cost 2) the estimated residual value of the asset (value at the end of useful economic life) -depreciable amount = cost - residual value 3) the length of the asset's expected useful economic life 4) the method of depreciation

4 types of Financial accounting

1) Income Statements 2) Statement of Financial position 3) Statement of Cash Flow 4) Statement of Changes in Equity

Balancing of accounts

1) compute the difference between the amounts in the debit and credit columns of an account and enter it on the side with the lower amount as a balance carried down (c/d) 2) draw paralllel lines under the balalnce (c/d) on both side and enter the total of each side (should be the same now) 3) enter the amount of the balance below the parallel line on the opposite side to the balance (c/d) and describe it as the balance brought down (b/d): this is the final balance of the account

Reducing balance method

1) convex profile: faster depreciation in earlier periods 2) operates by applying depreciation rate to NBV brought forward

Approach to posting (3 steps)

1) determine the 2 accounts affected 2) consider the flow of value (debit or credit) 3) identify the money value that is transferring

2 methods of depreciation

1) straight line method 2) reducing balance method

the valuation of non-current assets

2 methods of valuation -historical cost accounting -fair value

The accounting equation

Assets = Capital (equity) + Liabilities

Net Book Value

Cost - accumulated depreciation

cash discount double entry

Discount allowed to a customer Dr: discount allowed (expense) Cr: trade receivables ( decrease asset) discount received from a supplier Dr: trade payables Cr: discount received (income element)

double entry of an asset revalued upwards (fair value)

Dr the asset Cr the "revaluation reserve" (capital) -the increase in the revaluation reserve is part of other comprehensive income -the asset would have a higher value and capital would be higher by the same amount

Typical structure of the statement of financial position

Non-current assets + current assets =total assets Current liabilities + non-current liabilities = Total liabilities Net assets = Total assets - total liabilities = Capital or equiity

Cost of sales

Opening inventory + purchases - closing inventory

Disposals of non-current assets

Profit: if Proceeds of sale > NBV loss: if proceeds of sale < NBV

capital (equity)

amount of capital invested in the business by its owners (net of withdrawals) + retained profit -notional amount, which can be interpreted as the net investment of the owners

all day books

amounts entered in all the day books are given after deducting trade discount, but before deducting cash discount

non-current assets

assets the entity expects to use in future years i.e. not in the next accounting period -Intangible Assets -Available-for-Sale Assets -Tangible Assets -Investments in subsidiaries/associates

Balances of different types of accounts

at the end of an accounting period: 1) income/expense account balances are transferred to the profit and loss account. These accounts are not carried forward into the next period 2) asset, liability and capital accounts are carried forward into the next period, and will be indicated in the statement of financial position note: carried forward accounts balalnce as retained profit is retained forward as part of capital

current assets

cash (including bank deposits) and items that will be turned into cash in the next accounting period -Cash -Inventory -trade Receivables

Accounting for depreciation

e.g. asset X is to be depreciated by £A Dr depreciation £A (expense) Cr provision for depreciation on X £A -depreciation (expense), provision (liability). Sometimes a different expense account is used instead of "depreciation" -the provision accumulated depreciation on the asset over time

expenses

e.g. selling cost (vary with level of activity), salaries of administrative staff (time based)

gross profits

gross profit = revenue - cost of sales

accruals concept

income/expenses are recognised and recorded when they occur, and not necessarily when the cash is received or paid

Customers returning goods (returns in)

increase in an expense (debit)

when to use a Dr

increases in: -assets -expenses decreases in: -liabilities -capital -income

when to use a Cr

increases in: -liabilities -capital -income decreases in: -assets -expenses

statement of cash flow

info on cash in/out flows

credit note

inform the buyer of a reduction in the amount owed to the seller -because a good being returned or overcharge on the initial invoice

invoice

informs the buyer how much is owed to the seller for the goods supplied

Conceptual framework of the IASB

it describes: -the objective of the Financial Statement -the underlying characteristics of financial information -the elements of financial statments -recognition in financial statements -measurement in financial statements -the objective is to guide accounting regulators and preparers of financial statements

net profits

net profit = gross profit - other expenses

statement of changes in equity

reconciles opening and closing positions of equity components

Books of prime entry: cash book

recording cheques received and cash paid into the bank, and payments made by cheques and cash withdrawn from the bank. -written up from the bank paying-in book stubs and cheque book stubs, respectively

Books of prime entry: sales return day book

recording goods purchased on credit that have been returned by customers -written up from copies of the credit notes retained by the seller

depreciation

reflects the amount of the economic benefit of the non-current asset that has been consumed during a period -IAS 16 required all tangible non-current assets to be depreciated apart from land and investment properties

current liabilities

the entity expect to pay in one year -short term borrowing -trade payables

non-current liabilities

the entity expects to pay the obligation in periods beyond one year

Nature of a trial balance

trial balance: list of balances in the ledger, divided between accounts with debit and credit balances -debit balances = credit balances (every transaction has a credit and debit entry) -typically done at the end of the accounting period and again when profit for the period has been determined (though can be done at any time)

Preparation of financial statements from a trial balance

trial balance: lists the balances on the ledger accounts - these are used to prepare the financial statements -period end adjustments are necessary to comply with the matching principle cost of sales -depreciation -accruals and prepayments

trade receivables

type of current asset -money owed by customers who have bought on credit

posting

updating the accounting records with transactions

Credit balance

when the total amount of money on the credit side is greater than that of the debit side -increases in capital, liabilities and income are added to the credit side

profit

when total income is greater than total expenses -represents a positive change of the financial position of the business during the period

loss

when total income is less than total expenses -represents a negative change of the financial position of the business during the period