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Accounting Technicians Ireland

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Financial Accounting 1

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Financial Accounting
Course Manual

1
Academic Year 2011/2012

Course Manual

0000 0222

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Financial Accounting
     

Course Manual

 

 

 

   

Financial Accounting 

 

Table of Contents 
Foreword ........................................................................................................................................................ v  Copyright  ..................................................................................................................................................... vii  . Glossary ...................................................................................................................................................... viii  Syllabus ......................................................................................................................................................... ix  1  CHAPTER 1: INTRODUCTION TO ACCOUNTING  ............................................................................................. 1  . 1.1  1.2  1.3  1.4  1.5  1.6  1.7  1.8  2  INTRODUCTION .......................................................................................................................................... 3  ACCOUNTING ............................................................................................................................................ 3  ACCOUNTABILITY ....................................................................................................................................... 4  THE MAIN FINANCIAL ACCOUNTING STATEMENTS .............................................................................................. 7  TYPES OF BUSINESS ENTITY ........................................................................................................................... 8  USERS OF FINANCIAL STATEMENTS ............................................................................................................... 15  FINANCIAL ACCOUNTING AND MANAGEMENT ACCOUNTING ............................................................................. 18  ACCOUNTING TERMINOLOGY ...................................................................................................................... 21 

CHAPTER 2: ACCOUNTING CONCEPTS & CONVENTIONS .............................................................................. 25  2.1  2.2  2.3  2.4  2.5  2.6  2.7  2.8  2.9  2.10  2.11  2.12  2.13  2.14  2.15  2.16  2.17  2.18  2.19  2.20  2.21  2.22  2.23  2.24  2.25  2.26  2.27  2.28  THE BASIC PRINCIPLES OF ACCOUNTING  ........................................................................................................ 26  . ACCOUNTING CONCEPTS ............................................................................................................................ 26  THE CONFLICT BETWEEN ACCRUALS AND PRUDENCE CONCEPTS .......................................................................... 29  ACCOUNTING CONVENTIONS ...................................................................................................................... 29  A TRUE AND FAIR VIEW .............................................................................................................................. 31  ACCOUNTING POLICIES .............................................................................................................................. 32  ESTIMATION TECHNIQUES .......................................................................................................................... 32  MEASUREMENT BASES .............................................................................................................................. 33  SELECTING ACCOUNTING POLICIES  ............................................................................................................... 33  . REVIEWING AND CHANGING ACCOUNTING POLICIES ......................................................................................... 34  IAS 8 DISCLOSURE OF ACCOUNTING POLICIES ................................................................................................ 34  WHAT MAKES FINANCIAL INFORMATION USEFUL? ........................................................................................... 35  REGULATION AND STANDARDS .................................................................................................................... 35  PROFESSIONAL REGULATION ...................................................................................................................... 35  COMPANIES ACTS..................................................................................................................................... 36  WHAT IS A CONCEPTUAL FRAMEWORK? ........................................................................................................ 37  THE FRAMEWORK FOR FINANCIAL ACCOUNTING ............................................................................................. 37  RELEVANCE ............................................................................................................................................. 39  RELIABILITY ............................................................................................................................................. 39  COMPARABILITY ....................................................................................................................................... 39  UNDERSTANDABILITY ................................................................................................................................ 40  CONFLICTS IN THE QUALITATIVE CHARACTERISTICS OF ACCOUNTING INFORMATION ................................................ 40  THE ACCOUNTANT’S ROLE AND FUNCTION IN AN ORGANISATION ........................................................................ 41  AUDITING ............................................................................................................................................... 42  ACCOUNTING ETHICS ................................................................................................................................ 45  ACCOUNTING SCANDALS ............................................................................................................................ 45  CODES OF ETHICS ..................................................................................................................................... 47  WHISTLE BLOWING ................................................................................................................................... 48 

CHAPTER 3: DOUBLE ENTRY BOOK‐KEEPING ............................................................................................... 50  3.1  3.2  DOUBLE ENTRY BOOK‐KEEPING AND THE DUALITY CONCEPT .............................................................................. 51  THE ACCOUNTING EQUATION ...................................................................................................................... 52 

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..........................................................................................................................................5  3........... 179  ACCRUALS AND PREPAYMENTS – FINANCIAL STATEMENTS EFFECT  .............................. 202  8  CHAPTER 8: NON CURRENT ASSETS AND DEPRECIATION  ...............................................7  6..........................................................................................3  9............2  9...................................................................... 225  DEPRECIATION ............................................ 103  CHAPTER 4: INTRODUCTION TO FINANCIAL STATEMENTS ................................................................................................................................................................................................................................................................................12  3.......................................................3  6..................... 172  YEAR‐END ADJUSTMENTS .............................................................3  8....................... 2 8...............5  6............... 276  ii    ............................................................  59  2 9...................................................  14  1 4........................................................... 170  ACCRUED INCOME ........2  4................................................................................................ 239  DISPOSAL OF NON CURRENT ASSETS .......................................... 58  RECORDING CREDIT SALES AND PURCHASES TRANSACTIONS INCLUDING VALUE ADDED TAX (VAT) USING DAY BOOKS ........ 54  RECORDING CASH TRANSACTIONS ...................................................................................8  3............................................................................................................................................................7  NON CURRENT ASSETS ..................6  3......................4  6......3  INTRODUCTION TO FINANCIAL STATEMENTS .................................... 82  PREPARATION OF FINANCIAL STATEMENTS ..................................................................................................................................................................................................................... 265  PAYABLES/PURCHASES LEDGER CONTROL ACCOUNTS  ....2  8...................................................................2  ACCOUNTING CONCEPTS ........................................................................................................................................................1  6....... DEBITS AND CREDITS ................................................. 7  CHAPTER 7: IRRECOVERABLE DEBTS & ALLOWANCE FOR RECEIVABLES .................................................................................................................................................3  3................................... 180  .7  3........................................ 70  BALANCING OFF LEDGER ACCOUNTS ....................................................6  8................................ 123  5  CHAPTER 5: INVENTORY ..4  8............................................................9  3................................................................................................................................... 164  OPENING ACCRUAL ADJUSTMENTS .......... 194  TYPES OF ALLOWANCE ON THE STATEMENT OF FINANCIAL POSITION ........................4  3................ 173  PREPAID INCOME ........................................................................................................................................8  THE ACCRUALS CONCEPT ........................................... 63  BOOKS OF PRIME ENTRY .......1  8............................. 61  DOUBLE ENTRY CHECKLIST ............................1  7........................10  3..............................1  4.........................................................................................................13  3....................................................................5  NATURE AND PURPOSE OF CONTROL ACCOUNTS ......................................................... 248  9  CHAPTER 9:  CONTROL ACCOUNTS & CONTROL ACCOUNT RECONCILIATIONS ..................................................................................2  6.11  3..................  62  1 6............. SUPPLIER STATEMENTS ..... 91  PAYROLL  ....................Financial Accounting  3...................................4  9...........  93  1 7..  32  1 5.............................................................. SELF TEST QUESTIONS ........................................ 59  RECORDING SALES AND PURCHASES RETURNS ........................................................................................................................................................................................ 224  CAPITAL AND REVENUE EXPENDITURE .. 245  NON CURRENT ASSETS AND THE FINANCIAL STATEMENTS ............... 240  DISPOSALS AND THE INCOME STATEMENT ......... 260  CONTROL ACCOUNTS AND DOUBLE ENTRY ..........6  6................. 262  RECEIVABLES/SALES LEDGER CONTROL ACCOUNTS ............ 96  ............................... 99  SOLUTIONS TO SELF TEST QUESTIONS .................................................................................................................................................................................................... 133  6  CHAPTER 6: ACCRUALS AND PREPAYMENTS ..........................................................................................................14  4  LEDGER ACCOUNTS............................................... 229  IAS 16 REQUIREMENTS ........... 116  THE STATEMENT OF FINANCIAL POSITION ........ 163  ACCRUED EXPENDITURE ............................... 62  ELEMENTS OF VALUE ADDED TAX (VAT) ... 115  THE INCOME STATEMENT ................................1  9.................................................................................................................... 171  PREPAID EXPENDITURE ..................................................................................................................................................1  ACCOUNTING FOR INVENTORY ....5  8.  23  ........................................................................................................................................... 272  .................................

... 296  .... 283  10  CHAPTER 10: BANK RECONCILIATION STATEMENTS ..........................................................................................................................2  13.............................. 355  THE STATEMENT OF FINANCIAL POSITION ........4  INCOMPLETE RECORDS .............Financial Accounting 9............7  CONTROL ACCOUNT RECONCILIATIONS  ..................................................................................................................................................1  13......................................................................................... 330  ERRORS WHICH DO AFFECT THE BALANCING OF THE TRIAL BALANCE .........................................................................................3  12............................1  12......................................................................................................... 334  SUSPENSE ACCOUNT ......  95  2 10......................................................  25  4 14............................................................................................................................... 428  iii  ........................................................................1  14......................................................3  11....... 329  ERRORS WHICH DO NOT AFFECT THE BALANCING OF THE TRIAL BALANCE .................................... 277  ...................... 408  . 393  STEPS TO FOLLOW TO PREPARE FINANCIAL STATEMENTS FROM INCOMPLETE RECORDS  .......................................................................................2  11..................... 303  11  CHAPTER 11: CORRECTION OF ERRORS . 427  THE INCOME AND EXPENDITURE ACCOUNT ........................................ 336  12  CHAPTER 12: PREPARATION OF FINANCIAL STATEMENTS ......................  87  3 13..........................3  13.......................................4  IDENTIFICATION OF ERRORS ......................... 357  SOLE TRADER ACCOUNTS ............................................................................................  52  3 12.................2  NATURE AND PURPOSE OF BANK RECONCILIATION STATEMENTS  ....... 353  THE INCOME STATEMENT ............................................................................................................ 389  THE BALANCING FIGURE APPROACH.........1  10..............4  FROM TRIAL BALANCE TO FINANCIAL STATEMENTS .  28  3 11...............................................................2  14..........2  12......................................................................................................... 14  CHAPTER 14: ACCOUNTING FOR “NOT ‐FOR‐ PROFIT ORGANISATIONS” .............................6  9......... 388  NET ASSETS APPROACH ........................................................................................................................1  11.............................................................................................3  “NOT‐FOR‐PROFIT” ORGANISATIONS ............................................................. 358  13  CHAPTER 13: INCOMPLETE RECORDS ................................................................................................................................................................................. CONTROL ACCOUNTS – FINANCIAL STATEMENTS ................................................... PREPARATION OF A BANK RECONCILIATION STATEMENT ..... 426  THE RECEIPTS AND PAYMENTS ACCOUNT .....................

Financial Accounting    iv    .

the major two of which are: 1. Accounting Technicians Ireland and the Author cannot accept the responsibility for lack. The solutions to the questions are provided under separate cover and although they are the suggested solutions. students should not continue with subsequent chapters until they have completed the questions attaching to the chapter currently under review. but to provide a sufficiently detailed synopsis of the material and knowledge level required to meet the needs the current syllabus. Students should take particular note of the weighting attaching to this mandatory module that is clearly outlined in the syllabus. of information contained therein. Invariably. To gain the full benefit of the question-and-answer concept. it is not lack of knowledge which is the problem when it comes to examinations. students should refer to the relevant questions dealing with that chapter. to the rear of each chapter). when used in conjunction with the questions. Ideally. tutors and students both should recognise and appreciate that there might very well be different approaches which would. Method/Approach. On the completion of each chapter. The manual is not. under examination conditions. will be enough to attain a pass mark in the examination. Although no guarantees can be given. It is on the basis of this weighting that students should prepare their own timetable for study. (an integral part of the study material. be perfectly acceptable. Time Management and 2. or perceived lack. it is recommended that students should not refer to the solution until they have made a full and genuine attempt at each question. a comprehensive assimilation of Financial Accounting material. v  . it is believed that a comprehensive knowledge of the material contained in the manual.Financial Accounting Foreword While every effort is made to ensure that the information outlined in these notes is accurate. nor does it set out to be. rather it is a combination of other factors.

students should access the Accounting Technicians Ireland website for past papers.accountingtechniciansireland. if not eliminate. will certainly minimise. Good Luck.Financial Accounting  It is because of this that we recommend that when they have attained a knowledge of each chapter studied. these two major inhibiting factors. www. This advice holds good for all other subjects.   vi    .ie. Students who are prepared to utilise these past papers and “sit them under exam conditions”. in addition to the questions provided.

all references to “he” or “she” will be referred to as “he” in this manual. 47-49 Pearse Street. electrostatic. pdf. vii  . for any course of study and/or examination of any other body whatsoever without prior permission in writing from Accounting Technicians Ireland. No other implication whatsoever is implied from this policy. Referencing For the purposes of consistency. and it may not be reproduced. electronic. all references to “euro” or “sterling” will be referred to as “euro” in this manual.Financial Accounting Copyright This manual/workbook is issued by Accounting Technicians Ireland to students taking its examinations. or in part. No other implication whatsoever is implied from this policy. magnetic. recording or otherwise. may not be made available in any library. Dublin 2. For the purposes of presentation. mechanical. stored in a retrieval system or transmitted in any form or by any means – photocopying. This manual. or any part thereof. It may not be used in whole. without prior permission in writing from Accounting Technicians Ireland. in whole or in part.

as follows: A/C Bal b/f Bal c/f I/S SFP CB CRB CPB PAYE PRSI SDB SRDB PDB PRDB SLC PLC SO DD Account Balance brought forward Balance carried forward Income Statement Statement of Financial Position Cash Book Cash Receipts Book Cash Payments Book Pay As You Earn Pay Related Social Insurance Sales Day Books Sales Returns Day Book Purchases Day Book Purchases Returns Day Book Sales Ledger Control Purchases Ledger Control Standing Order Direct Debit     viii    .Financial Accounting  Glossary This manual contains a number of standard abbreviations.

Financial Accounting Syllabus Module 1: Financial Accounting Mandatory Module ix  .

Self Directed Learning Programme Entry requirements       Key Learning Outcome The key objective of this module is to provide learners with knowledge of accounting concepts and principles of accounting and the technical competency in the area of double entry accounting and accounts preparation for various types of business.Financial Accounting    Financial Accounting Subject Status Terminal Exam Module Pass Mark Learning Modes Pre-requisite: Mandatory 100% 50% Direct Lectures. Tutorials. Seminars.         Key Syllabus Elements and Weightings Accounting Fundamentals 15% Double-Entry Bookkeeping and Accounting Systems 50% Accounts Preparation 35%   x    .

competencies and know-how:- (a) A knowledge of the form and content of accounting records and the ability to record financial transactions in the books of original entry (b) The ability to demonstrate an understanding of and use the double entry system of bookkeeping to prepare a trial balance (c) An understanding of the distinction between capital and revenue expenditure (d) An ability to understand. explain and use control accounts. basic accounting concepts and principles     Double-Entry Bookkeeping and Accounting Systems On completion of this aspect of the module. learners will have acquired the following knowledge. bank reconciliation statements and suspense accounts as part of the internal control of an organisation  xi  .Financial Accounting Learning Outcomes linked to Syllabus Elements   Accounting Fundamentals On completion of this aspect of the module. competencies and know-how: - (a) (b) (c) An appreciation of and an ability to describe the function of and differences between financial accounting and management accounting An understanding of the different types of business entity and the accountant’s role in an organisation An ability to identify the various user groups which need accounting information and an appreciation of the characteristics of such information required to meet the objectives of each user group (d) An understanding of accounting terminology. participants will have acquired the following knowledge.

participants will have acquired the following knowledge. competencies and know-how:- (a) (b) An appreciation and understanding of the key features of financial statements An ability to prepare financial statements for sole traders and ‘not for profit’ organisations xii    .Financial Accounting      Accounts Preparation   On completion of this aspect of the module.

expenses Drawings Trade Receivables (debtors) and Trade payables (creditors) Introduction to financial statements                                                               xiii  . principles and scope of accounting Accountant’s role in an organisation Accountant’s role and function in an organisation Auditing Accounting terminology  Assets. income.Financial Accounting MODULE 1: FINANCIAL ACCOUNTING Specific Functional Knowledge and Competencies Understanding Application Analysis   Accounting Fundamentals Types of business entity:    Sole traders Partnerships Limited companies (15%)                                        Function of financial accounting and management accounting  Financial Accounting Management Accounting Purpose of accounting information Nature. liabilities.

accountants and historical experience Understanding Application Analysis                                                                       xiv    . accruals basis.Financial Accounting    Specific Functional Knowledge and Competencies   Basic accounting concepts and principles:   The business entity The accounting equation Underlying assumptions. going concern Users of accounting information and their information needs  The objectives of financial statements Users of accounting information and their information needs The qualitative characteristics of accounting information Ethical issues and responsibilities accruing  Ethical issues for the Accounting Technician Ethical issues for managers.

PAYE and PRSI Salaries/wages control accounts                       xv  .Financial Accounting Specific Functional Knowledge and Competencies   Understanding Application Analysis Double-entry Bookkeeping & Accounting Systems Form and content of accounting records   Business transactions and the purpose of accounting records Source documentation Books of original entry   Books of original (prime) entry Sales day book Purchases day book Sales returns day book Purchases returns day book Ledger accounting and double entry (50%)                                                                                Nominal ledger  Double entry bookkeeping The journal Posting from day books to nominal ledger Sales and purchases ledgers Accounting for VAT Irrecoverable VAT Accounting for wages.

Financial Accounting    Specific Functional Knowledge and Competencies   Extraction of the trial balance Distinction between capital and revenue expenditure  Explanation of capital and revenue expenditure Impact of incorrect treatment Control accounts  Understanding the purpose of control accounts Receivables control accounts Payables control accounts Contra entries Debit and credit balances at the beginning and end of an accounting period Incomplete records Bank reconciliation statements Bank statements and the banking system Identification of errors and omissions Updating the bank account in the ledger Preparation of bank reconciliation statements Understanding Application Analysis                                                                                 xvi    .

Financial Accounting Specific Functional Knowledge and Competencies   Accounting for errors and suspense accounts  Correction of errors Types of errors and their impact on the trial balance Correction of errors and journal entries Use of suspense accounts Accounting for depreciation and disposal of assets  Non current assets register Definition of depreciation Calculation of depreciation using the straight line and reducing balance methods Ledger accounting entries for depreciation Accounting for the disposal of non-current assets Understanding Application Analysis                                                         Accounts Preparation (35%)   Key features of financial statements Cost of goods sold Accruals Prepayments Discounts Irrecoverable debts and allowances for receivables                           xvii  .

Financial Accounting    Specific Functional Knowledge and Competencies   Non Current Assets Depreciation using straight line method and reducing balance method Disposal of non current assets Accounting for inventory Different valuation methods and their impact on reported profits Preparation of financial statements for sole traders   From the trial balance to financial statements The income statement as part of the double entry system Layout of financial statements Preparation of accounts for ‘not for profit’ organisations  Financial statements for clubs and societies Receipts and payments accounts Income and expenditure accounts Understanding Application Analysis                                                                       xviii    .

Answer TWO All Questions carry equal marks Pilot Paper Each of the 3 pilot papers will examine appropriate parts of this syllabus. Format of Examination Paper The Paper Consists of SIX Questions which will examine all key syllabus elements to ensure that learning outcomes are achieved SECTION A THREE Compulsory Questions SECTION B THREE Questions .Financial Accounting   Assessment Criteria   Assessment Techniques 100% Assessment based on the final exam.           xix  .

icai.AccountingTechniciansIreland. ACCA Irish Times Business Section (Fridays) Sunday Business Post Sunday Times (Business Section)   xx    .ie   Other Resources Business and Finance Accountancy Ireland.ie www. ACCA Student Newsletter.cimaglobal.com www.thepost.ie www.Financial Accounting      Essential Reading Financial Accounting Author: Accounting Technicians Ireland   Supplementary Reading   Web Resources www.accaglobal.ie www.com www. ICA Ireland Accountancy and Business.cpaireland.ireland.com www.

Explain the different types of business entity 3. 1  . Differentiate between Financial and Management accounting 5.Financial Accounting Introduction to Accounting 1 CHAPTER 1: INTRODUCTION TO ACCOUNTING LEARNING OUTCOMES Upon completion of this chapter you should be able to: 1. Understand and define accounting 2. Understand Accounting terminology REVISION RESOURCES EXAM QUESTIONS: Pilot and Past papers are available from the website of Accounting Technicians Ireland and are essential aides when studying Financial Accounting topics. List the users of the financial statements and their information needs 4.

is expected by your examiner. in this case International Accounting Standards and terminology. The objective of Financial Accountings to provide students with the knowledge to enable them to prepare a set of financial statements for a sole trader.Introduction to Accounting Financial Accounting   Welcome to Financial Accounting. The Financial Accounting syllabus (and this manual) by the Accounting Technicians Ireland has been written and will be examined under International Accounting Standards professional regulations. Please see below terminology changes from UK/Irish GAAP to International Accounting Standards. Profit and Loss A/C Balance Sheet Fixed Assets Stock Debtors Provision for bad debts Creditors International Accounting Standards Income Statement Statement of Financial Position Non Current Assets Inventory Receivables Allowance for Receivables Payables   2    . This is an important point to note as you prepare to commence your studies. It is important to note that for Financial Accounting that we follow the international professional regulations. UK/Irish GAAP Trading. The objective of financial statements as we will see throughout this manual is to provide information about the reporting entity’s performance and financial position that is useful to a wide range of users. As a student of the Accounting Technicians Ireland you are training for a professional qualification and therefore using the appropriate terminology and format.

We will also define the key accounting concepts and their importance in preparing financial statements. measuring and communicating economic information to permit informed judgments and decisions by users of the information”. in addition to their information needs. This definition is a good place to start.Financial Accounting Introduction to Accounting 1. This is done by way of a “set of accounts”. let’s look at the key words in the definition. It suggests that accounting is about providing information to others. As we will see. Accountancy or accounting is the art of communicating financial information about a business entity to users such as the owners of the business and the government.2 Accounting Accounting can be defined as “the process of identifying. The accounting system identifies and records “accounting transactions”.1 Introduction It is not easy to provide a concise definition of accounting since the word has a broad application within business. 1. Accounting information is economic information – it relates to the financial or economic activities of the business or organisation. The information is generally in the form of financial statements that show in money terms the economic resources under the control of management. - The “measurement” of accounting information is not a straight forward process. - Accounting information needs to be identified and measured. It involves making judgments about the value of assets owned by a business or liabilities owed by a business. In this chapter we will explore the concept of accounting. based on a system of accounting known as double-entry bookkeeping. the different types of business entities and the users of these financial statements. 3  . It is also about accurately measuring how much profit or loss has been made by a business in a particular period. the measurement of accounting information often requires subjective judgment to come to a conclusion.

a business. There are several forms of accounting communication (e. What is the purpose of financial statements? 1. annual reports and accounts. an organisation). The most common measurement of “performance” is profit. The following table provides examples of different types of organisations and how accountability is linked to their differing organisational objectives: 4    .Introduction to Accounting Financial Accounting   - The definition identifies the need for accounting information to be communicated. and what they need to know. The way in which this communication is achieved may vary.g. management accounting reports) each of which serve a slightly different purpose. The communication need is about understanding who needs the accounting information. To report on the financial position of an entity (e. To show how the entity has performed (financially) over a particular period of time (an “accounting period”).3 Accountability Accounting is about accountability. 2.g. 1. Most organisations are externally accountable in some way for their actions and activities. Accounting information is communicated using “financial statements”. They will produce reports on their activities that will reflect their objectives and the people to whom they are accountable.

Local county council) .Achievement of charitable aims . Tesco) .Other stakeholders (e. Concern) .g.Making a profit .Government departments All of the above organisations have a significant role to play in society and have multiple stakeholders to whom they are accountable. Helps management actually manage the organisation. 5  .Maximise spending on activities .Donors Local authorities (e.Creation of wealth . accounting is essentially an “information process” that serves several purposes: Providing a record of assets owned. How accounting information helps businesses be accountable: As we have said in our introductory definition. Providing reports showing the financial position of an organisation and the profitability of its operations.g.g. amounts owed to others and monies invested.Provision of local services . suppliers) Charities (e.g.Shareholders .Financial Accounting Introduction to Accounting Organisation Objectives Accountable to – examples Private/Public company (e.Charity commissioners . All require systems of financial management to enable them to produce accounting information. employees.

These needs can be described in terms of the following overall information objectives: Collection: Collection in money terms of information relating to transactions that have resulted from business operations. customers. 6    . accounting has come to be known as the “language of business”. There are two broad types of accounting information: 1. There are many potential users of accounting information. it needs a language that is understood by all in common. Financial Accounting: geared towards external users of accounting information. employees and their organisations. Summarising: Summarising data to produce statements and reports that will be useful to the various users of accounting information – both external and internal. This is usually referred to as “Book-Keeping”. Management accounting: geared more at internal users of accounting information. Hence. including shareholders.Introduction to Accounting Financial Accounting   - Enables potential investors to evaluate an organisation and make decisions. the underlying objective is the same – to satisfy the information needs of the user. Revenue). Anyone with an interest in the performance and activities of an organisation is traditionally called a stakeholder. 2. Although there is a difference in the type of information presented in financial and management accounts. suppliers. Interpreting and Communicating: Interpreting and communicating the performance of the business to the management and its owners. lenders. For a business or organisation to communicate its results and position to stakeholders.g. government departments (e. Recording and classifying: Recording and classifying data into a permanent and logical form. and society at large.

interpreted and actioned is called “Financial Management”. the regulation or control of what kind of information is prepared and presented goes much further. Generate cash.4 The main financial accounting statements The purpose of financial accounting statements is mainly to show the financial position of a business at a particular point in time and to show how that business has performed over a specific period. reported. The process by which accounting information is collected. the UK and international companies are required to comply with a wide range of Accounting Standards which define the way in which business transactions are disclosed and reported. Create wealth for the business. The key forecasting and planning tool is the “Budget”. 2. 3. which will be addressed in chapter 2. For financial accounting. care should be taken to ensure that the information presents an accurate and true reflection of the business performance and position.Financial Accounting Introduction to Accounting Forecasting and Planning: Forecasting and planning for the future operation of the business by providing management with evaluations of the viability of proposed operations. Provide an adequate return on investment bearing in mind the risks that the business is taking and the resources invested. the key objectives of financial management would be to: 1. which we explore in greater detail in Chapter 4. Accounting standards also address the calculations around transactions. accounting has adopted certain conventions which should be applied in preparing accounts (all of which we will explore later). Taking a commercial business as the most common organisational structure. To impose some order on what is a subjective task. Ireland.These are applied by businesses through their Accounting Policies. In preparing accounting information. 7  . 1.

A Statement of Financial Position for the business at the end of the reporting period. 2. What is profit? Profit is the amount by which sales revenue (also known as “turnover” or “income”) exceeds expenses (“or costs”) for the period being measured. It also shows how much has been invested in the business and what the sources of that investment finance were. the income statement measures “profit”. Income Statement for the reporting period. By contrast. the Income Statement provides a perspective on a longer time-period. Not surprisingly. the “snap-shot” picture will have changed.Introduction to Accounting Financial Accounting   For Financial Accounting purposes the two main financial accounting statements that help to achieve this aim are: 1. 8    . It is often helpful to think of a Statement of Financial Position as a “snap-shot” of the business – a picture of the financial position of the business at a specific point. It provides details of the financial performance of the business within a specific accounting period. A Statement of Financial Position shows at a particular point in time what resources are owned by the business (“assets”) and what it owes to other parties (“liabilities”). Whilst this is a useful picture to have. 1. Let’s now look at the different types of business entity. Partnership – a business owned and operated by two or more people.5 Types of business entity A business can be organised in one of several ways: Sole Trader – a business owned and operated by one person. The detail of what financial transactions took place in a particular period – and (most importantly) what the overall result of those transactions was. every time an accounting transaction takes place.

other than setting up a bank account and informing the tax authorities.there are few forms to fill in and to start trading. Becoming a sole trader can be risky as you will be liable to repay it from your personal wealth if necessary. Under law. i. Cheap and easy to start-up . 1. Keep all the profit – as the owner. The legal requirements of a sole trader are to: Keep proper business accounts and records for the Revenue Commissioners (who will collect the tax on profits) and if necessary VAT accounts. No obligation to produce a set of published financial statements. The main advantages of setting up as a sole trader are: Total control of the business by the owner. you and your business are one and the same thing – you are personally liable if your business is sued or owes any money. a sole trader and the business are the same legal entity. Business affairs are private – competitors cannot see what you are earning.e. all the profit belongs to the sole trader. Essentially.Financial Accounting Introduction to Accounting - Company – a business owned by its shareholders and operated by its directors. a sole trader is a business that is owned by one person. who are not necessarily the same people. the sole trader does not need to employ any specialist services. Comply with legal requirements that concern the protection of the customer 9  .1 Sole trader The simplest form of business is the sole trader.5. your liability is unlimited. It may have one or more employees. Your profits will be considered income and taxed accordingly as you are self employed as a sole trader. It offers the least personal protection. so will know less about how the business works and how it succeeds.

but most importantly. for instance.e. Such a risk often puts potential sole traders off setting up businesses.Introduction to Accounting Financial Accounting   (e. Sale of Goods Act). Can be difficult to raise finance. etc. As a result of the sole trader and the business being the same legal form. the sole trader is taxed based on income tax not corporation tax. This means that any money that the owner has put into the business could be lost. . i.2 Partnership A partnership is a business where there are two or more owners of the enterprise.e. How profits and losses should be divided. Can be difficult to enjoy economies of scale.5. A partnership is normally set up using a Deed of Partnership. Corporation tax rates are more favourable than income tax rates. starting capital). if the business continues to incur further costs then the owner has to pay these as well. Because they are small. and also makes them consider the other forms of business structure. bank may not lend large sums of money to sole traders who may be unable to avail of other forms of long-term finance unless they change their ownership status. There is a problem of continuity if the sole trader retires or dies – what happens to the business? The reasons for being a sole trader are often a balance between business and personal costs and benefits. lower cost per unit due to higher levels of production. A sole trader. This contains: 10    Amount of capital each partner should provide (i. Most partnerships are between two and twenty members though there are examples like accountancy firms and solicitors firms where there are more partners. 1. The main disadvantages of being a sole trader are: Unlimited Liability – A sole trader is liable for any debts that the business incurs. In some cases they may have to sell some of their own possessions to pay suppliers.g. may not be able to buy in bulk and enjoy the same discounts as larger businesses.

The Partnership Act of 1907 encompasses the UK. Of course the builder could team up with another builder as well – sharing the risk.Financial Accounting Introduction to Accounting - How many votes each partner has (usually based on the proportion of capital invested). A new partner may bring other skills and ideas to the business. For example. better premises to work from). Profits and losses are to be shared equally between partners. - Rules on how to take on new partners. Either would bring added expertise. and potentially the workload. complementing the work already done by the original partner. It provides a legal framework for Republic of Ireland partnerships. the Partnership Act of 1890 (amended in 1907) will apply to avoid any disputes in the future. The main disadvantages of becoming a partnership are: Have to share the profits. In the absence of this deed of partnership. working originally as a sole trader. The main advantages of a sole trader becoming a partnership are: Spreads the risk across more people. a builder. or how a partner leaves. No remuneration is paid to partners for acting in the business. Partner may bring money and resources to the business (e. Increased credibility with potential customers and suppliers – who may see dealing with the business as less risky than trading with just a sole trader. but also might bring added capital and/or contacts. Scotland and Northern Ireland. The act states that: No interest is paid on capital of the partners. 11  . Interest at the rate of 5% per annum is paid on loans made by the partners to the partnership in excess of their agreed capitals. How the partnership is brought to an end. so if the business gets into difficulty then there are more people to share the burden of debt. may team up with an architect or carpenter to form a partnership.g.

The next step for a partnership is to move towards becoming a private limited company. For people or businesses who have a claim against the company.Introduction to Accounting Financial Accounting   - Less control of the business for the individual. The advantages of remaining a partnership rather than becoming a private limited company are: Costs money to set-up a limited company (may need to employ a solicitor/accountant to set up the paper work). 1. and/or set up such a business. if the company fails. There can be one shareholder or many thousands of shareholders. but not all shareholders have to be directors. Partnership accounts are not examinable in the Financial Accounting examination. Disputes over workload. “limited liability” means that they can only recover money from the existing assets of the business. 12    . This encourages people to finance the company. knowing they can only lose what they have put in. Problems if partners disagree over the direction of the business. May need to spend money on an auditor to check the accounts before they are filed. Each shareholder owns part of the company.3 Limited company A Limited company is a business that is owned by its shareholders. run by directors and most importantly its liability is limited. each partner has an agreed portion of the business. When a partnership finishes. However some partnerships do not want to move to this stage. Company accounts are filed so the public can view them (and competitors). Directors often own shares in the company. Shareholders are also known as members. Limited Liability means that investors can only lose the money they have invested and no more.5. depending on how the Deed of Partnership is set up. As a group they select the directors who run the business.

The file for any company can be inspected at the Companies Registration Office for a nominal fee by a member of the general public. A private limited company may wish to become a Plc because: Shares in a private limited company cannot be offered for sale to the general public. a company has to register with the “Registrar of Companies”. 13  Shares in a Private limited . The difference between the two is: Shares in a Public limited company (Plc) can be traded on the Stock Exchange and be bought by members of the general public. meaning that the company is seen as separate from its shareholders.Financial Accounting Introduction to Accounting They cannot claim the personal assets of the shareholders to recover amounts owed by the company. especially if the business wants to expand. and is issued with a “Certificate of Incorporation”. This is why the statutory accounts are often referred to as the published accounts. A Limited company has to possess a “separate legal entity” from its shareholders. it is attractive to change status. It also needs to have a “Memorandum of Association” which sets out what the company has been formed to do. namely the Companies Acts. Limited companies must produce such accounts annually and may have to appoint an independent person to audit and report on them depending on certain size criteria. The distinguishing factor that differentiates a limited company from a sole trader and a partnership is that a limited company has to prepare annual “statutory accounts”. Limited companies can either be private limited companies or public limited companies. Therefore. so restricting the availability of finance. company are not available to the general public. who maintains a separate file for every company. Limited companies are governed very tightly by company’s legislation. To set up a limited company. a copy of the accounts must be sent to the Registrar of Companies which maintains a separate file for every company. this is the price to be paid for the benefit of limited liability. and “Articles of Association” which are internal rules including what the directors can do and voting rights of the shareholders. Once prepared.

e. If they have enough shares they can influence the management of the company. such as growth and investment. from banks. To do that. the price of the shares can go down as well as up. the company must do a “flotation”.g. They buy shares because: Shares normally pay dividends. 14    . which might mean that the business has to concentrate on short term objectives of creating profit. so investing in shares can be risky. The disadvantages of being a public limited company (Plc) are: Costly and complicated to set up as a Plc – you need to employee specialist bankers and lawyers to help organise the converting to the Plc. Shareholders own the company.Introduction to Accounting Financial Accounting   It is also easier to raise money through other sources of finance. If they buy enough. whereas it might be better to work on longer term objectives. The threat of takeover. Of course. It is important to note that a “Plc” does not necessarily mean that the company is quoted on the Stock Exchange. Companies on the Stock Exchange usually pay dividends twice each year. Certain financial information must be available for all parties. which is a share of the profits at the end of the year. they can then persuade other shareholders to join with them to vote in a new management team. competitors and customers included (would you want them to know how much profit you are making?) Shareholders in public companies expect a steady stream of income from dividends. because another company can buy up a large number of shares because they are traded publicly (can be sold to anyone). A good example is a “venture capitalist” that will often buy up to 80% of the shares of a company and insist on choosing some of the directors. Over time the value of the share might increase and can be sold for a profit – this is known as a “capital gain”.

This means selling all or part of the business to outside investors.Financial Accounting Introduction to Accounting Flotation A company may float on the stock market. 1. In summary for all three types of entity. this capital is divided into shares (Share Capital). the money put up by the individual. They will have their say at the Annual General Meeting (AGM) of the company. Therefore. the day-to-day running of the business is entrusted to the directors. is referred to as the business capital. in reality there are many users of accounts. The shareholders are therefore “divorced” from the running of the business for 364 days of the year. This generates additional funds for the business and can be a major form of fundraising. Company accounts are not examinable in the Financial Accounting examination. This is because the shareholders may have the money. However. This agency relationship between the shareholders and the directors is referred to as Corporate Governance. When shares in a “Plc” are first offered for sale to the general public the company is given a “listing” on the stock exchange. but not the time or management skills to run the company. In the case of a company.6 Users of financial statements It is easy to assume that the only users of accounting information are shareholders – since it is a requirement of company law that shareholders must receive financial statements. the ownership and control of the business may become separated. Corporate Governance As a business becomes larger. The following summarises the main users groups and provides examples of their areas of interest 15  . by the shareholders. In practice directors tend to have at least a modest shareholding in the company. This provides the director with an incentive to achieve good dividends and capital growth for the share (an increase in the share price). where the directors present the accounts and the results. who are employed for their skills. the partners or the shareholders.

They also need to be able to access whether a business will be able to pay dividends.6. Business value (share price).6. Management of working capital. assets owned). They require information to decide whether they should continue to invest in a business. Security of assets against which the lending may be secured. volumes.3 Payables Suppliers and trade payables require information that helps them understand and assess the short-term liquidity of a business.1 Investors Investors are concerned about risk and return in relation to their investments.Introduction to Accounting Financial Accounting   in accounts: 1. 1. The key accounting information for an investor is therefore: Information about growth. and measure the performance of the business’ management team.6. Investment requirements in the business. Comparative information of competitors. sales. overall level of profit). The key accounting information for lenders is therefore: Cash flow. Investment (amounts invested. . For example is the business able to pay short-term debt when it falls due? The key accounting information for creditors is therefore: 16    Cash flow. 1.2 Lenders Banks and loan stockholders who lend money to a business require information that helps them determine whether loans and interest will be paid when due. Profitability (profit margins.

Status and valuation of the company pension schemes/levels of company contributions.Financial Accounting Introduction to Accounting - Payment policy.6 Government There are many government agencies and departments that are interested in accounting information. the Revenue Commissioners need information on business profitability in order to levy and collect Corporation Tax. they have a longterm interest in the company’s range of products and services.5 Employees Employees (and organisations that represent them – e. local 17  . They are also likely to be interested in the pay and benefits obtained by senior management. Overall employment data (numbers employed. They are very interested in information about employment prospects and the maintenance of pension funding and retirement benefits.4 Receivables Customers and trade receivables require information about the ability of the business to survive and prosper. New product development.6. production capacity). The key accounting information for debtors is therefore: Sales growth.6. trade unions) require information about the stability and continuing profitability of the business. For example. Customs and Excise need accounting information to verify Value Added Tax (VAT) returns. 1. 1. 1. As customers of the company’s products. Investment in the business (e. The key accounting information for employees is therefore: Revenue and profit growth.6. Levels of investment in the business. They may even be dependent on the business for certain products and services.g. wages and salary costs).g.

as discussed above. International Accounting Standards (IAS’s) help to reduce the differences in the way companies draw up their financial statements. resident committees where the business is located in a residential area. as discussed above. 1. e.e.6. 1. Such reporting is usually done in the form of financial statements. and therefore they will not reveal details about product profitability. formed by various groups of individuals who have a specific interest in the activities and performance of businesses.7 Analysts Investment analysts are an important user group – specifically for companies quoted on the Stock Exchange. The financial statements are public documents. Internal users are. However.8 Public at large Interest groups. Much of this is provided by the detailed accounting disclosures that are required by authorities such as the London Stock Exchange.6. Management accounting is geared towards internal users of accounting information. creditors. Various regulatory agencies (i.7 Financial accounting and Management accounting As stated earlier there are two broad types of accounting information: Financial Accountings geared towards external users of accounting information. lenders and the government. financial accounts are prepared using accepted accounting conventions and standards. management and employees. additional accounting information is usually provided to analysts via informal company briefings and media interviews. the Environment Agency) need information to support decisions about grants. They require very detailed financial and other information in order to analyse the competitive performance of a business and its sector. debtors. for example. will also require accounting information. 1.Introduction to Accounting Financial Accounting   government need similar information to levy local taxes and rates. External users are.g. In order to facilitate comparison. Management 18    . investors. Such reporting is accomplished through custom designed reports.

management methods. 19  . for example by operating unit or by product line. assess profitability and so on. You will study Management Accounting as a complete subject in Second Year.Financial Accounting Introduction to Accounting need much more detailed and up-to-date information in order to control the business and plan for the future. They need to be able to cost products and production In order to facilitate this. accounts present information in any way which may be useful to management.

Although there is a difference in the type of information presented in financial and management accounting. Required by law.7. 20    . the underlying objective is the same – to satisfy the needs of the user. Normally prepared monthly. presenting and interpreting information used for: Formulation of strategy. Let’s compare the types of accounting briefly: 1. Planning and controlling activities. Prepared annually.1 Financial accounting Production of summary financial statements for external users. Information is computed and presented in order to be relevant to managers. Information is calculated and presented in accordance with strict legal and accounting requirements. Included budgets and forecasts of future activities. Decision making.2 Management accounting Production of detailed accounts.7. Reflects past performance and current position. Optimising the use of resources. as well as reflecting past performance. used by management to control the business and plan for the future. Not mandatory. 1.Introduction to Accounting Financial Accounting   Management accounting is an integral part of management activity concerned with identifying.

it is a performance statement. let’s comprehend the basic accounting terminology.8 Accounting terminology Prior to actually beginning other detailed chapters on accounting.Financial Accounting Introduction to Accounting In summary Accounting  Financial Accounting  Management Accounting  External users of  accounting  information  Internal users  of accounting  information  Investors  Payables  Management  Employees  Receivables  Government  1. Precise terminology is important in book-keeping and accounting. Sales – the exchange of goods and services for money. Reporting to the owners and user groups is done by means of financial statements. This report shows two forms of profit as follows: Gross profit is the difference between revenue/sales and the cost of making the product or service. this includes both cash and 21  . An Income Statement will show a profit or loss earned for the accounting period for which the report was prepared. primarily the Income Statement and the Statement of Financial Position. Net profit is calculated by subtracting a company’s total expenses (including cost of sales) from its revenue/sales.

g. There are two main types of costs: Costs of purchases for resale. Land & Buildings. Motor Vehicles. current liabilities. It represents the financial position of a company at a defined point in time. bank. Expenses . inventory. which must 22    . We will be exploring these concepts in detail in later chapters. rent and light & heat.g. Other costs such as wages. There are current assets. cash) and non current assets which the business owns and uses in the business for economic benefit (e. Liabilities Anything a company owes to people or businesses other than its owners is considered a liability. It lists the assets and liabilities. which are included in the cost of sales of the trading account.Introduction to Accounting Financial Accounting   credit sales. which can be readily turned into cash within a twelve month period (e. receivable. An asset is anything of value that the business owns – including cash. The Statement of Financial Position is a statement of position at the end of the accounting period. Premises. Assets In business and accounting. including the capital invested by the owner/owners. Purchases – buying goods for resale or consumption. Income – a more general term than sales including also interest received and rent received from letting part of the business premises.An expense is any cost of doing business resulting from revenuegenerating activities. Computers and Fixtures & Fittings). this includes both cash and credit purchases. Thus anything that belongs to the business or is due to the business is an asset of that business. assets are economic resources owned by the business or company. They are the cost of carrying on a trade or business. Assets get recorded in the Balance Sheet in terms of their monetary value. of the business at that time. There are two types of liability.

23  . stock or cash withdrawals.Financial Accounting Introduction to Accounting be paid within a year (e. Drawings Drawings mean any money or goods taken out of the business for the owners own personal use (sole trader’s drawings). payables. Receivables Receivables are customers who own money to the business as a result of credit sale transactions. the amount recorded is recorded in a capital account. We treat these as current assets as we anticipate getting paid for these goods within the next twelve months.g.000 to start a business.g. the business has purchased goods on credit. also called capital. Long-term loans). Drawings can be in the form of assets. Owners’ equity Owners’ equity. These are shown in the accounts but are not treated as a business expense. which are debts that extend beyond one year (e. Bank overdraft) and Non-Current Liabilities. in the statement of financial position. Payables Payables are suppliers who the business owes money to as a result of credit purchase transactions. is any debt owed to the business owners. the goods have been sold with payment terms being specified on the invoice. We treat these as current liabilities as we anticipate paying for these goods within the next twelve months. only to pay for them at a later date (within the payment terms on the invoice). if you invested €50. instead they are treated as a reduction to capital in the Statement of Financial Position. For example.

5 marks Question 4: Distinguish between Financial and Management Accounting. Pilot papers for this subject can be downloaded from www. that business can be organised in one of three ways.Introduction to Accounting Financial Accounting   SAMPLE QUESTIONS The following questions examine the key areas you are expected to know for this particular subject. 5 marks     24    . 5 marks Question 5: Identify four users of financial information.ie  Question 1: When an individual decides to start business. 5 marks Question 3: Each business type in Question 1 above has associated advantages and disadvantages. Provide a definition of each of these business types. 5 marks Question 2: Outline your understanding of “Limited Liability”. and include the type their information needs. and will assist you significantly in your preparation for your examination in May/August. For each of these business types provide two advantages and two disadvantages.AccountingTechniciansIreland.