Chapter 1 Introduction to accounting
Accounting:
 About quantitative information.
 Information is likely to be financial
 Useful for making decisions.
 Influenced by environment:
o Increase scope to include environmental matters.
o Challenges techniques that are needed.
Purpose:
 Planning,
 Controlling
 Decision support.
Used by:
 Internal users:
o Management:
 External users:
o Owners( shareholders)
Is it going well.
Did the management made good use of resources
How is it going to fare in the future.
o Lenders
Did it made sufficient profit( income statement)
Will the pay us back.
o Suppliers.
Does the enterprise stay in business
Does it expand
o Customers
Profitable
Will it stay in business
o Employees
How are we doing
Do we stay in business
o Government.
Taxes
o General public.
Financial accounting meets the needs of various external users by an annual report, a balance sheet,
an income statement and a cash flow statement
Limitations:
 Only one of the sources of information available to decision makers.
 Related to the past.
Chapter 2 Wealth and the measurement of profit
Income = That amount which an individual can consume and still be as well off at the end of the
period as he or she was at the start of the period.
Income Wealth
Wealth = static measure and represents a stock at a particular point in time. This stock can change
over time. Hence, the wealth measured at the start of the period will not necessarily be equal to the
wealth measured at the end of the period. This difference between the two is the profit of loss for
that period of time.
Profit= Represents the difference between the wealth at the start and at the end of the period.
Unlike wealth, which is essentially a static measure, profit is a measure of flow that summarizes
activity over a period.
Original cost= The cost of the item at the time of the transaction between the buyer and seller
Historic cost= The cost incurred by the individual or enterprise in acquiring an item measured at the
time of the originating transaction.
Replacement cost: The amount that would have to be paid at today’s price to purchase an item
similar to the existing item.
Economic value= An ideal measure of value and wealth. The value of the expected earnings from
using the item in question discounted at an appropriate rate to give a present-day value.
Net realizable value = an alternative measure of value to economic value. The amount that is likely to
be obtained by selling an item, less any costs incurred in selling.
Chapter 3 The measurement of wealth
The balance sheet= a statement, at one point in time, which shows all the assets owned by the
enterprise and all the amounts owed by the enterprise( liabilities).
The business entity principle= States the transactions, assets and liabilities the relate to the
enterprise are accounted for separately. It applies to all types of enterprise irrespective of the fact
that the enterprise may not be recognized as a separate legal or taxable entity.
The balance sheet
Use to evaluate the financial situation of the enterprise.
Liquidity = refers to the ease with which assets can be converted to cash in the normal course of
business.
Assets
Asset= A resource controlled by an enterprise as a result of past events from which future economic
benefits are expected to flow to the entity.
So it is an asset if:
o Controlled by the enterprise.
o A result of past events.
o Future economic benefits.
o Expected to flow to the enterprise.
Only if all 4 criteria are met.
Current asset: Is an asset which is either part of the operating cycle of the enterprise or is likely to be
realized in the form of cash within one year.
If it meets one of the 4 following criteria:
1. It is expected to be realized in, or is intended for sale or consumption in, the entities’ normal
operating cycle.
2. It is held primarily for the purpose of being traded.
3. It is expected to be realized within 12 months of the balance sheet date.
4. It is cash of cash equivalent.
Non-current asset: Includes everything that does not fall within the category of current assets.
Tangible asset: an asset that can be touched. (something physical)
Intangible asset: No physical evidence.
Fixed asset: An asset that is acquired for the purpose of use within the business and is likely to be
used by the business for a considerable period of time.
Liabilities:
Liability: A present obligation of the enterprise arising from past events, the settlement of which is
expected to result in an outflow from the enterprise of resources embodying economic benefits.
(that was a business owes)
Current liabilities: Those liabilities filling due for payment with one year.
Owners’ equity:
Owners’ equity :A claim on the assets of the enterprise. It is different from other liabilities in that the
amount cannot necessarily be determined accurately. It can be viewed as a residual claim on the
assets of the enterprise.
The balance sheet
Assets= liabilities + owners’ equity.
The principle of duality = The basis of the double-entry bookkeeping system on which accounting is
based. It states thet every transaction has 2 opposite and equal sides.
Chapter 4 The income statement and the cash flow statement
Income statement
Importance:
 Relates to a period of time
 Summarizes the transactions of the period.
 Tells you if the business if profitable or not
 Mostly used by the owners, sometimes by banks.
Revenue= The gross inflow of economic benefits during the period arising in the course of ordinary
activities of the entity when those inflows result in increases in equity, other than increases relating
to contributions from equity participants.
The realization principle= States that revenue should only be recognized when (1) the earning
process is substantially complete and (2) when the receipt of payment for the goods and services is
reasonably certain.
Revenue should be recognized when:
 Significant risks and rewards of ownership have been transferred to the buyer.
 Managerial involvement and control have passed.
 The amount of revenue can be measured reliably.
 It is probable that economic benefits will flow to the enterprise.
 The costs of the transaction, including future costs, can be measured reliably.
The matching principle: We must match the revenue earned during a period with the expenses
incurred in earning that revenue.
Expenses= An expired cost, a cost from which all benefits has been extracted during an accounting
period. ( Cost= a money sacrifice or the incurring of a liability in the pursuit of the business objective)
The expenses of goods for personal use should not be seen as an expense of the business but need to
be separated out and shown as withdrawals of the owner’s capital.
In which period is the cost an expense?
Cost of this year are expenses of this year:
The item is acquired during a year and consumed during that same year.
Cost of earlier years are expenses of this year:
 Wholly expenses of this year:
E.g. Stocks of goods in a shop at the end of the year.
The cost of buying those goods has been incurred in the year just ended but at the year end
the benefit has nog expired. They are assets at the year end. In the next year they will be
sold and thus will become expenses of the next year.
 Partly expenses of this year:
The costs are incurred at a point in time but the benefits are expected to accrue over a
number of years.
Cost of this year are expenses of subsequent years:
Costs in curred in the current period may be expenses of future periods.(See page 78)
The income statement
Purpose: to measure the profit of loss for the period.
Done by: summarizing the revenues for the period, matching the expenses incurred in earning those
revenues and subtracting the expenses from the revenues to arrive at the profit/loss.
R-E=p ( Revenue- expenses=profit)
Gross profit= Sales – cost of goods sold.
Net profit= Gross profit- operating costs, administrative costs and other charges.
Chapter 5 Introduction to the work sheet
Application of the principle of duality : If we increase our assets , we must have or increased our
liabilities, made profit, increased our owner’s equity, decreased another asset.
The worksheet
Title: Worksheet of (Name company) at (Date)
Colums
First 2 columns: the identification and description of the transaction. (Date & Event)
3 tm 10 : Assets
3+4 Colum: Non-current assets ( Everything that are not current assets)
3. Straight line
4. Reducing balance
5 t/m 10 Column:Current assets ( If 1.Controlled –not necessarily owned. 2.Arising from a past
economic event. 3. Providing future economic benefits. 4. The benefits are expected to flow to the
eterprise, Only if all 4 are true)
5. Current assets (other)
6. Amounts receivables/prepaids
7. Raw
8. WIP(Work in progress)
9. Finished goods
10. Cash
11 t/m 15 : Liabilities + Equity +Retained profit
11+12: Current Liabilities
11: Current Liabilities (other)
12 Accruals/Payables
13 Non current Liabilities
14 Equity
15 Revenue- Expenses
16: Control : (Liabilities + Equity +Retained profit )- Assets = 0
Liabilities: IF
1.do they give a claim on a part of the organization?
2.at fixed periods?
3.For known amounts of money?
Chapter 6 Inventory
Disadvantages of high levels of inventory:
 Money tied up in products
 Costs for space
 If necessary: loan to buy the inventory.
Therefore JIT (Just in time) might be a good solution
Inventory =
 products held for sale in the ordinary course of business.
 Or products in the process of production
 Or products in the form of materials or supplies to be consumed in the production process.
 So you have to have the intention to sell it or use it.
Work in progress: Products that are at an intermediate stage of completion.
Finished goods: Goods that have been through the complete production cycle and are ready for sale.
The nature of business has an impact on the type of inventory held.
Cost of goods sold = (Opening inventory ( at the start of the year) + purchases)- Closing inventory(at
the end of the year)
Net profit= Operating cash flow +/- change in inventory
Operating cash flow = the cash in and out flows arising from the trading activities of the enterprise.
Net realizable value= the estimated proceeds from the sale of items – the cost of selling
The valuation rule= inventory should be valued at the lower of cast and net realizable value.
The prudence concept = Profits are not anticipated and revenue is nor recognized until it’s realization
is reasonably curtain. Provision is made for all potential losses.
Inventory approaches’:
First in, first out:
First goods bought are the first sold.
Inventory hold at the end of the period is assumed to be purchases recently.
First in, Last out:
The last goods bought are the first sold.
Charges the latest price from suppliers against revenues, leaves the closing inventory at a value
based on outdated prices.
Average cost:
Compromise between First in, first out & First in, Last out.
No assumptions, in which way goods are used.
The average prices of the inventory are used.
Chapter 7 Amounts receivable and payable
Trade receivables: Money owed TO the business for the supply of goods. Also sales on credit terms,
the payment will be received later. Is a current asset
Prepayments: payments in advance.
Important: Has the benefit been used up or is there still some future to be obtained.
Used op: expense
Future benefits: asset
Trade payables: Amount owing at a point in time TO e.g. a supplier, amount of which is known how
much.
Accruals: Amount owing at a point in time TO e.g. a supplier, amount of which is NOT known how
much.
Chapter 8 Noncurrent assets, fixed assets and deprecation
Recap of previous chapters:
Asset = A resource controlled by the enterprise arising from a past even from which economic
benefits in the future are expected to flow to the entity.
Current assets: - Part of the operating cycle
- Likely to be realized in cash within 1 year.
Fixed asset: Acquired for the purpose of use within the business and used for a considerable time.
Income= Amount which a individual can consume and still be as well of at the end as at the start.
Differences between current and noncurrent assets:
- Intention
- Nature
New:
Materiality: An item that can be said to be material if its non- disclosure would lead to the accounts
being misleading in some way.
The costs of a non-current assets: If there has been an enhancement of the potential future benefits
the cost should be added to the cost of the asset. If not the costs are an expense.
Depreciation= the systematic allocation of the depreciable amount of an assets over its useful life.
We can only guess what the useful life will be.
Depreciable amount= the cost of an asset – residual value.
Why do we do this: To match the revenue with the expenses.
Carruing amount= the amount at which an asset is recognized after deducting any accumulated
depreciation
Two was to depreciated:
1. The straight line method
Assumption: The asset usage is equal for all periods of its usefull life
Depreciation = (Cost – residual value) / useful life
Preferred method
2. Reducing balance method:
Assumption: The asset declines more in the earlier years of the assets life than in the later years.
Rate of depreciation = 1-
𝑈𝑠𝑒𝑓𝑢𝑙𝑙 𝑙𝑖𝑓𝑒
𝑠𝑐𝑟𝑎𝑝 𝑣𝑎𝑙𝑢𝑒
√𝑐𝑜𝑠𝑡 𝑜𝑓 𝑎𝑠𝑠𝑒𝑡
Use if the assets are infected by the times used.
Sales of fixed asset: affected by the way of deprecation.
Chapter 9 Financing an business structures.
The finance used and the period of the finance should be matched to the period for which it is
required and the purpose for which it is used.
Short term finance( less than a year):
Trade credit : The possibility given by e.g. the supplier to pay after the goods have been delivered.
Depends on
 Credit worthiness of the business
 Importance to supplier.
Few costs, no security required.
Factoring company: Companies that specialize in providing a company a service for the collection of
payments from costumers,
Costs include an interest charge and a debt management charge.
Finance is secured on the receivables.
Bank overdraft
To possibility to use money from the bank. Interest only charged if the money is used.
Some form of security.
Medium term finance:
Loan: Should have a fixed purpose and period.
Repayment dates
Interest an set-up fees
Secured on assets
Hire Purchase: A finance company buys the assets and hires is to the business,
Fixed period. If fully paid for the asset is of the hiring company.
Leasing: Person can use the asset for a period of time in exchange for payment
Interest charges
Two forms of leasing:
1. An operating asset: rental agreement  asset
2. A finance lease: financing agreement
Long term finance:
Debt finance: source of long-term finance that is not equity finance.
Fixed period
Higher interest rates
Equity finance:
Two types.
1. Use of retained profit : use in sole proprietorship and partnership.
2. Contributed capital : From shares
Two types of shares:
1. Ordinary shares: get dividend, buy a share of the company but are not a part of the management.
2. Preference shares: get a fixed dividend but are less risky.
Chapter 10. Cash flow statements
The Cash flow statement.
Need: Where does the money come from and where does it go to?
 Regular cash flow
 One off cash flow
Types
Cash inflow:
 Money generated from trading,
 Money from new share issues or other forms of long-term finance.
 Money received from the sale of fixed assets.
Cash outflow:
 Money used to buy new fixed assets
 Money to pay tax and dividends
 Money to repay debenture holders or other providers of lon-term capital.
Subdivisions in the cash flow are made to provide information about the source and nature of the
cash flow.
Cash flows:
Cash inflows = increases in cash
Cash outflows = decreases in cash
Net cash flow consist of the net effect of cash inflows and cash outflows.
Operating activities = The principal revenue-producing activities of the entity and other activities that
are not investing of financing activities.
Increases and decreases in inventory:
An increase in the level of inventory must be subtracted from the profit to arrive at the net cash
from operations.
A decrease in the level of inventory must be added back to the profit to arrive at the net cash from
operations.
Increases and decreases in receivables and prepayments:
An increase in the level of receivables and prepayments must be subtracted from the profit to arrive
at the net cash from operations.
A decrease in the level of receivables and prepayments must be added back to the profit to arrive at
the net cash from operations.
Increases and decreases in payables and accruals:
An decrease in the level of in payables and accruals must be subtracted from the profit to arrive at
the net cash from operations.
A increase in the level of in payables and accruals must be added back to the profit to arrive at the
net cash from operations.
Depreciation and profits and losses on sales of fixed assets
The charge for depreciation for the year must be added to the profit to arrive at the cash from
operations.
A profit on the sale of fixed assets should be subtracted from the profit to arrive at the net cash from
operations.
A loss on the sale of fixed assets should be added to the profit to arrive at the net cash from
operations.
Investing activities:
Investments in non-current assets and sales of that category of assets.
Financing activities:
Money raised by issuing shares, debentures, loans etc.
Money used to redeem shares of debentures or pay back long term debt.
Anything related to the long-term financing of the business.
Chapter 11 Financial accounts & company accounts
Traditional approach of accounting:
Use a T account. Assets are shown as debit an liabilities as credit.
At the end of the period adjustments must be made:
- Depreciation
- Bad debts
- Accruals
- Pre payments
Final accounts:
For the income statement use the columns of revenue & expense
For the balance sheet use the final line.
Forms of organization:
 The sole proprietorship:
o One owner
o No formal guidelines for the format of accounts

Limited companies:
o Separate legal entity.
o Shareholders
o Listed or not listed
o Companies account should consist :
 Balance sheet
 Income statement
 Directors report
 Auditors report
Chapter 12 Financial statement analysis
Different users have different needs.
Investor group( equity investors):
 (Future) profitability




Management efficiency
Return on the investment
Risk being taken
Returns to owners
Preference shareholders:
 (Future) profitability
 Net realizable value of the assets
 Extent by which their dividends are covered by profit.
Lenders:
 Liquidity
 Net realizable value of the assets
 Profitability and future growth
 Risk
 Security
Employees:
 Profitability
 Liquidity
Auditors:
 Trends in sale
 Variations from norms
 Accounting policies
Profitability:
Can be found in the income statement
Look at if:
Is it more profitable than last year.
Is it more profitable than a similar business
Related to :
Past for evaluation
Future for prediction
Liquidity and financial risk:
Balance sheet
Financial risk involves long-term an d short-term solvency
Requirement and norms differ widely from industry to industry.
Context that needs to be taken into account:
 Size
 Riskiness of the business
 The economical, social and political environment
 The industry trends, effects of changes in technology
Other sources for information
 Government statistics
 Trade journals
 Financial press
 Databases
 Specialist agencies
Internal
 Annual report
 Accounts
Context of the annual report:
 Main statement and explanatory notes:
o Income statement ( revenue & expenses)
o Cash flow statement ( origin of the cash)
o Balance sheet ( position one point in time)
o Notes to the accountant
o The accounting policies statement
 Subsidiary statement:
o Statement of total recognized gains and losses
o Reconciliation of movement in shareholder finds
 Supplementary information:
o Chairman’s statement
o Review of operations
o Directors report
o Operating and financial review
o Auditors report
o Statement of corporate governance
Techniques of analysis.
Comparison of financial statements over time
Comparison of the rate and direction of change over time.
Absolute amount or percentages
Trend analysis
Time periods of 2/3 yers.
Makes the results easier to understand and interpret
The choice of an appropriate base year is vital.
If the base year is not typical the resultant analysis will at best be extremely difficult and at worst
actually misleading.
Choose the base year and then plot the trend in sales from there on.
Index number trends
Choose a base year. Set that base year to 100 and express the other year in terms of that base year.
Percentage changes
Identify the percentage change from year to year and examine the trend in this.
Common size statements
Expresses items in the balance sheet as percentages of the balance sheet total
Chapter 13 Internal users and internal information
For the management the annual account are not sufficient ,
Because:
 Are summarized ( no details)
 Only once a year
So the need:
 More detailed information
 Up to date information.
 Frequent information
 Decision-relevant information.
External user information needs:
 Taxation authorities
 Enterprise’s bankers.
o Two categories:
o Routine monitoring.
o Future needs ( cash flow statement, income statement)
Impacts of organizational size:
 More complex  more information needed.
 More information available.
 Not involved in day-to-day businesses.
The need of information should be balanced against costs.
Nature of the products can influence what information is needed
Structure influences which information is needed.
Chapter 21 Management of working capital
Working capital = difference between assets and current liabilities measured in monetary terms.
The resources employed in the management of working capital should reflect the needs of the
business.
Liquidity= the ability of the business to meet debt when they fall due.
It is wise to keep the investment in working capital to a minimum but invest sufficiently in current
assets to keep day-to-day trading efficiently.
Cost of working capital = direct costs + opportunity costs.
direct costs: The cost of the capital invested.
opportunity costs: returns for gone by investing in working capital rather tan some alternative
investment opportunity.
Overtrading= when a business had expanded its turnover to a level not supported by its investments
in working capital.
Working capital cycle: the period of time from the investment into current assets to the inflow of
cash derived from the investment.
Working capital cycle:
Raw materials turnover:
𝑟𝑎𝑤 𝑚𝑎𝑡𝑒𝑟𝑖𝑎𝑙𝑠
𝑝𝑢𝑟𝑐ℎ𝑎𝑠𝑒𝑠 𝑜𝑛 𝑐𝑟𝑒𝑑𝑖𝑡
∗ 365
𝑝𝑎𝑦𝑎𝑏𝑙𝑒𝑠
Minus payables turnover 𝑝𝑢𝑟𝑐ℎ𝑎𝑠𝑒𝑠 𝑜𝑛 𝑐𝑟𝑒𝑑𝑖𝑡 ∗ 365
𝑤𝑜𝑟𝑘 𝑖𝑛 𝑝𝑟𝑜𝑔𝑟𝑒𝑠𝑠
Plus WIP Turnover: 𝑐𝑜𝑠𝑡𝑠 𝑜𝑓 𝑔𝑜𝑜𝑑𝑠 𝑠𝑜𝑙𝑑 ∗ 365
Plus finished goods turnover
Plus receivables turnover :
𝑓𝑖𝑛𝑖𝑠ℎ𝑒𝑑 𝑔𝑜𝑜𝑑𝑠
𝑐𝑜𝑠𝑡 𝑜𝑓 𝑔𝑜𝑜𝑑𝑠 𝑠𝑜𝑙𝑑
𝑎𝑐𝑐𝑜𝑢𝑛𝑡 𝑟𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒
𝑠𝑎𝑙𝑒𝑠
∗ 365
∗ 365
= Working capital cycle in days.
How longer the working capital cycle the greater the investment.
Ways to reduce the working capital cycle.
 Reduce the time given to customers to pay their debts
( Risk: The find another supplier with longer terms)
 Reduce the inventory
(Risk: Items are out of stock)
 Delay payments to suppliers
(Risk: loss of good will of supplier)
Trade credit:
𝑡𝑟𝑎𝑑𝑒 𝑝𝑎𝑦𝑎𝑏𝑙𝑒𝑠
𝑝𝑢𝑟𝑐ℎ𝑎𝑠𝑒𝑠 𝑜𝑛 𝑐𝑟𝑒𝑑𝑖𝑡
∗ 365
Some suppliers offer discounts for earlier payment. It is wise to calculate if this early payment leads
to greater savings than when paying in a longer term.
Trade receivables:
The reach the optimum level of trade receivables you should keep in mind the following:
 Make a tradeoff between:
o Extending credit in order to increase sales and profit.
o The opportunity costs and administrations costs of carrying increased receivables.
 The level of risk a business is prepared to extend to individual customers.
 The investment in debt collection management,
The debt collection policies:
The overall debt collection policy of a firm should be set where the margin between the benefits
from the profits generate from the sales and the administrative and other costs incurred in debt
collection is at its greatest.
Credit control:
Important is the initial investigation of potential credit customers and the continuing control of
outstanding accounts. Main points to consider:
 References to see a potential customer’s financial standing.
 The credit rating of the customer.
 Adopt a conservative credit policy
 Look at the annual accounts.
Total credit control:
What is the total level of credit to be maintained or expand.
Main points to consider:
 Extra sales that a more generous credit policy would stimulate.
 The profitability of extra sales
 The extra length of the average debt collection period
 The required rate of return on the investment in additional receivables.
 The increase of bad debts
 Additional administration costs.
Average debt collection period can be measured by the receivables turnover date:
𝑡𝑟𝑎𝑑𝑒 𝑟𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠
∗ 365
𝑐𝑟𝑒𝑑𝑖𝑡 𝑠𝑎𝑙𝑒𝑠
Inventory
Important definitions:
Stock-outs= when there is a requirement for an item of inventory but none is available.
Lead time= The time which elapses between the placing of an order for inventory and the delivery.
Buffer inventory = The level of inventory held in case of unexpected high demand.
The order quantity= the number of units of an item in one order.
The reorder quantity= the balance of units remaining in inventory at which will be triggered an order
for additional inventory.
The reasons for holding inventory:
 As a buffer for unusual high demand.
 To take advantage of quantity discounts by buying in bulk.
 The delay in production caused by a lack of materials in kept to a minimum.
 To make sure that they don’t have to purchase at high prices.
 The loss of customer goodwill from not being able to meet demand.
 To take advantage of seasonal and other price fluctuations.
Inventory cost:
4 groups
The cost of the inventory self:
 Raw material
 Direct labour
 Associated indirect costs
Holding costs:
 Capital tied up in inventory
 Warehousing and handling costs
 Deterioration costs
 Obsolescence
 Insurance
 Pilferage
Ordering cots:
 Costs of raising orders
 Delivery costs
Stock out costs:
 Loss of sales
 Loss of customers ‘goodwill
 Cost of low production
 Extra cost if inventory should be bought at higher prices.
Inventory control
Achieved y collecting for each inventory item, details of the amounts used in a period, an exceptional
busy period and an exceptionally slack period.
Also the delivery times of the supplier should be analysed.
Reorder level = maximum delivery period * maximum usage.
Economic order quantity (Economic batch quantity)
= the order quantity for an item of inventory which minimizes costs.
Assumptions made
 Demand for the inventory is certain, constant and continuous
 The supply time also
 No stock-outs are permitted
 All prices are constant and certain
 The cost of holding inventory us proportional to the quantity of inventory held.
Q= the reorder quantity
C= the cost of placing an order
D= the usage of units
H= holding costs
Q= √
2𝐶𝐷
𝐻
JIT (Just in time)
Aim to have 0 inventory.
Highly depending on the supplier, so good relationships are important.
Relatively few suppliers. Supplier is an extension of the manufacturing process.
Cash management
Reasons for holding cash
 The transaction motive
To be able to meet payments when they fall due.
 The precautionary motive
Cash should be kept by a business in order to meet any unexpected outgoings.
 The speculative motive
Cash should be kept to take advantage of any unexpected beneficial opportunity.
Cost of holding cash  the opportunity cost = the profit foregone by note employing the cash
elsewhere.
𝑐𝑎𝑠ℎ 𝑏𝑎𝑙𝑎𝑛𝑐𝑒𝑠
Proportion of cash held = 𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑠𝑠𝑒𝑡𝑠