Accounting for Managers PDF

Accounting for Managers Dr. Neha Gupta, PhD Signalling Job applicants with superior skills or abilities would invest time and resources in acquiring superior educational qualifications in order to distinguish themselves from less skilled applicants. Signals should be costly Signall...

Accounting for Managers Dr. Neha Gupta, PhD Signalling Job applicants with superior skills or abilities would invest time and resources in acquiring superior educational qualifications in order to distinguish themselves from less skilled applicants. Signals should be costly Signalling mitigates information asymmetry. paying higher dividends, giving credible guarantees of higher returns, appointing reputable accounting firms to audit their financial statements, having respectable outsiders as independent directors, and conforming to superior standards of accounting and disclosure.  High quality financial reporting mitigates the problem of adverse selection by reducing information asymmetry and thus facilitates orderly functioning of the capital market, making it possible for entrepreneurs to raise funds at reasonable rates and investors to earn fair returns. Why should you know accounting? Since a company’s financial statements affect stock prices, a manager should know accounting. I plan to be in corporate strategy. Without accounting numbers strategy won’t make sense. I want to be an investment banker. I want to use accounting information to value firms. I was in marketing. Profitability analysis was an important part of my job. I want to learn it formally. I am going to do a start-up. I want to manage the accounting and finance function of my business. Using financial numbers I can analyze cases in marketing, operations and strategy better. The law requires the CEO and the CFO, to certify the financial statements. As a CEO, I should know what the items in the statements mean. According to American Accounting Association (AAA) defines Accounting as: The process of identifying, measuring and communicating economic information, to permit informed judgments and decisions by a user of the information. It is an application of the general theory of information, to the problem of efficient economic operations.  Purposes of Accounting Information Score Attention Problem Keeping Directing Solving Reporting on Signaling the user about Provision of such the financial the need to take a information that would health decision enable to find solutions Basic concepts of accounting – accepted as principles Property Rights the right of accounting entities to possess and alienate property – value It implies that the things of value to an entity can be transferred from one entity to another (say, machinery). Business Entity the entity is separate and distinct from the owners and the entity is liable to the owner Hence, in a limited liability company, the enterprise is liable to the owner (shareholder) based on the proportion of the capital investment (share capital) made by the latter  Going Concern entities have a life of infinite duration, unless facts are known that indicate otherwise the basis of valuation of resources is influenced more by their future utility to the business entity than by their current market valuation The continuity assumption does not imply, however, that the future will be the same as the past. The accountant expects that in the normal course of business the company will receive the full value of most of its accounts receivable. Accordingly, these items are recorded at their face value, less some deductions for anticipated bad debts, rather than at current liquidation value. Money Measurement Representation in a common denominator and amenable to summarization by addition & subtraction The obvious advantages of monetary expression in accounts are: a) It provides a simple measuring device to represent many different facts in a common denominator (say, Indian Rupees); and b) When things can be expressed in monetary terms, they are amenable to summarization by using addition, subtraction and relation. Limitations: Does not record factors such as the state of the president’s health, the attitude of the labor force. Fails to distinguish between the purchasing power of monetary units n different periods.  Matching Determining the profits after charging the expenses of a period with the revenues earned in the same period Realization Determines the point of time when revenue and hence returns (or profits) can be recognized objectively, unbiased, and with certainty Consistency Once a choice is made for the treatment of a transaction, the same is consistently followed Diversity among Independent Entities There are wide variations in the organization and operations of entities  requirements and demands are different  Conservatism Method of measurement, which ensures ‘the quality of being prudent: cautiousness’. “Anticipate no gains, but provide for all possible losses” and “if in doubt, write it off” Results in an understatement of profits and values Close nexus with idea of ‘capital maintenance Materiality Necessitated by practicability and feasibility a balance is always struck between accuracy and the costs of achieving it. Timeliness The idea of accounting periods is used so as to ensure regularity and timeliness of reporting Dependability of Data through Internal Control The data has to be dependable. Accounting equation This idea fundamental to accounting could be expressed as an equality: Assets = Liabilities + Owners Equity Owner(s) claim is residual: Owners Equity = Assets – Liabilities It shows the duality represented by ‘benefit- sacrifice’, from the point of the view of an entity Accounting equation Let us look at some examples of transactions changing the accounting equation Capital stock was issued for $100,000 cash Cash + $100,000; Capital stock + $100,000. Bonds payable of $25,000 were refunded with capital stock Bonds payable - $25,000; Capital stock + $25,000 Depreciation on plant and equipment equaled $8,500 for the year Retained earnings (Depreciation expense) - $8,500; Accumulated depreciation on plant and equipment + $8,500. Inventory was purchased for $15,900 cash Cash - $15,900; Inventory + $15,900. Accounting equation $9,400 worth of inventory was purchased on credit Inventory + $9,400; Accounts payable + $9,400. Inventory costing $4,500 was sold for $7,200 on credit Inventory - $4,500; Accounts receivable + $7,200; Retained earnings + $2,700 $3,500 in cash was received for merchandise sold on credit Cash + $3,500; Accounts receivable - $3,500. Dividends of $3,000 were declared Dividends payable + $3,000; Retained earnings - $3,000 The declared dividends of $3,000 were paid Cash - $3,000; Dividends payable - $3,000. The company declared a stock split, and replaced each outstanding share with two new shares No effect Let us understand all three statements with the following case and transactions Transaction 1: Investment by Owner On December 1, Chas Taylor forms a consulting business, named FastForward and set up as a corporation, that focuses on assessing the performance of footwear and accessories. Taylor owns and manages the business. The marketing plan for the business is to focus primarily on publishing online reviews and consulting with clubs, athletes, and others who place orders for footwear and accessories with manufacturers. Taylor personally invests $30,000 cash in the new company and deposits the cash in a bank account opened under the name of FastForward. Understanding financial statements case... Transaction 2: Purchase supplies for cash FastForward uses $2,500 of its cash to buy supplies of brand name footwear for performance testing over the next few months. Understanding financial statements case... Transaction 3: Purchase Equipment for cash FastForward spends $26,000 to acquire equipment for testing footwear Understanding financial statements case... Transaction 4: Purchase supplies on credit Taylor decides more supplies of footwear and accessories are needed. These additional supplies total $7,100, but as we see from the accounting equation in transaction 3, FastForward has only $1,500 in cash. Taylor arranges to purchase them on credit from CalTech Supply Company Understanding financial statements case... Transaction 5: Provide services for cash FastForward plans to earn revenues by selling online ad space to manufacturers and by consulting with clients about test results on footwear and accessories. It earns net income only if its revenues are greater than its expenses incurred in earning them. In one of its first jobs, FastForward provides consulting services to a power-walking club and immediately collects $4,200 cash Understanding financial statements case... Transaction 6 & 7: Payment of expenses in cash FastForward pays $1,000 rent to the landlord of the building where its facilities are located. It also pays $700 as salary to its only employee Understanding financial statements case... Transaction 8: Provide Services and Facilities for Credit FastForward provides consulting services of $1,600 and rents its test facilities for $300 to a podiatric services center. The rental involves allowing members to try recommended footwear and accessories at FastForward’s testing area Understanding financial statements case... Transaction 9: Receipt of cash from Account Receivables The client in transaction 8 (the podiatric center) pays $1,900 to FastForward 10 days after it is billed for consulting services. Understanding financial statements case... Transaction 10: Payments of Accounts Payable FastForward pays CalTech Supply $900 cash as partial payment for its earlier $7,100 purchase of supplies (transaction 4), leaving $6,200 unpaid. Transaction 11: Payment of Cash Dividend FastForward declares and pays a $200 cash dividend to its owner (the sole shareholder) Example Assume Tata Company began operations on January 1 and completed the following transactions during its first month of operations. Arrange the following asset, liability, and equity titles in a table. Cash; Accounts Receivable; Equipment; Accounts Payable; Common Stock; Dividends; Revenues; and Expenses. Jan. 1 Jamsetji Tata invested $4,000 cash in Tata Company in exchange for its common stock. 5 The company purchased $2,000 of equipment on credit. 14 The company provided $540 of services for a client on credit. 21 The company paid $250 cash for an employee’s salary. Solution Problem Mar. 1 Suresh begins business with cash, `50,000. 2 Takes a loan from Manish, `20,000. 3 Buys a computer for cash, `58,000. 6 Buys supplies on credit, `6,000. 9 Sells software for cash, `12,000. 12 Pays for a part of the supplies bought on March 6, `2,000. 17 Uses supplies for personal purpose, `1,000. 23 Returns defective supplies for immediate refund, `1,900. 26 Pays salaries, `4,000, and office rent, `1,200. 29 Sells software on credit, `8,000. 30 Withdraws cash for personal use, `3,500. 31 Uses supplies for business purpose, `1,400. Steps in Formation of Accounting Records Identify Analyze and Recording in Transaction Classify the Journal Transaction Transfer Ledger Entries Posting Financial Adjustment Preparing Statements Entries Worksheet Classification of Accounts The basic accounting equation reminds us that the accounts can be divided into the following five broad categories: Assets or the resources which a firm is enjoying Liabilities or the obligations of the firm towards outsiders Capital or the amount invested by the owners, the increase in such capital and the decreases in it. Income or expenses of the business affect the increase and decrease in capital. Therefore, two more forms of account Incomes or the amounts earned by the business Expenses or the amounts expended by the business Classification of Accounts Accounts Classified Assets Liabilities Capital Income Expense Ex. Land, Ex. Loans, Ex. Equity Ex. Sales, Ex. Cost of Stock, Cash Creditors, Capital, Share Interest Goods Sold, Bills Payable premium Income Depreciation Rules for Debit and Credit Difference between Journal and Ledger Points Journal Ledger Nature Style Book of primary entry Book of final entry Chronological record Analytical record Process Recording here is Recording here is known as ‘journalizing’ known as ‘posting’ Unit Unit of classification of Unit of classification of data is transaction data is account Objective Final accounts cannot Final accounts maybe be prepared from this. compiled with this. Recording Journal Entries d) Invest in Equipment Noodlecake purchases and receives $9,600 in computers, printers, and desks, in exchange for its promise to pay $9,600 at the end of the month. e) Pay Supplier Noodlecake pays $5,000 to the equipment supplier in (d). (f) Order Software Noodlecake signs a contract for program code for a game app for $9,000. No code has been received yet. Because this event involves the exchange of only promises, it is not considered a transaction. No journal entry is needed. (g) Receive Software Noodlecake receives the $9,000 of app game code ordered in (f), pays $4,000 cash, and promises to pay the remaining $5,000 next month. For each of the transactions given above (including the sample), write the journal entry using the format (omit explanations). For each of the transactions given above (including the sample), post the effects to the appropriate T-accounts and determine ending account balances. Show a beginning balance of zero.