Comparison bet accounting Purpose Financial Accoun Record historic transactions agement Accounting assist in controlling the business operations planning how the business will develop making decisions between alternatives Audience External parties - particularly Internal management and owners of shareholders, lenders and regulators the organisation Legal • prepare financial statements • No legal requirement to prepare requirements (in accordance with legal • No set format for presentation requirements) • prepare accounts for tax authorities 14 Comparison between financial and manageme accounting (cont.) Financial Accounting Management Accounting Format Must conform to accounting and legal requirements Presented in such a format as to be easily understood by managers Perspective Historic performance (i.e. backwards looking only) Both future perspective (for planning and decision-making) and historic perspective (for control) Nature of Information Almost entirely financial Both financial and non-financial Frequency of Preparation Usually once a year As often as necessary - daily, weekly preparation or monthly, depending upon the needs of managers. FINANCIAL ACCOUNTING 9.1 Sources of data The first part of the accounting process, i.e. recording business transactions is often driven by various source documents that provide evidence for the transaction and give all the relevant details. These documents include: Quotation A written offer to provide goods or services at a particular price. No transaction has taken place yet and therefore nothing is recorded in the accounts. Sales order An order note for goods required by a customer. Purchase order An order note for goods required from a supplier Goods received note A list of goods received from a supplier. Prepared by the recipient business. Goods despatched note A list of goods sent to a customer. Prepared by the seller. Invoice A demand for payment sent to a customer. Statement A document sent to a customer listing all transactions between the business and that customer. Credit note A note sent to a customer who returns goods or overpays. This reduces the amount owed by that customer. Debit note A note sent to a supplier to whom goods have been returned. It is in effect a request for them to issue a credit note. Remittance advice A document sent to a supplier alongside any payment sent to them. It details which invoices are being paid. Receipt A note to confirm that payment has been received. 9.2 Books of prime entry - part of the accounting process When a business is involved in a transaction, it is usual for this transaction to be recorded initially in a book of prime entry. A book of prime entry is not part of the ledger or double entry system, but simply a list of transactions of the same type. The common books of prime entry and the types of transaction recorded in them are: Book of prime entry Transaction type Sales day book (SDB) Credit sales Purchases day book (PDB) Credit purchases Sales returns day book (SRDB) Returns of goods sold on credit Purchases returns day book (PRDB) Returns of goods purchased on credit Chapter Asset accounts are DEBITS Liability accounts are CREDITS Capital accounts are CREDITS Revenue accounts are CREDITS Expense accounts are DEBITS 18 Types of ledger accour An asset account collects information about particular assets of a business. It mainly consists of debit entries. A liability account collects information about particular liabilities of a business. It mainly consists of credit entries. Asset and liability accounts appear on the statement of financial position at the end of the accounting period. An expense account collects information about particular costs of a business. It mainly consists of debit entries. A revenue account collects information about particular income of a business. It mainly consists of credit entries. Revenue and expenses appear in the statement profit or loss in order to compute profit for an accounting period. 19 Ledger account £ Debit side (Dr) Credit side (Cr) Entries on the DEBIT side: increases in Entries on the CREDIT side: increases in Assets Liabilities Expenses Income Drawings Capital £ 20 • Costs which are specifically attributed to unit of production, example, direct labour cost, direct expenses and subcontracted work • Fixed and variable production overheads that are incurred in converting materials into finished goods. • Fixed production overheads are those indirect costs of production that remain relatively constant regardless of the volume of production, example, cost of factory management and administration. • Variable production overheads are those indirect costs of production that vary directly or nearly directly, with the volume of production, example, indirect materials and labour. 34 Tangible non-current ass • A tangible non-current asset can be bought in its useable state and it could also be purchased and additional work may need to done on it to bring it to a working condition. • IAS 16, the accounting standard that deals with tangible non-current assets, requires that the cost includes all costs directly attributable to bringing the asset to its location and working condition for its intended use (i.e. to operate normally). It includes: - Initial purchase price - Initial training costs - Delivery costs - Legal fees - Non-refundable import taxes - Stamp duty - Installation costs • Subsequent expenditure which increases the economic benefit generated by the asset can be capitalised. • Other expenditure is revenue expenditure and must be expensed in the statement or profit or loss. 51 Research expenditure: This should be written off as an expense as it is incurred. Tangible non-current assets used for research purposes: These should be capitalised, and depreciated over their useful lives. Development expenditure: An intangible asset arising from development (or from the development phase of an internal project) may be recognised if an enterprise can demonstrate all of the following: • The technical feasibility of completing the intangible asset so that it will be available for use or sale. • The intention to complete the intangible asset and use or sell it. • The ability to use or sell the intangible asset. • How the intangible asset will generate probable future economic benefits. • The availability of adequate technical, financial and other resources to complete the development and to use or sell the intangible asset. • The ability to measure reliably the expenditure attributable to the intangible asset during its development. 62 Transactions Day books Day books or books of prime entry: individual transactions are entered first here. Ledger accounts: are in the general ledger or nominal ledger, which form the double entry books of account. They contain all the balances necessary to produce financial statements, i.e. asset, liability, income and expense accounts. They include: Control accounts: most notably receivables and payables control accounts. These are ledger accounts which summarise a large number of transactions. Receivables and payables ledgers are subsidiary or memorandum ledgers which record detailed transactions and allow staff to identify individual supplier (payable) and Ledger accounts Financial statements customer (receivable) balances. They are separate from the general ledger and are not usually part of the double entry system. 81 Glossary Accounting records Any listing or book which records the transactions of a business in a logical manner. Accrued expense An expense which has been incurred but not paid by the end of the accounting period. Assets Any tangible or intangible possession which has value. Statement of financial position A statement of assets, liabilities and equity at a point in time. Equity The residual interest in a company, paid to the owners when the business ceases to trade. Capital expenditure Expenditure on acquiring or improving non-current assets for use in the business and not for resale. Reported in the statement of financial position Statement of cash flows Provides information about cash receipts and cash payments during an accounting period. Credit note Records goods returned by a customer or the reduction of monies owed by a customer. Current asset Assets which the business intends to use, sell, or change regularly in the normal course of business. E.g. inventory, receivables and cash. Current liability A liability which is payable within 12 months of the reporting date. Financial accounting Day books Record the transactions of each day, and are used as an initial 'store' of information of the business transactions prior to recording the information in the ledger accounts. Debit note Sometimes raised by a purchaser of goods. It is a formal request for a credit note to be issued by the supplier. Financial accounting Concerned with accounting to users outside the enterprise for the way in which the business's funds have been used. Done by presenting a statement of financial position and income statement at least once every year. Financial management Seeks to ensure that financial resources are obtained and used in the most effective way to secure attainment of the objectives of the organisation. It is largely to do with the management of cash and investments. Statement of profit or loss and other comprehensive income. A summary of income and expenditure for a period of time, showing the profit or loss made in an accounting period, together with any items of other comprehensive income arising in the same accounting period. Ledger accounts Also known as T accounts. Pages in a book (the ledger) with a separate page reserved for transactions of the same type. Liabilities The financial obligations of an enterprise KAPLAN PUBLISHING FFA/F3 Management accounting An integral part of management activity inside the enterprise, concerned with identifying, presenting and interpreting detailed information used for formulation of strategy, planning and controlling activities, decision taking and optimising the use of resources. Non-current asset Any asset, tangible or intangible, acquired for retention by an entity for the purpose of providing a service to the business, and not held for resale in the normal course of trading. Non-current liability A liability which is payable more than 12 months after the reporting date. Prepayment An expense which has been paid in advance for a period which extends beyond the end of the current accounting period. Provision An amount written off to provide for the diminution in value of an asset (e.g. a provision for depreciation) or an amount retained to provide for a known liability whose amount cannot be determined with accuracy. A provision is treated as an expense in the income statement. Purchase order An agreement to purchase goods/services from a business. It is prepared by the purchaser. Revenue expenditure Expenditure on acquiring current assets, on running the enterprise and on maintaining non-current assets. Reported in the income statement. KAPLAN PUBLISHING ix Bookkeeping principles Accruals Concept Income and expenditure should be matched to the period in which it relates rather than when cash is received or paid Accrued expenditure This arises when the expenditure relating to the period has not been paid. The amount owing at the end of the period is adjusted as follows: Dr Expense (P&L) Cr Accrued expenditure (SFP liability) In an ongoing business there could be an opening and a closing accrual. Accrued expenditure - Proforma expense T account Expense Bank (total paid during the year) Bal c/d (closing accrued expense) X X Bal b/d (opening accrued expense) SOCI (total expense for the year) X X X X Bal b/d (opening accrued expense) x a KAPLAN PUBLISH* Accrued Income Accrued income arises when the income has been earned in the period but has not been received. The accrued income will be accounted for as follows: Dr Accrued income (SFP) Cr Income (P&L) PLAN PUBLISHING Bookkeeping principles Prepayments Prepaid expenditure This arises when the expenditure relating to the period has been paid in advance. The amount prepaid at the end of the period is adjusted as follows: Dr Prepayment (SFP asset) Cr Expense In an ongoing business there could be an opening and a closing prepayment. Prepaid expenditure - Proforma expense T account Expense Bal b/d (opening prepaid expense) Bank (total paid during the year) X X SOCI (total expense for the year) Bal c/d (closing prepaid expense) X X X X Bal b/d (opening prepaid expense) X 20 KAPLAN Methods of depreciation Straight line method % on cost or Cost - Residual Value _se'-. economic life ■facing balance method T>*s r^jnod results in higher depreciation Jmj in earlier years. A percentage is appied to cost in the first period and to net sec* .a._e n subsequent years TMe care! If assets have been sold during fee year trie accumulated depreciation Maust be reduced by the accumulated rt^«i a j tinr on the disposals, before the mn i* year s charge is calculated. Requirements of lASs and IFRSs Type of income Recognition Sale of goods In addition to the above general principles, the seller must: have transferred the significant risks and rewards of ownership' to the buyer not retain effective control (or a continuing management involvement) over the goods sold. Providing services Recognise by reference to degree of completion of transaction as at the end of the reporting period, provided that: the stage of completion can be measured reliably, and the costs incurred and the costs to be incurred to complete the transaction can be reliably measured. When these conditions are not met, revenue should be recognised only to the extent of the expenses recognised that are recoverable. Interest Recognise on a time proportion basis taking account of the yield on the asset. Royalties Recognise on an accruals basis in accordance with the relevant agreement Dividends Recognise when the shareholder's right to receive payment has been established. KAPLAN PUBLISHING -,. .....________Omftmit Intangible assets: IAS 38 The main area for examination in this standard is that of Research and Development Research - Definition Recognition Original and planned investigation undertaken with the prospect of gaining re* scientific or technical knowledge and understanding'. Expenditure on research should be recognised as an expense in the period in which it is incurred. 65 Development - Definition Recognition 'The application of research findings or other knowledge to a plan or design for the production of new or substantially improved materials, devices, products, processes, systems or services before the start of commercial production or use'. The cost of an internally generated development work The sum of all directly attributable costs to create the asset and make it ready for use in the manner intended by management. E.g. costs of materials, services and labour fees to register a legal right. Only expenditure incurred from the time that the intangible asset was recognised is included. Expenditure incurred during the research phase cannot be re-classified from an expense to an intangible asset. Recognise as an intangible asset, if and only if all the following can be demonstrated: the technical feasibility of completing the development the intention of the company to complete the development the ability of the company to use or sell the item how the intangible asset will generate future economic benefits the availability of adequate technical, financial and other resources to complete the asset the ability to measure reliably expenditure on the intangible asset during its development. When the requirements can all be demonstrated, subsequent expenditure should be classified as an intangible asset. KAPLAN PUBLISH* Amortisation Capitalised development costs must be amortised once commercial exploitation begins. The method should reflect the pattern in which the asset's economic benefits are consumed by the enterprise. If that pattern cannot be determined reliably, the straight-line method should be used. KAPLAN PUBLISHING Errors not revealed by the trial balance Error of omission no entry for a transaction has been made at all. Error of commission an amount has been correctly posted, but to the wrong account. E.g. a sale on credit to G Brown has been posted to the account of J Brown. Error of principle an item is posted to the wrong type of account. E.g. a new tyre for a van has been posted to the Van account (non-current asset) rather than to the Motor Repairs account (expense). Error of original entry an incorrect amount is posted to both the accounts in question Compensating error • two or more errors cancel out each other. They are difficult to locate and fortunately tend not to occur frequently. Reversal of entries the correct amounts have been posted to the correct accounts, but on the wrong side. Transposition errors e.g. $527 is recorded as $725 (The difference the error creates is always divisible by 9.) Not revealed by the trial balance if the same figure has been used on both sides of the double entry. Errors ind control accounts _ Errors revealed by the trial ■L balance Single sided entry - Only one side of the double entry has been made, e.g. the debit, but not the credit. Debit and credit entries have been made, but using different figures. Both entries have been made on the same side. An individual account has been miscast (i.e. added up incorrectly). An opening balance has not been brought down. Extraction error - the balance in the trial balance is different from the balance in the account. The suspense account A suspense account is an account in which debits or credits are held temporarily until sufficient information is available for them to be posted to the correct accounts. Why are suspense accounts created? Differences on a trial balance: when debits are not equal to the credits, the difference is put to a suspense account. Book-keeping uncertainty: where it is not clear to a book-keeper where to post one side of an entry, it may be debited or credited to a suspense account. ?6 KAPLAN PUBLISHING Statement of financial position Statement of financial position of ABC Company As at 31 December 20XX Assets $m $m Non-current assets Property, plant and equipment x Intangible assets x Investments x Current assets Inventories Trade and other receivables Cash Total assets Present all assets and liabilities in order of liquidity. Present non-current assets separately from current assets. Asset = current if: - part of operating cycle, or - held for trading purposes, or - expected to be realised within 12 months of BS date, or - cash or a cash equivalent. -"KAPLAN PUBLISHING 93 Equity and liabilities Equity Issued capital Reserves Retained earnings Non-current liabilities Long-term loans Current liabilities Trade and other payables Short-term borrowings (bank overdraft) x Tax x $m $m > Sum of the accumulated profits and losses ► Liability = current if: - expected to be settled in the normal course of the operating cycle of the entity, or - held primarily for the purpose of being traded, or - due to be settled within 12 months of the reporting date, or - no unconditional right to defer settlement to at least 12 months after the reporting date. Total equity and liabilities KAPLAN PUBLISHING Chapter 9 Statement of profit or loss and other comprehensive income ABC Company Statement of profit or loss and other comprehensive income for the year ended 31 December 20XX $m Revenue x Cost of sales x x Other income (x) Distribution costs (x) -* Analysis of expenses may be on Administrative expenses (x) the face of the IS or in the notes. x Finance costs (x) Profit before tax x Tax expense (x) Profit for the period x Other Comprehensive income: Revaluation Gain/Loss x/(x) Total Comprehensive Income x PUBLISHING 95 id accounts for limited companies Statement of changes in equity This shows all of the changes which have affected the various classes of equity (previously referred to as share capital and reserves). ABC Company Statement of changes in equity for the year ended 31 December 20XX Share Share Revaluatio capital premium reserve $000 $000 $000 Balance at 31 December Year 1 x x x Change in accounting policy - Re-stated balance x x x Changes in equity for Year 2 Surplus on revaluation of properties x x Deficit on revaluation of properties (x) 00 Net gains and losses not recognised in the SOCI x x Net profit for the period - x x Dividends paid 00 00 Issue of share capital x x x Balance at 31 December Year 2 x x x x x Retained Total earnings $000 $000 X X (x) (x) X X KAPLAN PUBLISHING Margin v mark-up With gross profit margin the percentage of profit is given by reference to sales revenue. Gross profit percentage or profit margin = Gross profit x 100 Sales revenue Margin x sales = Gross profit Thus if we know that sales revenue totals $8,000 and the gross profit percentage is 25%, the following can be deduced: $ % Sales revenue 8,000 (given) 100 Less: Cost of sales 6,000 J75 Gross profit 2,000 25 (given) The gross profit is calculated as follows: 25% x $8,000 = £2,000 All the other items are derived as balancing items With gross profit mark-up the percentage of profit is given by reference to cost of sales. Gross profit mark-up percentage = Gross profit x 100 Cost of sales Mark-up x cost of sales = Gross profit Thus if we know that cost of sales is $6,000 and the mark-up is one third, we can set out the following: Sales revenue Cost of sales Gross profit 8,000 6,000 (given) 2,000 Ratio 4 3 1 The gross profit is calculated as follows: 1/3 x $6,000 = $2,000 Exam trick MARGIN MARK-UP SALES COST OF SALES KAPLAN PUBLISHING lO_ An exam question will often provide you with margin and cost of sales or mark-up and sales. You will then be required to calculate the remaining figures in the trading account. This can be done using the following relationship' columns: Margin 25% Sales 2. 100% Cost of sales 3. 100-ratio Gross profit 1. Ratio Mark-up 25% Sales 3.100+ratio Cost of sales 2. 100% Gross profit 1. Ratio KAPLAN PUBLISHING Chapter 11 Statement of cash flows for the year ended 31 December 20X7 Net cash flow from operating activities Net profit before taxation Adjustments for Interest payable (interest expense) Depreciation/amortisation _:ss or. i soosal of non current assets IM on disposal of non current assets Operating profit before working capital changes increasevdecrease in inventories pncmoseV decrease in trade receivables tacrease. (Decrease) in trade payables Casfi generated from operations Mm .1 paid Income taxes paid X X X (X) (X) (X) X (X)/X (xyx X/(X) X (X) Net cash from operating activities 113 ement of cash flows Cash flows from investing activities $ $ Purchase of property, plant and equipment/intangible non current assets (X) Proceeds of sale of non current assets X Interest/dividends received X Net cash used in investing activities X/(X) Cash flows from financing activities Proceeds from issue of shares X Receipt of loans X Dividends paid (x) Repayment of loans (X) Net cash used in financing activities X/(X) Net increase/(decrease) in cash and cash equivalents X/(X) Cash and cash equivalents at the beginning of the period X/(X) Cash and cash equivalents at the end of the period X/(X) HA KAPLAN PUBLISHING