2857 accounting for governmental and non profit organizations 203203 chapter 3

 Accounting - a process of identifying, recording, summarizing, and reporting economic information to decision makers in the form of financial statements  Financial accounting - focus

 Accounting - a process of identifying,

recording, summarizing, and reporting

economic information to decision makers in the form of financial statements

 Financial accounting - focuses on the

specific needs of decision makers external

to the organization, such as stockholders, suppliers, banks, and government agencies

 The accounting system is a series of steps

performed to analyze, record, quantify,

accumulate, summarize, classify, report, and interpret economic events and their effects on

an organization and to prepare the financial statements.

 Accounting systems are designed to meet the needs of the decisions makers who use the financial information.

 Every business has some sort of accounting system.

◦ These accounting systems may be very complex

or very simple, but the real value of any

accounting system lies in the information that the system provides.

 Accounting information is useful to anyone who makes decisions that

have economic results.

• Managers want to know if a new product will be

profitable.

• Owners want to know which employees are productive.

• Investors want to know if a company is a good

investment.

• Creditors want to know if they should extend credit, how much to extend, and for how long.

• Government regulators want to know if financial

statements conform to requirements.

 Fundamental relationships in the making process:

decision-Event

Accountant’s analysis &

recording

Financial Statements Users

 The major distinction between financial and management accounting is the users of the information.

◦ Financial accounting serves external users.

◦ Management accounting serves internal users, such as top executives, management,

and administrators within organizations.

The primary questions about an organization’s success that decision makers want to know

Accountants answer these primary questions with three major financial statements.

 Balance Sheet - financial picture on a given day

 Income Statement - performance over a

given period

 Statement of Cash Flows - performance over

a given period

 Annual report - a document prepared by

management and distributed to current and potential investors to inform them about the company’s past performance and future

prospects.

◦ The annual report is one of the most common

sources of financial information used by investors and managers.

 The annual report usually includes:

◦ a letter from corporate management

◦ a discussion and analysis of recent economic events

by management

◦ footnotes that explain many elements of the financial statements in more detail

◦ the report of the independent auditors

◦ a statement of management’s responsibility for

preparation of the financial statements

◦ other corporate information

 What are the different sections

of the Balance Sheet?

The balance sheet (also called statement of

financial position or statement of financial condition) is a snapshot of the financial

status of an organization at a point in time

Assets are economic resources that

are expected to benefit future activities of the organization

Liabilities are the entity’s economic

obligations to others

Owners’ equity is the excess

of the assets over the liabilities.

Shareholders’ equity

Paid-in capital

Retained earnings

The owners’ equity of a corporation

is called shareholders’ equity share holders’ equity.

Sections of the balance sheet:

 Assets - resources of the firm that are

expected to increase or cause future cash

flows (everything the firm owns)

 Liabilities - obligations of the firm to outsiders

or claims against its assets by outsiders (debts

of the firm)

 Owners’ Equity - the residual interest in, or

remaining claims against, the firm’s assets

after deducting liabilities (rights of the owners)

The balance sheet equation:

Assets = Liabilities + Owners’

Equity

or

Owners’ Equity = Assets -

Liabilities

 Balance Sheet

 Income Statement (also called Statement of

Operations, Earnings Statement, Profit/Loss (or P&L)

Statement

 Statement of Changes in Stockholders’

Equity

Net income - Dividends = End of period total

equity

 Statement of Cash Flows

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Different categories of users need different kinds of information for making decisions These users can be divided into :

•Internal Users; and

•External Users

These are the persons who manage the business, i.e management at the top, middle, and lower levels Their requirements

of information are different because they make different types of decisions

The top level is more concerned with planning; the middle level is concerned equally with planning and control; and the lower level is concerned more with controlling operations Information is supplied on different aspects, e.g cash resources, sales estimates, results of operations, financial position, etc

All persons other than internal users come

in the group of external users External users can be divided into two groups:

 those having direct interest; and

 those having indirect interest

in a business organization

The main sources of information for external users are annual reports of business organizations, which state the financial position and performance and give the auditor’s report, director’s report and other information

Investors and creditors are the external users having direct interest Tax authorities, regulatory agencies, customers, labour unions, trade associations, stock exchanges, investors, etc are indirectly interested in the company’s financial strength, its ability to meet short-term and long-term obligations, its future earning power, etc for making various decisions.

These are economic resources of an enterprise that can be usefully expressed in monetary terms Assets are things of value used by the business in its operations.

 Fixed Assets

 Current Assets

 Fixed Assets are assets held on a term basis.

long-e.g Land, Building, Machinery, Plant,

Furniture and Fixtures, etc

 Current Assets are assets held on a term basis.

short-e.g Debtors, Bills receivable,

Stock(Inventory), Cash and Bank

balances, etc

These are obligations or debts that the enterprise must pay in money or services at some time in the future.

• Long-term liabilities

• Short-term liabilities

Long-term liabilities are those that are usually payable after a period of one year.

e.g A term loan from a financial institution,

debentures (bonds) issued by a company.

Short-term liabilities are obligations that are payable within a period of one year.

e.g Creditors, bills payable, overdraft from

a bank for a short period

Investment by the owner for use in the firm

is known as capital Owner’s equity is the ownership claim on total assets It is equal

to total assets minus total liabilities

These are the amounts the business earns

by selling its products or providing services

to customers Other titles and sources of revenue common to many businesses are: sales, fees, commission, interest, dividends, royalties, rent received, etc

These are costs incurred by a business in the process of earning revenue Generally, expenses are measured by the cost of assets consumed or services used during an accounting period The usual titles of expenses are: depreciation, rent, wages, salaries, interest, costs of heat, light and water, telephone, etc.

Purchases are total amount of goods procured by a business on credit and for cash, for use or sale In a trading concern, purchases are made of merchandise for resale with or without processing

In a manufacturing concern, raw materials are purchased, processed further into finished goods and then sold Purchases may be cash purchase or credit purchase

Sales are total revenues from goods or services sold or provided to customers Sales may be cash sales or credit sales

Stock (Inventory) is a measure of something on hand – goods, spares and other items – in a business

It is called stock on hand

In a trading concern, the stock on hand is the amount of goods which have not been sold on the date on which the balance sheet

is prepared This is also called closing

stock

In a manufacturing concern, closing stock comprises raw materials, semi-finished goods and finished goods on hand on the closing date

Similarly, opening stock is the amount of stock at the beginning of the accounting year

Debtors are persons and/or other entities who owe to an enterprise an amount for receiving goods and services on credit

The total amount standing against such persons and/or entities on the closing date, is shown in the Balance Sheet as Sundry Debtors on the asset side

Creditors are persons and/or other entities who have to be paid by an enterprise an amount for providing the enterprise goods and services on credit

The total amount standing to the favour of such persons and/or entities on the closing date, is shown in the Balance Sheet as Sundry Creditors

on the liability side

Accounting principles can be subdivided into two categories:

 Accounting Concepts; and

 Accounting Conventions

Accounting principles can be subdivided into two categories:

 Accounting Concepts; and

 Accounting Conventions

 Accounting Concepts

 Accounting Conventions

The term ‘concept’ is used to connote accounting postulates, that is necessary assumptions and conditions upon which accounting is based The term ‘convention’

is used to signify customs and traditions as

a guide to the presentation of accounting statements

Accounting Concepts

Accounting Conventions

Accounting Concepts

The term ‘concept’ is used to connote accounting postulates, that is necessary assumptions and conditions upon which accounting is based

Business is treated as a separate entity or unit apart from its owner and others All the transactions of the business are recorded in the books of business from the point of view

of the business as an entity and even the owner is treated as a creditor to the extent

of his/her capital

In accounting, we record only those transactions which are expressed in terms

of money In other words, a fact which can not be expressed in monetary terms, is not recorded in the books of accounts

Transactions are entered in the books of accounts at the amount actually involved Suppose a company purchases a car for Rs.1,50,000/- the real value of which is Rs.2,00,000/-, the purchase will be recorded

as Rs.1,50,000/- and not any more This is one of the most important concept and it prevents arbitrary values being put on transactions

It is persuaded that the business will exists for a long time and transactions are recorded from this point of view

Each transaction has two aspects, that is, the receiving benefit by one party and the giving benefit by the other This principle is the core of accountancy.

For example, the proprietor of a business starts his business with Cash Rs.1,00,000/-, Machinery of Rs.50,000/- and Building of Rs.30,000/-, then this fact is recorded at two places That is Assets account (Cash, Machinery & Building) and Capital accounts The capital of the business is equal to the assets of the business

Thus, the dual aspect can be expressed as under

Capital + Liabilities = Assets

or

Capital = Assets – Liabilities

Accounting is a historical record of transactions It records what has happened

It does not anticipate events This is of great important in preventing business firms from inflating their profits by recording sales and income that are likely to accrue

Strictly speaking, the net income can be measured by comparing the assets of the business existing at the time of its liquidation But as the life of the business is assumed to be infinite, the measurement of income according to the above concept is not possible So a twelve month period is normally adopted for this purpose This time interval is called accounting period

Accounting Conventions

The term ‘convention’ is used to signify customs and traditions as a guide to the presentation of accounting statements

In order to enable the management to draw important conclusions regarding the working

of the company over a few years, it is essential that accounting practices and methods remain unchanged from one accounting period to another The comparison of one accounting period with that of another is possible only when the convention of consistency is followed

This principle implies that accounts must be honestly prepared and all material information must be disclosed therein The contents of Balance Sheet and Profit and Loss Account are prescribed by law These are designed to make disclosure of all material facts compulsory

Financial statements are always drawn up

on rather a conservative basis That is, showing a position better than what it is, not permitted It is also not proper to show

a position worse than what it is In other words, secret reserves are not permitted

• Keeping systematic records

• Protecting properties of the business

• Communicating the results

• Meeting legal requirements

The first function of accounting is to keep a systematic record of financial transactions,

to post them to the ledger accounts and ultimately prepare final statements

The second important function is to protect the property of the business The system accounting is designed in such a way that it protects its assets from an unjustified and unwarranted use

The fourth and the last function of accounting is to meet the legal requirements under the Companies Act, Income Tax Act, Sales Tax Act and so on

Recording transactions in subsidiary books.

Classifying data by posting from subsidiary books to the accounts

Closing the books and preparation of final accounts

• Accounts in the names of persons are known as

“Personal Accounts”

• Accounts in the names of assets are known as

“Real Accounts”

• Accounts in respect of expenses and incomes

are known as “Nominal Accounts”

Accounts in the name of persons are known as personal accounts

Eg: Babu A/C,

Babu & Co A/C,

Outstanding Salaries A/C, etc.

These are accounts of assets or properties Assets may be tangible or intangible Real accounts are impersonal which are tangible or intangible in nature

Eg:- Cash a/c, Building a/c, etc are Real

Accounts related to things which we can feel, see and touch.

Goodwill a/c, Patent a/c, etc Real Accounts which are of intangible in nature