Introduction to Accounting
Accounting: Accounting is a way of
recording, analyzing and summarizing transactions of an entity.
·
The
transactions are recorded in “books of original entry”.
·
The
transactions are then analyzed and posted to the ledgers.
·
Finally
the transactions are summarized in the financial statements.
BAS= Bangladesh
Accounting Standard.
BFRS= Bangladesh
Financial Reporting Standards.
Balance Sheet: A list of all the assets
controlled and all the liabilities owed by a business as at a particular date:
it is a snapshot of the financial position of the business at a particular
moment.
Equity: The amount invested in a
business by the owners.
Income Statement: A record of income
recognized and expenditure incurred over a given period. It is a record of the
entity’s financial performance over a period of time. The statement shows
whether the business has more revenue than expenditure (a profit) or (a loss).
Capital expenditure: Expenditure which
results in the acquisition of long-term assets, or an improvement or
enhancement of their earning capacity.
Long-term assets are those which
will be kept in the entity for more than one year.
- Capital expenditure is not charged as an expense in
the income statement.
- Capital expenditure on long-term assets appears in
the balance sheet.
Revenue expenditure: Expenditure which is incurred either
- For trade purpose. This includes purchases of raw
materials or items for resale, expenditure on wages and salaries, selling
and distribution expenses and finance costs or
- To maintain the existing earning capacity of
long-term assets.
Revenue expenditure is charged to
the income statement of a period, provided that relates to the trading activity
and sales of that particular period.
Capital income: Proceeds from the sale of non-current assets.
The profits (or losses) from the
sale of long-term assets are included in the income statement for the
accounting period in which the sale takes place. For instant, the business may
sell machinery or property which it no longer needs.
Revenue income: Income derived from
- The sale of trading assets, such as goods held in
inventory.
- The provision of services.
- Interest and dividends received from business
investments.
The Accounting Equation
Asset: Something valuable which a business owns or has control
over. BAS Framework states that an assets is a resource controlled by the
entity as a result of past events from which future economic benefits are
expected to flow. Assets are key elements of financial statements.
Liability: Something which is owed to a third party. “Liability” is
the accounting term for the debts of a business. BAS Framework states that a
liability is a present obligation arising from past events, the settlement of
which is expected to result in an outflow of resources from the business
embodying economic benefits. Liability is key elements of financial statements.
Business Entity Concept: A Business is a separate entity for its
owners.
Although this may seem logical
and unrealistic you must try to appreciate it, as it is the basis of a
fundamental rule of accounting, which is that the liabilities plus the capital
of the business must always equal its assets. We will look at this rule in more
detail later in this chapter, but a simple example now will clarify the idea of
a business as a separate entity for its owners.
Capital: The amount an entity “owes” to its owner. BAS Framework
states that capital is the residual interest in the assets of the entity after
deducting all its liabilities. Equity is a key element of financial statements.
Accounting equation: ASSETS = CAPITAL + LIABILITIES.
Historical cost: Transactions are recorded at their cost when they
were incurred.
ASSETS = Capital + Profit
Profit: The excess of income over expenses.
Loss: The excess of expenses over income.
Income: Increases in economic benefits over a period in the form of
inflows or increases of assets or decreases in liabilities, resulting in
increases in capital/equity (Framework). It can include both revenue and gains.
Expenses: Decreases in economic benefits over a period in the form
of outflows or depletion of assets or increases in liabilities, resulting in
decreases in capital/equity (Framework).
Drawing: Money and goods taken out of a business by its owner.
Creditor: Person to whom a business owes money.
Debtor: Person who owes money to the business.
Accruals concept: The accruals concept requires earned is matched
with the expenses incurred in earning it.
NET ASSETS: Assets less Liabilities
Current Liabilities: are
debts which are payable within one year.
Non-current Liabilities: are
debts which are payable after one year.
Non Current assets: this
are acquired for long term use within the business. They are normally valued at
cost less accumulated Depreciation.
Current Asset: This are
expected to be converted into cash within one year.
Gross profit: Revenue from
sales, less (-) cost of sales.
Net profit: Gross profit less expense plus (+) non trading income.
Accrued Expense are added
to expense in the income statement and shown as balance sheet payables, because
they relate to the current period but have not been paid as cash in the period.
Gross profit
Gross profit margin =
× 100
Revenue
Business Expenses not
directly related to cost of sales appear in the income statement under one of
three headings.
Distribution Costs Expenses
associated with selling and delivering goods to customers.
Administrative costs
Expenses of providing management and administrative for the business.
Finance costs
Ø
Dividends on redeemable preference shares
Ø
Interest on loans
Ø
Bank overdraft interest
Recording Financial
Transactions
Invoice: Invoices are used
to record transactions which have been made on credit. This is where goods or
services are supplied but payment is not made straight away as there is a
Period of credit before they are actually due for payment. An invoice may
relate to a sales or purchase order. Invoices are source documents for credit
transaction.
Credit note: A
document issued to a customer relating to returned goods or refunds when a
customer has been overcharge for whatever reason. It can be regarded as a
negative invoice. It is a source documents for credit transaction.
Debit notes: A debit
note might be issued to a supplier as a means of formally requesting a credit
note from that supplier. A debit note is not a source document.
Delivery notes: When goods
or services are delivered to a customer in respect of a sale, they are usually
accompanied by a delivery note prepared by the seller. The delivery note is not
a source document for credit transactions.
Books of original entry: The
records in which the business first records transactions.
The main books of original entry
are:
1.
Sales day book
2.
Purchases day book
3.
Cash book
4.
The payroll
5.
The journal
Sales day book: The books
of original entry in respect of credit sales, including both invoices and
credit notes.
Purchases day book: The
books of original entry in respect of credit purchases, including both invoices
and credit notes.
Cash Book: The books of
original entry for receipts and payments in the business’s bank account.
What is the cash book used
for?
The cash book is used to record
money received and paid out by the business. The cash book deals with money
paid into and out of the business bank account. This could be money received on
the business premises in notes. Coins and cheques and subsequently paid into
the bank. There are also receipts and payments made by bank transfer, standing
order, direct debit and online transfer, plus bank interest and charges made
directly by the bank.
Petty cash book: The book
of original entry for small payments and receipts of cash.
Payroll: The book of
original entry for recording staff costs.
Ledger Accounting and
Double Entry
Nominal Ledger: An accounting
record which analyses the financial records of a business.
Double Entry Bookkeeping:
Each transaction has an equal but opposite effect. Every accounting event must
be entered in ledger accounts both as a debit and a credit.
Receivable ledger: The ledger
for customer’s personal accounts. It is not part of the nominal ledger or the
double entry system, but double entry rules apply to the receivables ledger
account.
Payable ledger: The ledger for supplier’s personal accounts. It is
not part of the nominal ledger or part of the double entry system, but double
rules apply to the payables account.
Trade discount: A reduction in the cost of goods, owing to the
nature of the trading transaction. It usually results from buying goods in
bulk. It is deducted from the list price of goods sold to arrive at a final
sales figure. There is no separate ledger account for trade discount.
Cash discount: A reduction in the amount payable in return for
immediate payment in cash, or for payment with in an agreed period. There are
separate ledger accounts for cash discounts: one for discount allowed to
customers, and one for discount received from suppliers.
VAT: is an indirect tax on the
supply of goods and services. Tax is collected at each transfer point in the
chain from prime producer to final consumer. Eventually the consumer bears
the tax in full and any tax paid earlier in the chain can be recovered by a
registered trader who paid it.
Preparing Basic Financial Statements
Trial Balance: A list of
nominal ledger balances shown in debit & credit columns, as a method of
testing the accuracy of double entry bookkeeping.
To a debit balance: in the TB, add debits & subtract credits
from the adjustments columns. If the result is positive, insert it in the debit
column. If it is negative, insert it in the credit column.
To a credit balance: in
the TB, subtract debits & add credit. If the answer is positive, insert it
in the credit column .If it is negative, insert it in the debit column.
Control Accounts, Errors & Omissions
Control Account: Nominal ledger account in which a record is kept of
the total value of a number of similar individual items. Control accounts are
used chiefly for trade receivables and
payables.
A receivable control account is a nominal ledger account in which
records are kept of transactions involving all receivables in total. The
balance on the receivables control account at any time will be the total amount
due to the business from all its credit customers.
A payable control account is a nominal ledger account in which
records are kept of transactions involving all payables in total and the
balance on this account at any time will be the total amount owed by the
business to all its credit suppliers.
Contra: When a person business is both a customer & a supplier,
amounts owed by and owed to the persons maybe “netted off” by means of a
contra.
Irrecoverable Debt: When a debt owed by a customer will never be
paid, the total amount is removed.
Dishonored Cheque: when a
customer cheque is paid into the business’s bank but the customer’s bank
refuses to honor payment of it, it is ‘written back’ so as to remove the
receipt of the cheque from the books.
Bank Statement: A record of transactions on the business bank
account maintained by the bank in its own books.
Bank Reconciliation: A comparison of a bank statement (sent
monthly, weekly or even daily by the bank) with the cash book. Differences
between the balance on the bank statement and the balance in the cash book
should be identified and satisfactorily reconciled.
Transposition errors: When two digits in an amount are accidentally
recorded the wrong way round.
Error of omission: Failing to record a transaction at all or making
a debit or credit entry but not the corresponding double entry.
Error of principal: Making double entry in the belief that
transaction is being entered in the correct accounts, but subsequently finding
out that the accounting entry breaks the ‘rules’ of an accounting principal or
concept. A typical example of such an error is to treat revenue expenditure
incorrectly as capital expenditure.
Errors of commission: A mistake is made recording transaction in
the ledger accounts.
Compensating errors: Errors which are, coincidentally, equal and opposite
to one another.
Suspense account: An account showing a balance equal to the
difference in a trail balance.
Accounting concepts and conventions
Fair presentation: The faithful representation of the effects of
transactions, other events and conditions in accordance with BAS Framework so
that the reliability of financial statements in maintained.
Accounting policies: The specific principals, bases, conventions,
rule and practices applied by an entity in preparing and presenting financial
statements.
Going concern: The entity is viewed as continuing in operation for
the foreseeable future. It is assumed that the entity has neither the intention
nor the necessity of liquidation or of ceasing to trade.
.
Accrual basis of accounting: Item are recognized as assets,
liabilities, equity, income & expenses (the elements of financial
statements) when they satisfy the definitions & recognition criteria for
those elements in BAS framework.
Material: Omissions or misstatements of items are material if they
could, individually or collectively; influence the economic decisions of users
taken on the basis of the financial statements. Materiality depends on the size
& nature of the omission or misstatement judged in the surrounding
circumstances. The size or the nature of an item, or a combination of both,
could be the determining factor.
Prudence: The inclusion of a degree of caution in the exercise of
the judgments needed in making the estimates required under conditions of
uncertainty, such that assets or income are not overstated & liabilities or
expenses are not understated & so
financial statements retain their reliability.
Substance over form: Transactions & other events are accounted
for & presented in accordance with their substance & economic reality
& not merely their legal form. Doing so enhances faithful presentation
& reliability.
Money measurement concept: Financial statements only deal with
those items to which a monetary value can be attributed.
Historical cost: Transaction are recorded at their cost when
they occurred.
Realizations concept: Income & profits are recognized when
realized.
Cost of Sales, Accruals & Prepayments
Cost of sales: Opening inventory + carriage inwards – closing
inventory. This amount is then deducted from revenue to arise at the business
gross profit.
Accruals (accrued expenses): Expenses which are charged against the
profit for a particular period, even though they have not yet been paid for.
Prepayments (prepaid expenses): Expenses which have been paid in
one accounting period, but are not charged against profit until a later period,
because they relate to that later period.
Irrecoverable debts and allowances
Irrecoverable debt: A debt which is not expected to be paid.
Writing off: Charging the cost of the debt against the profit for
the period.
Allowance for receivables: An amount in relation to specific debts
that reduces the receivables assets to its prudent valuation in the balance
sheet. It is offset against trade receivables, which are shown at the net
amount.
Inventories
Cost of inventories: All costs of purchase of conversion and of
other costs incurred in bringing the items to their present location and
condition.
Cost of purchase: The purchase price, import duties and other
non-recoverable taxes, transport, trading, handing and other costs directly
attributable to the acquisition of finished goods and materials.
Conversion costs: Any cost involved in converting raw materials
into final product, including labour, expenses directly related to the product
and an appropriate share of production overheads 9but not sales, administrative
or general overheads).
FIFO (first in, first out): Items are used in the order in which
they are received from suppliers, so oldest items are issued first. Inventory
remaining is therefore the newer items.
LIFO (last in, first out): Items issued originally formed part of
the most recent delivery, while oldest consignments remain in the bin.
AVCO (average cost): As purchase prices can change with each new
consignment received, the average value of an item is constantly changing. Each
item at any moment is assumed to have been purchased at the average price of
all the items together, so inventory remaining is therefore valued at the most
recent average price.
Standard cost: All inventory items are valued at a pre-determined
cost. If this standard cost differs from prices actually paid during the period
the differences is written off as a ‘variance’ in the income statement.
Replacement cost: The cost of an inventory unit is assumed to be
the amount it would cost now to replace it. This is often (but not necessarily)
the unit cost of inventories purchased in the next consignment following the
balance sheet date.
Non- current assets and depreciation
Useful life: The estimated economic life (rather than the potential
physical life) of the non-current asset.
Depreciation: The systematic allocation of the cost or valuation of
an asset, less its residual value, over its useful life.
Residual Value: The estimated amount that the entry would currently
obtain disposing of the asset after deducting estimated disposal costs.
Carrying amount: Cost less accumulated depreciation.
Accumulated depreciation: The amount of depreciation deducted from
the cost of a non-current asset to arrive at its carrying amount will build up
over time, as more depreciation is charged in each successive accounting
period. This is called accumulated depreciation.
Straight line depreciation: The depreciable amount is charged in
equal installments to each accounting period over the expected useful life of
the assets.
Reducing balance depreciation: The annual depreciation charge is a
fixed percentage of the brought forward carrying amount of the asset.
Accumulated depreciation: The total amount of the asset’s
depreciation amount that has been allocated to accounting period o date.
Assets register: A listing of all non-current assets owned by the
organization, broken down by department, location or asset type, and containing
non-financial information (such as chassis numbers and security codes) as well
as financial information.
Purchased goodwill: The excess of the purchase consideration paid
for a business over the fair value of the individual assets and liabilities
acquired.
Company Financial Statements
Rights Issue: New share are offered to existing shareholders in
proportion to their existing shareholding, usually at a discount to the current
market price.
Retained earnings: An equity reserve used to accumulate the
company’s retained earnings.
Bonus issue (or Capitalization issue or Scrip issue): An issue of
fully paid shares to existing shareholders, free of charge, in proportion to
their existing shareholding.
Retrospective application: Applying the new policy as if it had
always been in use, by adjustments in both the current accounting period and
the previous one. The reasons for and effects of the changes must also be
disclosed.
Change in accounting estimate: An adjustment of the carrying amount
of an assets or a liability that results from assessment of the present status
of and expected future benefits and obligations associated with assets and
liabilities. Changes in accounting estimates result from new information or new
developments and accordingly are not corrections of errors.
Prospective application: Recognizing the effect of a change in
accounting estimate in the current and future periods affected by the change.
Prior period errors: Omissions
from and misstatements in financial statements for prior periods in relation to
information which was available when those statements were prepared and could
reasonably be expected to have been taken into account at that time.
Sole Trader and Partnership Financial Statements
Partnership: The relationship which exists between persons carrying
on a business in common with a view of profit.
Appropriation of profit: Sharing out profits in accordance with the
partnership agreement.
Current Account: A record of the Profits retained in the business
by the partner.
