Book Three Session Three The Accounting Statements

A IMS AND OBJECTIVES OF SESSION T HREE Explain the use and relevance of two of the three major accounting statements used by businesses- the income statement and the balance sheet; Highlight and define the key terms used in the context of these accounting statements.

T HE T HREE M AIN A CCOUNTING S TATEMENTS 1. The Income Statement - Also known as the profit/loss account, the profit statement, the income & expenditure statement, or the receipts and payments account. 2. The Balance Sheet - Also known as the statement of financial position. 3. The Cash Flow Statement -Shows what cash came in and what cash went out over a period of time.

T HERE ARE FIVE BASIC ACCOUNTING ELEMENTS ( CONT ’ D ) Two accounting elements which appear in the income statement :  Expenses  Income Three accounting elements which appear in the balance sheet :  Assets  Liabilities  Equity

T HE I NCOME S TATEMENT It reports on certain financial aspects of transactions that have taken place during the accounting period that has just finished. It does so by showing what income has been earned and what expenses were incurred in earning it. If the income is larger than the expenses, then it becomes a profit. If the expenses are greater than the income, then it becomes a loss.

I NCOME S TATEMENT (C ONT ’ D ) Paula’s Pipes Income statement for the period 1 May to 31 October Income Fees for work completed in period Less plumbing components used 30,500 10,500 Gross profit20,000 Expenses Transport costs (petrol, repair to van) Marketing costs (advertising) Administration costs (bank fees, mobile phone, etc.) 1, Net Profit18,000

I NCOME S TATEMENT (C ONT ’ D ) RevenueExpenses -Revenue could also be called income or sales. -The income is what is earned for working for that period of time. -The cost of the components used not the cost of the components purchased in the period - Gross profit is a heading used in the income statement to show the profit from activities before the remainder of the costs of running the business are deducted. -Expenses cover the indirect costs of producing this period’s income. -Transport costs are a standard heading in many accounts. -Marketing costs are costs spent on advertising, etc. -Administration costs are costs used for all the other costs. - Net Profit: : what is left of the income after all the costs related to it have been allowed for. If the costs are greater than income, then there would be a loss rather than a profit.

T HE B ALANCE S HEET The balance sheet shows the financial position at a point in time, as one accounting period ends and another one starts. Three main elements of the balance sheet: A. Assets B. Liabilities C. Equity

B ALANCE S HEET ( CONT ’ D ) A) Assets They are things owned and controlled by the business that can generate future benefits in the form of income or service. These things can be of any size and maybe tangible or intangible: Accountants categorize assets into short and long term: Tangible Assets Things owned or controlled by a business that can be touched for example motor vehicles. Intangible Assets Things that cannot be touched, for example, money invested in another business. Short-term Assets/Current Assets Cash and cash equivalents Long-term/Fixed Assets Assets which cannot be easily converted into cash

B ALANCE S HEET (C ONT ’ D ) B) Liabilities They are the opposite of assets. They will cause an outflow of benefits in the form of income or services in the future. They are usually debts of the business that are or will become legally payable to other entities known as creditors. Liabilities are usually more straightforward for a business to measure than are many assets because they are normally payments due to other entities and will be referred to in money terms. Liabilities are divided into short and long term liabilities: Short-term Liabilities Those that are due to be paid off within a year. Long-term Liabilities Those that are due to be paid off in more than one year.

B ALANCE S HEET (C ONT ’ D ) C) Equity Also defined as capital, net worth, owner’s interest in the business, funds, shareholders’ funds, shareholders’ equity. The difference between assets and liabilities is referred to as equity. Equity is thought of as the amount the owners have invested in the business. E=A-L Where E=equity Where A= assets Where L= Liabilities

B ALANCE S HEET (C ONT ’ D ) Short-term or Long- term Type: Asset, Liability, Equity Item Long termAssetPacking Machine Long termAssetOffice computer Long termLiabilityMortgage on offices Long termAssetSchool building Long-term/intangibleAssetCopyright for a song Short termLiabilityPay owed to employee at balance sheet date N/AEquityProfit retained in the business Examples of Assets, Liabilities and Equities

B ALANCE S HEET (C ONT ’ D ) Paula’s Pipes Balance Sheet at 31 October Long-term assets Van Less depreciation 5, ,100 Short-term assets Stock of components Debtors Bank balance 2, ,750 Less Short-term liabilities Creditors Unearned income ,350 Working capital 2,400 Long –term liabilities Bank loan for van 2,500 Net assets 5,000 Equity Brought forward from last year Profits from this year Less Drawings 2,000 18,000 15,000 Owner’s equity 5,000

B ALANCE S HEET (C ONT ’ D ) (E XAMPLE )

T HE C ASH F LOW S TATEMENT A cash flow statement is also know as the statement of cash flows or funds flow statement. It is a financial statement showing how changes in balance sheet accounts and income affect the cash flow. The cash flow statement is concerned with the flow of cash in and out of an organisation. As an analytical tool, the statement of cash flows is useful in determining the short-term viability of a company, particularly its ability to pay bills.

T HE C ASH F LOW S TATEMENT

Book Three Session Four The Accounting World 4.4 the difference between financial and management accounting

D IFFERENCE B ETWEEN F INANCIAL & M ANAGEMENT A CCOUNTING Financial AccountingManagement Accounting A financial accounting system produces information that is mainly used by parties external to the organisation A management accounting system produces information that is mainly used for management purposes within an organisation. Financial accounting provides a record of performance of an organisation over a financial year and the financial value at the end of that financial year. Management accounting helps management to record, plan and control activities and aids the decision making process. Limited liability companies must by law prepare financial accounts. There are no legal requirements for an organisation to use management accounting. Financial accounting concentrates on the whole organisation, aggregating revenues and costs from different operations. Management accounting can focus on specific areas of a business’s activities. Financial accounting presents an essentially historical picture of past operations. Management accounting provides both a historical record of the immediate past & future planning tool. Accounting statements are usually required to be produced for a period of 12 months Accounting statements are produced as a once-off and also for varying periods. Financial accounting must operate within a framework determined by law and international and/or national accounting standards. No strict rules govern the way in which management accounting operates. Financial accounts are supposed to be produced in accordance with a format specified by accounting standards and by law. Management accounting has no specified format and no specific required statements.

D IFFERENCE B ETWEEN F INANCIAL & M ANAGEMENT A CCOUNTING (C ONT ’ D ) Type: Management accounting or Financial Accounting Accounting Information or Statement Financial accounting The profit earned by a business in a financial year Management accounting The sales forecast Financial accounting The equity of a business at the end of the financial year Management accounting The cost of running a particular part of a business Financial accounting The amount of cash coming into and leaving a business in a financial year.

Book Three Session Five Budgets and the budgeting process

A IMS AND OBJECTIVES OF SESSION F IVE Describe what budgeting is and why it is important for businesses; Outline how the budgeting process works; Look at different types of cost an how they behave in relation to changes in the level of business activity; Consider the behavioral implications of budgeting

D EFINING B UDGET A budget is a financial plan. It can be seen as a statement of the financial effects expected from the resource conversion process that the business has planned.

D IFFERENT T YPES OF C OSTS & T HEIR I MPACT ON B UDGETS Costs can be split into different types to reflect the way they arise The different types of costs need different budget treatment.

D IFFERENT T YPES OF C OSTS & T HEIR I MPACT ON B UDGETS ( CONT ’ D ) FlexibilityExampleDefinitionBudget Type Not very easy to cut-down on fixed costs, because they are time and activity related. Staff costs, rent payments. Costs that do not vary in relation to the chosen measure of activity. Fixed Organisations can attempt to cut down on variable costs through the efficient use of resources, and through sustainability. Electricity costs, telephone costs Costs of maintaining inventory. Costs that vary in relation to a chosen measure of activity. Variable These are the easiest budgets to change; if there is pressure to cut down on budget, it is simpler to cut-down on non- urgent maintenance, research and development. Non-urgent maintenance, research & development costs These are costs that are independent of the volume of activity like (fixed costs) but are not yet committed. Discretionary Contingency costs are problematic because you hope that the event does not occur, and it is unlikely to in any one year. Terrorist attack for example. These are costs related to special occasional events & contingencies. Contingency

B EHAVIORAL CONSEQUENCES OF BUDGETS One of the purposes of budgets is to motivate people, by giving targets to work towards, and against which they will be evaluated. Budgets can also have demotivating effects (e.g. budgets are set unrealistic)