ACCOUNTING AND FINANCIAL MANAGEMENT

CHAPTER 1
INTRODUCTION
SOME ASPECTS OF ACCOUNTING

Accounting can be called the language of business. The balance sheet and the associated
financial reports are the principal devices for presenting the financial position of a private or
public enterprise. Training in accounting and financial management has therefore had a
prominent place in any Management Development Program.

Although balance sheets are used throughout the world, their form and the terms used in
them vary from place to place according to national and local customs and law.
Furthermore, the interpretation of balance sheets is directly related to the associated
financial reports such as the profit and loss account, the sources and uses of funds
statement, the auditor’s certificate and the notes to the financial statements.

Accountants, managers, directors, chairmen and shareholders in public and private

enterprises need to be able to interpret financial reports, as do private investors, students of
accounting, trade union officials, and many persons concerned with the operation and
supervision of public affairs at the local or national level.

A CCOUNTING L ANGUAGE
Like any other language, the language of accounting can never express our thoughts with
absolute precision and clarity. This language is complex and many of the words do not mean
the same as they do in everyday life. WE must learn to think of the accounting rather than
the popular meaning of the words used in the accounting language

U NCERTAINTY
Accounting encompasses those facts about a business that can be expressed in monetary
terms. However, many important business facts such as the health of the management,
morale of the workers, status of the market, etc. cannot be expressed in financial terms.
Accounting therefore can only provide a limited picture of a business. Accounting figures are
at best professional estimates and not scientific facts. The key accounting concept is
materiality, where financial management concentrates on significant (material) values with
relatively little attention to small amounts and small errors.

C ONSERVATISM
The practice of accounting arose from practical business activities over a long period of
time. In order not to mislead the managers of the business (and also to prevent them from
having to pay any more income tax than absolutely necessary), accountants have tended to
be ultra conservative and to understate rather than overstate the financial position of a
business. Accounting practices therefore aim to take profits only when they are reasonably
certain, and yet by contrast, to provide for losses as soon as they are known or anticipated.

C ONSISTENCY AND COMPARABILITY

The basis of all profit is the accounting period during which the profit is realized. Thus 10000
units for a week is not the same as 10000 for a whole year. Accounting figues are not
significant in themselves but only when they are compared with other figures for similar
periods.The accountant therefore despite the problems of uncertainty and conservatism,
tries to be consistent in his judgement so that the figures he produces are comparable from
one period to another.

A CCOUNTING AND A UDITING STANDARDS

Generally accepted accounting practices (GAAP) are the concepts used to convert
accounting records into reliable accounting reports. In any country such standards may arise
from:

• The professional accounting associations

• The legal establishment of an accounting (plan compatable) especially in French

speaking countries

• Income tax laws which may require different accounting concepts for tax purposes

Similary generally accepted auditing standards are used for the professional audit of
accounting reports so that an independent professional auditor may give a clear certificate.
The auditor’s certificate generally states that the reports are prepared in accordance with
GAA standards and have been audited according to generally accepted auditing standards
to show a true and fair view of the business enterprise.

There is no set of detailed rules that is universally agreed upon for drawing up the financial
stetements of a business enterprise. As a result, balance sheets of different enterprises may
differ in detail from each other. The basic principles however are the same and all balance
sheets have something in common. Since a balance sheet expresses everything in monetary
values, accountants are often required to use their judgement in arriving at estimates to
reflect in the balance sheet. The criteria they use are very important, but even more
important is that they remain consistent in their methods.

Accounting figures are not significant in themselves. They are significant only when
compared with other similar figures. The significance also depends on the date or time
period to which the figures refer. To be useful, the financial statement should be audited by
independent professionals.

1. Balance Sheets are produced by Accountants. Before we look at a balance sheet

itself, let us look at a few general features of accounting practices to be borne in
mind

2. Accountants have different opinions on many subjects within the field of accounting
as well as outside it. So it is not surprising that there are some variations in
accounting practice to be found in different countries, or in different parts of the
same country, and even between different accountants working in the same place at
the same time

3. This means that there is no single universally accepted form for the presentations of
these financial statements which an accountant produces to describe the financial
 situation of a company or business enterprise. Individual differences amongst
accountants result in different forms of presentation of financial statements.

4. Despite these differences, there are some standard basic principles which are
generally accepted and these must be understood

5. However don’t be surprised if you come across a balance sheet that looks different
from the ones that you are used to. Different presentations may differ in the details
of the presentation but they all follow certain common basic principles

6. One reason for the differences in accounting practices is that it is difficult to assess
the monetary values of some of the items that appear in a balance sheet.

7. Although a balance sheet appears to make a very definite statement about various
sums of money, it may sometimes be deceptive and may often represent estimates
made by the accountant

8. For instance, the current value of land and buildings bought by the business 50 years
ago is only an estimate. Although the market value of the land may have
appreciated, the useful value of the land and building to the business may have come
down due to wear and tear and decay. The accountant must decide what to put down
in the balance sheet and it can at best be an estimate

9. Or take the example of a business enterprise that buys good for resale. When does it
actually make a profit on the particular item? When the item has been received into
stock, when the customer’s order for the same has been received, when the item is
dispatched to the customer, or when the customer pays for the sale. Again there is
uncertainty and the accountant has to make a judgment.

10. Most of these judgments are made in conformance with the generally accepted
accounting practices, but remember that the very precise sounding figures appearing
in a financial statement are estimates made by the accountant based on certain
accepted practices and the figures might vary in different parts of the country or
other countries.

11. But the criteria used by an accountant are less important than ensuring that he is
consistent in his practice. This is sometimes called the principle of consistency

12. Accounting figures are not significant in themselves. They are only significant when
compared with similar figures for another or previous period, or budget estimates, or
similar figures of another company

13. So accounts despite the problems of uncertainty, attempt to be consistent in their

judgment so that the figures they produce can be compared from one period to
another.

14. This brings us to another point, which is that the periods and dates used for reporting
are important for assessing the significance of the information contained in the
financial statements.
 15. Sometimes the financial position of a company may change drastically over a period
of time. The position on June 30, may be quite different from that on 1st January

16. Again a certain sum of money might represent a significant material profit if it was
made over a month, but may seem a poor profit for the whole year. In assessing the
significance (materialicity) of the figures in a financial statement, it is important to
know the period to which they refer.

17. Financial statements describe the financial situation of a business enterprise over
time. They are used by different parties who have relations with the enterprise, like
management, trade unions, government, creditors, banks, and shareholders. To be
useful, they must contain up to date information and they must be timely.

18. Most financial statements cover a period of one year. So the financial statements
must be available within 3 months of the end of the period to be useful and effective
for any control.

19. Financial statements are also submitted to auditors for an independent professional
opinion on the judgments made by the accountants in preparing them. This ensures
their reliability.

WHAT IS A BALANCE SHEET

A Balance Sheet is a statement of those assets and liabilities of a business enterprise that
can be expressed in terms of money. It shows both the assets and how they are financed.
The figures are estimates and not scientific facts.

The liabilities indicate what money has been made available to the business and from
where, and the assets show how the business has used the money made available to it.

Total Assets must always equal total liabilities which include those to creditors and
shareholders.

The balance sheet is supported by the following:

• The profit and loss statement (income and expenses statement)

• The sources and uses of funds (funds flow statement)

• Notes to the financial statements

• The auditor’s certificate

1. A balance sheet may look rather complicated but basically it is a simple statement
about a business that is produced at regular intervals showing what they own and
what they owe.

2. What a business owns are called its assets, and the various sums of money that a
business owes are called its liabilities. What would the buildings and manufacturing
equipment used in a business be called?
3. Assets include land and buildings, motor vehicles, and anything else that it owns and
are given a value in terms of money. Would stocks of raw materials held by a
manufacturing company be valued in terms of money and if so what would it be
called.

4. Stocks of raw materials and finished products owned by a business can be given a
value in terms of money and they what are they called

5. To acquire its assets, a business must obtain money from various sources. It may
borrow from banks and then it would owe the bank the borrowed sum of money.

6. The various sums of money borrowed from various sources are called its Liabilities

7. In addition to borrowing, many companies obtain a good deal of money from their
shareholders. Shareholders money is made available for the life of the company

8. This money borrowed from the shareholders is called shareholder’s funds and it is
subscribed for the life of the company and it will be repaid only if the business is
would up. Nevertheless, it is still owed to the shareholders

9. Since the money subscribed by the shareholders is owed to them, it is also part of
the company’s liabilities

10. Balance sheets may be presented in many ways but they must all show the assets
and liabilities of a company.

11. The simple balance sheet of Handicrafts Ltd is shown below. The balance sheet
contains and must contain:

a. The company name

b. The figures must be in terms of monetary values

c. It must have a date at which the balances are established

d. The liabilities and Assets must be equal

Handicrafts Ltd
Balance sheet as on 31st March 2009

Liabilities Rs Assets Rs
Money subscribed by 612 Land buildings 1750
shareholders 0 etc 0
Long term loan from financial 140 Raw materials 6920
institutions 00 etc
Bank overdraft 430
0
Total Liabilities 244 Total Assets 2442
20 0

12. The name balance sheet comes from the fact that the totals must always equal on
the assets and liabilities side. They in fact balance each other
13. Let us see why they are in balance. Look at the balance sheet above see that the
financial institutions, the bank, and the shareholders have all made money available
to the company and so they are owed the money they made available which are
called liabilities

14. We can see how the money provided for the company has been used by looking at
the assets

15. The Total assets and the total liabilities must match because they show the money
made available to the company and how they have been used

16. Here is another simple balance sheet. Look at it and compare with the earlier one.
This balance sheet has two things missing. They are:

Liabilities Rs Assets Rs
Money subscribed by 156 Land buildings 2080
shareholders 00 etc 0
Long term loan from financial 100 Raw materials 1200
institutions 00 etc 0
Bank overdraft 720
0
Total liabilities 328 Total assets 3280
00 0

17. Balance sheets can be set out in several ways depending on the way accountants
present them, but they must always have the two most important columns. The
assets and the liabilities

18. It is also important to note that several items that are valuable to a company may
not be expressible in monetary terms such as a good and skilled work force, a
foreseen significant political change. These are set out in the other statements that
go with the balance sheet. So the final picture of a company must be arrived at after
looking at all of them in totality

19. A small antique chair may not be an asset if its value is not materials enough. An old
piece of property might be valuable even if it is not used or usable