Introduction to Accounting-Part

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Bookkeeping

Bookkeeping is the art of recording monetary or business transactions in a regular and systematic manner.

It is concerned with the recording of business transactions on a day-to-day basis following certain guidelines.

It is the record keeping part of accounting and enables the business to determine the results of its business operations in terms of profit or loss.

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It keeps records of the transaction of the business systematically

At any given time it helps to ascertain nature and volume of transaction such as:

Expenses incurred & their amounts

Earnings and their amount

Amounts business owe to creditor

Amounts which others owe to the business

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It helps to safeguard the assets of the business from unjustified and unwarranted use.

It fulfills the requirements of various government laws relating to business operation.

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Accounting is the art of analyzing, recording, classifying, summarizing, interpreting and communicating in terms of money to the interested users to enable them to make economic decisions.

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This definition includes the following attributes of accounting

Events and transactions of financial nature are recorded

Events of non financial nature cannot be recorded

The records must be maintained in way to clearly display the significance of all events and transactions

The parties concerned must be able to clearly understand the message of results in the statements prepared.

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The accounts clerk or other accounting staff will determine the financial significance of each transaction or event in order to record it

A transaction is any event which involves an exchange between two or more persons.

Accounting is concerned with financial transactions (i.e. exchanges of money).

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Once a transaction is recognized as a business transaction, accountants keep careful and systematic records.

Transaction of a financial nature must be written down reasonably soon after occurrence in the books of accounts e.g. cash books, sales and purchases day books.

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Classifying means arranging business transactions into classes of similar items.

The purpose of classification in accounting is to group the recorded information under appropriate accounts.

For example, expenses may be classified into salaries, rent, stationery, cost of the goods sold.

One may classify sales as internal and external.

All cash transactions are recorded in the cash book.

Sales day books can be used to record credit sales and purchases day books can be used to record credit purchases.

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Summarizing means to bring together a number of items and express them in a single item.

For example, the accounts of various customers are grouped under a single item of debtors.

The accounts of suppliers are grouped under the title of creditors.

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In conclusion, the art of summarizing involves the preparation of an income statement, balance sheet, and other reports from the classified data in a manner useful to the users of accounting information (both the owner(s) of the information and the external users of the information).

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Interpretation means that: the accounts clerk or other accounting staffs are required to explain the contents of their statements and reports in a manner beneficial to the users, and to enable the users to make meaningful decisions/judgments about the profitability and/or financial position of the enterprise.

Interpretation is the main function of accounting staff since to date, the routine work of recording, classifying and summarizing business transactions can be easily managed by the electronic devices/computers.

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Reporting is done when the financial statements are communicated to the users both internal and external.

Internal users are the managers who use the financial reports for making decisions and plans for the future prosperity of the organization.

Examples of information that is useful for internal purposes include

Reports on the cost of manufacturing the goods produced by the entity

Reports on expected or forecasted financial outcomes (budgets)

Reports comparing the budgeted and actual financial outcomes.

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Users of financial statements include present and potential investors, employees, lenders, suppliers, and other trade creditors, customers, governments and their agencies and the public.

They use financial statements in order to satisfy some of their different needs for information.

Investors or shareholders

These are individuals who contribute their cash money into the business through buying shares to own health facilities.

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The providers of risk capital and their advisors are concerned with the risk inherent in, and return provided by, their investments.

They need information to help them determine whether they should buy, hold or sale.

Shareholders/stakeholders are also interested in information which enables them to assess the ability of the health facility to provide health services.

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The prospective investors are in need of detailed information about the progress of the concern.

They make decisions regarding the investment to be made in a particular health. facility on the basis of the information revealed by accounting financial statements.

They would like to know the data relating to past and present performance of the health facility, and details about decisions for the future programmes.

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Employees and their representative groups are interested in information about the stability and performance of the health facility.

They are interested in information which enables them to assess the ability of the health facility to provide services.

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These are long-term providers of loans to the health facility such as banks, mortgages, and long term debts.

They are interested in information that enables them to determine whether their loans, and the interest attached to them, will be paid when due.

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Interested in information that enables them to determine whether amounts owing to them will be paid when due.

Trade creditors are likely to be interested in an enterprise over a shorter period than lenders, unless the trade creditor is dependent upon the continuation of the enterprise as a major customer.

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Have an interest in information about the continuance of health services, especially when they have a long term involvement with, or are dependent on, the service.

Government and agencies

Interested in the allocation of resources. The allocation of resources determines the activities of the health facility and thus, the basis for national income and similar statistics.

The government has to collect income tax, sales tax, excise duty and other taxes from the business.

For this, it is necessary that proper accounts are made available to the government.

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Financial statements may assist the public by providing information about the trends and recent developments in the prosperity of the health facility and the range of its activities.

The management of a health facility

Has the primary responsibility for the provision of health services.

It is interested in the information contained in the financial statements in order to carry out its planning, decision-making and control responsibilities.

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Interested in knowing whether an organization can settle its obligation on scheduled dates in a timely manner.

As a result, the existing cash position, outstanding debts, present and future earnings of a health facility are of utmost concern

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Ten Elements of Financial Statements

Opening stock: The amount of goods on hand for the purpose of resale at the commencement of the accounting period.

The previous year’s closing stock will become the opening stock of the current period.

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It includes both cash and credit purchases. The purchase return and discount should be deducted from the purchases.

Direct Expenses: Expenses directly connected either with the purchases of goods or services or incurred to make the goods ready for resale

For examples: Freight, transit insurance, carriage inwards, dock charges, import duty, custom duty and wages.

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Revenue: Consists of services provided to health customers in exchange of cash or a promise to pay at later date (credit).

It includes both cash and credit.

Closing stock: The amount of goods remaining unused or unsold at the year end.

This is also an asset, and will be transferred to a balance sheet as well.

Income and expenditure: Income is the excess of revenue over the expenses paid or incurred during the period.

It is the difference between gross income and expenses incurred in generating the income.

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Expenses: Costs which are incurred in order to sell the service or medical goods to customers. These expenses are grouped into administration, selling and distribution expenses.

Examples of expenses are office rent, electricity, postage, telephone charges, printing and stationery, bank charges, depreciation, office salaries.

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Assets: Assets are economic resources (things of value) owned by the health facility which are expected over a period of time to benefit operations. Types of assets include non-current assets (formerly Fixed or long-term assets) and current assets

Non-current assets: Divided into tangible and intangible noncurrent assets.

Tangible non-current assets: These are assets that can be seen, felt or touched.

They are the assets acquired by the health facility to assist the health services operations for a long period of time such as land, building, medical apparatus, plant and machinery, furniture, motor vehicle, office equipment, premises, fixtures and fittings.

Intangible non-current assets: These are the assets that cannot be seen, felt or touched. They are also used by the firm for the long period time generating revenue.

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Current assets: These are assets acquired by the business to be converted into cash at the earliest opportunity such as debtors, stock of medicines, cash, and bills receivable, payments in advances.

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Liabilities: Debts or claims of the creditors against the health facility provider arising on accounts of goods or services or assets acquired on credit. There are two types of liabilities:

Non-current liabilities and current liabilities

Non-current liabilities (formerly long-term liabilities): Liabilities which do not become due for payment within a year such as long-term bank loan, mortgages.

Current liabilities: Liabilities expected to be cleared within a year, such as trade creditors, bills payable, and bank overdrafts/incomes received in advance.

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Represents the resources invested by the government or health facility into the health facility.

Includes the amount of fund increase either by fresh investments by the government or by the health facility itself

Can also include the amount of net income earned by the health facility.

The drawings and losses reduce the amount of capital.

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Qualitative characteristics of financial statements are those attributes that make the information provided in the financial reports useful to users.

The four main qualitative characteristics of financial statements are

Understandability

Relevance

Reliability

Comparability

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Understandability

An essential quality of information provided in the financial statement is that it is readily understandable by users.

For this purpose, the users are assumed to have a reasonable knowledge of business, economic activities and accounting, and a willingness to study the information with reasonable diligence.

Relevance

To be useful, information must be relevant on the decision-making needs of users.

Information has the quality of relevance when it influences the economic decisions of users by helping them evaluate past, present or future events or confirming or correcting their past evaluation

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Reliability

To be useful, information must also be reliable.

Information has the quality of reliability when it is free from material error and bias.

Information that is reliable can also be depended upon by users to faithfully represent that which it is intended / expected to represent.

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Comparability

Users must be able to compare the financial reports of an entity through time in order to identify trends in its financial position and performance.

Users must also be able to compare the financial reports of different entities in order to evaluate their relative financial position, performance and changes in financial position.

The measurement and display of financial effect of like transactions and other events must be carried out in a consistent way throughout an entity, and also in a consistent way for different entities.

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Accounting Policies

Are the specific principles, bases, conventions, rules and practices adopted by an enterprise in preparing and presenting financial statements.

Management should select and apply an entity’s accounting policies so that the financial statements comply with all the requirements of the applicable financial accounting standards.

Financial accounting relies on several underlying concepts that have significant impact on the practice of accounting.

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Accounting Assumptions and Concepts

There are seven basic assumptions and concepts of accounting. They include

Separate entity assumption

Going concern assumption

Money measurement

Currency stability

Accrual basis concept

Realization concept

Conservatism/prudence concept

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Separate Entity Assumption

The business is an entity that is separate and distinct from its owners so that the finances of the firm are not co-mingled with the finances of the owners.

Without such separation or distinction, the affairs of the firm will be mixed up with private affairs as well as other business affairs of the proprietor, and the true picture of the firm will not be available.

Items recorded by accountants or proprietors in the books of the business are restricted to the transaction of the business. In the eyes of law, a business is a legal entity which can sue or can be sued.

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Going Concern Assumption

This assumes that the business will continue to be in operation for the foreseeable future when the end-of-year financial statements are being prepared.

It is assumed that the firm has neither the intention, nor the need to restrict scale of operations, nor to liquidate its materials.

Money Measurement

Accounting records only those transactions which are expressed in monetary terms.

An event will not be recorded unless its monetary effect can be measured with a fair degree of accuracy.

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Currency Stability

Since money is accepted as a common denominator, it is assumed that it should be stable in its value e.g. USD, Pound, Euro.

This assumption becomes less tenable with high inflation rate economies like Zimbabwe.

Accrual Basis Concept

It states that income and expenditure (revenue and expenses) are recognized when earned or incurred, and not necessarily when money is actually received or paid.

The revenue and expenses are recorded in the financial statements of the period to which they relate.

When monetary revenue is earned or any expense is incurred, it must be recorded in the books of accounts (e.g. sale or purchase of goods on credit).

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Realization Concept

Income is recognized for the purpose of recording only when income is received– either in the form of cash or in the form of any other asset.

The income which is likely to accrue in the future is not recorded in the books of account

For example if customer ‘A’ promises to buy some goods worth 500,000/= in future, but he is not buying anything now.

At the present, there is no transaction to be recorded, because there is no income that has been received by the business.

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Conservatism Concept or Prudence Concept

Conservatism means early recognition of unfavourable events.

It is a policy of playing safe in a world of uncertainties.

The concept has two aspects: recognize revenues and recognize expenses.

Recognize revenues (increases in retained earnings/income only when they are reasonably certain).

Revenues are recognized only when they are reasonably certain, whereas expenses are recognized as soon as they are reasonably possible.

This concept explains why bad debts expenses are recognized in the period in which the related sales/revenues are recorded, rather than later when some customers actually default payments.

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Recognize expenses (i.e. decreases in retained earnings, as soon as they are reasonably possible).

The concept is the basis for recognizing future warranty costs as expenses in the period warranted goods are sold, rather than later when warrant costs are paid.

In other words, according to the conservatism/prudence concept, profits are not anticipated but recognized only when realized due to the uncertainty of future events.

It is important to recognize that the amount of profit cannot be determined with certainty, and represents only a best estimate in the light of available information.

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There are six fundamental principles of accounting.

Historical Cost Principle

Full Disclosure

Consistency Principle

Materiality

Matching principle

Duality

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Historical Cost Principle

Assets are reported and presented at their original costs and no adjustment is made for changes in the market value.

Assets are normally shown at cost price.

This principle prohibits accountants to report assets at the current (market value) price because doing that implies that the asset is in the marketplace.

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Full Disclosure

All information required about the business entity that is needed by users is disclosed in an understandable form.

All information of significant impact on financial statements should be clearly displayed to all interested parties (users) to enable them to make informed decisions.

Everything should be transparent (all accounting procedures/records should be visible/available to all users, there should not be any hidden information).

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Consistency Principle

Once management adopts a method to be used in financial statements, it should be applied consistently without change (within a certain period of time). For example:

Depreciation methods: straight line, reducing balance, sum of year’s digits

Stock (Inventory) valuation methods: First in, first out (FIFO), last in, first out (LIFO) and weighted average method (WA).

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Materiality

Something is determined to be material if its exclusion from financial statements could result in a misleading interpretation of financial statements.

Materiality is the discretion of management.

Whatever one organization’s management determines to be material does not necessarily mean that another organization’s management will categorize that same thing as material.

The determination of something as material usually depends on the financial soundness of that management/enterprise.

A wealthy enterprise may treat or qualify a transaction to be immaterial, while the poor enterprise may treat the same amount as material.

Significant events must be noted, insignificant events can be disregarded. In all cases, there must be full disclosure of all important information.

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Matching Principle

States that expense are recognized in the same period as the related revenue.

The matching principle requires that all expenses incurred in generating that same revenue must be recognized. Therefore, the net income is considered to be the result income generated, minus the expenses required to generate that income.

In other words, matching involves comparison of the revenue and expenses that were used to generate that income in order to determine the net profit or loss position for the period.

Comparison should be made of the same period.

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Duality

Every transaction has two aspects, and both aspects should be recognized and recorded by the business firm. One aspect is debit and the other one is credit.

To every transaction, there should be a debit entry to correspond with credit transaction and vice versa.

This is the basis of the double entry system of bookkeeping and accounting.

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Bookkeeping is the art of recording monetary or business transactions in a regular and systematic manner.

There are four qualitative characteristics of financial statements which include understandability, comparability, reliability and relevance.

There are seven basic assumptions and concepts of accounting.

There are six fundamental principles of accounting.

Accounting is all about analyzing, recording, summarizing, interpreting and communicating financial information to interested users.

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What is bookkeeping?

What is accounting?

Who are some of the users of financial statements?

What are the elements of financial statements?

What are the four qualitative characteristics of financial information?

What are the seven basic assumptions and concepts of accounting?

What are the six fundamental principles of accounting?