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ACCOUNTING
Submitted by:
GIDEON V. MAMENTA
INTRODUCTION TO ACCOUNTING
Accountancy is the process of communicating financial information
about a business entity to users such as shareholders and managers
(Elliot, Barry & Elliot, Jamie: Financial accounting and reporting).
Accounting has been defined as:
the art of recording, classifying, and summarizing in a significant
manner and in terms of money, transactions and events which
are, in part at least, of financial character, and interpreting the
results thereof.(AICPA)
Users of Accounting Information - Internal & External
Accounting information helps users to make better financial decisions.
Users of financial information may be both internal and external to the
organization.
Internal users (Primary Unsers) of accounting information include
the following:
its
Introduction to Accounting
Accountancy is the process of communicating financial information
about a business entity to users such as shareholders and managers
(Elliot, Barry & Elliot, Jamie: Financial accounting and reporting).
Accounting has been defined as:
the art of recording, classifying, and summarizing in a significant
manner and in terms of money, transactions and events which
are, in part at least, of financial character, and interpreting the
results thereof.(AICPA)
Users of Accounting Information - Internal & External
Accounting information helps users to make better financial decisions.
Users of financial information may be both internal and external to the
organization.
its
separate accounting system for the public sector arises because of the
different aims and objectives of the state owned and privately owned
institutions. Governmental accounting ensures the financial position
and performance of the public sector institutions are set in budgetary
context since financial constraints are often a major concern of many
governments. Separate rules are followed in many jurisdictions to
account for the transactions and events of public entities.
Tax Accounting refers to accounting for the tax related matters. It is
governed by the tax rules prescribed by the tax laws of a jurisdiction.
Often these rules are different from the rules that govern the
preparation of financial statements for public use (i.e. GAAP). Tax
accountants therefore adjust the financial statements prepared under
financial accounting principles to account for the differences with rules
prescribed by the tax laws. Information is then used by tax
professionals to estimate tax liability of a company and for tax
planning purposes.
Forensic Accounting is the use of accounting, auditing and
investigative techniques in cases of litigation or disputes. Forensic
accountants act as expert witnesses in courts of law in civil and
criminal disputes that require an assessment of the financial effects of
a loss or the detection of a financial fraud. Common litigations where
forensic accountants are hired include insurance claims, personal injury
claims, suspected fraud and claims of professional negligence in a
financial matter (e.g. business valuation).
Project Accounting refers to the use of accounting system to track the
financial progress of a project through frequent financial reports.
Project accounting is a vital component of project management. It is a
specialized branch of management accounting with a prime focus on
ensuring the financial success of company projects such as the launch
of a new product. Project accounting can be a source of competitive
advantage for project-oriented businesses such as construction firms.
Social Accounting, also known as Corporate Social Responsibility
Reporting and Sustainability Accounting, refers to the process of
reporting implications of an organization's activities on its ecological
and social environment. Social Accounting is primarily reported in the
form of Environmental Reports accompanying the annual reports of
companies. Social Accounting is still in the early stages of development
and is considered to be a response to the growing environmental
consciousness amongst the public at large.
What are Financial Statements?
2. Income Statement
Income Statement, also known as the Profit and Loss Statement,
reports the company's financial performance in terms of net
profit or loss over a specified period. Income Statement is
composed of the following two elements:
o Income: What the business has earned over a period (e.g.
sales revenue, dividend income, etc)
o Expense: The cost incurred by the business over a period
(e.g. salaries and wages, depreciation, rental charges, etc)
directly
in
equity
(e.g.
Definition
Statement of Financial Position, also known as the Balance Sheet,
presents the financial position of an entity at a given date. It is
comprised of three main components: Assets, liabilities and equity.
9
10
11
130,000
30,000
60,000
220,000
Current assets
Inventories
Trade receivables
Cash and cash equivalents
12
13
14
12,000 10,000
25,000 30,000
8,000
10,000
45,000 50,000
265,000 250,000
100,000
50,000
15,000
165,000
TOTAL ASSETS
120,000
30,000
50,000
200,000
100,000
40,000
10,000
150,000
Non-current liabilities
Long term borrowings
Current liabilities
Trade and other payables
7
Short-term borrowings
8
Current
portion
of
long-term
6
borrowings
Current tax payable
9
Total current liabilities
Total liabilities
TATAL EQUITY AND LIABILITIES
35,000
50,000
35,000
10,000
25,000
8,000
15,000
15,000
5,000
2,000
65,000 50,000
100,000 100,000
265,000 250,000
Classification of Components
Statement of financial position consists of the following key elements:
Assets
An asset is something that an entity owns or controls in order to derive
economic benefits from its use. Assets must be classified in the
balance sheet as current or non-current depending on the duration
over which the reporting entity expects to derive economic benefit
from its use. An asset which will deliver economic benefits to the entity
over the long term is classified as non-current whereas those assets
that are expected to be realized within one year from the reporting
date are classified as current assets.
Assets are also classified in the statement of financial position on the
basis of their nature:
Inventories balance includes goods that are held for sale in the
ordinary course of the business. Inventories may include raw
materials, finished goods and works in progress.
Cash and cash equivalents include cash in hand along with any
short term investments that are readily convertible into known
amounts of cash.
Liabilities
A liability is an obligation that a business owes to someone and its
settlement involves the transfer of cash or other resources. Liabilities
must be classified in the statement of financial position as current or
non-current depending on the duration over which the entity intends to
settle the liability. A liability which will be settled over the long term is
classified as non-current whereas those liabilities that are expected to
be settled within one year from the reporting date are classified as
current liabilities.
Liabilities are also classified in the statement of financial position on
the basis of their nature:
Equity
Cash
Short-term investments
Accounts Receivable
Inventory
Prepayments (Prepaid expenses)
The assets above represent the current assets that are usually found
on the typical balance sheet. As shown, the assets are arranged in
descending order in order of liquidity, from cash, which is the most
liquid asset, to prepayment, which is the least liquid of the five items
above.
The management of current assets is fundamental to the operating
success of a business. This is where the vital operating assets are
found, driving the day-to-day activity of the company. Companies are
forced to spend significant sum of money to ensure proper
management of current assets.
For instance, cash is usually monitored by the company's Treasury
department, which focuses on the management of bank accounts,
investments, lockboxes etc. Accounts receivable is managed with
collections and credit staff, while inventory is managed with an array of
staff for purchasing, disbursement and valuation.
Assets, Liabilities & Equity - An Intro (Part II)
It's the current assets that provide the fuel for the engine of growth in
a company. Inventory is a good example of the importance of current
assets. Inventory represents assets being held by the company for
sale, and the speed of the movement of the inventory through the
company is of significant importance to the operating success of the
company.
Fixed Assets
Fixed assets are those assets owned by a company that contributes to
the company's income but are not consumed in the income generating
process and are not held for cash conversion purposes. Fixed assets
are tangible items usually requiring significant cash outlay and lasting
for an extended period of time.
When an asset is purchased, the value of the asset is not recorded
against the company's revenue, but is entered by opening a separate
account for the account. This accounting process is known as
capitalizing.
For accounting purposes, a portion of the value of the fixed asset is
charged against profit during each accounting period. This process is
called depreciation.
Straight line
Declining/Reducing balance
Machinery
Motor Vehicles
Leasehold Improvements
Because of the cash outlay involved, the purchase of most fixed assets
is usually preceded by an extended period of cost/benefit analysis by
the company's accounting staff. The aim of this analysis is to
determine, as best as possible that the asset purchased will add value
to the company during its useful life, by generating greater positive
cash flow than it cost when it was purchased. '
Fixed assets are usually booked at the acquisition cost. However, in
some cases additional costs may be incurred to make the asset
useable. This cost should also be included in the cost of the fixed asset.
Consider the purchase of a refrigerator by a grocery store. The
refrigerator cost 10,000, however it needed a special thermostat to
allow it to operate in the store. Because the thermostat cost the
company a 1,000, the value of the refrigerator will be recorded as
11,000 (10,000 + 1,000).
During the life of the asset, the following costs will be capitalized:
Any extensive service that will extend the life of the asset
Liability is a source of funds for a company, and the company will use
the fund (purchasing power) to enhance the business (purchase fixed
assets, inventory, pay creditors etc.)
Liabilities are contractual obligations and companies are required to
honor their liability contracts or face legal suits. The content of a
liability contract may be extremely simple or very complex. Some
creditors may request that the borrowing company pay interest on its
debt, as well as maintain certain accounting ratios, a specific cash
balance or a certain level of net worth, while another credit may simple
require repayment of the principal at a particular time.
Current Liabilities
Current liabilities may be viewed as the flip side of current assets, and
requires similar managerial attention as current assets. Current
liabilities represent the amount owed to creditors due for payment
within 12 months.
Current liabilities are usually amount owed for operating expenses,
dominated by accounts payable. However in many cases, current
liabilities also include Current Portion of Long Term Debt, which is the
amount of long-term debt due for payment in less than 12 months.
Managing current liabilities is very important to a company's cash flow
process and extended viability. Failure to appropriately manage current
liabilities will result in working capital issues, which could lead to
operating failures.
Current liabilities are ideally settled using current assets, necessitating
the combined management of the two. Current assets less current
liabilities are called working capital.
The following are a few of the current liabilities you may see on the
typical balance sheet:
Accounts Payable
Notes Payable
Wages Payable
Accruals/accrued expenses
Bonds
Debentures
Mortgages
Each loan will have some kind of agreement for repayment, including
the due dates and the specific amount. The loan contract may also
include the following: Any applicable interest rate, a default clause, a
listing of the collaterals being held by the creditor, any covenants
associated with the loan and a convertibility clause. Prudent
Preferred Stock
Common Stock
Retained Earnings
Preferred Stock
Retained earnings
Treasury stock