Principles of Accounting

LECTURE 1, 2 & 3

LECTURER: MD. REZAUL KABIR E-MAIL: mrkabir@iba-du.edu

Module Learning Outcomes

Upon successful completion of the module students should be able to: I. II. III. IV. V. VI. understand and explain accounting concepts/terminology prepare basic financial statements calculate basic accounting ratios/numbers analyse and interpret financial statements by using ratios appreciate the limitations of traditional accounting model consider accounting from an international context

FROM A USERS PERSPECTIVE

Power of Accounting 1
Enron Enron's share price, which hit a high of US 90 per share in mid-2000, dropped to less than a 1 by the end of November 2001. It was the largest corporate bankruptcy in U.S. history until WorldCom's 2002 bankruptcy.
Issue: Enron's non-transparent financial statements did not clearly detail its operations and finances with shareholders and analysts, earnings and the balance sheet were drawn up to show a favourable picture of its performance.
3

Power of Accounting 2
WorldCom

Telecoms company filed the largest ever US bankruptcy in July 2002. Scott Sullivan, former chief financial officer, and David Myers, its former chief controller were arrested August 1, 2002 on criminal charges of conspiracy to commit securities fraud.
Issue: Accountancy fraud. The company inflated earnings by transferring $3.9bn out of the company's normal operating expenses and classifying it instead as capital investment. That trick kept the expenses off the profit and loss account.

What is accounting?
Identifying, measuring and recording Processing AND Communicating economic information to the users. (AAA, 1966)

Users of accounting information

Management

Employee

Shareholders

Company

Public

Customers

Government

FA V. MA
POINTS Nature FA External Backward Whole entity Strict MA Internal Forward Segments Flexible

Scope
Regulation

Reporting frequency

Annual

Any
7

Key financial statements

1. 2. 3. 4. Balance sheet Profit and Loss statement Cash flow statement Notes to the financial statements

Balance Sheet
Balance Sheet as at 30th June 2003 xx | Fixed Assets xx | Current Assets xx | ---===

Capital Long-term liabilities Current liabilities Total

xx xx ---===

The Accounting Equation

Assets = Capital + Liabilities

10

How are you doing?

Which one of the following equations is incorrect? a. Assets = Capital + Liabilities b. Asset Liabilities = Capital c. Assets + Capital = Liabilities d. Assets - Capital = Liabilities
11

Profit and loss statement

Profit and Loss Statement for the year ended 30th June 2003 Sales Less: Cost of sales Gross Profit Less: Expenses ---Net Profit xx xx ---xx xx xx ==

12

Cash Flow Statement

Cash Flow Statement for the year ended 30th June, 2003 Opening balance of cash Cash receipts Total Cash Payments Closing balance of cash Total xx xx ---xx === xx xx ---xx ===

13

Notes to the accounts

Disclosure of accounting policies Break up of summary figures in the financial statements

14

Progress Check 1
Which one of the following statement is incorrect:
a. Balance Sheet as at 31st October, 2007 b. Profit and Loss Statement as at 31st October, 2007 c. Cash flow statement for the year ended 31st October, 2007 d. Profit and Loss Statement for the year ended 31st October, 2007
15

Forms of Business Organisations

(a) Sole Proprietorship

(b) Partnership
(c) Listed Companies (d) Non-profit making organisations (e) Public sector
16

Progress Check 2: Fill in the blanks

Manchester United ------------------- Birmingham City Council ------------- UK Cancer Research ---------------- John & Khan Accountants ------------ Walsall Grocery -----------------------

17

Accounting Equation A company has 100,000 of assets and 60,000 in owners equity. What amount of liabilities does the company have? a. 40,000 b. 60,000 c. 100,000 d. 160,000
1-18
18 2008 Pearson Prentice Hall. All rights reserved.

Net income occurs when: a. expenses exceed revenues. b. revenues exceed expenses. c. assets exceed liabilities. d. revenues exceed liabilities.

1-19
19 2008 Pearson Prentice Hall. All rights reserved.

Lecture 2
Accounting Cycle
It refers to a process through which financial statements are produced. It involves the following steps:

20

Accounting Cycle
Recording (Journal entry)

Classifying (Ledger entries)

Balancing (Trial Balance)

Communicating (financial statements)

21

DOUBLE ENTRY BOOKKEEPING Accountants record transactions by using accounts which look like a large T and therefore, they are usually called Taccounts.

---------------------------------------------| | | | |
22

Book-keeping Rules 1
Each account is split into two halves:
the LEFT hand side is called debit the RIGHT hand side is called credit

For any transaction debit must equal credit. For the whole set of accounts total debits must equal total credits.

23

Book-keeping Rules 2
Increases in asset and expense accounts are debits Increases in capital, liability and income accounts are credits

Decreases are the opposite

24

Progress Check 1
What are the two aspects of each of the following transactions?
owner withdraws 2,000 in cash sale of goods for 2,000 cash

25

Example: John's shop

Day 1 a Day 2 John starts a corner shop with 1,000. He puts it into a business bank account. He bought various items of goods for sale in his shop for 500 and paid by cheque.

Day 3
Day 7

He paid weekly rent for the shop 50 by cheque.

He sold all of the goods bought earlier for 700 in cash and deposited the money into the business bank account

26

Recording transactions in journal

Day 1 Debit: Bank A/C ------------------------------------------ 1000 Credit: Johns Capital A/C--------------------------------1000 Day 2 Purchases --------------------------------------------------------- 500 Bank --------------------------------------------------------------Day 3 Rent ---------------------------------------------------------50 Bank ---------------------------------------------------------------Day 7 Cash ---------------------------------------------------------700 Sales ------------------------------------------------------------Bank ----------------------------------------------------------700 Cash --------------------------------------------------------------

500

50

700
700

27

Ledger Entries 1
Bank A/C Cash A/C _______________________________________________________________________________ | | | | Johns Capital 1000 | Purchases 500 Sales 700 | Bank 700 Cash 700 | Rent 50 === | === | Balance 1150 -----| ----Johns Capital A/C 1700 | 1700 -------------==== | ===

| Bank 1000

28

Ledger Entries 2
Purchases A/C _______________________________ | Bank 500 | | Rent A/c Bank 50

| | |

________________ Sales A/C ____________ | Cash 700 | |

________________ | | |

29

Balancing of accounts and Trial balance

Johns shop: Trial balance at day 7 Dr 1150 500 700 50 ______ 1700 _____ 1700
30

Cr 1000

Bank Capital Purchases Sales Rent

Johns shop Profit and loss account for days 1 - 7

Sales Cost of books sold Gross profit 700 __ 500_ 200

less: Expenses: Rent Net profit

___50__ 150

31

Johns shop Balance sheet as at day 7

Assets Bank Total assets 1150 __________ 1150

Capital and Liabilities Capital introduced Profit for the period Total capital and liabilities

1000 150 __________ 1150

32

Johns shop Cash flow statement for days 1 - 7

Opening Balance Receipts: Sales Introduction of capital 0 700 1000 1700 ==== 500 50 550 1150 1700 ====

Payments: Purchases Rent Closing Balance

33

Lecture 3

Examine the basic accounting principles

34

GAAP- What is it?

The practice of accounting is governed by a set of principles
or fundamental assumptions

These are more commonly termed as Generally Accepted Accounting Principles (GAAP). Accountants follow these principles while preparing the financial statements.

35

1. Money Measurement Convention

Only include items which can be quantified in monetary terms. Examples of resources that cannot be quantified in monetary terms and not included on the Balance Sheet:
the value of the workforce and management the relationship with customers the health of the president of the company.

36

2. Historical Cost Convention

Valued on a (historical) cost basis, i.e. acquisition cost. Example:
a house was bought 10 years ago at 100,000. Current market value of the house is now 300,000. show it at 100,000 in the balance sheet.
37

3. Business Entity Convention

Owners are separate from business.
Accounts are kept for the entities not for the person who owns it.

Example:
The capital provided by the owner/shareholder to the business.
38

4. Dual Aspect Convention

Each transaction has two aspects debit and credit.
Example: What are the two aspects of each of the following transactions?
purchased 1,000 goods on credit owner withdraws 2,000 in cash sale of stock (purchased for 1,000) for 2,000 cash

39

5. The going concern concept

An enterprise will continue in operational existence for the foreseeable future Example: assets valued at their acquisition cost

40

6. Consistency concept
Consistency of accounting treatment of similar items for each accounting period and from one period to the next Example: Depreciation method Purpose:
limit the possibility of manipulations meaningful comparison - users confidence is increased

41

7. Accrual/matching concept

revenue and expenses are recognised in the period they are incurred this may not coincide with the date of cash receipt or payment Examples:
stock sales costs (accruals, prepayments)

42

8. Prudence/conservatism concept (1)

Anticipate no profits or income until and unless it is realised but provide for all possible future losses
Examples:
provision for doubtful debts valuation of stock

43

8. Prudence/conservatism concept (2)

Arguments for:
compensate for over-optimism Prevent overstating profits the only practical way of dealing with future uncertainty

Arguments against:
-- Conflict with other accounting concepts:
with the consistency with the matching

44

9. Periodicity Concept
Business will run for an indefinite period Divide the life of a business into smaller periods
These are called accounting period.

It could vary from one month to one year depending on the information requirements of the business.
Usually, in most of the cases it is one year,

Example: 1st January to 31st December or 1st July to 30th June.

45

Progress Check 2
Which one of the following is not an accounting concept?
a. Business Entity
b. Consistency c. Matching

d. Conservatory

46

Progress Check 3 Prudence concept says that:

a. Anticipate all profits irrespective of their realisation prospect b. Anticipate no profits until it is realised c. Do not provide for future losses until they are incurred

d. Provide for all future income and expenses

47