ImperialBusinessX: ICBS001 Accounting Essentials

Accounting Equation

The basic accounting equation can be expressed as follows: assets - liabilities = equity.

Accounting period

The accounting period is generally a quarter or a year and reflects all of the financial activity that occurred during that time.

Accruals

Another term for accrued expenses.

Accumulated depreciation

Fixed assets such as plant and equipment and industrial buildings are depreciated over their expected life i.e. each year a portion of the original cost is written off (annual depreciation). Accumulated depreciation is the total amount of the original cost that has been written off by the accountants (note that it is totally independent of considerations of market value or actual wear and tear). The item is found in the balance sheet.

Administrative costs

Include all executive, organisational and clerical costs associated with the general management of an organisation rather than with manufacturing, marketing or selling. Examples of administrative costs include executive compensation, general accounting, secretarial, public relations and similar costs involved in the general administration of the organisation as a whole.

Assets

On the balance sheet, this term represents all the resources of the business plus any money (or resources) owed to the business.

Balance sheet  

One of three primary financial statements, shows the status of a company’s assets, liabilities, and owner's’ equity on a given date.

Also known as the Statement of financial position

Bad debt

Debt, usually consisting of trade receivables, account receivables or receivables, that may not be collected. This has to be written off from the account.

Break-even

The point at which the costs incurred by a product are equal to the income generated by that product.

Budget

The estimation of revenues and expenses for a specified future period of time. Budgets are re-evaluated on a periodic basis.

Cash

On a balance sheet, this includes all cash held in tills or cash boxes plus any surplus in current accounts at the bank.

Cash flow from financing activities

This represents the difference between the inflow and outflow of cash from financial activities. Inflows could come from sources such as cash from investors (new equity introduced) or new loan capital raised. Outflows could come from transactions such as payment of dividends to shareholders, loan repayments and the interest on loans.

Cash flow from investments

This represents the difference between the inflow and outflow of cash from investing activities. Inflows could come from sources such as the sale of fixed assets (e.g. property) or investments. Outflows could come from transactions such as the purchase of fixed assets or investments.

Cash flow from operations

This represents the difference between the cash receipts from selling the company’s products or services and the cash payments from operations.

This represents the cost of purchasing or manufacturing the goods or services that were sold during the period. For example, the cost of materials for manufactured goods or cost of labour for services. In a manufacturing company, this can be calculated by: opening stock + purchases – closing stock.

Cost volume profit

A management accounting technique that is concerned with the effect of sales volume and product costs on the operating profit of a business.

Creditors

On a balance sheet, this is the total of money owed to suppliers at the balance sheet date for stocks purchased and expenses incurred but not yet paid for.  This is categorised as a current liability on the balance sheet.  

Trade payables

Also known as accounts payable in the US.

Current assets

This refers to all those assets that would normally be expected to be converted into cash or otherwise used up during the company’s accounting year.

Current liabilities

This covers those claims that are expected to be satisfied within the next financial year.

Conservatism concept

The conservatism concept holds that accountants should always take a cautious approach when producing financial statements. For example:

• That accounts recognise expected future losses immediately, subject to the test that this results in reporting a more reliable figure for profit.

• That whenever there are alternative procedures or values, the accountant will choose the one that results in a lower profit, a lower asset value and a higher liability value.

It is also known as the prudence concept.

Debtors

On a balance sheet, these are amounts owed to the company by its customers for goods that have been sold on credit.  

Trade receivables

Also known as accounts receivable in the US.

Direct costs can be completely attributed to the production of specific goods and services. Examples include direct labour costs and direct material costs.  

Published income statements also show dividends for the year (received by the shareholders) and the remaining profit which is retained by the business (retained earnings). The owners’ claim (equity capital) is therefore increased by the profit for the year but reduced by the dividend distributed during the year, i.e. the retained earnings reserve in the balance sheet increases if profit for the year is greater than dividends for the year and decreases if profit for the year is less than dividends for the year. If the company makes a loss (retained earnings is negative) then this amount is subtracted from the retained earnings reserve in the balance sheet.

Depreciation

Depreciation is the method of allocating the cost of assets being used during their effective life.

Drawings

A drawing account records withdrawn money from a business by its owners. The account is used primarily for businesses that are taxed as sole proprietorships or partnerships.

Can be also called withdrawals.

Duality

One of several major concepts which underpin the financial statements of a company, requires that the sum of the total assets of a business must equal the sum of the total claims on the assets of the business. This is a basic identity of financial accounting, often referred to accounting equation, which means that a correctly prepared balance sheet must balance.

Equity

This is the claim of the owners, typically the ordinary shareholders and in some cases the preference shareholders.

Expenditure

This leads to the acquisition of resources in order to help generate future revenues. Thus purchasing a machine, new land and plant, etc, represents the acquisition of fixed assets, not expenses.

Expenses

Expenses are defined as the cost of resources used up in an operating period. They usually refer to things that are consumed during the operational cycle. Typical examples include purchases, wages, depreciation, etc. Expenses are not the same thing as cash expenditure.

Feasibility

The information should be collected easily and economically.

Fixed assets

These include tangible, long-lived assets bought for the running of the business in the long term such as factories, offices, equipment, etc.  Property and land are also classified as fixed assets. Intangible assets such as patents, goodwill and research and development may also appear as fixed assets on the balance sheet.  Except in the special case of an asset revaluation, fixed assets are shown in the accounts at their original (historical) cost.  

Also known as non-current assets.

Fixed costs

Costs which do not change as the production level changes.

Financial performance

A measure of the results of the organisation in monetary terms, for example, profit and revenue.

Gross profit

Gross profit is calculated as total revenues (equivalent to total sales) minus the cost of goods sold.

Also called gross margin or gross income.

Historic cost

An asset is recorded in the balance sheet based on its nominal or original cost when acquired by the company.

Implementation

In the implementation step, objectives are translated into budgets. The budgeted financial statements are put together as a master budget.

Income statement

One of the three primary financial statements. A report on a company’s financial status describing revenues and expenses over a specific period of time.

Also known as the profit and loss account.

Indirect costs

Costs that cannot be traced to units of production. As such, they need to be separated from direct costs to keep track of their development.

Liabilities

The debts of a company and other financial obligations, the opposite of assets.

Limited company

The liability of owners is limited to what they have invested. The company is a separate legal entity from its shareholder.

Long-term debt

Loans and obligations with a maturity of longer than one year, usually accompanied by interest payments.  This can include long-term loans and mortgages.

It can be debt or loan.

Management accounting

Management accounting is the process of identifying, analysing, interpreting and communicating internal information to inside users.

Manufacturing costs

Costs necessary to convert raw materials into products. Can be split into direct materials, direct labour and manufacturing overheads.

Marketing or selling costs

Include all costs necessary to secure customer orders and get the finished product or service into the hands of the customer. Examples of marketing costs include advertising, shipping, sales travel, sales commissions, sales salaries and costs of finished goods warehouses.

Matching concept

The matching concept states that the revenues and expenses of a transaction should be shown together (matched) in the same accounting period regardless of the actual timing of their cash settlement.

Non-manufacturing costs

Non-manufacturing costs consist of marketing and selling costs, and administrative costs.

NPV

The cash flows of an investment, adjusted for the time value of money, recognising the fact that later cash flows have less value.

Objectivity

The information should be impartial, unbiased and free from subjective valuation.

Payback method

Enables us to estimate how long it will take before an investment will pay for itself.

Partnership

Two or more people join together to pool their assets and share profits and liabilities.

Prime cost:

Prime cost is the total of both direct costs and direct labour. Hence, they are directly related to the production process. Examples include raw material purchase, wages of the production team, etc.

Prepaid expenses

On a balance sheet, these are typically services that have been paid for but not yet used up.  An insurance policy paid for in advance, can be thought of as a right to insurance cover over the time of the policy. If rent is paid in advance, the right to use the premises until payment is again due is regarded as an asset.

Also known as prepayments.

Profit for the financial year

This represents the ‘bottom-line’ measure of financial performance, i.e. it is the profit that has been produced for the shareholders of the business after deducting both interest and corporation tax expenses.

Provision for tax

Taxes on sale and profits are paid after the year end because the exact figures for sales and profits (hence taxes) are not known until the accounts are finalised after the end of the financial year. So some tax is often found to be owing when the accounts are finally produced. This is categorised as a current liability on the balance sheet.  

Also known as taxes payable in the US.

Relevance

The information generated by an accounting system should impact the decision-making of someone perusing the information.

Revenue

Amount generated from sales of goods or services, or any other use of capital or assets, associated with the main operations of a company before any costs or expenses are deducted.

Realisation concept

This states that a profit on an asset is reported in the income statement only when the asset is sold, i.e. we cannot include increases in the value of an asset in reported profit until the asset is sold.

This is the income realised from selling goods or services before deductions for expenses for an accounting period. Sometimes simply referred to as revenue or sales.

Share premium account

When ordinary shares are issued on the stock market, it is likely that the issue price will exceed the par value of the shares. If the investors pay the company an excess over the par value of the shares, then that excess is recorded in a share premium account.

Straight line depreciation

Calculates an equal amount of depreciation each accounting period. Depreciation expenses are estimated by dividing the difference between the asset’s historical cost and the salvage value by the number of years it is expected to be used.

Stock

On a balance sheet, these are the goods that the company is in business to sell. They also include raw materials and partly manufactured goods.  

Also known as inventory.

Sole trader

An individual trades under his own name. The owner is 100% responsible for the business liabilities and its debts and also retain full control of the business and profit.

Time value of money

The concept of time value of money states that money available at the present time is worth more than the same amount in the future.

Variable costs

Costs that react to the change in product level.

Valuation

An estimation of the monetary worth of an asset.