Introduction to Accounting and Finance

1. Introduction

  • Classification and recording of monetary transactions,
  • The presentation and interpretation of the results of those transactions to assess performance over a period and the financial position at a given date, and
  • The monetary projection of future activities arising from alternative planned courses of action

2. Types of accounting

Financial Accounting

  • The preparation of financial information
  • For shareholders and other external users
  • Historical information
  • Statutory obligations
  • Includes Taxation and Audit

Management Accounting

  • The preparation of financial information
  • For internal users, i.e. management
  • Supports decision-making, planning and control
  • Forward-looking information

Financial Management

  • Managing the organisation’s finances
  • Concerned with:
    • Investment Decisions
    • Financing Decisions

3. Ethics of accounting

Qualities of Reliable Information

  • Faithful representation of what it is supposed to represent
  • Neutral – free from bias
  • Free from material error – do not affect decisions taken by users
  • Complete – all aspects of the business should be included
  • Prudence – no overstatement of assets or profits or understatement of losses and liabilities
  • Comparability – accounts should be comparable with those of other similar enterprises, and from one period to the next

Characteristics of useful information

  • Relevance – relevant to the needs of the users
  • Understandability – information should be in a form that is understandable to user groups
  • Reliability – information should be of a standard that can be relied upon by external users so that it is free from error and can be depended upon by users in their decisions

Accounting influences

  • Historical factors – as society changes accounting changes
  • Country factors – different rules for different countries but note the emergence of International Accounting Standards
  • Technological factors – move from paper-based systems to computer-based systems
  • Organisational structure – the size of the business enterprise

Ethical Codes

  • Professional bodies will have a code of ethics for their members ICAEW, ACCA, CIMA etc
  • International Federation of Accountants (IFAC)
  • “IFAC has long recognised that a fundamental way to protect the public interest is to develop promote and enforce internationally recognised standards as a means of ensuring the credibility of information upon which investors and other stakeholders depend”

     (IFAC Handbook 2012)

4. Principles of accounting

To answer the question “What can I do for the best?” consider three ethical elements.

  • 1.’I’, because ethics are about your individual professional responsibility to act.
  • 2. ‘do’ because ethics are about practical courses of action in the real world where things are not always about what you do but how you do them
  • 3.  ‘best’ because ethics are not about doing what is right or wrong, but often involves making choices between courses of action, both of which might be unpalatable or give rise to problems

Fundamental principles

1) Integrity – straightforward and honest in all professional business relationships

2) Objectivity – should not allow bias, conflict of interest or undue influence of others to override professional or business judgements

3) Professional competence and due care – duty to maintain professional knowledge and skill at the level required to ensure that a client or employer receives competent professional service based on current developments in practice, legislation and techniques.  Act diligently and follow applicable technical and professional standards when providing professional services

4) Confidentiality – respect the confidentiality of information acquired from professional and business relationships and should not disclose any such information to third parties without proper and specific authority unless there is a legal or professional right or duty to disclose. Such information should not be used for the professional accountant’s or third parties’ personal advantage.                       

5)  Professional Behaviour – should comply with relevant laws and regulations and should avoid any action that discredits the profession

5. Purpose/types of accounting

Why keep accounts?

  • To control the use of resources
  • To keep track of assets and liabilities
  • To plan effectively for the future
  • To provide useful information; to present and potential investors, creditors and other users in making rational investment, credit and similar decisions
  • A permanent record of financial transactions
  • Data for published accounts
  • Statutory obligations
  • Tax purposes

Main Financial Statements

  • Statement of Financial Position (Balance Sheet) – position statement
  • Income Statement (Profit and Loss Account) – performance statement
  • Statement of Changes in Equity
  • Cash Flow Statement – changes in the financial position
  • Statement of accounting policies and other explanatory notes

The objective of financial statements

To provide information about:

  • The financial position
  • Performance
  • Changes in the financial position
  • Financial statements prepared in this way meet the common needs of most users
  • Users expected to use reliable historic information to help them evaluate future performance and make economic decisions

Budget

A budget is a short-term plan.  It is linked to the organisation’s long-term plan by:

  • Setting long-term objectives
  • Converting objectives into action plans on which the budget is based
  • Monitoring actual performance against the budget and using this information to update the long term plan

Benefits of cash budgeting

  • Ensure sufficient cash is available when needed
  • Reveal any expected cash shortage so that other funding can be put in place in good time
  • Identify areas where payment can be delayed or inflows brought in earlier
  • Reveal cash surpluses which can be invested or utilised elsewhere

The objective of financial statements

The objective of financial statements is to provide information about the financial position, performance and changes in the financial position of an enterprise that is useful to meet the common needs of most users.

Users expect to use reliable historic information to help them evaluate future performance and make economic decisions

Main Financial Statements

  • Statement of Financial Position (Balance Sheet) – position statement
  • Income Statement (Profit and Loss Account) – performance statement
  • Statement of Changes in Equity
  • Cash Flow Statement – changes in the financial position
  • Statement of accounting policies and other explanatory notes

The Accounting Process

Business Transactions -> Books of Prime Entry -> Ledger Accounts – >Trial Balance -> Published Financial Statement

Business Transactions & Source Documents

A business transaction is an event that affects the finances of a business. The information for business transactions usually comes from source documents.

Source documents include:

  • Receipts;
  • Purchase orders;
  • Invoices;

Books of Prime Entry

  • Purchases Day Book
  • Purchase Returns Day Book
  • Sales Day Book
  • Sales Returns Day Book
  • Cash Book
  • Petty Cash Book
  • Journals

Double Entry

  • System of Accounting
  • Every financial transaction produces 2 accounting entries

Debit entries = credit entries

6. The balance sheet

Assets and Liabilities

Asset

  • Something valuable that the business owns or has the use of
  • Can be used in the long-term or short term

Liability

  • Something which is owed by the business to someone else
  • Can be used in the long-term or short term

Non-current assets

  • Assets to be used by the business to earn income or make profit directly or indirectly e.g. factory, production machinery, equipment, hotel furniture
  • Useful life > I year
  • Subject to depreciation

Current Assets

  • Inventory to be turned into cash < I year
  • Cash owed for goods and services sold/provided on credit and due usually within one year – receivables (debtors)
  • Amounts paid in advance
  • Cash in the bank

Non-current liabilities

  • Loans – repayable > 1 year
  • Debentures

Current liabilities

  • Loans – repayable < 1 year
  • Bank overdraft
  • Trade payables
  • Expenses owing
  • Tax payable

The Accounting Equations

Capital = Assets –  Liabilities