Unit 9 Accounting

9.I.A

Reading

The main concepts and documents

Read the following passage and answer the questions which follow it.

Businesses measure their financial performance by recording and classifying sales, purchases and other transactions, They then present this information in a way which makes it possible to evaluate their past, present and future performance. The various accounting activities are usually divided into two distinct parts: financial accounting and management accounting.

Financial accounting is concerned with preparing information for users outside the organisation. For example, suppliers, banks and other lenders may want to know about the company's profit potential; government agencies are concerned with regulating the business and collecting taxes.

Management accounting, on the other hand, is designed to meet the needs of a particular company. These range from analysing costs - so that management knows exactly how much it costs to produce a given product and how well the business is performing - to financial planning, which involves forecasting sales, costs, expenses and profits and which enables management to spot problems and opportunities, and allocate resources rationally by developing a budget.

Financial accounting is carried out by public accountants who are responsible for auditing the company's financial statements. These are called chartered accountants in the UK. They are independent of the business and provide an objective analysis of the statements before reporting them to shareholders, investors or tax officials. They also provide other financial services including management consulting and tax accounting.

Management accounting is carried out by private accountants who are usually either employed or hired by the business itself or in certain cases by a government agency to supervise the company's accounting system and book-keeping staff and to generate and interpret financial reports.

Book-keepers represent the most routine accounting function of recording all transactions (sales, purchases, loans, wage payments, etc). The highest-ranking financial accountants typically have the title of Controller or Financial Vice-President, and spend their time monitoring and cross-checking all financial data so that top management can be certain that the company is using assets to best advantage.

All companies use an accounting system that records every transaction affecting assets (things which the company owns) and liabilities (things which the company owes). However, within a short period of time the numerous transactions recorded by a book-keeper are likely to mount up. In order to simplify the situation, accountants summarise the transactions by preparing a number of financial statements, the three most important of which are:

• the balance sheet

• the income statement (profit and loss account)

• the statement of changes in financial position (cash flow forecast).

Accountants in the UK have to prepare a further document called the Statement of Source and Application of Funds.

The balance sheet

The balance sheet is prepared at least once a year, at the end of either the calendar year or the fiscal year. It is often referred to as a picture of a company's financial position frozen at a given moment in time, and shows where the company's money came from (liabilities and owners' equity) and where it went to (assets). Figure 20 shows a simplified balance sheet in both American and British layouts. A glossary of terms appears on the next page.

Glossary

current assets

Resources that can be converted into cash within one year

cash

Funds on hand or in bank accounts or savings accounts, and which can be withdrawn at short notice.

marketable securities

Any investment readily convertible into cash.

accounts receivable

Amounts owed by customers.

allowance for doubtful accounts

Some accounts receivable are unlikely to be paid and are therefore deducted.

notes receivable

Written and signed promises by customers to pay a stated sum on a certain date. The customer's bank is usually responsible for collection.

inventory

Assets tied up in things to be eventually sold - raw materials, goods in process (work in progress) and finished goods.

prepaid expenses

Services paid for but not yet used and which can be cancelled and turned into cash.

fixed assets

Resources you intend to keep, such as buildings, and which you need to run your business.

depreciation

The spreading out of the cost of a tangible asset over its useful life. For intangible assets the equivalent accounting procedure is called amortisation. Land is the only fixed asset which does not depreciate.

intangible assets

Assets having no physical existence but which can be licensed or sold to others.

goodwill

An intangible asset which corresponds to a company's reputation. When a business is purchased, goodwill represents the difference between the company's face value and the price that the purchaser is willing to pay.

current liabilities

Debts that the company will have to pay within one year.

accounts payable

Accounts that have to be paid within 30 days, usually to suppliers who have offered 30 days credit.

notes payable

Written and signed promises to pay a creditor a stated sum on a certain date.

accrued expenses

Expenses incurred but for which bills have not yet been received or recorded. Wages and salaries are examples of accrued expenses.

long-term liabilities

Debts that fall due more than a year after the balance sheet has been drawn up.

owner's equity

The figure which appears on the balance sheet represents the amount raised by the shareholders when the stock was issued.

retained earnings

All previous earnings minus the amount distributed as dividends.

1 What is the difference between:

• financial accounting and management accounting?

• public accountants and private accountants?

• a controller and a book-keeper?

• assets and liabilities?

• the P & L account and the cash flow forecast?

2 Match the following US and UK terms.

US

UK

1 Statement of changes in financial position

a Finance Director

2 Income statement

b Fixed asset investments

3 Financial Vice-President

c Cash flow forecast

4 Public accountants

d Bills of exchange payable

5 Marketable securities

e Trade creditors

6 Accounts receivable

f Chartered accountants

7 Accounts payable

g Inventory stock

8 Notes payable

h P & L account

9 Merchandise inventory

i Trade debtors

10 CEO

j Managing Director

3 By referring to the documents presented on pages 110 and 112, explain how the following amounts are arrived at. The first one has been done for you.

a Gross profit: net sales minus cost of goods sold

b Net income:

c Pre-tax profit:

d Net profit:

e Total assets:

f Total shareholders' equity:

9.I.B

Vocabulary

Defining key terms

I Match the following terms with their definitions:

Terms

1. financial accounting

2. management accounting

3. budget

4. public accountants

5. private accountants

6. audit

7. assets

8. liabilities

9. balance sheet

10. goodwill

11. income statement

12. book-keepers

13. controllers

14. accounts receivable

15. depreciation

16. cash flow forecast

Definitions

1. concerned with preparing information for internal use

2. a financial blueprint of estimated revenues and expenses for a given period of time

3. people involved in record-keeping and other clerical jobs in accounting

4. a financial statement showing the sources and uses of an organisation's cash

during an accounting period

5. concerned with preparing information for outside users

6. evaluation of the accuracy and reliability of a company's financial statements

7. statement of a firm's assets, liabilities and owners' equity at a specific moment

in time

8. the highest-ranking accountant in a firm

9. the spreading out of a tangible asset's cost over its estimated useful life

10. accountants who are independent of the organisations they serve

11. the value of a business's reputation

12. valuable things owned by a company

13. debts or obligations the company owes

14. accountants employed by a business to supervise the accounting system

15. amounts due from customers

16. statement showing the firm's overall profitability

2 Divide into two teams. Each member of each team reads aloud a definition and asks one member of the opposing team to give the corresponding term. The person answering must not consult his or her notes and has five seconds to answer in order to earn a point.

9.I.C

Vocabulary

Classifying

Make a copy of the grid below and place the following items in it.

1. three trucks

2. a patent on a new process devised by Calypso Potteries pic

3. 12 tons of clay

4. interest due on a bank loan

5. mortgage

6. 10,000 shares in the company

7. a lap-top computer for the CEO

8. taxes

9. a 'Calypso' trademark

10. three industrial kilns

11. an unpaid invoice for 600 dishes purchased last month by a Swedish department store

12. the lease on a warehouse

13. money in the company safe for day-to-day expenses

14. the copyright for the series of Calypso publications Pottery through the ages

15. unpaid invoice for last week's clay delivery

16. the unexpired portion of an insurance policy

9.I.D

Project

Drawing up a balance sheet and income statement

From the following information prepare a balance sheet and an income statement (US layout).