1. Accounting Fundamentals

2. On completing this chapter, you will be able to: Understand why keeping accounts is so important. Analyse the main users and uses of business-accounting records. Identify and understand the main components of an income statement (profit and loss a/c). Identify and understand the main components of balance sheet. Analyse business accounts by using ratio analysis. Evaluate the limitations of ratio analysis and of published accounts.

3. Why keeping accounting records? Accounts are financial records of business transactions, which are needed to provide essential information. Enables to know the position of the business. Internal and External users of accounting information Business Managers Banks Creditors, such as suppliers Customers Government and tax authorities Investors, such as shareholders in the company. Workforce Local community

4. Limitations of published accounts Companies will only release the absolute minimum accounting information as laid down by company law. Businesses like sole traders do not have to disclose any information at all to the public. Company directors wish to avoid sensitive information falling to the hands of competitors or even pressure groups that could take action against the interest of the business. Information that does not have to be published in a co.’s annual report and account include: Details of the sales and profitability of each good or service produced by the company and of each department. Future budgets or financial plans etc.

5. Are the published accounts really accurate? Stakeholders are concerned about the accuracy of the published accounts. Company cannot publish accounts with misleading and deliberate intent- they are checked by independent auditors. However, a/cing decisions are not always based accurately. While compiling accounts it is necessary to use judgment and estimation. Co.’s attempt to make their account presentable, with accountants involved in ‘window dressing’. Common ways of window dressing- –reducing amount of depreciation of Fixed assets, such as machines in order to increase declared profit and increase asset values. –Giving stock levels a higher value than they are worth.

6. Management and Financial Accounting MA-Preparation of information for managers on any financial aspect of a business, dept etc FA- Collection of data on daily transactions. MA-Analysing internal accounts. FA-preparation of the published report and a/cs of a business- bal sheet, income statement. MA- Info. made available to managers of the business. FA-Info. used by external groups MA- No set of rules required to maintain an account. FA- Accountants are bound by the rules.

7. Foundations of accounting-a/cing concepts and conventions. Double-entry principle Accruals (biz transactions are recorded when they occur and not when related payments are made or received) Money-measurement principle(common form of measuring wealth) Conservatism-prudence concept Realisation concept (recorded when legal title to the goods is transferred)

8. Main business accounts The Income Statement -This records the revenue, costs and profit(loss) of a business over a given period of time. This used to be known as the profit & loss account. -A detailed income statement is mostly produced for internal use because managers will need much info as possible. -A less detailed summary will appear in the published accounts of companies for external users. It will be produced less frequently, but at least once a year.

9. 3 sections of an Income Statement -Trading account.(Gross profit, sales revenue, cogs) -Profit and loss account. (Net profit, PAT) -Appropriation account. (Dividend, Retained profit) The uses of income statements Used to measure and compare the performance of the business over time or with other firms. The actual profit data can be compared with the expected profit levels of the business. Prospective investors may assess the value of putting money into a business from the level of profits being made. Bankers or lenders will need the information to help decide whether to lend money to the business.

10. Balance Sheet While income statement presents a picture of a firm’s economic activities over a period of time, balance sheet is a snapshot of its financial and physical assets and its liabilities at a point in time. The balance sheet reports the firm’s financial position at a point in time. It consist of 3 elements. - Assets= an item of monetary value that is owned by a business -Liabilities= a financial obligation of a business that is required to pay in the future. -Shareholder’s equity=total assets- total liabilities Shareholders equity comes from- Capital invested in a company through the purchase of shares. (Share capital). Retained earnings of the company accumulated over time through its operations. Let us look at the example given in book. Table no 29.5

11. Current Assets- it includes cash and other assets that will likely be converted into cash or used up within one year. Current Liabilities- obligations that are to be met within one year. CA-CL = Working Capital. Not enough working capital may indicate liquidity problems. Too much of WC indicates inefficient use of assets. Non current Assets- do not meet the definition of current assets because they will not be converted into cash or used up within one year. It provides information about firm’s investing activities, which form the foundation upon which the firm operates. Non current Liabilities- do not meet the criteria of current liabilities. It provides the information about the firm’s long term financing activities.

12. Other Information in published accounts Cash Flow Statement- third and final main account published in the annual report and accounts. It focuses on how the company’s cash position has changed. -Records the cash inflows and outflows from the business over a period of time. -By focusing on cash, this statement help managers realize why a profitable business might be running out of cash and why a loss making business could be cash rich. The Chairman’s Statement – General report on company performance over the past year. -Future prospects of business. -political and economical impact to the company’s prospects.

13. The Chief Executive’s Report- more detailed analysis of the last financial year, often broken down by area of main product divisions. The Auditor’s Report- Report by a independent audit firm on the accuracy of the accounts and the validity of accounting methods used. -if there is no distortion in the accounts, the auditors will state that the accounts give a ‘true and fair view’ of business’s performance and current position. -if there are concerns, auditors will qualify their report with details of points of disagreement between themselves and management.

14. Notes to the accounts- The main accounts contain only basic information needed to assess the position of the company. -Do not contain detail information. -This along with other details are contained at the end of the annual report and accounts in the ‘notes to the accounts ’