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INTRODUCTION TOINTRODUCTION TO

ACCOUNTINGACCOUNTINGWeek 1: LECTURE 1Week 1: LECTURE 1

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Aims of the LectureAims of the Lecture What is Accounting and the purpose What is Accounting and the purpose

of Accounting.of Accounting. The use of Financial StatementsThe use of Financial Statements Users of Financial StatementsUsers of Financial Statements Accounting cycle during a periodAccounting cycle during a period Forms of business organizationsForms of business organizations The accounting equation The accounting equation Solution of exercisesSolution of exercises

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A service that is systematically A service that is systematically recordingrecording and and summarizingsummarizing the the financial  financial transactions of a business and then transactions of a business and then analyzinganalyzing, verifying and reporting the , verifying and reporting the results. results.

The person in charge for the execution of The person in charge for the execution of accounting is known as an Accountant, and this accounting is known as an Accountant, and this individual is typically required to follow a set individual is typically required to follow a set of rules and regulations of the IFRS (International of rules and regulations of the IFRS (International Financial Reporting Standards). Financial Reporting Standards).

What is Accounting?What is Accounting?

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Purpose Purpose of Accountingof Accounting

Accounting allows a company to Accounting allows a company to analyze the financial performance of analyze the financial performance of the business and look at statistics such the business and look at statistics such as net profit. Therefore the as net profit. Therefore the management is able to make informed management is able to make informed judgment and better decision.judgment and better decision.

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Financial StatementsFinancial Statements

The Accounting service is analyzing data with The Accounting service is analyzing data with the preparation of financial statements. the preparation of financial statements. The The most widely used financial statements are:most widely used financial statements are:

The Statement of Financial Position (Balance The Statement of Financial Position (Balance Sheet) and Sheet) and

The Income Statement (Trading and Profit & The Income Statement (Trading and Profit & Loss account). Loss account).

To achieve its goals, an accounting system may To achieve its goals, an accounting system may make use of computers and video displays as well as make use of computers and video displays as well as handwritten records and reports printed on paperhandwritten records and reports printed on paper

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USERS OF FINANCIAL STATEMENTSUSERS OF FINANCIAL STATEMENTSThe financial accounts provide a wealth of The financial accounts provide a wealth of information that is useful to various users of financial information that is useful to various users of financial informationinformation

INVESTORS CUSTOMERS

MANAGEMENT OWNERS SUPPLIERS

EMPLOYEES USERS LENDERS

THE PUBLIC COMPETITORS GOVERNMENT

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• Managers:Managers: need information on a monthly basis to need information on a monthly basis to control the business, plan for the future and evaluate control the business, plan for the future and evaluate profitability. They prepare budgets based on past profitability. They prepare budgets based on past performance and they compare it to actual results. performance and they compare it to actual results.

• Owners:Owners: The financial Statements tell the owners The financial Statements tell the owners just how successful the business has been and also just how successful the business has been and also summarise in brief its present financial positionsummarise in brief its present financial position

• Investors:Investors: are concerned with how are concerned with how securedsecured and and profitable profitable is their investment in the specific company. is their investment in the specific company. This is shown in the income statement.This is shown in the income statement.

• Employees:Employees: are interested to know if an employer are interested to know if an employer can offer secure employment, possible salary increases can offer secure employment, possible salary increases and retirement benefits. They are also interested in the and retirement benefits. They are also interested in the pay and benefits obtained by senior management!pay and benefits obtained by senior management!

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• Lenders:Lenders: Banks and other financial institutions who Banks and other financial institutions who lend money to a business require to know if they will lend money to a business require to know if they will be repaid. This is shown in the balance sheet which be repaid. This is shown in the balance sheet which displays the solvency of the firmdisplays the solvency of the firm. .

• Government:Government: need to know how the economy is need to know how the economy is performing so as to plan financial policies. Also the performing so as to plan financial policies. Also the tax authorities evaluate the tax witch is payable by tax authorities evaluate the tax witch is payable by the companies with the use of financial statements.the companies with the use of financial statements.

• Suppliers:Suppliers: need to know need to know if the business is able to if the business is able to

pay short-term debt when it fallspay short-term debt when it falls due.due.

• Competitors:Competitors: wish to compare wish to compare their own their own performance against that of other firms that are performance against that of other firms that are operating in the same sector. operating in the same sector.

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Accounting Cycle During Accounting Cycle During PeriodPeriod

Also known as “Also known as “bookkeeping cycle bookkeeping cycle ”, is the process of ”, is the process of recording and processing the accounting events of a recording and processing the accounting events of a company. The series of steps begin when a transaction company. The series of steps begin when a transaction occurs and end with its inclusion in the financial statements. occurs and end with its inclusion in the financial statements.

The The mainmain steps of the accounting cycle are steps of the accounting cycle are::    

Collecting and analyzing data from transactions and events.Collecting and analyzing data from transactions and events. Posting entries to the general ledger.Posting entries to the general ledger. Adjusting entries appropriately.Adjusting entries appropriately. Preparing an adjusted trial balance.Preparing an adjusted trial balance. Organizing the accounts into the financial statements.Organizing the accounts into the financial statements. Closing the books.Closing the books. Preparing a post-closing trial balance to check the accounts.Preparing a post-closing trial balance to check the accounts.

. . 

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Forms of business Forms of business organizationsorganizations

Sole Trader:Sole Trader: Owned and operated by one Owned and operated by one person, although there might be any person, although there might be any number of employees. A Sole Trader is number of employees. A Sole Trader is fully and personally liable for any losses fully and personally liable for any losses that the business might take.that the business might take.

Partnership:Partnership: Owed Owed and operated by two and operated by two or more people called the ‘partners’or more people called the ‘partners’..

Partners are ‘jointly and severally’ Partners are ‘jointly and severally’ liable for any losses that the business liable for any losses that the business might make.might make.

Traditionally the big accounting firms have Traditionally the big accounting firms have been partnershipsbeen partnerships

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Company:Company: Owned by many people Owned by many people (shareholders)(shareholders) and and operated by many people operated by many people (thought not necessarily the (thought not necessarily the same).same).

• There can be one shareholder or many thousands of There can be one shareholder or many thousands of shareholders.shareholders.

• Each shareholder owns part of the company.Each shareholder owns part of the company.• As a group, they elect the directors who run the As a group, they elect the directors who run the

business.business.• Directors often own shares in theirs companies.Directors often own shares in theirs companies.• Not all shareholders are directors.Not all shareholders are directors.• Companies are almost always limited companies Companies are almost always limited companies

(This means that the shareholders will not be (This means that the shareholders will not be personally liable for any losses the company personally liable for any losses the company incurs).incurs).

• Their liability is limited to the nominal value of the Their liability is limited to the nominal value of the shares that they own.shares that they own.

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For all three types of organization, For all three types of organization, the money contributed by the the money contributed by the individual, the partners or the individual, the partners or the shareholders is referred to as theshareholders is referred to as the business capital.business capital.

In the case of a company the capital In the case of a company the capital is divided into shares. is divided into shares.

CapitalCapital

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Financial StatementsFinancial Statements 1. Balance Sheet:1. Balance Sheet: is a statement of the assets, liabilities is a statement of the assets, liabilities

and owners’ equities and owners’ equities as at a specific point in timeas at a specific point in time (next day (next day things could be different).things could be different).

AssetsAssets – are things – are things ownedowned by the business such as motor by the business such as motor vehicles, machinery, inventory (goods manufactured or purchased vehicles, machinery, inventory (goods manufactured or purchased for resale), money outstanding by debtors, balance at bank and for resale), money outstanding by debtors, balance at bank and prepaid expenses. prepaid expenses.

Assets are divided into Assets are divided into fixed assetsfixed assets: : A long-term tangible  piece A long-term tangible  piece of property that a firm owns and uses in the production of its of property that a firm owns and uses in the production of its income and is not expected to be consumed or converted into income and is not expected to be consumed or converted into cash any sooner than at least one year's time, and cash any sooner than at least one year's time, and current current assetsassets: the value of all assets that are reasonably expected to be : the value of all assets that are reasonably expected to be converted into cash within one year in the normal course of converted into cash within one year in the normal course of business. . business. . Goodwill is an Intangible F.A. Goodwill is an Intangible F.A.

LiabilitiesLiabilities – are amounts – are amounts owed owed such as money due to creditors, such as money due to creditors, bank overdrafts, short term loans.bank overdrafts, short term loans.

Owners’ equityOwners’ equity – is a type of liability but this amount is due to – is a type of liability but this amount is due to the owner of the business rather than to ‘outsiders’. It increases the owner of the business rather than to ‘outsiders’. It increases by any new capital brought in and by the net profit made by the by any new capital brought in and by the net profit made by the business and reduces by any amounts withdrawn by the owner. business and reduces by any amounts withdrawn by the owner.

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Statement of Financial Position Statement of Financial Position (Balance Sheet)(Balance Sheet) as at 31st as at 31st December 20YYDecember 20YY

FixedFixed AssetsAssets

Land and BuildingsLand and Buildings

Furniture and FittingsFurniture and Fittings

Motor VechiclesMotor Vechicles

GoodwillGoodwill

€

X

X

X

X

CurrentCurrent AssetsAssets

StockStock

DebtorsDebtors

BankBank

CasCash h

X

X

X

X

Capital Capital

Add Net ProfitAdd Net Profit

Less DrawingsLess DrawingsX

X

€

XX

Current LiabilitiesCurrent Liabilities (amounts due within a year)(amounts due within a year)

CreditorsCreditors

Bank OverdraftBank Overdraft

Short Term LoanShort Term Loan

X

X

X

Long-term Loan

X

X X

Long-term Liabilities Long-term Liabilities (repayable later than one year)(repayable later than one year)

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The Accounting EquationThe Accounting Equation Assets = Liabilities + CapitalAssets = Liabilities + Capital

Or otherwise :Or otherwise : Capital=Assets-Liabilities Capital=Assets-Liabilities

The balance sheet must always balance which The balance sheet must always balance which means means

must always satisfy the above equation, at any must always satisfy the above equation, at any time time

assets equals liabilities plus the capital .assets equals liabilities plus the capital .

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2. Income Statement: 2. Income Statement: Presents the results of Presents the results of operations operations for a period of time.for a period of time. It usually covers a It usually covers a year of business activity in contrast to balance year of business activity in contrast to balance sheet which is as at a specific point in time. sheet which is as at a specific point in time.

The income statement is prepared following the The income statement is prepared following the accruals accruals concept:concept: the income and expenses are recorded as they the income and expenses are recorded as they occurred regardless of whether cash has been received or occurred regardless of whether cash has been received or paid .paid .

Income Income – the sales revenue shows the income from – the sales revenue shows the income from goods/services sold in the year. goods/services sold in the year.

Expenses Expenses – in order to make revenues we must incur – in order to make revenues we must incur expenses: an outflow of money to pay for an item or service expenses: an outflow of money to pay for an item or service e.g. wages, rents, electricity e.t.ce.g. wages, rents, electricity e.t.c

The income statement is split into two parts a) the Trading The income statement is split into two parts a) the Trading account which gives the gross profit and b) the Profit & Loss account which gives the gross profit and b) the Profit & Loss account which gives us the Net Profit.account which gives us the Net Profit.

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Trading and Profit & Loss accountTrading and Profit & Loss account

Opening StockOpening Stock

Add PurchasesAdd Purchases

Less Purchases ReturnLess Purchases ReturnLess Closing stockLess Closing stock

€

X

XX

X

Gross Profit c/dGross Profit c/d

Wages and SalariesWages and SalariesInsuranceInsuranceRentRent

Depreciation of motor vehiclesDepreciation of motor vehiclesand Furniture's and Furniture's

Bad DebtsBad Debts

X

X

X

X

X

SalesSalesLess Sales ReturnsLess Sales Returns

X

€

X

Discounts ReceivedDiscounts Received

X

X

Cost of SalesCost of Sales X

X

Gross Profit b/dGross Profit b/d

Office ExpensesOffice ExpensesX

XDiscount allowedDiscount allowed

Net Profit Net Profit

X

X

X

X

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The above layout of the income statement is not mainly The above layout of the income statement is not mainly useful but it assists the appreciation of the actual double useful but it assists the appreciation of the actual double entry processes and the realization that the income entry processes and the realization that the income statement is part of the double entry.statement is part of the double entry.

The modern-vertical layout is as follows:The modern-vertical layout is as follows:

Income statement:Income statement: Trading and Profit & Loss accountTrading and Profit & Loss accountSales xSales xLess Cost of Sales:Less Cost of Sales:Op. Stock xOp. Stock xPurchases xPurchases xLess Closing stock (x) (x)Less Closing stock (x) (x)GROSS PROFIT xxGROSS PROFIT xxLess Expenses (x)Less Expenses (x)NET PROFIT xxxNET PROFIT xxx

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Main Types of Business TransactionsMain Types of Business Transactions

Duality Concept: Duality Concept: Each and every transaction that Each and every transaction that the business makes has two aspects and has a double the business makes has two aspects and has a double effect on the business balance sheet and/or income effect on the business balance sheet and/or income statement and the accounting equation.statement and the accounting equation.

B/ce SheetB/ce Sheet Incm Incm StatStat..

1. SALES OF GOODS: 1. SALES OF GOODS: If with cash cash sales If with cash cash sales If with credit debtors sales If with credit debtors sales 2. PURCHASES: 2. PURCHASES: If with cash cash If with cash cash stock stock If with credit creditors If with credit creditors stock stock 3. PURCH. OF FIXED ASSETS: 3. PURCH. OF FIXED ASSETS: If with cash cash If with cash cash F. A F. A If with credit creditors If with credit creditors F.A F.A

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B/ce SheetB/ce Sheet Incm StatIncm Stat 4. PAYMENT OF EXPENSES: 4. PAYMENT OF EXPENSES: cashcash expense expense 5. BRING NEW CAPITAL: 5. BRING NEW CAPITAL: cashcash

capitalcapital 6. DRAWINGS: 6. DRAWINGS: cash cash

capitalcapital

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The business entity conceptThe business entity concept Accepted accounting principles require that a Accepted accounting principles require that a

set of financial statements describe a specific set of financial statements describe a specific business body, which is called business body, which is called business business entityentity..

Financial Accounting information relates only Financial Accounting information relates only to the activities of the business entity and not to the activities of the business entity and not to the activities of its owner. to the activities of its owner. For e.g. if the For e.g. if the owner buys a car for him and his family to owner buys a car for him and his family to use personally, this transaction will not use personally, this transaction will not influence the balance sheet elements at all.influence the balance sheet elements at all.

The business entity is treaded as The business entity is treaded as separateseparate from its owners.from its owners.

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ExercisesExercises