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Financial Accounting - Summary

Programme outline

 Introduction
Financial accounting vs. management accounting vs. financial management vs. auditing,

Financial Accounting Vs. Management Accounting

 Primary purpose

 Examples of reports

 Orientation

 Users

 Fundamental or unifying equation

 Compulsory or optional

 External standards governing preparation

 Monetary & non monetary information content

 Precision of information

 Details relating to segments / products etc.

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Financial Accounting - Summary

Financial Accounting Management Accounting

Primary purpose is to maintain systematic records of past Primary purpose is to support managerial decision-making.
transactions.
Examples include Balance Sheet, P & L & Cash Flow Examples include budgets, feasibility reports etc.
statements
Records and reports the financial history i.e. the past of the Includes future information (forecasts, plans etc.) as well as
organisation past information
More concerned with measuring financial position and More concerned with establishing plans for the future i.e.
changes in financial position. Planning and achieving compliance with these plans i.e.
Control)
Users include managers, shareholders, etc. (Hence the Users are managers and other authorised personnel. Hence
term "external accounting") the term "internal accounting”
Built around the fundamental equation Does not have a single unified structure
Assets = Liabilities + Owners Equity
Is compulsory Is optional
Governed by externally imposed standards Has no externally imposed standards
Emphasis is on monetary information Deals with non-monetary information as well as monetary
information. E.g. physical quantity for production, weight,
volume, labour hours, machine hours etc.
Focuses on the organisation as a whole Focuses on relatively small parts of the organisation.
More emphasis on precision and accuracy of information Management needs information rapidly in order to avoid "
Analysis Paralysis " Therefore less emphasis on precision
and accuracy of information
Financial Accounting reports are the end products of the Management Accounting reports are means to other ends
system i.e. Balance Sheet, P & L & Cash Flow statements e.g. they facilitate planning, co-ordination and control.

Similarities between financial accounting & management accounting do exist. E.g. the need for objectivity, verifiability etc.

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Financial Accounting - Summary

FINANCIAL MANAGEMENT
Financial management can be viewed as the process of developing a long-term perspective on the funding and
management of funds for all organisations. The longer term strategic emphasis contrasts, perhaps, with the traditionally
perceived role of the management accountant.

INVESTMENT IN = SOURCE OF FUNDS


BUSINESS

ASSETS = LIABILITIES + OWNERS


EQUITY

LONG SHORT = SHORT LONG OWNERS


TERM TERM TERM TERM EQUITY
ASSETS ASSETS LIABILITIES LIABILITIES

LONG WORKING = LONG OWNERS


TERM CAPITAL TERM EQUITY
ASSETS (STA – STL) LIABILITIES

How is the business to be funded? The mix of sources of funding available to business of different sizes, and the
advantages and disadvantages of the various alternatives is seen as a core part of the syllabus. As with economic issues,
however, it is expected that candidates will be able to take the theories and relate them to specific business situations.
What techniques can we use to ensure that money is invested wisely? Certainly DCF is central to investment
decision-making, but it is not the only appraisal technique available. Indeed research suggests that, in practice, many
firms use payback or ROCE in preference to the more complex net present value approach when making investment
decisions. The need to apply criteria for the selection of investments clearly arises because companies do not have an
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Financial Accounting - Summary

unlimited supply of funds. When capital is rationed it becomes important to ensure that the money available is used in the
most effective manner. This means that candidates must also understand how to compare projects when capital is
rationed: what alternative ranking systems are available and which is the preferred option?
How does working capital management affect the financial success of the company?
Investing money wisely assumes that there is money available to invest, but this will not be the case if working capital is
ineffectively managed. An understanding of the importance of tight working capital management to the long-term survival
of a business is a core theme in financial management. The financial management topics include working capital
management, covering cash, debtors, stock and creditors.
This idea links working capital management back to the topic of sources of funds, and demonstrates how good financial
management forms a type of control loop. Managers set their objectives (subject to external influences) and then seek to
raise the required level of funding. If the funding mix is correct and good investment decisions are made, then the
business should flourish. If sales are inadequate, or growth is very rapid, then cash flow can become a problem, and
objectives need to be re-defined and the whole process re-commences. Working capital management completes the
circle of financial management.

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Financial Accounting - Summary

AUDITING

Let us understand the role of auditing and auditor. In most public limited companies there is separation of ownership &
management. A typical structure of a public limited company is as follows;

SHAREHOLDERS

AUDITORS

BOARD OF DIRECTORS

MD / CEO

DEPARTMENTAL MANAGER

EXECUTIVES

SUPERVISORS

CLERICAL STAFF

Definition
"The independent examination of and expression of opinion on the financial statements of an enterprise by an appointed
auditor in pursuance of that appointment, and in compliance with any relevant statutory obligations.”
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Financial Accounting - Summary

Auditor
The Companies Act (Chapter 50) requires that every company registered under the Act must be audited by an approved
company auditor. The external auditor is an independent person, and certain statutory and professional rules are set with
a view to seek to ensure his independence.

The Companies Act requires that the auditor carry out an examination sufficient to allow him to form an opinion as to:

(i) The truth and fairness of the accounts;


(ii) The maintenance of proper books of account;
(iii) The degree of compliance with the provisions of the Statement of Accounting Standard and the Companies Act.

The above have become important in the present context where owners delegate the day-to-day management of an
enterprise to others, i.e. the directors the company has adopted a limited liability form.

Hence the auditor ii appointed by the shareholders to act on their behalf in the capacity of agent thereby effectively
monitoring the activities of the directors by seeking to ensure that any improprieties are fully disclosed. This is referred to
as an agency theory".

The essence of agency theory is that as owner-managers take in additional external finance, the role of` the owner-
manager contracts into that of a managing agent for the external shareholders, whose demand for timely, reliable financial
information increases.

While studying the role of external auditor as defined by the auditing profession and as determined by regulation and by
statute law, it is worth considering the public's perceptions of the role of the auditor. The public have excessive
expectations, and this has caused considerable concern within the profession. This has come to be known as "the
expectation gap"

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Financial Accounting - Summary

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Financial Accounting - Summary

Definition of Accounting

"Accounting is ... an art of recording, classifying & summarising in a significant manner & in terms of money only,
transactions & events which are of financial nature & interpreting results thereof"

Various steps in accounting;

Recording Day Books Day to day recording of


transactions

Classifying Ledgers 1 page is reserved for each


item (account)

Summarising Trial Balance Verification of accuracy of


books of accounts

Interpretation Financial Statements Preparation of reports

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Financial Accounting - Summary

Financial Statements
Financial statements are the end result of financial accounting process. They are output of financial accounting system.

Income Statement or Balance Sheet


Profit & Loss Account
Asset = Liability + Owners Equity
Revenue – Expenses = Income (or profit)

Cash Flow Statement


$ Receipts - $ Payments =
Changes in cash balance

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Financial Accounting - Summary

EXPLAIN TERMS TO UNDERSTAND FINANCIAL STATEMENTS

 Asset
 Liability
 Revenue
 Expense
 Owner’s equity / Capital & Reserves / Shareholders’ funds / Capital

Why study these terms?


Because they are building blocks of financial statements.

Financial Statements
Financial statements are the end result of financial accounting process. They are output of financial accounting system.

Income Statement or Balance Sheet


Profit & Loss Account
Asset = Liability + Owners Equity
Revenue – Expenses = Income (or profit)

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Financial Accounting - Summary

Accounting Terms - Asset, Capital, Liability, Revenue, Expense

Assets:
Assets are valuable resources that are owned or controlled by a firm. They represent probable future economic benefits
and arise as the result of past transactions or events. Examples of assets include cash, accounts receivable (the right to
receive cash in the future), inventory (merchandise manufactured or acquired for re sale to customers), equipment, land,
and investments.

Types

Non Current assets / Fixed assets Current Assets

 Fixed Assets are not meant for conversion in to cash  Current Assets are meant for conversion in to
or equivalent in the next accounting year. cash or equivalent in the next accounting year.

 Long term use in business  Circulatory nature

 Fixed or permanent nature  Transitory nature

 Examples:  Examples:
Furniture Stock or Inventory
Land Debtors or Accounts Receivable
Premises Cash
Vehicle Bank
Building Marketable securities
Office Equipment Prepayments
Plant etc.
Machinery
etc.

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Financial Accounting - Summary

Liability:

Liabilities are present financial obligations of the firm. They are probable future sacrifices of economic benefits (usually
cash) that arise as the result of past transactions or events
Types

Long term / Creditors: amounts falling due after more Short term / Current /Creditors: amounts falling due
than one year within one year

 Date of maturity: after next accounting year.  Date of maturity: during next accounting year.

 Examples:  Examples:
Term loan Creditors or Accounts payable
Bonds / debentures Accruals
etc. Bank overdraft
etc.

Owners’ equity / Capital & reserves: Represents owner’s contribution to business. It includes Share capital & reserves
Owners’ equity represents the owners’interest in the assets of the business. Owners can obtain an interest in their business
either by making direct investments or by operating the business at a profit and retaining the profits in the firm.
Owners’equity is also referred to as the residual interest, a term that implies the owners’ interest is what remains after
creditors’ claims have been honored. This can most easily be seen by rearranging the basic accounting equation:

A-L=OE

Question> Are profits represented by cash?

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Financial Accounting - Summary

Expenses: Refers to expired / exhausted benefit in revenue generation process. E.g. Rent, salary, transport charges,
advertisement expenses etc.
Expenses arise from consuming resources in order to generate revenues. The cost of inventory so ld to
customers illustrates an expense. .Losses are similar to expenses in that they decrease assets or increase
liabilities, but they are not central to
a firm’s major activities. The sale of land at an amount less than its carrying value would result in a loss.

Types of expenses for manufacturing firms

Production cost of sales Example:


Purchases of raw material
Wages, Manufacturing expenses etc.

Purchase cost of sales Example:


Purchases cost of goods sold, Carriage inward, etc.

Other expenses Example:


Office & Administration expenses
Sales & Distribution expenses
Finance expenses
Taxation
etc.

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Financial Accounting - Summary

Types of expenses for trading firms

Purchase cost of sales Example:


Purchases of finished goods, Carriage inward, etc.

Other expenses Example:


Office & Administration expenses
Sales & Distribution expenses
Finance expenses
Taxation
etc.

Types of expenses for service firms

Other expenses Example:


Office & Administration expenses
Sales & Distribution expenses
Finance expenses
Taxation
etc.

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Financial Accounting - Summary

Revenue: means gross earnings. E.g. sales, interest received / commission received / dividend received.
Revenues are inflows of assets (or reductions in liabilities) that result from providing goods and services to
customers; they arise from a firm’s ongoing operations. Gains, as with revenues, increase assets or decrease
liabilities, yet they arise from activities that are not central to a firm’s major operations. For example, a gain would
result from selling land for more than its carrying (book) value.

Types

Main source of revenue Other revenue


Example: Sales etc. Example: Interest received / rent received / dividend received etc.

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