ACCG 11900 Introduction to Accounting A

Lecturer - Ian Crawford

Clinics - Fridays, 12 - 1, 0C2

Notices - See Economics Dept.

Week Topic

INTRODUCTION TO FINANCIAL ACCOUNTING1 Background, introduction to the main financial statements2 The three main financial statements3 More on balance sheets and profit and loss accounts4 More on cash flow statements5 Accruals and prepayments, depreciation and sale of fixed assets,

bad and doubtful debts6 Incomplete records re debtors and creditors and cost of sales,

introduction to trial balances and double entry7 More on double entry, and more incomplete records8 Test9 Working capital management, bank reconciliations10 Ratio analysis

CHRISTMAS HOLIDAY1 PROGRESS TEST2 Tackling exam-style questions

A C C O U N T I N G I N F O R M A T I O NW h a t d o e s i t r e c o r d a n d w h o i s i t f o r ?

P a s t e v e n t s F u t u r e e v e n t s E x t e r n a l u s e r s I n t e r n a l u s e r s

P u b l i s h e d B u d g e t s S u p p l i e r s M a n a g e r sF i n a n c i a l a n d G o v e r n m e n t E m p l o y e e s

S t a t e m e n t s F o r e c a s t s C r e d i t o r sI n v e s t o r s

B a n k s S h a r e h o l d e r sO t h e r L e n d e r s

Financial Accounting

External reporting/users Legal requirements Financial information Annual

• Past events

ACCOUNTS

Paint a picture of a business at a point in time

Net worth= ASSETS – LIABILITIES

OWNS OWES

Explain how changes in the net worth came about, i.e.show

(i) Profitability(ii) Liquidity

Fundamental Accounting Concepts

Accruals (matching)

Consistency

Prudence

Going concern

Substance over Form

Rules Which Affect Accounts

Accounting Standards / Accountancy bodies

Companies Acts / Company Law

Stock Exchange Requirements

Audit Reports / Auditing legislation

Taxation Requirements

Forms of Businesses

Business is always accounted for separately

Sole Traders (single owner)

Partnerships (multiple owners)

Companies (single or multiple owners)

LLPs (multiple owners)

Incorporation as a Company

Limited liability of owners

Taxation differences (corporation tax not personal income tax)

Succession and control (company is independent of its owners)

Greater financing opportunities (e.g. listed companies sell shares to the public)

Costs of compliance and administration

3 Main Financial Statements• Balance Sheets:

– Show: ‘A snapshot of a business at a point in time.’

– Show: The net worth of a business.

– Net Worth = Owners’ equity.

• Profit and Loss Accounts:– Show: The profitability of the business.

– Explain changes in Net Worth.

• Cash Flow Statements:– Show: The liquidity of the business.

– Show: Sources and applications of funds.

– Explain changes in cash

show them Somerfield accountsexplain assets, liabilitiespoint out layout of items

Balance Sheets

• Show: – snapshot of business at point in time (the balance

sheet date)– net worth = net assets = total assets - total

liabilities– working capital (= net current assets)– owners’ equity (= capital + reserves)– sources of finance (= owners’ equity + long-term

liabilities)

The Balance Sheet Equation • Net Worth = Owners’ Equity

• Horizontal Format:– Total Assets = Total Liabilities + Owners’

Equity

• Vertical Formats:# 1 Fixed Assets + Working Capital - Long-Term

Liabilities = Owners’ Equity# 2 Fixed Assets + Working Capital = Long-

Term Liabilities + Owners’ Equity

• Discuss pictorial representation, Bristol Industries and Invented Ltd

• Point out differences in vertical formats

• note horizontal format as example 2.2 in textbook

• Explain briefly what each item is

• Start talking about differences between company accounts and other business accounts (e.g. proprietor’s capital)

• Capital and reserves:– If you don’t know how much was invested or

brought forward from last year, and how much is this year’s profit, just use the total figure.

Impact of Different Business Forms• The owners’ equity bit at the bottom of the

balance sheet changes depending on the business form

• Sole trader– no share capital, just capital. No dividends -

drawings may be either in P&L or B/S

• Partnership– like sole trader, but show each partner’s share

separately

• Company– share capital and reserves, dividends in P&L

Profit and Loss Accounts

• Show:– history book of transactions over past period– prepared on accruals basis (matching)– explains changes in net worth from one balance

sheet to the next– profit = income - expenditure– income = sales revenue (turnover) + other– expenditure = cost of sales + expenses (+ divs)– COS = op. Stock + purchases - cl. stock

• Discuss Invented Ltd, esp. with reference to dividends, and net profit/operating profit/PBIT.

• Note bank interest (on overdraft) is part of operating profit

• Explain idea of depreciation - non cash item

Cash Flow Statements

• Show:– history book of cash flows over past period– liquidity (without cash, businesses fail)– sources and applications of funds– explan changes in cash from one balance sheet to the

next

• Remember:– profit is not the same as cash, and cash is not the

same as profit

• Discuss Invented Ltd

• note depreciation is added back as it is a non cash item - explain (briefly) what it is (again!)

Balance Sheet Examples (remember the impact of different business forms)

• A. Dr Seatham Rythe

• B. Fast and Furious

• C. Cosmetics Ltd

The Ashton Company• This is still a simple example, but notice that

there are ‘incomplete records’

• This is very common - get used to it now!

• Here the only missing information is the retained profit reserve for the balance sheet - we can work it out because we know that the balance sheet should balance

• In future questions could be missing figures for sales, debtors, purchases, creditors, etc.

• Pay careful attention to the layout

How Transactions Affect the Balance Sheet

1. Joe Smith invests £1,000 cash in his new business.

How Transactions Affect the Balance Sheet

2. The business spends £100 cash on stock.

How Transactions Affect the Balance Sheet

3. The stock is sold for £150 cash.

What would have happened if the stock was sold on credit?

How Transactions Affect the Balance Sheet

4. More stock costing £50 is bought on credit.

Profit and Loss Account for this Example

The Ashton Company Again

• We have the opening balance sheet (p.19)

• We are told what transactions have occurred over the past period (September)

• We have to piece together the new (closing) balance sheet, and the profit and loss account

• Remember to distinguish cash and profit

Cash Flow Statements• Remember, these explain changes in cash• First, calculate the net cash flow from operating

activities, adding back non-cash items to operating profit (=net profit=PBIT)

• Depreciation is a non-cash item– depreciation is way of spreading the cost of a fixed

asset over its useful economic life (application of the accruals concept)

– it is deducted from fixed assets in the balance sheet (accumulated amount), and from the P&L account (charge for period only)

• Go through first example

• NOTE ERROR RE OPERATING PROFIT!– see corrected version on additional handout

• NOTE ERROR RE INTEREST PAID!– see corrected version on additional handout

• Nick’s Newsmart example