EME ACCOUNTING .pdf

12 Accounting for School Management S. O. Adedeji Introduction There are lots of misconceptions about accounting. To some people, accounting is a highly technical field, which can be...

12 Accounting for School Management S. O. Adedeji Introduction There are lots of misconceptions about accounting. To some people, accounting is a highly technical field, which can be understood only by professional accountants. In this book, the writer has tried to stimulate both the novice and the experienced in accounting in such a way that the former will effortlessly grasp the subject while the latter is re-invigorated. Nearly everyone practices accounting in one form or the other mostly on daily basis. Accounting is the art of measuring, communicating and interpreting financial activities. Whether you are preparing a household budget, balancing your chequebook, preparing your income or tax return, you are working with accounting concepts and accounting information. Accounting has often been called the language of business. Since language is a means of social communication, it is only logical that a language should change to reflect changes in our environment, our lifestyles and our technology. Technical Definitions of Accounting Meigs and Meigs (1981) defined “Accounting as a means of social communication in which changes and improvements are continually being made in order to communicate business information more effectively”. For instance, as society has become increasingly interested in measuring the profitability of business organisations, accounting concepts and techniques have been changing to make such measurement more meaningful and more reliable. To Nikolai, Bazlay and Stallman (1990), "Accounting is the process of providing quantitative information about economic entities to aid users in making decisions concerning the allocation of economic resources". The American Accounting Association defines accounting as "the process of identifying, measuring and communicating economic information to permit informed judgments and decisions by users of the information”. It emphasises identification, measurement, recording, retaining and communication of information through the use of accounting system. Decisions concerning the allocation of economic resources include inter alia whether to buy, sell, or hold investment. They also include whether to extend credit to company, desiring a loan, and whether to manufacture and sell a particular product etc. Accounting information is used in making each of these decisions. Moreover, Charles, Gray and John (1983) opined that, "Accounting is the major means of communicating information about the impact of financial activities". Thus, information is provided to decision-makers in the forms of financial statement. To prepare these statements, accountants analyse, record, quantify, accumulate, summarise, classify, report and interpret numerous events and their financial effects on the organisation. The accountants do the design of accounting system after considering the types of information described by the managers and other decision-makers. Bookkeepers and computers then perform the more routine tasks of following detailed procedures designed by accountants. While some accounting system may be highly complex and requires the skills and talents of many people, the real value of any accounting system lies in the information it produces. Accounting information is useful to anyone who must make judgement and decisions that have economic consequences. Such decision-makers include managers, owners, investors and politicians etc. The remaining part of this chapter will be discussed under five sections, the first will consider nature, scope and purpose of accounting, while the second looks at the traditional accounting assumptions and conventions; section three examines the rudimentary accounting equation and the rules of double entry book keeping, section four illustrates the income statement, trading profit and loss account as well as the preparation of the balance sheet, while the last section discusses the uses of accounting information in the decision making process. 1. Nature of accounting The underlying purpose of accounting is to provide financial information about an economic entity. The financial information provided by an accounting system is needed by managerial decision-makers to help them plan the control of the activities of the economic entity. In order to provide useful financial information about a business enterprise accounting system is very crucial. Therefore, accounting system is the method used by a business to keep record of its financial activities and to summarise these activities in periodic accounting report. It therefore suffices to say that a good accounting system should possess the following characteristics before it can be regarded as useful in satisfying the needs of various user groups: i. Understandability: This implies the expression, with clarity, of accounting information in such a way that it will be understandable to users - who are generally assumed to have a reasonable knowledge of business and economic activities. ii. Relevance: This implies that, to be useful, accounting information must assist a user to form, confirm or maybe revise a view - usually in the context of making a decision (e.g. should I invest, should I lend money to this business? Should I work for this business?). iii. Consistency: This implies consistent treatment of similar items and application of accounting policies iv. Comparability: This implies the ability for users to be able to compare similar companies in the same industry group and to make comparisons of performance over time. Much of the work that goes into setting accounting standards is based around the need for comparability. v. Completeness: This connotes that it is important that a complete record be maintained of every financial transaction. Reliability of information contained in the financial statements is achieved only if complete financial information is provided relevant to the business and financial decision-making needs of the users. Therefore, information must be complete in all material respects. Incomplete information reduces not only the relevance of the financial statements, it also decreases its reliability since users will be basing their decisions on information which only presents a partial view of the affairs of the entity. vi. Ease of Securing Information: It means a good accounting system must provide promptly desired information on receipts and expenditure or on any other financial transactions; vii. Simplicity of Records and Reports: A good financial accounting system must be simple and direct; viii. Uniformity of Forms and Procedures: The accounting system used in a place must be meaningful; and ix. Degree of Permanency: A good accounting system must provide some degree of permanency required in the various types of accounts. Accounting is a discipline that affects people in their personal lives just as much as it affects very large businesses. People use accounting ideas when planning what they are going to do with their money. Some of the plans may have to be written down in form of a budget and some may simply be kept in the mind. The complexity of business organisations calls for the necessity of recording and interpreting of financial transactions. For an organization to function effectively and efficiently, it needs a constant recording, processing and interpreting of different types of financial information. Scope of accounting Accounting as a field is divided into three major aspects as follows: (i) Financial Accounting (ii) Cost Accounting; and (iii) Management Accounting. (a) Financial Accounting This is concerned with preparing account, and statements, which report the financial position and operating performance of a business entity to the stockholders. It helps the people outside the business entity-owners, creditors, government officials and other interested parties to know the financial statement prepared by a company's management. This process includes the preparation of balance sheet, trading, profit and loss account,' cash flow statements and value added statements etc. Elements of these processes of financial accounting include: i. The recognition and recording of financial transactions; ii. The design of information systems processing of accounting information; iii. The introduction of internal control and safeguarding both the accuracy of the recording process and the security of the resources owned: and iv. Summarising the information and preparation of financial records for use by internal and external uses. (b) Cost Accounting This may be defined as the rendering of cost data by means of operating a cost recording system. Some of the duties of a cost accountant will be directed towards evaluating stocks and Work-in-Progress (WIP). The cost accountant is responsible for supplying, estimating and ascertaining prices and reflecting cost incurred. This aspect of his work however, is over-shadowed by the important function of maintaining an information service to provide cost data for management. He is concerned with finding the actual cost of products. (c) Management Accounting In management accounting, cost and financial data are used to advise management in planning, organizing, directing and controlling the activities of an enterprise. The management accountant uses cost data to advise management on financial matters. It is vital for the management accountant to be familiar with the cost system because if there are shortcomings in the cost data he/she uses, the bulk of assignment will be meaningless. Both the cost and financial data are tools for the management accountant and their limitations must be appreciated before they can be properly used. For the purpose of this book, distinctions shall be made between financial accounting, which is the most popular form of reporting financial information and rendering stewardship accounting and other forms of accounting i.e. cost accounting and management accounting. Differences between Financial Accounting and other Forms of Accounting Financial Accounting Other Forms of Accounting Financial accounting details the Other forms of account are used to aid I performance of an organisation over a management records, plan and control the defined period of time and at the end of organisational activities and to help in that period. decision making process. Ii Limited company must by law-prepare There is no legal requirement to prepare Financial Accounts. management account or any other acts except financial account. Iii The format of published financial account is determined by law such as The format is entirely at management CAMD 1990. BOF1D. SAS and decision. Insurance Decree Financial Accounts concentrate on the iv. business as a whole, aggregating revenue Others focus on specific areas or an and" expenditure/cost from different organisation's activities. operations. Financial Account present essentially Management and cost accounting are both v. historic picture of past operations. historic and future planning tools.  The main objective of Financial Accounts Other forms of accounts have the objectives vi. is to give account of ones stewardship. of meeting the information demanded by the management. Users of financial accounting are many, vii. both internal and external e.g. equity investors, loan creditors. Government Management team is the main user. Research Analysts Group. viii. Financial accounting reports are All these factors do not significantly influenced by the following factors. influence the preparation of other forms of Accounting conversion, accounting reports. (i) Accrual, Matching, prudence, going (ii) concern. Professional (iii) Pronouncements, Statement of Standard Accounting Practice (SSAP), Financial Accounting Standard (FAS), International Accounting Standard (IAS) Statutory Pronouncements e.g. CAMD 1990, Productivity, Price and Income Board Guidelines There is no rigidity about the time of management account reports; they could be ix. Financial accounting reports are mostly prepared either on a daily, weekly, monthly prepared on annual basis or half yearly or quarterly basis. As a matter of fact, they basis. could be prepared at any point in time as deem necessary and needed. x. Financial records are mainly concerned Management account on the other hand with profits. considers all aspects of management. xi. Management accounting, unlike financial accounting taps extensively from other well- developed disciplines such as economics, statistics, operational research and psychology etc. It is as a result of this factor (inter-disciplinary relationship) that management accounting is regarded as an inter-disciplinary science. Purpose and Uses of Accounting Information The primary purpose of accounting is to have control on the business properties. Control can be exercised in various ways: (i) ensure control-check on the activities of the directors (stewards) and also check on the activities of the employees; (ii) ensure the rendering of stewardship and general financial information to' management; (iii) ensure that equity is properly represented, that is, owners equity and other interests of other providers of capital e.g. loan, debenture and preference share capital are duly represented by the assets both fixed and liquid, tangible and intangible; (iv) make available proper books of accounts kept in line with the statutory requirement and according to the standardised concepts and conventions for the auditors to express independent view of the truth and fairness of the organisation; (v) prevent errors from being committed and where errors have been committed, it makes for easy, detection. This is achieved through the use of various control accounts;  (vi) prevent fraud, and where frauds have been committed, it makes for easy detection. This is achieved through investigation via the use of various control accounts; (vii) serve as a basis of appraisal such as; - performance/evaluation appraisal - project appraisal; and - investment appraisal. (viii) make information available for all the three levels of management for decision-making. Such as: - strategic information for the top management, in order to make their long-run/strategic planning and decisions. These are the board of directors, - Tactical information for the middle level management for example, managers, to make their medium-run/tactical planning and decisions; and - operational information for employees and other clerical officers to make their short- run, operational planning and decisions of routine activities; and (ix) help the decision-makers in resource allocation. Resources are in form of men, money, materials and machine (the four Ms). Management with the help of accounting techniques identifies the most profitable product line and high contribution and then allocates or concentrates resources on the production of this product. Uses of Accounting Information Managers use accounting information in the following ways: i. formulating the policies of the organisation; ii. planning and controlling the activities of the organisation; iii. performance appraisal at strategic, departmental and operational levels; iv. making decisions on alternatives courses of action; v. projects and investment appraisal; vi. evaluating stock and work-in-progress; vii. analysing the cost and the benefits of a product and the product line; and viii. supplying, estimating and ascertaining prices and also reflecting cost incurred; and ascertaining cost per unit of a product. Managers at all levels use accounting information for planning, controlling and evaluating the operations of the organisations, be it educational or industrial. The Users of Accounting Information The users of accounting information, especially in the educational system, can be divided into two categories, namely: i. Internal Users: This includes the people in the school, i.e. people that will deal directly with both the human resources (student and other resources such as chairs and table. Human resources include the principals and heads of departments. They use this information to know the capacity of the students that they can give admission in school. ii. External Users: The people in the ministry such as the inspectors, supervisors, commissioners for education, minister of education, etc constitute the users of accounting information. Accounting information is of high importance to the people in this category because they are the people, who are going to provide all the necessary resources that are needed in achieving the educational goals, be it of the nation, state and at the local levels. iii. Other users: The other users of accounting information are: a) The equity investors (i.e. present and potential shareholders). Their interests and needs are: - evaluating the performance; - assessing the effectiveness in achieving the company's objectives; - ascertaining the experience and background of directors and officials  - assessing the liquidity of the company, its present, or future requirements for additional capital and long term loans; - estimating future prospects, dividend payments policy of the company; - making comparison with either past performance or similar organisation; - evaluating opportunity cost of either investing in the company or elsewhere - ascertaining ownership and control of the company. - evaluating managerial performance, and - assessing the stability and vulnerability of the company. b) The Loan Creditor Groups (Existing and potential debenture/loan stockholders, banks and financial institutions). In addition to these points identified above, for equity their needs would include: - estimating future prospects of capacity to make cash payments; - ability to meet interest payment from income; and - evaluating financial stability and the level of capital gearing c) The Employee Group (existing potential and past employees). In addition to some of the creditor needs, their areas of interests include: - evaluating employment terms; - estimating remuneration capacity; and - assessing positions and prospects of individual establishment d) The Analyst – ‘Adviser’ Group (Financial analysts, journalists, trade unions, stockbrokers, and others, such as "credit rating agencies). In addition to the above, their needs would be more specific and would relate to some particular fulfillment, for example, - calculating the efficiency profitability ratios; - short-term solvency and liquidity; - long-term solvency and stability; - investment ratios. e) The Business Contract Group (Customer, trade creditors, competitors and others). Their requirement/in addition to some of the above will be: - future level of production; - nature of the company business and procedures; - market positions. f) The government (Inland Revenue, Customs and Excise, other departments and agencies). In addition to some of the above, their interests, will be: - statistical information ; - taxation and regulations; and - other legal, safety and health compliance requirements. 2. Accounting Assumptions and Conventions Accounting assumptions and conventions are the rules and guidelines by which the accountant lives. All accounts and accounting statements should be created, preserved and presented according to the assumptions and conventions. Accounting is the language of business. It is used in the business to describe the transactions entered into by all kinds of organisations. In the process of doing this, certain assumptions and conventions are used to aid and guide accounting practices. Each of the assumptions and conventions are discussed in this section. Assumptions Business Entity: The business entity concept states that a business and the owner(s) are two separate Legal Entities. Accounting information is prepared from the point of view of the organisation as an entity separated from its owners. It describes an economic unit, which enters into business transactions that must be recorded, summarised and reported. The entity is regarded as separate from its owner or owners; the entity owns its own property and has its own debts. Consequently, for each business entity, there should be a separate set of accounting records. A balance sheet and an income statement are intended to portray the financial position and the operating results of a single business entity. If the owner introduces his or her personal affair with that of the transactions of the business the resulting financial statements will be misleading and will fail to describe the business fairly. Business entity is therefore used to mean the person of an enterprise as distinct from the person of the owner, it could also mean a group of persons carrying on an economic activity, and constitute a unit usually recognised as having a separate and distinct existence from that of the business enterprise. Being an artificial person, a company has an existence independent of its members. It can own property, enter into contract and conduct any lawful business in its own name. It can sue and can be sued in the court of law. A shareholder cannot be held responsible for the acts of the company insolvency. The best example here concerns that of the sole trader or one-man business: in this situation you may have the sole trader taking money by way of ‘drawings’: money for his own personal use. Despite it being his business and apparently his money, there are still two aspects to the transaction: the business is ‘giving’ money and the individual is ‘receiving’ money. So, the affairs of the individuals behind a business must be kept separate from the affairs of the business itself. This concept restrains accountants from recording of owner’s private/personal transactions. It also facilitates the recording and reporting of business transactions from the business point of view. Money Measurement: Money Measurement concept, also known as measurability concept, means that only transactions and events that are capable of being measured in monetary terms are recognised in the financial statements. Accounting is only concerned with those facts that can be measured in monetary terms with a fair degree of objectivity. Hence, money is used as the basis of measurement. This means that account can never show the whole of the information needed to give you a full picture of the state of the business or how well it is being conducted. The implication of this is, quite simple, that by just looking at a set of accounting figures does not tell you all that you would like to know about a business. Accountants do not report items unless they can be quantified in monetary terms. Items that are not accounted for (unless someone is prepared to pay something for them) include things like workforce skill, morale, market leadership, brand recognition, quality of management etc. Cost and Value: Assets are normally shown at cost price and that this is the basis for assessing the future usage of the asset. The cost of input is expressed in terms of what was paid for it when it was bought. Thus, purchase price is a measure of cost, which is assumed to be an indicator of value. ". This requires that transactions should be recorded at the price ruling at the time, and for assets to be valued at their original cost. Going Concern: This assumes that accounting information of an organisation is prepared based on the continuity and going concern of the life of the organisation. That is, the life of the organisation in respect of which the information is prepared will go beyond the current period covered. The concept always assumes that the life of the organisation will continue to operate for an indefinitely long period of time. Only if the business was going to be sold or closed down would it be necessary to show how much the assets would fetch. Going concern is one of the fundamental assumptions in accounting on the basis of which financial statements are prepared. Financial statements are prepared assuming that a business entity will continue to operate in the foreseeable future without the need or intention on the part of management to liquidate the entity or to significantly curtail its operational activities. Therefore, it is assumed that the entity will realise its assets and settle its obligations in the normal course of the business. It is the responsibility of the management of a company to determine whether the going concern assumption is appropriate in the preparation of financial statements. If the going concern assumption is considered by the management to be invalid, the financial statements of the entity would need to be prepared on break up basis. This means that assets will be recognised at amount, which is expected to be realised from its sale (net of selling costs) rather than from its continuing use in the ordinary course of the business. Assets are valued for their individual worth rather than their value as a combined unit. Liabilities shall be recognized at amounts that are likely to be settled. Accruals Concept: Financial statements are prepared under the accruals concept of accounting, which requires that income, and expense must be recognised in the accounting periods to which they relate rather than on cash basis. An exception to this general rule is the cash flow statement whose main purpose is to present the cash flow effects of transaction during an accounting period. Under accruals basis of accounting, income must be recorded in the accounting period in which it is earned. Therefore, accrued income must be recognised in the accounting period in which it arises rather than in the subsequent period in which it will be received. Conversely, prepaid income must not be shown as income in the accounting period in which it is received but instead it must be presented as such in the subsequent accounting periods in which the services or obligations in respect of the prepaid income have been performed. Expenses, on the other hand, must be recorded in the accounting period in which they are incurred. Therefore, accrued expense must be recognized in the accounting period in which it occurs rather than in the following period in which it will be paid. Conversely, prepaid expense must not be shown as expense in the accounting period in which it is paid but instead it must be presented as such in the subsequent accounting periods in which the services in respect of the prepaid expense have been performed. Accruals basis of accounting ensures that expenses are "matched" with the revenue earned in an accounting period. Accruals concept is therefore very similar to the matching principle. Conventions Objectivity: That accounting information should be as possible, a record of facts that can be verified independently and not subject to personal interpretation or opinion. Thus, it should be possible for an independent accountant to use documentary evidence to arrive at the figures recorded in the accounting statement in which the information is presented. This implies that accounting information is prepared and reported in a "neutral" way. In other words, it is not biased towards a particular user group or vested interest In drawing up accounting statements, whether they are external "financial accounts" or internally-focused "management accounts", a clear objective has to be that the accounts fairly reflect the true "substance" of the business and the results of its operation. The theory of accounting has, therefore, developed the concept of a "true and fair view". The true and fair view is applied in ensuring and assessing whether accounts do indeed portray accurately the business' activities. To support the application of the "true and fair view", accounting has adopted certain concepts and conventions, which help to ensure that accounting information is presented accurately and consistently. Consistency: Business transactions may be recorded in different ways. This convention suggests that the accountant can use his/discretion to choose any available method that is suitable for the entity concerned. However, once a particular method is chosen, it is expected that it shall be used consistently from year to year in order to provide for comparison and similarity in results over time. Apparently, if the accountant finds it necessary to change, he/she should clearly state the reasons and the effects of the changes. However, constantly changing the methods would lead to a distortion of the profits calculated from the accounting records. Because the methods employed in treating certain items within the accounting records may be varied from time to time, the concept of consistency has come to be applied more and more rigidly. Because of these sorts of effects, it is now accepted practice that when an entity chooses to treat items such as depreciation in a particular way in the accounts, it should continue to use that method year after year. If it is necessary to change the accounting method being employed then an explanation of the changes and the effects on the results must be shown as a note to the accounts being presented. Conservatism: The convention portrays the accountant's attitude as a pessimist rather than optimist. The accountant tends to look at the gloomy rather than the bright side of financial affairs. His/her familiar maxim is "do not count your chickens before they are hatched. Thus, profits are not to be recognised or recorded until actually realised. It is this concept more than any other that has given rise to the idea that accounting is a sarcastic, mean and boring profession!! Basically the concept says that whenever there are alternative procedures or values, the accountant will choose the one that results in a lower profit, a lower asset value and a higher liability value. The concept is summarised by the well- known phrase ‘anticipate no profit and provide for all possible losses’. Revenue and profits are included in the balance sheet only when they are realised (or there is reasonable ‘certainty’ of realising them) but liabilities are included when there is a reasonable ‘possibility’ of incurring them. Materiality: Accounting does not serve a useful purpose if the effort of recording a transaction in a certain way is not worthwhile. In other words, time should not be wasted, in the elaborate recording of trivial items, such as recording stapling pin. And office pin, etc each time they are bought. As we can see from the application of accounting standards and practices, the preparation of accounts involves a high degree of judgement. Where decisions are required about the appropriateness of a particular accounting judgement, the "materiality" convention suggests that this should only be an issue if the judgement is "significant" or "material" to a user of the accounts. The concept of "materiality" is an important issue for auditors of financial accounts. Prudence: This concept means that normally accountant will take the figure, which will understate rather than overstate the profit while recording. The need to value the inventory at the lower of cost stems from the concept of prudence, which requires that the assets of the entity must not be stated above the amount expected to be earned from its use or sale. For example, if an inventory costs N100, 000 but its net value is only N70, 000 the inventory is recorded at the year end as N70, 000. Recording inventory at a lower amount has the effect of reducing profit because a decrease in closing inventory increases the cost of sales (expense). In other words, the concept assumes that: - Assets should not be overvalued - Liabilities should not be undervalued - The financial statements does not reflect overstatement or understatement of gains or losses but neutral - Profit or revenue should only be recorded when they are realised. 3. Accounting Equation and Double Entry Book Keeping The whole of financial accounting is based on the accounting equation. This can be stated to be that for a firm to operate, it needs resources, and that those resources have to be supplied to the firm by someone. The resources possessed by the firm are known as assets. Obviously, the owner of the business would have supplied some of these resources. The total amount supplied by the owner is known as capital or owners equity. If in fact, he/she was the only one who had supplied the assets then the following equation would hold true: Assets = Capital On the other hand, someone will normally have provided some of the assets other than the owner. The indebtedness of the firm for these resources is known as liabilities. The equation can now be expressed thus: Assets = Capital + Liabilities The equality of assets on the one hand and of the claims of the creditors and owner on the other hand is expressed in this equation: Assets =Liabilities + Owner’s Equity; N 89. 400.00 = N 14,400.00 + N75, 000.00 It can be seen that the two sides of the equation will have same totals. This is because we are dealing with the same thing from two different points of view. It is a fact that the totals of each side will always equal one another, and that this will always be true no matter how many transactions are entered into. The actual assets, capital and liabilities may change, but the equality of assets with that of the total of capital and liabilities will always hold true. To emphasise that the equity of the owner is residual element, secondary to the claims of creditors, it is often helpful to transpose the terms of the equation, as follows: Assets - Liabilities Owner's Equity N 89, 400.00 – N 14, 400.00 = N75, 000.00 The accounting equation is expressed in a financial position/statement called the balance sheet. Let us consider the components of this equation one by one. Assets: Assets are economic resources, which are owned by a business and are expected to benefit future operations. Assets may have definite physical form such as building; merchandise. On the other hand, some assets exist not in physical or tangible form, but in the form of valuable legal claims or rights. Examples of the latter are amounts due from customers, investments in government bonds and patent rights. In sum assets could be held in two forms; namely: fixed and current assets. Fixed Assets: Are regarded as those assets of material value that have long-life. They are held to be used in the business, and are not primarily for resale or for conversion into cash in a short run. Fixed assets, with the exception of land have a limited number of years of useful life. For instance, motor vans, machines, buildings and fixtures do not last forever. The useful life of a fixed asset is the length of time during which it will yield benefits to the individual or organisation that has acquired it. However, due to old age and frequency of maintenance, the capacity of the asset to yield benefits tends to fall. The fall in value of an asset as a result of age, usage or obsolescence is regarded as depreciation. That is, the part of the cost of the fixed asset consumed during its period of use by the firm. Thus, it has become a cost for services consumed in the same way as costs for such items as wages, rent and lighting. Depreciation is, therefore, treated as an expense and must be charged against the profit and loss account before ascertaining the net profit or loss. Provision for depreciation suffered will therefore have to be made in the books in order to determine the net profit. Current Assets: These are assets held in the form of cash or other forms, which are intended to be converted into cash within the accounting period. Liabilities: Liabilities are debts. All business concerns have liabilities; even the largest and most successful companies find it convenient to purchase merchandise on credit rather than to pay cash at the time of each purchase. The liability arising from the purchase of goods or services on credit is called an account payable, and the person or company to whom the account payable is owed is called a creditor. A business concern frequently finds it desirable to borrow money as a means of supplementing the funds invested by the owner, thus enabling the business to expand more rapidly. The borrowed funds may, for example, be used to buy goods or pay for services. On the other hand, the borrowed money might be used to buy new and more efficient machinery, subsequently enabling the company to turn out a larger volume: of products at a lower cost. When a business borrows money for any reason, a liability is incurred and the lender becomes a creditor of the business. The form of the liability when money is borrowed is usually a note payable, a formal written promise to pay a certain amount of money, plus interest, at a definite future time. An account payable, unlike the note payable, does not involve the issuance of a formal written promise to the creditor, and it does not call for payment of interest. When a business has both notes payable and account payable, the two types of liabilities are shown separately in the balance sheet. The sequence in which these two liabilities are listed is not important, although notes payable is usually shown as the first item among the liabilities. The creditors have claims against the assets of the business, usually not against any particular asset but against the assets in general. The claims of the creditors are liabilities of the business and have priority over the claims of owners. Creditors are entitled to be paid in full even if such payment should exhaust the assets of the business, leaving nothing for the owner. Owner's Equity/Capital: The owner's equity in a business represents the resources invested by the owner; it is equal to the total assets minus the liabilities. The equity of the owner is a residual claim because the claims of the creditors legally come first. If you are the owner of a business, you are entitled to whatever remains after the claims of the creditors are fully satisfied. Increase in Owner's Equity: If you begin a small business of your own, you will probably invest cash and possibly some other assets to get the business started. Later, as the business makes payments for rent, office equipment, advertising, salaries to employees, and other items, you may find it necessary to supply additional cash to the business or invest money earned from other sources. Hopefully, before long, the business will become self-sustaining. Whenever, as owner of the business, you transfer cash or other personally owned assets to the business entity, your ownership equity will increase. In summary, the owner's equity in a business comes from two sources: (i) Investment by the owner; and (ii) Earnings from profitable operation. Decrease in Owner's Equity: If you are the owner of a single proprietorship, you have the right to withdraw cash or other assets from the business at any time. Since you are strongly interested in seeing the business succeed, you will probably not make withdrawals, which would handicap the business entity in operating efficiently. Once the business achieves momentum and financial strength, you may choose to make substantial withdrawals. Withdrawals are most often made by writing a cheque drawn on the company's bank account and payable to the owner. However, other types of withdrawals also occur, such as taking office equipment out of the business for personal use by the owner, or by causing cash belonging to the business to be used to pay a personal debt of the owner. Every withdrawal by the owner reduces the total assets of the business and reduces the owner's equity. In summary, decreases in the owner's equity in a business are caused in two ways: (i) Withdrawals of cash or other assets by the owner; and (ii) Losses from unprofitable operation of the business. The Double Entry Book Keeping Double entry book keeping is the technique of recording transaction so as to disclose the dual aspects in every transaction. The essential feature of double entry book keeping is that the two aspects are always involved in every business transaction. These aspects are the giving and receiving of value. To show the full effect of each transaction, accounting must therefore show its effect on each of the two items, be they assets, capital or liabilities. The procedure of double entry is based on the fact that all business dealings tit into one of a limited number of types of transactions one part of which is represented by a debit entry (left hand) and -the other by a credit entry (right - hand). In the light of these assertions, the double entry book keeping can be well explained with the following: (i) A business transaction which increases the value of one asset will lead to a corresponding decrease in another asset; (ii) Alternatively, an increase in assets may be accompanied by an equal increase in liabilities where the assets are acquired on credit or account. (iii) A transaction involving the use of assets in the settlement of liabilities will reduce assets and liabilities by the same amount. The Journal The journal, or book of original entry, is a chronological (day-by-day) record showing for each transaction the debit and credit changes caused in specific ledger accounts. At convenient intervals, the debit and credit entries recorded in the journal are transferred to the accounts in the ledger. The updated ledger accounts in turn serve as the basis from which the trial balance and other financial statements are prepared. The journal shows all information about a transaction in one place and also provides an explanation of the transaction. In a journal entry, the debits and credits for a given transaction are recorded together, but when the transaction is recorded in the Ledger, the debits and credits are entered in different accounts. Moreover, the journal helps to prevent errors. For instance, if transactions were recorded directly in the ledger, it would be very easy to make mistakes such as omitting the debit or the credit or entering the debit twice or the credit twice. Such errors are not likely to be made in the journal, since the offsetting debits and credits appear together for each transaction. It is of course possible to forget to transfer a debit or credit from the journal to ledger account, but such an error can be detected by tracing the entries in the ledger accounts back to a journal. Many businesses maintain several types of journals. The nature of operations and the volume of transactions in a particular business determine the number and type of journals needed. The simplest type of journal is called general journal. It has only two columns, one for debits and the other for credits; it may be used for all types of transactions. The process of recording a transaction in a journal is called journalising. To illustrate the' use of the general journal, we shall now journalise the transactions of Opeolu Trading Store for the month of April 199x. Illustration of a journal March 1 Mr. Opeolu started business with cash 50,000 March 3 Bought furniture and fittings on account 10,000 March 5 Cash purchases 8,500 March 7 Bought office equipment on account 25,000 March 9 Bought stationery with cash 5,000 March 11 Sold goods for cash 6,400 March 15 Credit sales to Aina 2,500 March 17 Granted loan to Ojo (Sales boy) 2,800 March 20 Additional deposit by Mr. Opeolu 30,000 March 22 Received as earning from sales of land and 40,000 invested in the business March 24 Received from Ojo as part repayment of loan 1,800 March 26 Made the following payment: i. equipment 10,000 ii. staff salaries 12,500 iii. furniture and fittings 6,400 From the above information let us first prepare a general journal and later use the same to prepare the ledger accounts and the trial balance respectively. There are three rules that guide the preparation of a good journal. They are: i. for every transaction there are two parties involved and they must be properly identified; ii. identify the giving side and receiving end; iii. debit the receiving end and credit the given side. Note: In journalising, the account to be debited must be recognised first. General Journal of Opeolu Trading Store as at March 31 199x Date Particular Dr Cr Cash 50,000.00  Capita) 50,000.00 March 1 Being cash invested in the business by Mr. Opeolu Furniture and fittings 10,000.00 Creditors 10,000.00 March 3 Being the furniture and fittings bought on account Purchases 8,500.00 March 5 Cash 8.500.00 Being cash purchases Equipment 25,000.00 March 7 Creditors 25.000.00 Being equipment bought on account Stationery 5,000.00 March 9 Cash 5,000.00 Being stationery bought with cash Cash 6,400.00 March 11 Sales 6,400.00 Being cash sales Debtor (Aina) 2,500.00 March 15 Sales 2,500.00 Being credit sales to Aina Loan (Ojo) 2,800.00 Cash 2,800.00 March 1 7 Being- the loan granted to Ojo Cash 30,000.00 March 20 Capital 30,000.00 Being additional cash invested by Opeolu Cash 40,000.00 Earning 40,000.00 March 22 Being money earned from the sales of land Cash 1,800.00 Loan (Ojo) 1,800.00 March 24 Being part repayment of loan granted to Ojo Creditors 16,400.00 Staff salaries 12,500.00 March 26 Cash 28,900.00 Being sundry payment on equipment, staff salaries and furniture and fillings The ledger Ledger accounts are a means of accumulating/ in one place, all the information about changes in specific assets, liabilities, and owner's equity. For example, a ledger account for the asset cash provides a record of the amount of cash receipts, cash payments, and the current cash balance. By maintaining a cash account, management can keep track of the amount of cash available for meeting different cash obligations. This record of cash is also useful in planning future operations and in advance planning of applications for bank loans. Moreover, the development of annual budget requires estimating in advance the expected receipts and payments of cash, these estimates of cash flow are naturally based to some extent on the ledger accounts showing past cash receipts and payments. The process of transferring information from journal to the ledger for the purpose of summarising is called posting. The journal provides the information for posting. The ledger is also called a T account because of its resemblance to the letter T. Having briefly explained what a ledger is let us now illustrate a typical ledger using the preceding information on Opeolu general journal. Here, we are going to post all the information into individual accounts. Dr Cash Account Cr Capital 80,000.00 Sales 6,400.00 Purchases 8,500.00 Earning 40,000.00 Stationery 5,000.00 Loan (Ojo) 1,800.00 Loan (Ojo) 2,800.00 Creditors 16,400.00 Salaries 12,500.00 Bal. c/d 83,000.00 128,200.00 128,200.00 Bal. b/d 83.000.00 Dr Capital Account Cr Cash 80,000.00 Dr Furniture and fittings Account Cr Creditors 10,000.00 Dr Purchases Account Cr Cash 8,500.00 Dr Equipment Account Cr Creditors 25,000.00 Dr Stationery Account Cr Cash 5,000.00  Dr Sales Account Cr Cash 6,400.000 Debtor 2,500.00 Dr Loan Account Cr Cash 2,800.00 Cash 1,800.00 B al. c/d 1,000.00 2,800.00 2,800.00 Bal. b/ 1.000.00 Dr Earnings Account Cr Cash 40,000.00 Dr Debtor Account Cr Sales 2,500.00 Dr Creditors Account Cr Furniture & Fittings 10,000.00 Equipment 25,000.00 Cash 16,400.00 Bal. c/d 18,600.00 35,000.00 35,000.00 Bal. b/d 18.600.00 Dr Salaries Account Cr Cash 12,500.00 Note: Except when the two sides of the ledger are involved in the transactions, it is not necessary to balance a one sided transaction. The trial Balance The trial balance provides proof that the ledger is in balance. The agreement of the debit and credit totals of the trial balance gives assurance that: i. equal debit and credits have been recorded for all transactions;  ii. the debit or credit balance of each account has been correctly computed; and iii. the addition of the account balances in the trial balance has been correctly performed. Preliminary to preparing the trial balance, the debit and credit amounts in the ledger account must be totaled to reflect the balance brought down. If there is only one item entered in a column, as earlier showed under the illustrations on ledger, no footing is necessary. To find the balance of an account, it is necessary to determine the difference between the footings by subtraction. Since asset and expense accounts are debited for increases, these accounts normally have debit balance. Similarly, since liabilities, capital and revenue accounts are credited to record increases; these accounts normally have credit balances. The balance of an account should be entered on the side of the account that has the larger total. The footings and balances of accounts should be written in small figures or underlined just below the last entry. If the footings of an account are equal in amount, the account is said to be in balance. Let us now use the balances brought down in ledger accounts of Opeolu Trading Store to prepare a trial balance. Trial Balance of Opeolu Trading Store as at April 30 199x Particular Dr. Cr 1. Cash 83,000.00 2. Capital 80,000.00 3. Furniture and fittings 10,000.00 4. Creditors 18,600.00 5. Purchases 8,500.00 6. Equipment 25,000.00 7. Stationery 5,000.00 8. Sales 8,900.00 9. Loan (Ojo) 1,000.00 10. Earnings 40,000.00 11. Debtor 2,500 12. Staff salaries 12,500.00 Debtor 147,500.00 147,500.00 Trial Balance and Errors The preparation of trial balance does not provide complete proof of the accuracy of the ledger. It does not show that transactions have been correctly analysed and recorded in proper accounts. The trial balance indicates that the debits and credits entries are equal. It proves only one aspect of the ledger, and that is the equality of debits and credits. However, there are several types of errors that will not affect the balancing of a trial balance. These are: (i) Errors of omission - where a transaction is completely omitted from the books. (ii) Errors of commission - where the correct amount is entered but in the wrong person's account, for example when loan granted S. Eden is treated into the account of C. Eden, commission error has been committed. (iii) Errors of principle - where an item is wrongly entered in another account, that is when an asset such as furniture is debited to an expenses account in the trading profit and loss account, an error of principle has been committed. (iv) Compensating errors – this is where one error cancels out another error. For instance, when creditors account was increased by N150.00, which was, compensated by an increase in debtors account by the same amount (N150.00) then these two errors would cancel out in the trial balance.  (v) Errors of original entry – this is where the original figure is wrongly entered, although double entry is still properly observed using this figure incorrectly entered. For instance, entering N79.00 for credit sales, which was actually N97.00. (vi) Complete reversal of entries – this is where the correct accounts are entered into the wrong sides of the account, for example, debiting the creditor and crediting the debtor. 4 Income Statement Income statement is a summary of the revenues and expenses of an accounting cycle. It is prepared to reflect a period of time, a month or a year depending on the size of the organisation. For instance, a small business unit may find it easy to prepare a monthly income statement but this may be practically impossible for a fairly large organisation. Income statement, profit and loss account refers to the outcome of the summary of revenues and expenses of an accounting period. When we measure the net income earned by a business enterprise we are measuring its economic performance - its success or failure as a business enterprise. The owner, the manager, and the company's banker are anxious to see the latest available income statement and thereby judge how well the company is doing. From the trial balance presented of a trading company (Adeola Trading Co.), let us prepare the Income Statement/Trading Profit and Loss account for the month ending. April 30, 199x, using only the relevant information. Trial Balance of Adeola Trading Co.) Items Dr Cr Stock April 1 4,000 Sales 30,000 Purchases 16,000 Salaries 4,600 Motor expense 1,500 Rent expense 1,400 Insurance 650 General expense 700 Land 20,000 Equipment 5,000 Debtors 2,000 Creditors 5,000 Cash in hand 1050 Cash at Bank 1100 Capital 23,000 58,000.00 58.000.00 Note: Stock at April 30 was N5, 250.00 Trading Profit and Loss account of Adeola Trading Co. as at April 30, 199x Items Dr Cr Sales 30,000.00 Opening Stock 4,000 Purchases 16,000 Good available for sales 20,000 Less closing stock 5,250  Cost at goods sold 14,750 Gross Profit c/d 15,250 30,000.00 30.000.00 Gross profit b/d 15,250 Expenses 4,600 Salaries 1,500 Motor exp. 1,400 Rent exp. 650 Insurance 700 8,850 Net Profit c/d 6,400 15,250.00 15,250.00 Net Profit b/d 6,400.00 Note: The income statement is the “scoreboard” of a firm’s performance during a particular period of time. The income statement or the trading profit and loss account presents the summary of revenues, the expenses, and net income (or net loss) of a firm for a specific period of time. It depends on the size of the firm. The income statement serves as a measure of the firm’s profitability. A firm’s operation is profitable when total revenue exceeds total expenses. A net profit is declared in this situation, but when the reverse happens, the firm’s operation is said to be unprofitable and a net loss will result. Functions of the Income Statements 1. It gives a concise summary of the firm’s revenue and expenses during a period of time. 2. It measures the firm’s profitability. 3. It accumulates economic data – revenue and expenses in accordance with the equation: Revenue (R)- Expenses (E) = Net Income (NI) The N1 could be profit or loss depending on which one is greater between R & E. 4. It measures net income by matching R and E according to basic accounting principles. 5. It communicates information regarding the results of the firm’s activities to the owners and others. The Balance Sheet The purpose of the balance sheet is to show the financial posting of a business at a particular date. It is the statement of financial position, disclosing the assets and liabilities of a business as well as the owner's equity at a given period of time. The following balance sheet was prepared to portray the financial position of Adeola Trading Co. as at April 30, 199x. Balance Sheet of Adeola Trading Co as at April 30, 199x Capital 23.000 Fixed Assets Net profit 6.400 - Land 20,000 - Equipment 5,000 29,400  25,000 Current Assets Creditors 5,000 - Cash in hand 1,050 - Cash at bank 1,100 - Debtors 2,000 - Closing Stock 5,250 N34,400 N34,400 Note: The balance sheet sets forth in its heading three items: (a) the name of the business; (b) the name of the financial statement. "Balance Sheet" and (c) the date of the balance sheet. Below the heading is the body of the balance sheet, which consists of three distinct sections: assets, liabilities, and owner's equity-capital. The balance sheet or the statement of financial position is one of the most significant financial statements. It indicates the financial condition or the state of affairs of a business at a particular point in time. Specifically, the balance sheet contains information about the resources and obligations of a business entity and about its owner’s interest in the business at a particular point in time. The balance sheet of a firm, in the language of accounting, communicates information about the assets, liabilities and owner’s equity of the firm as at a specific date. It provides a snapshot close of the firm’s accounting period, usually a year, six months or less than that depending on the size of the firm. Functions of the Balance Sheet The three important functions served by balance sheets are: 1. It gives a concise summary of the firm’s resources (assets) and obligations (liabilities and owner’s equity). 2. It is a measure of the firm’s liquidity. 3. It is a measure of the firm’s solvency. The balance sheet shows the state of the firm’s affairs – assets owned by the firm and the claims against them. It reflects the economic results of management polices. In addition, the balance sheet contains information about the firm’s liquidity position. Liquidity refers to the firm’s ability to pay its debts as they mature. The net current asset, which is the difference between current assets and current liabilities, is the measure of a firm’s liquidity. 5. Accounting Information and Decision Making Process For an organization to function effectively, it needs a constant supply of different types of information. Accounting information is needed about the different types of input and their cost of acquisition. Similarly, information is needed about the costs of the various activities relating to the conversion of inputs. Moreover, there is a need for information about the value of outputs produced by the organization’s economic activities. Without such information, it will be difficult to measure the performance and the effectiveness of the organization. Decision Making Process We are faced with decisions almost continuously in our personal lives and in business. Many decisions are so routine that we may not even realize they are decisions, such as what clothes to wear each day or what to have for breakfast. Other decisions cause us to be more conscious of the decision process because the decision is made less frequently and is of greater consequences, such as buying a car or choosing a job. Like personal decisions, business decisions vary in complexity and importance. Many decisions require no action at all. Other business decisions, however, are much more complex, such as plant – expansion or new- product decisions. Decision-making is both an art and a science. It is an art because decisions are made using both subjective and objective data. Decision makers must decide how to combine a variety of inputs into a logical decision framework. Decision-making is a science because many complex decisions can be reduced to simple components by means of quantitative methods. For example, many firms examine only a small portion of production output, using statistical techniques to determine whether production processes are operating within acceptable tolerance limits. Each individual makes decision in a slightly different way. However, most people agree that the decision- making process include the following: 1. Defining the problem, 2. Identifying alternative, 3. Accumulating relevant information, and 4. Making the decision. Let me expatiate on each of these points one by one. Defining the Problem. Perhaps the most important phase of decision-making is problem definition because all other activities in the process depend upon this phase. If managers do not have a clear understanding of the specific problem at hand, they may spend considerable time and effort identifying alternatives and gathering information, which is irrelevant to solving the real problem. Incorrectly defined problem wastes time and resources, so decision makers should not be too hasty in moving on to the alternative phase of the decision making process. Varied complex problems may require much analysis before a clear definition is reached. Identifying Alternatives: After the problem has been defined, the next thing is how to solve it. Usually, there is more than one feasible solution to every problem. Identifying alternatives is the ideal phase of decision-making in which managers can use their ingenuity. Creativity is the watchword in identifying alternatives and there is no need to be cautious or inhibited in this process since the alternatives are evaluated in the later phase. Unfortunately, previous experiences and bias often limit the variety of alternatives that managers consider. Accumulating Relevant Information: Decision making may desire a variety of information to assist in making decisions. Some information may be subjective and some objective, some may be internal to the organization and some may be external. Some information may be based on past costs or events, and some may be based on management expectations about future costs or events. Whatever the nature of the information, it must be relevant to the decision at hand. The idea is to select only those items of information that affect the decision and discard those that do not. In this age of information explosion and development in information communication technology (ICT), decision makers may be inundated with data. This phenomenon is referred to as information overload by decision theorists. Hence, managers must cautiously select only those items of information that can be assimilated into logical decision framework. Information should increase decision makers’ knowledge or reduce their uncertainty. Relevant information increases the knowledge of a particular situation and reduces the risk of selecting wrong course of action. Making the Decision: It may appear to you that once the problem is defined, alternative ideas and relevant information are selected, the making of the decision is simple. Seldom is that the case, particularly, in making decisions, no single variable dominate in decision criteria but different variables interact and affect one another. For example, in choosing a career, you may consider economic potential, job satisfaction, lifestyle, advancement potential, geographical location and other variables. Some careers may rank high for some variables and low for others. The final decision depends on the decision model or evaluation of your benefit. A decision model is simply a description of how a decision is made. Role of Accounting Information in Decision Making The accounting aids play a major role in management decision-making. Financial information is necessary for planning and decision-making, and to meet the working capital requirement in an organization. Accounting employs the use of historical and estimated data to assist management in the day-to-day decision-making and operations of the organization. It deals with specific problems that confront the organization; identifying alternative courses of actions and selecting the best out of the identified courses of actions. Financial accounting, also referred to as general accounting, deals with the basic accounting requirements by all types of economic concern, be it private, public or educational institution. It is primarily concerned with recording of transactions and periodic preparation of financial statement from the record. In this regard, the function of the financial manager is central to the overall success of the organization. He focuses on balancing of risks and returns in order to maximize the market price of the owner’s equity. Basic Functions of a Financial Manager The financial manager is involved in three major functions apart from his routine function such as keeping day-to-day financial records of a business transactions as well as data classification, which connotes summarising and interpreting the records of transactions. These functions are: Financial Planning: This is one of the most important of all the functions of a financial manager. The financial manager is the central actor in the process of planning the company’s financial needs and use of funds. He frequently participates in setting the long-run objectives of the business. His recommendation on the long-run plans concerning plant expansion, replacement of machinery and equipment or other expenditures, which involve the use of large sums of money, forms the basis of the long-run plans. He is equally involved in the short-run plans of the firm. Managing Assets: The financial manager determines how the funds of the company should be invested economically through useful choice of alternatives for the use of funds. He also plans the flow of funds and decides upon other most profitable allocation among the various assets. This is the most challenging of all the functions of a financial manager. Raising Funds: The financial manager determines when raising of funds for the organization becomes necessary. When cash outflow is greater than its cash inflow resulting into cash imbalance, he will find it necessary to obtain funds from outside the business through borrowing, sales of items or buying on credit. Other routine functions of a financial manager include providing for liquid assets, generating earnings and taking financial decisions. Organization of Financial Management The organization of financial management differs among companies, and the sphere of financial management is not clearly defined in practice. Consequently, we should not make the mistake of thinking that the operations of every company’s finances revolve around the financial manager. The role of the financial manager and the extent of his participation in financial functions will vary according to the policy of the company, the size of the company and his own ability and those of other officers and directors. In line with this, senior financial officers are called by different titles in different organizations, such as treasurers, financial controllers, financial directors and even bursars in higher education institutions. However, the functions, which constitute financial management, are the same and in most organizations the importance and his functions cannot be over emphasised. Reading Lists Adekunle, S.A. (l998). Management Accounting Vol. 1. Charles T., Gary L.S. and John A.E. (l983). Introduction to Financial Accounting. (USA): Prentice Hall Inc. Frank Wood (1972). Business Accounting 1. (Second Edition), London: Longman Group Limited. Grant, J. C. (1975). Accounting Made Simple. London: Allen & Company Limited. ICAN PATHFINDER (May/June 994). Foundation Examination, Suggested Solution. Lagos: ICAN ICAN (1998). Foundation Pilot Questions and Solution 1998. Lagos: ICAN ICAN PATHFINDER (May 1999). Intermediate Examination Suggested Solution, Lagos: ICAN Inanga. F. L. (1990). Principles of Accounting Ibadan. Heinemann Educational Books (Nig.) Limited. Nikolai, L. A. Bazley, J.D. and Stallman. J.C. (1990). Principle of Accounting. U.S.A, PWS-Kent Publishing Company. Longe, R. S. (1988). Practical Accounting. Ibadan: Fabamigbe Publishers. Meigs, W. B. and Meigs, R.E (1981). Accounting: The Basis for Business Decision. U.S.A: McGraw.