JADRANKA KAPIC, Ph.D.

ACCOUNTING

Professor Jadranka Kapic, Ph.D. ACCOUNTING Original title Raunovodstvo II izdanje 2011. godina Publisher Faculty of Economics Sarajevo For publisher Dean Professor V eljko TRIVUN, Ph.D. Reviewers Professor Mehmed JAHIC, Ph. D. Professor Selim DURMIC, Ph.D. Translation by Belma Hadzihalilovic-Kasumovic Circulation: 100CIP - Katalogizacija u publikaciji Nacionalna i univerzitetska biblioteka Bosne i Hercegovine, Sarajevo 657(075.8) KAPI, Jadranka Accounting / Jadranka Kapi ; [prevela Belma Hadihalilovi-Kasumovi]. - Sarajevo : Faculty of Economics, 2011. - 492 str. : graf. prikazi ; 24 cm Prijevod djela: Raunovodstvo. - Bibliografija: str. 487-492. ISBN 978-9958-25-062-0 COBISS.BH-ID 19039494

CONTENTSPREFACE ......................................................................................................................... 13 CHAPTER ONE ACCOUNTING FRAMEWORK 1. Introductory Review ............................................................................................... 17 1.1. Historical Evolution of Accounting ......................................................................... 17 2. Definition and Structure of Accounting .......................................................................... 20 2.1. Definition of Accounting ......................................................................................... 20 2.2. Structure of Accounting ............................................................................... 23 2.2.1. Business Objectives and Activities................................................................. 26 3. Forms of Organization of a Legal Entity ............................ 30 3.1. Sole Proprietorships ......................................................................... 30 3.2. Partnership ....................................................................................................... 30 3.3. Corporation or Company (Joint-Stock Company) ........................................... 31 3.3.1. Advantages of Joint-Stock Companies .......................................................... 32 3.3.2. Disadvantages of a Joint-Stock Company .................................. 33 4. Classification of Accounting .................................................................. 35 5. Bookkeeping Systems ................................................................................ 39 5.1. Simple Bookkeeping System ................................................................................... 39 5.2. Cameral Bookkeeping System ......................................................... 43 5.3. Constant Bookkeeping System ................................................................ 43 5.4. Double Entry Bookkeeping System .................................................... 45 CHAPTER TWO SUBJECT OF ACCOUNTING COVERAGE 6. Elements of Financial Position ........................................................................... 53 6.1. Assets .................................................................................................................. 56 6.1.1. Fixed Assets ............................................................................................... 56 6.1.1.1. Fixed Intangible Assets ......................................................... 56 6.1.1.2. Fixed Tangible Assets ................................................................... 57 6.1.1.3. Long-Term Financial Assets ................................................. 58 6.1.1.4. Fixed Assets, as Assets Held For Sale ...................................... 59 6.1.2. Current Assets ................................................................................................ 60 6.1.2.1. Current Tangible Assets ............................................................... 60 6.1.2.2. Cash, Short-Term Receivables, Short-Term Financial Placements And Prepayments and Accrued Income ........................................... 60 6.2. Liabilities ................................................................................................................. 60 6.2.1.Current Liabilities ................................................................................... 60

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6.2.2. Non-Current (Long-Term) Liabilities ............................................................ 61 6.3. Equity ...................................................................................................................... 61 7. Elements of Business Operations Performance....................................................... 62 CHAPTER THREE: ACCOUNTING PRINCIPLES AND STANDARDS AS FRAMEWORK OF FAIR FINANCIAL REPORTING 8. Accounting Principles and Standards as Framework of Fair Financial Reporting ......... 73 8.1. Generally Accepted Concepts .................................................................................. 74 8.2. Generally Accepted Accounting Principles ..................................................... 75 9. International Financial Reporting Standards (IFRS) Including International Accounting Standards (IAS) ................................................. 78 CHAPTER FOUR CONTENT OF BASIC FINANCIAL STATEMENTS (BALANCE SHEET AND INCOME STATEMENT) 10. Concept of Financial Statements ...................................................... 87 10.1. Balance Sheet .................................................................................................. 88 10.1.1. Principles of Balance Positions Entry .............................................. 90 10.1.2. Preparation and Content of Balance Sheet ............................... 92 10.1.3. Problem of the Valuation of Balance Positions ............................ 94 10.1.4. Basic Balance Changes ............................................................................ 97 10.1.4.1. Increase of Assets and Increase of Liabilities ............................ 97 10.1.4.2. Increase of Assets with Simultaneous Decrease of Assets ........ 98 10.1.4.3. Decrease of Assets and Decrease of Liabilities ......................... 99 10.1.4.4. Increase of Liabilities with Simultaneous Decrease of Liabilities ............................................................. 100 10.1.5. Types of Balance Sheet .......................................................................... 101 11. Income Statement ....................................................................................................... 105 11.1. Concept and Content of Income Statement ........................................................ 105 11.1.1. Form and Preparation of Income Statement ........................................... 109 11.1.2. Components of Income Statement of Service and Trade Companies ..... 127 CHAPTER FIVE CHARACTERISTIC, CONTENT AND PHASES OF ACCOUNTING PROCESS 12. Characteristic and Phases of Accounting Process ...................................................... 137 12.1. Business Transaction as an Input of Accounting Process .................................. 139 12.2. Bookkeeping Documents .................................................................................. 140 12.2.1. Classification of Bookkeeping Documents ............................................ 141

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12.2.2. Validity of Bookkeeping Documents ..................................................... 143 12.2.3. Preservation of Bookkeeping Documents ............................................. 144 13. Bookkeeping Accounts .............................................................................................. 145 13.1. Concept and definition of Account ................................................................... 145 13.1.1. Types of Accounts ................................................................................. 146 13.1.2. Types of Bookkeeping Accounts ........................................................... 148 13.1.3. Explanation of concepts payable and receivable ............................. 150 13.1.4. Opening of Bookkeeping Accounts ....................................................... 154 13.1.5. Fundamental Rules of Recording Business Events. in Bookkeeping Accounts ...................................................................... 155 13.1.6. Closure of Bookkeeping Accounts ......................................................... 156 13.1.7. Chart of Accounts .................................................................................. 158 14. Business Books .......................................................................................................... 162 14.1. Main Business Books ........................................................................................ 162 14.1.1. Day-Book ............................................................................................... 162 14.1.2. General Ledger ...................................................................................... 168 14.2. Sub-Ledger Business Books .............................................................................. 170 15. Financial Statements as Outputs of Accounting Process ........................................... 172 15.1. Pre-Conclusion Activities ................................................................................. 172 15.2. Inventory .......................................................................................................... 173 15.3. Bookkeeping Errors and Methods of Their Correction ...................................... 177 15.4. Gross Balance and Closing Sheet ...................................................................... 182 15.5. Preparation of Main Financial Statements ......................................................... 186 CHAPTER SIX ACCOUNTING COVERAGE OF TYPICAL BUSINESS EVENTS OF ACCOUNTING PROCESS 16. Accounting of Non-Current Assets ............................................................................ 197 16.1. Non-Current Intangible Assets .......................................................................... 197 16.1.1. Patents, Licenses, Concessions, Trademarks and Other Rights .............. 200 16.1.2. Foundation Costs / Costs of Foundation ................................................. 201 16.1.3. Development Costs ................................................................................ 203 16.1.4. Goodwill ................................................................................................ 205 16.2. Current Tangible Assets .................................................................................... 209 16.2.1. Land ....................................................................................................... 210 16.2.2. Property, Plants and Equipment ............................................................. 212 16.2.2.1. Acquisition of Construction Buildings From Own Assets ....... 214 16.2.2.2. Construction Buildings ........................................................... 216 16.2.2.3. Construction of Buildings From Own Assets .......................... 218 16.2.2.4. Acquisition of Plants and Equipment From Own Assets ......... 221 16.2.2.5. Acquisition of Plants and Equipment From Borrowed Funds, use of bank loans .................................................................... 222 16.2.2.6. Acquisition of Non-Current Assets within Gov. Grants and Gov. Assistance ........................................... 224

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16.2.3. Subsequent Costs Investment In Assets (non-current intangible assets) ............................................... 227 16.3. Depreciation Cost .............................................................................................. 229 16.3.1. Elements Influencing Calculation Of Depreciation ................................ 230 16.3.2. Methods of Depreciation ........................................................................ 234 16.3.2.1. Linear Depreciation Method ................................................... 234 16.3.2.2. Digressive Depreciation Method ............................................. 235 16.3.2.3. Progressive Depreciation Method ........................................... 237 16.3.2.4. Functional Depreciation Method ............................................. 238 16.3.2.5. Calculation and Book Recording of Depreciation Costs ......... 238 16.4. Change of Depreciation rates ............................................................................. 240 16.5. Withdrawal from Use, Disposal and Removing from Books, Property, Plants and Equipment ........................................................................ 242 16.5.1. Withdrawal of Assets from Use ............................................................. 242 16.5.2. Writing Off Property, Plants and Equipment ......................................... 243 16.5.3. Sale of Property, Plants and Equipment not classified in Accordance with IFRS to be Held for Sale ................. 244 16.6. Long-Term Financial Investments ..................................................................... 247 16.6.1. Interests (Shares) in Associated Legal Entities ...................................... 248 16.6.2. Interests in Dependant Entities and Other Associated Legal Entities .... 248 16.6.3. Loans to Associated Legal Entities ........................................................ 249 16.6.4. Interests in Non-Associated Legal Entities ............................................ 249 16.6.5. Extended Loans ...................................................................................... 251 16.6.6. Investment in Debt Securities ................................................................ 251 16.7. Long-Term Receivables .................................................................................... 253 17. Accounting Coverage of Current Assets .................................................................... 255 17.1. Concept of Current Assets ................................................................................. 255 17.2. Accounting Monitoring of Cash and Cash Equivalents ..................................... 256 17.2.1. Petty Cash .............................................................................................. 257 17.2.2. Provisional Gyro Account ...................................................................... 259 17.2.3. Issued Foreign Exchange Letter of Credit .............................................. 261 17.2.4. Cheques ................................................................................................. 262 17.2.5. Bill of Exchange ..................................................................................... 263 17.3. Short-Term Financial Investments .................................................................... 268 17.3.1. Accounting Problems of Monitoring Extended Short-Term Loans ........ 269 17.4. Accounting Monitoring of Receivables from Buyers ........................................ 271 17.5. Accounting Monitoring of Inventories .............................................................. 272 17.5.1.Accounting Monitoring of Inventories of Material ................................. 272 17.5.1.1. Accounting Monitoring of Material in phase of acquisition (purchase) and Storage ...................... 273 17.5.1.2. Book Recording and Calculation of Material Acquisition cost, when Variable Costs are Allocated to Several Types of Material .................................. 274 17.5.1.3. Material in Finishing Off and Processing ............................... 280 17.5.1.4. Accounting Monitoring of Material Consumption ................. 284

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17.5.1.5. Surpluses of Material in Warehouse ........................................ 293 17.5.1.6. Accounting Monitoring of Material Disposal ......................... 294 17.5.1.7. Accounting Monitoring of Inventories of Spare Parts and Small Inventory ................................................................299 17.5.2. Accounting Coverage of Goods ............................................................. 302 17.5.2.1. Inventories of Goods in Wholesale Shop ................................ 305 17.5.2.2. Increase and Decrease of Selling Price .................................... 308 17.5.2.3. Goods in Shop ......................................................................... 309 17.6. Analysis of Inventories ...................................................................................... 310 17.7. Prepaid Costs of Future Period (Prepayments and Accrued Income) ................ 311 18. Accounting Coverage of Equity ................................................................................. 314 18.1. Concept of Equity .............................................................................................. 314 18.2. Shares as Financing Instrument of Joint-stock Company .................................. 315 18.3. Accounting Monitoring of Changes in Earned Equity ....................................... 322 18.3.1. Dividends ............................................................................................... 322 18.3.2. Declaration and Payment of Share Dividends ........................................ 325 18.4. Loss ................................................................................................................... 327 18.5. Earning per Share .............................................................................................. 329 19. Accounting Coverage of Liabilities ............................................................................ 333 19.1. Long-Term Liabilities ....................................................................................... 335 19.2. Current (Short-term Liabilities) ......................................................................... 342 CHAPTER SEVEN COST ACCOUNTING 20. Cost Accounting ......................................................................................................... 349 20.1. Concept of Costs ............................................................................................... 349 20.1.1. Classification of Costs ........................................................................... 350 20.2. Accounting Monitoring of Costs Per Natural Types .......................................... 352 20.2.1. Costs of Material, Energy, Spare Parts and Small Inventory .................. 353 20.2.2. Costs of Employees ................................................................................ 358 20.2.3. Costs of Services .................................................................................... 361 20.2.4. Allocation of Costs ................................................................................. 371 20.3. Accounting Monitoring of Production Process .................................................. 375 20.3.1. Cost Calculation Methods and Systems ................................................. 378 20.3.1.1. Cost Calculation Methods ....................................................... 379 20.3.1.2. Transfer of Production Costs and Use of Calculation .............. 381 20.1.2.3. Calculation Methods ............................................................... 381 20.3.1.4. Accounting Monitoring of Final Products ............................... 387 20.3.2. Cost calculation Systems ....................................................................... 392 20.3.2.1. Cost Calculation Systems in Accordance with Actual Costs ... 393 20.3.2.2. Calculation System Per Standard Costs ................................... 404 20.3.2.2.1. Concept of Standard Costs .................................... 404 20.3.2.2.2. Calculation System per Standard Costs ................. 406

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CHAPTER EIGHT ACCOUNTING COVERAGE OF REVENUES, EXPENSES AND DETERMINATION OF FINANCIAL RESULTS 21. Accounting Coverage of Revenues ............................................................................ 425 21.1. Definition and Structure of Revenues ................................................................ 425 21.2. Measurement and Recognition of Revenues ...................................................... 426 21.3. Operating Revenues .......................................................................................... 429 21.3.1. Revenues From Sale of Products ............................................................ 429 21.3.2. Revenues From Provided Services......................................................... 432 21.3.3. Revenues from Sale of Goods ................................................................ 434 21.3.3.1. Revenues from Wholesale Goods ........................................... 434 21.3.3.2. Revenues from Sale of Goods in Transit ................................. 437 21.3.3.3. Revenues from Sale of Goods in Retail Shop .......................... 439 21.4. Financial Revenues ............................................................................................ 442 21.4.1. Revenues From Interests ........................................................................ 442 21.4.2. Positive Foreign Exchange Differences ................................................. 444 21.4.3. Revenues in the Amount of Realized Gains at Sale of Shares and Business Interests ............................................................................ 446 21.4.4. Gains from Sale of Property, Plants and Equipment .............................. 448 21.5. Other Revenues ................................................................................................. 449 21.5.1. Revenues from Subsidies, Grants, Subventions, Incentives ................... 449 21.5.2. Revenues From Written-off Liabilities and Collected Previously Written-Off Liabilities ......................................................... 451 21.5.3. Revenues from Penalties, Fines, Rewards, Withdrawal Fees ................. 451 21.5.4. Revenues from Sale of Material, Spare Parts and Small Inventory ........ 451 21.5.5. Other Revenues ...................................................................................... 452 21.5.5.1. Revenues from Cancellation of Value Correction of Inventories .......................................................................... 452 22. Accounting Coverage of Expenses ............................................................................. 454 22.1. Definition and Structure of Expenses ................................................................ 454 22.2. Operating Expenses ........................................................................................... 456 22.2.1. Costs of Sold Products ........................................................................... 456 22.2.2. Costs of Provided (Calculated Services) ................................................ 457 22.2.3. Acquisition Cost (Acquisition Value) of sold Goods as Expenses in Income Statement .................................. 457 22.2.4. Distribution Costs .................................................................................. 458 22.2.5. Costs of Management, Sale and Administration .................................... 459 22.2.6. Inventory Value Adjustment .................................................................. 460 22.2.7. Other Operating Expenses ...................................................................... 463 22.3. Financial Expenses ............................................................................................ 463 22.3.1. Interests .................................................................................................. 464 22.3.2. Negative Foreign Exchange Differences ................................................ 466 22.3.3. Losses From Impaired Value and Disposal of Fixed Assets ................... 469

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22.3.3.1. Losses From Impairment and Disposal of Property, Plants and Equipment ............................................................. 470 22.3.3.1.1. Losses From Impairment of Property, Plants and Equipment ........................................... 470 22.3.3.1.2. Losses From Disposal (sale) of Property, Plants and Equipment ........................................... 472 22.4. Other Expenses .................................................................................................. 473 22.4.1. Acquisition Value of Sold Material, Spare Parts and Small Inventory ... 474 22.4.2. Donation Expenses ................................................................................ 474 22.4.3. Shortages ............................................................................................... 475 22.4.4. Fines, Penalties and Damage Compensation .......................................... 477 22.4.5. Non-Performing Receivables Write-Off ................................................ 477 23. Determination of Financial Results ............................................................................ 483 Bibliography .................................................................................................................... 487 Other Material .................................................................................................................. 491

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PREFACE

The book entitled Accounting is primarily intended for the students of the School of Economics and Business in Sarajevo, for studying the course of the same title, but those interested in the company accounting issues, may also use it. Taking this as a starting point, this book is structured in an appropriate manner comprised of eight chapters. At the beginning of each chapter, the objective aims of studying have been indicated as a notice to the readers as to what they can learn if they study that particular part of the book. At the end of each chapter, check-up questions for verifying the knowledge and understanding have been pointed out. In the first chapter, introductory topics are discussed, such as an introduction to historical evolution of accounting, defining accounting, structure of accounting, business aims and activities, organization of legal entities, classification of accounting and book-keeping systems. The second chapter is devoted to the financial position elements and financial performance of business operations of a legal entity. There is an approach of correct defining and classification of assets, liabilities, equity, revenues, expenses and defining of operating results. The third chapter starts with accounting principles, assumptions and standards as frameworks for preparing and presenting financial reporting. The fourth chapter is devoted to the basic financial statements as a base for studying accounting. The aim of these presentations is to acquaint the readers with the meaning and use of balance sheet for assessing financial stability of a legal entity, and income statement for assessing business profitability. This chapter elaborates the principles of the valuation of balance positions. In this regard, there are special emphases on the link between basic financial statements prepared on the basis of economic categories (balance sheet and income statement). With this, main financial statements of manufacturing companies, which are predominantly intended for the needs of external users, are completed. At the end of this part of the book, the issue related to the components of income statement of service and trading companies is elaborated. The fifth chapter starts with the explanation of accounting process. It is conceived in a manner that students can get acquainted with the basis of this process. Thus, we start with the phases of accounting process (input, processing, output), which corresponds with the approach of the book and preferring the accounting as a part of an information system of a legal entity. The conceptual part elaborates business transactions and bookkeeping documents as evidence on validity of a business event occurrence and basis of data entry into the accounting process (input). Following this, bookkeeping accounts and business books as instruments of the accounting process, which perform pre-conclusion activities of the process (inventory, error correction, preparing a trial balance) are elaborated and, at the end, conclusion activities and preparation of main financial statements. In order to deepen the acquired knowledge, a simplified example of preparing basic financial statements has been provided in the book.

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The sixth part of the book is related to the content of theory and application, with the aim of deepening previously acquired knowledge about basic economic categories, their phases and their undergoing processes, as well as the basis of the accounting coverage. In that respect, the accounting issue of non-current assets is first elaborated. By following the accounting process it is going through, this part also elaborates the accounting issue of depreciation. Following this, there is an explanation of the accounting issue of monitoring the process within current assets. This part does not elaborate the accounting issue of monitoring the production and final products, although these assets are included in current assets. Respecting the logic of assets circulation, the accounting issue of monitoring production and final products is elaborated in the part of the cost accounting. Starting from basic financial statements as a base and a starting point of studying accounting, in further elaboration, focus is on the accounting issue of equity and liabilities. In this part the acquired knowledge on the accounting understanding of equity is extended, by elaborating the problem of the accounting monitoring of the paid shareholders equity, treasury shares, earned equity, as well as loss and its coverage. This part of the book further elaborates the meaning of liabilities and examples of liabilities classification are provided. The focus is on recognition and valuation of liabilities, as well as the accounting treatment of provisions as potential liabilities. The seventh chapter is planned for elaborating the basic problem, presentation of the accounting information mainly for the needs of internal users. The focus of presentation is on further elaboration of costs-related problem classification of costs for the needs of internal reporting, places and bearers of costs and cost calculation systems. At the end of this part of the book, students shall get familiar with foundations of the accounting for the needs of managing, i.e. managerial accounting. In that respect, fields related to standard costs and areas of their application are elaborated, preparation of plans of legal entities, as well as the possibility for monitoring the realization of the planned volumes. In the eighth part, the accounting problem of monitoring the elements of income statement is elaborated, and is divided into the areas of revenues, expenses and determining the operating results. At last, I would like to thank Professor Mehmed Jahic, Ph.D. and Professor Selim Durmic, Ph.D. for their efforts in reviewing the book, to the publisher School of Economics and Business of Sarajevo University, which accepted publishing of this project, as well as to the users of the book from whom I expect well-intentioned suggestions for improving quality of this university book. Sarajevo, 2011 Author

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CHAPTER ONE

ACCOUNTING FRAMEWORKStudy objectives1. Historical evolution of accounting 2. Defining accounting and its role in business decision-making process 3. Forms of organization of legal entities 4. Accounting classification 5. Bookkeeping systems

1. INTRODUCTORY REVIEW

Major work in the world is performed in the companies. Companies are groups of people that work together for achieving one or more objectives. In their work, companies use resources building, equipment, material and various services. All these resources are to be paid and financed. For their work to be effective, people, that is, managers in the company, require information on the values of mentioned resources, ways of their financing and results achieved with their use. Stakeholders outside the company need relevant information in order to make judgments about the company. Accounting is a system which provides relevant information. Companies may be classified as profit and non-profit companies. The main objective of companies from the first group is achieving profit, while companies from the second group have other objectives, such as: managing state-related issues, provision of social services, education, etc. Out of total number of employees in developed countries (eg.USA) almost two thirds work in profit companies, and one third in the state and other non-profit companies. Accounting of profit and non-profit companies in basic lines is similar. Therefore, the focus of presentation is on the accounting of profit-making companies.

1.1. HISTORICAL EVOLUTION OF ACCOUNTINGAccounting dates back to many centuries. Naturally, we cannot know when people started doing accounting in their heads. Through the history, it is known that 5 000 BC transactions between tribes of Sumerian civilization were recorded by using symbols, also these symbols were used in Mesopotamia around 3 200 BC. Such records were written on boards made of clay. Clerks in Babylon and Egypt acquired formal accounting education before 3000 BC. Persia under Dario (521-486 BC) had government clerks who conducted sudden audits of the province accounting, and in Jewish civilization similar audits were conducted, where the main clerk was at the second ranking position in the Government. In Ancient Greece, in 1400 BC, it was usual that slaves were both clerks and auditors. Slaves could be tortured, and it was supposed that reports of slaves were more realistic than reports of free persons, as free persons were protected by law from drastic technique of verification of correctness. Accounting in Greece got more important. On the state buildings, records on expenditure of their construction were carved. For example, a board on Parthenon displayed that it had cost 469 silver talents or around USD 2 million, at the current values. For comparison purposes, Keops Pyramid in Egypt had cost 1 500 talents, and this data goes back to the accounting records carved on the pyramid on which Herodot made reports. In the Roman Empire, in 200 BC,

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treasurers (lat. Quaestor) (principals of office of the State Property Management) of certain regions, were responsible for monitoring local state accountants. Treasurers (quaestors) had themselves submitted reports, when they were questioned by examiners, from which the modern expression auditor (from Latin word audire which means listening) originates. In the early 4th century, in Byzantine Empire, Konstantin established a public administration school in which accounting was taught. Roman Empire under Karlo the Great (742-814) applied Roman and Persian examples of state accountants and auditors. Following the Kings death, the Parliament was dismissed, and the Empire collapsed.1 Special importance for the evolution of accounting in the Middle Ages was introduction of Arabic numbers (Fibonacci, 12th century), as well as discovery of mechanical movable type printing (Johannes Gutenberg, early 15th century first printing house in Mainz, Germany). Members of rich classes of owners, traders and priests, above all, literate and privileged, were accountants in the Middle Ages. Evolution of accounting and accounting profession was based on transfer of skill and tradition in keeping book records. At that time, there was no education system for the accounting profession. Traditional transfer of accounting skill, especially double-entry bookkeeping, was developed and maintained by wellknown Venetian, Genovian and Florentine families (Bracci, Lorenzo, Medici). In the 15th century, branches of the family Medici Bank had to submit annual balance sheet to the Main Office in Florence. In England, for example, Henri VII supported accountants. In the accounting history, a special place is dedicated to the double-entry bookkeeping. A large number of accounting historians, especially Italians, explore occurrence and evolution of double-entry bookkeeping. Genova and the 15th century are treated by Italian accountants as a place and time of emergence of double-entry bookkeeping. Therefore, in Genova in 1340 the oldest General Ledger was found (Massari of Genova)2 in which trading transactions were recorded in accordance with the double-entry bookkeeping principle. Italian Luka Pacioli and Benko Kotrulic from Dubrovnik had a huge historical role in the evolution of accounting. Double-entry bookkeeping system, which represents a spine of accounting, was published in a written form by Luca Pacioli in 1494 in the book named Summa de arithmetica, geometria, proportioni, et proportionalita,3 printed in Venice. Therefore, the work of Luca Pacioli is the first printed work in which the author systematized and popularized double-entry bookkeeping method, and accounting profession regards him as the father of modern accounting. The latest research determined that the first written scientific document on double-entry bookkeeping methods was written by Benko Kotrulic in Napoli in 14581

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Willard E. Sone, Antecedents of the accounting profession, Accounting review, April 1969, page 284-290. R. Riahi-Belkaovi, Accounting Theory, Business press, London, 2000, pg. 2 Gray / Needles, Financial Accounting, General approach, Banja Luka, 2002, pg. 56 (translation)

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On Trade and Perfect Trader and published in Venice in 1573. In its work, the author explained accounting principles, and especially principles of accuracy, promptness and disclosure of traders book.4 In 1605, Dutch engineer and mathematician S. Stevin made the first annual financial statement, and in 1673 French J. Savary prescribed creation of balance sheet every two years under the influence of the French Trade Law (CODE DE COMMERCE). At he end of the 17th and in the early 18th century, industrial revolution and needs of international market imposed an imperative of a growing harmonization of legal regulations in the accounting field. Evolution of accounting profession limited further development of accounting, and thus creation of a good quality of the accounting legislation. Market development required a systemic approach to the education for the accounting profession only as from the 19th century. Preconditions for development of the accounting profession were: - development of professional associations and - introduction of accounting at universities. In England in 1854 the first association of accountants was established, and in 1880 the Institute of Certified Public Accountants of England and Wales was established. In 1887, the first accounting association was established in the USA, American Association of Public Accountants (AAPA) which, in its articles of association clearly defined the accountants education programme. In 1896, The State of New York passed the Law on Certification of Public Accountants (Certification of Public Accountants). In 1900 School for Accounting, Finance and Trade was opened at New York University and thereby the most important step was made in the University education of the accounting profession. The twentieth century is the century of full development of the accounting profession. Technology revolution during the 20th century speeded up growth of financial markets and the need for harmonization of the accounting practice regulation and reporting practice increased. At the end of the 20th and in the early 21st century, globalization of world economy imposed an imperative for harmonized basis of financial reporting. Although most countries had their national accounting standards developed, for the reporting needs at the international markets, US Accounting standards (USGAAP)5 or international financial reporting standards66 were used.

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For further details see: M. Z ebic, Life and Work of Benko Kotrulic from Dubrovnik and his records: On Trade and Perfect Trader, Titograd, 1963. Georgette i. Bailey, Ken Wild, International Accounting standards: A guide to preparing accounts accountancy books, Institute`s Publisher, Deloite & Touche, 1998. B. Needles, Financial Accounting Houghton Mifflin, co., Boston, 1989, pp. 2-12.

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2. DEFINITION AND STRUCTURE OF ACCOUNTING2.1. DEFINITION OF ACCOUNTINGIn the course of a long historical evolution of accounting, its various definitions have come up from a vast number of individuals and accounting institutions, as a result of various approaches, technical basis of accounting, objectives and users of reporting. Defining the accounting is often a research challenge, but is not an easy task of the accounting researchers. Research of the role and structure of accounting is a demanding research task, especially in the modern circumstances of globalization of financial markets and modern information technology. The following aspects are most often mentioned in the accounting literature of developed countries: accounting as an art, technique or skill; accounting as a scientific discipline; accounting as a service function of a legal entity / company; accounting as a part of the management accounting system of a legal entity / company.

Accounting as an art, technique or skill Accounting as an art, technique or skill is the oldest definition which, under accounting, implies art or skill of recording business events. This definition dates back to the period of medieval Italian families (the Florence family Medici is important). A similar definition was made in 1941 by the American Institute of Certified Public Accountants (AICPA), which defines accounting as an art of recording, classifying and summarizing in terms of money expressed business transactions, as well as interpretation of results of this art7. We often talk about accounting as a business language or language of financial decision-making process, and it needs to be learned with the aim of managing the company. Accounting as a scientific discipline The focus of many authors is defining accounting as a scientific discipline. E.S. Hendriksen provided the most important definition of accounting as a scientific discipline in which he claims: Accounting as a theory may be defined as a logical making of conclusions on the basis of establishing principles that provide a7

B. E. Needles, Financial... quoted, pp. 2-3; W. B. Meigs, R. F. Meigs, Accounting: The basis for business decision, McGraw Hill, New Y ork, 1987.

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framework in which accounting practice operates, but also a guide for development of new practice and procedures.8 According to the systematization of disciplines of economy and management studies9, there are two fields of research with the attached disciplines which include accounting: 1) functional accounting (finance, marketing, human resources management and production management) and 2) instrumental accounting (a science about computers, management, management economics and quantitative analysis). Each of these scientific disciplines, including accounting, has its positive and normative features. Positive features of accounting, that is, accounting theory, , include all the existing knowledge on the accounting terms, categories, principles, procedures, methods and instruments. This is the knowledge about accounting category system. Normative part of accounting means application of adopted accounting principles, procedures, methods and instruments for achieving certain objectives. That part of accounting includes positive legislative regulation from the field of accounting and adopted accounting standards, which represent a framework for defining the accounting policy. Accounting theory (principles, methods and similar) is created on the basis of research of the accounting practice. Therefore, accounting practice supplements the theory, and vice versa. Accounting as service function When a legal entity company is observed as a group of functions, it is not disputable that accounting is one of the service functions, which generates the accounting information for its users. Thus, a group of authors emphasize the following definition: Accounting is a service function of a company. The function of accounting is provision of accounting information on business events to the stakeholders such as managers, investors and lenders.10 Accounting as a service function that provides relevant accounting information to the internal and external users is also defined by AICPA, which claims that accounting should ensure quantitative information, primarily of financial nature on business operations of a company with the aim of using them in business decision-making process11.

8 9 10

11

E. S. Hendriksen, Accounting theory, R. D. Irwin, Illionois, 1963, pg. 1. E. S. Hendriksen, Accounting theory, R. D. Irwin, Illionois, 1963, pg. 1. L. G. Chasteen, R. E. Flaherty, m. C. O,connor, Intermediate Accounting, McGraw Hill, New Y ork, 1989, pg. 1. AICPA: Statement of the accounting principles Board, No. 4., item. 40., New Y ork, 1970.

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Information provided by accounting for the purpose of decision-making process should meet the following qualitative criteria: relevance, reliability, comparability and understandability. Accounting as a part of management information system of a legal entity With the development of information technology in the seventies and eighties12 there is a frequent definition of accounting as a part of information system. One of the widely accepted definitions of accounting as a system is the following: Accounting is an information system. Accounting information system is a sub-system of management information system13. This definition of accounting as an information system has been further processed and put in more concrete context: Accounting is information system which measures business events, processes information into reports, and communicates through the information with the decision makers of a legal entity14. Accounting, although treated as a sub-system of major management information system, also represents a system with all the elements that are inter-linked (input, process and output), and this is illustrated in the following manner15:

Figure 1. Accounting as an information system for business decision-making process of a legal entity

12 13 14 15

Gray / Needles: Financial...,quoted, pg.. 3. Gray / Needles: Financial..., quoted, pg. 3. Gray / Needles: Financial...,quoted, pg. 4. Gray / Needles: Financial Accounting, A Global Approach Houghton Mifflin Company, Boston, 1999, pp. 3. and 4.

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As shown on the figure, accounting as an information system is comprised of the following elements: valuation, that is, measurement or quantification of business events in value indicators, as well as their recording in the accounts (input), processing or data processing in business books and preparation of financial statements, and disclosure of financial statements with which accounting communicates with the internal and external users of financial statements and thus provides them with the information necessary for business decision-making process (output).

2.2. STRUCTURE OF ACCOUNTINGA content or structure of accounting is a dynamic category. The content changed as the environment changed, and thereby the concept of accounting. Content of accounting is directly conditioned by the concept, that is, objectives of accounting, assumptions and accounting principles. Accounting concept, according to the research conducted by the American AICPA in 1959, was developing from traditional to modern.16 According to the traditional concept, accounting was primarily classified in line with the category system and accounting procedures in terms as to what is accounting. According to this concept, the targeted orientation of accounting was of secondary character. Modern accounting concept, which has been dominating from early sixties until now, subordinates the content of accounting to the objectives of the users of accounting information. Information users (internal and external) in a modern accounting concept, are at the first place. Starting from the users objectives, a modern functional structure (content) of accounting has also been determined. According to this concept, accounting performs several functions that may also be formed as organizational parts of accounting, and those are17: 1) 2) 3) 4)16

function of data processing in the future, function of data processing in the past, function of monitoring of data processing and function of data analysis.

17

Report of AICPA, according to: E. S. Hendriksen, Accounting Theory, R. D. Irwin, Illionis, 1963, pp. 6 and 7. Evolution and Definition of Traditional Accounting Concept in Anglo-Saxon region according to: E. S. Hendriksen, Accounting Theory, quoted, pp. 15-34.

23

Accounting theory and practice in the 1960s and `1970s in our region accepted the structure of accounting, whose constituent parts are:

Figure 2. Structure (content) of accounting

Accounting planning is focused on data processing in the future. For making efficient business decisions, not only what happened in the past is relevant, but we also require business information on how to channel business activities, how it should be, how we would want it to be, and thus, we have accounting planning. On the basis of relevant accounting information, though not only accounting information, but also information from other functions, we plan data in accounting terms that will be the subject of bookkeeping records. The aim of accounting planning is projection and presentation of information related to the future financial position, performance and changes of financial position of a legal entity. Results of accounting planning are different types of preliminary calculations, planned calculations or reports, plans (estimates), etc. Strategic planning is not accounting planning. It is conditioned by the evolution of science and technology, etc. It is a long-term and medium-term planning. Accounting planning is specific by its short-term nature within a business year, which coincides with a calendar year (twelve months), so we reconcile a fiscal year 01. 01. 31. 12. of a current year. Bookkeeping is the most important part of accounting according to this concept. Bookkeeping records, in line with the double-entry bookkeeping, all the occurred business events that fulfill the criteria to become the subject of the bookkeeping records. There are following conditions: 1) business events should occur historical character; 2) they should be documented based on the valid document, i.e. in a form of electric records; 3) they should be presented in value; 4) they should have an impact on a change of accounting categories (assets, liabilities, equity, revenue, expenses, financial result and its allocation). Business events that meet the requirements of bookkeeping events shall be entered into business books which are classified into basic books ( day-book and

24

general ledger) and sub-ledger records (petty-cash, inventory book and various sub-ledger records). The final result of entire bookkeeping process is a comprehensive set of financial statements (balance sheet, income statement, statement on equity changes, cash flow statements and records attached to financial statements). Technique of bookkeeping data processing may be traditional (based on a simple manual processing, using simple tools) and modern (uses modern information technology). After preparation, financial statements are disclosed to the internal and external users. Accounting control is part of accounting which verifies accuracy and quality of data contained in the results of the accounting planning and bookkeeping. There are two aims of accounting control: 1) protection of assets from loss and theft and 2) provision of accuracy of accounting data. Traditional concept of accounting control relates to the primary control of documentation (formal, material), and to the control of the accounting procedures from data entry to their processing and reporting. A modern concept of internal control systems, as well as monitoring system, significantly differs in conceptual terms from the traditional one. Accounting analysis links the results of the planning process with the results of bookkeeping processing (estimates, calculations, financial statements, etc). The aim of analysis is to determine discrepancies between the planned aims and achieved results, as well as to determine the causes of the occurred discrepancies. Only on the basis of a qualitative analysis of objectives (planning) and achieved results (estimates and financial statements) management may undertake appropriate measures for removing occurred discrepancies. Such a concept of accounting analysis significantly differs in the objectives and structure from modern financial analysis and analysis of financial statements (vertical and horizontal analysis, as well as analysis of indicators). Accounting disclosure has a task to present the relevant accounting information to the users, which is a result of planning process, bookkeeping, control and analysis. Information should be relevant, reliable, comparable and understandable. Users can receive such information in traditional forms (written report or verbal information) or through modern media (internet or e-mail). Accounting disclosure or, as we often come across in the literature, the accounting information is a part of the entire system of information and presents provision of accounting data and information to their users,18 especially to the company management with the aim of achieving business objectives.18

Mehmed Jahic Financial Accounting, Institute for Accounting and Audit of FBH, Sarajevo, 2003, pg. 8.

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2.2.1. Business objectives and activitiesBusiness operations represent an activity of a legal entity whose aim is production and sale of products, sale of goods or services to the buyers at prices that will ensure an adequate return to its owners.19 For example, some companies that sell basic products, goods or services are: Volvo cars, trucks and buses, Nike sports wear and footwear, Sony wholesale electric devices, Hilton hotels hotel services, British Airways services of passenger air-traffic. Therefore, owners of initial capital (investors) invest capital (in a form of money, objects, rights), establish a company with the aim of achieving a profit or return on invested capital (principal) by engaging into business activities. A need to realize, that is, to earn a satisfactory profit, in order to attract and retain invested capital, is an objective called profitability. Apart from this, business activities must achieve the second objective, and that is liquidity. Liquidity is possession of sufficient available financial means to pay out due debts. A company endeavors to achieve business objectives (profitability, liquidity) by getting engaged in business activities. It is often illustrated in the following manner20:

Figure 3. Business objectives and activities19 20

Gray / Needles, Financial...,quoted, pg. 4. Gray / Needles, Financial..., quoted, pg. 5.

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Business activities within regular business operations of a company, respecting business continuity principle, have three elements: 1) Financial activity acquiring initial capital from owners or lenders / banks in order to resume regular business operations. Financial activity implies debt repayment to creditors and payment of yield on investments / profit to the owners (eg. dividend payment, which may be treated as investment in progress by shareholders). 2) Each company also needs to have investment activities. For the acquired initial capital, a company purchases land, buildings and other resources, in order to resume regular business operations, which belong to the field of investment activities. 3) Each company also operates with regular activities; those are the so-called operational activities production and sale of products to buyers, acquisition and sales of goods, sales of services, employment of managers, employees and payment of taxes to the state. Decision makers users of accounting information There are numerous users of accounting information on financial position, performance and changes of financial position of a legal entity. It is often illustrated as follows21:

Figure 4. Users of accounting informtion21

Gray / Needles, Financial..., quoted, pp. 7-10.

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The figure shows internal and external users of accounting information in order to make decisions, and those are management, that is, persons that manage business operations, as well as an entire number of stakeholders, including investors, employees, lenders, suppliers and other trading creditors, customers, government bodies and their agencies, as well as public. Management (heads and administration) has the biggest responsibility for preparation and presentation of a set of financial statements of a company, not only for its own use, but also for other users that rely on financial statements, which are their main source of information on financial position assessment, performance and changes of financial position of a legal entity. Lenders are interested in a full set of financial statements that will enable them to determine whether their loans and the interest attached to them, will be paid when due. Investors are owners or potential owners of shares of a legal entity. They provide risk capital, and are interested in the return on their investments, as well as in possible risks which such investment carries. Investors require accounting information that will help them make a decision to hold, purchase or sell shares of a legal entity. Employees are interested in an indicator on financial position, that is, performance of business operations and prospects of a company, its development from the aspect of safe employment, level of salaries, working conditions. Suppliers and other creditors are interested in information that enables them to determine whether amounts owing to them will be paid when due. Creditors are normally more interested in a short-period survival of a company, unless they continuously rely on a legal entity as their major customer. Customers are interested in information on business continuity of a legal entity, especially when they depend on it or they have long-term business relations. Government and their agencies are interested in information on activities of a company with the aim of distribution of resources, economic policy, possibility of tax collection. Public. Accounting information is important for informing the public and its representatives. Thus, for example, a legal entity may contribute to local economy development in several ways, such as employment of large number of people or patronage of local suppliers.

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It is relevant to note that companies worldwide prepare and present a full set of financial statements for external users. Although financial statements, which are compiled in different countries, look very similar, there are also many differences, which are a consequence of different economic, social, political, legislative and cultural factors. In accounting terms, different countries have developed in different directions, and, for example, at passing legislative regulation they had different understanding on relative importance of some external users of financial statements. So, for example, in Canada, USA or Great Britain, investors had the biggest priority in accordance with relevant information on share market, unlike France, Germany and Japan, where the interest of creditors and government agencies is important, and especially tax agencies. So, in this respect, in 1973 a Committee for International Accounting Standards was established, while, International Standards Accounting Board (ISAB), was established in London in 2001, with the aim of reducing the differences in reporting through harmonization of accounting practice at global terms.22

22

Also in BiH basis for harmonization are IFRS and IAS.

29

3. FORMS OF ORGANISATION OF A LEGAL ENTITY3.1. SOLE PROPRIETORSHIPSA form of organization in the ownership of a single person is often referred to in the literature as sole proprietorship or own legal entity.23 It is the most numerous and the simplest form of organization of a legal entity, which in Anglo Saxon countries encompasses 70 % of all legal entities. According to the American legislation, there is no significant legal difference between the owner and a legal entity, as overall assets, liabilities and equity are in the ownership of a single person. Sole proprietorships are most often concentrated in trade and service sector. Owner as a manager makes decisions without consultation with others. Namely, the owner allocates profit or covers a loss and is responsible for settlement of all liabilities arising from business operations.24 Therefore, sole proprietorship is responsible for liabilities with all its property. In case of non-liquidity in liabilities payment, the owner shall even sell its own property (house, furniture, etc.).

3.2. PARTNERSHIPPartnership is a form of organization which occurs by joining two or more natural persons who operate as co-owners. This is a traditional form of organization in which those who provide service such as doctors, lawyers, auditors, etc. operate. In Anglo Saxon countries, out of the total number of all legal entities, 20% relate to the partnership. There are following types of partnership: (general partnership); (limited partnership); (master limited partnership); (joint ventures).

General partnership is a form in which each of (general) partners is responsible with its entire property for the liabilities of a legal entity.23 24

Gray / Needles, Financial..., quoted, pg. 10. Gray / Needles, Financial..., quoted, pg. 10.

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Limited partnership is a type of organization with one or more general partners, and one or more limited partners responsible for liabilities only up to the amount of paid stakes. Master Limited partnership operates mainly as joint-stock company, and trades with stakes in the financial market. However, unlike joint-stock company, earnings of partners are taxed only once, while with the joint-stock company, profit of a company is first taxed, and after that, cash dividends of shareholders are also taxed. Joint ventures are contracting organizations, which include two or more physical entities with the aim of participating in the joint profit on the basis of incurred costs or in line with some other criteria. As specific forms of non-joint stock companies, which are a tradition of organization in the European countries (especially German and French legislative regulation), and they are also widely spread in BIH, and those are companies with limited liabilities (llc.)25. Legal entities with a legal title of limited liability company (llc) are defined as companies in which one or more legal or physical entities invest initial investments with which they participate in the previously agreed initial capital. No founder can undertake more initial stakes when establishing a company. If some member of a company does not invest the initial stake for which it has a responsibility, other members of a company are obliged to do so proportionally to their stakes in a company. Significant feature of limited liability company is that members of a company are not responsible for the liabilities of a company.26

3.3. CORPORATION OR COMPANY (JOINT-STOCK COMPANY)A Corporation or company (joint-stock company) is a legal entity, which exists separately from its owners shareholders27. Joint-stock companies in developed world nowadays create over 80% of worlds gross product, and they constitute around 20% in overall number of legal entities. The remaining gross product relates to partnerships and sole proprietorships. Joint-stock companies are major companies.25 26 27

Law on Enterprises, Official Gazette of the Federation of BIH, no. 23/99, 45/00, 2/02, 29/03. Mehmed Jahic, Financial...,quoted, pp. 459-460. Gray / Needles, Financial...,quoted, pp. 12-16.

31

Market value of some joint-stock companies in the financial markets at the end of 20th 28 and early 21st 29 century reached several hundreds of USD billion. A joint-stock company has a legal status at the court, which means it may press charges and charges may be pressed against it. As a legal entity, joint-stock company signs contracts and pays profit tax. In this type of company, a management function is separated from the ownership function. For the mentioned basic features, a joint-stock company has advantages and disadvantages compared to other types of legal forms of companies. From the accounting aspect, there are significant advantages and disadvantages of a joint-stock company as a legal entity. From accounting point of view, joint-stock companies in BIH do not differ crucially from other joint-stock companies elsewhere in the world, because of the application of IFRS.30

3.3.1. Advantages of joint-stock companiesAdvantages of organizing legal entities into joint-stock companies may be the following31: there is no personal responsibility of shareholders; equity is more easily accumulated; easier transfer of ownership; continuity (permanency) of business operations; professional management. When we speak about shareholders responsibility, we should bear in mind that lenders of a joint-stock company (banks, suppliers, owners of bonds, etc.) have receivables towards the property of the joint-stock company, and not towards their own (private) property of shareholders. Invested amounts into shares of some company represent an investment risk for the shareholders; however, those investments do not put at risk other property of shareholders. A large number of shareholders represent a certain advantage of a joint-stock company. Easy equity accumulation as an advantage of a joint-stock company is reflected in easy transferability of28 29

30

31

Gray / Needles, Financial..., quoted, pp. 12-16. For example at NYSE (New Y Stock Exchange) in 2001, the value of Microsoft o r General ork Electric exceeded USD 300 billion. Differences in accounting monitoring of shareholders equity between some countries are minimum nowadays, taking into account application of American Accounting Standards (US GAAP) or International Financial Reporting Standards (IFRS). R. Meigs, R. W. Meigs, Accounting, Foundation of business decision making process, ninth edition, Mate llc.,Zagreb, 1999, pg. 650 (translation).

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financial instrument called a share. A share is an ownership (principal) financing instrument of a joint-stock company. With the issue and sale of shares, a joint-stock company allows small or large shareholders to generate equity. Large joint-stock companies with over a million of shareholders are usually referred to as public, and those with a small number of shareholders are referred to as closed jointstock companies. Shares as ownership instruments of financing, specific for jointstock companies used to create shareholders capital, are appropriate instrument for transfer of ownership. Shares may change its owners (registered share or bearer share) in the financial market without difficulties. Change of an owner of a share (buying or selling of a share) takes place in an organized financial market a stock exchange. With respect to business continuity, joint-stock companies, compared to other types of legal entities, have relatively better stability. Ownership is transferred without problems through shares trading and it is this feature of easy transfer of ownership that provides business continuity of a joint-stock company. Other types of legal entities do not have such a feature, for example, limited liability company, etc. Namely, in other types of legal persons, with withdrawal or death of an owner individual business continuity or survival of a company comes under question. Management of joint-stock companies is separated from owners and in the managing theory of a company, it is emphasized as a second important targeted group (together with shareholders of joint-stock companies). Shareholders are owners32 of a joint-stock company, but they cannot manage business activities of the joint-stock company on a daily basis, so they transfer the management function to the management, which they appoint, select or confirm every year at the annual shareholders assemblies. Governing boards or managements are appointed in the joint-stock companies (bodies of managers or directors), which manage business operations of the company. Shareholders cannot individually participate in managing a company, but they realize this right with their votes in the work of a shareholders assembly.

3.3.2. Disadvantages of a joint-stock companyA joint-stock company, as a dominant legal entity in creating gross product at a global level, has certain disadvantages, and we emphasize the following in particular:32

Stake in the ownership of a joint-stock company is called a share. Contract on founding a company, that is, articles of association of a company, precisely provides a maximum number of shares which a joint-stock company can issue. Number of shares in possession of shareholders, represents equity in the possession of shareholders. It may be smaller than a number of shares defined by the contract or decision on founding a company. A shareholder invests into a company cash or other resources. In return, a shareholder gets shares, which represent proportional stake in the ownership of a joint-stock company.

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double taxation problem, need for greater legislative regulation and separated ownership from control. Taxation that relates to joint-stock companies is of aa more complex structure than taxation related to other types of legal entities. Profit of a joint-stock company is primarily taxed, and then dividends as an element of allocation of net profit, which belongs to shareholders, are also taxed. This practice of taxation, first profit of joint-stock company and then dividends of shareholders, is sometimes referred to as double taxation. Founding and business operations of joint-stock companies, especially when it comes to regulating primary and secondary market, are legally better regulated than other types of legal entities.33 Such firmer legislative regulation influences an increase of administration, and thereby general costs of business operations of joint-stock companies. Separation of ownership function from operational-control function is a significant weakness of joint-stock companies, because of natural conflict between shareholders and management. Control of daily business operations is performed by management, which has different objectives from owners, whose control function is often reduced to voting in shareholders assembly.

33

In the Federation of BIH those are: Law on Accounting and Audit, Law on Enterprises , Law on Securities, etc..

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4. CLASSIFICATION OF ACCOUNTING

In accounting theory, and nowadays in accounting practice too, there is classification of accounting from coverage aspect to: a) micro accounting and b) macro accounting. By observing tasks and a role of accounting from broader social aspect, macro accounting represents a social accounting which can be national, state and international accounting which, as an idea is more and more established in modern expert literature. 34 Micro accounting is business accounting, i.e. accounting of a company / companies focused on achieving profit and it is often referred to as business language. At the end of the 20th century, two targeted significant changes occurred which had an impact on changes of company accounting. The first one relates to the world economy globalization and an increase of requirements of users on business operations of companies. The second one relates to development of information technology. Given these two main objectives, accounting of a company may be divided into three specific parts: financial accounting, cost accounting and management accounting. These three parts of business accounting, i.e. accounting of a company, are inter-linked, and can be illustrated in the following way35:

Figure 5 Functional classification of business accounting

34 35

Janko Klobucar, Accounting, Faculty of Economics Sarajevo, Sarajevo, 2003 pg. 9. T. C. Horngern, G. Foster, M. S. Datar, Cost Accounting, Prentice Hall, Englewood Cliffs, New Yersey, 1994, pp. 4-5.

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Financial accounting is a part of accounting which is primarily focused on external users, such as owners, creditors and other. Thus, in practice it is referred to as external accounting. In financial accounting, there are records of business books, such as daybook, general ledger, sub-ledger records and other ancillary records. They are used to record, classify and sum up the data on the basis of which a full set of financial statements is prepared. Prepared financial statements, after conducted procedure of an audit by independent auditor, are disclosed and sent to external users. Financial accounting provides historical data (eg. data on inventories, customers, suppliers, investments, creditors), which are important both for internal and external users. Management Accounting36 is a part of accounting that provides information primarily to internal users, such as management, at all levels of decision-making process and responsibilities of a legal entity. The most important activities of management accounting are planning and control. In the planning process, objectives of a legal entity are defined as well as parts of management accounting. An outcome of planning are plans and calculations. Control is an activity of determining discrepancies between objectives and achieved results. In a process of control, special reports are compiled (eg. report on revenue execution, report on cost execution, etc.). Management control, thus, assumes identification of responsibility area that will enable its efficiency. Therefore, area of responsibility represents a homogenous segment of a company, within which its manager has authorities to make certain decisions and responsibility for its successful functioning. Each area of responsibility has its inputs and outputs from whose relation conclusions are made about its performance. While inputs in all areas are expressed in costs, on the other hand, outputs in some areas of responsibility may be expressed through selling value and / revenues (sales department), while it is not possible in other departments (manufacturing departments of responsibility). A link between inputs (direct material, direct labor, etc.) and outputs (final products) is strong and visible in manufacturing departments, that is, in inputs and outputs within the production function. Thus, areas or centers of responsibility are formed within production function and may include a small group of homogenous machines, entire production line or entire manufacturing department. Thus, for example, in a control of daily consumption of direct material, management assesses that there is an increase of direct material consumption in manufacturing department. In analysis of discrepancy cause, management possibly comes to a conclusion that supplied material has poor quality or there was a discrepancy between direct material consumption as a result

36

A name originates from the word management and includes internal decision makers as major users of internal accounting. For more details see T. C. Horngern, G. Foster, M. S. Datar, Cost accounting, quoted, pg. 2.

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of a fault on the machine or its obsoleteness, or non-adequate control and similar, so there was unfavorable discrepancy of quantity consumption of direct material. Certainly, management analyses favorable and unfavorable discrepancies from the cost-benefit analysis aspect.37 Cost accounting has a wider importance than management accounting. It contains all parts of management accounting and one part of financial accounting. The most significant area of this accounting are costs, and those are: cost monitoring in line with natural types, places and bearers, cost production planning, sale, administration, methods and systems of cost calculation, etc. Thus, cost accounting undertakes from financial accounting all the activities related to cost records, as well as methods and systems of costs calculation of production and other costs. As cost management is an important segment of success, cost accounting includes activities of planning and control of costs. This means that cost accounting contains historical information on costs, but also information on what those costs should have been, which is important to the management for making business decisions. Apart from classification of business accounting, i.e. accounting of a company to financial, management and cost accounting, in practice we have other two types of accounting, and it is more appropriate to observe them separately. Those are: fiscal accounting and internal audit. Fiscal accounting is accounting that should be involved in studying and application of tax system, records and payment of tax liability.38 Internal Audit is conducted in order to ensure that a full set of financial statements is real, true and correct with the purpose of protecting companies resources from excess spending, inadequate use and disposal, as well as to provide adequate implementation of a business policy of a company at all business levels. Simply said, the purpose of internal audit is to ensure protection of resources of a company from unfair behavior of employees, protection of shareholders from unfair behavior of managers (protection from various speculations of managers which damage a company), protection of TOP-management from unfair behavior of managers at lower levels, provision of fairness and correctness in the official financial statements. Thus, for the mentioned objectives and features, internal audit should be organized as a special field of accounting.

37

38

Jadranka Kapic, Valorization of inventories and their revalorization in the inflationary conditions, Doctorial dissertation, Faculty of Economics, Sarajevo, 2003, pp. 220-250. Mehmed Jahic, Financial..., quoted, pg. 17.

37

This is a classification of business accounting in stable conditions of monetary currency. In inflationary conditions, accounting information loses its form as a result of change in purchasing power of currency. Given that all the users of accounting information require realistic figure of financial statements, it is necessary to ensure harmonization of accounting information in accordance with the new circumstances, i.e. inflationary circumstances.39 From the early 20th century, there is a mention in the accounting theory of accounting in inflationary circumstances (i.e. inflationary accounting), and it represents a special information accounting system of monitoring changes in a company and its harmonization with the official price growth rates (inflation or leveling) in line with market conditions of acquisition and sale. Adjustment of accounting information in the inflationary circumstances is primarily conducted with the aim of real presentation of financial position, performance and changes of a financial position of a legal entity, that is, for the needs of current business operations and occasional comparative analysis.

39

The word inflation itself refers to the overstretched situation and originates from Latin word inflare meaning bloating, blowing. (B. Klaic, Big Dictionary of Foreign Words, Zagreb, 1972, pg. 553.) In monetary economy, increase of money value is referred to as deflation, and decrease of money value is referred to as inflation.

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5. BOOKKEEPING SYSTEMS

Historical evolution of accounting was preceded by the evolution of bookkeeping. According to the manner of book entry of business events, principles on which book entries are based, the aim that is to be achieved, and business books records, there are following basic bookkeeping systems: a) b) c) d) simple bookkeeping system, cameral bookkeeping system constant bookkeeping system and double-entry bookkeeping system.

5.1. SIMPLE BOOKKEEPING SYSTEMSimple bookkeeping represents the first organizational system of records, which was used already in ancient countries in their trade shops. The basic feature of simple bookkeeping is an isolated recording of changes of some property parts, change of some balance of assets, or change of liabilities balance, which are presented in special books that are not inter-linked. Characteristic of simple bookkeeping is that it only records liabilities for the acquired property part, and it does not make records on private capital invested in a trade shop. Furthermore, simple bookkeeping does not present revenues and expenses, which either increased or reduced private capital. So, for example, in simple bookkeeping system, collection of receivables in cash from rent of business premises is entered into books only as an increase of cash in cashbook, while realized revenue is not registered. Historical development of business events records system varied from simple bookkeeping to the double entry bookkeeping. At the same time, simple bookkeeping with all its features has undergone evolution path, from non-organized, in which only some events were recorded, which an owner wanted to preserve from forgetting, to the organized, which represents more modern form of simple bookkeeping, but still does not register revenues and expenses and does not present private capital. Books of simple bookkeeping, which regularly make records, are: cashbook, which records incoming and outgoing payments of cash; book of debtors and creditors, which records all receivables and liabilities; inventory book.

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Cash book had the following form:INCOMING PAYMENT Date Event description CASH BOOK Amount Date OUTGOING PAYMENT Event description Amount

Cashbook shows a balance and changes of cash balance in petty cash. Initial balance is shown on the left side, all incoming payments of cash are recorded on the left side, and all outgoing payments are recorded on the right side. Debtor-creditor relations with customers and suppliers are recorded in such a manner that for each purchaser or supplier a new page in the book of debtors and creditors is opened. Each page is divided vertically and has the left and right side. So, for example, the balance of receivables from purchaser is determined by adding all increased debts of a purchaser to the initial balance, which is recorded on the left side, and by deducting all collections of receivables, which are recorded on the right side. Balance of liabilities from a supplier is determined by adding all increases of liabilities towards suppliers, which are recorded on the right side to the initial balance of liabilities, which are recorded on the right side, and by deducting all outgoing payments, which are recorded on the left side. Form of records of these books was following:PAYABLE Date Desc. DEBTORS BOOK Amount Date RECEIVABLE Desc. Amount

In its heading, debtors or creditors book had the title of debtors or creditors and it was possible to assess a character of account by their initial balance. Calculation of business operations results in simple bookkeeping system and cannot be determined directly based on book entry, as there are no records on incurred expenses and revenues, but financial result is determined through conducting inventories, that is, based on the book of inventories which is composed after stock taking in trade shop. Stocktaking is used to make inventory lists of the whole property of a single trade shop on a certain date. This is normally done at the end of business year (31 December), since financial result is normally determined for a certain period of time, i.e. for the past business year. On that occasion, an inventory list of all the assets is conducted, which a trade shop disposes with: plants and equipment, goods in a shop and in warehouse, cash, receivables from debtors (customers, banks and others). Following this, stock taking of liabilities of a trade shop towards creditors (suppliers, bank and other liabilities) is performed.

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Determination of assets is conducted by counting and measuring in the shop and warehouse, and determination of receivables and liabilities is performed on the basis of records in the book of debtors and creditors, which is kept in trade shop. On the basis of inventory taking, an inventory book of trade shop is compiled. The following data are entered into a book of inventories: name of a trade shop and date on which inventory list is being compiled, number, description and amount. In a column for description, assets are first entered, i.e. assets of a shop classified by type, quantity and value. Following this, liabilities are entered, i.e. liabilities of a shop, classified by type and value indicators. At the end, recapitulation is compiled in which there are total assets, total liabilities and own assets (net property) of a shop, which represent a positive difference between total assets that the shop disposes with and its total liabilities towards creditors. Inventory book may be shown in the following:Trade Shop XPg... Inventory book Date 31 Dec of current year

No

Description AUXILLIARY COLUMN

amount MAIN COLUMN

I 1. 2.

ASSETS Petty Cash Salt 200 kilos per KM 1 Sugar 300 kilos per Mm1 Oil 100 l per KM 1.5 etc. receivables from customers cust. a cust. b etc. Total assets LIABILITIES Loan from bank Supplier y etc. Total liabilities RECAPITULATION Total assets Total liabilities Private assets 110 000 80 000 30 000 3 000 ...... Xxxxx 50 000 30 000 80 000 200 300 150 ...... 5 000 10 000 ...... Xxxxx 20 000 40 000

3.

50 000 110 000

II 1.

III 1. 2. 3.

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In order to determine a financial results of a shop, it is necessary, apart from final inventory on 31st December of the current year, to also have an initial inventory under 1st January of the current year. By comparing values of own assets (net property) at the end of a period 31 December with the value of own assets (net property) at the beginning of a period 1 January, financial result of that period is calculated. Therefore, if a shop on 31 of December had its own assets in the amount of KM 30.000, if for example at the beginning of the year, it had own assets in the amount of KM 20.000, a positive financial result was achieved in the amount of KM 10.000. Otherwise, if a shop, for example at the beginning of the year had its own funds in the amount of KM 35.000, it has then achieved a negative result in the amount of KM 5.000. General formula for calculating a financial results in simple bookkeeping: where: Fr = S2 S1

S1 own funds at the beginning of a period, S2 own funds at the end of the period, Fr financial result. If: Fr (+) than S2 > S1 profit; Fr () than S2 < S1 loss; Fr (0) than S2 = S1 neutral...

These are the cases of the simplest calculation of financial result. However when determining a financial result in simple bookkeeping, it is necessary to take into consideration results that arise from regular business operations of a shop. For example, it is necessary to allocate all additional incoming or outgoing payments by the owner of a shop Up or all payments Ip or from a shop which does not have a character of regular business operations, as they represent additional investments or non-specific withdrawal by the owner of funds from a shop. Thus, in such a situation it is necessary to include additional incoming or outgoing payments in calculation of financial result, which we can present in the following manner: S1 = Up + S1, i.e own funds at the beginning of a period increased by incoming payments, S2 = Ip + S2, i.e. own funds at the end of a period increased by outgoing payments. We calculate financial result in simple bookkeeping in situation when we have additional incoming and outgoing payments in the accounts, by the following formula: profit Fr (+) then S2 > S1 loss Fr () then S2 < S1 neutral Fr (0) then S2 = S1 Fr = S2 S1, so if

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Transitional form of simple bookkeeping in line with double entry bookkeeping is an extended simple bookkeeping which, apart from books of some property parts keeps records of some, for owners interesting expenses (for example, book of discounts on goods40), but modern accounting theory does not pay such a big attention to the mentioned phases, because of their non-applicability in modern conditions.

5.2. CAMERAL BOOKKEEPING SYSTEMCameral bookkeeping system was based on the simple bookkeeping, and was developed in the 17th century for the needs of monitoring state expenditure and revenues. It was applied in public-legal institutions in which business operations were taking place in line with the budget, and thus, in the past it was named budget bookkeeping. Nowadays budget accounting is modernized and has all the features of double entry bookkeeping sy