Session Topic: Business Accounting Content Summary: Introduction to accounting. Transactions, source documents and double-entry book-keeping.

Underlying concepts and conventions. User information needs. The key accounting equations.

Learning Objectives: On completion of this session you should: Understand the role of accounting in business Be able to identify the main users of accounting information and their main information needs Understand the principles of transaction based double entry book-keeping Understand the fundamental concepts and conventions on which accounting is based Calculate profit and prepare a simple balance sheet from a trial balance Discussion Questions: Preston Garages Limited Information needs Reading References: Eddie McLaney and Peter Atrill Accounting 2nd Edition 2002 Chapters 1 & 2 (pp 43-47)

BUSINESS ACCOUNTING Accounting is concerned with the recording of financial data arising from transactions undertaken by a business enterprise, and with the provision of financial reports derived from this same data to assist informed decision making. Book-keeping is the process whereby financial data arising from business transactions is recognised, collected and recorded in a firms accounting records, using a system known as double-entry book-keeping. Financial reporting is about the construction and availability of financial information or reports about a business that may be useful to interested users in allowing them to assess an enterprises performance and financial position. The accounting system embraces process and reporting functions and is shown diagrammatically below: Transactions

Data (input)

Recorded & Summarised (process)

Reports (output)

Evaluation & Interpretation

Decision Making The development of the corporate economy, in which large complex businesses and sophisticated financial markets dominate, has led to the need for better quality and more timely financial information. Although often thought of as a precise subject producing reliable and accurate information, this cannot always be the case. Full information may not be readily available, price paid may not necessarily reflect fair value, nor do all relevant factors have an assigned monetary value. Decisions are about the future, and the future is inherently uncertain.

Book keeping Book - keeping is a data processing activity whereby the monetary value of each transaction is entered into the accounting records using a double entry recording system. The entries are supported by source documents, such as invoices. Each transaction has two effects for a business. For example, a company makes monetary payments to the suppliers of goods or services it receives, and receives monetary payments from customers in exchange for goods or services it has sold to them. The accounting system will record both the receipt (cash, goods or service received) and the payment (sale or service provided or cash payment) element of each transaction. It does this by putting like items together in what are known as accounts. Cash movements will be recorded in a cash account, sales recorded in a sales account, wages recorded in a wages account etc. Examples: A cash account records all the cash receipts received and all the cash payments made by a business; a purchases account records all purchases, whether paid for by cash or bought on credit; asset accounts record the acquisition or disposal of assets, such as plant, machinery, equipment, fittings. A separate account will be open for each type of asset. Financial ledger The various accounts are contained within a financial ledger. The ledger may be manual or computerised. The information within the financial ledger enables a business to identify the level of sales, costs and expenses by type, the balance of cash an enterprise has at any point in time, what other assets it may have, and the monies it might owe or be owed. This information is derived directly from the accounting system described above. For example, if a marketing manager wanted to know the level of sales since the beginning of the financial year, they need to look only at the total in the sales account, as this account records all sales. Each sale is not recorded separately in the financial ledger as this would involve too much detail, but rather the totals for each day or week are recorded. More detailed information may be contained in day books. A finance manager who may want to know what cash the business currently has, and would refer to the balance on the cash account, as this account records both monies received and monies paid out and the balance will be constantly changing. The days of the hand written manual ledger are largely past, though the language that was created is still in use today. Accounting records are increasingly being recorded using sophisticated computerised accounting packages.

The focus of this module is in using the information provided, rather than learning how to record accounting data. However, understanding how the recording system works is useful to that task. Trial balance Periodically the totals or balances on the accounts are extracted from the ledger and simply listed on a schedule referred to as a trial balance. This is done to: 1. show that the accounting system is in balance 2. provide the base information from which financial statements are constructed. The total or balance on the individual accounts represent either: (i) an expense total (ii) a sales total (iii) an asset value (iv) a liability value, or (v) the owners/shareholders capital. Financial reporting statements The principal financial reports prepared by most businesses, and certainly all limited liability companies, are the profit and loss statement and the balance sheet. The former provides information concerned with financial performance over a past period of time, the latter with an enterprises financial position on the last day of that period. The information included in these two reports is derived from the trial balance, which is a summary of the account balances in the financial ledger. The key accounting equations concerned with the two financial statements are: Profit = Sales less Expenses Assets less Liabilities = Owners Capital Owners capital is normally referred to as shareholder funds, as it is a businesss shareholders who own the company. Providers of goods and services on credit to a company, and those who loan the business money are referred to as creditors. Should a company sell goods or services to its customers on credit, those owing the business money are referred to as debtors. Management Accounting Whereas financial accounting is focused more on the production of financial reports about an entitys performance for shareholders and other users, management accounting is more concerned with providing information to assist managers in planning and control, and in decision making. Both areas of accounting rely on the same accounting system and draw on the same data, albeit in different forms. For example, financial reporting will deal with aggregated data such as total labour costs, whereas management accounting requires labour costs to be broken down between production areas, products, manufacturing stages or by category of employee to be of practical use to local management.

Accounting concepts and conventions Accounting concepts and conventions have evolved over many years as a result of business practice and the need to ensure some commonality across industries in the way companies report their performance. They represent the underlying rules upon which accounting reports are based. Accounting records relate to a business entity with data expressed in monetary terms based on historic costs arising from transactions. Financial reports presume that a business will continue as a going concern and relate to periods of time for profit/loss measurement, or points in time for financial position. The data used is adjusted where necessary to ensure that sales and expenses are matched to the period regardless of when cash payments are actually made or received. A prudent approach is adopted whereby profits are not reported until realised, but potential losses are provided for. The need to ensure greater consistency and comparability in financial reporting has led to some agreement as to areas of good practice, and put pressure on companies to comply with recommended financial reporting standards. Globalisation will inevitably accelerate this process, particularly for those companies that are international in character and those looking to raise funds from capital markets. Types of enterprise The most significant type of business enterprise is the limited liability company. Whilst the majority of these are private, owner managed, and not listed on a capital market, it is the smaller number of large, publicly quoted companies that dominate the corporate sector in many industrialised nations. Limited liability limits a shareholders liability to the money invested when buying the shares. Although the investment may be lost, the investor would not be called upon to take on company debts if the business were to fail. Companies may be involved in trading (retailing or wholesaling), manufacturing or be in a service-related industry. Information users There are a number of groups that have financial information needs that they expect to be satisfied by a business enterprise. For a company these might include: 6 Shareholders: current and potential investors, concerned with performance, risk and return, value and future prospects Suppliers: ability of customers to pay for goods sold on credit and sales growth potential Lenders: ability to pay interest and repay capital, security available Employees: job security, career opportunities, profitability and wage rise capability Government: tax revenues, economic data and local government policies Customers: continuity of supply, profit margins The public: community issues, environmental concerns

Different groups have different information needs and it is unlikely each will have their requirements fully satisfied. Regulatory Framework The main authorities that regulate the content of published financial reports of limited companies are the government through the disclosure requirements it lays down, the accounting profession via reporting standards and accepted good practice, and the capital market's listing requirements to which all listed companies are expected to comply with. Discussion Questions

1. Preston Garages Ltd own and operate five petrol filling stations. Each site also has car washing facilities and a convenience store. The companys accounting records show it to have assets valued at 2.1 million, and liabilities of 1.6 million. The company is considered to be more profitable than similar businesses. Describe what forms these assets and liabilities may take in practice. What is the accounting value of the business to its owners? Does this figure represent a reliable indication of what the company is worth in your view? 2. Compare the financial information needs of company shareholders with those who are potential lenders to the business.