INSTITUTE OF DISTANCE LEARNING KNUSTEXECUTIVE MBA/MPA CEMBA/CEMPA 560 ACCOUNTING AND FINANCE

LECTURE ONE BLOCK ONE PREPARATION OF FINANCIAL STATEMENTSUNIT 1 TYPES AND FORMS OF BUSINESS

CLASSIFICATION BY LEVEL OF ACTIVITY Primary FirmsInvolved in extractive industries such as mining, agriculture, oil extraction etc

Secondary FirmsInvolved in processing and manufacturing

Tertiary FirmsInvolved in the provision of services in banking, insurance, education etc.

CLASSIFICATION BY SECTOR Public Sector Business OrganisationFor profit or non-profit controlled by government.

Private Sector OrganisationsOwned by the private sector. eg. Nestle Ghana, Unilever

CLASSIFICATION BY LEGAL STRUCTURE1. Sole Proprietorship One-person business

1. Partnership Two or more and up to 20 persons

1. Limited Companies One or more persons (in Ghana) but must have at least 2 directors.

SOLE PROPRIETORSHIP FEATURESEasy formation Capital Provided by one person Secrecy Owner enjoys all profits and suffers losses alone Small in size Unlimited liability Decision making is easier

PARTNERSHIP FEATURES Easy to set-up Shared work load , profits and risks Diversified pool of expertise is provided Unlimited liability Delay in decision making Two good heads are better than one. Lack of continuity Relatively larger capital base

PARTNERSHIP DEED Formation is based on agreement called a partnership deed (constitution) The deed provides ,among others,Name of Partnership The nature of business Profit and loss sharing ratio Salary payment to active partner(s), if any. Whether drawings should be allowed and interest on drawings

LIMITED COMPANY A body corporate formed under the Companies Code of 1963, Act 179 or an existing company. (Ghanas Companies Act) Justice John Marshal in 1819 defined a corporation as an artificial being, invisible, intangible and existing only in contemplation of law Thus, a company is a legal person having many rights and responsibilities.

Characteristics of a Company Separate legal entity Limited Liability Transferability of shares Ability to acquire a broad capital base Continuous existence Common Seal

Types of a company Private CompanyLimited by shares Limited by guarantee Unlimited

Public CompanyLimited by shares Limited by guarantee Unlimited

Formation of a company Documents neededMemorandum of Association Articles of Association

In Ghana these two are combined and termed Regulations of a company These describe the nature, objects, scope, the bye-laws governing the conduct of business etc.

Classes of sharesTwo main classes: Ordinary shares/ Equity sharesEntitles the holder to share in the residual income and or capital of the company Give the holder the right to vote Give the holder pre-emptive rights

Preference SharesCarries fixed returns Ranks first in dividend payments

Types of preference shares Cumulative Preference Shares Non-Cumulative Preference Shares Participative Preference shares Non-Participative preference Shares Redeemable Preference Shares Convertible Preference Shares

Issuance of Shares Shares may be issued at par value or no par value The nominal value (par value) is the price assigned to the share on issue No par value Shares do have any stated value assigned to the shares

UNIT 1.1 ACCOUNTING DEFINED In 1941, The American Institute of Certified Public Accountants (AICPA) defined accounting as: The art of recording, classifying and summarizing in a significant manner and in terms of money, transactions and events which are, in part at least, of financial character and interpreting the results thereof.

Definition of Accounting (Cont.) American Accounting Association defines Accounting as the process of identifying, measuring and communicating economic information to permit informed judgment and decisions by the users of the information. The information is primarily financial, stated in money terms.

FUNCTION OF ACCOUNTING AICPA in 1970 stated that the function of Accounting is to to provide quantitative information, primarily financial in nature, about economic entities that is intended to be useful in making economic decisions.

ACCOUNTING HISTORY The first book describing the double entry bookkeeping systems was written by an Italian Renaissance Mathematician, Friar Luca Pacioli and was published in 1494. The book named Summa de Arithmatica, Geometrica, Proportioni et Proportionalita was primarily a mathematical work containing a section on double entry bookkeeping.

ACCOUNTING HISTORY(CONT.) Paciolis work discussed the rationale of keeping accounting records and provided detailed description and codification of the double entry system. The emergence of joint stock companies in the 1600s and the New York Stock market crash in the 1929 in which investors suffered heavy losses marked the starting point of modern accounting.

Accounting History The need to provide, disseminate reliable and timely and useful information led to the introduction of what is termed Generally Accepted Accounting Principles (GAAP). These principles were developed with the participation of Institute of Chartered Accountants from other countries.

ACCOUNTING STANDARDS Accounting Standards are pronouncements made by the standard setters which are expected to be used in the preparation of financial statements. The standard setters include Ghana national Accounting Standards Board (GNASB), Accounting Standards Board (ASB) in the U.K, Financial Accounting Standards Board (FASB)in the U.S.

The international Accounting Standards Board (IASB) constituting the professional accounting bodies which are members of international Federation of Accountants (IFAC) such as ICA (Ghana), ACCA, ICA(Eng &Wales), AICPA, ICA(Scotland), etc. Standards are not static; but are revised continuously to suit changing business environment.

USERS OF ACCOUNTING INFORMATION Different groups have direct or indirect interest in a business organisation and for that matter accounting information. These groups include:o The Equity Investor Group

Include existing and potential shareholders who are concerned with returns on their investments.

Users of Accounting Informationo The Loan-Creditor Group

Interested in credit worthiness of the business and long term solvencyo The Employees Group

Interested in profitability, stability and vulnerability of the business since their livelihood is tied to the success of the businesso The Government

Interested for tax purposes, safeguarding the interest of both lenders and investors

Users (Cont.)o The Analyst Advisory Group Includes financial Analysts, journalists, credit-rating agencies &other groups of advisory services. Interested in general financial performance of business and future prospects for use by media, investors, competitors , etc. o The Business-Contact Group Includes customers, trade creditors and suppliers and competitors etc.

MAJOR FIELDS OF ACCOUNTINGFinancial accounting is the preparation of financial statements summarizing past events, usually in the form of profit and loss accounts and balance sheets. These historic statements are mainly of interest to outside parties such as investors, loan providers and suppliers

Major Fields of Accounting (Cont.)Management accounting The provision of much more detailed information about current and future planned events to allow management to carry out their roles of planning, control and decision-making. Cost Accounting and responsibility accounting are two significant parts of Management Accounting.

Major Fields of Accounting (Cont.)Tax Accounting Financial Statements are prepared using GAAP. Accounting standards allow flexibility in the treatment of different items which may not acceptable to the tax authorities. The preparation of tax returns has become a specialized field. Tax planning requires the thorough knowledge of the tax laws

ACCOUNTING EQUATION AND TRANSACTION ANALYSIS SOURCES OF FINANCE FOR A BUSINESS Assets of a business are financed from two sources. External &Internal

External sources to finance a businesss assets are referred to as Liabilities Internal Sources are contributions from ownersowners equity. Assets = External sources + Internal Sources

Accounting Equation Assets = Liabilities + Capital Assets are the resources the business owns which are expected to benefit it in future. Liabilities are creditors claims against the assets of the firm. Capital is the claim of the owners against the assets of the firm. The accounting equation will always remain in balance

For the equation to be in a balance, whatever decreases or increases one side of it must lead to a decrease or an increase in the other side. That is the dual aspect concept.

EFFECTS OF BUSINESS TRANSACTIONS ON THE ACCOUNTING EQUATION.

ILLUSTRATION 1 John started business with GH 15,000 and deposited it in the business bank account Assets = Owners Equity (Capital) GH 15,000 = GH 15,000 Mr. John borrows GH 10,000 from Mr. Mills and puts it into the bank Account of the business.

Effects of Transactions on the Accounting Equation His assets will increase to GH25,000 and the claims against the resources by the owners and outsiders will also be GH25,000. Therefore, the equation will be shown as below. = LIABILITIES + CAPITAL ASSETS Bank = Loan + Capital 25,000 = 10,000 + 15,000

Mr. John used GH12,000 of the money at the bank to purchase plant. The balance at the bank will decrease to GH13,000 and Plant will increase by GH12,000 without changing the claims against the business.

The accounting equation will be

Illustration Cont.ASSETS = LIABILITIES +CAPITAL GH GH GH GH Bank + Plant = Loan + Capital 13,000 + 12,000 = 10,000 + 15,000 The business bought goods on credit from a supplier costing Gh5,500

Both assets and claims against the business will increase by Gh5,500. Stock will increase by Gh5,500 and Creditors will also increase by Gh 5,500. The transaction will affect the equation as follows:

ASSETS = LIABILITIES +CAPITAL GH GH GH GH GH GH Bank + Plant + stock = Loan + Creditors + Capital 13,000 +12,000 +5,500=10,000 +5,500 + 15,000 NOTE: Payment for expenses decreases Assets and decreases capital Revenues increase Assets and increase Capital

The business paid for an expense of Gh500 by cheque. Assets(bank) will reduce by Gh500 and Capital will also reduce by the same amount. The effect of the transaction will be as follows:

ASSETS = LIABILITIES +CAPITAL GH GH GH GH GH GH Bank + Plant + stock = Loan + Creditors + Capital 13,000 +12,000 +5,500=10,000 +5,500 + 15,000 (500) 0 0 0 0 (500) 12,500 +12,000+5,500= 10,000+5,500+14,500

The Accounting equation is expressed in a financial statement called the balance sheet. Mr. Johns balance sheet will therefore be as shown in the next slide.

John Enterprise

Balance Sheet as at 31st December, 20.. GH GH Assets: Capital Plant 12,000 14,500 Stock 5,500 Creditor 5,500 Bank 12,500 Loan (Mills) 10,000 30,000 30,000

Illustration 2The following information relates to Ashili Enterprise for the month of January, 2008. a) Started business with GH25,000cash. b) Deposited GH15,000 in a newly opened bank account. c) Bought goods costing GH5,500, on credit from Jalal. d) Purchase machinery GH10,000 paying GH7,000 immediately by cheque.

Illustration (Cont.)e) Sold goods costing GH2500 to Zidan on credit for GH3, 000. f) Borrowed GH4,000 cash from Sham. g) Cash purchases of goods GH5,300, h) Zidan paidGH2,200, cash in partial settlement of his debt. i) Goods withdrawn for personal use GH500.

Required: show the effect of each transaction on the accounting equation and prepare a balance sheet as at 31st January, 2008.

Analysis of Illustration 2Started business with GH25,000cash

a) ASSETS = LIABILITIES + CAPITAL Cash = 0 + Capital 25,000 = 0 + 25,000Deposited GH15,000 in a newly opened bank account.

b) Cash + Bank Old bal. 25,000 + 0 Effects (15,000) + 15,000 10,000 + 15,000

= =

Capital 25,000 0 25,000

Analysis (Cont.)Bought goods costing GH5,500, on credit from Jalal.

c)

Cash + Bank + Stock

= Creditors + Capital = 0 = 5,500 5,500 + + 25,000 0 25,000

Old bal. 10,000 + 15,000 + 0 Effect 0 + 0 + 5,500 New 10,000 15,000 5,500

Purchase machinery GH10,000 paying GH7,000 immediately by cheque. d) Cash + Bank + Stock + Machinery= Creditors + Capital Old bal. 10,000 + 15,000 + 5,500 + 0 = 5,500 + 25,000 Effects 0 + (7,000) + 0 + 10,000 3,000 + 3,000 New 10,000 8,000 5,500 10,000 8,500 + 25,000

Sold goods costing GH2500 to Zidan on credit for GH3, 000.e) Cash + Bank + Stock + Machinery + Debtors = Creditors+ Capital Old bal. 10,000 + 8,000 + 5,500 + 10,000 + 0 = 8,500 + 25,000 Effects 0 + 0 (2,500) + 0 + 3,000 = + 0 + 500 10,000 8,000 3,000 10,000 3,000 8,500 25,500

Borrowed GH4,000 cash from Sham.f) Cash + Bank + Stock + Machinery + Debtors= Creditors + Loan+ Capital Old bal. 10,000 + 8,000 + 3000 + 10,000 + 3,000 = 8,500 + 0 + 25,500 Effects 4,000 + 0+ 0+ 0 + 0 = 0 + 4,000 + New 14,000 8,000 3,000 10,000 3,000 8,500 4,000 25.500

0

Cash purchases of goods GH 5,300,g) Cash + Bank + Stock + Machinery + Debtors= Creditors + Loan+ Capital Old bal.14,000 + 8,000 + 3000 + 10,000 + 3,000 = 8,500 + 0 + 25,500 Effects (5,300) + 0 + 5,300 + 0 + 0 = 0 + 4,000 + 0 New 8,700 8,000 8,300 10,000 3,000 8,500 4,000 25.500

Zidan paidGH2,200, cash in partial settlement of his debt.h) Cash + Bank + Stock + Machinery + Debtors= Creditors + Loan+ Capital Old bal.8,700 + 8,000 + 3000 + 10,000 + 3,000 = 8,500 + 0 + 25,500 Effects 2,200 + 0 + 5,300 + 0 + (2,200) = 0 + 4,000 + 0 New 10,900 8,000 8,300 10,000 800 8,500 4,000 25.500

Goods withdrawn for personal use GH500.i) Cash + Bank + Stock + Machinery + Debtors= Creditors + Loan+ Capital Old bal.10,900 + 8,000 + 8300 + 10,000 + 3,000 = 8,500 + 0 + 25,500 Effects 0+ 0+ (500) + 0 + 0 = 0 + 4,000 + (500) New 10,900 8,000 7,800 10,000 3,000 8,500 4,000 25.000

Ashili EnterpriseBalance Sheet as at 31 January 2008GH Capital 25,000 Long term Liabilities: Loan 4,000 Current Liabilities: Creditors 8,500 37,500 GH Fixed Assets Machinery 10,000 Current Assets: Stock 7,800 Debtors 800 Bank 8,000 Cash 10,900 27,500 GH

UNIT 1.2 : The Recording Process Most companies employing more than a handful of staff use the system of recording called double entry bookkeeping. This system records both cash and credit transactions as they occur at their different times. The name double entry derives from the fact that each individual transaction is entered twice, recognizing two aspects.

These two aspects are referred to by accountants as debits and credits.

To Summarize:DEBIT SIDE Expenses Increase in Assets ( including customers debts) Decrease in liabilities Cash receipts CREDIT SIDE Income Liabilities ( including owing to suppliers) Decrease in Assets Cash Payments

AN ACCOUNT An account is a statement, which records all the transactions of a specific class, which have taken place during a given period. Account in its simplest form, has three elements: (1) a title consisting of a particular assets, liability or owners equity; (2) a left side, which is called debit side; and (3) a right side, which is called the credit side

This form of account, illustrated below, is called a T account because of its resemblance to the letter T. Account Title Left or debit side Right or credit side

CLASSIFICATION OF ACCOUNT Personal and Impersonal Account (divided into Real and Nominal Accounts) Ledger accounts which bear the names of individuals, partnerships or companies are called PERSONAL ACCOUNTS; All other accounts are called IMPERSONAL ACCOUNTS.

Impersonal accounts may be further sub-divided into two classes: Real Accounts Recording transactions in property and material objects. (E.g. motor van, Land and Building, stock, cash etc) Nominal Accounts records expenses, losses, revenue, incomes or gains. (E.g. sales, purchases, rent and rates, interest paid and receive, etc)

Accounting Cycle1.The process of recording, classifying and summarizing which is repeated in the same order each accounting period is referred to as the ACCOUNTING CYCLE. 2. Several steps are involved from recording of transactions, analysis of those transactions to the generation of financial statements. These steps are collectively called the Accounting Cycle.

Accounting Cycle (Cont.) Analyse the transactions in terms of its effects on the accounting equation Pass the entry in the journal Post the entry to the ledger Balance accounts and extract trial balance Pass and post adjusting entries Prepare financial statements

The Journal THE GENERAL JOURNAL Many businesses maintain several types of journals. The nature of operation and the volume of transactions in a particular business determine the number and types of journals needed. The simplest form of journal is general journal

General Journal The general journal has two money columns, one for debits and the other for credits It may be used for recording any type of transaction in an organisation. The process of a recording transaction in a journal is called journalizing the transaction.

Format of General JournalDate Descripti Post Ref. Dr. on Cr.

Journal entries are illustrated using the transactions of B. Hanan enterprise in the illustrations following:

Illustration The following transactions took place in the books of B. Hanan Enterprise for the month of July, 2008 July 1. Started business with GH4,230 cash 3. Bought goods for cash GH1,755 8. Bought goods on credit GH2,000 from Lincoln 10. Sold goods for cash GH3,000

Illustration (Cont.)July 14. Deposited GH1,800 in a newly opened bank Account 15. Bought motor van by cheque GH820 16. Sold goods on credit to Saani GH8,000 17. Received cheque GH6,000 from Saani part-payment of his account 20. Paid for stationary GH1,150 by cash

as

Illustration (Cont.)July 22. Paid GH1,200 cheque to Lincon as part payment of his account 25. Paid Wages and salaries by cheque GH3,500 27. Cash withdrawn by the proprietor for his personal use GH250 31. Paid the following expenses by cash; electricity GH25 and insurance GH30

Illustration (Cont.) Requirement: Journalise the above transactions and post in a ledger account, balance off the accounts and extract a trial balance.

General Journal ExampleDate Description Post Dr. Ref 4,230 Cr. 1/7/08 Cash a/c Capital a/c (Being cash invested by the owner) Purchases a/c Cash a/c (Being cash purchase of goods) Purchases a/c Creditor (Lincoln ) a/c (Being goods bought on credit from Lincoln)

4,230

3/7/08

1,755

1,755

8/7/08

2,000

2,000

Journal (Cont.)Date10/7/08

DescriptionCash a/c Sales a/c (Being goods sold for cash) Bank a/c Cash a/c (Being cash deposited in a newly open bank) a/c Motor van a/c Bank a/c (Being motor van bought by cash) Debtor (Saani) a/c Sales a/c (Being credit sales of goods to saani) Bank a/c Debtor (Saani) a/c (Being part payments of goods sold to Saani)

Post Ref.

Dr.3,000

Cr.

3,000 1,800 1,800

14/7/08

15/7/08

820 820 8,000 8,000 6,000 6,000

16/7/08

17/7/08

Journal (Cont.)Date20/7/08

DescriptionStationery a/c Cash a/c (Being stationery bought in cash) Creditor (Lincoln) a/c Bank a/c (Being part payment of goods bought on credit) Wages and salaries a/c Bank a/c (Being wages paid by cheque) Drawings a/c Cash a/c (Being cash withdrawn by the business owner) Electricity a/c Insurance a/c Cash a/c (Being electricity and insurance paid by cash)

Post Ref.

Dr.1,150

Cr.

1,150 1,200 1,200 3,500 3,500 250 250 25 30 55

22/7/08

25/7/08

27/7/08

31/7/08

THE LEDGER The record used to keep track of the increases and decreases in a single item in a balance sheet is called a ledger account, or simply an account. The entire group of accounts is kept together in account records called the ledger.

POSTING ENTRIES TO THE LEDGER Posting refers to transferring accounting entries from the journal on to the ledger. As a matter of fact, every debit entry has a corresponding credit entry and vice versa. Account titles take name of the corresponding entry.

The General LedgerCapital Account

GH 31/7/08 Balance c/d

GH 4,230 1/7/08 Cash 4,230 4,230 4,320 1/8/08 Balance b/d 4,320

Cash Account 1/7/08 10/7/08 Capital Sales GH 4,230 3,000 3/7/08 Purchases GH 1,755 1,800 1,150 250 25 30 2,220 7,230

14/7/08 Bank 20/7/08 Stationery 27/7/08 Drawings 31/7/08 Electricity 31/7/08 Insurance 7,230 1/8/08 Balance b/d 2,220 31/7/08 Balance c/d

Purchases Account 3/7/08 Cash 8/7/08Lincoln(creditor) 1/8/08 Balance b/d GH 1,755 2,000 31/7/08 Balance c/d 3,755 3,755 GH 3,755 3,755

Lincoln (Creditor) Account GH 22/7/08 31/7/08 Bank Balance c/d 1,200 8/7/08 800 2,000 Purchases

GH 2,000 2,000 800

1/8/08

Balance b/d

31/7/08 Balance c/d

Sales Account GH 11,000 10/7/08 Cash 11,000 16/7/08 Saani (Debtor) 1/8/08 Balance b/d

GH 3,000 8,000 11,000 11,000

Bank Account 14/7/08 17/7/08 Cash Saani GH 1,800 15/7/08 Motor Van GH 820

6,000 22/7/08 Lincoln (creditor) 1,200 25/7/08 Wages and Salar. 3,500 7,800 2,280 31/7/08 Balance c/d 2,280 7,800

1/8/08

Balance b/d

Motor Van Account 15/7/08 1/8/08 Bank Balance b/d GH 820 31/7/08 820 820 Balance c/d GH 820 820

Saanis (debtor) Account GH 8,000 17/7/08 Bank . . 31/7/08 Bal. c/d 8,000 2,000 GH 6,000 2,000 8,000

16/7/08 Sales

1/8/08 Balance b/d

Stationery Account 20/7/08 1/8/08 Cash Balance b/d GH 1,150 31/7/08 1,150 1,150 Balance c/d GH 1,150 1,150

Wages and Salaries Account GH 3,500 31/7/08 Balance c/d 3,500 3,500 GH 3,500 3,500

25/7/08 Bank 1/8/08 Balance b/d

Drawings Account GH 27/7/08 Cash 1/8/08 Balance b/d 250 31/7/08 250 250 Balance c/d GH 250 250

Electricity Account 31/7/08 1/8/08 Cash Balance b/d GH 25 31/7/08 25 25 Balance c/d GH 25 25

Insurance Account 31/7/08 1/8/08 Cash Balance b/d GH 30 31/7/08 30 30 Balance c/d GH 30 30

B. HANAN ENTERPRISE Trial Balance at 31st July, 2008 PARTICULARS Capital Cash Purchases Creditor Lincoln Sales Bank Motor Van Debtor Saani Stationery Wages and Salaries Drawings Electricity Insurance DEBIT GH 2,220 3,755 2,280 820 2,000 1,150 3,500 250 25 16,030 CREDIT GH 4,230 800 11,000

30

. .. 16,030

UNIT 1.3 FINANCIAL STATEMENTS

COMPONENTS OF FINANCIAL STATEMENTS The International Financial Reporting Standards (IFRS) states the complete set Financial Statement as follows: Statement of Financial Position (Balance Sheet) Statement of Comprehensive Income (Income Statement) Statement of Changes in Equity Cash Flow Statements Accounting Policies & Notes

Objectives of F. S Provision of information about Financial position Financial Performance Changes in Financial Position

To help users in making economic decisions

Objectives of F.S (Cont.) Show the results of Management Stewardship of resources entrusted to it. Helps users of financial statements in predicting the entitys future cash flows and in particular, the timing and certainty.

These objectives are achieved through fair presentation of financial statements.

Fair PresentationAchieved through the provision of useful information in the financial statement, where transparency is securedFair Presentation = Transparency Transparency = Full Disclosure+ Fair Presentation

QUALITATIVE CHARACTERISTICS OF FINANCIAL STATEMENTS

Qualitative Characteristics of F.SReliability Should be free from material error and bias and can be depended upon by users to represent faithfully that which it either purports to represent or could reasonably be expected to represent. Key ingredients of reliability: Completeness, neutrality, faithful representation, substance over form

Qualitative Characteristics Comparability Should be presented in a consistent manner over time to enable users make significant comparison. To be comparable, financial statements must show consistency, uniformity and accounting policies fully disclosed.

Other Characteristics of F. SMateriality (Threshold quality) Information is material if its omission or misstatement could influence economic decision of users taken on the basis of the financial statement. Materiality depends on nature and size of the item.

Characteristics (cont.)Substance Over Form Transactions and other events be accounted for and presented in accordance with their substance and economic reality and not merely their legal form. Disclosure Users must be informed of the accounting policies employed in preparing F.S., any changes and the effects of those changes.

Characteristics (cont.)Prudence The inclusion of degree of caution in the exercise of judgements needed in making the estimates required under the condition of uncertainty such that assets or income are not over stated and liabilities or expenses are not under stated.

Characteristics (cont.)Consistency Measurement and display of financial effects of like transactions and other events must be carried out in a consistent way through out an enterprise and over time for that enterprise and in a consistent way for different enterprises.

BASIS OF ACCOUNTING1. Cash Basis 2. Accrual Basis Cash basis Revenues are recorded when cash is receive and expenses when cash is paid. The net income or loss is the difference of cash inflows from revenue and cash outflow for expenses.

Basis of Accounting (Cont.)Accrual basis Revenues are recognised in the period in which they are earned and expenses when they are incurred

KEY ASSUMPTIONS UNDERLYING PREPARATION OF FS. Accounting EntityThe business entity is treated as a separate entity apart from its owners and other entities. It is important in order to evaluate the performance of the business. An entity owns its assets and incurs its liabilities.

Going Concern The entity will continue to operate for the foreseeable future

Accrual basis Effects of transactions and other events are recognized when they occur (not when the cash flows). The effects are recorded and reported in the financial statements of the periods to which they relate.

Assumptions (Cont.) Cost PrincipleStates that acquired assets and services should be recorded in the books of accounts at their exchanged price (called historical cost) agreed by the parties.

Stable Currency AssumptionAssumes that moneys purchasing power is relatively the same.

ELEMENTS OF FINANCIAL STATEMENTS1. Assets 2. Liabilities 3.Equity The first three are directly related to the measurement of financial position 4. Income 5.Expenses

The last two are directly related to the measurement of financial performance

Assets Resources controlled by the enterprise as a result of past events and from which future economic benefits are expected to flow to the enterprise. Assets are classified as current and noncurrent.

Assets (Cont.)Non current Assets are expected to be in the business for more than one year (12 calendar months) are referred to noncurrent assets. Eg. Equipment, plant, Land and buildings, Investment property etc.

Assets (Cont.)Current Assets are expected to be realized or intended for sale or consumption in the entitys normal operating cycle Assets held primarily for trading Assets expected to be realized within 12 months after balance sheet date. Cash or cash equivalents

Liabilities An entitys indebtedness to third parties. Claims against the assets of the business by outsiders Liabilities can be current or noncurrent

Current Liabilities are: liabilities expected to be settled in the entitys normal operating cycle liabilities held primarily for trading Liabilities due to be settled within 12 months after the balance sheet date.

Noncurrent Liabilities Liabilities due to be settled more than 12 months after the balance sheet date Long-term interest-bearing liabilities to be settled within 12 months after the balance sheet date can be classified as noncurrent if the original term is greater than 12 months it is the intention to refinance or reschedule the obligation The agreement to refinance or reschedule is completed on or before the balance sheet date

Profit and Loss Account Displays businesss revenues and expenses Displays net profit or loss for a specific period Difference between revenues and expenses results in either profit or a loss Profit increases capital Loss decreases capital

Revenues and expenses: Some examplesREVENUES Sales Interest Income Fees EXPENSES Cost of Goods Sold Salary expense Rent expense Tax expense Interest expense

P&L Account (Cont.) A proper heading for the Income Statement will have three lines: the name of the company, the name of the statement, and the period of time the statement covers. Eg. Haneef Company Ltd. Income Statement For the Year Ended December 31, 2006

Income Statement ExampleHaneef Company Ltd. Income Statement For the Year Ended December 31, 2006 Revenues: Sales Interest income Total revenue Expenses: Wages and salaries General expenses Rent Telephone Office supplies Total expenses Net income 250,000 500 250,500 125,000 20,000 10,000 7,000 3,000 165,000 85,500

Balance Sheet The Balance Sheet lists the assets, liabilities, and equity accounts of the company. The Balance Sheet is prepared as ona particular day, and the accounts reflect the balances that existed at the close of business on that day. The Balance Sheet is prepared on the last day that the Income Statement covers.

Balance Sheet (Cont.) If the Income Statement is for the period ending December 31, 2006, the Balance Sheet would be as on December 31, 2006. The date can be stated in a variety of formats. All of the following are acceptable: As on December 31, 2006 December 31, 2006 On December 31, 2006 As at 31st December, 2006

Typical accounts that are classified as assets, liabilities, and equity accounts. Assets Liabilities Equity Cash Capital Accounts receivable Prepaid expenses Inventory Land Building Equipment Vehicles Accounts payable Salaries payable Taxes payable Unearned revenue Notes payable Bonds payable Mortgage payable Ordinary share Paid-in capital Retained earnings

A good general rule of Thumb Any account that has the word receivable in its title will be an asset, Any account that has the word payable in its title will be a liability. Any account that has the word expense in its title is likely to be classified as an expense on the Income Statement, except for the account Prepaid expenses, which is an asset.

Rule of Thumb (cont.) Any account with the word income or revenue in its title is classified as revenue on the Income Statement, except for the account Unearned revenue, which is a liability. A sample Balance Sheet is shown in the next slide.

Haneef Company Ltd. Balance Sheet as at December 31, 2006 Assets: Noncurrent Assets Property, Plant &Equipment Current Assets Inventory Accounts receivable Prepaid expenses Cash Total Assets Liabilities: Accounts payable Salaries payable Notes payable Total Liabilities (i) Owners Equity: Ordinary Shares Income surplus Total Owners Equity (ii) Total Liabilities and Owners Equity (i)+(ii) 110,000 90,000 25,000 50,000 75,000 350,000 50,000 75,000 65,000 190,000 10,000 150,000 160,000 350,000

Balance Sheet On the Balance Sheet, the largest numbers in each section are not necessarily listed first. On the asset side of the Balance Sheet, the accounts are listed in order of their liquidity. Liquidity means nearness to cash. Cash is listed first, since cash is already cash. Each current asset is then listed in the order in which it is expected to become cash.

Accounts receivable comes second, since this company believes that its accounts receivable will be collected prior to the other assets being turned into cash. On the liability side, the accounts are listed in the order in which they are expected to be satisfied (a fancy way of saying paid). In a classified Balance Sheet, the assets are separated into current and noncurrent (or longterm)

Balance Sheet (Cont.) Liabilities are similarly classified as current and noncurrent.

Adjustments to Final accounts Items requiring adjustments Accrued expenses Accrued income Prepaid expenses Prepaid revenue (unearned revenue) Depreciation Bad debts and doubtful debts provisions

Accrued Expenses Unpaid expenses: economic benefit has already been acquired but payment has not yet been made. An expense and a liability is to be recognised.

AdjustmentsExpense Account Amount per Trial balance X Add expense owing at close X B/S X Less Expense owing at start (X) X I/S

Prepaid ExpenseExpense Account Amount per Trial balance X Add expense prepaid at start X Less expense prepaid at close B/S X I/S

X (X)

Prepaid RevenueRevenue Account Amount per Trial balance X Add unearned revenue at start X Less unearned revenue at close X I/S

X (X) B/S

Accrued Income Income earned but not yet recordedAdjustments

Revenue Account Amount per Trial balance X Add accrued income at end X X Less accrued income at start (X) X I/S

B/S

Depreciation Fixed Assets are long-lived assets and benefit several accounting periods Their costs therefore need to allocated as an expense over their useful life. The systematic allocation of this cost is called depreciation. The recognition of depreciation means the recognition of an expense and the decrease in the value of an asset.

The decrease in the value of an asset is not recorded directly in the asset; rather a contra account provision for depreciation is opened. The original cost of an asset is an objective measure where as provision for depreciation is an estimate

The balance sheet discloses the original cost and the provision for depreciation (or called Accumulated depreciation) The resulting figure is the book value

Bad Debts: Credit sales have become a must these days and bad debts occur when there are credit sales. Bad Debt is a loss to the business and a gain to the debtor. Bad debts are charged to income statement.

P&L Example

ILLUSTRATION The following trial balance was extracted from the records of Asana, a petty trader at 31st December 2007. DR CR GH GH Capital 43,235 Drawings 6,150 Stock in trade (1st January 2007) 2,100 Purchases 40,500 Sales 94,400 Returns outwards 1,300 Carriage outwards 860 General expenses 1,250 Motor expenses 1,900 Salaries 26,500 Discount allowed 350 Discount received 240 Rent and rates 950 Insurance 500 Bad debt written off 1,200 Provision for bad and doubtful debt 750 Premises at cost 25,000 Furniture and fixtures 15,000 Motor van at cost 9,000 Cash in hand 250 Cash at Bank 4,970 Debtors and Creditors 20,500 17,055 156,980 156,980 The following information should be taken into consideration. ( i ) Stock in trade at 31st December, 2007 was GH 3,500 (ii) Provision of doubtful is to be adjusted to 5% of debtors (iii) Prepaid insurance GH50: Motor expenses outstanding GH40 (iv). during the year Asana withdrew goods costing GH200 for his private use. No entries have been made in the books for the withdrawal. (iV) Provide for depreciation for the year: furniture and Fixtures GH3,000 and Motor van 15% on cost. You are required to prepare: (a) Trading and profit and loss account for the year ended 31st December, 2007.

Workings1. Provision for doubtful debts Amount in Trial balance (old) 750 New Provision (5% *20,500) 1025 B/S Increase in provision 725 I/S

Workings (cont.)2. Insurance expense Amount in the trial balance 500 Less prepaid at close 50 B/S Insurance expense 450 I/S 3. Motor Expenses Amount in trial balance 1900 Amount outstanding 40 B/S Motor Expense 1940 I/S

Workings (Cont.)4. Drawings Amount in trial balance 6,150 Goods withdrawn 200 Trading Total 6,350 B/S 5. Purchases 40,500 Less goods drawings Net purchases 40,300

200

Workings (Cont.)6.Depreciation: Furniture & Fittings Motor Van (15% of 9000) 3,000 1,350

4,350

I/S

ASANA ENTERPRISE TRADING AND PROFIT AND LOSS ACCOUNT FOR THE YEAR ENDED 31ST DECEMBER 2007 GH Sales Less cost of sales: Opening stock Add purchases (w5) Less Returns outwards Cost of goods available for sale Less Closing stock Cost of goods sold Gross Profit Discount s received 40,300 1,300 39,000 41,100 3,500 37,600 56,800 240 57,040 2,100 GH GH 94,400

Profit and Loss account (Cont.) Gross Profit Discount Allowed Rent and Rates Insurance (W 2) Bad Debts written off Motor Expenses (W3) Provision for doubtful debt (W1) General Expenses Salaries Carriage outwards Depreciation (W6) 350 950 450 1,200 1,940 275 1,250 26,500 860 4,350 38,125 Net Profit 18,915 57,040

ASANA ENTERPRISE BALANCE SHEET AS AT 31ST DECEMBER,2007Fixed Assets Premises Furniture & Fixtures Motor van Current Assets Stock Debtors Less Provision Cash at bank Cash in hand Prepaid insurance Current Liabilities Creditors Outstanding motor expenses Financed by: Capital Add net profit Less Drawings 43,235 18.915 62,150 6,350 55,800 17,055 40 17,095 11,150 55,800 20,500 1,025 19,475 4,970 250 50 28,245 3,500 Cost GH 25,000 15,000 9,000 49,000 3,000 4,350 Depreciation GH 1,350 Net Book Value GH 25,000 13,650 6,000 44,650

IAS 7: CASH FLOW STATEMENT Cash generally refers to cash in hand and all current and deposit account with the bank less all bank overdrafts. A cash flow statement will therefore explain the changes during a particular period (normally an accounting period) between the opening and closing balances on the cash position.

Cash Flow Statement On September 1991, the Accounting Standards Board (ASB) of Great Britain and Ireland issued the Financial Reporting Standard No. 1 Cash Flow Statement (FRS 1) to be adopted as soon as possible and regarded as standard in respect of financial statements relating to accounting periods ending on or after 23 March 1992.

FRS 1 superseded SSAP 10. The International Accounting Standards Committee has also issued a new standard (revised) International Accounting Standard Cash Flow Statements (IAS 7).

IAS7 DEFINITIONS Cash cash in hand and deposits repayable on demand with any bank or other financial institutions. Cash includes cash in hand and deposits denominated in foreign currencies. Cash equivalents short term, highly liquid investments which are readily convertible into known amounts of cash and which are subject to an insignificant risk of changes in value.

IAS 7 DEFINITIONS (CONT.) Cash equivalents include investments and advances denominated in foreign currencies provided that they fulfill the above criteria. Cash flows are inflows and outflows of cash and cash equivalents.

IAS7 DEFIINTIONS(Cont.) Cash flows exclude movements between items that constitute cash or cash equivalents because these components are part of the cash management of an entity rather than part of its operating, investing and financing activities. Cash management includes the investment of excess cash in cash or cash equivalent.

The cash flow statement of this Unit is based on the provisions of IAS 7.

OBJECTIVE OF IAS 7 To require reporting entities falling within its scope to report on a standard basis their cash generation and cash absorption for a period. To this end reporting entities are required to providing a primary financial statement analyzing cash flows under the standard headings.

Standard Headings of C.F.Sa) Operating activities b) Investing activities, c) Financing activities

OPERATING ACTIVITIES Cash flows from operating activities are in general the cash effects of transactions and other events relating to operating or trading activities. Net cash flow from operating activities represents the net increase or decrease in cash and cash equivalents resulting from the operations shown in the profit and loss account in arriving at operating profit.

Operating Activities (Cont.) Cash flow from the primary revenueproducing activities of the entity.

INVESTING ACTIVITIES The cash inflows included in the investing activities are those related to the acquisition or disposal of any asset held as a fixed asset or as a current asset investment (other than assets included within cash equivalents).

FINANCING ACTIVITIESFinancing activities of companies include receipts from or payments to external providers of finance of amounts in respect of principal amounts of finance.

Interest, Taxes and DividendsInterest and taxes paid are treated as part of operating activities under IAS 7 while dividends paid can regarded as operating or financing activities whichever is suitable

FORMAT Cash Flow Statement For The Year Ended 31st December 2002 m m Operating Activities Net Cash Flow from Operating Activities XXX Investing Activities: Payments to acquire intangible fixed assets (XXX) Payment to acquire tangible fixed assets (XXX) Receipts from sale of tangible fixed asset XXX Net cash Outflow from investing activities Net Cash Inflow Before Financing Financing: Issue of equity shares Issue of treasury shares Repurchase or acquisition of shares Redemption of Debent. or redeemab.prf.share Net cash inflow from financing Increase in cash and cash equivalents

(XXX) XXX

XXX XXX (XXX) (XXX) XXX XXX

INDIRECT METHOD NOTES Reconciliation of operating profit to net cash inflow/outflow from operating activities Operating profit Depreciation charges Loss on sale of tangible fixed Assets Increase in stock Increase in debtors Increase in creditors Cash generated from operations Interest received Interest Paid Company Tax Paid Dividends Paid Net cash in(out)flow from operating activities million XXX XXX XXX (XXX) (XXX) XXX XXX XXX (XXX) (XXX) (XXX) XXX

ILLUSTRATION The following summarized balance sheets relate to ABC Co. Ltd. BALANCE SHEET AS AT 31ST DECEMBER 2006/2007 Fixed Assets Fixed Assets at cost Less Accum Depreciation Investment at cost Total Fixed Assets Current Assets: Stocks Debtors Cash and Bank Total Current Assets Current Liabilities Bank Overdraft Creditors Taxation Proposed Dividends Total current Liabilities Net Current Assets Total Assets Represented by: Stated Capital Capital Surplus Income Surplus 2006 GH000 500 200 300 200 500 400 1,350 100 1,850 650 230 150 1,030 820 1,320 500 150 670 1,320 2007 GH000 650 300 350 50 400 700 1,550 2,250 60 790 190 130 1,170 1,080 1,480 750 200 530 1,480

ILLUSTRATION (CONT.) Additional Information: i) During the year to 31st December 2007, some fixed assets originally costing GH25,000 with depreciation of GH10,000 had been sold for GH 20,000 in cash. Similarly, some of the investments originally costing Gh 150,000 had been sold for cash at their book value. ii)The taxation balance disclosed in the above balance sheets represents the actual amount agreed with IRS. All taxes were paid on their due dates. iii)No interim dividend was paid during the year to 31st December 2007 iv) During the year to 31st December 2007, the company made 1-for-2 right issues of 250 equity shares at 120 GHp per share. Required: Prepare a cash flow statement for the company for the year to 31st December 2007 in accordance with the requirements of IAS7.

WORKINGS

ABC COMPANY LTD, BALANCE SHEET ANALYSISFIXED ASSETS Less Accum.. Depr Investment CURRENT ASSETS Stocks Debtors Cash and Bank CURRENT LIABILITIES Bank Overdraft Creditors Taxation Proposed Dividends Net Current Assets Total Assets Represented by: Stated Capital Capital Surplus Income Surplus

2006500 200 300 200 400 1,350 100 650 230 150 1,030 820 1,320 500 150 670

2007650 300 350 50 700 1,550 60 790 190 130 1,170 1,080 1,480 750 200 530

INFLOWS100 150

OUTFLOWS150

300 200 100 60 140 40 20

250 50 140

1,320

1,480

850

850

Fixed Assets AccountsBalance b/f Purchases 500,000 175,000 675,000 Sales Bal c/d 25,000 650,000 675,000

Depreciation Provision AccountsOn disposal 10,000 Bal c/d 300,000 310,000 Bal b/d charged in the year 200,000 110,000 310,000

Investment s AccountsGh Cost 200,000 200,000 Disposal Bal c/d Gh 150,000 50,000 200,000

Profit on sale of fixed assetsGH Cost 25,000 Acc. Depr. 10,000 Book Value 15,000 Profit 5,000 Sales Proceeds 20,000

Computations of Profit before TaxLoss as per the Accounts Add: back proposed dividends Provisions for tax Profit before tax - 140 130 190 180

ABC COMPANY LIMITED CASH FLOW STATEMENT FOR THE YEAR ENDED 31ST DECEMBER 2007 OPERATING ACTIVITIES Net cash flows from operations Add: back depreciation charges Less profit on sale of fixed assets Increase in Stock Increase in debtors Increase in Creditors Cash generated from operations Dividends paid Income Tax paid Net Cash outflow from operating activities INVESTING ACTIVITIES: Purchase of fixed Assets Sale of Investment Sale of fixed Assets Net cash outflow from investing activities NET CASH OUTFLOW BEFORE FINANCING 180 110 -5 -300 -200 140 -75 -150 -230 -455 -175 150 20 -5 -460

CASH FLOW STATEMENT(CONT.)NET CASH OUTFLOW BEFORE FINANCING FINANCING Stated Capital issue of equity shares 250 Increase in Capital surplus 50 NET CASH OUTFLOW FOR THE YEAR 160 -460

300 -

ANALYSIS OF CHANGES IN CASH 31/12/2006 cash balance Overdraft Net cash outflow during the year 31/12/2007 Cash balance Overdraft Bank balance as at 31/12/2007 100 100 -160 -60 -60 - 60

Computation of dividend and tax paidDividend Balance as at 31/12/2006 150 Agreed for 2007 130 Expected balance for 2007 280 But actual balance 130 Therefore amount paid 150 Tax 230 190 420 190 230