MEM 5209: FINANCIAL

MANAGEMENT IN EDUCATION
LESSON THREE AND FOUR
LECTURER: Dr. Ruth Thinguri
EMAIL: nthinguri@yahoo.com or
SEMESTER: April, August, December.2015
MODULE LEADER:
VENUE:
LESSON 3&4:1:DEFINITIONS
Assets. An asset is something of value the company owns.
Assets can be tangible or intangible.
Tangible assets are generally divided into three major
categories: current assets (including cash, marketable
securities, accounts receivable, inventory, and prepaid
expenses); property, plant, and equipment; and long-term
investments.
Intangible assets lack physical substance, but they may,
nevertheless, provide substantial value to the company
that owns them. Examples of intangible assets include
patents, copyrights, trademarks, and franchise licenses.
LESSON 3&4:1:DEFINITIONS
 Fixed assets:
 Property, plant, and equipment is the title given to long-lived
assets the business uses to help generate revenue. This category is
sometimes called fixed assets. Examples include land, natural
resources such as timber or mineral reserves, buildings, production
equipment, vehicles, and office furniture. With the exception of
land, the cost of an asset in this category is allocated to expense
over the asset's estimated useful life.
 Long-term investments include purchases of debt or stock issued
by other companies and investments with other companies in joint
ventures. Long-term investments differ from marketable securities
because the company intends to hold long-term investments for
more than one year or the securities are not marketable.
LESSON 3&4:1:DEFINITIONS
 Current assets typically include cash and assets the company reasonably
expects to use, sell, or collect within one year. Current assets appear on
the balance sheet (and in the numbered list below) in order, from most
liquid to least liquid. Liquid assets are readily convertible into cash or
other assets, and they are generally accepted as payment for liabilities.
 Cash includes cash on hand (petty cash), bank balances (checking, savings,
or money-market accounts), and cash equivalents. Cash equivalents are
highly liquid investments, such as certificates of deposit and U.S. treasury
bills, with maturities of ninety days or less at the time of purchase.
 Marketable securities include short-term investments in stocks, bonds
(debt), certificates of deposit, or other securities. These items are classified
as marketable securities—rather than long-term investments—only if the
company has both the ability and the desire to sell them within one year.
LESSON 3&4:1:DEFINITIONS
 Accounts receivable are amounts owed to the company by
customers who have received products or services but have not
yet paid for them.
 Inventory is the cost to acquire or manufacture merchandise for
sale to customers. Although service enterprises that never
provide customers with merchandise do not use this category for
current assets, inventory usually represents a significant portion
of assets in merchandising and manufacturing companies.
 Prepaid expenses are amounts paid by the company to
purchase items or services that represent future costs of doing
business. Examples include office supplies, insurance premiums,
and advance payments for rent. These assets become expenses as
they expire or get used up.
LESSON 3&4:1:DEFINITIONS
Liabilities. Liabilities are the company's existing
debts and obligations owed to third parties. Examples
include amounts owed to suppliers for goods or
services received (accounts payable), to employees for
work performed (wages payable), and to banks for
principal and interest on loans (notes payable and
interest payable). Liabilities are generally classified as
short-term (current) if they are due in one year or less.
Long-term liabilities are not due for at least one year.
LESSON 3&4:1:DEFINITIONS
Owner's equity. Owner's equity represents the
amount owed to the owner or owners by the company.
Algebraically, this amount is calculated by subtracting
liabilities from each side of the accounting equation
from Assets. Owner's equity also represents the net
assets of the company.
LESSON 3&4:1:DEFINITIONS
ACCOUNTING EQUATION:
 Every business transaction will have an effect on a company’s financial
position. The financial position of a company is measured by the following
items:
 Assets (what it owns)
 Liabilities (what it owes to others)
 Owner’s Equity (the difference between assets and liabilities)
 The accounting equation (or basic accounting equation) offers us a simple
way to understand how these three amounts relate to each other.
The accounting equation for a sole proprietorship is:
Assets = Liabilities + Owner’s Equity
The accounting equation for a corporation is:
Assets = Liabilities + Stockholders’ Equity
LESSON 3&4:1:DEFINITIONS
If a company keeps accurate records, the accounting
equation will always be “in balance,” meaning the left
side should always equal the right side.
The balance is maintained because every business transaction
affects at least two of a company’s accounts. For example,
when a company borrows money from a bank, the company’s
assets will increase and its liabilities will increase by the same
amount.
When a company purchases inventory for cash, one asset will
increase and one asset will decrease. Because there are two or
more accounts affected by every transaction, the accounting
system is referred to as double entry accounting.
LESSON 3&4:1:DEFINITIONS
 ACCOUNTING RECORDS: Manual or computerized records of assets and liabilities,
monetary transactions; various journals, ledgers, and supporting documents (such as
agreements, checks, invoices, vouchers), which an organization is required to keep for certain
number of years.
 BUSINESS TRANSACTION :An economic event that initiates the accounting process of
recording it in a company's accounting system. Business transactions are ordinarily
summarized in books called journals and ledgers. You can buy them at your local stationery
or office supply store.
 A transaction engaged in by a business that initiates the accounting cycle of that business.
Business transactions are recorded in order to maintain accurate account balances, to ensure
accountability, to establish historical business activity data, and to provide information to
decision-makers for determining business strategy.
 every business transaction affects at least two of a company’s accounts. For example, when a
company borrows money from a bank, the company’s assets will increase and its liabilities
will increase by the same amount. When a company purchases inventory for cash, one asset
will increase and one asset will decrease. Because there are two or more accounts affected by
every transaction, the accounting system is referred to as double entry accounting.
LESSON 3&4:2: ACCOUNTING CONCEPTS
 Generally Accepted Accounting Principles(GAAP):
 Accountants use generally accepted accounting principles (GAAP) to
guide them in recording and reporting financial information.
 “GAAP” is the law of accounting-rules for conducting behaviors in a
way acceptable to the majority of people.
 GAAP comprises a broad set of principles that have been developed by the
accounting profession and the Securities and Exchange Commission (SEC).
 Two laws, the Securities Act of 1933 and the Securities Exchange Act of 1934,
give the SEC authority to establish reporting and disclosure requirements.
 However, the SEC usually operates in an oversight capacity, allowing the
FASB and the Governmental Accounting Standards Board (GASB) to
establish these requirements. The GASB develops accounting standards for
state and local governments.
LESSON 3&4:2: ACCOUNTING CONCEPTS
 FASB: Since 1973, the Financial Accounting Standards Board (FASB)
has been the designated organization in the private sector for
establishing standards of financial accounting that govern the
preparation of financial reports by nongovernmental entities. Those
standards are officially recognized as authoritative by the Securities and
Exchange Commission (SEC)
 GASB: The Governmental Accounting Standards Board (GASB) is the
independent organization that establishes and improves standards
of accounting and financial reporting for U.S. state and local
governments(PUBLIC SECTOR). Established in 1984 by agreement of
the Financial Accounting Foundation (FAF) and 10 national associations of
state and local government officials, the GASB is recognized by
governments, the accounting industry, and the capital markets as the
official source of generally accepted accounting principles (GAAP) for state
and local governments.
LESSON 3&4:3: PRINCIPLES OF
ACCOUNTING
GAAP has introduced basic accounting principles which govern
accounting process. The include the following:
Entity concept. Financial records must be separately
maintained for each economic entity.
Business entities include businesses, governments, school
districts, churches, and other social organizations.
 Although accounting information from many different entities
may be combined for financial reporting purposes, every
economic event must be associated with and recorded by a
specific entity.
In addition, business records must not include the personal
assets or liabilities of the owners.
LESSON 3&4:3: PRINCIPLES OF
ACCOUNTING
 Monetary unit concept. Any business entity's accounting records include only
quantifiable transactions.
 Certain economic events that affect a company, such as hiring a new chief
executive officer or introducing a new product, cannot be easily quantified in
monetary units and, therefore, do not appear in the company's accounting
records. Furthermore, accounting records must be recorded using a stable
currency. Businesses in the United States usually use U.S. dollars and in Kenya
Ksh is used for this purpose.
 Full disclosure principle. Financial statements normally provide information
about a company's past performance.
 However, pending lawsuits, incomplete transactions, or other conditions may
have imminent and significant effects on the company's financial status.
 The full disclosure principle requires that financial statements include disclosure
of such information. Footnotes supplement financial statements to convey this
information and to describe the policies the company uses to record and report
business transactions.
LESSON 3&4:3: PRINCIPLES OF
ACCOUNTING
 Time period concept. Most businesses exist for long periods of time, so artificial time
periods must be used to report the results of business activity.
 Depending on the type of report, the time period may be a day, a month, a year, or another
arbitrary period. Using artificial time periods leads to questions about when certain
transactions should be recorded.
 For example, how should an accountant report the cost of equipment expected to last five
years? Reporting the entire expense during the year of purchase might make the company
seem unprofitable that year and unreasonably profitable in subsequent years. Once the time
period has been established, accountants use GAAP to record and report that accounting
period's transactions.
 Accrual basis. accounting concept. In most cases, GAAP requires the use of accrual basis
accounting rather than cash basis accounting.
 Accrual basis accounting, which adheres to the revenue recognition, matching, and cost
principles discussed below, captures the financial aspects of each economic event in the
accounting period in which it occurs, regardless of when the cash changes hands.
 Under cash basis accounting, revenues are recognized only when the company receives cash
or its equivalent, and expenses are recognized only when the company pays with cash or its
equivalent.
LESSON 3&4:3: PRINCIPLES OF
ACCOUNTING
 Revenue recognition principle. Revenue is earned and recognized upon product
delivery or service completion, without regard to the timing of cash flow.
 Suppose a store orders five hundred compact discs from a wholesaler in March,
receives them in April, and pays for them in May. The wholesaler recognizes the
sales revenue in April when delivery occurs, not in March when the deal is struck
or in May when the cash is received.
 Similarly, if an attorney receives a $100 retainer from a client, the attorney doesn't
recognize the money as revenue until he or she actually performs $100 in services
for the client.
 Matching principle. The costs of doing business are recorded in the same period
as the revenue they help to generate. Examples of such costs include the cost of
goods sold, salaries and commissions earned, insurance premiums, supplies used,
and estimates for potential warranty work on the merchandise sold. Consider the
wholesaler who delivered five hundred CDs to a store in April. These CDs change
from an asset (inventory) to an expense (cost of goods sold) when the revenue is
recognized so that the profit from the sale can be determined.
LESSON 3&4:3: PRINCIPLES OF
ACCOUNTING
Cost principle. Assets are recorded at cost, which equals the value
exchanged at the time of their acquisition. In the United States
and other countries, even if assets such as land or buildings
appreciate in value over time, they are not revalued for financial
reporting purposes.
Going concern principle. Unless otherwise noted, financial
statements are prepared under the assumption that the company
will remain in business indefinitely. Therefore, assets do not need
to be sold at fire-sale values, and debt does not need to be paid off
before maturity. This principle results in the classification of assets
and liabilities as short-term (current) and long-term. Long-term
assets are expected to be held for more than one year. Long-term
liabilities are not due for more than one year.
LESSON 3&4:3: PRINCIPLES OF
ACCOUNTING
 Relevance, reliability, and consistency. To be useful, financial
information must be relevant, reliable, and prepared in a consistent
manner. Relevant information helps a decision maker understand a
company's past performance, present condition, and future outlook so
that informed decisions can be made in a timely manner. Of course,
the information needs of individual users may differ, requiring that the
information be presented in different formats. Internal users often
need more detailed information than external users, who may need to
know only the company's value or its ability to repay loans. Reliable
information is verifiable and objective. Consistent information is
prepared using the same methods each accounting period, which
allows meaningful comparisons to be made between different
accounting periods and between the financial statements of different
companies that use the same methods
LESSON 3&4:4:MINISTRY OF EDUCATION REGULATIONS
AND PROCUREMENT PROCEDURES
 Regulations
The Ministry of Education issues specific instructions with regard to the spending of
and accounting for funds. For example:
 1 Funds released by the MoE for one purpose should not be diverted for another
purpose.
2 It compels you to obtain approved authority for spending on an item.
3 All expenditures incurred should be recorded in an acceptable manner according
to the Standard Accounting Practice (SAP).
 4.If the need for expenditure arises, contrary to the approved budget, written
authority should be sought from the MoE or the governing body or PTA.
 Procurement procedures
1.It is advisable to use the Tender Board or Purchasing Body to control expenditure.
 2.If there is any bidding, it is done by the board of governors through its Finance
Committee.
 3Interested parties are not allowed to supply goods/services to the institution. 4.It is
not always easy to protect yourself from this last problem.
LESSON 3&4:4:MINISTRY OF EDUCATION REGULATIONS
AND PROCUREMENT PROCEDURES
 Financial flexibility
Where flexibility is possible, the total amount of money available to the school can be
enlarged and better value gained. It can be done in two ways:
 1Borrowing of funds from one vote to another: Internal borrowing is justifiable
because under-spent accounts can compensate for overspent accounts. For example,
maintenance of vehicles ( a very expensive item) may lead to borrowing from general
accounts. Internal borrowing also helps to counteract uncontrolled prices and inflation.
However, such adjustment must be done with the approval of the governing body.
 Carrying balances forward: An increasing number of institutions carry forward
unspent capitation from one year to another; and over-spending is carried forward as a
deficit to be paid off next year.
 There are three advantages of this Financial flexibility practice:
 1 Institutions can plan their expenditure if necessary outside the limits of one financial
year.
2 There is no risk of losing unspent funds.
3 Schools spend less time on administration of funds, because there is no longer any need
to balance expenditure exactly against income.
LESSON 3&4:5: ACCOUNTING
CYCLE/FINANCIAL RECORDING PROCESS
LESSON 3&4:6:THE FINANCIAL
STATEMENTS
After analyzing transactions, we need a way to present the
results. We use the financial statements to do so. These are
the formal report of an entity’s/organization’s financial
information .
The primary financial statements are
Balance sheet for both profit and non-profit making
activities
Trial balance
Cash flows and cash flow focus
Income and expenditure accounts
Income statement
LESSON 3&4:6:THE FINANCIAL
STATEMENTS: BALANCE SHEET
THE NAME OF THE BUSINESS, BALANCE SHEET
 PERIOD/DATE
ASSET CAPITAL +LIABILITIES

FIXED ASSETS ONWER’S EQUITY/CAPITAL

Land and plant
Machinery
Buildings
Vehicles

CURRENT ASSETS LIABILIITES

Cash in hand LONGTERM LIABILIITES
Cash at bank Bank loans
Stock
Debtors

SHORTERM LIABILIITES.
accounts payable
Wages payable
Creditors
bank overdrafts

TOTALS TOTALS
LESSON 3&4:7:DISCUSSION ACTIVITY
AFTER GOING THROUGH THE LESSON
COMPLETE THE EXERCISE PROVIDED AS AN
ATTACHMENT Q1-Q9
LESSON 3&4:8: CASH FLOW AND
CASHBOOK
 Cash book: ledger in which all cash receipts and payments
(including bank deposits and withdrawals) are recorded first, in
chronological order, for posting to general ledger. Cash book is
regularly reconciled with the bank statements as an internal auditing
measure.
 Single Column Cash Book
 It has only one. column on each side for amount In fact, it is written
just like cash account in the ledger (being real account what comes in
is debited; what goes out is credited). This form of 'cash book has the
same ruling as that of a ledger account There is no need of having a
cash account in the ledger. The purpose is ably served by cash book
itself. Posting from debit (receipt) side of the cash book is done to the
credit side of concerned accounts and from the credit side of cash
book to the debit side of concerned accounts
LESSON 3&4:8: CASH FLOW AND
CASHBOOK
 Double column cashbook: It is treated as two accounts of ledger. The
cash column on its Dr and Cr sides together constitutes a cash in hand
account while the bank columns on its two sides together constitutes a
cash at bank account. These two accounts are balanced separately.
 Three column cashbook: it accommodates the cash discount offered to
debtors to stimulate them to promptly pay their dues. This a reduction
in the amount due if it is paid within a prescribed period. It is allowed
only when the amounts due is actually received. Since this is an expense
to the person owing it, it should be debited in his ledger and credited to
the cashbook.
 Note a trader may also be offered a cash discount by his suppliers. When
he actually settles his dues, a reduction is allowed in the amount due by
his suppliers. He must debit his cash book with the discount received
and the same will be credited to the suppliers account.
LESSON 3&4:8: CASH FLOW AND
CASHBOOK
In financial accounting, a cash flow statement, also
known as statement of cash flows or funds flow
statement, is a financial statement that shows how
changes in balance sheet accounts and income affect
cash and cash equivalents, and breaks the analysis
down to operating, investing, and financing activities.
Essentially, the cash flow statement is concerned with
the flow of cash in and cash out of the business. The
statement captures both the current operating results
and the accompanying changes in the balance sheet.
LESSON 3&4:9:BANK RECONCILIATION
 Bank reconciliation statement is a report which compares the bank balance
as per company's accounting records with the balance stated in the bank
statement.
 It is normal for a company's bank balance as per accounting records to
differ from the balance as per bank statement due to timing differences.
Certain transactions are recorded by the entity that are updated in the
bank's system after a certain time lag. Likewise, some transactions are
accounted for in the bank's financial system before the company
incorporates them into its own accounting system. Such timing differences
appear as reconciling items in the Bank Reconciliation Statement.
 The purpose of preparing a Bank Reconciliation Statement is to detect any
discrepancies between the accounting records of the entity and the bank
besides those due to normal timing differences. Such discrepancies might
exist due to an error on the part of the company or the bank.
LESSON 3&4.10:IMPORTANCE OF
BANK RECONCILIATION
 Preparation of bank reconciliation helps in the identification of errors in the
accounting records of the company or the bank.
 Cash is the most vulnerable asset of an entity. Bank reconciliations provide the
necessary control mechanism to help protect the valuable resource through
uncovering irregularities such as unauthorized bank withdrawals. However, in order
for the control process to work effectively, it is necessary to segregate the duties of
persons responsible for accounting and authorizing of bank transactions and those
responsible for preparing and monitoring bank reconciliation statements.
 If the bank balance appearing in the accounting records can be confirmed to be
correct by comparing it with the bank statement balance, it provides added comfort
that the bank transactions have been recorded correctly in the company records.
 A bank reconciliation will also detect some types of fraud after the fact; this
information can be used to design better controls over the receipt and payment of
cash.
 Monthly preparation of bank reconciliation assists in the regular monitoring of cash
flows of a business.
LESSON 3&4:11:PREPARING A BANK
RECONCILIATION STATEMENT
Following is a sample Bank Reconciliation Statement:

Swara school
Bank Reconciliation Statement as at 31 December 2011
Balance as per corrected Cash Book 1 xxxx
Add:
UnpresentedCheques 2 xxxx
Less:
Deposits in Transit 3 xxxx
Errors in Bank Statement 4 xxxx
Balance as per Bank Statement 5 xxxx
LESSON 3&4:11: PREPARING A BANK
RECONCILIATION STATEMENT
Balance as per corrected Cash Book:
This is the starting point of a bank reconciliation.
Corrected bank balance is calculated by adjusting the
cash book ledger balance for transactions that are
recorded by the bank but not by the entity as shown
below:
LESSON 3&4:11: PREPARING A BANK
RECONCILIATION STATEMENT
Balance as per Cash Book xxxx
Add:
Direct Credits 6 xxxxx
Interest on Deposit 7 xxxxx
Less:
Bank Charges 8 xxxxx
Direct Debits 9 xxxxx
Standing Order 10 xxxxx
Errors in Cash Book 11 xxxxx
Balance as per corrected Cash Book 12 xxxxx
LESSON 3&4:12: GROUP ACTIVITY
AFTER GOING THROUGH THE LESSON
COMPLETE THE EXERCISE PROVIDED AS AN
ATTACHMENT Q1-Q9
LESSON 3&4:13: SELFTEST QUESTIONS
 Accounting practices in economic entities are
governed by principles of accounting. Discuss the
principles and explain how they work
Explain terms assets, liability and net worth. Using the
balance sheet equation show how they are interrelated
Prepare balance sheets from the information
provided.
Distinguish between a cashbook and a cash flow
statement.
Prepare cash books using the information provided.