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 andunincorporated entitiesG. Prepare simple consolidated financial statementsH. Interpretation of financial statements 4. Detailed syllabusA. The context and purpose of financialreporting The scope and purpose of, financialstatements for external reporting Users and stakeholders needs The main elements of financial reports The regulatory framework Duties and responsibilities of those chargedwith governance. 5. ContinuesB. The qualitative characteristics of financial information The qualitative characteristics of financial information 6. ContinuesC. The use of double-entry and accounting systems Double entry bookkeeping principles including themaintenance of accounting records and sources ofinformation. Ledger accounts, books of prime entry, and journals 7. ContinuesD. Recording transactions and eventsSalesCashInventoryTangible non-current assetsDepreciationIntangible non-current assets and amortisationAccrual and prepaymentsReceivables and payablesProvisions and contingenciesCapital structure and finance costs 8. ContinuesE. Preparing trial balance Trial balance Correction of errors Control accounts and reconciliations Bank reconciliations Suspense accounts 9. ContinuesF. Preparing basic financial statements Statements of financial position Income statements and statements ofcomprehensive income Disclosure notes Events after the reporting period Statements of cash flows Incomplete records 10. ContinuesG. Preparing simple consolidated financialstatements Subsidiaries Associates 11. ContinuesH. Interpretation of financial statements Importance and purpose of analysis of financialstatements Ratios Analysis of financial statements 12. Examination ApproachThe syllabus is assessed by a two hour paperbased orcomputer-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 haveconsidered 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 - FinancialProfit maximisationGrowth and market sustainabilitySurvivalDiscourage competitors 17. Non-financial Welfare of employees Customer satisfaction Welfare of management Supplier relationship Responsibility to society 18. Users and stakeholders needs Users of financial statements need relevant andreliable information. To provide such information, the profession hasdeveloped a set of principles and guidelines calledConceptual Framework. The framework is to be the foundation for building aset of coherent accounting standards and rules. Also to be a reference of basic accounting theory forsolving emerging practical problems of reporting. 19. User groups of financial Statements Accounting information is required for a wide range of usersboth within and outside the business. Managers Shareholders Suppliers Lenders The tax authorities Employees Government The Public 20. ContinuesUser Group ExplanationManager/DirectorsManagers/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 topay its debts; customers need to know that the companyis a secure source of supply and is in no danger ofclosing down.LendersLenders will want to ensure that the company is able to meet interest payments, and eventually to repay the amounts advanced. 21. ContinuesUser GroupExplanationThe Tax authorities Want to know about business profits in order to assessthe tax payable by the company.Employees Need to know about the companys financial situationbecause their future careers and the level of theirwages and salaries depend on it.GovernmentInterested in the allocation of resources and in theactivities of enterprises. Also require information inorder to provide a basis for national statistics.The PublicWant information because enterprises affect them inmany ways, e.g. by providing jobs and using localsuppliers, or by affecting the environment (e.g.pollution). 22. Management accounting and financial accounting Management accounts are produced for internalpurposes they provide information to assistmanagers in running the business. Financial accounts are produced to satisfy theinformation requirements of external users. Financial accounting is the preparation of accountingreports for external use. Management accounting is the preparation ofaccounting reports for internal use. 23. Continues Management accountants produce information which is forward-looking,and used to prepare budgets and make decisions about the futureactivities of a business. They also compare actual performance with budget and try to takecorrective action where necessary. Financial accountants, however, are usually solely concerned withsummarising historical data, often from the same basic records asmanagement accountants but in a different way. This difference arisespartly because external users have different interests from managementand do not need very detailed information. In addition, financial statements are prepared under constraints (such asInternational Financial Reporting Standards and company law) which donot apply to management accounts. 24. Types of business entitySole Trader, Partnership and LimitedLiabilities companies 25. Sole Trader/Proprietorship A sole proprietorship business is owned by oneperson who is called a sole proprietor. Since the sole proprietor is not a legal entity, theowner is entitled to all profits generated from thebusiness. However, the owners liability is unlimited, not justwhen the business is having financial difficulty, butalso when the business fails and he faces bankruptcy. In this case, the creditors may sue him for debtsincurred and also obtain a court order to claim againsthis personal assets, including his house. 26. Continues Normally, a persons ability to run a soleproprietorship business is limited to his area ofexpertise, which means he relies mainly on himself. He has the freedom to use his entrepreneurial skills tothe maximum, make his own decisions and run thebusiness as he wishes. However, to be a successful entrepreneur, he willneed to get relevant advice from experts in fields he isunfamiliar with. This expertise is sometimes unavailable when oneoperates as a sole proprietor. 27. Advantages Easy and cheap to set up since there is a limitedpaperwork. 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 andthe profit generated from the business, this would bethe reason why many sole proprietorship businessesnever take off in a big way. In many cases, even when a sole proprietorshipbusiness is successful, all profits generated are taxedon a personal basis and tax exemptions are limited topersonal and family matters. Very often in sole-proprietorship operations, there isno business succession plan and the business mayno longer operates with the retirement or demise ofthe sole proprietor. The owners liability is unlimited, in the event ofbankruptcy. 29. Partnership As its name suggests, this form of entity is when two ormore persons come together to carry out a business.However, the maximum number of persons allowed in apartnership is 20. Examples include an accountancy/audit firm, a medicalpractice and legal practice and they are generally formedby contractual agreement which is legally binding on allpartners. In the UK, the provisions of the Partnership Act 1890 applywhere no partnership agreement exists. Partnerships are not separate legal entities from theirowners and they have unlimited personal liability for debtsof the business. A new form of partnership called Limited liabilitypartnership (LLP) has emerged in some jurisdictions. 30. Advantages This form of business is cheap, easy to set up, withminimal documentation and paperwork. There are much fewer guidelines and formalitieswherein there is no requirement to appoint auditors,company secretary or tax agents. They do not need to disclose their financialstatements 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 thebusiness runs into trouble. There are costs to be incurred in setting up thepartnership agreements. In the event of the death or illness of partners, thepartnership may cease to exist. Consensus between partners are required whentaking decisions and this could lead to slower decisionmaking. In the absence of any agreement to the contrary, theresignation of one partner automatically terminatesthe partnership agreement. 32. Limited liability companies The meaning of limited companies is that theliabilities of its members are limited to the amountof shares they hold in the company. Members/shareholders are not responsible fordebts of the company unless if there is anypersonal guarantee. Shareholders may be individuals or othercompanies. Company Act 2006 is the legislation applicable inthe UK. A LLC is a separate entity from its owners. 33. Agency theory The principals (shareholders) appoint someagents (directors) to run the business on theirbehalf. Shareholders are the owners they providecapital and receive a return usually inform ofdividends. Declaration of dividends is at the discretion of thedirectors. In some cases directors could also beshareholders. 34. The reporting requirements for LLCs in the UK Must be registered at Companies House There must be MoA and AoA deposited with theRegistrar of Companies Have at least one director for Private LLC and two forPublic LLC who may also be the shareholder(s) Financial statements must be prepared for filing toCompanies House Large companies should have audited financialreports The financial should be available to the shareholders 35. Advantages Themost obvious advantage is the liabilityprotection to its shareholders which limits theirexposures to the amount of share capital that theysubscribed for. Another advantage is the simplicity to transfer existingshares or issue additional shares to new investors. Unlike sole proprietors or partnerships, there is noneed to wind up the company in the event of death ofits shareholders or directors. They have access to wider pull of resources Tax advantages to being a LLC. The company taxrate may be lower than income tax rate for individuals. LLC is a separate entity from its owners which maysue or be sued separately. 36. Disadvantages The companys financial affairs will be accessible bythe public. Compliance with the Companies Act. Althoughcomplying itself is not a disadvantage, the amount ofeffort required to comply with the Act is much morethan a sole proprietor/partnership. The company had to perform annual audits on itsfinancial statements. At least one company secretary is required to manageits statutory submissions and returns as well asattending and preparing minutes for board andshareholders meetings. Incorporation cost is high, and there are yearlyrecurring 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 broadclassifications of items found in financial statements and replacesSFAC No.3, expanding its scope to include not-for profitorganisations 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 FinancialStatements SFAC No.7: Using Cash Flows information and Present Value inAccounting Measurements 41. Overview of the conceptual FrameworkBasic Objectives: The basic objectives of financial reporting are to provideinformation that is:- 1. Useful to those making investment and credit decisions whohave a reasonable understanding of business andeconomic activities 2. Helpful to present and future investors, creditors and otherusers in assessing future cash flows 3. About economic resources, the claims on those resourcesand the changes in them 42. Qualitative Characteristics The IASBhasidentifiedthequalitative 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 Secondaryqualities 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 differententerprises2.Useful to users in identifying real similarities anddifferences 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: Alleconomic benefits resultingchanges in equity fromfrom past transactions non-owner sources Liabilities: Probable future Revenues: Inflows fromsacrifices of economic benefitsentitys ongoing operationsresulting from past transactions Equity/Net assets: Residual Expenses: Outflows frominterest in assets after entitys ongoing operationsdeducting liabilities or Gains: Increases in equityownership interest from incidental transactions Investment by Owners: Losses: Decreases inIncreases 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 beaccumulated and reported in a manner that assumes the entity is separateand distinct from its owners or other business units. Going-Concern Assumption - In the absence of contrary information, abusiness entity is assumed to remain in existence for an indeterminateperiod of time. The current relevance of the historical cost principle isdependent on the going-concern assumption. Monetary Unit Assumption - In the United Kingdom, economic activities of anentity are measured and reported in pound. These pounds are assumed toremain relatively stable over the years in terms of purchasing power. Inessence, this assumption disregards any inflation or deflation in theeconomy in which the entity operates. Periodicity Assumption - The life of an economic entity can be divided intoartificial time periods for the purpose of providing periodic reports on theeconomic activities of the entity. 49. Basic Principles Historical Cost Principle -Acquisition cost is the most objective andverifiable basis upon which to account for assets and liabilities of a businessenterprise. Cost has been found to be more definite and determinable thanother suggested valuation methods. Revenue Recognition Principle - Revenue is recognised when the earningprocess is virtually complete and an exchange transaction has occurred.Generally, this takes place when a sale to another individual or independententity has been confirmed. Confirmation is usually accomplished by atransfer of ownership in an exchange transaction. Matching Principle - Accountants attempt to match expenses incurred whileearning revenues with the related revenues. Use of accrual accountingprocedures assists the accountant in allocating revenues and expensesproperly among the fiscal periods that compose the life of a businessenterprise. Full Disclosure Principle - In the preparation of financial statements, theaccountant should include sufficient information to permit the knowledgeablereader to make an informed judgment about the financial condition of theenterprise in question. 50. The regulatory framework 51. The Regulatory framework of accounting The main objective of accounting is to presentfinancial information to users. Users need to beable to rely on the information provided in thosefinancial statements to enable them to makeappropriate decisions. Accountants need some guidance in the way inwhich they prepare the financial statements. Weshall look at some of the ways in whichaccountants take decisions on methods ofaccounting and valuation for certain items in futurelectures. 52. Accounting Conventions/concepts/principles Going concern - Going concern implies that thebusiness will continue in operation for the foreseeablefuture, and that there is no intention to put thecompany into liquidation or to make drastic cutbacks tothe scale of operations. Accruals - The accruals concept states that, incomputing profit, amounts are included in the accountsin the period when they are earned or incurred, notreceived or paid. Prudence - Prudence is the concept that specifies, insituations where there is uncertainty, appropriatecaution is exercised in recognising transactions infinancial records. 53. ContinuesConsistency - 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 theprinciple that transactions and other events areaccounted for and presented in accordance with theirsubstance and economic reality and not merely theirlegal from. Business entity (the entity concept) - This conventionseparates the individual(s) behind a business from thebusiness itself, and only records transactions in theaccounts that affect the business. Money measurement - This limits the recognition ofaccounting events to those that can be expressed inmoney terms. 55. Continues Historical cost The historical cost of an asset is theoriginal amount paid for an asset when it was acquiredand thus non-current assets should be stated in theirhistorical costs less accumulated depreciation. The dual aspect - This convention is the basis of double-entry bookkeeping and it means that every transactionentered into has a double effect on the position of theentity as recorded in the ledger accounts at the time ofthat transaction. The realisation convention - This convention states thatwe recognise sales revenue as having been earned atthe time when goods or services have been supplied anda sales invoice issued. 56. The theory of capital expenditure Current purchasing power (CPP) accounting - Thismethod of accounting considers the effects of changingprice levels by reference to an index, for examplemovements in the retail price index (RPI) in the UK. Itdistinguishes between monetary and non-monetaryitems. RPI - The RPI is a measure of inflation published eachmonth. It is based on the prices of items bought by theaverage family. Monetary items - Examples of monetary items includecash and bank balances, receivables and payables.These are valued in a currency such as dollar, yen orsterling regardless of the changes in the price level. 57. Non-monetary assets These are items that do not suffer a loss in value in aperiod of changing price levels. They include non-current assets, inventories and shareholders equity(ordinary shares and reserves). Holding gains/losses - The holding of monetary itemswill, in periods of inflation, give rise to holding gains orlosses. 58. Current cost accounting Current cost accounting (CCA) is a method of adjustinghistorical cost accounts for the effects of changingprice levels by using indices specific to theorganisation. Thus CCA attempts to measure theactual rate of inflation experienced by the businesswhereas CPP attempts to measure the rate of inflationexperienced by the business owners. Fair Value - fair value may be defined as the value ofan asset in an arms length transaction betweenknowledgeable buyer and seller of that asset. 59. Duties and responsibilities of those charged with governance 60. Duties Those charged with governing a company areresponsible for the preparation of the financialstatements. Corporate governance (CG) is the system used indirecting and controlling a company. This is necessitated because the management andownership of a company reside in the hands ofdifferent people and this could lead to conflicts ofinterest. The board of directors (BOD) of a company areusually charged with governance of a company sincethey are the top echelons. The duties and responsibilities of directors are usuallylaid down in law and are wide ranging. 61. Legal responsibilities of directors Directors have a duty of care to show reasonablecompetence in the discharge of their duties andmay have to indemnify the company against losscaused by their negligence. Directors also have fiduciary duty to the companywhich means that they must act in the bestinterest of the company, in utmost good faith andhonesty. The Company Act 2006 in the UK sets out 7statutory 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 orarrangementThe primary aim is create wealth for the shareholders 63. Responsibility for the financial statements The responsibility to the preparations of financialstatements lies with the directors. This preparation must be in accordance with the applicablefinancial reporting framework such as IFRS. Directors are responsible for the internal controlsnecessary to forestall any material misstatement to due toerror or fraud in the preparation of the financial statements. They are also responsible for the prevention and detectionof fraud. It is also their responsibility to ensure that companycomplies with relevant laws and regulations. This responsibility should be stated in the financialstatements. The company should be reported as going concern unlessif 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 arerecorded in the sales day book. Sales returns day book any credit salesreturned by the customers are recorded in thesales returns day book. Purchase day book all credit purchasesare recorded in the purchase day book. 68. Continues Purchase returns day book any credit purchasesreturned to the suppliers are record in the purchasereturns day book. Cash book All cash transaction are recorded in thecash book. Petty cash book lists all cash payments for smallitems, and occasional small receipts. Journal is a record of unusual transactions. It isused to record any double entries made which do notarise 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 DateInvoiceCustomer Sales ledgerTotal amt ref invoicedJan 10 247 Jones & CoSL14 105.00 248 Smith Ltd.SL886.40 249 Alex & Co SL631.80 250 FTMS CollegeSL91,264.601,487.80 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 BookDate Supplier Purchase TotalPurchases Electricityledger ref amount invoicedMar 15 AbbeyPL 31315.00 315.00 AhmadPL 4629.4029.40 TENPL 42116.80 116.80 Emmy PL 12100.00 100.00 561.20 444.40116.80 72. Continues The purchase ledger reference is a referenceto the purchase ledger which is a record ofwhat each supplier is owed. The purchase day book analyses the invoiceswhich have been received. In this example,three of the invoices related to goods whichthe business intends to re-sell (calledpurchases) and the other invoice was anelectricity 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 GoodsSales ledger Amountref 30 April Emily3 pairs of SL 82135.00 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 SupplierGoods 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 paidout of the business bank account. The cash book records transactions involving the bankaccount, such as cheque payments, lodgements ofcash and cheques into the bank account, standingorders, direct debits and bank charges. Some cash, in notes and coins, is usually kept on thepremises in order to make occasional payments forsmall items of expense. This cash is accounted forseparately in a petty cash book (which we will look atshortly). 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 lessdiscount allowed $20c) Payment from credit customer Been $720d) Payment from credit customer Seed $150 lessdiscount allowed $10 77. Continuese) 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 NarrativeTotal 2011 $ 1 Sept Balance b/d* 900 Cash sale80 Receivable: Hay 380 Receivable: Been720 Receivable: Seed140 Loan: Len Dinger1,800 Cash sale 150Sale of non-current asset200 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 comesto $4,370. However this is not the amount to be carried forwardto the next day. First we have to subtract all thepayments made during 1 September. 80. ContinuesThe payments part of the cash book for 1 September would looklike this. CASH BOOK (PAYMENTS)Date Narrative Total2011 $1 Sept Payable: Kew120 Payable: Hare 310 Telephone 400 Gas bill280 Petty cash100 Machinery purchase1,500 Balance c/d 1,660 4,370 81. Continues Payments during 1 September totalled $2,710. Weknow that the total of receipts was $4,370. That meansthat there is a balance of $4,370 $2,710 = $1,660 tobe carried down to the start of the next day. As you can see this balance carried down is noted atthe end of the payments column, so that the receiptsand payments totals show the same figure of $4,370 atthe end of 1 September. And if you look to the receipts part of this example, youcan see that $1,660 has been brought down ready forthe next day. 82. Lecture example 2 - Two-column cash book2011 February1Opening 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 920.10Vehicles repairs of RM 460 were paid by cheque.11Cash 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 theowner. 31 Paid consultancy fees in cash RM 3,200.Hood paid us in cash RM 960. 84. Solution Cash bookBank CashBank Cash(RM) (RM)(RM) (RM)Balance b/d600 10,000Building rent 2,300Kong20,000 Mehdi8,600Sales1,900 Moore 920Kwai 340 Vehicle repairs460Sales1,510 Drawings 1,000Hood960Robertson5,000Sales1,220 Purchases 1,300 Wages 2,760 Fine 750 Drawings 2,000 Consultancy fee 3,200 Balance c/d5,8602,38023,670 12,86023,670 12,860 85. Bank statements Weekly or monthly, a business will receive a bankstatement. Bank statements are used to check that the balanceshown in the cash book agrees with the amount onthe bank statement. This agreement or reconciliation is the subject of alater chapter. 86. Petty cash book The petty cash book lists all cash payments for smallitems, and occasional small receipts. Most businesses keep a small amount of cash on thepremises 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 cashaccount. Petty cash can also be used for occasional smallreceipts, such as cash paid by a visitor to make aphone call or to take some photocopies. There are usually more payments than receipts andpetty cash must be topped up with cash from thebusiness bank account. 87. Continues Under what is called the imprest system, the amount ofmoney in petty cash is kept at an agreed sum or float(say $100). Expense items are recorded on vouchers as theyoccur. $Cash still held in petty cashXPlus voucher paymentsXMust equal the agreed sum/floatX 88. Continues The total float is made up regularly (to $100,orwhatever the agreed sum is) by means of a cashpayment from the bank account into petty cash. The amount paid into petty cash will be the totalof the voucher payments since the previous top-up. The format of a petty cash book is the same asfor the cash book, with analysis columns for itemsof expenditure. 89. The Journal The journal is a record of unusual transactions. It isused to record any double entries made which do notarise from the other books of prime entry. Whatever type of transaction is being recorded, theformat of a journal entry is as follows.DateDebit Credit $ $Account to be debited XAccount to be creditedX(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 JanuaryPut 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 JanuaryCash account2,000 Capital account2,000 (Initial capital introduced)1 JanuaryBrushes & combs a/c 50 Cash account 50 (The purchase for cash of brushes & combs as non-current assets)1 JanuaryHair dryer asset account150 Sundry payables account *150 (The purchase on credit of hair driers as non-current assets)30 January Rent expense account300 Cash account 300 (The payment of rent to 31 March) 93. Continues Dr.Cr.30 January Cash account600 Sales account600 (Cash takings)31 January Receivables account 80 Sales account80 (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 tobookkeeping 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 endand 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 whathas happened in the past in an organisation It is part of the accountability system It relates yesterdays activities in financial terms Reports Annual Financial Statementso Annual Report and Statutory Accounts Monthly control reports 101. Example: Monthly Control ReportCurrent Month As at 30th JuneYear to dateBudget Actual VarianceExpenditureBudget toActual to Variance Date Date Supplies andGeneral Charges 40,000 43,000-3,000Basic pay230,000250,000 -20,000 25,000 26,000-1,000 Part tim e basic150,000165,000 -15,000 15,000 14,500500Casual pay 90,000 80,00010,000 20,000 19,000 1,000 Adm inistrative staff 150,000148,0002,000 18,000 20,000-2,000Photocopy costs100,000110,000 -10,000 21,000 24,000-3,000Materials120,000125,000 -5,000 10,0006,000 4,000Books 50,000 56,000 -6,0006,0006,0000 Heating Pow er & Light39,000 40,000 -1,0005,0004,000 1,000Cleaning30,000 31,000 -1,0001,0001,500 -500Fax 6,0005,0001,0002,0001,800200Telephone12,000 10,0002,0001,0002,000-1,000Consum ables 6,0006,00005005000 Hospitality9,000 10,000 -1,0001,5002,000 -500 Maintenance 6000 7000 -1,000800700100Travelling Expenses 5,0004,500500200500 -300 Stationery 1,0001,500 -500700100600Office Expenses 4,0005,000 -1,000200 - 2000Office Equipm ent1,0001,500 -5003,0003,500 -500 Rent & Rates20,000 19,0001,0001,0001,0000 Sundries 6,000 10,000 -4,000171,900176,100-4,200 Sub Total 1,029,0001,077,500 -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 beincurred repeatedly, for example the cost of atelephone call, a days pay, a box of bandages, a litre offuel They are items which have a oneoff use..once boughtand useda second must be bought..and a third..etc In general, expense items represent day-to-dayoperational activity.low value long term items .. suchas a mobile phone will also be included Expenses are recorded and totalled at the end of eachmonth and each year. 104. What is income? Income is the sum earned for providing goods orservice, whether or not any payment has beenreceived. It too represents monies from operational activityand, items which are frequently repeated forexample, the sale of a chocolate bar or the price ofa bus ticket. Income is totalled monthly and annually to reflectwhat 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 sumsowed to suppliers, known as creditors, or long-termsuch as loans, leases and mortgages. These latter items contribute to long term funding,without which, the organisation would not be able topurchase assets. All liabilities carry with them the obligation to repayand 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 thissum. A key way this sum is increased is through theIncome and Expenditure account. Any excess incomeover expenditure belongs to the owners and can beleft in the organisation by way of an increase in capital. Without capital an organisation cannot begin its life norgrow, as without money new assets cannotbepurchased. 108. key terms.. assetsliabilities/ balance capitalsheetrevenue incomeexpenses/income statement 109. The statement of financial position Is a position statement which evaluates wealth at apoint in time. It considers capital costs. Consists of assets and claims on those assetsAssets (owned)Claims (owed) CurrentCurrent liabilities Non-CurrentLong-term LoansOwners capitalBut, asClaims = Liabilities + Capital then, Assets = Liabilities + Capital 110. Income Statement The difference between costs & income Profit & loss account / Income & expenditureaccount Shows where the resource was spent Covers a period of time Matches expenses and income to time period Expenses represent the cost INCURRED, resourceused or consumed in providing the service duringthe accounting period Income is that which is EARNED from and relatedto 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 areallocated to the period in which the benefit /expense isincurred 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 itsown ledger account It records the details of transactions relating to theparticular item Original paper system was T accounts Each account is identified by a unique code Debit Credit 117. Lecture example 1 The accounts of MSUreveal the following: Consider how the following Capital18 900transactions will affect theFixtures3 500accounts;Loan2 000 MSU buys stocks of goods onStocks4 950 credit for 770.Debtors 3 280 One of the debtors pays 280Creditors 1 600 in cash.Vehicles4 200 New fixtures are purchasedCash - bank 6 450 with a cheque for 1000.Cash - hand 120 118. Double Entry Book-Keepingasset 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 endwe measure if we have any items left What remains = stock/inventory to carry forward, i.e.: closing stock/inventory Whats 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 eachstock item at the end we then see how much wehave leftthis determines how much of the item wehave used..i.e. the expense incurred But we may have had stock/inventory at the beginningopeningstock/inventory sent goods backreturns outwards been charged for deliverycarriage in All the above help determine the value of the itemsused 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 UsedX 125. Lecture example 2 A hospital is trying to establish the cost ofcleaning 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 materialsused? 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 ieclosed and re-opened for the next accountingperiod Income statement = income & expenses The closing balances on these accounts aretransferred out and the new accounting periodstarts with zero balances. 127. Balancing off accountsSupplier A10/5 Returns out 40 1/5 Purchases69024/5 Paid cash 3004/5 Purchases66 bal c/d4167567561/6 bal b/d416A 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 Craccounts Income 155 Total debit entriesPurchases 60= total credit entries Expenses25 Starting point for the Wages 30derivation of the financialVehicle 120statements Fittings70 Adjustments to the trial Capital150balance lead to the creationof the operating statement305 305and 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 inwhich 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 linebasis is appropriate - will be charged to theI&E accounts in each of the years and what isshown in the balance sheet? Using a reducing balance of 33% recalculatethe 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 Drbad debts expense Crbad and doubtful debt provision Provision is a balance sheet account it offsets the debtors inthe BS the account is carried forward and is adjusted eachyear based on debtors balance any movement in the provisionis 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 ReportCurrent Month As at 30th JuneYear to dateBudget Actual VarianceExpenditureBudget toActual to Variance Date Date Supplies andGeneral Charges 40,000 43,000-3,000Basic pay230,000250,000 -20,000 25,000 26,000-1,000 Part tim e basic150,000165,000 -15,000 15,000 14,500500Casual pay 90,000 80,00010,000 20,000 19,000 1,000 Adm inistrative staff 150,000148,0002,000 18,000 20,000-2,000Photocopy costs100,000110,000 -10,000 21,000 24,000-3,000Materials120,000125,000 -5,000 10,0006,000 4,000Books 50,000 56,000 -6,0006,0006,0000 Heating Pow er & Light39,000 40,000 -1,0005,0004,000 1,000Cleaning30,000 31,000 -1,0001,0001,500 -500Fax 6,0005,0001,0002,0001,800200Telephone12,000 10,0002,0001,0002,000-1,000Consum ables 6,0006,00005005000 Hospitality9,000 10,000 -1,0001,5002,000 -500 Maintenance 6000 7000 -1,000800700100Travelling Expenses 5,0004,500500200500 -300 Stationery 1,0001,500 -500700100600Office Expenses 4,0005,000 -1,000200 - 2000Office Equipm ent1,0001,500 -5003,0003,500 -500 Rent & Rates20,000 19,0001,0001,0001,0000 Sundries 6,000 10,000 -4,000171,900176,100-4,200 Sub Total 1,029,0001,077,500 -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. Reportscontent in brief Balance Sheet Own Income Statement Assets Income Non-Current Current Less Owe Expenses Liabilities= Long term Current Profit/Loss Capital Original Accumulated surpluss 139. Basic Income Statement Income1000 Cost of goods sold(750) Gross Profit 250 Expenses(50) Net Profit to be retained200Balance Sheet 140. The Balance Sheet - format Non-Current Assets1000Current AssetsInventory150Receivables250Cash 200 600Total Assets 1600Current LiabilitiesPayables 150Overdraft250 400Long Term Liabilities 300Net Assets 900CapitalOwners Share Capital 700Retained profit200 900