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• Economics and Finance (UFPB2) is the topic of the lecture
• The subject is the introduction to the accounting system
• Hassen A. Wako can be contacted at [email protected]

Lesson Objectives

• Explain the purpose and nature of accounting in business
• Explain the benefits of keeping accounting records
• Explain the principles and five steps involved in the accounting system
• Define key terms: sales revenue, credit sales, cash sales, purchases, purchases returns (returns outwards), sales returns (returns inwards), overheads and profit
• Recognise the primary elements of an income statement
• Calculate profit as Total Revenue (TR) minus Total Costs (TC)
• Define key balance sheet terms like assets, liabilities, capital, trade receivables/debtors, and trade payables/creditors
• Distinguish between current and non-current assets, tangible and non-tangible assets, and current and non-current liabilities
• Explain capital/owner's equity
• Apply the accounting equation: Assets = Liabilities + Capital

What is Accounting?

• Accounting is the language of business
• It is the recording and presentation of business activities in the form of business accounts
• It involves three main elements: recording, reporting, and advising
• Recording involves business transactions in financial terms
• Reporting involves financial information being relayed to the owners and other relevant parties
• Advising involves advising the owners and other parties on how to use the reports to make future decisions

Bookkeeping, Accounting, Finance

• Bookkeeping is the basic recording of business transactions in financial terms
• Accounting is the process of taking the information recorded by the bookkeeper and presenting it in financial reports
• Accounting concerns collecting, analysing, and communication financial information
• Finance concerns the ways in which funds for a business are raised and invested

Uses of Accounting Information

• Businesses maintain records of financial transactions to quantify parameters like sales, expenses, and profits
• The aim is to present these figures in a way that measures the business's success
• Accounting information is used by both insiders (owners, managers) and outsiders (lenders, suppliers, customers, employees, government, investment analysts)

Accounting Information for the Owner(s)/Manager(s)

• Purchases of goods to date
• Sales revenue (turnover) to date
• Expenses to date
• Trade receivables are the total amount owed to the business, by names of trade receivables and the specific amount owed by each of them
• Trade payables are the amount owed to the business, along with the names of trade payables, and the amount owed to each.
• The assets and liabilities owned by the business, in addition to the net worth
• Profits made in a specific time frame

Who Uses Accounting Information?

• Customers want to know if the business can continue to meet their needs
• Competitors assess how they can best compete against a rival company
• Employees consider whether to continue working and if they should ask for a higher salary
• Government considers whether the company should pay corporate tax and if it needs financial support
• Community representatives decide whether to allow a company to use more space
• Investment analysts decide if clients should invest (buy/sell/hold)
• Suppliers decide whether to continue supplying, especially on credit
• Lenders consider whether to lend money or demand payment of existing loans
• Managers want to know if the company's performance needs improvement
• Owners assess whether to invest more, sell, and what the risks and returns are

Forms of Accounting Records

• Written accounting records are the traditional form of bookkeeping, where the bookkeeper enters each transaction into the ledger in handwriting.
• Written accounting records are especially advantageous for small businesses
• Computer accounting records offer a very accurate means of recording business transactions
• Computer accounting records are more cumbersome and time-consuming to set up, which is a disadvantage for small businesses
• Basic accounting principles remain the same across both sets of records

Business Accounts

• Business accounts kept accurately
• Business accounts should be up-to-date
• Business accounts should be confidential i.e. not revealed to external outlets
• Business accounts should be neat in their layout
• Business accounts should be recorded using ink, rather than in pencil

Accounting Concepts

• Two basic accounting concepts: business entity and money measurement
• Business entity: the accounts record and report transactions of the business exclusively
• The owner's personal finances and the business finances should be separated
• Money measurement: the system uses money as the common denominator to record and report all transactions

Accountants

• Financial accountants prepare statements like the profit and loss sheet to present to stakeholders, tax authorities etc
• Cost accountants gather information to allow businesses to estimate the costs in the future
• Management accountants preprare reports and make recommendations for the owner(s) or managers of the business.
• Auditors (external and internal) check that accounting procedures are followed and are proper

The Accounting System

• Five Steps:
• Source Documents
• Primary Accounting Records
• Double-Entry Bookkeeping
• Trial Balance
• Financial Statements
• Source documents include invoices, credit/debit notes, cheques, and bank transfers.
• Primary accounting records entail the recording of transactions in a summary book
• Double-entry bookkeeping relates to transferring data from the summary book to the ledger
• Trial balance involves checking transaction accuracy
• Financial statements comprise profit and loss assessments, asset-liability-capital calculations

Business Documents

• Purchase order
• Delivery note
• Invoice
• Credit note
• Statement of account
• Remittance advice
• Paying-in slip counterfoils, cheque counterfoils, bank transfers/statements
• A counterfoil is part of a cheque, receipt, ticket, or other document that is torn off and kept as a record by the person issuing it.

Business Documents - The Flow of Documents

• Buyer
• Order Placed -> Purchase Order
• Goods Received -> Delivery note (+Goods)
• A refund requested -> Credit Note (if needed)
• Payment Made -> Remittance Advice
• Seller
• Order received -> Purchase Order
• Goods supplied -> Delivery note (+Goods)
• Payment requested -> Invoice
• A refund agreed -> Credit Note (if needed)
• Payment requested again -> Statement of account
• Payment received -> Remittance Advice

Purchase Order

• Includes:
• Date
• PO #
• Company Name
• Vendor
• Ship To
• Item #
• Description

Invoice

• Includes:
• Invoice number
• Name and address of seller
• Name and address of buyer
• Date of sale/tax-point
• Reference numbers, quantity, price, delivery date
• Trade discount allowed (if any)
• Total amount due
• Terms of trade (payment due date)
• Seller's VAT registration number
• Amount of VAT charged

Credit Note

• Seller issues to:
• faulty goods being returned
• refund being requested for overcharge
• buyers taking advantage of prompt payment discount (PPD)

Statement of Account

• Seller sends at the end of each month
• Includes:
• Name and address of seller
• Name and address of buyer
• Date of statement
• Details of transactions
• Balance currently due

Recording of Transactions - Primary Accounting Records

• Also known as Books of Prime (Original) Entry
• Summaries of invoices, credit notes, and banking documents issued and received during the course of the working day
• Sales day books
• Purchase day book
• Sales returns day book
• Purchases returns day book
• Cash book
• Petty cash book
• Journal

Double-Entry Accounts - The Ledger

• Double-entry bookkeeping entails making two entries in the accounts for each transaction
• It is the basis of the accounting system
• Entries are entered into the ledger, which is divided into sections (sub-ledgers)
• Each division of the ledger has multiple accounts

Divisions of the Ledger

• Sales ledger – Personal accounts of trade receivables
• Purchase ledger - Personal accounts of trade payables
• Cash books – Cash accounts, bank accounts, and a petty cash book
• General (nominal) ledger – Remainder of the accounts

Trial Balance

• Double-entry bookkeeping involves making two entries for each transaction, opening it up to error
• The trial balance effectively checks the entries made over a given period and will pick up most errors
• It is the source of information for preparing financial statements

Financial Statements

• Aims to give a picture of the business's performance and financial position
• Three types regularly produced:
• Income statement (Statement of Profit or Loss, P or L)
• Balance sheet (Statement of Financial Position)
• Cash Flow Statement: summary of the amount of cash and cash equivalents leaving and entering a company

Income Statement (Statement of P or L)

• Profit or Loss = Revenue (Income) – Expenses
• Demonstrates the profit due to the owner after all expenses have been deducted from income
• If the business manufactures goods, the statement of P or L also includes a manufacturing account
• Information for the calculation is taken from the double-entry system

Balance Sheet (Statement of Financial Position)

• Assets: what the business owns
• Current Assets: Items used in everyday business operations e.g. inventory
• Non-Current Assets: Items bought for use in the business e.g. premises
• Liabilties: what the business owes e.g. bank loans (Current + Non-current)
• Capital (Owner's Equity): Money or assets bought in by the owner

The Accounting Equation:

• Assets – Liabilities = Capital
• Every business transaction will change the balance sheet and the equation, however, the equation will always balance
• Examples:
• Business pays trade payable: Asset down, Liability down
• Business buys computer: Asset up, Asset down
• Owner introduces new capital by paying cheque into the bank: Asset up, capital up