Accounting

Financial Accounting vs Management Accounting

Financial accounting focuses mainly on past events. It records and summarises financial transactions to satisfy the information needs of external users, such as investors. The presentation of financial reports is also subject to strict rules and standards, such as IAS and IFRS. For example, an accountant may prepare the Statement of Financial Position of a business at a particular point in time using historical financial information.

Management accounting focuses mainly on future planning for internal users. It can be prepared as often as management requires and does not have the same strict presentation rules as financial accounting. For example, a manager may estimate a business's future expenses and revenue and compare them with the actual results.

Useful Financial Information

Understandable - financial information should be understandable to users who have some knowledge of accounting.
Relevant - financial information should be valuable and useful for users.
Reliable - financial information should be free of bias, complete, and accurate.
Comparable - financial information should be compared with other businesses and time periods.

Users of Financial Information

Investors – they use financial information to assess the performance of the business and management and to decide whether to invest or continue investing.

Government – it uses financial information to assess taxation and to check that businesses comply with the law.

Creditors – they use financial information to assess whether a business can repay its debts and whether it is creditworthy.

Employees – they use financial information to assess whether a business can provide long-term job security, good pay and working conditions.

Limitations of Financial Information

Information relates to one entity – financial information mainly provides information about one specific business.

Information must be quantifiable – financial information must be measurable and capable of being presented in monetary terms.

Historical information – financial information mainly contains information relating to past events and past accounting periods.

Exclusion of non-financial factors – important information that cannot be measured in monetary terms may be excluded from financial statements.

Entity: Sole Trader vs Partnership vs LLC vs Non-profit Organization

An entity is a business or organisation. A business may manufacture or sell goods and services to customers. Not all organisations are businesses seeking to make a profit.

A sole trader is a business owned by one person. The owner has complete control over running the business and owns the business assets. A sole trader has unlimited liability and usually has little regulation.

A partnership is a business owned by two or more people. The partners share control over running the business. A partnership usually has unlimited liability and has stricter regulation than a sole trader.

A limited liability company is a business owned by shareholders and is a separate legal entity from its owners. Shareholders have limited liability, which means their liability is limited to the amount they have invested in the business. A limited liability company usually has greater regulation than a sole trader and partnership and may have tax advantages.

A not-for-profit organisation is an organisation whose main purpose is to provide a service to the public rather than to make a profit. Examples include charities, clubs, schools and hospitals.

Main objectives of an accounting system

To record and control business transactions.

To maintain accuracy in recording.

To meet the requirements of the law.

To present final financial statements.

To present other financial reports and analyses.

Sole Trader

Advantages:

• The owner is their own boss.

• The owner keeps all profits.

• Low start-up costs.

• Simple business structure.

• Maximum privacy.

• Little regulation.

Disadvantages:

• Unlimited liability for business debts.

• Limited capacity to raise capital.

• Total responsibility for day-to-day decisions.

• Taxation may be a disadvantage.

• Difficult for the owner to take holidays.

Partnership

Advantages:

• Two heads are better than one.

• Low start-up costs.

• Greater borrowing capacity.

• Partners' business affairs are private.

• Limited regulation.

Disadvantages:

• Each partner may be liable for total partnership debts.

• Risk of disagreement between partners.

• Costs associated with setting up the partnership.

LLC

Advantages:

• Limited liability.

• Tax advantages.

• Wealth of expertise.

• The company does not dissolve if directors leave.

• Greater ability to raise finance.

Disadvantages:

• Costs associated with setting up the company.

• High volume of paperwork.

• High levels of regulation.

• Complex accounting treatments.

Asset vs Liability

Asset is a resource owned by a business as a result of past events. Assets are expected to bring economic benefits to the business. Assets can be current, such as cash or prepayments, or non-current, such as a factory or machinery.

Liability is an obligation or amount owed by a business as a result of past events. Liability can be current, such as a trade payable or bank overdraft, or non-current, such as loan.

Cpital vs Drawing

Capital is money invested or kept in a business by its owners. For example, if an owner invests $10,000 in a business, capital also increases by $10,000.
Closing Capital = Opening Capital + Capital Introduced + Net Profir - Losses - Drawings

Drawings are money and other assets taken out of a business by its owners for personal use. Drawings reduce the owner’s capital. For example, if a business owns a car and the owner takes the car out of the business for personal use, it is treated as drawings.

Concepts

Going concern means a business is expected to continue operating for the foreseeable future. The business shows no signs of shutting down. For example, if a business is stable and plans to work in the future, it is going concern.

Prudence is cautious presentation of financial position of a business. Assets and profits should not be overstated, and possible losses should be cosidered. For example, if a asset is damaged, its value should be reduced in an account.

Accruals and Matching means that transactions are recorded when they occur, not when money is actually moved. All income and expenses should be recorded in the accounting period in which they occur. For example, if a business purchases goods on credit on 6 September, the transaction should be recorded on the same day even though the business pays for the goods later.

Consistency means that accountants should use the same accounting treatment and methods from year to year. For example, if a business uses one method for an item, it should continue using this method in future accounting periods.

Business entity means personal accounts and business accounts should be kept separate. For example, if Willy buys a car for personal use, the transaction should not be recorded in the business accounts.

Financial Statements

The Statement of Profit or Loss records the income and expenses of a business over an accounting period, usually a financial year, and shows the profit or loss for that period.

Revenue − Cost of Sales = Gross Profit

Satement of Financial position records total assets, liability, and equity of a busines at a specific point in time, and shows the financial position of the business.
Assets - Liability = Equity

Accounting Balances

Revenue is income earned by a business form selling goods or providing services. Revenue is recorded before subtracting expenses. For example, if Spar sells goods for $1000, its Revenue is $1000.

Cost of Sale is the total cost of goods or services that have been sold by a business.
Cost of Sales = Opening Inventory + Purchases - Closing inventory
For example, if Spar purchases goods for $600 and sells all of them, its COS is $600.

Gross profit is profit that is remain after subtracting cost of sales.
Gross Profit = Revenue - Cost of Sales
For example, if Spar purchases goods for $600 and selles all of them for $1000, its Gross Profit is $400.

Net Profit is the profit remaing after subtracting other expenses form Gross Profit.
Net Profit = Gross Profit - Expenses
For example, if Spar purchases goods for $500, sells all of them for $1000, and pays $300 for business expenses, its Net Profit is $200.

Inventory

Inventory is goods owned by a business that have not been sold.

Opening Inventory is the inventory remaining from the previous accounting period at the beginning of the current period.

Closing Inventory is the unsold inventory remaining at the end of an accounting period.

For example, if SPAR has 100 unsold chocolate bars at the end of the year, these bars are Closing Inventory. They become Opening Inventory at the beginning of the next year.

Current assets vs Non-current assets

Non-current Assets are long-term assets that are expected to be used by a business for more than one year. Examples include machinery, factories and vehicles.

Current Assets are short-term assets that are expected to be sold, used or converted into cash within one year. Examples include cash, prepayments, trade receivables and inventory.

Trade payable vs Trade receivable

Trade receivables are current assets that arise when customers owe money to a business for good or services. For example, if a customer buys products for $20 on credit, the business' trade receivable increases by $20.

Trade payables are current liablity that arises when a business owes money to its suppliers for goods. For example, if a business purchases good for $1000 on credit, the business owes more, so its trade payable increases by $1000.

Current Liablility vs Non-current Liablility

Current Liabilities are short-term obligations that are expected to be paid within one year. Examples include bank overdrafts, trade payables and accruals.

Non-current Liabilities are long-term obligations that are due after more than one year. An example is a long-term bank loan.

Double-Entry Bookkeeping

Double-Entry Bookkeeping is a method of recording financial transactions. All transactions affects at least two accounts, which may involve assets, liabilities, capital, income, and expenses. Total debits must equal total credits.

Balancing (closing) a ledger account

Balancing a ledger account maens calcualting the difference between total debits and total credits to find the closing balance of the current accounting period. The closing balance becomes the opening balance at the begining of the next accounting period.

Book of Original Entry vs Nominal Ledger vs Trial Balance

Books of Original Entry are accounting books that record business transaction first, before they are transferred to the Nominal Ledger.

The Nominal Ledger records transactions transferred from Books of Original Enrty into idividuals accounts. It contains all the accounts of the business and uses Double-Entry Bookkeeping.

Trial Balance is a statement that summarises the debit and credit balances extracted from Nominal Ledger. It is prepared to assess the arithmetical accuracy of Double-Entry Bookkeeping. Total debits must equal total credits.

Difference: The Books of Original Entry contain the first records of transactions, while the Nominal Ledger records transactions transferred from Books of Original Entry into individual accounts.

Capital Expenditure vs Revenue Expenditure

Capital expenditure is long-term expenditure on purchasing or improving non-current assets and bringing them into use. IAS states that costs of bringing a non-current asset into working is treated as Capital expenditure. It is recorded as a non-current asset in the Statement of Financial Position. For example, if a business purchases a car for $10,000 and pays $150 for delivery, its total Capital expenditure is $10,150.

Revenue expenditure is day-to-day expenditure on running business, including maintaining and repairing non-current assets. It is recorded as an expense in the Statement of Profit or Loss. For example, if a business purchases a building and in a year pays for maintenance, this is treated as Revenue expenditure.

Ethical responsibilities

Integrity means being straightforward and honest. For example, when an accountant notices that revenue has been overstated, they report the error instead of hiding it to make the comapny looks more profitable.

Objectivity means avoid bias, conflic of interests and external influance that can affect professional judgement. For example, if an accountant prepares a report for a business, they should not change figures due to pressure from managers.

Professional Competence and Due Care means maintaining professional skills and knowledge and performing duties carefully and diligently. For example, if an accountant prepares the Statement of Profit or Loss, they should know how to prepare it and carefully check it for errors.

Confidentiality means respecting confidential information received during profecional work. For example, if an accountant works for Spar, they should not provide confidential information about Spar to its competitors.

Professional Behaviour means complying with relevant laws and regulations and behave appropriately toward clients, colleagues, and the public. For example, if an accountant works for a business, they should comply with relevant regulations and avoid behaviour that could damage their professional reputation.

Accruals vs Prepayments

Accured Expenses are current liability that arise when a business incurs expenses but has not yet paid for them at the end of an accounting period. For example, if a business pays for electricity every three months and has not paid for the last three months when the financial year ends, the unpaid amount is an accured expense.
SOFP - current liability
SOPL - expense

Prepayments are current assets that arise when a business pays expenses in advance, before the related service are used. For example, if a business pays rent for the next accounting period, its prepayments increase.
SOFP - current asset
SOPL - expense

Bad Debt vs Doubtful Debt

A Bad Debt is a debt that is owed by a customer who cannot repay it. For example, if a customer purchases products on credit and then goes bankrupt and cannot to repay the debt, the amount owed is treated as a Bad Debt.

A Doubtful Debt is a debt that is owed by a customer who may not repay it. For example, if a customer purchases products on credit and experiences financial difficulties and may not repay the debt, the amount owed is treated as a Doubtful Debt.

Provision for Doudful Debts vs Bad Debt Recovered

A Provision for Doubtful Debts is an estimate of possible losses from customers who may not repay their debts. It is created according to the Prudence Concept to account for these potential losses.
Provision increases - expense in SOPL
Provision decreases - income in SOPL

A Bad Debt Recovered occurs when a customer repays a debt that was previously written off as a Bad Debt. For example, if a customer goes bankrupt and cannot repay a debt, the business writes it off as a Bad Debt. If the customer later receives money and repays the debt, this is treated as a Bad Debt Recovered.

Discount Allowed vs Discount Received

Discount allowed occurs when a business give a discount to its credit customers. For example, if a customer owes $100 to a business and later the business allow a disount of $10, the trade receivable becomes $90.
DR: Discount allowed
CR: Trade receivable

Discount received occurs when a business received a discount from its suppliers. For example, if a business owes $1000 its suppliers and later receives a $200 discount, the trade payable becomes $800.
DR: Trade payable
CR: Discount received

Control Accounts

Control accounts are use to represent the total balances of similar account, such as Trade payables and Trade receivables.

A dishonoured cheque occurs when a cheque has been issued, but the bank refuses to process the payment. For example, a customer owes $100 to a business and later pays by cheque, but the bank refuses to process the payment, so it is treated as a dishonoured cheque, and the customer still owes $100.

Contra occurs when a creditor and a debtor owe each other money and agree to reduce their obligations by a certain amount. For example, a customer owes $100 to a business, and the business owes $200 to the same customer. Later, they agree to reduce their obligations by $100. This is treated as contra, and the business still owes $100.