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F3 Financial Accounting 1-4
F3 Financial Accounting 1-4
F3 Financial Accounting 1-4
F3 Financial Accounting 1-4
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F3 Financial Accounting 1-4

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  • 1. Financial Accounting (F3/FFA) July 2012 Session
  • 2. Syllabus Structure
  • 3. Main capabilitiesOn successful completion of this paper, candidates should beable to:A. Explain the context and purpose of financial reportingB. Define the qualitative characteristics of financial informationC. Demonstrate the use of double-entry and accounting systemsD. Record transactions and eventsE. Prepare trial balance including identifying and correcting errorsF. Prepare basic financial statements for incorporated and unincorporated entitiesG. Prepare simple consolidated financial statementsH. Interpretation of financial statements
  • 4. Detailed syllabusA. The context and purpose of financial reporting The scope and purpose of, financial statements for external reporting Users‟ and stakeholders‟ needs The main elements of financial reports The regulatory framework Duties and responsibilities of those charged with governance.
  • 5. Continues…B. The qualitative characteristics of financial information  The qualitative characteristics of financial information
  • 6. Continues…C. The use of double-entry and accounting systems Double entry bookkeeping principles including the maintenance of accounting records and sources of information. Ledger accounts, books of prime entry, and journals
  • 7. Continues…D. Recording transactions and events Sales Cash Inventory Tangible non-current assets Depreciation Intangible non-current assets and amortisation Accrual and prepayments Receivables and payables Provisions and contingencies Capital structure and finance costs
  • 8. Continues…E. Preparing trial balance Trial balance Correction of errors Control accounts and reconciliations Bank reconciliations Suspense accounts
  • 9. Continues…F. Preparing basic financial statements Statements of financial position Income statements and statements of comprehensive income Disclosure notes Events after the reporting period Statements of cash flows Incomplete records
  • 10. Continues…G. Preparing simple consolidated financial statements Subsidiaries Associates
  • 11. Continues…H. Interpretation of financial statements Importance and purpose of analysis of financial statements Ratios Analysis of financial statements
  • 12. Examination ApproachThe syllabus is assessed by a two hour paperbased or computer-based examination.Questions will assess all parts of the syllabusand will include both computational and non-computational elements. The examination willconsist of 50 two mark questions.
  • 13. News!!!!From December 2011, Paper F3/FFA saw two mainnew examinable areas added to its syllabus – thepreparation of simple consolidated financialstatements and the interpretation of financialstatements.
  • 14. Lecture 1 –The scope and purpose of, financial statements for external reporting
  • 15. What is Accounting? Accounting is the process of collecting, recording, summarising and communicating financial information. There are many purposes of accounting. You may have considered the following. Control over the use of resources Knowledge of what the business owes and owns Calculation of profits and losses Cash budgeting Effective financial planning
  • 16. Objectives of a business - FinancialProfit maximisationGrowth and market sustainabilitySurvivalDiscourage competitors
  • 17. Non-financial Welfare of employees Customer satisfaction Welfare of management Supplier relationship Responsibility to society
  • 18. User‟s and stakeholders‟ needs Users of financial statements need relevant and reliable information. To provide such information, the profession has developed a set of principles and guidelines called Conceptual Framework. The framework is to be the foundation for building a set of coherent accounting standards and rules. Also to be a reference of basic accounting theory for solving emerging practical problems of reporting.
  • 19. User groups of financial Statements Accounting information is required for a wide range of users both within and outside the business. Managers Shareholders Suppliers Lenders The tax authorities Employees Government The Public
  • 20. Continues…User Group ExplanationManager/Directors Managers/Directors are appointed by the companys owners to supervise the daily activities of the company on their behalf. They need information about the companys current and expected future financial situation, to make informed decisions.Shareholders Want to assess how effectively management is performing and how much profit they can withdraw from the business for their own use.Suppliers/Customers Suppliers want to know about the companys ability to pay its debts; customers need to know that the company is a secure source of supply and is in no danger of closing down.Lenders Lenders will want to ensure that the company is able to meet interest payments, and eventually to repay the amounts advanced.
  • 21. Continues…User Group ExplanationThe Tax authorities Want to know about business profits in order to assess the tax payable by the company.Employees Need to know about the companys financial situation because their future careers and the level of their wages and salaries depend on it.Government Interested in the allocation of resources and in the activities of enterprises. Also require information in order to provide a basis for national statistics.The Public Want information because enterprises affect them in many ways, e.g. by providing jobs and using local suppliers, or by affecting the environment (e.g. pollution).
  • 22. Management accounting and financial accounting Management accounts are produced for internal purposes – they provide information to assist managers in running the business. Financial accounts are produced to satisfy the information requirements of external users. Financial accounting is the preparation of accounting reports for external use. Management accounting is the preparation of accounting reports for internal use.
  • 23. Continues… Management accountants produce information which is forward-looking, and used to prepare budgets and make decisions about the future activities of a business. They also compare actual performance with budget and try to take corrective action where necessary. Financial accountants, however, are usually solely concerned with summarising historical data, often from the same basic records as management accountants but in a different way. This difference arises partly because external users have different interests from management and do not need very detailed information. In addition, financial statements are prepared under constraints (such as International Financial Reporting Standards and company law) which do not apply to management accounts.
  • 24. Types of business entitySole Trader, Partnership and Limited Liabilities companies
  • 25. Sole Trader/Proprietorship A sole proprietorship business is owned by one person who is called a sole proprietor. Since the sole proprietor is not a legal entity, the owner is entitled to all profits generated from the business. However, the owner‟s liability is unlimited, not just when the business is having financial difficulty, but also when the business fails and he faces bankruptcy. In this case, the creditors may sue him for debts incurred and also obtain a court order to claim against his personal assets, including his house.
  • 26. Continues… Normally, a person‟s ability to run a sole proprietorship business is limited to his area of expertise, which means he relies mainly on himself. He has the freedom to use his entrepreneurial skills to the maximum, make his own decisions and run the business as he wishes. However, to be a successful entrepreneur, he will need to get relevant advice from experts in fields he is unfamiliar with. This expertise is sometimes unavailable when one operates as a sole proprietor.
  • 27. Advantages Easy and cheap to set up since there is a limited paperwork. The owner is in full control of the business He/she takes all the rewards alone Relax compliance for reporting obligations It is usually flexible
  • 28. Disadvantages His capital is limited to the availability of his funds and the profit generated from the business, this would be the reason why many sole proprietorship businesses never take off in a big way. In many cases, even when a sole proprietorship business is successful, all profits generated are taxed on a personal basis and tax exemptions are limited to personal and family matters. Very often in sole-proprietorship operations, there is no business succession plan and the business may no longer operates with the retirement or demise of the sole proprietor. The owner‟s liability is unlimited, in the event of bankruptcy.
  • 29. Partnership As its name suggests, this form of entity is when two or more persons come together to carry out a business. However, the maximum number of persons allowed in a partnership is 20. Examples include an accountancy/audit firm, a medical practice and legal practice and they are generally formed by contractual agreement which is legally binding on all partners. In the UK, the provisions of the Partnership Act 1890 apply where no partnership agreement exists. Partnerships are not separate legal entities from their owners and they have unlimited personal liability for debts of the business. A new form of partnership called Limited liability partnership (LLP) has emerged in some jurisdictions.
  • 30. Advantages This form of business is cheap, easy to set up, with minimal documentation and paperwork. There are much fewer guidelines and formalities wherein there is no requirement to appoint auditors, company secretary or tax agents. They do not need to disclose their financial statements to the general public. Access to wider pull of resources – additional capital, skills and expertise. Division of roles and responsibilities. Risk is spread among partners. No company tax on the business
  • 31. Disadvantages Partners have unlimited liability in the case the business runs into trouble. There are costs to be incurred in setting up the partnership agreements. In the event of the death or illness of partners, the partnership may cease to exist. Consensus between partners are required when taking decisions and this could lead to slower decision making. In the absence of any agreement to the contrary, the resignation of one partner automatically terminates the partnership agreement.
  • 32. Limited liability companies The meaning of limited companies is that the liabilities of its members are limited to the amount of shares they hold in the company. Members/shareholders are not responsible for debts of the company unless if there is any personal guarantee. Shareholders may be individuals or other companies. Company Act 2006 is the legislation applicable in the UK. A LLC is a separate entity from its owners.
  • 33. Agency theory The principals (shareholders) appoint some agents (directors) to run the business on their behalf. Shareholders are the owners – they provide capital and receive a return usually inform of dividends. Declaration of dividends is at the discretion of the directors. In some cases directors could also be shareholders.
  • 34. The reporting requirements for LLCs in the UK Must be registered at Companies House There must be MoA and AoA deposited with the Registrar of Companies Have at least one director for Private LLC and two for Public LLC who may also be the shareholder(s) Financial statements must be prepared for filing to Companies House Large companies should have audited financial reports The financial should be available to the shareholders
  • 35. Advantages The most obvious advantage is the liability “protection” to its shareholders which limits their exposures to the amount of share capital that they subscribed for. Another advantage is the simplicity to transfer existing shares or issue additional shares to new investors. Unlike sole proprietors or partnerships, there is no need to wind up the company in the event of death of its shareholders or directors. They have access to wider pull of resources Tax advantages to being a LLC. The company tax rate may be lower than income tax rate for individuals. LLC is a separate entity from its owners which may sue or be sued separately.
  • 36. Disadvantages The company‟s financial affairs will be accessible by the public. Compliance with the Companies Act. Although complying itself is not a disadvantage, the amount of effort required to comply with the Act is much more than a sole proprietor/partnership. The company had to perform annual audits on its financial statements. At least one company secretary is required to manage its statutory submissions and returns as well as attending and preparing minutes for board and shareholders‟ meetings. Incorporation cost is high, and there are yearly recurring fees to be paid such as audit, accounting, company secretarial and tax fees.
  • 37. Quiz time!!!
  • 38. Solution1. C2. B3. A4. D
  • 39. Lecture 2 – The qualitative characteristics of financial information
  • 40. Statements of Financial Accounting Concepts SFAC No.1: Objectives of Financial Reporting (Business) SFAC No.2: Qualitative Characteristics of Accounting Information SFAC No.6. Elements of Financial Statements - defines the broad classifications of items found in financial statements and replaces SFAC No.3, expanding its scope to include not-for profit organisations SFAC No.4: Objectives of Financial Reporting (Non-Business) – Guidelines for Non-for-profit and governmental entities SFAC No.5: Recognition and Measurement Criteria in Financial Statements SFAC No.7: Using Cash Flows information and Present Value in Accounting Measurements
  • 41. Overview of the conceptual FrameworkBasic Objectives:  The basic objectives of financial reporting are to provide information that is:- 1. Useful to those making investment and credit decisions who have a reasonable understanding of business and economic activities 2. Helpful to present and future investors, creditors and other users in assessing future cash flows 3. About economic resources, the claims on those resources and the changes in them
  • 42. Qualitative Characteristics The IASB has identified the qualitative characteristics of accounting information that distinguish better (more useful) information from inferior (less useful) information for decision making purposes Primary qualities are relevance and reliability of accounting information Secondary qualities are comparability and consistency of reported information
  • 43. Primary qualities - Relevance To be relevant, accounting information must be capable of making a difference in a decision For information to be relevant, it should have predictive or feedback value, and it must be presented on a timely basis Predictive value – helps users make predictions about ultimate outcome of past, present and future events Feedback value - helps users confirm or correct prior expectations Timeliness - available to decision makers before it loses its capacity to influence their decisions
  • 44. Primary qualities - Reliability Information is reliable when it can be relied on to represent the true situation For accounting information to be reliable, it should be verifiable, is a faithful representation, and it is reasonably free of error and bias Verifiability – when given the same information and using the same measurement methods, independent users can obtain the same results Representational faithfulness - when it represents what really existed or happened Neutrality – when it is factual, truthful and unbiased
  • 45. Secondary qualities - Comparability Comparability and consistency of reported information Information about an enterprise is more useful if it can be compared with similar information about another enterprise (comparability) and with similar information about the same enterprise at other points in time (consistency) For information to be comparable, it must be1. Measured and reported in a similar manner for different enterprises2. Useful to users in identifying real similarities and differences between enterprises
  • 46. Secondary qualities - Consistency Entity is considered to be consistent in its use of accounting standards when it applies the same accounting treatment to similar events from period to period Companies can change methods, if the change results in better reporting Disclosure for change :-1. Nature of the change2. Effect of the change3. Justification for the change
  • 47. Basic Elements of Financial StatementsBalance Sheet Income Statement Assets: Probable future  Comprehensive Income: All economic benefits resulting changes in equity from from past transactions non-owner sources Liabilities: Probable future  Revenues: Inflows from sacrifices of economic benefits entity‟s ongoing operations resulting from past transactions Equity/Net assets: Residual  Expenses: Outflows from interest in assets after entity‟s ongoing operations deducting liabilities or  Gains: Increases in equity ownership interest from incidental transactions Investment by Owners:  Losses: Decreases in Increases in net assets equity from incidental Distributions to Owners: Decreases in net assets transactions
  • 48. Recognition and Measurement in FinancialStatements of Business Enterprises.Basic Assumptions: Economic Entity Assumption - The economic activities of an entity can be accumulated and reported in a manner that assumes the entity is separate and distinct from its owners or other business units. Going-Concern Assumption - In the absence of contrary information, a business entity is assumed to remain in existence for an indeterminate period of time. The current relevance of the historical cost principle is dependent on the going-concern assumption. Monetary Unit Assumption - In the United Kingdom, economic activities of an entity are measured and reported in pound. These pounds are assumed to remain relatively stable over the years in terms of purchasing power. In essence, this assumption disregards any inflation or deflation in the economy in which the entity operates. Periodicity Assumption - The life of an economic entity can be divided into artificial time periods for the purpose of providing periodic reports on the economic activities of the entity.
  • 49. Basic Principles Historical Cost Principle - Acquisition cost is the most objective and verifiable basis upon which to account for assets and liabilities of a business enterprise. Cost has been found to be more definite and determinable than other suggested valuation methods. Revenue Recognition Principle - Revenue is recognised when the earning process is virtually complete and an exchange transaction has occurred. Generally, this takes place when a sale to another individual or independent entity has been confirmed. Confirmation is usually accomplished by a transfer of ownership in an exchange transaction. Matching Principle - Accountants attempt to match expenses incurred while earning revenues with the related revenues. Use of accrual accounting procedures assists the accountant in allocating revenues and expenses properly among the fiscal periods that compose the life of a business enterprise. Full Disclosure Principle - In the preparation of financial statements, the accountant should include sufficient information to permit the knowledgeable reader to make an informed judgment about the financial condition of the enterprise in question.
  • 50. The regulatory framework
  • 51. The Regulatory framework of accounting The main objective of accounting is to present financial information to users. Users need to be able to rely on the information provided in those financial statements to enable them to make appropriate decisions. Accountants need some guidance in the way in which they prepare the financial statements. We shall look at some of the ways in which accountants take decisions on methods of accounting and valuation for certain items in future lectures.
  • 52. Accounting Conventions/concepts/principles Going concern - Going concern implies that the business will continue in operation for the foreseeable future, and that there is no intention to put the company into liquidation or to make drastic cutbacks to the scale of operations. Accruals - The accruals concept states that, in computing profit, amounts are included in the accounts in the period when they are earned or incurred, not received or paid. Prudence - Prudence is the concept that specifies, in situations where there is uncertainty, appropriate caution is exercised in recognising transactions in financial records.
  • 53. Continues…Consistency - The consistency convention is that the accounting treatment of like items should be consistently applied from one accounting period to the next.Materiality - A matter is material if its omission or misstatement would reasonably influence the decisions of a user of the accounts. In preparing accounts it is important to decide what is material and what is not, so that time and money are not wasted in the pursuit of excessive detail.
  • 54. Continues… Substance over form - Substance over form is the principle that transactions and other events are accounted for and presented in accordance with their substance and economic reality and not merely their legal from. Business entity (the entity concept) - This convention separates the individual(s) behind a business from the business itself, and only records transactions in the accounts that affect the business. Money measurement - This limits the recognition of accounting events to those that can be expressed in money terms.
  • 55. Continues… Historical cost – The historical cost of an asset is the original amount paid for an asset when it was acquired and thus non-current assets should be stated in their historical costs less accumulated depreciation. The dual aspect - This convention is the basis of double- entry bookkeeping and it means that every transaction entered into has a double effect on the position of the entity as recorded in the ledger accounts at the time of that transaction. The realisation convention - This convention states that we recognise sales revenue as having been earned at the time when goods or services have been supplied and a sales invoice issued.
  • 56. The theory of capital expenditure Current purchasing power (CPP) accounting - This method of accounting considers the effects of changing price levels by reference to an index, for example movements in the retail price index (RPI) in the UK. It distinguishes between monetary and non-monetary items. RPI - The RPI is a measure of inflation published each month. It is based on the prices of items bought by the average family. Monetary items - Examples of monetary items include cash and bank balances, receivables and payables. These are valued in a currency – such as dollar, yen or sterling – regardless of the changes in the price level.
  • 57. Non-monetary assets These are items that do not suffer a loss in value in a period of changing price levels. They include non- current assets, inventories and shareholders‟ equity (ordinary shares and reserves). Holding gains/losses - The holding of monetary items will, in periods of inflation, give rise to holding gains or losses.
  • 58. Current cost accounting Current cost accounting (CCA) is a method of adjusting historical cost accounts for the effects of changing price levels by using indices specific to the organisation. Thus CCA attempts to measure the actual rate of inflation experienced by the business whereas CPP attempts to measure the rate of inflation experienced by the business owners. Fair Value - fair value may be defined as the value of an asset in an arm‟s length transaction between knowledgeable buyer and seller of that asset.
  • 59. Duties and responsibilities of those charged with governance
  • 60. Duties Those charged with governing a company are responsible for the preparation of the financial statements. Corporate governance (CG) is the system used in directing and controlling a company. This is necessitated because the management and ownership of a company reside in the hands of different people and this could lead to conflicts of interest. The board of directors (BOD) of a company are usually charged with governance of a company since they are the top echelons. The duties and responsibilities of directors are usually laid down in law and are wide ranging.
  • 61. Legal responsibilities of directors Directors have a duty of care to show reasonable competence in the discharge of their duties and may have to indemnify the company against loss caused by their negligence. Directors also have fiduciary duty to the company which means that they must act in the best interest of the company, in utmost good faith and honesty. The Company Act 2006 in the UK sets out 7 statutory duties of directors as shown below:
  • 62. Directors should: Act within their powers Promote the success of the company Exercise independent judgement Exercise reasonable skill, care and diligence Avoid conflicts of interest Not accept benefits from their parties Declare an interest in a proposed transaction or arrangementThe primary aim is create wealth for the shareholders
  • 63. Responsibility for the financial statements The responsibility to the preparations of financial statements lies with the directors. This preparation must be in accordance with the applicable financial reporting framework such as IFRS. Directors are responsible for the internal controls necessary to forestall any material misstatement to due to error or fraud in the preparation of the financial statements. They are also responsible for the prevention and detection of fraud. It is also their responsibility to ensure that company complies with relevant laws and regulations. This responsibility should be stated in the financial statements. The company should be reported as going concern unless if there is any information to the contrary.
  • 64. Quiz time
  • 65. Solution1. C2. C3. D4. A5. B6. C7. C8. C9. A10. B
  • 66. Lecture 3 – The books of prime entry
  • 67. Books of prime entryBooks of prime entry are used to list andsummarise the information on sourcedocuments. Sales day book - all credit sales are recorded in the sales day book. Sales returns day book – any credit sales returned by the customers are recorded in the sales returns day book. Purchase day book – all credit purchases are recorded in the purchase day book.
  • 68. Continues… Purchase returns day book – any credit purchases returned to the suppliers are record in the purchase returns day book. Cash book – All cash transaction are recorded in the cash book. Petty cash book – lists all cash payments for small items, and occasional small receipts. Journal – is a record of unusual transactions. It is used to record any double entries made which do not arise from the other books of prime entry.
  • 69. Sales and purchase day books The sales day book list all invoices sent out to customers. Sales Day Book Date Invoice Customer Sales ledger Total amt ref invoiced Jan 10 247 Jones & Co SL14 105.00 248 Smith Ltd. SL8 86.40 249 Alex & Co SL6 31.80 250 FTMS College SL9 1,264.60 1,487.80
  • 70. Continues… The column called sales ledger ref is a reference to the sales ledger which is a record of what each customer owes the business. It means, for example, that the sale to Jones & Co for $105 is also recorded on page 14 of the sales ledger.
  • 71. The Purchase day book The purchase day book list all invoices from suppliers. Purchase Day Book Date Supplier Purchase Total Purchases Electricity ledger ref amount invoiced Mar 15 Abbey PL 31 315.00 315.00 Ahmad PL 46 29.40 29.40 TEN PL 42 116.80 116.80 Emmy PL 12 100.00 100.00 561.20 444.40 116.80
  • 72. Continues… The purchase ledger reference is a reference to the purchase ledger which is a record of what each supplier is owed. The purchase day book analyses the invoices which have been received. In this example, three of the invoices related to goods which the business intends to re-sell (called purchases) and the other invoice was an electricity bill.
  • 73. Sales and purchase returns day books The sales returns day book lists goods (or services returned (or rejected) by customers for which credit notes are issued. Sales returns day book Date Customer Goods Sales ledger Amount ref 30 April Emily 3 pairs of SL 82 135.00 boots
  • 74. The purchase returns day book The purchase returns day book lists goods (or services) returned to suppliers (or rejected) for which credit notes have been received or are expected. Purchase returns day bookDate Supplier Goods Purchase Amount ledger ref29 April Boxes Ltd 300 boxes PL 123 46.60
  • 75. The cash book The cash book lists all money received into and paid out of the business bank account. The cash book records transactions involving the bank account, such as cheque payments, lodgements of cash and cheques into the bank account, standing orders, direct debits and bank charges. Some cash, in notes and coins, is usually kept on the premises in order to make occasional payments for small items of expense. This cash is accounted for separately in a petty cash book (which we will look at shortly).
  • 76. Lecture example 1At the beginning of 1 September, Robin Plenty had $900in the bank. During 1 September 2011, Robin Plenty hadthe following receipts and payments.a) Cash sale – receipt of $80b) Payment from credit customer Hay $400 less discount allowed $20c) Payment from credit customer Been $720d) Payment from credit customer Seed $150 less discount allowed $10
  • 77. Continues…e) Cheque received for cash to provide a short-term loan from Len Dinger $1,800f) Second cash sale – receipts of $150g) Cash received for sale of machine $200h) Payment to supplier Kew $120i) Payment to supplier Hare $310j) Payment of telephone bill $400k) Payment of gas bill $280l) $100 in cash withdrawn from bank for petty cashm) Payment of $1,500 to Hess for new plant and machinery
  • 78. SolutionThe receipts part of the cash book for 1 September would look like this. CASH BOOK (RECEIPTS)Date Narrative Total 2011 $ 1 Sept Balance b/d* 900 Cash sale 80 Receivable: Hay 380 Receivable: Been 720 Receivable: Seed 140 Loan: Len Dinger 1,800 Cash sale 150 Sale of non-current asset 200 4,370 2 Sept Balance b/d* 1,660* b/d = brought down (i.e. brought forward)
  • 79. Continues… The cash received in the day amounted to $3,470. Added to the $900 at the start of the day, this comes to $4,370. However this is not the amount to be carried forward to the next day. First we have to subtract all the payments made during 1 September.
  • 80. Continues…The payments part of the cash book for 1 September would looklike this. CASH BOOK (PAYMENTS)Date Narrative Total2011 $1 Sept Payable: Kew 120 Payable: Hare 310 Telephone 400 Gas bill 280 Petty cash 100 Machinery purchase 1,500 Balance c/d 1,660 4,370
  • 81. Continues… Payments during 1 September totalled $2,710. We know that the total of receipts was $4,370. That means that there is a balance of $4,370 – $2,710 = $1,660 to be carried down to the start of the next day. As you can see this balance carried down is noted at the end of the payments column, so that the receipts and payments totals show the same figure of $4,370 at the end of 1 September. And if you look to the receipts part of this example, you can see that $1,660 has been brought down ready for the next day.
  • 82. Lecture example 2 - Two-column cash book 2011 February 1 Opening cash balance RM 10,000. Opening bank balance RM 600. 2 Kong lent us RM 20,000 by cheque. 3 Paid building rent by cash RM 2,300. 4 We paid Mehdi by cheque RM 8,600. 5 Cash sales RM 1,900. 7 Kwai paid us by cheque RM 340. 9 We paid Moore in cash RM 920. 10 Vehicles repairs of RM 460 were paid by cheque. 11 Cash sales paid direct into the bank RM 1,510.
  • 83. Continues… 15 Hood paid us in cash RM 960. 16 Owner withdrew by cheque RM 1,000. 19 We repaid a previous loan taken from Robertson RM5,000 by cheque. 21 Goods for resale were purchased. This was paid by cash, RM 1,300. 22 Cash sales paid direct into the bank RM 1,220. 25 Paid wages by cash RM 2,760. 26 Paid a fine to the government by cheque RM 750. 30 Withdrew RM 2,000 from the bank account for personal use of the owner. 31 Paid consultancy fees in cash RM 3,200. Hood paid us in cash RM 960.
  • 84. Solution Cash book Bank Cash Bank Cash (RM) (RM) (RM) (RM)Balance b/d 600 10,000 Building rent 2,300Kong 20,000 Mehdi 8,600Sales 1,900 Moore 920Kwai 340 Vehicle repairs 460Sales 1,510 Drawings 1,000Hood 960 Robertson 5,000Sales 1,220 Purchases 1,300 Wages 2,760 Fine 750 Drawings 2,000 Consultancy fee 3,200 Balance c/d 5,860 2,380 23,670 12,860 23,670 12,860
  • 85. Bank statements Weekly or monthly, a business will receive a bank statement. Bank statements are used to check that the balance shown in the cash book agrees with the amount on the bank statement. This agreement or reconciliation is the subject of a later chapter.
  • 86. Petty cash book The petty cash book lists all cash payments for small items, and occasional small receipts. Most businesses keep a small amount of cash on the premises to make occasional small payments in cash – e.g. to buy a few postage stamps etc. This is often called the cash float or petty cash account. Petty cash can also be used for occasional small receipts, such as cash paid by a visitor to make a phone call or to take some photocopies. There are usually more payments than receipts and petty cash must be topped up with cash from the business bank account.
  • 87. Continues… Under what is called the imprest system, the amount of money in petty cash is kept at an agreed sum or float (say $100). Expense items are recorded on vouchers as they occur. $Cash still held in petty cash XPlus voucher payments XMust equal the agreed sum/float X
  • 88. Continues… The total float is made up regularly (to $100,or whatever the agreed sum is) by means of a cash payment from the bank account into petty cash. The amount paid into petty cash will be the total of the voucher payments since the previous top- up. The format of a petty cash book is the same as for the cash book, with analysis columns for items of expenditure.
  • 89. The Journal The journal is a record of unusual transactions. It is used to record any double entries made which do not arise from the other books of prime entry. Whatever type of transaction is being recorded, the format of a journal entry is as follows.Date Debit Credit $ $Account to be debited XAccount to be credited X(Narrative to explain the transaction)
  • 90. Continues… A narrative explanation must accompany each journal entry. It is required for audit and control, to indicate the purpose and authority of every transaction which is not first recorded in a book of prime entry.
  • 91. Lecture example 3The following is a summary of the transactions of Abbey beauty salon1 January Put in cash of $2,000 as capital Purchased brushes and combs for cash $50 Purchased hair driers from Gilroy Ltd on credit $15030 January Paid three months rent to 31 March $300 Collected and paid-in takings $60031 January Gave Mrs Sullivan a perm, highlights etc on credit $80Although these entries would normally go through the other books ofprime entry (eg the cash book), it is good practice for you to show thesetransactions as journal entries.
  • 92. Solution JOURNAL $ $ Dr. Cr.1 January Cash account 2,000 Capital account 2,000 (Initial capital introduced)1 January Brushes & combs a/c 50 Cash account 50 (The purchase for cash of brushes & combs as non-current assets)1 January Hair dryer asset account 150 Sundry payables account * 150 (The purchase on credit of hair driers as non-current assets)30 January Rent expense account 300 Cash account 300 (The payment of rent to 31 March)
  • 93. Continues… Dr. Cr.30 January Cash account 600 Sales account 600 (Cash takings)31 January Receivables account 80 Sales account 80 (The provision of a hair-do on credit)* Note. Payables who have supplied non-current assets areincluded amongst sundry payables. Payables who have suppliedraw materials or goods for resale are trade payables. It is quitecommon to have separate payables accounts for trade andsundry payables.
  • 94. Quiz time
  • 95. Lecture 4 – Double entry and accounting system
  • 96. Bookkeeping  What is it?  System of recording financial transactions  Known as double-entry bookkeeping  Two sides to every transaction  Is part of and feeds into the financial reporting system.
  • 97. Aims This lecture seeks to provide a introduction to bookkeeping – what it is and how it is carried out. To do this we will consider:  The financial reporting system  Examine how records are kept  Explain the transactions and how they are recorded  Consider how adjustments can be made  And how the records are used to generate month end and year end figures
  • 98. Lecture Content  The lecture will aim to cover:  an introduction to financial reporting  terminology  the accounting process  the financial statements
  • 99. Financial Reporting Definitions
  • 100. Financial Reporting  What is it?  Financial reporting is the means of reporting what has happened in the past in an organisation  It is part of the accountability system  It relates yesterdays activities in financial terms  Reports  Annual Financial Statements o Annual Report and Statutory Accounts  Monthly control reports
  • 101. Example: Monthly Control Report Current Month As at 30th June Year to dateBudget Actual Variance Expenditure Budget to Actual to Variance Date Date Supplies and General Charges 40,000 43,000 -3,000 Basic pay 230,000 250,000 -20,000 25,000 26,000 -1,000 Part tim e basic 150,000 165,000 -15,000 15,000 14,500 500 Casual pay 90,000 80,000 10,000 20,000 19,000 1,000 Adm inistrative staff 150,000 148,000 2,000 18,000 20,000 -2,000 Photocopy costs 100,000 110,000 -10,000 21,000 24,000 -3,000 Materials 120,000 125,000 -5,000 10,000 6,000 4,000 Books 50,000 56,000 -6,000 6,000 6,000 0 Heating Pow er & Light 39,000 40,000 -1,000 5,000 4,000 1,000 Cleaning 30,000 31,000 -1,000 1,000 1,500 -500 Fax 6,000 5,000 1,000 2,000 1,800 200 Telephone 12,000 10,000 2,000 1,000 2,000 -1,000 Consum ables 6,000 6,000 0 500 500 0 Hospitality 9,000 10,000 -1,000 1,500 2,000 -500 Maintenance 6000 7000 -1,000 800 700 100 Travelling Expenses 5,000 4,500 500 200 500 -300 Stationery 1,000 1,500 -500 700 100 600 Office Expenses 4,000 5,000 -1,000 200 - 2000 Office Equipm ent 1,000 1,500 -500 3,000 3,500 -500 Rent & Rates 20,000 19,000 1,000 1,000 1,000 0 Sundries 6,000 10,000 -4,000171,900 176,100 -4,200 Sub Total 1,029,000 1,077,500 -48,500
  • 102. Key Terms assets liabilities/ capital expenses revenue /income
  • 103. What is an expense? An expense is a short term ‘consumable’, which will be incurred repeatedly, for example the cost of a telephone call, a days pay, a box of bandages, a litre of fuel… They are items which have a one–off use..once bought and used…a second must be bought..and a third..etc In general, expense items represent day-to-day operational activity….low value long term items .. such as a mobile phone will also be included… Expenses are recorded and totalled at the end of each month and each year.
  • 104. What is income?  Income is the sum earned for providing goods or service, whether or not any payment has been received.  It too represents monies from operational activity and, items which are frequently repeated for example, the sale of a chocolate bar or the price of a bus ticket.  Income is totalled monthly and annually to reflect what has been earned during that time period.
  • 105. What is an asset?  An asset is an item owned by the organisation, it has value and can be ‘fixed’ or ‘current’.  Fixed assets provide benefit beyond a year and current assets have a life less than one year.  Fixed assets are made up of physical and financial assets. Land, buildings, equipment, vehicles and furniture and fittings make up the physical fixed assets, which put in place the infrastructure through which operational activity is conducted.  Stock, debtors and cash make up the current assets.
  • 106. What is a liability?  Liabilities are sums owed from the organisation. They can be short-term such as overdraft or sums owed to suppliers, known as creditors, or long-term such as loans, leases and mortgages.  These latter items contribute to long term funding, without which, the organisation would not be able to purchase assets.  All liabilities carry with them the obligation to repay and many of them carry interest payments.
  • 107. What is capital? Capital is the owners’ original investment  although it is rarely repaid, it is ‘technically’ a debt. Without this money the organisation would not exist. Further investment from the ‘owners’ increases this sum. A key way this sum is increased is through the Income and Expenditure account. Any excess income over expenditure belongs to the ‘owners’ and can be left in the organisation by way of an increase in capital. Without capital an organisation cannot begin its’ life nor grow, as without money new assets cannot be purchased.
  • 108. ……key terms….. assets liabilities/ balance capital sheet revenue income expenses /income statement
  • 109. The statement of financial position Is a position statement which evaluates wealth at a point in time. It considers capital costs. Consists of assets and claims on those assets Assets (owned) Claims (owed) Current Current liabilities Non-Current Long-term Loans Owners capital But, as Claims = Liabilities + Capital then, Assets = Liabilities + Capital
  • 110. Income Statement The difference between costs & income  Profit & loss account / Income & expenditure account Shows where the resource was spent Covers a period of time Matches expenses and income to time period  Expenses represent the cost INCURRED, resource used or consumed in providing the service during the accounting period  Income is that which is EARNED from and related to the service provided
  • 111. The Accounting Process
  • 112. Basis of Preparation = Accrual Accounting Income and expenditure based system  Income and expenditure are matched so that they are allocated to the period in which the benefit /expense is incurred Starting point: Transactions must be recorded….  Basis of gathering accounting information is double- entry bookkeeping
  • 113. The double entry system Records transactions - two sides to each  debit and credit side Separate accounts – uniquely identified  called ledger accounts  based on chart of accounts Ledgers - books of record  general/nominal  accounts payable  accounts receivable Trial balance
  • 114. …..etc…... Trial Balance Adjustments  stock/inventory  depreciation  bad debts  accruals and prepayments Annual Financial Statements ... but it begins with recording transactions….
  • 115. The ledgers  General /nominal  Main list of all accounts  Total balances maintained on this ledger  Accounts payable  Records purchases  Links to suppliers / creditors / payables  Also called purchase or bought ledger  Accounts receivable  Records „sales‟ or income  Links to customers / debtors /receivables  Also called sales ledger
  • 116. Ledger Accounts Each item (asset, expense, liability, capital or income) has its own ledger account It records the details of transactions relating to the particular item Original paper system was „T‟ accounts Each account is identified by a unique code Debit Credit
  • 117. Lecture example 1 The accounts of MSU reveal the following:  Consider how the following Capital 18 900 transactions will affect the Fixtures 3 500 accounts; Loan 2 000  MSU buys stocks of goods on Stocks 4 950 credit for £770. Debtors 3 280  One of the debtors pays £280 Creditors 1 600 in cash. Vehicles 4 200  New fixtures are purchased Cash - bank 6 450 with a cheque for £1000. Cash - hand 120
  • 118. Double Entry Book-Keeping asset liabilities/capital expenses income = = debit credit
  • 119. Rules of Debit & Credit  Every transaction effects two accounts  A debit  increases an asset or expense account  decreases an income or liability account  A credit  increases an income or liability account  decreases an asset or expense account
  • 120. Types of accounts  Asset and liability accounts – are ongoing accounts  Non Current (fixed) assets, loan and capital accounts once established – remain..  Current assets and liability accounts also remain but move very regularly up and down as, for example, cash at bank  Income and expenditure accounts differ in that each year we start with a zero balance and record all income and all expenditure into its own separate account. The aim is to establish a total amount for each item, e.g. telephone
  • 121. An exception… purchases/stock Purchases …are an expense item  For example – chocolate bars in a shop Inventory/Stock is an asset…  Unsold chocolate bars in a shop We record all purchases as expenses.. At year end…we measure if we have any items left…  What remains = stock/inventory to carry forward, i.e.: closing stock/inventory  What‟s used = purchases  Purchases are the only expense item where we cannot simply look to the balance on the account
  • 122. But… Through the year we record all the purchases of each stock item… at the end we then see how much we have left…this determines how much of the item we have used..i.e. the expense incurred But we may have  had stock/inventory at the beginning…opening stock/inventory  sent goods back…returns outwards  been charged for delivery…carriage in All the above help determine the value of the items used
  • 123. Returns..  When we send something back…  returns outwards  When something comes back to us…  returns inwards  Set up separate accounts for each…  For a return outwards:  reduce supplier account  increase returns outwards account  For a return inwards:  reduce customer account  increase returns inwards account
  • 124. ..and how much did we use? £ Opening Stock/Inventory X + Purchases X - Returns outwards (X) + Carriage inwards X - Closing Stock/Inventory (X) = Cost of Goods Used X
  • 125. Lecture example 2  A hospital is trying to establish the cost of cleaning materials used in a year.  Opening stock/inventory value £ 12,400  Purchases £ 87,300  Returns £ 7,600  Carriage inwards £ 1,200  Closing stock/inventory £ 14,250  What is the cost of the cleaning materials used?
  • 126. Balances on Accounts Each ledger account is „balanced off‟  all debit balances are assets or expenses  all credit balances are liabilities or income Balance sheet = asset & liability accounts  The balances on these accounts are „ongoing‟ ie closed and re-opened for the next accounting period Income statement = income & expenses  The closing balances on these accounts are transferred out and the new accounting period starts with zero balances.
  • 127. Balancing off accounts Supplier A 10/5 Returns out 40 1/5 Purchases 690 24/5 Paid cash 300 4/5 Purchases 66 bal c/d 416 756 756 1/6 bal b/d 416A balance on a supplier account is a ‘credit’ balance which meanswe have a ‘creditor’ (payable).For customer accounts, a ‘debit’ balance means we have a ‘debtor’(receivable).
  • 128. Trial Balance List of balances on ledger Dr Cr accounts Income 155 Total debit entries Purchases 60 = total credit entries Expenses 25 Starting point for the Wages 30 derivation of the financial Vehicle 120 statements Fittings 70 Adjustments to the trial Capital 150 balance lead to the creation of the operating statement 305 305 and the balance sheet
  • 129. Preparing accounts  From trial balance we prepare year end and month end figures..  Accrual basis – 4 main adjustments  Stock/inventory  Depreciation of fixed assets  Bad debts  Accruals & prepayments
  • 130. Fixed Assets  Capital expenditure  buildings, equipment, vehicles, fixtures and fittings  Provide benefit beyond the accounting period  Accruals system - match cost to benefit - by depreciation
  • 131. Depreciation Allocation of the cost of an asset to the years in which benefit is gained Key  historic cost  useful life  residual value  method  main - straight line or reducing balance Assets recorded at :  Net Book Value = cost - accumulated depreciation
  • 132. Lecture example 3 An asset is bought for £100,000 It has an estimated useful life of 4 years The residual value will be £20 000. What depreciation - assuming the straight line basis is appropriate - will be charged to the I&E accounts in each of the years and what is shown in the balance sheet? Using a reducing balance of 33% recalculate the above.
  • 133. Entering the transactions Cost of asset is recorded when purchased  Only removed when asset disposed of Two accounts record depreciation Depreciation expense  Income Statement account Depreciation provision (accumulated depreciation)  Balance sheet account  Carry forward each year of assets life  Offsets cost to give NBV on balance sheet
  • 134. Bad Debts Debtors are sums owing to us – but not yet paid Bad debt - money owed which is unlikely to be received Treatments  specific debts are written off  Dr bad debts expense account  Cr debtor account  general provision is established as policy  Dr bad debts expense  Cr bad and doubtful debt provision  Provision is a balance sheet account – it offsets the debtors in the BS – the account is carried forward and is adjusted each year based on debtors balance – any movement in the provision is treated as an expense on the income statement.
  • 135. The Month – End result  Management accounts  On-going figures on a monthly basis  Current month and year to date  Reports on individual cost centres  Line items included  Compared to budgets - variances  Basis is accruals – prepayments and accruals included
  • 136. Example: Monthly Control Report Current Month As at 30th June Year to dateBudget Actual Variance Expenditure Budget to Actual to Variance Date Date Supplies and General Charges 40,000 43,000 -3,000 Basic pay 230,000 250,000 -20,000 25,000 26,000 -1,000 Part tim e basic 150,000 165,000 -15,000 15,000 14,500 500 Casual pay 90,000 80,000 10,000 20,000 19,000 1,000 Adm inistrative staff 150,000 148,000 2,000 18,000 20,000 -2,000 Photocopy costs 100,000 110,000 -10,000 21,000 24,000 -3,000 Materials 120,000 125,000 -5,000 10,000 6,000 4,000 Books 50,000 56,000 -6,000 6,000 6,000 0 Heating Pow er & Light 39,000 40,000 -1,000 5,000 4,000 1,000 Cleaning 30,000 31,000 -1,000 1,000 1,500 -500 Fax 6,000 5,000 1,000 2,000 1,800 200 Telephone 12,000 10,000 2,000 1,000 2,000 -1,000 Consum ables 6,000 6,000 0 500 500 0 Hospitality 9,000 10,000 -1,000 1,500 2,000 -500 Maintenance 6000 7000 -1,000 800 700 100 Travelling Expenses 5,000 4,500 500 200 500 -300 Stationery 1,000 1,500 -500 700 100 600 Office Expenses 4,000 5,000 -1,000 200 - 2000 Office Equipm ent 1,000 1,500 -500 3,000 3,500 -500 Rent & Rates 20,000 19,000 1,000 1,000 1,000 0 Sundries 6,000 10,000 -4,000171,900 176,100 -4,200 Sub Total 1,029,000 1,077,500 -48,500
  • 137. The Year- End Result  Accounting statements  Operating Statement  Income and Expenditure  Profit and Loss Account  Income Statement  Balance Sheet  Accounting policies  Additional notes
  • 138. Reports…content in brief  Balance Sheet  Own Income Statement  Assets Income  Non-Current  Current  Less  Owe Expenses  Liabilities =  Long term  Current Profit/Loss  Capital  Original  Accumulated surplus‟s
  • 139. Basic Income Statement £ £ Income 1000 Cost of goods sold (750) Gross Profit 250 Expenses (50) Net Profit to be retained 200 Balance Sheet
  • 140. The Balance Sheet - format £Non-Current Assets 1000Current AssetsInventory 150Receivables 250Cash 200 600Total Assets 1600Current LiabilitiesPayables 150Overdraft 250 400Long Term Liabilities 300Net Assets 900CapitalOwners Share Capital 700Retained profit 200 900

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