Accounting System Lecture Notes PDF

Lecture Overview Introduction The Accounting System Economics and Finance (UFPB2) 1. Introduction to the Accounting System Hassen A. Wako [email protected] 1/36...

Lecture Overview Introduction The Accounting System Economics and Finance (UFPB2) 1. Introduction to the Accounting System Hassen A. Wako [email protected] 1/36 Economics and Finance (UFPB2)  Lecture Overview Introduction The Accounting System Introduction The Accounting System 1. Source/Business Documents 2. Recording of Transactions – Primary Accounting Records 3. Double-Entry Accounts – the Ledger 4. Trial Balance 5. Financial Statements 2/36 Economics and Finance (UFPB2)  Lecture Overview Introduction The Accounting System Lesson Objectives By the end of this topic, students should be able to: I Explain the nature and purpose of accounting in business. I Explain the benefits of keeping accounting records for a business and other stakeholders. I Explain the principles and five steps involved in the accounting system. I Define key terms: sales revenue, credit sales, cash sales, purchases, purchases returns (returns outwards), sales returns (returns inwards), overheads and profit. I Recognise the primary elements of an income statement. 3/36 Economics and Finance (UFPB2)  Lecture Overview Introduction The Accounting System Lesson Objectives... I Calculate profit (TR − TC ) I Define key terms (of the balance sheet): assets, liabilities, capital, trade receivables/debtors, trade payables/creditors. I Distinguish between current & non-current assets, tangible & non-tangible assets, and current & non-current liabilities. I Explain capital/owner’s equity. I Apply the accounting equation: Assets = Liabilities + Capital. 4/36 Economics and Finance (UFPB2)  Lecture Overview Introduction The Accounting System What is Accounting? I Accounting: I is the language of business. I is the recording and presentation of business activities in the form of business accounts. I Accounting involves three main elements: I Recording business transactions in financial terms. I Reporting financial information to the owner(s) and other parties. I Advising the owner(s) and other parties on how to use the reports and make future decisions. 5/36 Economics and Finance (UFPB2)  Lecture Overview Introduction The Accounting System Bookkeeping, Accounting, Finance I Bookkeeping: the basic recording of business transactions in financial terms. I Accounting: taking the information recorded by the bookkeeper and presenting it in the form of financial reports (both retrospective and forward looking reports). Alternatively, accounting is concerned with collecting, analysing and communicating financial information. I Finance: is concerned with the ways in which funds for a business are raised and invested. 6/36 Economics and Finance (UFPB2)  Lecture Overview Introduction The Accounting System Uses of Accounting Information I Businesses keep records of financial transactions in order to: I quantify items such as sales, expenses and profits; I present these figures in a meaningful way to measure the success of the business. I Accounting information is used by various stakeholders: both insiders (owners, managers) and outsiders (lenders, suppliers, customers, employees, government, investment analyst...) 7/36 Economics and Finance (UFPB2)  Lecture Overview Introduction The Accounting System Accounting Information for the Owner(s)/Manager(s) I Purchases of goods to date I Sales revenue (turnover) to date I Expenses to date I Trade receivables – amount owed to the business (total, names of trade receivables, the amount owed by each) I Trade payables – amount owed by the business (total, names of trade payables, the amount owed to each) I Assets owned by the business, liabilities owed by the business, net worth of the business I Profits made during a particular time period... 8/36 Economics and Finance (UFPB2)  Lecture Overview Introduction The Accounting System Who Uses Accounting Information? I Customers: Can the business continue to meet my needs? I Competitors: How can I best compete against company X? I Employees: Should I continue working here? Should I demand a higher salary? I Government: Should the company pay corporate tax? Does it need financial support? I Community representatives: Allow company to use more space? Community premises? 9/36 Economics and Finance (UFPB2)  Lecture Overview Introduction The Accounting System Who Uses Accounting Information? I Investment analysts: Should clients invest in the company? Buy/sell/hold? I Suppliers: Should I continue to supply the company? Supply on credit? I Lenders: Should I lend money to the company? Demand payment of existing loans? I Managers: Does the company’s performance need to improve? Future direction? I Owners: Invest More? Sell? What are the risks and returns? 10/36 Economics and Finance (UFPB2)  Lecture Overview Introduction The Accounting System Forms of Accounting Records 1 Written accounting records: traditional form of keeping ‘the books’, where the bookkeeper enters each transaction into the ledger in handwriting. Especially for small businesses. 2 Computer accounting records: a very accurate method of recording business transactions (advantage), but it could be cumbersome and time-consuming to set up, particularly for small businesses (disadvantage). I The basic principles are the same. 11/36 Economics and Finance (UFPB2)  Lecture Overview Introduction The Accounting System Business Accounts I Business accounts should be kept: I accurately I up-to-date I confidentially (not revealed to people outside the business) I neat in the layout I using ink (not using pencil). 12/36 Economics and Finance (UFPB2)  Lecture Overview Introduction The Accounting System Accounting Concepts I Two basic accounting concepts which underlie all aspects of accounting: 1 Business entity: the accounts record and report transactions of the business only. The owner’s personal financial transactions and the business financial transactions should be kept entirely separate. 2 Money measurement: the system uses money as the common denominator in recording and reporting all transactions. 13/36 Economics and Finance (UFPB2)  Lecture Overview Introduction The Accounting System Accountants I Financial accountant: prepares financial statements (income statement, balance sheet) meant mainly for stockholders, tax authorities, and other outsider users. I Cost accountant: obtains information on raw material, labor... costs of the business and estimates costs for the future. I Management accountant: Prepares reports and makes recommendations to the owner(s) or managers of the business. I Auditors (external & internal): Check that accounting procedures have been followed properly. 14/36 Economics and Finance (UFPB2)  1. Source/Business Documents Lecture Overview 2. Recording of Transactions – Primary Accounting Records Introduction 3. Double-Entry Accounts – the Ledger The Accounting System 4. Trial Balance 5. Financial Statements The Accounting System 15/36 Economics and Finance (UFPB2)  1. Source/Business Documents Lecture Overview 2. Recording of Transactions – Primary Accounting Records Introduction 3. Double-Entry Accounts – the Ledger The Accounting System 4. Trial Balance 5. Financial Statements Business Documents I Purchase order I Delivery note I Invoice I Credit note I Statement of account I Remittance advice I Paying-in slip counterfoils, cheque counterfoils, bank transfers/statements Counterfoil: part of a cheque, receipt, ticket, or other document that is torn off and kept as a record by the person issuing it. 16/36 Economics and Finance (UFPB2)  1. Source/Business Documents Lecture Overview 2. Recording of Transactions – Primary Accounting Records Introduction 3. Double-Entry Accounts – the Ledger The Accounting System 4. Trial Balance 5. Financial Statements Business Documents 17/36 Economics and Finance (UFPB2)  1. Source/Business Documents Lecture Overview 2. Recording of Transactions – Primary Accounting Records Introduction 3. Double-Entry Accounts – the Ledger The Accounting System 4. Trial Balance 5. Financial Statements Purchase Order 18/36 Economics and Finance (UFPB2)  1. Source/Business Documents Lecture Overview 2. Recording of Transactions – Primary Accounting Records Introduction 3. Double-Entry Accounts – the Ledger The Accounting System 4. Trial Balance 5. Financial Statements Invoice Details include: I Invoice number I Name and address of seller I Name and address of buyer I Date of sale/tax-point I Reference numbers, quantity, price, delivery date I Trade discount allowed (if any) I Total amount due I Terms of trade (payment due date) I Seller’s VAT registration number I Amount of VAT charged 19/36 Economics and Finance (UFPB2)  1. Source/Business Documents Lecture Overview 2. Recording of Transactions – Primary Accounting Records Introduction 3. Double-Entry Accounts – the Ledger The Accounting System 4. Trial Balance 5. Financial Statements Credit Note Seller issues credit note: I faulty goods are returned I refund is requested for overcharge I buyers takes advantage of prompt payment discount (PPD) 20/36 Economics and Finance (UFPB2)  1. Source/Business Documents Lecture Overview 2. Recording of Transactions – Primary Accounting Records Introduction 3. Double-Entry Accounts – the Ledger The Accounting System 4. Trial Balance 5. Financial Statements Statement of Account Seller sends it at the end of each month. Details: I Name and address of seller I Name and address of buyer I Date of statement I Details of transactions (invoices, credit notes, payments) I Balance currently due 21/36 Economics and Finance (UFPB2)  1. Source/Business Documents Lecture Overview 2. Recording of Transactions – Primary Accounting Records Introduction 3. Double-Entry Accounts – the Ledger The Accounting System 4. Trial Balance 5. Financial Statements Recording of Transactions – Primary Accounting Records I Primary Accounting Records or Books of Prime (Original) Entry: summaries of invoices, credit notes and banking documents issued and received during the course of the working day. 1. Sales day book – a list of sales made (from invoices issued). 2. Purchase day book – a list of purchases made (from invoices received). 3. Sales returns day book – a list of returns in 4. Purchases returns day book – a list of returns out 5. Cash book – compiled from cash receipts, till rolls, paying-in slip counterfoils, cheque counterfoils, banks transfers... 6. Petty cash book – small cash purchases. 7. Journal – non-regular transactions not recorded elsewhere. 22/36 Economics and Finance (UFPB2)  1. Source/Business Documents Lecture Overview 2. Recording of Transactions – Primary Accounting Records Introduction 3. Double-Entry Accounts – the Ledger The Accounting System 4. Trial Balance 5. Financial Statements Double-Entry Accounts – the Ledger I Double-entry bookkeeping: making two entries in the accounts for each transaction. I It is the basis of the accounting system. I The entries are entered into the ledger, which is divided into sections (sub-ledgers). I Each division of the ledger has multiple accounts. 23/36 Economics and Finance (UFPB2)  1. Source/Business Documents Lecture Overview 2. Recording of Transactions – Primary Accounting Records Introduction 3. Double-Entry Accounts – the Ledger The Accounting System 4. Trial Balance 5. Financial Statements Divisions of the Ledger 1. Sales ledger – personal accounts of trade receivables (i.e., customers to whom the business has sold on credit). 2. Purchase ledger – personal accounts of trade payables (i.e., suppliers to whom the business owes money). 3. Cash books – comprises cash accounts, bank accounts, and a petty cash book. 4. General (nominal) ledger – the remainder of the accounts: income and expense accounts (sales, purchases, wages...), accounts for assets and liabilities of the business (non-current assets, inventory, non-current liabilities, owner’s capital). 24/36 Economics and Finance (UFPB2)  1. Source/Business Documents Lecture Overview 2. Recording of Transactions – Primary Accounting Records Introduction 3. Double-Entry Accounts – the Ledger The Accounting System 4. Trial Balance 5. Financial Statements Trial Balance I Because double-entry bookkeeping involves making two entries for each transaction, it is open to error. I The trial balance effectively checks the entries made over a given period and will pick up most errors. I Besides being an arithmetic check, it is the source of valuable information which is used to prepare the financial statements of the business. 25/36 Economics and Finance (UFPB2)  1. Source/Business Documents Lecture Overview 2. Recording of Transactions – Primary Accounting Records Introduction 3. Double-Entry Accounts – the Ledger The Accounting System 4. Trial Balance 5. Financial Statements Financial Statements I Aim to provide a picture of the financial position and performance of a business. I 3 financial statements that are regularly produced: 1. Income Statement (Statement of Profit or Loss, P or L) 2. Balance Sheet (Statement of Financial Position). 3. Cash Flow Statement: summary of the amount of cash and cash equivalents entering and leaving a company. 26/36 Economics and Finance (UFPB2)  1. Source/Business Documents Lecture Overview 2. Recording of Transactions – Primary Accounting Records Introduction 3. Double-Entry Accounts – the Ledger The Accounting System 4. Trial Balance 5. Financial Statements Income Statement (Statement of P or L) Profit or Loss = Revenue (Income) − Expenses I It shows the profit due to business owner(s) after all expenses have been deducted from income. I If the business manufactures goods, the statement of P or L also included a manufacturing account. I The information needed for the calculation are taken from the double-entry system. 27/36 Economics and Finance (UFPB2)  1. Source/Business Documents Lecture Overview 2. Recording of Transactions – Primary Accounting Records Introduction 3. Double-Entry Accounts – the Ledger The Accounting System 4. Trial Balance 5. Financial Statements Income Statement (Statement of P or L) 28/36 Economics and Finance (UFPB2)  1. Source/Business Documents Lecture Overview 2. Recording of Transactions – Primary Accounting Records Introduction 3. Double-Entry Accounts – the Ledger The Accounting System 4. Trial Balance 5. Financial Statements Balance Sheet (Statement of Financial Position) 1 Assets: items the business owns. I Current Assets: items used in the everyday running of the business. e.g. inventory, trade receivables, cash, money in bank. I Non-current Assets:items bought for use in the business. e.g premises, vehicles, computers. 2 Liabilities: items that the business owes. e.g. bank loans, overdrafts, trade payables. Current + Non-current. 3 Capital (Owner’s Equity): money or assets introduced by the business owner(s). It is what the business owes to the owner(s). 29/36 Economics and Finance (UFPB2)  1. Source/Business Documents Lecture Overview 2. Recording of Transactions – Primary Accounting Records Introduction 3. Double-Entry Accounts – the Ledger The Accounting System 4. Trial Balance 5. Financial Statements Balance Sheet (Statement of Financial Position) The Accounting Equation: Assets − Liabilities = Capital I Every business transaction will change the balance sheet and the equation, however, the equation will always balance. I Examples: 1. Business pays trade payable: Asset ↓, Liability ↓ 2. Business buys computer: Asset ↑, Asset ↓ 3. Owner introduces new capital by paying cheque into the bank: Asset ↑, Capital ↑ 30/36 Economics and Finance (UFPB2)  1. Source/Business Documents Lecture Overview 2. Recording of Transactions – Primary Accounting Records Introduction 3. Double-Entry Accounts – the Ledger The Accounting System 4. Trial Balance 5. Financial Statements Balance Sheet (Statement of Financial Position) Decide whether assets, liabilities, equity decrease or increase Transaction Type Assets Liabilities Capital Bought fixed assets on credit Bought inventory on credit Paid supplier invoices Sold shares Paid creditors Received payment from debtors Received loan from bank Sold an old (office) computer 31/36 Economics and Finance (UFPB2)  1. Source/Business Documents Lecture Overview 2. Recording of Transactions – Primary Accounting Records Introduction 3. Double-Entry Accounts – the Ledger The Accounting System 4. Trial Balance 5. Financial Statements Balance Sheet (Statement of Financial Position) 32/36 Economics and Finance (UFPB2)  1. Source/Business Documents Lecture Overview 2. Recording of Transactions – Primary Accounting Records Introduction 3. Double-Entry Accounts – the Ledger The Accounting System 4. Trial Balance 5. Financial Statements Balance Sheet (Statement of Financial Position) 33/36 Economics and Finance (UFPB2)  1. Source/Business Documents Lecture Overview 2. Recording of Transactions – Primary Accounting Records Introduction 3. Double-Entry Accounts – the Ledger The Accounting System 4. Trial Balance 5. Financial Statements Balance Sheet (Statement of Financial Position) 34/36 Economics and Finance (UFPB2)  1. Source/Business Documents Lecture Overview 2. Recording of Transactions – Primary Accounting Records Introduction 3. Double-Entry Accounts – the Ledger The Accounting System 4. Trial Balance 5. Financial Statements Exercise Classify the following as Asset (current, non-current, intangible), Liability (current, non-current), or capital. I Cash I Long term loans I Unearned revenues I Investments I Factory plant I Trademark I Accounts payable I Manufacturing machines I Short term loans I Salaries payable I Interest payable I Wages payable I Accounts receivable I Agricultural land I Patents I Inventory I Lawsuits payable I Copyrights I Customer deposits I Shareholder’s equity I Income taxes payable I Prepaid insurance I Real estate I Bonds I Warranty liability I Goodwill I Owner’s equity I Office building 35/36 Economics and Finance (UFPB2)  1. Source/Business Documents Lecture Overview 2. Recording of Transactions – Primary Accounting Records Introduction 3. Double-Entry Accounts – the Ledger The Accounting System 4. Trial Balance 5. Financial Statements Exercises I Exercise 1.1 (Page 15) I Exercises 1.2, 1.4, 1.5, 1.6, 1.7 (Page 16) I Exercise 1.8 (Page 17) I Exercise 4.1 (Page 55) 36/36 Economics and Finance (UFPB2)