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Ch. 30 Accounting Fundamentals

A level Business

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15 views5 pages

Ch. 30 Accounting Fundamentals

A level Business

Uploaded by

Ahmed Wahid
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd
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CH.

30 ACCOUNTING FUNDAMENTALS
Management and financial accounting

Accounting concepts and conventions


1. Double-entry principle
 Every transaction has 2 effects – debit and credit
2. Accruals
 All prepayments and overdues must be recorded in the books
of accounts
3. Money-measurement principle
 Only items with a monetary value should be recorded
4. Conservatism – prudence concept
 Accountants should provide for all losses but never anticipate
a gain
5. Realisation concept
 Revenue and profits should only be recorded when the legal
title of the goods is transferred.

Income statement
 A record of the company’s profits, revenue and expenses over a
given time period
 Trading account – shows gross profit and cost of sales
 Profit and loss account – shows overall profit and overhead
expenses
 Appropriation account – shows dividends and retained earnings

Uses of income statement


 Measure and compare the performance with competitors or over
time
 Actual profit can be compared with estimated profit
 Banks & creditors need the information to decide whether or not to
lend the business
 Prospective investors assess the level of risk and earnings on
investment
 Low quality & high-quality profit is identified

Statement of financial position


 Records a business’s assets, liabilities and capital at a certain point
of time
 Sources of shareholder’s equity:
 Selling of shares – share capital
 Retained earnings of a company

Non-current assets
 Assets kept for long term use
 Ex. land, machinery
 Intangible assets – goodwill, copyrights, patents

Current assets
 Short term assets which can easily be turned into cash
 Ex. trade receivables, cash, bank balance, inventory

Current liabilities
 Short term debts
 Ex. overdrafts, trade payables

Working capital
 Current assets – current liabilities

Shareholder’s equity
 Share capital + retained earnings

Non-current liabilities
 Long term debts
 Ex. loans, debentures, bonds

Other published accounts


1. Cash-flow statement –
 Focuses on the cash available in the business
 Includes a company’s cash inflows and outflows over the year
2. Chairman’s statement –
 General report about the company’s major achievements and
future plans
3. Chief executive’s report –
 More detailed analysis of the previous year
4. Auditor’s report
5. Notes to accounts

Ratio analysis
Profitability ratios
1. Gross profit margin – compares gross profit with revenue. How
successful the company is in maintaining its cost of sales
Gross profit margin = gross profit/revenue * 100
2. Operating profit margin – compares operating profit with
revenue. How successful the company is in maintaining its overhead
costs?
Operating profit margin = operating profit/revenue * 100

Liquidity ratios
1. Current ratio
o Current assets/current liabilities
o Safe ratio between 1.5-2
o Depends on the industry
2. Acid test ratio/quick ratio
o Current assets – inventory/current liabilities
o Safe ratio between 1-1.5

Limitations of ratio analysis


 Incomplete analysis
 Limited use on its own. Must be compared with other business or
over time
 Some may be window dressed
 Ignored qualitative information
 Only provides the problem, doesn’t suggest solution

Users of accounting information


1. Managers
 Measure business performance
 Compare against targets, previous time periods and
competitors
 Assist in decision making
 Control and monitor the operation of each department
 To set targets or budgets for the future and review these
against actual performance.
2. Banks:
 To decide whether to lend money to the business
 To assess whether to allow an increase in overdraft facilities
3. Creditors, such as suppliers:
 To see if the business is secure and liquid enough to pay off its
debts
 To assess whether the business is a good credit risk
 To decide whether to press for early repayment of debts.
4. Customers:
 To assess whether the business is secure
 To determine whether they will be assured of future supplies
 To establish whether there will be security of spare parts
 and service facilities.
5. Government and tax authorities:
 To calculate how much tax is due from the business
 To determine whether the business is likely to expand and
create more jobs and be of increasing importance to the
country’s economy
 To assess whether the business is in danger of closing down,
 creating economic problems
 To confirm that the business is staying within the law in terms
of accounting regulations.
6. Investors, such as shareholders in the company:
 To assess the value of the business and their investment in it
 To determine what share of the profit’s investors are receiving
 To decide whether the business has potential for growth
 If they are potential investors, to compare these details with
those from other businesses before making a decision to buy
shares in a company
 If they are actual investors, to decide whether to consider
selling all or part of their holding.
7. Workforce:
 To assess whether the business is secure enough to pay
wages and salaries
 To determine whether the business is likely to expand or be
reduced in size
 To determine whether jobs are secure
 To find out whether, if profits are rising, a wage increase can
be afforded
8. Local community:
 To see if the business is profitable and likely to expand, which
could be good for the local economy
 To determine whether the business is making losses and
whether this could lead to closure.

Limitations of published accounts


 Future plans
 Performance of each department/division
 Company’s effect on the environment
 Research & development plans

Accuracy of published accounts


 Window dressed accounts
 Done to influence stakeholders to lend money/invest

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