Accounting

(1)

Assets:

Any item of

Any item of economic value

economic value

owned by an

owned by an individual

individual

or

corporation

, especially that which could be converted

to

to cash

cash

..

Examples

Examples::

cash,

cash, securities

securities

,, accounts receivable

accounts receivable

,, inventory

inventory

,, office

office

equipment

,, real estate

real estate

, a car, and other

, a car, and other property

property

. On a

. On a balance

balance

sheet

, assets are equal to the sum of

, assets are equal to the sum of liabilities

liabilities

,, common stock

common stock

,,

preferred stock

, and

, and retained earnings

retained earnings

Assets are divided into the following categories: Assets are divided into the following categories:

current assets

(cash and other

(cash and other liquid

liquid

items),

items), long-term assets

long-term assets

((real

real

estate

,,

plant

, equipment), prepaid and

, equipment), prepaid and deferred assets

deferred assets

((expenditures

expenditures

for

future

future costs

costs

such as

such as insurance

insurance

,, rent

rent

,, interest

interest

), and

), and intangible assets

intangible assets

((trademarks

trademarks

,, patents

patents

,, copyrights

copyrights

,, goodwill

goodwill

).

Accounting

“Accounting is an art of recording classifying summarizing in

significant manner transaction of an event at least in the part of

financial character and interpreting the result thereof.” The

systematic

recording, reporting, and

recording, reporting, and analysis

analysis

of

of financial

financial

transactions

of a

of a business

business

.. Accounting allows a

.. Accounting allows a company

company

to

to analyze

analyze

the

the financial performance

financial performance

of the business, and look at

of the business, and look at statistics

statistics

such

as

as net profit

net profit

..

A c c o u n t i n g C o n c e p t A n d C o n v e n t i o n s

In

dra

win

g

up

acc

ou

nti

ng

sta

tem

ent

s,

whe

the

r

the

y

are

ext

ern

al

"financial accounts" or internally-focused "management accounts", a

clear objective has to be that the accounts fairly reflect the true

"substance" of the business and the results of its operation.

The theory of accounting has, therefore, developed the concept of a

"true and fair view"

. The true and fair view is applied in ensuring

and assessing whether accounts do indeed portray accurately the

business' activities.

(2)

To support the application of the "true and fair view", accounting has adopted certain concepts and conventions which help to ensure that accounting information is presented accurately and consistently.

Accounting Conventions

The most commonly encountered convention is the "historical cost convention". This requires transactions to be recorded at the price ruling at the time, and for assets to be valued at their original cost.

Under the "historical cost convention", therefore, no account is taken of changing prices in the economy.

The other conventions you will encounter in a set of accounts can be summarised as follows:

Monetary measurement

Accountants do not account for items unless they can be quantified in monetary terms. Items that are not accounted for (unless someone is prepared to pay something for them) include things like workforce skill, morale, market leadership, brand recognition, quality of management etc.

Separate Entity

This convention seeks to ensure that private transactions and matters relating to the owners of a business are segregated from transactions that relate to the business.

Realisation With this convention, accounts recognise transactions (and any profits arising from them) at the point of sale or transfer of legal ownership - rather than just when cash actually changes hands. For example, a company that makes a sale to a customer can recognise that sale when the transaction is legal - at the point of contract. The actual payment due from the customer may not arise until several weeks (or months) later - if the customer has been granted some credit terms.

Materiality An important convention. As we can see from the application of accounting standards and accounting policies, the preparation of accounts involves a high degree of judgement. Where decisions are required about the appropriateness of a particular accounting judgement, the "materiality" convention suggests that this should only be an issue if the judgement is "significant" or "material" to a user of the accounts. The concept of "materiality" is an important issue for auditors of financial accounts.

Accounting Concepts

Four important accounting concepts underpin the preparation of any set of accounts:

(3)

Going Concern

Accountants assume, unless there is evidence to the contrary, that a company is not going broke. This has important implications for the valuation of assets and liabilities.

Consistency Transactions and valuation methods are treated the same way from year to year, or period to period. Users of accounts can, therefore, make more meaningful comparisons of financial performance from year to year. Where accounting policies are changed, companies are required to disclose this fact and explain the impact of any change.

Prudence Profits are not recognised until a sale has been completed. In addition, a cautious view is taken for future problems and costs of the business (the are "provided for" in the accounts" as soon as their is a reasonable chance that such costs will be incurred in the future.

Matching (or "Accruals")

Income should be properly "matched" with the expenses of a given accounting period.

Key Characteristics of Accounting Information

There is general agreement that, before it can be regarded as useful in satisfying the needs of various user groups, accounting information should satisfy the following criteria:

Criteria What it means for the preparation of accounting information

Understandability This implies the expression, with clarity, of accounting information in such a way that it will be understandable to users - who are generally assumed to have a reasonable knowledge of business and economic activities

Relevance This implies that, to be useful, accounting information must assist a user to form, confirm or maybe revise a view -usually in the context of making a decision (e.g. should I invest, should I lend money to this business? Should I work for this business?)

Consistency This implies consistent treatment of similar items and application of accounting policies

Comparability This implies the ability for users to be able to compare similar companies in the same industry group and to make comparisons of performance over time. Much of the work that goes into setting accounting standards is based around the need for comparability.

Reliability This implies that the accounting information that is presented is truthful, accurate, complete (nothing significant missed out) and capable of being verified (e.g. by a potential investor).

(4)

Objectivity This implies that accounting information is prepared and reported in a "neutral" way. In other words, it is not biased towards a particular user group or vested interest

Basic Accounting Concepts

As we saw in the previous chapter, accounting is based on 5 basic account

types: Assets, Liabilities, Equity, Income and Expenses. We will now

expand on our understanding of these account types, and show how they are

represented in GnuCash. But first, let's divide them into 2 groups, the balance

sheet accounts and the income and expense accounts.

3.1.1. Balance Sheet Accounts

The three so-called Balance Sheet Accounts are Assets, Liabilities, and

Equity. Balance Sheet Accounts are used to track the changes in value of

things you own or owe.

Assets is the group of things that you own. Your assets could include a car,

cash, a house, stocks, or anything else that has convertible value. Convertible

value means that theoretically you could sell the item for cash.

Liabilities is the group of things on which you owe money. Your liabilities

could include a car loan, a student loan, a mortgage, your investment margin

account, or anything else which you must pay back at some time.

Equity is the same as "net worth." It represents what is left over after you

subtract your liabilities from your assets. It can be thought of as the portion

of your assets that you own outright, without any debt.

3.1.2. Income and Expense Accounts

The two Income and Expense Accounts are used to increase or decrease the

value of your accounts. Thus, while the balance sheet accounts simply track

the value of the things you own or owe, income and expense accounts allow

you to change the value of these accounts.

Income is the payment you receive for your time, services you provide, or

the use of your money. When you receive a paycheck, for example, that

(5)

income include commissions, tips, dividend income from stocks, and interest

income from bank accounts. Income will always increase the value of your

Assets and thus your Equity.

Expenses refer to money you spend to purchase goods or services provided

by someone else. Examples of expenses are a meal at a restaurant, rent,

groceries, gas for your car, or tickets to see a play. Expenses will always

decrease your Equity. If you pay for the expense immediately, you will

decrease your Assets, whereas if you pay for the expense on credit you

increase your Liabilities.

GnuCash Accounts

This section will show how the GnuCash definition of an account fits into the

view of the 5 basic accounting types.

But first, let's begin with a definition of an account in GnuCash. A GnuCash

account is an entity which contains other sub-accounts, or that contains

transactions. Since an account can contain other accounts, you often see

account trees in GnuCash, in which logically associated accounts reside

within a common parent account.

A GnuCash account must have a unique name (that you assign) and one of

the predefined GnuCash "account types". There are a total of 13 account

types in GnuCash. These 13 account types are based on the 5 basic

accounting types, the reason there are more GnuCash account types than

basic accounting types is that this allows GnuCash to perform specialized

tracking and handling of certain accounts. There are 7 asset accounts ( Cash,

Bank , Stock , Mutual Fund, Currency, Accounts Receivable, and Asset ),

3 liability accounts (Credit Card, Accounts Payable, and Liability, ), 1

equity account (Equity), 1 income account (Income), and 1 expense account

(Expense).

These GnuCash account types are presented in more detail below.

3.2.1. Balance Sheet Accounts

The first balance sheet account we will examine is Assets, which, as you

remember from the previous section, refers to things you own.

(6)

To help you organize your asset accounts and to simplify transaction entry,

GnuCash supports several types of asset accounts:

1.

Cash Use this account to track the money you have on hand, in your

wallet, in your piggy bank, under your mattress, or wherever you

choose to keep it handy. This is the most liquid, or easily traded, type

of asset.

2.

Bank This account is used to track your cash balance that you keep in

institutions such as banks, credit unions, savings and loan, or

brokerage firms - wherever someone else safeguards your money. This

is the second most liquid type of account, because you can easily

convert it to cash on hand.

3.

Stock Track your individual stocks and bonds using this type of

account. The stock account's register provides extra columns for

entering number of shares and price of your investment. With these

types of assets, you may not be able to easily convert them to cash

unless you can find a buyer, and you are not guaranteed to get the same

amount of cash you paid for them.

4.

Mutual Fund This is similar to the stock account, except that it is used

to track funds. Its account register provides the same extra columns for

entering share and price information. Funds represent ownership shares

of a variety of investments, and like stocks they do not offer any

guaranteed cash value.

5.

Currency If you trade other currencies as investments, you can use

this type of account to keep track of them. The register is similar to the

stock register, except that you enter exchange rates instead of prices.

6.

Accounts Receivable (A/Receivable) This is typically a business use

only account in which you place outstanding debts owed to you. It is

considered an asset because you should be able to count in these funds

arriving.

7.

Asset For personal finances, use this type of account to track

"big-ticket" item purchases that significantly impact your net worth.

Generally, you can think of these as things you insure, such as a house,

vehicles, jewelry, and other expensive belongings.

The second balance sheet account is Liabilities, which as you recall, refers to

what you owe, money you have borrowed and are obligated to pay back some

day. These represent the rights of your lenders to obtain repayment from you.

Tracking the liability balances lets you know how much debt you have at a

given point in time.

(7)

GnuCash offers three liability account types:

1.

Credit Card Use this to track your credit card receipts and reconcile

your credit card statements. Credit cards represent a short-term loan

that you are obligated to repay to the credit card company. This type of

account can also be used for other short-term loans such as a line of

credit from your bank.

2.

Accounts Payable (A/Payable) This is typically a business use only

account in which you place bills you have yet to pay.

3.

Liability Use this type of account for all other loans, generally larger

long-term loans such as a mortgage or vehicle loan. This account can

help you keep track of how much you owe and how much you have

already repaid.

The final balance sheet account is Equity, which is synonymous with "net

worth". It represents what is left over after you subtract your liabilities from

your assets, so it is the portion of your assets that you own outright, without

any debt. In GnuCash, use this type of account as the source of your opening

bank balances, because these balances represent your beginning net worth.

There is only a single GnuCash equity account, called naturally enough,

Equity.

i n t r o d u c t i o n t o a c c o u n t i n g

Introduction

It is not easy to provide a concise definition of accounting since the word has a broad application within businesses and applications.

The American Accounting Association define accounting as follows:

"the process of identifying, measuring and communicating economic information to permit informed judgements and decisions by users of the information!.

This definition is a good place to start. Let's look at the key words in the above definition:

- It suggests that accounting is about providing information to others. Accounting information is economic information - it relates to the financial or economic activities of the business or organisation.

(8)

- Accounting information needs to be identified and measured. This is done by way of a "set of accounts", based on a system of accounting known as double-entry bookkeeping. The accounting system identifies and records "accounting transactions".

- The "measurement" of accounting information is not a straight-forward process. it involves making judgements about the value of assets owned by a business or liabilities owed by a business. it is also about accurately measuring how much profit or loss has been made by a business in a particular period. As we will see, the measurement of accounting information often requires subjective judgement to come to a conclusion

- The definition identifies the need for accounting information to be communicated. The way in which this communication is achieved may vary. There are several forms of accounting communication (e.g. annual report and accounts, management accounting reports) each of which serve a slightly different purpose. The communication need is about understanding who needs the accounting information, and what they need to know!

Accounting information is communicated using "financial statements" What is the purpose of financial statements?

There are two main purposes of financial statements:

(1) To report on the financial position of an entity (e.g. a business, an organisation);

(2) To show how the entity has performed (financially) over a particularly period of time (an "accounting period").

The most common measurement of "performance" is profit.

It is important to understand that financial statements can be historical or relate to the future.

Accountability

Accounting is about ACCOUNTABILTY

Most organisations are externally accountable in some way for their actions and activities. They will produce reports on their activities that will reflect their objectives and the people to whom they are accountable.

The table below provides examples of different types of organisations and how accountability is linked to their differing organisational objectives:

(9)

Organisation Objectives Accountable to (examples) Private or public company (e.g. BP, Tesco) - Making of profit - Creation of wealth - Shareholders

- Other stakeholders (e.g. employees, customers, suppliers)

Charities (e.g. Save the Children) - Achievement of charitable aims - Maximise spending on activities - Charity commissioners - Donors Local Authorities (e.g. Leeds City Council)

- Provision of local services - Optimal allocation of spending budget

- Local electorate

- Government departments Public services (e.g.

transport, health) (e.g. National Health Service, Prison

Service)

- Provision of public service (often required by law) - High quality and reliability of services

- Government ministers - Consumers

Quasi-governmental agencies

(e.g. Data Protection Registrar, Scottish Arts Council)

- Regulation or instigation of some public action - Coordination of public sector investments

- Government ministers - Consumers

All of the above organizations have a significant roles to play in society and have multiple stakeholders to whom they are accountable.

All require systems of financial management to enable them to produce accounting information.

How accounting information helps businesses be accountable

As we have said in our introductory definition, accounting is essentially an "information process" that serves several purposes:

- Providing a record of assets owned, amounts owed to others and monies invested;

- Providing reports showing the financial position of an organisation and the profitability of its operations

- Helps management actually manage the organisation

- Provides a way of measuring an organisation's effectiveness (and that of its separate parts and management)

(10)

- Helps stakeholders monitor an organisations activities and performance

- Enables potential investors or funders to evaluate an organisation and make decisions

There are many potential users of accounting Information, including shareholders, lenders, customers, suppliers, government departments (e.g. Inland Revenue), employees and their organisations, and society at large. Anyone with an interest in the performance and activities of an organisation is traditionally called a stakeholder.

For a business or organisation to communicate its results and position to stakeholders, it needs a language that is understood by all in common. Hence, accounting has come to be known as the "language of business"

There are two broad types of accounting information:

(1) Financial Accounts: geared toward external users of accounting information (2) Management Accounts: aimed more at internal users of accounting information

Although there is a difference in the type of information presented in financial and management accounts, the underlying objective is the same - to satisfy the information needs of the user. 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 Recording and

Classifying

Recording and classifying data into a permanent and logical form. This is usually referred to as "Book-keeping"

Summarising

Summarising data to produce statements and reports that will be useful to the various users of accounting information - both external and internal

Interpreting and Communicating

Interpreting and communicating the performance of the business to the management and its owners

Forecasting and Planning

Forecasting and planning for future operation of the business by providing management with evaluations of the viability of proposed operations. The key forecasting and planning tool is the "Budget"

The process by which accounting information is collected, reported, interpreted and actioned is called "Financial Management". Taking a commercial business as the most common organisational structure, the key objectives of financial management would be to:

(11)

(1) Create wealth for the business

(2) Generate cash, and

(3) Provide an adequate return on investment bearing in mind the risks that the business is taking and the resources invested

In preparing accounting information, care should be taken to ensure that the information presents an accurate and true view of the business performance and position. To impose some order on what is a subjective task, accounting has adopted certain conventions and concepts which should be applied in preparing accounts.

For financial accounts, the regulation or control of what kind of information is prepared and presented goes much further. 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. These are applied by businesses through their Accounting Policies.

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.

The three main financial accounting statements that help achieve this aim are: (1) The profit and loss account for the reporting period

(2) A balance sheet for the business at the end of the reporting period (3) A cash flow statement for the reporting period

A balance sheet shows at a particular point in time what resources are owned by a business ("assets") and what it owes to other parties ("liabilities"). It also shows how much has been invested in the business and what the sources of that investment finance were.

It is often helpful to think of a balance sheet as a "snap-shot" of the business - a picture of the financial position of the business at a specific point. Whilst this is a useful picture to have, every time an accounting transaction takes place, the "snap-shot" picture will have changed.

By contrast, the profit and loss account provides a perspective on a longer time-period. If the balance sheet is a "digital snap-shot" of the business, then think of the profit and loss account as the "DVD" of the business' activities. The story of what financial transactions took place in a particular period - and (most importantly) what the overall result of those transactions was.

(12)

Not surprisingly, the profit and loss account measures "profit". 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.

Basic Concepts

A transaction in a double entry accounting system such as GnuCash is an

exchange between at least 2 accounts. Thus, a single transaction must always

consist of at least two parts, a "from" and a "to" account. The "from" account

is passing value to the "to" account. Accountants call these parts of a

transaction Ledger Entries. In GnuCash, they are called Splits.

For example, you receive a paycheck and deposit it into your savings account

at the bank. The transaction that occurs is that your bank savings account

(an asset) received money from your income account. Two accounts are

affected, and in this case there is a net increase in your equity.

Working with transactions in GnuCash is performed using what is known as

the account register. Every account you create has an account register. It

will appear familiar to you as it looks very similar to the log used to track

checkbooks.

<<<

�

The accounting equation is Assets = Liabilities + Owner’s Equity. This is the same format used in a sole proprietorship’s balance sheet. (A corporation’s balance sheet will use Stockholders’ Equity instead of Owner’s Equity.)

The accounting equation will always remain in balance if double-entry accounting is followed accurately. For example, if a company borrows $10,000 from its bank, Assets increase by $10,000 and Liabilities increase by $10,000. When a

company buys inventory with cash, one Asset (Inventory ) increases and one Asset (Cash) decreases. If the owner invests $5,000 of personal assets in the business, the company’s Assets increase and Owner’s Equity increases. If the owner withdraws $2,000 from the business for her personal use, the company’s Assets decrease and Owner’s Equity decreases.

Revenues causes Owner’s Equity to increase, and expenses cause Owner’s Equity to decrease. If the company earns $1,500 in service fees, the company’s Assets (Cash or Accounts Receivable) will increase and Owner’s Equity will increase. When the company incurs electricity charges, the company’s Liabilities

(13)

increase and Owner’s Equity decreases. If the company pays for ads to appear in this week’s newspaper, Assets decrease and Owner’s Equity decreases.

Bookkeepers and accountants will be entering amounts into two or more accounts for every transaction. This occurs with business accounting software as well, but the software might be doing part of the entries behind the scenes.