Introduction to Accounting

 Accounting is basically about storing financial information.

 It is a process of recording and refining this information for

control, analysis and planning purposes.
Introduction to Accounting

 The main users of this information are

the business owners, shareholders and
the internal management.

 Other users, such as the government,

require financial information eg. Tax
statements.
Introduction to Accounting

 Potential shareholders and investors

require financial information so they can
judge the balance between return on
money invested and the risk involved.

 Trade creditors and lending organisations

need financial information to develop
specific credit policies.
Introduction to Accounting

 Other groups interested in financial

information may be:

 Employees
 Employee associations
 Customers
 Competitors
 Industry trade Associations
Introduction to Accounting

 Because there is such a wide range of

users the form of the information
must vary.

 Each group has different needs so

the degree of sophistication, form of
presentation and timing of
information will vary accordingly.
Introduction to Accounting

 The aim of processing financial information is

to enable the interested parties associated with
the business to:
 Recognise how it has performed
 Maintain control over financial affairs
 Take advantage of business opportunities
 Establish budgets
 Compare performance against expectations
and targets (REFER TO BUDGETS
LATER IN THIS PRESENTATION)
Introduction to Accounting

 The function of accounting for internal

management purposes is to transfer the
mass of information contained in business
transactions into accounting records from
which accounting reports can be prepared.

 This process has two basic elements:

 recording and
 reporting.
 Introduction to Accounting

Business Accounting Accounting

Transactions Records Reports

Recording Reporting
Process Process

Business Journals and Profit and

Documents Ledgers Loss
Balance Sheet
Introduction to Accounting

 Common accounting reports focus on:

 Financial profitability – The

performance of the business is
examined over a period of time. Most
commonly reported by a Profit and
Loss Statement
Assets

 An asset is anything of value that is owned by the business.

 Assets include
 Current/short Term Assets such as:
 stock, debtors and cash
 Fixed Assets such as:
 equipment, furniture and fittings, land, buildings,
motor vehicles, computer equipment, plant &
machinery
 When we do a budget to plan the future purchasing of
assets, this is called a “Capital Expenditure (Capex)
Budget”, not to be confused with the “Capital”
contribution the owner often makes when he starts a
business, called “Owner’s Equity”.
Liabilities

 Liabilities are amounts owed by

the business.

 Liabilities could be the result of

purchasing goods on credit,
overdraft and loans of money to
the business.
Owners Equity

 Owner’s Equity (or Proprietorship) is

the owner’s interest in the business.
 Owners Equity is the “claim” that the
owners have on the business as a result
of cash/assets which they put into the
business as well as all profits which
have accumulated.
 Owner’s Equity = Assets - Liabilities
Revenue

 Transactions which have the effect of

increasing profit create revenue.

 Revenue is usually associated with the

inflow of money into the business.

 Revenue is mostly in the form of cash from

trade sales made by the business.
Expenses

 Transactions that have the effect of

reducing the profit of the business
are called expenses.
 Expenses usually involve the outflow
of assets in the form of cash from the
business.
 Examples of expenses are rent,
wages, advertising costs, insurance
etc.
Accounting Equations

 There are two principal accounting

equations that involve the five
accounting elements discussed
previously.

 Assets = Owner’s Equity + Liabilities

 Revenue – Expenses = Profit/Loss

General Ledger

 Since any transaction will either decrease

or increase an asset, liability, owner’s
equity, revenue or expense a record that
describes such an effect is needed.

 The general ledger does this, as well as

provide a running balance for these items
at any time.
General Ledger

 The most commonly used format has

columns which allow for:
 The date of the transaction
 Detail of the journal reference from
where the information is generated
 The effect of the transaction
 The disclosure of a progressive balance
for the item.
General Ledger

Date Journal Effect Balance

Reference + -
Double Entry Accounting

 Double entry accounting is a universally

accepted method of recording financial
information from journals to ledgers.

 The roots of this procedure can be traced

back to 14th century Italy where it was
used by monks and merchants as a
bookkeeping process.
Double Entry Accounting

 Double entry accounting has the basic

premise that each and every transaction
will have two effects; a debit (DR) and a
credit (CR).

 In a ledger format the effect of a debit

is listed on the left hand side, and a
credit on the right hand side.
Double Entry Accounting

 For every amount debited to one

account in the ledger, there must be an
equal amount credited to another
account in the ledger.

 Note: Many people misunderstand the

meaning of the words debit and credit.
The word debit is a derivative of the
word for left in 14th century Italian!
Double Entry Accounting

 The transaction is first classified and

then the double entry effect is
determined using the following table.
Double Entry Accounting

Item Movement Effect

Increase Debit
Asset
Decrease Credit
Increase Credit
Liability Decrease Debit
Increase Credit
Owner’s Equity Decrease Debit
Increase Credit
Revenue Decrease Debit
Increase Debit
Expense
Decrease Credit
Double Entry Accounting

 The following table provides

examples of how double entry
accounting is applied to different
accounts in the general ledger.
Double Entry Accounting

Transaction (DR) Accounts/Effects (CR)

Owner contributes cash
Cash at bank (A) Owners capital (OE)

Bank loan obtained Cash at bank (A) Bank Loan (L)

Credit purchase of stock
Inventory (A) Accounts Payable (L)

Cash payment for rent Rent expense (E) Cash at bank (A)
Cash sale Cash at bank (A) Sales (R)
Credit sale Accounts Receivable (A) Sales (R)
Repay Loan Bank Loan (L) Cash at bank (A)
Trial Balance

 An extract of the ledger balances can be

taken from the general ledger at any time.

 This extract is called a Trial Balance, and

it provides a check on the arithmetical
accuracy of the double entry accounting
process.
Trial Balance

 Accounts are listed on the left hand side

of the form, and their balances are
listed on the right, separated into debit
and credit.

 Usually arithmetical accuracy is proved

if the total of the debits is equal to the
total of the credits.
Trial Balance

 Some errors may still be present in the

trial balance, even if the total debits match
the total credits. E.g.
 Entries may be posted to the wrong
ledger accounts
 Transactions may be left out all
together
 Compensatory arithmetical errors have
occurred
Trial Balance

 If the trial balance does not balance, the

recording process must be retraced to
locate the error, and fix it.

 Note: This is an example of how the

accuracy of the recording process is
crucial if the next step in the accounting
process is to be accurate!
Trial Balance

 Accounting reports such as the Profit

and Loss Statement and the Balance
Sheet can be created using information
extracted from the trial balance.

 The following is an example of a trial

balance.
Trial Balance
Trial Balance as at 31 May

Code Item DR ($) CR ($)

101 Cash In Bank 6147

102 F&B Stocks 7540
121 Kitchen Equip. 8500
122 Furniture and Fittings 5000
123 Office Equipment 1580
201 Bank Overdraft 3000
301 Capital Contributions 7960
321 Accumulated Profits 1000
401 Sales Food 13120
402 Sales Beverage 3687

28767 28767
Financial Reporting

 Once all of the recording of financial

information has been finished, and the
trial balance has proved the accuracy of
information, we can move on to the
next step of the accounting process…
Reporting.
Financial Reporting

 There are any number of financial reports

that can be generated to show different
information regarding the financial
position of a company.

 The two that we will be focusing on

predominantly are the Balance Sheet and
Profit and Loss Statement.
Balance Sheet

 The balance sheet is an itemized listing

of the accounting equation

Assets = Liabilities + Owners Equity

 It consists of all of the asset, liability

and owner’s equity accounts present in
the general ledger.
Balance Sheet

 The balance sheet report helps to apply an

actual monetary value to the principles of
assets, liabilities and owners equity.

 By creating a balance sheet, a reflection of

the financial structure and stability of the
business can be obtained.
 Balance Sheet Example
Balance Sheet as at 31 May
$ $
Current Assets
Cash 1250
Fixed Assets
Land 70000
Total Assets 71250
Current Liabilities
Trade Creditors 5000
Long-Term Liabilities
Loan 30000
Owner’s Equity 36250
Capital Contribution 30000
Nett profit 6250
Total Liabilities + Owners Equity 71250
Balance Sheet

 The business’s financial position

(sometimes referred to as financial
stability) is highlighted by the Balance
Sheet.

 A comparison can be made between the

proportion of assets, liabilities and
owner’s equity.
Balance Sheet

 The Balance Sheet highlights the proportions

of the business that can be claimed by external
parties (Liabilities), and what can be claimed
by the owners (Owner’s Equity).

 The Balance Sheet can also be used as a

monitoring tool to ensure goals concerning
asset acquisition and debt reduction etc. are
being achieved.
Balance Sheet

 If a balance sheet highlights a reasonably

high proportion of owners equity to
liabilities the company can be said to be
stable.

 If liabilities are close to the amount of

owners equity, or exceed owners equity,
the company can be considered unstable,
and likely not able to pay its liabilities.
Profit and Loss Statement/
Income Statement
 The profitability of a business is found by applying the
accounting equation:

 Revenue - Expense = Profit/Loss

 The Profit and Loss Statement (“P&L”) provides an analysis

of a business‘s trading performance over a period of time.
 The P&L is also referred to as the Income Statement,
although it lists all Income/ (Revenue) as well as
Expenses/(costs/losses)
Profit and Loss Statement

 The profit and loss statement is broken

down into two categories.
 Profit
 Loss

 Further elements of the statement can

include sales, cost of goods sold, gross
profit, operating expenses and net profit.
Sales

 This item of the profit and loss

statement shows a breakdown of
income from cash and credit trade
sales.
Cost of Goods Sold

 This shows the cost of the trading

stocks used up in the trading process.

 Cost of goods sold can be calculated

with the following formula:
Cost of Goods Sold

Stock on hand at beginning of accounting

period
+
Purchases during period
-
Stock on hand at end of period
=
Cost of goods sold
Gross Profit

 Gross profit is the difference sales and the cost of goods sold.

 It reflects the profit made from trading activity after selling the
physical product without taking into account any other expenses.
Operating Expenses

 These are the costs of running the business.

 Operating expenses do not include the cost of goods sold.

Net Profit

 Net profit is sometimes referred to as

the bottom line.

 It reflects the profit or loss made by the

business after all expenses have been
taken into account.
Profit and Loss Statement

Profit and Loss Statement for month ending 31 May

$ $
Revenue
Sales 1 000 000
COGS
Cost of Sales 600 000
Gross Profit 400 000
Operating Expenses
Salaries 35 000
Marketing 100 000
Administration 20 000 155 000
Net Profit Before Tax 245 000
Provision for Tax 45 000
Net Profit After Tax 200 000
Profit and Loss Statement

 The profit and loss statement is very

important to a business, as it shows
information concerning the cashflow of
a business.

 As cash is the hub of any business, this

statement can highlight the financial
success of the business.
Profit and Loss Statement

 Generating money is the primary

concern of almost any business.

 In order for a business to grow and

prosper, it needs to make money.

 The profit and loss statement can

identify if this is happening or not.
 Analysing Financial reports

• Accounting involves a flow of information

concerning a business, permitting it to make
informed judgements and decisions.

• Developing and understanding financial reports is

only a part of accounting.

• Analysing reports and using them for internal

control is an essential application for accounting
information.
Management Accounting

 Management accounting is concerned with

providing information relevant to the
needs of the internal decision makers of an
organisation.

 Management accounting involves the

analysis of reports generated specifically
for different departments of a business, as
well as employees at different levels of
responsibility.
Management Accounting

 Management accounting involves future estimates of financial

performance and stability (budgets) as well as past events and
the current position, hence it:

 Includes statistical data as well as dollar figures

 Tends to be reported more regularly
 Is tailored specifically to management requirements
Variances

 A variance is the difference between actual

financial performance and budgeted
financial performance.

 They can help identify, on a short term

basis, any unusual differences in the
overall operating performance of a
business.
Potential Accounting Variances

 The following slides detail some

common problems that may be
experienced by businesses, and
highlighted in management
accounting reports.

 Similarly, actions to correct these

problems have been included.
Potential Accounting Variances

 A common misconception regarding

accounting is that it operates
independently to other areas of the
business…This is not the case.

 The following information demonstrates

how accounting is linked to other parts of
the business, and how it can be used to
improve operations.
High Labour Costs

 Un-happy staff –results in high absenteeism

 High staff turnover

 Extra staff costs, training, recruitment, casuals

 Industrial disputes can reduce turnover

 Workers morale can affect production

 Skill levels of workers

Action

 Identify where the costs are generated

from and take the appropriate action

 Eg. High turnover of staff may be a result

of poor recruitment and or job satisfaction

 This would be the area to concentrate on

in this example
High Food Costs

 Wastage

 Price changes due to change in economic climate

 Poorly trained staff

 Too much stock on hand

 Poor food storage control and ordering

 Unreliable suppliers

 Consider tendering for suppliers

 Availability of products, substitutes can be expensive

Action

 This can be a result of many things

 Eg. Wastage, excess stock, increased

prices, poor choice of substitute due to
unavailability

 This can be overcome with training,

possible tender arrangements for suppliers
High Equipment Costs

 Inadequate maintenance program in place

 Poor quality equipment

 Cost of replacing equipment

 Availability of equipment required

 Poor staff training and, equipment

 Theft

 Breakages
Action

 The areas described need to be addressed

 Ongoing breakages and theft will only add

to ongoing high costs in this area

 Training may aid in the use of equipment

and possibly a maintenance program
High/low sales

 Sales decline can reduce profits

 Sales increase –can affect labour

 Change in market can affect sales

 Change in interest rates can affect buyer

behaviour
Action

 There needs to be a review of sales figures

to show what is not performing and make
adjustments inline with the strategic
direction of the company

 Sales figures can affect labour costs and

again these need to be checked against
operating performances
High Borrowings/Loans

 Interest payments absorbs profits

 Economic climate can affect interests rates,

and consumer confidence

 Rental agreements can change which can

affect the bottom line

 Change to government regulation in regards

to gearing and tax laws
High Operating Performance

 Gross profit / sales

 Profits can be good but conditions apply

 High cost of goods

 Heavily geared (borrowings) absorb profits

 Economic changes can affect interest rates

 Cash flow can be affected as a result of higher cost outlaid

Current Performance
VS
Historical data
 This can show trends in previous operating performances and give some
indication as to why

 Identifies high and low periods and why

 Increased/decrease in profits due to:

 Low sales, high staff turnover, Interest rates, competition etc.

***** E N D O F R E V I S I O N *****
Aristotle

“ First, have a definite, clear, practical

idea: a goal and an objective.
Second, have the necessary means to
achieve your ends; wisdom, money,
materials and methods.
Third, adjust all your means to that
end.”
 What is a budget?
A budget is a financial plan with measurable outcomes.

Budgets are route maps for a business to reach its destination.

Budgets are forecasts in monetary or quantitative terms.

Budgets translate management policies and goals into measurable outcomes.

What is a budget?
The process of planning, allocating resources and
identifying measurable outcomes is called
budgeting.

Budgets provide organised estimates of:

Revenue
Expenditure
Staffing levels
Equipment needs
And much more
What is budgetary control?

Applying budgetary control involves:

 checking actual income and

expenditure at regular intervals

 including financial commitments in all

appropriate documentation to ensure
accurate monitoring
What is budgetary control?

 identifying and reporting deviations, and

the significance of deviations, according to
enterprise policy

 investigating appropriate options for more

effective management of deviations

 advising appropriate personnel of budget

status in relation to targets within agreed
time frames
Four Key Areas of Budgeting:

 Planning

 Organising

 Motivating

 Controlling
Budgets and Financial Management:

 Financing—the supply of funds required

to run a business like short term working
capital to finance operating activities or
long term funds for the acquisition of
non-current assets.

 A budget allows these cash inflows and

outflows to be forecast, gauged and
monitored
Investing

 Involves the way funds are used

 All sources of finance have a cost---

Interest on a loan or return on owner’s
capital

 Therefore we must budget for funds

invested in assets give a return greater
than the cost of finance,
Operations

 Operating profits are an important

source of finance

 Profits can either be retained by the

business or paid to the owners in the
form of “drawings” in the case of a
sole trader or “a dividend" in the
form of a company
What is a budget?
In summary, budgeting:
Allows for the evaluation of business decisions

Sets targets in quantifiable terms

Provides benchmarks

Is a good means of communication

Summarizes large amounts of information

Allows for controls and checks

Ensures accountability by managers

Advantages of Budgets:

 Encourages staff to think about the future

 Involves staff in team approach in future direction
 Decision making more clearly focused
 Improves efficiency of organisational structure by defining
responsibilities communication lines and problems.
 Amount of supervision reduced through planned
allocation of tasks & staff accountability
 Sets performance benchmark
 Pinpoints SWOTs Therefore allows improvement
 Highlights need for accurate accounting system and forces
regular variance analysis
Organising the budget:

 After the future goals and objectives

are set ,the next step in the budget

process is to determine the type of

budget to be used
Types of budgets

 Capital budget

 Operating budget

 Departmental budget

 Cash budget

 Master budget
 Capital budget(Fixed Assets)

A capital budget relates to items requiring

capital expenditure and often requires the
allocation of substantial funds to projects
(e.g. refurbishment, building extension,
renovation or replacement schedule)
 Operating budget

The operating budget contains profit

projections based on projected income and
expenses.
 Departmental budget

A departmental budget relates to revenue and

expenses of a department for a given period of time,
usually one year.

It projects departmental profit and is a sub-set of the

operating budget.
 Cash budget

A cash budget is a projection of cash flow

in a business detailing the sources of funds
and the application of funds on a monthly
basis.
 Master budget

The master budget is a comprehensive budget

covering all activities of the organisation. It
comprises a budgeted operating statement
and a budgeted balance sheet.
 Budgets as plans

 A long-term budget is a strategic plan.

 A long-term budget will usually range between

3 to 5 years.

 It is a reflection of the long-term goals of an

organisation.
Budgets as plans

 An annual budget is an operational plan.

 Annual budgets are forecasts for one year

periods.

 The annual budget is developed to align

with the goals set in long-term budgets.
Budgets as plans

 A monthly budget is a performance plan.

 Monthly budgets are used in conjunction

with short-term goals.

 They will often include information such

monthly sales, profit and payroll targets
etc.
Information sources for budget
preparation

 Performance data from previous periods

 Financial proposals from key stakeholders

 Pricing and other information from suppliers

 Profile customers

 Competitor research
 Further information sources for
budget preparation:
 industry trends
 planned local events or issues
 management policies and procedures
 enterprise budget preparation guidelines
 declared commitments in given areas of operation
 grant funding guidelines or limitations
The budgeting PROCESS

1. Assessing market and economic conditions and

the strategic plan of the business

2. Establishing attainable goals

3. Allocating resources

4. Planning to achieve the established goals

The budgeting PROCESS

5. Setting standards and

communicate these to all stakeholders

6. Comparing actual performance with budgeted

targets and investigating deviations

7. Implementing corrective action

8. Revisiting the budgeting process for continuous

improvement.
Balance Sheet

 The balance sheet represents all of the

Asset, Liability and Owners Equity
(Proprietorship) accounts of a business.

 It reflects the financial structure of the

business.
Profit and Loss Statement

 The profit and loss statement represents

the revenue and expense accounts of a
business.

 It demonstrates the profit or loss made by

an organization, and reflects the success of
the business’s operations.
Cash Flow Statement

 The cash flow statements monitor the

receipts and payments of cash within a
business.

 This statement shows what money has

been made and spent each month to
ensure a business has enough cash to cover
its expenses.
 Variance analysis

Comparing actual results with forecasted results

and identifying differences with possible reasons.

During budget variance analysis comparisons are

made between different critical indicators to
ensure the budget’s goals are being met.
Budget Variances

 Budget variances could occur for a number of reasons:

 High or low business levels

 Unforeseen events that affect business levels

 Increased labor turnover

 External market (competitive) changes

 Unrealistic forecasting
 Poor internal control and security procedures
Budget Variances

 Common budget variances include:

 Actual COGS different to budgeted COGS

 Actual labor costs different to budgeted labor

costs

 Negative cash flow statement figures