This article discusses the fundamental principles of accounting and their importance in financial reporting. It covers concepts like economic entity assumption, monetary unit assumption, full disclosure principle, going concern principle, materiality principle, revenue recognition principle, matching principle, and principle of conservatism.
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Accounting 1
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Contents SCENARIO 1..................................................................................................................................3 Question 1:...................................................................................................................................3 Question 2....................................................................................................................................5 Question 3: Difference between financial statement and financial report.................................10 Question 4: Fundamental principles of accounting...................................................................12 Question 5..................................................................................................................................13 SCENARIO 2................................................................................................................................14 Question 1: Bank reconciliation................................................................................................14 Question 2: Control accounts.....................................................................................................15 Question 3: Suspense account...................................................................................................16 Question 4..................................................................................................................................17 Question 5..................................................................................................................................18 CONCLUSION..............................................................................................................................20 REFERENCES..............................................................................................................................21 2
INTRODUCTION Financial accounting is a concept of recording, classifying, analysing and evaluating the financial transactions of an organisation. This process requires special skills of knowledge of financial theories and concepts(Berry, 2018). The main aim of this report is to build an understanding regarding the double entry system and the process of recording a business transaction. For this purpose, this report is classified into two sections. The first section of this report will address five questions related to different types of business transactions. In these section journal entries, ledger accounts, trial balance, P&L account and balance sheet will be developed along with analysing the difference between financial statement and financial report.In the second section of this report, the concepts of suspense account and control account are analysed along with bank reconciliation. This section will represent the practical implication of such concepts by the use of rectification account and updated cash book. SCENARIO 1 Question 1: Types of business transaction Business transaction is an event which has occurred in an economic organisation which can be measured in terms of money. Such events have a financial impact on the organisation. There are different types of business transactions and in this case, all these business transactions are classified as external and internal transactions. Internal transactions are those events in which no external parties such as investors, supplier or debtors are involved. These transactions are does not include any exchange of money with external parties but its occurrence highly impacts financial position of the organisation. These transactions include depreciation, accumulated depreciation, realising of losses and many more(Cascino and et.al, 2019). On the other hand external business transactions are opposite of above transactions as it includes involvement of external parties as well. Business entity exchanges money from external parties for such transactions and the scope of such transactions are much higher than the internal. These transactions include purchase of raw material from suppliers, sales of finished goods to customers, purchase of current and non-current assets, purchasing services from external service 3
providers such as repairing, advertising etc., paying wages and salaries to employees, payment of taxation, payment of electricity, gas, stationary and other miscellaneous expenses. Single entry and double entry book keeping Single entry bookkeeping system is the easiest procedure to record business transactions as in this system only cash transactions are recorded when they become due. In this system, all the transactions of a business entity are recorded in a single column as a single entry in the primary book of journal(Dutta and Patatoukas, 2017). This method is more appropriate for micro business which does not involve high number of cash transactions and can be only used to track the cash position of the business. A typical format of single entry bookkeeping is presented below: DateDescriptionTransaction valueBalance XX-XX-XXXXÂŁ000.00ÂŁ000.00 On the other hand, double book keeping system is highly complex than the method analysed above. In this system, every transaction is recorded into two accounts in order to ensure that credit and debit of trail balance is equal. This method if book keeping is considered as high reliable and validated as it helps in ensuring that the accounting books are appropriately developed if the balance of debit and credit are equal. This system is appropriate for any type of organisation having any scale, scope or objective. A typical format of double book keeping system is present below: DateDescriptionL.FDebitCredit XX-XX-XXXXÂŁ000.00 ÂŁ000.00 Trial balance and its importance The term trial balance is used for a worksheet and not for an account which is used for book keeping all the business transactions which are transacted in an accounting year(Haskin and Burke, 2016). This type of worksheet is divided into columns for debit and credit and the balance of both the transactions is required to be equal. There are various significant points of trial balance which represents its importance for business entities and some of these significant points are identified below: 4
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Trial balance helps an organisation to check the arithmetical accuracy of their accounts by ensuring the equal balance of the both sides of trial balance. Trial balance is a worksheet which acts as a base to prepare financial reports of business position such as income statement and balance sheet. Trial balance also plays an important role in the comparative analysis. A business organisation can check the balances of accounts of one year and then compare it to last year trial balance. This worksheet also helps in rectify the errors which has made by the management in developing accounts. Trial balance also helps in developing the budgets for future areas and helps in identifying KPIs and benchmarks(Horák and Bokšová, 2018). A typical format of trial balance is developed below: Account nameDebit (£000)Credit (£000) Question 2 Journal entries for each transaction 5
Ledger accounts 6
7
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Trial balance Trail Balance Particulars Debit amount Credit Amount Cash in hand11070 Cash at bank60675 Net Capital65000 Purchases expenses18000 Bills payable14000 Bills receivable12000 Sales expenses26000 Equipment account3000 9
Prepaid Insurance account expenditure75 Prepaid Rent expenses150 Stationary account expenses30 Total105000105000 Question 3: Difference between financial statement and financial report Financial report is a document which includes monetary transaction of an organisation. Such reports are developed to record the effect of every financial transaction on the functioning of the organisation. There is not specific interval of developing these reports(Kaya and Akbulut, 2018). On the other hand, financial statement is one of the mandatory documents which are required to be developed by every business transaction. Every financial statement is a report but every financial report is not a financial statement. In order to analyse the uses of such documents and their users, the comparative analysis between both the statements is conducted below: Basis of differenceFinancial reportFinancial statement ContentFinancialreportsincludeallthe monetarytransactionsofa business organisation. Financialstatementsonlyinclude those transactions and information which are a requirement given by governance authority. GovernanceThe process of financial reporting isgovernedbyIASB (InternationalAccounting Standards Board). On the other hand, the process of developing financial statements is governedbythestandards developedbyIASBwhichare InternationalFinancialReporting Standards. ScopeThe scope of financial reports are wider than financial statements as ithasbeenidentifiedthatall financial statements are financial reports but not all reports can be Thescopeofsuchdocumentsis narrower(Kolitz, 2016). 10
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financial statements. ExamplesTherearevariousexamplesof financialreportswhichinclude bankstatement,account receivablesreport,debtor’s analysis report, bas debts reports and many more. Ontheotherhand,thereareno examplesoffinancialstatements but there are four types of financial statementswhichincludeincome statement, balance sheet (statement of financial position), statement of cashflows,andstatementof changes in equity. RequirementThe financial reports are needed bybusinessmanagerstogather informationregardingexpenses andpurchaseswhichthe organisation has done in order to develop budgets for future year. Thescopeofusingfinancial reportsismuchwiderasthese reportscanprovideallthe information about an organisation. Thesereportsareusedbythe companies to develop a financial strategy so that they can ensure reliable profits and cash flow in the company. Ontheotherhand,thefinancial statement can only be used for a certainrequirements.These statementsareneededby stakeholdersofthecompanyto analyse the financial performance, financial position, cash position and equitypositionforthecompany. Thesestatementshelpinthe procedure of decision making by theexternalinvestorstodecide whether they want to invest in a certain company or not(Maynard, 2017). UsersUsers of financial reports include businessmanagers,board membersandalltheusersof financialstatementsasthese statementsarealsoapartof financial reports. Onthecontrary,theusersof financialstatementsinclude investors,suppliers,creditors, government, clients, public, debtors and many others. 11
Question 4: Fundamental principles of accounting Fundamental accountingprinciplesare the guidelineswhich restrictsand limitsthe business organisations while developing financial statements and reporting financial data. There are various fundamental principles which govern the business organisation. These principles are based on the standards given by “generally accepted accounting standards” and “international financial reporting standards”. Some of the important fundamental principles of accounting include: Economic entity assumption – According to this principle, a business organisation must be given its own identity and name under which it can do business. The entity of the business organisationmustbedifferentfromtheentityofitsowner (Najid and et.al., 2016). Monetary unit assumption – This principle states that all the financial transaction which have occurred in a business organisation must be recorded using a same monetary unit so that a familiarity and consistency can be maintained. Full disclosure principle – This financial principle is a regulation of the entire business organisation which states that all the business transactions must be recorded in the organisation’s financial statements so that a true and fair judgement can be passed on the financial performance and position of that company. Going concern principle – According to this principle, a business organisation must continue to exist regardless to the event of owner’s death. Unless, a business organisation is dissolved, it assumed to be existed. Materiality principle – This principle states that only monetary transaction can be recorded in the financial statements of business entity and those transactions must be recorded as soon as they occur so a monetary value is received or paid by the organisation. Revenue recognition principle – Amount can be only recognised or recorded by the organisation as soon as it is earned and not when it is received by the organisation. Matching principle – According to this principle which acts as a guideline to business organisations, the total of debit and credit sides of the financial statements must be equal or matched. Expenses incurred by an entity must always be matched from the revenue generated by that organisation(Porter, 2019). 12
Principle Of Conservatism – This is one of the most essential guideline for business organisation which state business organisations must be conservative by nature and should be prepared for the worst. According to this principle, expected inflow of money in the organisation must always be recorded in the organisation when it is actually received but the expected outflow of money should be recorded when there is doubt of that outflow. This principle helps in an organisation for future financial crises(Schroeder, Clark and Cathey, 2019). Question 5 Profit and loss account ParticularAmount Revenue125000 less:sales returns1500 Total Revenue123500 Less: Cost of goods sold83500 Discount received1000 Rent received in advance4850 Gross profit45850 Expenses: Rent & rates expenditure1500 Telephone expenses900 Insurance expenses7500 Bad debts1200 Depreciation5000 Wages and salaries13200 Provision for bad-debts (934) Less: Bad debts written off (650)284 Outstanding expenditure340 Net profit15926 Balance sheet LiabilitiesAmountAssetsAmount 13
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Capital120800Bank balance10594 Less: Drawings5150115650Cash in hand340 Creditors3900Debtors12500 Rent received490Motor expenses25000 Reserves balance15926less: Depreciation540019600 Suspense account7489Prepaid insurance411 Loan provided100000 143455143445 SCENARIO 2 Question 1: Bank reconciliation Bank reconciliation is a procedure in which an entity matches their accounting records with the balances of the information gained from their bank statement. The two statements which are required in this process are cash book of the entity and pass book provided by the bank. The process of bank reconciliation is necessary for an organisation to be conducted as it can help in ascertain the differences between the two books. The information on the bank statement is provided by the bank and includes the bank’s record of all transactions which impacts the entity’s bank account. There can be various reasons due to which pass book and cash book do not reconcile and these reasons can be identified using bank reconciliation statement. The reasons due to which preparation of bank reconciliation statement is necessary are deposit in transit, outstanding check and NSF. When an entity deposit money value in their bank account, it does not immediately is reflected in their pass book as the procedure of depositing the money takes time and this time can result into non reconciliation of the both books for which BRS is prepared(Sithole and Abeysekera, 2017). Another reason for which BRS is necessary is outstanding cheque. Sometimes, the business entity records an inflow of money for the received cheque value but if it is not yet been presented or recorded to bank yet then the both books can show different value and that value is balanced in BRS. NFS check is the abbreviation for not sufficient funds. Sometimes, business managers receives and deposits the cheque to the bank but if the account of that account holder does not have sufficient balance then it will get dishonoured due to which both books will not reconcile and this difference can be addressed in BRS. 14
The reconciliation between cash book and pass book can be achieved by the preparation of bank reconciliation statement. This BRS is necessary as it can assist in elimination the difference between both the books and also helps in maintaining the records of every error which has been made by the management of organisation in order to make sure that such error will not be repeated in future. Question 2: Control accounts Control account is a financial account which is developed to be included in general ledger. This account sums up the balances in subsidiary accounts in order to present a summarised view of accounts which have large number of transactions. The most common accounts of which balances are summed by control accounts are accounts receivable and accounts payable. Both of these accounts are documents which usually have high number of transactions and it order to analyse them it is important to summarise them using a control account. According to the financial accounting process the balances of such accounts are recorded into subsidiary level ledger account rather than recording into general ledger. Control accounts play an important role in the financial management and some points which can represent this important role and identified below: The major role which control account play in financial management is that it keeps the general ledger free from details due to which general ledger is not cluttered with a lots of information(Thornton, 2018). Control account helps the financial management process to run smoothly as it provides correct and summarised balance which helps in preparing financial statement. Even after recording only summarised value in the control account, the detail information of each control account can be found in subsidiary account which assist in being cluttered free and having all the information which can be used in auditing and developing cost accounts. Generally, there are three types of control accounts including debtor’s control account, creditors’ control account and stock control account. All these accounts play an important role in financial management. The debtors’ control account helps in identifying the total amount which is required to be paid by the company to their debtors. The creditors control account helps in summarising the amount which is required to be received by the 15
company and lastly stock or inventory control account helps in keeping the track of used raw material. All these three control accounts have more transactions in a month than the entire business have in an year, due to which it is important to develop a control account for each of such account so that in financial statement, only balance value can be recorded instead of recording multiple values. Question 3: Suspense account A suspense account is a general ledger account in which value is recorded for a temporary period in order to identify from where that value is being received and in which account it should be recorded. A suspense account is developed when a business entity is has left with a unknown monetary value which has no destination to be recorded in, then a suspense account is opened to record that value in this account but for only a temporary period so that organisation can figure out that in which account that value should be recorded and what is its correct destination. A suspense account is drafted by the financial accountant of an organisation and there are various reasons due to which it is drafted and some of those main reasons are highlighted below: ď‚·The most important reason of drafting a suspense account is to identify the reason due to which balance of credit and debit side in trial balance do not match. Without developing trial balance with equal sides, further financial statements cannot be developed. So, in order continue the process of development of financial statements like income statement and balance sheet, the suspense account is opened having the value of difference between the credit and debit side of the trial balance. ď‚·A suspense account is drafted when an organisation receives a payment but it is unidentifiable that in which account that received money should be recorded. So, in order to not to waste time and continue the process of financial statement development, a suspense account is developed with the value of money which is received as a payment to the company(Zhang, Low and Seow, 2020). ď‚·Another reason of opening or drafting the suspense account is the purchase of a fixed asset but the fixed asset is yet not revived due to which name of the seller or the invoice number is yet to be identified. In such case, financial manager opens a suspense account for a temporary period and as soon as the invoice and fixed asset is being received the 16
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amount of suspense account is transferred top the appropriate account in which it was intended to be recorded. Question 4 Updated cash book and Bank reconciliation statementas on 28th February 2010 Difference between direct debit and standing order, Bank charges, Dis-Houner Cheque Direct debitStanding orderBank chargesDis-Houner Cheque MeaningDirectdebitisa facility which is given to the clients of banks. In this facility, client canprovideadirect order to their bank for debitinganamount fromtheirbank accountataregular interval.Thisfacility isasafeservice provided by banks to Thisfacilityis similar to the direct debit facility but in caseofstanding order, customers are onlyallowedto order their bank to make a payment on theirbehalfwhen the payment is of a certainvaluepre statedbycustomer A bank charge is afeewhichis paidbythe customer to their banks against the facilities used by them.These facilitiescan includedirect debitand standingorders statedbefore. This is a penalty whichischarge by the bank from theircustomer whentheir cheque is held as dishonoured. It is apenaltywhich is compulsory to bepaidbythe customer. 17
their customers (What is direct debit. 2020). at a regular interval.Thisfeeisa mandatory chargetothe customer. ExampleA customer can order their bank to pay their generalutilitybills likeelectricity,gas etc.ataregular interval as these bills becameduetoa certaininterval.It must be consider that customerscanalso ordertopayan amountwheneverit becomesdueina regular interval like a month or quarter. Acustomercan provideastanding order to the bank to make a payment for theirinstalmentof loan,EMIetc.as thesepaymentsare offixedvalueand incurataregular interval.This facility can also be usedforgym membershipora clubhouse membership. Acustomerhas topayfeesfor theATM facilities, overdraft facilitiesand even for an extra chequebook request. A cheque is held as dishonoured if theclient’s account does not havesufficient balanceorif therearefew defectsinthe chequesuchas overwriting. Question 5 Journal entries 18
Suspense account 19
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CONCLUSION From the above report, it has been found that financial accounting is not only a concept but is a process which is adopted by every organisation to record their business transactions and then develop financial statements from those records. The above report is the summarisation of various financial concepts and accounts from which it has been concluded that financial statements and reports are different from each other but of these are developed by using the guidelines and principles of financial accounting. The section of the above report also helps in reaching to the conclusion that there are accounts like suspense and control account which helps in proper functioning of financial management process. 20
REFERENCES Books and Journals Berry, L.E., 2018.Financial accounting demystified. McGraw-Hill,. Cascino, S. and et.al, 2019. The usefulness of financial accounting information: Evidence from the field.Available at SSRN 3008083. Dutta,S.andPatatoukas,P.N.,2017.Identifyingconditionalconservatisminfinancial accounting data: theory and evidence.The Accounting Review.92(4). pp.191-216. Haskin, D.L. and Burke, M.M., 2016. Incorporating sustainability issues into the financial accounting curriculum.American Journal of Business Education (AJBE).9(2). pp.49-56. Horák, J. and Bokšová, J., 2018. Influence of Big Data on Financial Accounting.International Advances in Economic Research.24(2). pp.205-206. Kaya,I.andAkbulut,D.H.,2018.Bigdataanalyticsinfinancialreportingand accounting.PressAcademia Procedia.7(1). pp.256-259. Kolitz, D., 2016.Financial accounting: a concepts-based introduction. Taylor & Francis. Maynard, J., 2017.Financial accounting, reporting, and analysis. Oxford University Press. Najid, N.A and et.al., 2016. Use of amazacc brain teaser card for financial accounting classroom: Non-accounting students. InRegional Conference on Science, Technology and Social Sciences (RCSTSS 2014)(pp. 19-26). Springer, Singapore. Porter, J.C., 2019. Beyond debits and credits: Using integrated projects to improve students’ understanding of financial accounting.Journal of Accounting Education.46. pp.53-71. Schroeder,R.G.,Clark,M.W.andCathey,J.M.,2019.Financialaccountingtheoryand analysis: text and cases. John Wiley & Sons. Sithole,S.T.M. and Abeysekera,I., 2017.Accountingeducation:a cognitiveloadtheory perspective. Routledge. Thornton, S.C., 2018. A Collection of Case Studies on Financial Accounting Concepts. Zhang, T., Low, L.C. and Seow, P.S., 2020. Using online tutorials to teach the accounting cycle.Journal of Education for Business.95(4). pp.263-274. Online Whatisdirectdebit.2020.[Online].Availablethrough: <https://www.directdebit.co.uk/DirectDebitExplained/Pages/WhatIsDirectDebit.aspx> 21