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