Unit 1

Managerial Accounting

Accounting as a decision-
making tool
Index

Key ideas 3
1.1. Introduction and objectives 3
1.2. Financial Accounting Debit and Credit 4
1.3. Entering Income and Expenses into Accounts 6
1.4. Closing Operations. Fast Closing 7
1.5. Calculation of Accounting Profit/Loss 8
1.6. Annual Accounts 9
1.7. Solved exercises 12

In deep 20

Test 21
 Key ideas

1.1. Introduction and objectives

Accounting is the information system in which companies collect their economic

transactions in chronological order with the aim of providing an Accurate Picture of
the economic and financial situation and assets of the company, in compliance with
valuation standards and accounting principles common to all businesses and covered
by international standards.

Using Financial Accounting to record the company’s transactions is mandatory. Each

country has its own legislation, but globalization has made accounting systems in
each country converge toward a single regulatory body that all countries have
adopted: International Accounting Standards (IAS).

By the end of this chapter, the student should be able to:

1. Enter simple transactions into accounts.

2. Locate items in the Annual Accounts, distinguishing whether they are flow or fund
magnitudes.
3. Differentiate between assets, spending and payment on the one hand and
between liabilities, net income and receipts on the other.
4. List the accounting obligations of companies.

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1.2. Financial Accounting Debit and Credit

Financial accounting or Double-Entry accounting started to be used spontaneously by

entrepreneurs in the Middle Ages. Its basic functioning is simple to explain: each
transaction is recorded as an entry called the accounting entry. It consists of two
parts: on the right-hand side, the origin of the resources that were used in the
transaction is entered, and on the left-hand side, what has been done with them is
entered; that is to say, the application of the funds. The funds cannot grow or
decrease in a mere transaction, so the amounts on the right and to the left must add
up to the same. By mere convention, the left-hand side of the accounting entry is
referred to as the «debit» and the right-hand side, «credit».

According to this definition, if you purchase a chair for 80 euros in cash, the origin of
the resources will be the cash from a bank account, and the intended use of the
resources is the chair itself. The accounting entry would be the following:

. debit . . credit .
80 Chair to Bank Current Account 80

The greatest virtue of this method of recording transactions is control. In a single

entry where the resources come from and what has been done with them are
recorded at the same time. There can be no difference between the two amounts.
This allows the sequence of transactions to be reconstructed (traceability) and that
there can be no loss of funds, these being recorded. For example, if you sold the chair
for 65 euros in cash (therefore losing 15 euros), the entry would be

. debit . . credit .
65 Bank Current Account to Chair 80
15 losses from the sale of the chair

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Unit 1. Key ideas
This explains why in financial accounting the debit and credit amounts always add up
to the same amount.

The basic accounting reasoning for making any entry is as follows:

1. Identify which assets are involved in the transaction. Usually this is simple: it is
sufficient to identify the subject of the transaction. In the case of the first entry we
have done, it would be «chair» and «cash in bank accounts».

2. Check whether the accounts involved Did you know...

represent rights to receive payment The early history of double-entry
(assets) or obligations to pay accounting can be found in Europe during
the Middle Ages. Since antiquity, there
(liabilities) for the company, have been accounting records in the simple
regardless of whether in the entry form of a list of collections and payments
in a column of amounts (and in Roman
analyzed, they increase or decrease. numerals, of course). The innovation
In our case, both the chair and the introduced with double-entry was the
notion of control. Since all accounting
money that the company has in their
entries have to tally (adding up to the same
bank accounts are rights to receive in credit and debit), it is impossible to
payment. change an asset without simultaneously
making another entry for the same amount
and using the opposite sign. In other
3. Check whether in the analyzed words, if something is missing, you can
locate the entry for that output to see
transaction, said accounts increase
what the consideration was. If you're
or decrease. interested in the subject, you can extend
your studies via in the following link:

4. On the left-hand side of the entry, http://www.iicpa.com/De%20Computis%2

increases in assets or decreases in 0et%20Scripturis.HTML

liabilities will be recorded; and on the

right-hand side, the opposite; that is to say, decreases in assets and increases in
liabilities. This is called the «Fundamental Credit and Debit Convention»:

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Unit 1. Key ideas
 . debit . . credit .
Increase in assets Increase in liabilities
Decrease in liabilities Decrease in assets

The consequence is that the negative sign is not used when making accounting
entries. Decreases are recorded on the side opposite increases.

5. Finally, make the entry using the information in the previous four steps.

At the end of every year, the company will draw up its Balance Sheet, which consists
of a list of accounts with their balance. In our case, the «chair account» would not
appear since the debit and credit entries add up to the same amount. The impact on
the Balance Sheet of the two entries above would be €15 less in the bank account
and losses for the same amount.

1.3. Entering Income and Expenses into Accounts

Expenses are no more than the application of resources that the company incurs with
the aim of generating income of a larger amount. For this reason, expenses behave
like assets: they increase, being entered on the debit side (on the left) and decrease
where applicable, being entered on the right-hand side (credit). The opposite is true
of income accounts because they are the origin of resources. Income accounts
represent the creation of value on the part of the company.

For example, if the company pays an electricity bill amounting to 100 euros, the entry
would be:

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Unit 1. Key ideas
 . debit . . credit .
100 Expenses for electricity to Bank Current Account 100

If we charge 120 euros for advice, we would enter the income in the accounts like
this:
. debit . . credit .
120 Current Bank Account to Income from services 120

1.4. Closing Operations. Fast Closing

Financial accounting brings together the company’s economic history, so it needs

documentation showing that the transactions have occurred and the amount. It is
not possible to enter transactions that have not yet occurred; only past transactions.

For just over a century in most countries, accounting legislation has required that at
least once a year, the relevant parties must calculate earnings by deducting expenses
incurred during that year from income. In both cases, what has been paid or received
is not relevant, but what which has been «earned»; that is, that the right to receive
payment or the obligation to pay from a legal point of view already exists. That is why
there is a definition of financial accounting that affirms how lawyers describe
financial economic transactions: it is important to take into account rights to receive
payment and obligations to pay because collection and payment are a mere
consequence of the existence of rights to receive payment and obligations to pay.

Before calculating earnings in a process called «accounting adjustment» by

subtracting income expenses, the company must make some entries that do not
come with supporting documentation related to third parties. This basically refers to
provisions and amortization, although there are other, somewhat more complex
operations (accrued income, balance adjustment or reclassification of maturities in

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Unit 1. Key ideas
the short-term or long-term) that can be studied by consulting the bibliography. I am
not covering this now in order to avoid focusing on accounting content that does not
form part of the course’s objectives.

Amortization consists of posting as an expense the portion of the value of fixed assets
that has been lost during the financial year, through its use or the simple passage of
time.

Accounting Provisions are expenditure accounts which show future outgoings for
reasons that have already occurred in the past. For example, if the company comes
to the end of year without having received its electricity bill for December, it must
enter the expense in the accounts by means of a provision.

Fast closing consists of using provisions at the end of the period to have data about
earnings and the Balance Sheet as soon as possible after the end of the period, and
the reporting can be issued although the invoices and paperwork for these
transactions will take some days or weeks to arrive.

1.5. Calculation of Accounting Profit/Loss

Companies are required to calculate their profit/loss at least once a year. This is done
through accounting adjustment, which consists of subtracting expenses and carrying
the balance of income to a Balance Sheet account called the «Profit and Loss
Account».

For example, if we adjust all the entries that we have done so far in this unit, the entry
would be the following:

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Unit 1. Key ideas
 . debit . . credit .
120 Service Revenue to Electricity expenditure 100
to Losses on sale of the chair 15
to Profit and Loss Account 5

As can be seen, adjustment consists of leaving a zero balance in the income and
expenditure accounts, taking the Profit and Loss Account as a counterpart. The
Balance Sheet will still tally (assets and liabilities showing the same amounts) because
both book entries and the adjustment entry also tally.

1.6. Annual Accounts

Annual accounts are accounting documents which the company prepares (or
formulates) at the close of the previous year following instructions from its directors,
which shareholders then approve at the Ordinary General Meeting and which the
company must file at a public registry available to anyone who wishes to consult
them. They consist of

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Unit 1. Key ideas
1. Balance Sheet, a list of all accounts with their
balance that does not contain income nor
expenses because these will have been
settled on calculating earnings during the
adjustment process. All amounts are
magnitude funds; that is, the amount they
have at a specific date.
2. Profit and Loss Account, with all accounts of
income and expenditure incurred during the
financial year. All amounts that are «flow»
magnitudes; that is, they correspond to a
period of time, not to a specific date.
3. Cash Flow Statement, a summary of the
movements of the cash accounts during the
year.
4. Statement of Changes in Net Equity, with the
movements of the accounts open between the company and its shareholders
5. A Report, a text with more detail about some sections of said documents.
You might find this useful
The format of Annual Accounts
is different depending on the
size of the company. For small
businesses, there are some
simplified models, but the
content of the Annual Accounts
of large businesses is very broad.
In addition, if the shares of the
company's common stock are
traded in financial markets, the
content tends to be expanded to
increase transparency. See, as
an example, the Annual
Accounts of Iberdrola via the
next link. Read at least up to
page 11:
https://www.iberdrola.com/wc
orp/gc/prod/en_US/corporativo
s/docs/IB_Annual_Financial_Inf
ormation.pdf

The Directors must prepare the Annual Accounts during the first quarter and send
them to the shareholders for approval. Following indications about the date, the
Ordinary General Meeting will be convened for approval of the accounts with
minimum notice of one month. The shareholders are the owners of the company and
may request changes to the accounts and ask the directors to prepare the accounts
again, but this is unusual, because they can give directions to the director at any time
during the financial year.

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Unit 1. Key ideas
In deep

The company’s accounting obligations

Companies’ accounting obligations depend on their size, although the

essential content is universal for companies and self-employed
professionals.

The obligation to publish accounting information is relatively recent and

is not universal; that is, it is not applicable in all countries worldwide. The
reason for that obligation is the encouraging of free competition. The
existence of a market economy has two basic requirements: (I) freedom
and an absence of barriers on entry to and exit from the market for
suppliers and users, and (ii) equal access to information (preferably
without charge) for actual or potential suppliers and users. The obligation
to publish accounting information contributes precisely to that second
objective: if a company is achieving a high level of profitability in its
activity, this must be known by other companies that can access their
market or are already in it, as the competition that will be generated
between them will force the prices that they put on all their products
down. This will result in better prices for users or consumers. From this
point of view, carrying out financial accounting becomes a sort of tax in
kind that companies must assume in order to be able to act in certain
markets.

However, this reasoning, which can be robust from a theoretical point of

view, is weakened when said publication is not universal; that is, when it
is not applicable in all countries, even though the economy is becoming
increasingly globalized. It is very frustrating for companies required to
publish their financial information to see how their competitors located
in other countries where there is no obligation to file accounting
information, do not furnish their own accounting information, because
this asymmetry entails, in reality, a distortion of free competition rules.

With regard to the day-to-day operational decisions of the company,

these are based more on information that facilitates control management
than on financial accounting, given that accounting information is not
available until a few days or weeks after the accounting events have
occurred. This is because it is necessary to have all the information
necessary for accounting before making account entries and that

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Unit 1. Key ideas
 includes, for example, information from banks, the Treasury or other
suppliers, all of which can take some time to reach the company.

In addition, accounting information is prepared according to certain

criteria that do not necessarily coincide with those a company applies to
documenting its decisions. For example, tangible assets are valued in
accounting at the acquisition or historical price and that value may have
varied over time. The decision is usually taken considering the market
value of tangible assets and not the acquisition value that appears in the
accounts.

You can check the «In deep» section to expand your knowledge on this
subject.

1.7. Solved exercises

Case 1

The ABC S.A. consulting company is ending its fiscal year, the date is 12/31/20XX. The
following data was provided by the company to be able to carry out the necessary
accounting adjustments. Use the template to enter the changes.

 During January 20XX, the company bought a new building, which cost €1,000,000.
The company has estimated that the accounting depreciation of the building for this
year is €25,000.
 In December of 20XX, the company concluded a service to a client for a total of
€30,000 (21% VAT not included). The corresponding invoice was issued and is
expected to be paid the following year.
 In December of 20XX, the company concluded a service to a client for a total of
€50,000 (21% VAT not included). The corresponding invoice was issued. €10,000 of
this invoice has already been paid, and the rest will be paid during the following year.

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Unit 1. Key ideas
 In October of 20XX, the company took out a loan for €300,000 from a bank. The
interest for the loan is 5% per annum. No adjustments have been accounted for at
the end of the year.

Case 2

The company XYZ, S.A. began operating on 01/01/20XX.

The partners initially contributed €1,000,000 for the acquisition of fixed assets (non-
current assets) for €1,500,000. The amount necessary for this acquisition was requested
from the bank, through a long-term loan. We assume there are no stocks or taxes at the
beginning and end of the year.

During the year 20XX, it processed the following transactions:

 Sales: €5,000,000.
 Cost of sales: €4,000,000.
 Salaries: €500,000.
 General expenses: €100,000.
 Provision for depreciation: 20,000.
 Financial costs: 3% yearly for the loan.
 Taxes to be paid on profits amount to 25%. Payable during the following year.
 Out of sales, 10% of payments have not been collected.
 There are pending payments to suppliers for a total of €500,000.
 The rest of the expenses are paid within the 20XX fiscal year.

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Unit 1. Key ideas
The management requests:

1. Opening balance sheet.

2. Balance sheet and income statement as of 12/31/20XX.
3. On 12/31/20XX, is the company in a position to pay pending amounts to its suppliers?
4. If the answer is no, how can this be resolved?

Use the following templates.

ASSETS 01/01/20XX 12/31/20XX

Fixed assets
Accumulated depreciation
Non-current Assets
Customers
Cash
Current Assets
TOTAL

PASSIVE + NET EQUITY 01/01/20XX 12/31/20XX

Share capital
Year profit
Net worth
Long-term loan
Non-Current Liabilities
Short-term bank debts
Taxes payable
Suppliers
Current Liabilities
TOTAL
€0.00 €0.00

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Unit 1. Key ideas
 Income Statement 12/31/20XX

Sales
Cost of sales
Gross Margin
Salaries
General expenses
Provision for depreciation
Result of the operation
Financial costs
Profit before taxes
Taxes (25%)
Net result

Case 3

Company XYZ SA has decided to solve the problem of not being able to pay its suppliers
to prevent any problems in the supply of raw materials.

For this purpose, it comes up with two alternatives:

1. Collect money from clients earlier. To achieve this, it offers a 2% discount on advance
payments. This discount will be accounted for as a smaller sales volume.
2. Request a credit facility from the banks to alleviate this transitory situation. The cost
would be 4% per annum. For calculation purposes, we will suppose that the credit
facility will be used for two months.

The student is asked to produce the Income Statement and Balance Sheet for both
decisions.

NOTE: when calculating the use of the credit facility, you must take into account the
iteration that will occur between this facility and the financial costs.

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Unit 1. Key ideas
Solution case 1

Produce the corresponding accounting entries as of 12/31/20XX.

a)
. DEBIT . . CREDIT .
€25,000 Provision for depreciation to Accumulated depreciation €25,000

b)
. DEBIT . . CREDIT .
€36,300 Clients to Sales €30,000
to VAT payable €6,300

c)
. DEBIT . . CREDIT .
€60,500 Clients to Sales €50,000
to VAT payable €10,500
. DEBIT . . CREDIT .
€10,000 Banks to Clients €10,000

d)
. DEBIT . . CREDIT .
€3,750 Financial costs to Short term bank loans €3,750.

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Unit 1. Key ideas
Solution case 2

ASSETS 01/01/20XX 12/31/20XX

Fixed assets €1,500,000.00 €1,500,000.00
Accumulated depreciation €0.00 €-20,000.00
Non-current Assets €1,500,000.00 €1,480,000.00
Customers €0.00 €500,000.00
Cash €0.00 €385,000.00
Current Assets €0.00 €885,000.00
TOTAL €1,500,000.00 €2,365,000.00

PASSIVE + NET EQUITY 01/01/20XX 12/31/20XX

Share capital €1,000,000.00 €1,000,000.00
Year profit €273,750.00
Net worth €1,000,000.00 €1,273,750.00
Long-term loan €500,000.00 €500,000.00
Non-Current Liabilities €500,000.00 €500,000.00
Short-term bank debts €0.00
Taxes payable €91,250.00
Suppliers €500,000.00
Current Liabilities €0.00 €591,250.00
TOTAL €1,500,000.00 €2,365,000.00

Income Statement 12/31/20XX

Sales €5,000,000
Cost of sales €-4,000,000
Gross Margin €1,000,000
Salaries €-500.000.
General expenses €-100.000.
Provision for depreciation €-20.000.
Result of the operation €380.000.
Financial costs €-15.000.
Profit before taxes €365.000.
Taxes (25%) €-91.250.
Net result €273.750.

3. No, it cannot be paid. The debt amount is €500,000 and there is only €385,000
available in cash.
4. Requesting a credit facility or short-term loan either for the total amount owed to
suppliers or for the difference. It is also possible to renegotiate with the clients to
reduce the collection period.

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Unit 1. Key ideas
Solution case 3

1. Collect money from clients earlier. To achieve this, it offers a 2% discount on advance
payments. This discount will be accounted for as a smaller sales volume.

ASSETS 01/01/20XX 12/31/20XX

Fixed assets €1,500,000.00 €1,500,000.00
Accumulated depreciation €0.00 €-20,000.00
Non-current Assets €1,500,000.00 €1,480,000.00
Customers €0.00 €500,000.00
Cash €0.00 €0.00
Current Assets €0.00 €500,000.00
TOTAL €1,500,000.00 €1,980,000.00

PASSIVE + NET EQUITY 01/01/20XX 12/31/20XX

Share capital €1,000,000.00 €1,000,000.00
Year profit €273,175.00
Net worth €1,000,000.00 €1,273,175.00
Long-term loan €500,000.00 €500,000.00
Non-Current Liabilities €500,000.00 €500,000.00
Short-term bank debts €115,766.67
Taxes payable €91,058.33
Suppliers €0.00
Current Liabilities €0.00 €206,825.00
TOTAL €1,500,000.00 €1,980,000.00

Income Statement 12/31/20XX

Sales €5,000,000.00
Cost of sales €-4,000,000
Gross Margin €1,000.000
Salaries €-500.000
General expenses €-100.000
Provision for depreciation €-20.000
Result of the operation €380.000
Financial costs €-15.767
Profit before taxes €364.233
Taxes (25%) €-91.058
Net result €273.175

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Unit 1. Key ideas
2. Request a credit facility from the banks to alleviate this transitory situation. The cost
would be 4% per annum. For calculation purposes, we will suppose that the credit
facility will be used for two months.

ASSETS 01/01/20XX 12/31/20XX

Fixed assets €1,500,000.00 €1,500,000.00
Accumulated depreciation €0.00 €-20,000.00
Non-current Assets €1,500,000.00 €1,480,000.00
Customers €0.00 €500,000.00
Cash €0.00
Current Assets €0.00 €500,000.00
TOTAL €1,500,000.00 €1,980,000.00

PASSIVE + NET EQUITY 01/01/20XX 12/31/20XX

Share capital €1,000,000.00 €1,000,000.00
Year profit €270,156.25
Net worth €1,000,000.00 €1,270,156.25
Long-term loan €500,000.00 €500,000.00
Non-Current Liabilities €500,000.00 €500,000.00
Short-term bank debts €119,791.67
Taxes payable €90,052.08
Suppliers €0.00
Current Liabilities €0.00 €209,843.75
TOTAL €1,500,000.00 €1,980,000.00

Income Statement 12/31/20XX

Sales €5,000,000
Cost of sales €-4,000,000
Gross Margin €1,000,000
Salaries €-500.000
General expenses €-100.000
Provision for depreciation €-20.000
Result of the operation €380.000
Financial costs €-19.792
Profit before taxes €360.208
Taxes (25%) €-90.052
Net result €270.156

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Unit 1. Key ideas
 In deep

The company’s accounting obligations

The rules applicable to financial accounting

The rules applicable to financial accounting are published and updated by the ICAC.
They are also available on the website of the Spanish State.

Access the document from the virtual classroom or through the following web page:
http://www.icac.meh.es/Documentos/CONTABILIDAD/PGC%20ingles%20intro.pdf

BOE-A-2007-19966

In the case of small and medium-sized enterprises (SMES), the content of the General
Accounting Plan is reduced.

In both cases it is important that you become familiar with the sections of the plan in
order to be able to quickly locate the response to questions arising in day-to-day
accounting.

Access the document from the virtual classroom or through the following web page:
https://www.boe.es/buscar/act.php?id=BOE-A-2007-19966

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Unit 1. In deep
 Test
1. If a company purchases a desk for the office in 100 euros in cash, the entry would
be:
A. 100 desk to 100 Capital.
B. 100 desk to 100 Debts.
C. 100 desk to 100 Cash.
D. 100 Cash to 100 desk.

2. The company returns 100 euros of capital to partners

A. 100 Cash in banks to 100 Capital.
B. 100 Public Relations Spending to 100 Capital.
C. 100 Capital to 100 Expenses.
D. 100 Capital to 100 Cash in banks.

3. The balance sheet reflects

A. The list of a company’s rights to receive payment and obligations to pay on
a specific date.
B. The income and expenditure for a period.
C. The cash flow statements.
D. The assets of the company exclusively.

4. Unlike expenditure, assets

A. Never go through the income statement.
B. Are not really necessary for the activity.
C. Represent the long-term revenue of the company.
D. Pass through the income statement using accounting depreciation.

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Unit 1. Test
5. Highlight the correct statement.
A. Expenses are posted as assets: they increase the credit and diminish the
debit.
B. Expenses are posted as assets: they increase the debit and decrease the
credit.
C. Expenses are posted as liabilities with the shareholders.
D. Assets are posted as income because both are favorable for the company.

6. Fast closing consists of

A. Fast calculation of profit.
B. Provisioning entries yet to be documented in order to have a result as soon
as possible.
C. Closing the company quickly every year.
D. None of the above.

7. Indicate what forms part of the Annual Accounts

A. Balance Sheet and Profit and Loss Account.
B. The documents in A plus the Cash Flow Statement.
C. The documents in B plus changes in net equity.
D. All of the above.

8. Accounting adjustment consists of

A. Calculating profit/loss.
B. Paying tax arrears.
C. Paying debts.
D. Distributing profits.

9. The balance of the account for office desks at the end of the year
A. Is a magnitude flow if desks are purchased during the year.
B. It is a magnitude fund if it is at zero.
C. Is a magnitude fund in any case.
D. Is a magnitude flow in any case.

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Unit 1. Test
10. The Statement of Changes in Equity brings together
A. The profit from the point of view of the shareholders.
B. The movements of accounts that relate to the company and its owners.
C. The movement of short-term liabilities accounts.
D. Only the payment of dividends.

Managerial Accounting
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Unit 1. Test