INTRODUCTION TO THE ACCOUNTING STATEMENTS The purpose of this course is to introduce you to basic bookkeeping and accounting and thus to eplain the basis upon which financial information is recorded, aggregated and communicated. Broadly speaking the recording aspect of accountancy work is called 'bookkeeping' and this is governed by the application of well-worn and generally accepted principles. Rather than define and eplain these principles one by one we will look at an individual setting up a business and the way in which he records his transactions. Having seen the way in which transactions are recorded we will be able to look at the preparation of his financial statements, which are the Balance Sheet and the Trading and Profit and Loss Account. First, we will consider some of the broad concepts. 1. Distinction between Bookkeeping and Accounting The systematic recording and classifying of business transactions is called bookkeeping. The procedures adopted in bookkeeping and the interpretation of the results obtained is called accounting. Accounting is thus a broader term than bookkeeping and encompasses the term bookkeeping since accounting determines the principles to be used, the records to be kept and the procedures to be followed. 2. The Business Entity Principle This is one of the rules of bookkeeping and there never is, nor can be, any departure from it. This rule is that the business must be thought of as something completely separate and distinct from those who own it. You must always think in terms of what the business does and how it is affected by its actions. Whatever the form of the business organisation may be - sole trader, partnership or limited company - for bookkeeping purposes that organisation is a separate entity. So, if we are discussing the business of a sole trader we do not take into account his/her other activities (eg personal possessions and transactions). 3. The Concept of Double-Entry (or the dual aspect concept) If a business is separate and distinct from its owners, it follows that a new business has nothing until it enters into obligations with its owners or with third parties. CIPFA 1
The very first obligation will usually be borrowing from the owner. In the case of a sole trader the owner is called a proprietor and the position of the business which has entered into an obligation with its proprietor can be seen as an equation where:- The things owned by the business = The amount owing to the proprietor. In the public sector, this translates to: The things owned by the organisation = Tapayers Equity The term tapayers equity is used to recognise that all public sector assets are owned by the public. The things owned by the organisation are called ASSETS and the amount owing to the proprietor (tapayer) in the beginning is called CAPITAL. In practice, various public sector bodies will have different terminology for Capital e.g. General Reserves. Therefore the equation becomes: ASSETS = CAPITAL Even at this early stage in business we are touching on the concept of double-entry. We see that to record an asset we must also acknowledge and record an amount owing in respect of that asset. Thus, for everything owned there is a corresponding amount owing i.e. there are two sides. Each transaction that the organisation undertakes will require these two sides and therefore two bookkeeping entries one to record the asset (the thing owned) and one to record the liability (the amount owing). For every debit there will be a corresponding credit. 4. The Accounting Equation We looked a little earlier at an equation to describe an obligation entered into by the business with its proprietor: The things owned by the business = The amount owing to the proprietor (the public). This equation is the beginning of the accounting equation. The ultimate equation is: CIPFA 2
NET ASSETS = PROPRIETOR'S INTEREST (TAXPAYERS EQUITY) To see how we get from the first stage of the equation to the ultimate accounting equation we will look at setting up a fictitious public sector agency and recording the transactions of that organisation. The Story of the National Administration Agency (NAA) NAA was set up by the Department of Administrative Affairs to oversee the implementation of efficiency targets identified by Government. As part of the 2010 spending review, a sum of 1m was earmarked for set up costs during 2011/12. Officers within DAA were tasked with setting up the agency and Departmental Finance set up a bank account into which the 1M was drawn down from the consolidated fund. It was decided that the terminology to be used to describe capital within the Aqency would be General Reserves. At this early stage we can establish the first accounting equation that will represent the separate entity of the NAA. ASSETS (cash) = GENERAL RESERVES (Tapayers Equity) How are Academies funded to undertake their operations? The equation is: 000 000 Cash at bank General Reserves = ASSETS = CAPITAL Is there a specific piece of terminology for capital in your organisation? Whilst some agency staff were to be based at the Departments, there was a need to have additional accommodation for staff. Having carried out an economic appraisal, the Department opted to purchase premises at a cost of 750,000. Using the original allocation, the Department bought the desired property. This will change the contents of the equation to: CIPFA 3
000 000 Property General Reserves + Cash at bank 250 = But we still have: ASSETS = GENERAL RESERVES (At this point just check that you understand that although the type of asset held is changing they are still assets and are still equal to the money invested by the tapayer (Capital/General Reserves). The agency then ordered goods from suppliers. The goods were 5 computers, each costing 3,000 and stationery, costing 2,000. The goods arrived three weeks later. At this point in time, the business owned more assets and had liabilities to pay for them (it owed money to suppliers called creditors). Also note the term stock. Property 750 General Reserves + + IT Equipment Creditors + = Stock + Cash 250 1,017 1,017 And still: ASSETS = GENERAL RESERVES + LIABILITIES CIPFA 4
The invoices were authorised and paid two weeks later. now changes to: The equation Property 750 General Reserves + + IT Equipment 15 Creditors 0 + Stock 2 = Cash 233 Or: ASSETS = GENERAL RESERVES + LIABILITIES ASSETS = TAXPAYERS EQUITY + LIABILITIES We are now nearing the ultimate accounting equation. equation we have just derived: Taking the ASSETS = TAXPAYERS EQUITY + LIABILITIES and moving the liabilities to the other side of the equation we have: ASSETS - LIABILITIES = TAXPAYERS EQUITY Or: NET ASSETS = TAXPAYERS EQUITY CIPFA 5
An Introduction to the Balance Sheet The Balance Sheet is a statement of the assets and liabilities of a public sector organisation at a particular point in time. It is the accounting equation: NET ASSETS (Assets - Liabilities) = TAXPAYERS EQUITY (General reserves + Retained Surplus/(Deficit)) When a public sector organisation draws up its Balance Sheet, it will analyse and divide up the assets and liabilities so that anyone reading it can see in more detail what sort of assets and liabilities the organisation has. The typical format of a Balance Sheet is shown on the net page. CIPFA 6
Balance Sheet as at 31 March 2011 Fied Assets Freehold Property Plant and Machinery CURRENT ASSETS Stock Debtors Cash Less: CURRENT LIABILITIES Creditors Accruals () () NET CURRENT ASSETS NET ASSETS X TAXPAYERS EQUITY General Reserves Retained Surpluses X CIPFA 7
We will now look again at the NAA and the position it had reached. If you remember we had epressed the position of the organisation in the form of the accounting equation: Property 750 General Reserves + + IT Equipment 15 Creditors 0 + Stock 2 = Cash 233 ASSETS = PROPRIETOR'S INTEREST (TAXPAYERS EQUITY) + LIABILITIES Or: ASSETS LIABILITIES (NET ASSETS) = TAXPAYERS EQUITY CIPFA 8
We can now rearrange this into a Balance Sheet format. FIXED ASSETS 000 000 Property 750 IT Equipment 15 CURRENT ASSETS Cash at bank 233 Stock 2 Less: CURRENT LIABILTIES 235 Creditors 0 NET CURRENT ASSETS 235 NET ASSETS TAXPAYERS EQUITY General Reserves CIPFA 9
An Introduction to the Income and Ependiture Account The Income and Ependiture Account shows a detailed analysis of the income and ependiture in a period that has resulted in the surplus (or deficit) for the period. A typical Income and Ependiture Account would be as follows: Income and Ependiture Account for the Year Ended 31 March 2011 INCOME Less: EXPENDITURE Salaries and Wages Rent Rates Lighting and Heating Stationery Insurance () OPERATING SURPLUS Interest Paid SURPLUS FOR THE YEAR () Note how brackets round a figure can be used to indicate that is being deducted from the figure above it. The Trial Balance A Trial Balance can be prepared at any time during the year. The most important Trial Balance is the one etracted at the end of the year before preparing the Financial Accounts of the organisation. Once the ledger accounts have been balanced, every ledger account is listed and the balance of each account is inserted under either the debit column or the credit column (depending on whether the balance is a debit balance or a credit balance). Both columns are totalled and by virtue of CIPFA 10
the double-entry principle should be equal. If they are not equal then there must be an error in the books of account. This list of balances is known as the TRIAL BALANCE. A proforma trial balance is shown below:- Capital Account Property Fitures and Fittings Vehicles Cash Account Salaries and Wages Rates Income Debtors Creditors Supplies and Services Dr Cr CIPFA 11