Financial Accounting Books of Accounts
What is Financial Accounting Dr. Clive Vlieland-Boddy FCA FCCA MBA
The Purpose of Accounting • To provide accurate financial information on the performance of a firm. • Managers need this to enable them to make their planning and control. • Outsiders need this to be able to evaluate the firms position and whether they will or will not trade with it. • Shareholders and investors need to see that their investment is good.
The Accounting Process • Set of activities involved in converting information about transactions into financial statements.
Business Transactions Business document is prepared, e.g. order form, invoice Debits and credits posted to accounts in a ledger Information entered chronologically into a Prime Book of Entry Financial statements prepared -- balance sheet & income statement The Process of Accounting • An orderly recording of all financial transactions (by hand or now normally electronically)
The Impact of Computers on the Accounting Process • Simplifies the accounting process by automating data entry and calculations. • Available products are customized for businesses of different sizes. • Entrepreneurs and small businesses: QuickBooks, Peachtree, Sage and BusinessWorks. • Larger firms: Computer Associates, Oracle, and SAP. • Software that handles accounting information for international businesses is also available.
Cash Inventory Payables Equipment Receivables Receivables Accounts An organized format used by companies to accumulate the dollar effects of transactions.
Basic principles • Most businesses borrow money to help them to operate. • Liabilities shows how much money has been borrowed or invested – and where it came from. • The term ‘balance’ means that all the money invested or borrowed must be accounted for in another section, called assets.
must equal The key principle of a balance sheet All assets All liabilities
Duality of Effects Most transactions with external parties involve an exchange where the business entity both gives up something and receives something in return.
Nature of Business Transactions Exchanges of assets and liabilities between the business and one or more other parties. Borrow cash from Bank Owes that money to the bank
Nature of Business Transactions Exchanges of assets and liabilities between the business and one or more other parties. Sell £500 of products to customer Customer owes £500.
Essentials of accounting systems • Cost Effective • Be of real use to those who need the information • Be flexible • Enable the business to be controlled
Development of an Accounting System Analysis Planning and identifying information needs and sources Follow-up Design Monitoring and correcting any weaknesses Creating documents, procedures, and reports Implementation Installing the system, training personnel, and making the system work
Flow of Accounting Data Transaction Occurs Source Documents Prepared Transaction Analysed Transaction Entered in Day Book & Posted to Ledger
The Basics • Businesses buy and sell products and incur expenses, known as overheads, with the objective of making a profit. • Transactions can be either Cash or Credit
Cash v Credit Transactions • Most shoppers who go into a sweet shop or a snack bar will pay for their purchases in Cash. • The sweet shop and the snack bar will usually order supplied from a wholesaler who will often deliver them directly to them. • Usually the supplier will invoice the sweet shop or snack bar and some days later, they will receive payment for that invoice.
Cash and Credit (Accruals) Accounting • Cash will normally be put in a till and once a day taken to the bank. • Cheques are often written out days after the invoice is received and then sent to the supplier. • The cash transaction is therefore completed as it takes place, whilst the credit transaction is only completed when the cheque is received by the supplier and banked by them.
Accounting Methods for Measuring Performance • Strict cash basis of accounting. • Revenues are recorded when cash is received and expenses are recorded when cash is paid. • Accrual basis of accounting. • Revenues and expenses are recorded on an economic basis independently of the actual flow of cash.
Cash Basis Accrual Basis Easy to understand. Theoretically difficult. Provides a reliable picture of the change in cash and the firm’s liquidity. Provides a more reliable picture of the economic changes in wealth. Revenues and expenses are recorded according to cash inflows and outflows. Revenues and expenses are recorded according to economic change in wealth (the rules are discussed later on in this clinic). Can be manipulated by changing the cash flows timing. Can be manipulated by the changing the recognition rules. Cash V Accrual Basis of Accounting
What is the issue…. • Whilst a cash transaction is completed immediately, we need to appreciate that with a Credit transaction, that there is an outstanding responsibility of the sweet shop or the snack bar to pay for the supplies they have received. • We therefore need to record the fact that the Credit transaction is not completed. It is outstanding until paid.
Basic Books of Accounts • Cash Book • Petty Cash Book • Sales Day Book • Purchased Day Book • Sales or Accounts Receivable Ledger • Purchase or Accounts Payable Ledger • General or Nominal Ledger
The Cash Book • This is an item by item summary of the enterprise's bank account. • This shows Money Banked or other bank receipts and Cheques and other payments out of the bank. • The Receipts are shown on the left and the payments on the right. • The balance can be reconciled to the balance on the bank statement.
The Petty Cash Book • Most enterprises keep a small amount of cash in a tin to meet sundry daily expenses which are paid in cash. • Milk and coffee. A taxi fare. A rail fare for a member of staff. • The tin is normally replenished with cash drawn from the bank. • The left side of the book shows the reimbursements from the bank and the right the expenses paid out. • This book is of minor importance.
Sales Day Book or Journal • This is a summary of the sales made. Normally individually. The date, the amount and the name of the customer. • It is what the name says. Sales Day Book.
Date Customer Name Reference Amount Parts Service 2 July 2008 JJ Manufacturing SI1 2500 2500 29 July 2008 ABC Products AI2 3200 3200 ------- ------- ------- Total 5700 2500 3200 ==== ==== ==== Sales Day Book
Purchase Day Book or Journal • This is a summary of the daily purchases so as to record what the enterprise has incurred by way of supplies and expenses.
Date Supplier Name Reference Amount Electricity Widgets 10 July 2006 Electricity Company PI1 1000 1000 12 July 2006 Widget Company PI2 1600 1600 ------- ------- ------- Total 2600 1000 1600 ==== ==== ==== Purchase Day Book
Sales or Accounts Receivable Ledger • This records all Credit sales that have been made to customers. • Normally a page is for each customer. • It shows the sales made and the payments that the customer has made. • The balance on a customers account represents the amount that the customer owes the enterprise. • This money which will be received is called Accounts Receivable
QUESTION: What is an accounts receivable ledger? ANSWER: An accounts receivable ledger is a subsidiary ledger that contains a separate account for each customer.
Purchase or Accounts Payable Ledger. • This records all Credit purchases from suppliers. • Normally a page for each supplier. • It shows the goods or serviced received and the payments that have been made. • The balance on an account represents the amount that the enterprise owes the supplier. • This money which will be paid is called Accounts Payable.
The Accounts Payable Ledger NAME International Apparel Shop TERMS n/30 ADDRESS 1718 Sherry Lane, New Town DATE DESCRIPTION POST. DEBIT CREDIT BALANCE REF. 20-- JAN. 1 Balance 1,600.00 23 Invoice 7985, 01/23/-- P1 5,120.00 6,720.00 • The accounts payable ledger has three money columns. • The Balance column is presumed to contain credit amounts.
QUESTION: What is an accounts payable ledger? ANSWER: An accounts payable ledger is a subsidiary ledger that contains a separate account for each supplier.
When cash is paid to a supplier for an outstanding invoice, the transaction is first recorded in a Bank Payments Book. Bank Payments
NAME International Apparel Shop TERMS n/30 ADDRESS 1718 Sherry Lane, Dallas, New Town DATE DESCRIPTION POST. DEBIT CREDIT BALANCE REF. 20-- Jan. 1 Balance 1,600.00 23 Invoice 7985, 01/22/-- P1 5,120.00 6,720.00 27 BP1 2,400.00 4,320.00 The cash payment is then posted to the individual creditor’s account in the accounts payable ledger. Posted from page 1 of the Bank Payments Book
RELATIONSHIP BETWEEN LEDGERS The subsidiary ledger is separatefrom the general ledger. Accounts Receivable is a control account.
4 Fundamental Accounting Concepts • Going Concern - That the business will continue and not be liquidated. • Accruals (or Matching) - That income is matched with expenditure. You match the sale with the cost of that sale. • Consistency - What you did last year you do this. Otherwise figures would be meaningless. • Prudence - Caution is essential. Note “Prudence must prevail”
The Structure of Accounts There are essentially three principal financial statements as well as notes and additional explanations. • The Balance Sheet • The Income Statement • The Cash Statement • Notes to the Accounts (Footnotes) • Other statements in published accounts.