Financial record keeping

Transcription

1 Financial record keeping 01 Introduction All businesses and many other types of organization will need to keep records of any financial transactions that take place. However, it makes sense to introduce some accounting terminology before we look at any system of recording financial transactions. We will begin by explaining some of the frequently used terms whose meaning may not be immediately obvious. These terms are assets, liabilities and capital : Assets are resources that are used within the business. These can take the form of physical resources used to facilitate production, such as premises and equipment. Assets can also include resources which are used as a part of the production process, such as materials that are going to be converted into goods, the cash used to purchase more assets and the outstanding amounts owed to the business by its customers. Liabilities are debts of the business that are outstanding. These are any borrowings which the business will repay at some point in the future. These can be short-term debts which are to be repaid in the next few days, such as an expense which has yet to be paid, but can also be long-term debts not to be repaid until many years in the future, such as a mortgage. Capital refers to the value of the owner s resources placed within the business. This can take the form of money invested in the business but can also take the form of owner s assets brought into business use, such as the owner s vehicle. The withdrawal of capital from the business by the owner is known as drawings. The capital, along with the liabilities of the business, enables the business to acquire assets which can be used as part of the business operations. This leads us to the accounting equation, which can be simply stated as follows: Assets = Capital + Liabilities

2 2 Accounting for Non-Accountants This equation must always hold true. To explain why the equation always holds, we must consider what the equation is telling us that the resources in use within the business must have been financed either from the owner s resources or by borrowing resources. Once the business has become established and if the business is profitable, we can modify the equation to allow assets to be financed out of the profits of the business in addition to the capital and liabilities. The process of recording and maintaining records of financial transactions is known as bookkeeping. However, there are two types of bookkeeping that are commonly practised by business organizations single-entry and double-entry bookkeeping. Single-entry bookkeeping Very small businesses (usually one-person organizations known as sole traders) and other types of organization such as charities, clubs and other small not-for-profit organizations may keep their financial records through a process of single-entry bookkeeping where each transaction is recorded as one single entry. This is bookkeeping at it simplest and often can be as basic as the maintenance of only a receipts and payments account. An example of a receipts and payments account is shown in Figure 1.1. Figure 1.1 Receipts and payments account 2013 Receipts 2013 Payments 1 Feb Capital 1,000 4 Feb Purchases Feb Sales Feb Electricity Feb Loan: R Day Feb Purchases Feb Sales Feb Balance c/d 1,831 2,345 2,345 1 Mar Balance b/d 1,831 This account shows all the monies received by the business and all the monies paid out by the business. The balance left over at the end of the month represents the current amount of money still left in the business bank account. The receipts and payments account is more commonly known as a cashbook. The cashbook will record all transactions involving money either being received or being spent either in the form of cash or as money taken from or paid into the firm s bank account. If a firm maintains a receipts and payments account as its main financial record it will still need to keep records and details of the types of payment and types of receipt in each transaction. This will enable a firm to calculate

3 Financial Record Keeping 3 the level of profit or loss generated. However, these extra details will often be kept in a memorandum form meaning that they are not part of the firm s accounting system, but are there as financial records to provide information only. A more detailed variation on the cashbook can be used if managers want to monitor and control the type of expenses paid out by the firm more closely. A multi-column approach to the cashbook would be well suited to a business that wanted to keep records that show the effect of VAT (Value Added Tax) separately from its overall purchases and sales. An example of a multi-column cashbook appears in Figure 1.2. Figure 1.2 Multi-column cashbook Receipts Payments 2014 Details Bank Sales VAT 2014 Details Bank Purchases VAT Other expenses 1 Apr Balance b/d Apr Insurance Apr E Mahoney Apr P Beard Apr F Tindall 6 8 Apr K Sutton Apr Wages In Figure 1.2 the analysed columns enable a firm to keep records for VAT, which is necessary once firms reach a certain size (as measured by their sales turnover). Problems with single-entry bookkeeping Although popular with very small organizations, there are a number of limitations in relying on single-entry bookkeeping as a method of keeping financial records. 1 In the receipts and payments account, expenditure will appear but this does not allow the separation of expenditure on day-to-day running expenses and expenditure on assets. This is an important distinction for when a firm wants to calculate the level of profit for the period, assets would not normally be deducted as expenses. 2 Double-entry bookkeeping has a number of built-in checks, which means it is easier to spot mistakes with double-entry accounting (though mistakes still occur). Single-entry bookkeeping has no self-checking mechanism. 3 Attempting to control expenditure will require detailed records of where a business spends money. This is not easy unless there are separate records (ie individual accounts) maintained for each type of

4 4 Accounting for Non-Accountants expense. This limitation can be minimized through the use of a multi-column cashbook. 4 Lack of full accounting records will make theft from the business by business employees more likely. Obviously a one-person organization will not face this problem. Double-entry bookkeeping Once a business begins to grow beyond a certain size and certainly once the maintenance of financial records moves beyond the very straightforward, it will make sense for the financial transactions of the business to be recorded using the double-entry system of bookkeeping. It is widely believed that the system of double-entry bookkeeping was developed and formally set out by Luca Pacioli in the late 15th century. The term double-entry arises out of the fact that each and every financial transaction will require two entries. These are known as a debit entry and a credit entry and each will be recorded in a separate account. The account in which the transaction is recorded will depend on the nature of the transaction. An example of how a double-entry account would appear is shown in Figure 1.3. F i g u r e 1.3 Example of double-entry account presentation Account name Debit side (Dr) Credit side (Cr) Date Account details Amount ( ) Date Account details Amount ( ) Given the T -shaped appearance of the accounts they are often referred to as T accounts. Accounts will be opened and an entry made in the account for each different type of transaction that the business undertakes. This means that there will be separate accounts for each type of asset, each type of expense and each type of income. In addition there will be separate accounts opened for every individual credit supplier and credit customer of the business. All the transactions between the business and the owner will also be recorded in either a capital account or a drawings account, depending on whether the owner is adding resources to or withdrawing resources from the business. There are different rules to be applied when making entries on the bookkeeping system to tell us which side of the account a transaction is to

5 Financial Record Keeping 5 be. Many of the basic transactions would involve the rules for double-entry bookkeeping illustrated in Figure 1.4. FIgurE 1.4 Rules used in double-entry bookkeeping All asset accounts All liability accounts All capital accounts Debit Credit Debit Credit Debit Credit Increases Decreases Decreases Increases Decreases Increases All expense accounts All income accounts Debit Credit Debit Credit Increases Decreases Decreases Increases These rules will make more sense if we see some examples of them in action. Example 1.1 On 3 June 2013, the owner of the business places 2,000 of her own money into the bank account of the new business. Bank Jun Capital 2,000 Capital Jun Bank 2,000 Explanation Here the asset of bank is increasing, which requires a debit entry, and the capital of the business (resources from the owner) is also increasing, which requires a credit entry. Notice how each account in effect cross-references the account containing the other entry for the double-entry transaction. This facilitates the ability to check that the system of bookkeeping is being correctly maintained.

6 INDEX NB: page numbers in italic indicate figures or tables absorption costing allocation of direct costs 117 apportionment and reapportionment of overheads , 118 global overhead recovery multi-department overhead recovery 116 overabsorption overhead absorption rate (OAR) problems with underabsorption vs marginal costing accounting concepts accruals 51 55, 75 consistency going concern 74 historical costs 78 materiality 76 money measurement objectivity prudence 74 realization 77 recognition 77 review questions separate entity 76 see also accounting standards accounting rate of return (ARR) accounting ratios see ratio analysis accounting software 14 accounting standards 78 79, Accounting Standards Board (ASB) Financial Reporting Council 294, 294 Financial Reporting Standard for Smaller Entities (FRSSE) Financial Reporting Standards (FRSs) 79, 295, 303 draft FRS for micro-entities future options for Generally Accepted Accounting Principles (GAAP) 78 79, , 295, future of International Accounting Standards (IASs) 79, IAS , 269, 276, 278, 281, 283 IAS IAS 7 284, 315 IAS IAS IAS IAS IAS IAS , 271 IAS International Accounting Standards Board (IASB) 73, 79, 294, Conceptual Framework 73, International Financial Reporting Standards (IFRS) Foundation 295, 296 International Financial Reporting Standards (IFRSs) 79, 296, 308 IFRS review questions 311 Statements of Recommended Practice (SORPs) 295 Statements of Standard Accounting Practice (SSAPs) 79, 295, 303, 310 Urgent Issues Task Force (UITF) 294, 295 Accounting Standards Board (ASB) accruals (accounting concept) 51 55, 75 acid test ratio activity-based costing (ABC) , 130 aged debtors schedule amortization 272 annual return auditor s report contents overview directors report International Accounting Standard (IAS) 1 267

7 366 Index notes to the financial statements review questions statement of cash flows 284 statement of changes in equity statement of comprehensive income statement of financial position worked example asset turnover (ratio) assets 1, bank balance 37 cash balance 37 current assets depreciation 55 60, 75 asset disposal and the balance sheet cost of asset 56 depreciation method expected useful life 56 residual value 56 intangible assets 34, 35, 77, 269, inventory 36 investments 35 non-current assets 34 outstanding balances 37 short-term investments 37 tangible assets 34 trade receivables 36 auditor s report average cost method (AVCO) 274 bad debts balance b/d 8 balance c/d 8 balance sheet 33 49, 42 adjustments to accruals concept 51 55, 55 bad debts depreciation discounts 61, 62 doubtful debts 61 prepayments 52 53, 55 review questions assets bank balance 37 cash balance 37 current assets depreciation 55 60, 75 intangible assets 35 inventory 36 investments 35 non-current assets 34 outstanding balances 37 short-term investments 37 tangible assets 34 trade receivables 36 capital in a limited company format of horizontal format 40 vertical format 40, 41 see liabilities review questions Bannerman ruling 266 batch costing BDO International 266 bonus issue bookkeeping 8 11 balancing accounts 8, 8 11 trial balance 11 12, 12 worked example 9 11 daybooks double-entry bookkeeping 3, 4, 4 8 accounting software 14 examples 5 8 rules of 4 5, 5 three-column accounts 14, 14 ledgers 13 review questions single-entry bookkeeping 2 4 multi-column cashbook 3, 3 problems with 3 4 receipts and payments account 2, 2 terminology 1 assets 1 capital 1 liabilities 1 books of prime entry 13 break-even analysis break-even chart , 141 break-even output level limitations of margin of safety total costs 140, 140 total revenue 139, 139 budgeting cash budget example budget incremental budgeting master budget 187, 192 materials budget 187 production budgets 187, review questions sales budget 187 uses of budgets control 186 coordination 186 forecasting

8 Index 367 motivation planning 185 zero-based budgeting buffer level (inventory) 192, 215 capital 1, in a limited company capital investment appraisal accounting rate of return (ARR) considerations capital budgets 239 economic climate 239 costs and benefits 224 definition of capital investment discounted cash flow compound interest 231 discount factors 232, 232 weighted average cost of capital (WACC) discounted payback 238 internal rate of return (IRR) , 237 net cash flows net present value (NPV) payback review questions sunk costs 224 cashbook 2 3, cash budget cash discounts 61, cash flow from financing activities 319 cash flow from investing activities cash flow from operating activities direct method 316 indirect method interest and dividends 318 cash sales 220 Companies Act consistency (accounting concept) continuous operation costing , 124, process costing service costing 128 contract costing convertible shares 250 cost centres 108 cost units 108 costing see absorption costing activity-based costing (ABC) , 130 continuous operation costing , 124, process costing service costing 128 cost centres 108 cost units 108 direct costs direct expenses 109 direct labour 109 direct materials 108 fixed costs , 110 stepped fixed costs 110, 110 indirect costs 109 life-cycle costing 131 marginal costing and break-even analysis and closing down a business segment contribution 138 and make-or-buy decisions and optimal production plans review questions and special order decisions vs absorption costing review questions sources of information 107 specific order costing , 124 batch costing contract costing job costing 124 standard costing review questions standards variance analysis target costing 131 variable costs 111, 111 credit checking 218 current assets current ratio 347 damage and spoilage (inventory cost) 211 daybooks cashbook 2 3, journal 13, 14 purchases daybook 13 returns inwards daybook 13 returns outwards daybook 13 sales daybook 13 debentures 39 debt factoring debt management aged debtors schedule cash discounts cash sales 220 credit checking 218

9 368 Index debt factoring invoice management 217 legal action 220 debt/equity ratio 351 Deloitte Touche Tohmatsu 266 depletion (of an asset) 56 depreciation 55 60, 75 asset disposal and the balance sheet cost of asset 56 depreciation method reducing balance straight line 57 expected useful life 56 depletion 56 obsolescence 56 residual value 56 development expenditure 272 direct costs direct expenses 109 direct labour 109 direct materials 108 directors report discounted cash flow compound interest 231 discount factors 232, 232 weighted average cost of capital (WACC) discounted payback 238 discounts 61, 62 dividend cover (ratio) dividend yield (ratio) 355 dividends per share (DPS) 354 double-entry bookkeeping 3, 4, 4 8 accounting software 14 examples 5 8 rules of 4 5, 5 three-column accounts 14, 14 doubtful debts 61 earnings per share (EPS) 354 economic order quantity (EOQ) efficiency ratios 336, asset turnover inventory turnover 344 trade payables days 345 trade receivables days equity 40 Ernst & Young 266 example budget Financial Accounting Standards Board (FASB) 297 financial records see bookkeeping Financial Reporting Council 294, 294 Financial Reporting Standard for Smaller Entities (FRSSE) Financial Reporting Standards (FRSs) 79, 295, 303 draft FRS financial statements 12, see also balance sheet; income statements; statement of cash flows first in, first out (FIFO) 274, 275 fixed costs , 110 stepped fixed costs 110, 110 gearing ratios 336, debt/equity ratio 351 interest cover 353 weighted average cost of capital (WACC) general ledger 13 general reserve 252 Generally Accepted Accounting Principles (GAAP) 78 79, , 295, future of global overhead recovery going concern (accounting concept) 74 Grant Thornton 266 historical costs (accounting concept) 78 IN01 application form 246, 248 income statements classifying expenditure 27 capital expenditure 27 capital receipts 27 revenue expenditure 27 revenue receipts 27 definition of 21 profit cost of goods sold gross profit net profit 24 review questions and the trial balance 25 incremental budgeting indirect costs 109 intangible assets 35 interest cover (ratio) 353 internal rate of return (IRR) , 237 International Accounting Standard (IAS) , 269, 276, 278, 281, 283 International Accounting Standard (IAS) International Accounting Standard (IAS) 7 284, 315, 318

10 Index 369 International Accounting Standard (IAS) International Accounting Standard (IAS) International Accounting Standard (IAS) International Accounting Standard (IAS) International Accounting Standard (IAS) International Accounting Standard (IAS) , 271 International Accounting Standard (IAS) International Accounting Standards Board (IASB) 73, 79, 294, Conceptual Framework 73 International Financial Reporting Standard (IFRS) International Financial Reporting Standards (IFRS) Foundation 295, 296 International Financial Reporting Standards (IFRSs) 79, 296, 308 inventory costs buffer level 192, 215 bulk discounts 214 damage and spoilage 211 economic order quantity (EOQ) just-in-time management monitoring costs 211 obsolescence 211 reorder level 215 storage costs 211 theft 211 inventory turnover (ratio) 344 investor ratios 336, dividend cover dividend yield 355 dividends per share (DPS) 354 earnings per share (EPS) 354 limitations of price/earnings (P/E) ratio issued share capital job costing 124 journal 13, 14 just-in-time management (inventory) KPMG 266 labour efficiency variance 170 labour variances 170 Late Payment of Commercial Debts (Interest) Act liabilities 1, accruals 38 bank overdraft current liabilities 37 debentures 39 non-current liabilities taxation owing 38 trade payables 37 life-cycle costing 131 limited companies, accounting for annual return auditor s report contents overview directors report International Accounting Standard (IAS) notes to the financial statements review questions statement of cash flows 284 statement of changes in equity statement of comprehensive income statement of financial position worked example bonus issue capital 251 financial statements balance sheet income statements formation of 246 limited liability, meaning of private company limited by guarantee 247 private limited companies 247 private unlimited company 247 public limited companies reserves capital reserves revaluation reserve 253 revenue reserves 252 share premium review questions rights issue share capital convertible shares 250 dividends 248 ordinary shares preference shares Limited Liability Partnership Act liquidity ratios 336, acid test ratio current ratio 347

11 370 Index manufacturing businesses, accounting for cost of manufacturing goods 85 example accounts factory overheads prime cost 84 review questions 100 marginal costing and break-even analysis break-even chart , 141 break-even output level limitations of margin of safety total costs 140, 140 total revenue 139, 139 and closing down a business segment contribution 138 and make-or-buy decisions and optimal production plans review questions and special order decisions vs absorption costing master budget 187, 192 materiality (accounting concept) 76 materials budget 187 materials variances materials price variance 169 materials usage variance 169 money measurement (accounting concept) multi-department overhead recovery 116 net present value (NPV) net realizable value 74 nominal ledger 13 non-recourse factoring 220 not-for-profit organizations, accounting for 91 99, 92 balance sheet 98 99, 99 income and expenditure account income sources bar trading subscription fees review questions statement of affairs 98, 99 objectivity (accounting concept) obsolescence (depreciation) 56 obsolescence (inventory cost) 211 operating cycle see working capital ordinary shares overhead absorption rate (OAR) overhead variances Pacioli, Luca 4 partnerships, accounting for balance sheet 90, 90 capital accounts 88 current accounts 88 example accounts interest on capital 87 interest on drawings 88 limited liability partnerships 91 partnership salaries 87 profit sharing 88 review questions preference shares price variances 168 price/earnings (P/E) ratio PricewaterhouseCoopers 266 prime cost 84 private company limited by guarantee 247 private limited companies 247 private unlimited company 247 process costing production budgets 187, profit cost of goods sold gross profit net profit 24 profit margin (ratio) gross profit margin 338 profit maximization 21 profitability ratios profit margin return on capital employed (ROCE) 337 return on equity (ROE) prudence (accounting concept) 74 public limited companies purchases daybook 13 purchases ledger 13 ratio analysis efficiency ratios 336, asset turnover inventory turnover 344 trade payables days 345 trade receivables days gearing ratios 336, debt/equity ratio 351 interest cover 353 weighted average cost of capital (WACC) investor ratios 336, dividend cover dividend yield 355 dividends per share (DPS) 354 earnings per share (EPS) 354

12 Index 371 limitations of price/earnings (P/E) ratio liquidity ratios 336, acid test ratio current ratio 347 profitability ratios profit margin return on capital employed (ROCE) 337 return on equity (ROE) review questions realization (accounting concept) 77 receipts and payments account 2, 2 recognition (accounting concept) 77 recourse factoring 220 reorder level 215 research expenditure 272 reserves capital reserves revaluation reserve 253 revenue reserves 252 share premium retained earnings 252 return on capital employed (ROCE) 337 return on equity (ROE) returns inwards daybook 13 returns outwards daybook 13 review questions 311 rights issue sales budget 187 sales daybook 13 sales ledger 13 sales variances 173 Sarbanes-Oxley Act 266 scrip issue see bonus issue Securities and Exchange Commission (SEC) 301 separate entity (accounting concept) 76 service costing 128 share capital 39 40, convertible shares 250 dividends 248 ordinary shares preference shares single-entry bookkeeping 2 4 multi-column cashbook 3, 3 problems with 3 4 receipts and payments account, 2, 2 specific order costing , 124 batch costing contract costing job costing 124 standard costing review questions standards attainable 166 basic 166 current 166 ideal 166 review of , 167 variance analysis budget flexibility interpreting variances interrelationships of variances labour variances 170 materials variances overhead variances price variances 168 sales variances 173 volume variances 168 statement of affairs 98, 99 statement of cash flows 284, cash flow from financing activities 319 cash flow from investing activities cash flow from operating activities direct method 316 indirect method interest and dividends 318 cash vs profit capital expenditure 314 loans 315 non-cash profit 314 overtrading 314 foreign exchange transactions review questions worked example statement of changes in equity statement of comprehensive income statement of financial position see balance sheet Statements of Recommended Practice (SORPs) 295 Statements of Standard Accounting Practice (SSAPs) 79, 295, 303, 310 storage costs (inventory) 211 sunk costs 224 T accounts see double-entry bookkeeping tangible assets 34 target costing 131 theft (inventory cost) 211 total labour cost variance 170 total materials cost variance 169 trade payables 37 trade payables days (ratio) 345 trade receivables 36 trade receivables days (ratio)

13 372 Index Urgent Issues Task Force (UITF) 294, 295 variable costs 111, 111 variance analysis budget flexibility interpreting variances interrelationships of variances labour variances 170 materials variances overhead variances price variances 168 sales variances 173 volume variances 168 volume variances 168 wage rate variance 170 weighted average cost of capital (WACC) , working capital cash management 221 debt management aged debtors schedule cash discounts cash sales 220 credit checking 218 debt factoring invoice management 217 legal action 220 inventory costs buffer level 192, 215 bulk discounts 214 damage and spoilage 211 economic order quantity (EOQ) just-in-time management monitoring costs 211 obsolescence 211 reorder level 215 storage costs 211 theft 211 liquidity ratios 210 review questions 222 trade payables working capital cycle , 208 zero-based budgeting