African Sisters Education Collaboration
Sisters Leadership Development Initiative (SLDI)
FINANCE TRACK 2014
The program overview
The Finance training program will keep you at the top of your game. Gain the knowledge,
behaviors and confidence to meet the challenges of today’s difficult economy. With the SLDI
finance training programs you will benefit from the latest financial management strategies
and techniques to keep your skills sharp and your financial acumen strong and focused. The
intention of this training is to demonstrate to participants that maximizing firm value
necessitates focusing on more than shareholders.
The finance track will cover key areas in finance and accounting. The track has been divided
into four core models.
This model covers the following topics:
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Stewardship, integrity and accountability in the finance profession
Understanding the finance code of conduct
Introduction to accounting
Financial management overviews
 Understanding how to set meaningful and important goals for you
 How to use debt to achieve your goals
 How to choose the assets that will help you achieve your goals
 Budgeting and budgetary control
 Effective financial planning
 Introduction to books of accounts
TRAINING METHOD
A workshop approach will be used in order to encourage exchange of knowledge amongst
participants in a highly participatory manner. Techniques to be used will include plenary
discussions and presentations, practical exercise, case study and group work.
Expectations: Upon completion of this module of the finance track, participants will be able
to:
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Uncover drains on profitability
Make smarter decisions that deliver higher profitability
Effectively use a budget to enhance their overall financial position
Identify any debt issues and how to use debt as a wealth creating tool
Understand how the various investments operate
Work confidently with a financial adviser
Workshop Activities Include:
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Analyzing and creating income statements, balance sheets and cash flow statements
Establishing and managing realistic operating budgets
Selecting the most profitable projects or activities
Calculating a budget to achieve financial goals
Applying financial principles to real-world situations
Expected outcome:
At the end of this week participants will learn how to:
• Here we start by reinforcing some key points:
•Organizational strategy is determined by:
 The organization’s core values and views about how they want to operate.
 Market conditions that determine where they can find a competitive niche.
 Strategy is developed by applying theory from the key business disciplines: marketing,
accounting, and management, finance, and information systems.
•
Resources are necessary to execute the strategy. Those resources that lead to a
positional advantage are usually intangible and often relationship based. The organization
develops a resource mix that is not imitable by competitors.
•
Stakeholders (consumers, value chain partners, investors, employees, and publics)
supply the resources. The organization must understand what motivates them to contribute
to the organization. The organization must clearly understand what it needs from the
stakeholders. Often there are conflicting expectations from different stakeholders which
need to be balanced. Sometimes stakeholders may have relationships between themselves
that affect how the organization works with them to assemble their resource mix.
1.0 Stewardship, Accountability and Integrity
Like a real steward the financial manager prepares the meal.
Note food per say but funds. Funds are for the organization what food is for the body.
Without fund the organization will die.
Accountability means cooking the meal with the right recipes.
It also means using the right quantities of the recipes.
Too much salt, pepper and oil will spoil the taste.
It implies also that the cook knows how to apply the recipes.
Integrity means been truthful about what was cook.
No stealing, pilfering and keeping for personal use illegally.
It means also, cleaning the hands to avoid contamination by gems
This is how a good financial manager is likening to a good cook.
Stewardship & Accountability
As finance officers, we are constantly reminded that we must be good stewards of the public
trust, ensuring the resources of our organizations are well protected and used efficiently to
accomplish the missions for which our organizations exist. We are also charged with making
certain our management practices ensure the long-term sustainability of the organization.
Finance officers specifically carry this fiduciary responsibility for the organization. They must
see to it that managers fulfill all regulatory, legal, and reporting requirements imposed by
federal, state, and local governments as well as meeting accounting guidelines and standards
specific to the nonprofitorganisation. Add to that ensuring the organization complies with all
restrictions imposed by donors on the use of their contributions.
To accomplish all of this requires the organization to set up a well-integrated financial
management cycle featuring:
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accurate and dependable accounting
effective internal controls procedures
transparent reporting
informed analysis
responsible planning
appropriate responses to its financial data
2.0 Code of Conduct for Financial Managers
Introduction
This Code of Ethical Conduct for Financial Managers ("Code") applies to all Financial
Managers. Financial Managers are Director, Chief Financial Officer, Controller, Treasurer, Tax
Director, Audit Director, Assistant Controller, Assistant Treasurer and managers reporting to
each of these positions who are responsible for accounting and financial reporting.
This Code covers a wide range of financial and non-financial business practices and
procedures. This Code does not cover every issue that may arise, but it sets out basic
principles to guide all. If a law or regulation conflicts with a policy in this Code, the Financial
Manager must comply with the law or regulation. If a financial manager has any questions
about this Code or potential conflicts with a law or regulation, they should contact PAID-WA
or an Audit Director.
Financial Code Principles and Responsibilities
Financial Managers shall adhere to and advocate to the best of their knowledge and ability
the following principles and responsibilities governing their professional and ethical conduct.
1. Act with honesty and integrity, including the ethical handling of actual or apparent
conflicts of interest between personal and professional relationships.
2. When disclosing information to constituents, provide them with information that is
accurate, complete, objective, relevant, timely and understandable. Reports and
documents that Tenneco files with the Securities and Exchange Commission or
releases to the public shall contain full, fair, accurate, timely and understandable
information.
3. Comply with rules and regulations of federal, state, provincial and local governments,
and other appropriate private and public regulatory agencies, including the Securities
and Exchange Commission and New York Stock Exchange.
4. Act in good faith, responsibly, with due care, competence and diligence, without
misrepresenting material facts or allowing their independent judgment to be
subordinated.
5. Protect and respect the confidentiality of information acquired in the course of their
work except when authorized or otherwise legally obligated to disclose. Confidential
information acquired in the course of their work shall not be used for personal
advantage.
6. Share knowledge and maintain skills important and relevant to constituents' needs.
7. Proactively promote ethical behavior as a responsible partner among peers in the
work environment and community.
8. Achieve responsible use of and control over all assets and resources employed by or
entrusted to them.
9. Be responsible for implementing and maintaining an adequate internal control
structure and procedures for financial reporting, including disclosure controls.
10.Promptly report code violations to Tenneco's General Counsel and Audit Director.
THREATS AND SAFEGUARDS
Threats may be created by a broad range of relationships and circumstances. When a
relationship or circumstance creates a threat, such a threat could compromise, or
could be perceived to compromise, a professional accountant’s compliance with the
fundamental principles. A circumstance or relationship may create more than one
threat, and a threat may affect compliance with more than one fundamental principle.
Threats fall into one or more of the following categories:
(a) Self-interest threat – the threat that a financial or other interest will
inappropriately influence the accountant’s judgment or behavior;
Examples of circumstances that may create self-interest threats for a member in
practice include, but are not limited to:
(i) A financial interest in a client or jointly holding a financial interest with a client
(ii) Having a close business relationship with a client
(iii) Concern about the possibility of losing a client
(iv)Potential employment with a client
(v) Contingent fees relating to an assurance engagement
(vi) A loan to or from an assurance client or any of its directors or officers
(vii) Discovering a significant error when evaluating the results of a previous
professional service performed by a member of staff working with or for the
member.
(b) Self-review threat – the threat that an accountant will not appropriately evaluate
the results of a previous judgment made or service performed by the accountant,
or by another individual within the accountant’s firm or employing organization, on
which the accountant will rely when forming a judgment as part of providing a
current service;
Examples of circumstances that may create self-review threats include, but are not
limited to:
(i) The discovery of a significant error during a re-evaluation of the work of the
member in practice
(ii) Reporting on the operation of financial systems after being involved in their
design or implementation
(iii) Having prepared the original data used to generate records that are the subject
matter of the engagement
(iv)A member of the assurance team being, or having recently been, a director or
officer of that client
(v) a member of the assurance team being, or having recently been, employed by
the client in a position to exert significant influence over the subject matter of the
engagement
(vi) Performing a service for a client that directly affects the subject matter of the
assurance engagement.
(c) Advocacy threat – the threat that a professional accountant will promote a client’s
or employer’s position to the point that the professional accountant’s objectivity is
compromised;
Examples of circumstances that may create advocacy threats include, but are not
limited to:
(i) Promoting shares in a listed entity when that entity is a financial statement audit
client
(ii) Acting as an advocate on behalf of an assurance client in litigation or disputes
with third parties.
(d) Familiarity threat ─ the threat that due to a long or close relationship with a client
or employer, a professional accountant will be too sympathetic to their interests or
too accepting of their work;
Examples of circumstances that may create familiarity threats include, but are not
limited to:
(i) a member of the engagement team having a close or personal relationship with
a director or officer of the client
(ii) a member of the engagement team having a close or personal relationship with
an employee of the client who is in a position to exert direct and significant
influence over the subject matter of the engagement
(iii) a former partner of the firm being a director or officer of the client or an
employee in a position to exert direct and significant influence over the subject
matter of the engagement
(iv) accepting gifts or preferential treatment from a client, unless the value is clearly
insignificant
(v) long association of senior personnel with the assurance client.
(e) Intimidation threat – the threat that an accountant will be deterred from acting
objectively because of actual or perceived pressures, including attempts to exercise
undue influence over the accountant.
Examples of circumstances that may create intimidation threats include, but are not
limited to:
(i) being threatened with dismissal or replacement in relation to a client engagement
(ii) an assurance client indicating that he will not award a planned non-assurance
contract to the member in practice if the member in practice continues to disagree
with the client’s accounting treatment for a particular transaction
(iii) being threatened with litigation
(iv) being pressured to reduce inappropriately the quality or extent of work performed
in order to reduce fees
(v) feeling pressured to agree with the judgement of a client employee because the
employee has more expertise on the matter in question
SAFEGUARDS
Safeguards are actions or other measures that may eliminate threats or reduce them
to an acceptable level. They fall into two broad categories:
(a) Safeguards created by the profession, legislation or regulation; and
(b) Safeguards in the work environment.
Safeguards created by the profession, legislation or regulation include:
• Educational, training and experience requirements for entry into the profession.
• Continuing professional development requirements.
• Corporate governance regulations.
• Professional standards.
• Professional or regulatory monitoring and disciplinary procedures.
Certain safeguards may increase the likelihood of identifying or deterring unethical
behavior. Such safeguards, which may be created by the accounting profession,
legislation, regulation, or an employing organization, include:
• Effective, well-publicized complaint systems operated by the employing
organization, the profession or a regulator, which enable colleagues, employers and
members of the public to draw attention to unprofessional or unethical behavior.
• An explicitly stated duty to report breaches of ethical requirements.
Firm-wide safeguards in the work environment may include:
(i) development of a leadership culture within the firm that stresses the importance of
compliance with the fundamental principles
(ii) development of a leadership culture within the firm that establishes the
expectation that members of an assurance team will act in the public interest
(iii) policies and procedures to implement and monitor quality control of engagements
(iv) documented policies regarding the identification of threats to compliance with the
fundamental principles, the evaluation of the significance of these threats and the
identification and the application of safeguards to eliminate or reduce the threats,
other than those that are clearly insignificant, to an acceptable level or when
appropriate safeguards are not available or cannot be applied, terminate or decline
the relevant engagement
(v) for firms that perform assurance engagements, documented independence policies
regarding the identification of threats to independence, the evaluation of the
significance of these threats and the evaluation and application of safeguards to
eliminate or reduce the threats, other than those that are clearly insignificant, to an
acceptable level
(vi) documented internal policies and procedures requiring compliance with the
fundamental principles
(vii) policies and procedures that will enable the identification of interests or
relationships between the firm or members of engagement teams and clients
(viii) policies and procedures to monitor and, if necessary, manage the reliance on
revenue received from a single client
(ix) using different partners and engagement teams with separate reporting lines for
the provision of non-assurance services to an assurance client
(x) policies and procedures to prohibit individuals who are not members of an
engagement team from inappropriately influencing the outcome of the engagement
(xi) timely communication of a firm’s policies and procedures, including any changes to
them, to all partners and professional staff, and appropriate training and education on
such policies and procedures
(xii) designating a member of senior management to be responsible for overseeing the
adequate functioning of the firm’s quality control system
(xiii) advising partners and professional staff of those assurance clients and related
entities from which they must be independent
(xiv) a disciplinary mechanism to promote compliance with policies and procedures
(xv) published policies and procedures to encourage and empower staff to
communicate to senior levels within the firm any issue relating to compliance with the
fundamental principles that concerns them.
Engagement-specific safeguards in the work environment may include:
(i) involving an additional member to review the work done or otherwise advise as
necessary
(ii) consulting an independent third party, such as a committee of independent
directors, a professional regulatory body or another member
(iii) discussing ethical issues with those charged with governance of the client
(iv) disclosing to those charged with governance of the client the nature of services
provided and extent of fees charged
(v) involving another firm to perform or re-perform part of the engagement
(vi) rotating senior assurance team personnel.
Depending on the nature of the engagement, a member in practice may also be able
to rely on safeguards that the client has implemented. However, it is not possible to
rely solely on such safeguards to reduce threats to an acceptable level.
Safeguards within the client’s systems and procedures may include:
(i) when a client appoints a member in practice or a firm to perform an engagement,
where appropriate persons other than management ratify or approve the
appointment
(ii) the client has competent employees with experience and seniority to make
managerial decisions
(iii) the client has implemented internal procedures that ensure objective choices in
commissioning non-assurance engagements
(iv) the client has a corporate governance structure that provides appropriate
oversight and communications regarding the firm’s services.
Ethical Conflict Resolution
An accountant may be required to resolve a conflict in complying with the
fundamental principles.
When initiating either a formal or informal conflict resolution process, the following
factors, either individually or together with other factors, may be relevant to the
resolution process:
(a) Relevant facts;
(b) Ethical issues involved;
(c) Fundamental principles related to the matter in question;
(d) Established internal procedures; and
(e) Alternative courses of action.
Waivers of the Code
Any waiver of this Code for Financial Managers may be made only by the Audit Committee of
the Board of Directors and will be promptly disclosed as required by law governing the
establishment. Requests for waivers must be made in writing to the head of the
establishment prior to the occurrence of the violation of the Code.
3.0 INTRODUCTION TO ACCOUNTING
In business activity a lot of “give & take” exist which is known as transaction. Transaction
involves transfer of money or money’s worth. Thus exchange of money, goods & services
between the parties is known to have resulted in a transaction. It is necessary to record all
these transactions very systematically & scientifically so that the financial relationship of a
business with other persons may be properly understood, profit & loss and financial position
of the business may be worked out at a particular date. The procedure to record all these
transactions is known as “Book-keeping”.
There are various terminologies used in the Accounting which are being explained as under: 1) Assets: An asset may be defined as anything of use in the future operations of the
enterprise & belonging to the enterprise. E.g., land, building, machinery, cash etc.
2) Equity: In broader sense, the term equity refers to total claims against the enterprise. It is
further divided into two categories.
i. Owner Claim - Capital
ii. Outsider’s Claim – Liability
Capital: The excess of assets over liabilities of the enterprise. It is the difference between
the total assets & the total liabilities of the enterprise. e.g., if on a particular date the assets
of the business amount to 10.000 FCFA & liabilities to 3,000FCFA then the capital on that
date would be 7,000FCFA
Liability: Amount owed by the enterprise to the outsiders i.e. to all others except the owner.
e.g.: trade creditor, bank overdraft, loan etc.
3) Revenue: It is a monetary value of the products or services sold to the customers during
the period. It results from sales, services & sources like interest, dividend & commission.
4) Expense/Cost: Expenditure incurred by the enterprise to earn revenue is termed as
expense or cost. The difference between expense & asset is that the benefit of the former is
consumed by the business in the present whereas in the latter case benefit will be available
for future activities of the business e.g. raw material, consumables & salaries etc.
5) Drawings: Money or value of goods belonging to business used by the proprietor for his
personal use.
6) Owner: The person who invests his money or money’s worth & bears the risk of the
business.
7) Sundry Debtors: A person from whom amounts are due for goods sold or services
rendered or in respect of a contractual obligation. It is also known as debtor, trade debtor,
accounts receivable.
8) Sundry Creditors: It is an amount owed by the enterprise on account of goods purchased
or services rendered or in respect of contractual obligations. e.g., trade creditor, accounts
payable.
3.1 ACCOUNTING CYCLE
After taking decisions such as selecting a business, selecting the form of organization of
business, making decision about the amount of capital to be invested, selecting suitable site,
acquiring equipment & supplies, selecting staff, getting customers & selling the goods etc. a
business man finally resorts to record keeping.
The following is the complete cycle of Accounting
a) The opening balances of accounts from the balance sheet & day to day business
transaction of the accounting year are first recorded in a book known as journal.
b) Periodically these transactions are transferred to concerned accounts known as ledger
accounts.
c) At the end of every accounting year these accounts are balanced & the trial balance is
prepared.
d) Then the final accounts such as trading & profit & loss accounts are prepared.
e) Finally, a balance sheet is made which gives the financial position of the business at the
end of the period.
3.3 ACCOUNTING ASSUMPTIONS
In the modern world no business can afford to remain secretive because various parties such
as creditors, employees, Government, investors & public are interested to know about the
affairs of the business. The affairs of the business can be studied mainly by consulting final
accounts and the balance sheet of the particular business. Final accounts & the balance sheet
are the end products of book keeping. The need for generally accepted accounting principles
arises from two reasons:
1) To be logical & consistent in recording the transaction
2) To conform to the established practices & procedures
The International Accounting Standards Committee (IASC) treats the following as the
fundamental assumptions:
1. Going Concern: In the ordinary course accounting assumes that the business will continue
to exist & carry on its operations for an indefinite period in the future.
The entity is assumed to remain in operation sufficiently long to carry out its objects and
plans. The values attached to the assets will be on the basis of its current worth. The
assumption is that the fixed assets are not intended for re-sale.
2. Consistency: There should be uniformity in accounting processes and policies from one
period to another. Only when the accounting procedures are adhered to consistently from
year to year the results disclosed in the financial statements will be uniform and comparable.
3. Accrual: Accounting attempts to recognize non-cash events and circumstances as they
occur. Accrual is concerned with expected future cash receipts and payments. It is the
accounting process of recognizing assets, liabilities or income amounts expected to be
received or paid in future. Common examples of accruals include purchases and sales of
goods or services on credit, interest, rent (unpaid), wages and salaries, taxes.
a) Assets Accounts: These accounts relate to tangible and intangible assets. e.g., Land a/c,
building a/c, cash a/c, goodwill, patents etc.
b) Liabilities Accounts: These accounts relate to the financial obligations of an enterprise
towards outsiders. e.g., trade creditors, outstanding expenses, bank overdraft, and long-term
loans.
c) Capital Accounts: These accounts relate to the owners of an enterprise e.g. Capital a/c,
drawing a/c.
d) Revenue Accounts: These accounts relate to the amount charged for goods sold or
services rendered or permitting others to use enterprise’s resources yielding interest, royalty
or dividend. e.g., Sales a/c, discount received a/c, dividend received a/c, interest received
a/c.
e) Expenses Account: These accounts relate to the amount spent or lost in the process of
earning revenue e.g. Purchases a/c, discount allowed a/c, royalty paid a/c, interest payable
a/c, loss by fire a/c.
3.4 SYSTEMS OF RECORDING
There are three methods of recording of entries which are explained as under:
Single Entry System: This system ignores the two fold aspect of each transaction as
considered in double entry system.
Under single entry system, merely personal aspects of transaction i.e. personal accounts are
recorded. This method takes no note of the impersonal aspects of the transactions other
than cash. It offers no check on the accuracy of the posting and no safeguard against fraud
and because it does not provide any check over the recording of cash transactions, it is called
as “imperfect accounting”.
Double entry system: The double entry system was first evolved by Luca Pacioli, who was a
Franciscan Monk of Italy. With the passage of time, the system has gone through lot of
developmental stages. It is the only method fulfilling all the objectives of systematic
accounting. It recognizes the two fold aspect of every business transaction.
Cash or receipt basis is the method of recording transactions under which revenues and
costs and assets and liabilities are reflected in accounts in the period in which actual receipts
or actual payments are made. “Receipts and payments account” in case of clubs, societies,
hospitals etc., is the example of cash basis of accounting.
Accrual or mercantile basis is the method of recording transactions by which revenues;
costs, assets and liabilities are reflected in accounts in the period in which they accrue.
This basis includes considerations relating to outstanding; prepaid, accrued due and received
in advance.
Hybrid or mixed basis is the combination of both the basis i.e. cash as well as mercantile
basis. Income is recorded on cash basis but expenses are recorded on mercantile basis.
4.0 FINANCIAL MANAGEMENT OVERVIEW
Finance can be defined as the science and art of managing money.
At the personal level, finance is concerned with individuals’ decisions about how much of
their earnings they spend, how much they save, and how they invest their savings.
In a business context, finance involves the same types of decisions: how firms raise money
from investors, how firms invest money in an attempt to earn a profit, and how they decide
whether to reinvest profits in the business or distribute them back to investors.
4.1Career Opportunities in Finance:
I.
Financial Services
Financial Services is the area of finance concerned with the design and delivery of advice and
financial products to individuals, businesses, and governments.
Career opportunities include banking, personal financial planning, investments, real estate,
and insurance.
II.
Managerial finance
Managerial finance is concerned with the duties of the financial manager working in a
business.
Financial managers administer the financial affairs of all types of businesses—private and
public, large and small, profit-seeking and not-for-profit.
They perform such varied tasks as developing a financial plan or budget, extending credit to
customers, evaluating proposed large expenditures, and raising money to fund the firm’s
operations.
4.2 Legal Forms of Business
A sole proprietorship is a business owned by one person and operated for his or her own
profit.
A partnership is a business owned by two or more people and operated for profit.
A corporation is an entity created by law. Corporations have the legal powers of an individual
in that it can sue and be sued, make and be party to contracts, and acquire property in its
own name.
Table 1.1 Strengths and Weaknesses of the Common Legal Forms of Business Organization
Table 1.2 Career Opportunities in Managerial Finance
The role of business ethics
Business ethics are the standards of conduct or moral judgment that apply to persons
engaged in commerce.
Violations of these standards in finance involve a variety of actions: “creative accounting,”
earnings management, misleading financial forecasts, insider trading, fraud, excessive
executive compensation, options backdating, bribery, and kickbacks.
Ethics programs seek to:
I.
II.
III.
IV.
reduce litigation and judgment costs
maintain a positive corporate image
build shareholder confidence
gain the loyalty and respect of all stakeholders
The expected result of such programs is to positively affect the firm’s share price.
4.2 Governance and Agency
1. Corporate governance
Corporate governance refers to the rules, processes, and laws by which companies are
operated, controlled, and regulated.
It defines the rights and responsibilities of the corporate participants such as the
shareholders, board of directors, officers and managers, and other stakeholders, as well as
the rules and procedures for making corporate decisions.
The structure of corporate governance was previously described in Figure 1.1.
2. Government regulation
Government regulation generally shapes the corporate governance of all firms.
During the recent decade, corporate governance has received increased attention due to
several high-profile corporate scandals involving abuse of corporate power and, in some
cases, alleged criminal activity by corporate officers.
3. Agency issue
A principal-agent relationship is an arrangement in which an agent acts on the behalf of a
principal. For example, shareholders of a company (principals) elect management (agents) to
act on their behalf.
Agency problems arise when managers place personal goals ahead of the goals of
shareholders.
Stakeholder Diagram
INTEGRATING STAKEHOLDER THEORY INTO FINANCIAL PERFORMANCE
5.0 BUDGETING AND BUDGETARY CONTROL
A budget is a forward financial plan. It provides a prediction of expected flows of money in
and out of the firm in the immediate future. Normally, a budget will be prepared in advance
of a period of time, usually a year but could be on a monthly or quarterly basis
Functions of budgets
Planning
Budgeting forces managers to plan, and therefore consider, alternative future courses of
action, to evaluate them properly and to decide on the best alternative. It also encourages
managers to anticipate problems before they arise, thus giving themselves time to consider
alternative ways of overcoming them when they do happen, and to prepare for
circumstances (even simple course of action such as prearranging a bank overdraft will be
possible as part of the budgeting process). Budgeting tends to produce better results than
decisions made 'on the spot'.
Co-ordination
Without a full system of budgetary control, managers of different functions within the firm
(i.e. sales, production, finance, etc) may make decisions about the future which are in
conflict with other departments.
Control
Comparisons of budgeted data and the actual data (when it occurs) are a procedure known
as variance analysis. Comparing what was expected (the budget) with what actually
happened can help mangers to control the finances in a more direct manner.
Motivation
Involving people throughout the organisation in the process of budgeting will help to bring
the staff closer together. By setting targets, staff are more likely to feel involved within the
organisation and therefore are likely to be more highly motivated.
Cash budgets
A cash budget, also known as a cash flow forecast, is a prediction of future cash inflows and
cash outflows over a period of time. Cash budgets are produced by many firms and are
probably the type of budget that will appear in examination questions most frequently.
Fortunately, cash budgets, with a little practice, are fairly straightforward to produce.
Cash inflows
A cash inflow is any amount of money that the firm received. This will include, money
received from sales (either cash sales or receipts from debtors), as well as any other form of
money. Any loans taken out by the firm would also be included as a cash inflow, as would the
sales of any fixed assets.
Cash outflows
A cash outflow is any money that is spent by the firm. This will involve money spent on
purchases of stocks, money spent on wages and other bills. It will also include capital
expenditure on the purchases of fixed assets, as well as loan repayments and tax payments.
Net cash flow
For any period of time, usually over a month, a firm's net cash flow can be calculated. It is the
difference between the cash inflows to the firm and the cash outflows.
The net cash flow is calculated as follows:
Net cash flow = Cash inflows - Cash outflows
Differences between cash flow and profit
Although a cash budget is fairly easy to prepare, it can be confusing to deal with after
spending lots of time focusing on the production of profit and loss accounts. This is because
the principles of a cash budget are different from those used in the production of profit and
loss account.
The profit and loss account is drawn up on the accruals basis. This means that incomes are
expenses are accounted for in the period in which they are incurred not when they are paid
or received. Capital revenue and incomes are not included in the profit and loss account.
A cash budget is drawn up on the basis on cash received and cash paid. It does not matter
what the money is for, it will be included in the period the cash flow appears.
Example 1
Alec Powell is a sole trader who buys and sells electrical goods. The following sales are
expected over the six-month period from November 2005 to April 2006.
-
Purchases Sales
Fcfa(000) Fcfa(000)
Nov 12,000
17,000
Dec 14,000
22,000
Jan
13,000
18,000
Feb 14,000
14,000
Mar 15,000
16,000
Apr 18,000
18,000







Wages are paid each month of Fcfa1, 000,000 which are paid in month that they are
incurred.
Overhead expenses are due each month of Fcfa800, 000 and these are paid one month
in arrears.
On 1 March 2006, a new van is purchased for Fcfa8, 000,000. The old van is sold on 15
April for Fcfa 1,500,000.
Sales are all on credit and we allow a two-month credit period
Half of the purchases are on credit - we are allowed a month credit period - and half
are for immediate settlement,
The balance at the bank as at 31 December 2005 was Fcfa 1000,000 (overdrawn)
Produce a cash budget for the four-month period ending 30 April 2006.
Developing accounting controls
The recording of transactions should not be just for the purpose of preparing financial
statements but should be so developed that significant information for planning and control
is produced simultaneously. Accounting controls are an integral part of the budgetary control
system.
Communication
It goes without saying that there should be top management support in making the
budgetary control system successful. Top management should not only educate all involved
concerning the usefulness of the system, but also communicate the goals, objectives, means
of implementing the budget, and responsibilities of each departmental head. The success of
the budgetary control system depends very much on the kind of information which forms
the input to the whole process.
Coordination
The development of a budgetary control system is an activity which requires coordinated
efforts from different departments and at various levels. To ensure that staff become
involved and participate in a useful and meaningful manner, all efforts need to be
coordinated.
Budget administration
The complexities involved in preparing the budget and implementing the budgetary control
system are many. Management has to put in an effort to ensure that the basic objectives of
budgeting are achieved.
Control
Planning is a process of stating what we want to achieve, and trying to achieve what has
been planned. Future outcomes are controlled on the basis of what has been achieved in
past. Control is possible only if we have established criteria against which the actual
accomplishments can be compared.
Variance analysis
Planning and control are future-oriented activities. However, past achievements cannot be
altogether ignored, because it is on the basis of past achievements that one draws
expectations about the future.
FLEXIBLE BUDGETS AND STANDARD COSTING
Flexible Budgeting
The Budgetary Control Process – Actual results are seldom equal to budgeted goals. The
difference between actual results and budgeted goals are called variances. Variances need to
be identified, investigated, and corrective actions taken. There are four major steps involved
in the budgetary control process:
1.
2.
3.
4.
Develop the budget based on planned objective (last chapter)
Compare actual results to budgeted amounts and analyze the differences
Take corrective and strategic actions if necessary
Establish new objectives and start the budgeting cycle over with new budgets
Fixed Budgets – Fixed budgets are known as “static” budgets, because the budget remains at
the same levels used when the budget was created. It does not change, even though
considerations that went into developing the budget might change. If actual production is
different than budgeted production, it is difficult to analyze budgetary variances when fixed
budgets are used.
Flexible Budgets – These are budgets that “flex” or change with varying levels of activity. For
example, if the original budget called for producing 1,000 units, but a company actually
produced 1,200 units, a revised budget would be created for 1,200 units. Flexible budgets
assist management in evaluating performance. We will work on creating flexible budgets in
class, but the strategy is to identify costs as either variable or fixed. Variable costs will
change as the output changes, but fixed costs will remain the same. There is a good
example of such a budget on Pg. 883 of our text. You will notice that the budget takes the
form of a contribution margin income statement.
Favorable and Unfavorable Variances: The differences between the Budgeted Amounts and
the Actual results will either be favorable or unfavorable. We will be using abbreviations as
we work through the variances as follows:
 F = Favorable: When compared to budgeted amounts, the actual cost is lower than
budgeted. Or, actual revenues are higher than budgeted.
 U = Unfavorable: When compared to budgeted amounts, the actual cost is higher than
budgeted. Or, actual revenues are lower than budgeted.
Standard Costs
Standard Costs are preset costs for delivering a product or service under normal conditions.
They are used by management in evaluating performance. There are many people involved
in developing standard costs.
For example, there are standard costs for direct materials purchases. The purchasing
department would be involved in setting these standards. There are standard costs for direct
material usage; the production manager would set such standards based on historical
experience or time-and-motion studies.
There are also standards for direct labor pay rates and labor efficiency. The human resources
and/or payroll departments would provide the accountant the data for the pay rate
standards. The production manager will work with the accountant in setting standards for
labor efficiency.
Summary of Variance Formulas
Variance name
Materials Price
Variance
Materials Quantity
Variance
Labor Rate Variance
Labor Efficiency
Variance
Controllable Variance
Formula
(Actual price –
Standard price) *
Actual qty.
(ASA)
(Actual quantity used
– Standard quantity
allowed) * Standard
price
(ASS)
(Actual pay rate –
Standard pay rate) *
Actual hours worked
(ASA)
(Actual hours worked
– Standard hours
allowed) * Standard
pay rate/hour
(ASS)
Actual total overhead
Purpose of the variance
Computes the difference between actual
cost paid per unit for direct materials and
the standard cost per unit for direct
materials.
Computes the difference between the
actual number of direct materials units
used and the standard number of direct
materials allowed, based on units made.
Calculates the difference between the
actual hourly labor rate paid and the
standard labor rate per hour.
Calculates the difference between the
actual number of hours worked and the
standard number of hours allowed. The
standard direct labor hours allowed is
based on actual production.
Computes overhead variance for costs
(Factory Overhead)
Volume Variance
(Factory Overhead)
costs, less
Applied total
overhead from the
flexible budget
Budgeted fixed
overhead costs at
capacity, less
Applied fixed
overhead
usually under management control.
This variance measures the difference
between operating at the standard level
for units produced and production
capacity. When unfavorable, it calculates
fixed costs wasted by not producing up to
capacity. A favorable variance indicates
more units were produced than expected.
Extensions of Standard Costs
Standard costs for control
Management personnel have two basic duties: those revolving around planning, such as
budget creation, and control. Using reports that detail differences between actual results
and budgeted amounts, or reports that detail standard cost variances, assist management in
controlling operations. Significant variances should be investigated and corrective actions
taken quickly. This is an example of management by exception.
Standard costs for services
Companies providing services may also use standard costing. For example, banks often have
standards on how much time tellers should take to process customer transactions. The
computer used by the tellers tracks the time on each transaction, and a report is produced
summarizing the teller’s actual time taken against the standard.
Standard cost accounting systems
Many accounting systems incorporate variance accounts in their general ledger, and are
programmed to record variances in the accounts.
For example, assume that a company has standard direct materials of 5 pounds per unit. The
standard cost per pound is $1.00. During the month, 1,000 units were produced. The actual
quantity of material used was 5,100 pounds. The actual price paid per pound was $.90.
The direct material variances would be calculated as follows:
Price: ($.90 - $1) * 5,100 pounds = $510 F
Quantity: (5,100 pounds – 5,000 pounds #) * $1 = $100 U
# 1,000 units produced * 5 pounds per unit = 5,000 pounds
A standard cost accounting system would record the direct materials usage as follows:
Debit
Goods in Process Inventory (5,000 * $1)
5,000
Direct Materials Quantity Variance
100
Direct Materials Price Variance
Raw Materials Inventory (5,100 pounds * $.90)
Credit
510
4,590
This practice simplifies recordkeeping, saves accountants’ time, and helps in preparing
reports.
TYPES OF BUDGET
Just about all firms will budget for future finances. It would be expected that a firm starting
out would have to present a budgeted set of final accounts, as well as a cash budget in order
to borrow money from a bank. Sole traders are more likely to produce only one or two of the
following budgets. However, to gain from the benefits outlined above, larger firms would be
expected to produce all of the following types of budgets.
Forecast
Future
Conditions
Accounting
Theory
Management
Theory
Cost of Production
Personnel Budget
Behavioral
Motivators
Superior
Financial
Performance
Assess
Current
Conditions
Marketing
Theory
Production Budget
On the basis of
FLEXIBILITY
Finance
Theory
Information
Systems
Business
Knowledge
Research Budget
Cash Budget
Operating Budget
CLASSIFICATION ACCORDING TO TIME
1. Long Term Budgets: The Budgets are prepared to depict long term planning of the
business. The period of long term budgets various between five to ten years. The long term
planning is done by the top'-level management and generally it is not known to lower levels
of management. Long-term budgets are prepared for some sectors of the concern such as
capital expenditure, research and development, long-term finances etc. These budgets are
useful for those industries where gestation period is long i.e.,-machinery, electricity, and
organization.
2. Short Term Budgets: These budgets are generally for one or two years and are in the form
of monetary terms. The consumer's goods industries-like sugar, cotton, textiles, etc., use
short-term budget.
3. Current Budget: The period of current budget is generally of months and weeks. The
budgets relate to the current activities of the business. According to I.C.W.A. London
"Current budget is a budget which is established for use over a short period of time and is
related to current conditions".
CLASSIFICATION ON THE BASIS OF FUNCTION
It is important to understand that each of the following budgets in merely a sub-budget (for
a particular area of the business) of the overall master budget for the firm. The different
types of budget are as follows:

Sales budget: the expected level of sales - usually by value but could also be by sales
volume (units) as well.

Production budget: once the level of sales has been budgeted, the expected
production (in units of output) will be set in the production budget.

Purchases budget: once the production budget has been drawn up, the purchases
budget will then be produced - this will outline the purchases of materials and other
inputs into the production process.

Debtors budget: this will be based on the expected level of credit sales and also, the
credit period offered by the firm to customers - it will show how much we are owed by
our debtors at any particular time

Creditors budget: this will be based on the expected level of credit purchases and also,
the credit period offered to the firm to suppliers - it will show how much we owe our
creditors at any particular time

Cash budget: also known as a cash flow forecast, this shows the cash inflows and cash
outflows as they occur for a period of time.





Master budgets: this is set of budget final accounts (a budgeted profit and loss
accounts and a budgeted balance sheet). It is know as a master budget because it is
based on all the other sub-budgets.
Personnel Budget: The budget anticipates the quantity of personnel required during a
period for production activity. This may be further split up between direct and indirect
personnel budgets.
Research Budget: The budget relates to the research work to be done for
improvement in quantity of the products or research for new products.
Capital Expenditure Budget: The budget provides a' guidance regarding the amount of
capital that may be required for procurement of capital assets during the budget
period.
Operating Budget: The budget shows planned operations for the forthcoming period,
including revenues, expenses and related changes in inventory. It covers in its ambit
Sales Budget, Production Budget, Cost of Production Budget, etc. Thus, it is the
principal part of Master Budget of the business. The operating budget usually consists
of
i) Programmed budget and ii) Responsibility budget.
i) Programmed Budget: It consists of expected revenues and costs of various products
or projects that are termed as the major programmers of the firm. Such a budget can
be prepared for each product time or project showing revenues, Costs and the relative
profitability of the various programmers. Programmer budgets*are thus useful in
locating areas where efforts may be required to reduce costs and increase revenues.
They are also useful in determining imbalances and inadequacies in programmers so
that corrective action may be taken in future.
ii) Responsibility Budget: It is a budget, which identifies the revenues and costs, with
an individual responsible for their incurrence. Such a budget is an excellent control
device since it identifies with the individual only such revenues and costs which are
controllable by him. The regarding the actual results are collected from different
operations and compared with the budgeted figure to find out whether the individual
has what he expected.
Example
Will Todd produces model cars that he produces and sells to local retailers. He has decided
to produces a full set of financial budgets to help him plan ahead. The following data is
available January to July 2003.
Month Sales (number of cars)
Jan
50
Feb
60
Mar
60
Apr
80
May
100
Jun
120
Jul
150








Each model car will be sold for £50.
The raw materials needed for the production of each car will cost £30
Materials are purchased in the month of production
He obtains one month's credit from the supplier of raw materials
He give two month credit to the retailers
The production in each month should be organised so that the closing stock at the end
of each month is equal to the next month's sales.
The stock as at January 1st 2003 is 30 cars
Assume that, at the start of the year, there are no amounts owing from debtors and no
amounts owing to creditors
From this data we can produce the following budgeted examples for the six month period
ending 30 June 2003. Once you have read each section, try to produce the relevant budget
from these figures and then follow the link to see how you got on.
Sales budget
A sales budget should really be based on up to date market research concerning future
trends in demand. However, many firms will simply base the future level of sales of past
trends. They may extrapolate from past data (i.e. looking at the average change in sales over
the past few years as the basis for predicting future sales). Other factors to be considered
would also include:





Forecasted changes in national income - to estimate changes in consumer spending
Any changes in legislation, taxes or regulations expected in the future
New competition, or changes in existing competitors actions
Expected changes in tastes and fashions
Seasonal factors - most products will have seasonal peaks and troughs in sales
The sales budget will be calculated on the expected sales volume (sales in units) and the
selling price of each unit, to give us the overall sales value expected. Of course, any change in
price may also have the additional effect on the level of sales volume.
Production budgets
Once the sales level has been budgeted for, the other budgets can then be generated as a
result. This will involve constructing budgets for production, for purchases of raw materials,
as well as for cash.
The production budget will follow on from the sales budget and will specify when and how
many units will need to be produced to satisfy the sales level forecasted - note that the
production budget is presented in units rather than in financial terms. If production is a
lengthy process, then it is important that the budget is accurate so that sales are not lost
because of inadequate levels of output.
For each month the production required will equal the sales, plus the desired closing stock,
less the opening stock. For example, at the start of January we had 30 cars in stock, we
expected to sell 80 during January, and we should have 60 left at the end of the month (for
February's sales). Therefore production for January would be 80 + 60 - 30 = 110 cars.
Remember:
Opening stock + production - sales = closing stock
Therefore production for each month will be equal to: Sales + closing stock - opening stock
All this is saying is that you must produce enough so that you can satisfy your requirements
for how much closing stock you require, plus the sales that you will generated in that month,
not forgetting that you already have some stocks available from the previous month
Purchases budget
Once the production budget has been finalised, the firm will know exactly how many units of
materials and other inputs will be need to be purchased. The purchases budget is simply an
expression of the production budget but in financial terms. Although it is possible that some
purchases will be made in the period before the production takes place.
Debtors budget
The debtor's budget shows the balance owed to the firm by the debtors of the firm. This will
be determined by:


Level of credit sales
Length of credit period offered.
Once, the sales budget has been produced, if the firm's credit policy has been decided, then
the debtors budget can be produced.
Creditors budget
Once the level of purchases has been decided (which will comes from the production budget,
which, in turn, comes from the sales budget). The firm will then be able to draw up the
creditors budget. This budget outlines how much at any time is owed to the suppliers of the
firm
Master budget
A master budget is the term used to describe a budgeted profit and loss account and a
budgeted balance sheet. Although it is a budget, and has not actually happened, it is still
drawn up using the same principles as a profit and loss account and a balance sheet that are
based on actual data.
The data used to construct the cash budget can also be used to produce the master budget,
This can cause confusion - switching from one technique to the other.
Example 1
M Gibb - balance sheet as at 31 December 2007
-
Fcfa
Fcfa
Fcfa
Fixed assets
-
-
50,000
Premises
-
-
-
Equipment
-
20,000 -
Less deprecation -
14,000 6,000
-
-
-
56,000
Current assets
-
-
-
Stock
5,500
-
-
Debtors
11,000 -
-
Cash at bank
4,750
21,250 -
-
-
-
-
Current liabilities -
-
-
Creditors
-
9,000
-
-
-
-
-
Working capital
-
-
12,250
-
-
-
-
Net assets
-
-
68,250
-
-
-
-
Financed by:
-
-
-
Capital
-
-
50,000
Add net profit
-
-
25,000
-
-
-
75,000
Less Drawings
-
-
6,750
-
-
-
68,250
Additional information:
1. Sales and purchases are all on credit - with one month's credit being allowed by us and by
our suppliers.
2. Expected sales and purchases are as follows:
-
Jan
Feb
Mar
Apr
May
Jun
Sales (£)
15,000 24,000 29,000 34,000 34,000 36,000
Purchases (£) 12,000 18,000 20,000 26,000 28,000 35,000
3. The owner takes personal cash drawings each month of £500
4. Wages and salaries amount to £2,400 each month
5. Insurance of £100 is paid each month
6. Overheads are £300 per month and are paid when they are due.
7. New equipment is purchased on 1 March 2007 for £6,000
8. Equipment is to be depreciated at 10% on cost - one month's ownership equal's one
month's depreciation.
9. Rent is received of £400 each quarter on 1 January and 1 April.
10. Stock in trade on 30 June 2007 was valued at £5,700
=Example 1 - answer
M Gibb - cash budget for six months ended 30 June 2007
-
Jan
Feb
Mar
Apr
May
Jun
-
£
£
£
£
£
£
Cash inflows
-
Receipts from debtors 11,000 15,000 24,000 29,000 34,000 34,000
Rent received
400
-
-
400
-
-
Total inflows
11,400 15,000 24,000 29,400 34,000 34,000
Cash outflows
-
Payments to creditors 9,000
12,000 18,000 20,000 26,000 28,000
Wages & Salaries
2,400
2,400
2,400
2,400
2,400
2,400
Insurance
100
100
100
100
100
100
Overheads
300
300
300
300
300
300
Drawings
500
500
500
500
500
500
Equipment
-
-
6,000
-
-
-
Total outflows
12,300 15,300 27,300 23,300 29,300 31,300
Net cash flow
(900)
(300)
(3,300) 6,100
4,700
2,700
Opening balance
4,750
3,850
3,550
250
6,350
11,050
Closing balance
3,850
3,550
250
6,350
11,050 13,750
Notes to the cash budget:
1. The opening balance of cash at the start of January is taken from the balance sheet's
cash at bank figure. The closing balance will then appear on the budgeted balance
sheet as at 30 June.
2. The receipts from debtors for January will be December's sales. This data is taken from
the Balance sheet as at 31 December - under the debtors figure.
3. The payments to creditors for January will be found under the creditors figure on the
balance sheet as at 31 December.
4. The sales and purchases figures for June will not appear in the cash budget as they are
not paid or received until July - which is outside the cash budget. However, they will
appear as debtors and creditors on the balance sheet as at 30 June.
5. Depreciation is not a cash flow - and will not belong in any cash budget.
6. Drawings appears in a cash budget but not in a budgeted profit and loss account.
The forecast set of final accounts will appear as follows:
M Gibb - forecast trading and profit and loss account for six months ended 30 June 2007
-
£
£
Sales
-
172,000
Less Cost of goods sold -
-
Opening stock
5,500
-
Add Purchases
139,000 -
-
144,500 -
Less Closing stock
5,700
138,800
Gross profit
-
33,200
Add Rent receivable
-
800
Less Expenses
-
34,000
Wages and salaries
14,400
-
Insurance
600
-
Overheads
1,800
-
Depreciation
1,200
18,000
Net profit
-
16,000
The depreciation provision is based on the following:
£20,000 x 10% = £2,000 x 6 months = £1,000
£6,000 x 10% = £600 x 4 months = £200
Total depreciation = £1,200
M Gibb - forecast balance sheet as at 30 June 2007
-
£
£
£
Fixed assets
-
-
50,000
Premises
-
-
-
Equipment
-
26,000 -
Less deprecation -
15,200 10,800
-
-
-
60,800
Current assets
-
-
-
Stock
5,700
-
-
Debtors
36,000 -
-
Cash at bank
13,750 55,450 -
Current liabilities -
-
Creditors
35,000 -
-
-
-
Working capital
-
-
30,450
-
-
81,250
Financed by:
-
-
-
Capital
-
-
68,250
Add net profit
-
-
16,000
-
-
-
84,250
Less Drawings
-
-
3,000
-
-
-
81,250
Net assets
-
Note the following:
1. Drawings only appear on the balance sheet and the cash budget but not the profit and
loss account.
The closing balance on the cash budget becomes the cash at bank figure on the balance
sheet.
What is budgetary control? State the main objectives of budgetary control. What are the
steps in budgetary control?
In every business planning is the most important function to perform. Planning of different
firms depends upon so many factors. Planning is done for comparing the actual performance
with standard performance. Budgets are also prepared in advance. Budgets are prepared to
check the availability of finance according to the demand of project. So budgetary control is
also essential tool of management to control cost and maximizes profits.
Meaning of budget: A budget is a detail plan of operations for a specific period of time. In
the present era everyone is with the term budget because it essential in life. A budget is
prepared for the effective utilization of resources, which will help in achieving the set
objectives. Budgets are also very important in individual life as it is important in business
firms.
The following are the essential of budget:
(a) It is prepared in advance and is based on future plan of action.
(b) It relates to a future period and is based on objectives to be attained.
(c) It is a statement expressed in monetary or physical unit prepared for the formulation
of policy.
Meaning of budgetary control: Every business firms have main objective to maximize the
profits and to minimize the cost. An organization cannot run properly without a good
budgetary system. Budgetary control system is very helpful in bringing economy in business.
Budgetary control is applied to a system of management and accounting control by which all
the operations and output are forecasted in a proper manner to achieve the best possible
profits.
The essential of budgetary control:
(i)
Establishment of budgets.
(ii)
Executing responsibilities in order to perform the specific tasks to attain the
objectives.
(iii) Continuous comparison of actual performance with standard performance.
(iv) Taking corrective actions if there is any deviation.
(v)
Revision of budgets.
Steps in installation of a system of budgetary control:
A system of budgetary control in firm should be installed after taking care of following
requisites of budgeting.
(i)
What is likely to happen?
(ii)
What are the objectives to achieve?
(iii) How to minimize the cost?
(iv) What is the allotted time to complete the production?
In order to make an effective system of budgetary control following steps should take under
care:
Organization chart: An organization should have a proper chart from where authority and
responsibility of each executive get clear. If organization chart is not clear then there may be
conflicts among the employees. if duties are clear among the workers then every person will
be answerable for his performance. Nobody can blame to other for the poor performance.
Determination of objectives: it is very important that the objectives should be very clear to
all the executives in the organization. Having determined the objectives of budgetary control
the following future problems will have to be sorted out:
Laying down a plan for the implementation of the firm’s objectives.
Coordination of the activities of the different departments.
Controlling each function to get best possible results.
Budget manual: The budget should be in writing. It should be like a rulebook in which
objectives should be clear. Following of the some important matters covered in budget
manual.
A statement regarding the objective that how that objective can be achieved.
Functions and responsibilities should be clear.
Timetable for all stages of budgeting.
Reports, statement and other records to be maintained.
Responsibility for budgeting:
Budget controller: there should be someone budget controller. Chief executive should be
responsible in the form of budget controller for budget programme. Budget controller should
be technically sound person.
Budget committee: budget controller by his own may not be successful in all the process.
There should be a proper to assist him all the time. There should be members from all the
departments of the organization like production, finance, sales etc. each head of the
department will have his own subcommittee and person will be responsible to his respective
head.
Fixation of budget period: By budget period we mean the period for which we are going to
prepare a budget. Period of budget depends on so many factors as (i) nature and size of
business (ii) the controlling techniques applied. A seasonal nature business need short term
budget and for a regular nature business we can opt a long-term budget plan.
Determination of key factors: key factors always very important for every organization.
Budgetary control system should be capable of using key factors in a proper manner. Key
factors may be the raw material, labour; finance etc. budgetary control system must give
guidance to select a profitable unit among more than one option if any.
Motivation: budgetary control should be motivating to the employees. The system should be
applicable to those only ho are responsible about their duty.
The budget should cover all the phases.
Making of forecasts: after studying all the steps then forecast should start for the future.
There should be alternative forecast for the future. The best forecast should send to top
management for converting that forecast in budget.
Approval from top management: The top management should approve the final budget.
Without the approval of top authorities budget controller cannot pass the budget.
Advantages of budgetary control
The advantages of budgetary control system are as follows:
(1) The objectives of the organization as a whole & the results which should be achieved by
each department within this overall framework are defined by the budgetary control.
(2) When there is a difference between actual results & budget, then the extent by which
actual results have exceeded or fallen short of the budget is revealed by the budgetary
control.
(3) The variances or other measures of performance along with the reasons of difference
between the actual results with those from budgeted is indicated by the budgetary control.
Also, the magnitude of differences is established by it.
.
(4) As the budgetary control reports on actual performance along with variances & other
measures of performance; for correcting adverse trends, a basis for guiding executive action
is provided by it .
(5) A basis by which future budget can be prepared or the current budget can be revised is
provided by the budgetary control. .
(6) A system whereby in the most efficient way possible the resources of the organization are
being used is provided by the budgetary control. .
(7) The budgetary control indicates how efficiently the various departments of the
organization are being coordinated.
.
(8) Situations where activities & responsibilities are decentralized, some centralizing control
is provided by the budgetary control .
(9) The budgetary control provides means by which the activities of the organization can be
stabilized, where the organization’s activities are subject to seasonal variations.
.
(10) By regularly examining the departmental results, a basis for internal audit is established
by the budgetary control.
.
(11) The standard costs which are to be used are provided by it .
(12) For the purpose of paying a bonus to employees, a basis by which the productive
efficiency can be measured is provided by the budgetary control.
Limitations of Budgetary Control
The main limitations of budgetary control are:
(1) It used the estimates as a basis for the budget plan.
.
(2) In order to fit with the changing circumstances the budgetary programme must be
continually adapted. Normally for attaining a reasonably good budgetary programme,
it takes several years.
.
(3) A budget plan cannot be executed automatically. Enthusiastic participation is
required by all levels of management in the programme.
.
(4) The necessity of having a management & administration will not be eliminated by
any budgetary control system. The place of the management is not taken by it; rather
it is a tool of the management.
Exam tips - budgeting and budgetary control

Make sure that you can construct the different types of budget based on the
information given. Cash budgets are by far the most likely ones to come up in any
examination, but it is possible for other types to appear.

When drawing a cash budget, always remember that it is on a cash only basis - that
means no provisions (e.g. depreciation) and no accruals would need adjusting for. If
you've just been constructing a profit and loss account then it can be confusing having
to switch from the accruals concepts to the cash only idea in fairly quick succession. Be
on your guard and avoid silly errors.

If constructing a forecast set of final accounts, always remember to use the final cash
figure in your cash budget as the bank or cash balance.

Look at all the information carefully - it will be used in some form.

The construction of some budgets may not start at the beginning - it will help you to
see the construction of the budget as similar to a puzzle solving exercise where you
can only put so much information in initially and then add more in as the 'jigsaw'
becomes clearer.

The effect of budgeting on the organisation (possible and negative) will need to be
considered as well - learn the purposes of budgeting and why a firm would want to
budget in the first place.
Financial Statements
This chapter will introduce you the financial statements for a merchandiser and how to
prepare the closing entries for a merchandiser. It will also introduce you to reversing entries.
The chapter has four major objectives:
1. Learn to prepare a multiple-step income statement;
2. Learn to prepare a classified balance sheet.
3. Learn to compute and analyze the current ratio, inventory turnover ratio, and gross
profit percentage.
4. Prepare the four closing entries for a merchandising company.
Financial Statements
The same three financial statements that we learned for a service-oriented company will also
be used for a merchandiser. However, they will look different. The main challenge will be to
prepare a multiple-step income statement. See the separate handout of the skeleton based
multi-step income statement for additional help. To refresh your memory, the three financial
statements that you will need to prepare are:



The Income Statement
The Statement of Owner’s Equity
The Balance Sheet
As you will recall, they need to be prepared in this prescribed order, because the contents of
one follows the next.
The Multiple-Step Income Statement
Unless given, the source for the numbers on income statement is from the worksheet
columns. As discussed previously, a vast majority of merchandising companies use the
multiple-step format of an income statement. The Cost of Good Sold will be the most
challenging part of this worksheet.
An example of a completed multiple-step income statement is on page 457. There is much
more information given on this income statement than on others we prepared in this course.
The main difference is the use of many subtotals that are not accounts in the general ledger,
such as “Net Sales,” “Cost of Goods Sold,” “Gross Profit on Sales,” and other. Preparing the
multiple-step income statement will be much easier if we can learn the accounts that are
added or subtracted to arrive at these subtotals.
The major subtotals on a multiple-step income statement are:
Net Sales
Less: Cost of Goods Sold
Gross Profit on Sales
Less: Operating Expenses
Net Income from Operations
+\- Other Income or Other Expense
Net Income
Each major subtotal is arrived by adding or subtracting various general ledger accounts. The
accounts added or subtracted are detailed below.
Net Sales = Sales - Sales Discounts - Sales Returns and Allowances
Cost of Goods Sold = Beginning Inventory + Net Purchases + Freight In - Ending Inventory
Cost of Goods Sold, in detail:
Merchandise Inventory, January 1
XXX
Add: Net Purchases:
XXX
Purchases
Add: Freight In
X
Delivered Cost of Purchases
XXX
Less Purch Ret/Allow
(xx)
Less Purch Discounts
(xx)
Net Delivered Cost of Purchases
Total Merchandise Available for Sale
XX
XXXX
Less Merchandise Inventory, December 31
XXX
Cost of Goods Sold
XXX
Gross Profit =
Net Sales
- Cost of Goods Sold
Operating Expenses =
Selling Expenses & General and Administrative Expenses
Selling Expenses are those directly related to the sales or marketing functions. They include
any sales salaries, commissions, advertising, depreciation of store equipment, and others.
The General and Administrative expenses are all the other day-to-day operating expenses
not related to the sales function and include the salaries of clerical workers,
accounting/finance people, rent, utilities, general office supplies, business insurance, and
rent.
Net Income from Operations: Gross Profit – Total Operating Expenses
Other Income: Other income is any other revenue besides sales. This will include rental
income, dividend income, or any gains on sale of assets, such as equipment.
Other Expenses: These include non-operating costs, such as interest expense or losses on
sale of assets.
Net Income: Net Income from Operations + Other Income – Other Expenses
As stated previously, you MUST KNOW HOW TO PREPARE this multi-step income statement.
You need to practice, practice, and practice.
Statement of Owner’s Equity
The statement of owner’s equity has not changed. As a review, this is the format:
Capital, January 1
XXX
Add: Additional investments, if any
XXX
Subtotal
XXX
Add: Net Income
XXX
Less: Withdrawals
(XXX)
Increase in capital
XXX
Capital, December 31
XXX
The Balance Sheet
The Balance sheet looks very much the same. The only change is now you will be required to
classify your balance sheet. (Almost all companies – even service enterprises – do this. This
text waited until Chapter 13 to introduce this new format.)
The following summarizes the classification criteria in the new balance sheet:
Account
Category
Assets
Classifications
Definition
Current Assets
Assets that will be
converted to cash, or
"used up," within one
year from the date of
the balance sheet.
Property and
Equipment
Assets that (1) are
tangible, (2) have long
useful lives, usually
exceeding 3 years,
and (3) are used in
business operations.
Examples of
Accounts Included
Cash, Accounts
Receivable,
Merchandise
Inventory, Prepaid
Insurance, Prepaid
Rent, Supplies
Land, Equipment,
Building,
Machinery,
Furniture and
Fixtures. Also
includes the
Accumulated
Depreciation
accounts as contraassets
(except Land, which
is not
depreciated).
Liabilities
Current liabilities
Long-term
liabilities
Owner’s
Equity
No subclassifications.
Liabilities that are
expected to be paid,
or otherwise
terminated, within one
year
from the date of the
balance sheet.
Liabilities that are
expected
to be paid, or
otherwise
terminated, after one
year from the date of
the balance sheet.
The owner's capital
balance at the end of
the year, after closing
entries.
Accounts Payable,
Wages
Payable, Unearned
Revenue, and
Notes
Payable—current
portion.
Notes Payable, due
after one year.
Owner, Capital. The
amount comes
from the statement
of owner’s equity.
Why bother with these new statement formats?
Well, there are several good reasons to learn these: 1) To pass the next test, 2) because
that’s what financial statements in the real world look like, 3) because many common
financial ratios and analyses will use components from these statements, and 4) because you
will have money to invest someday and need to learn what some key ratios mean so you can
make an informed investment choice.
Some common financial analysis
Working Capital and the Current Ratio
Working Capital is a very basic financial statement analysis tool. Working Capital = Current
Assets – Current Liabilities. This is why analysts need to see a classified balance sheet. The
amount of working capital is of key concern to management and to lenders and creditors.
Another way to view the company’s liquidity is called the current ratio. The current ratio is
calculated as follows:
Current Ratio = Current Assets */* Current Liabilities
Bankers and other creditors will calculate a firm’s current ratio, and compare it to the
industry average.
The Inventory Turnover Ratio
The inventory turnover shows the number of times inventory is replaced during the
accounting period. It is an indicator of how fast the company is selling its merchandise
inventory. This is of great interest to bankers and other creditors, as sales of merchandise
inventory give the company its cash to repay debt.
The Inventory turnover ratio is calculated as:
Cost of Goods Sold */* Average Inventory
Average inventory is calculated as:
(Beginning inventory + Ending Inventory)*/* 2
The Gross Profit Percentage
The gross profit percentage reveals the amount of gross profit kept from each sales dollar. It
is calculated as follows:
Gross Profit */* Net Sales
Closing Entries
Remember why we need closing entries:

To close out nominal accounts in order to be ready for the next new fiscal year

To transfer net income and drawing to the owner’s capital account.
The purpose of doing the closing entries has not changed. We just need to tweak the
process a little.
For Service Business
for Merchandisers
Close revenues
Close Income Stmt accounts with credit balances (i.e.,
Sales, Purchases Discounts)
Close expenses
Close Income Stmt accounts with debit balances (i.e.,
Rent Expense, Sales Discounts)
Close Income Summary
Close Income Summary ***
Close Drawing
Close Drawing
Statement of Cash Flows
The statement of cash flows is a required component of financial statements.
BASICS OF CASH FLOW REPORTING
Purpose of the Statement of Cash Flows
The statement of cash flows is one of the five financial statements required by GAAP. The
other four required financial statements are:
1. Income Statement
2. Retained Earnings Statement or Statement of Stockholders’ Equity
3. Balance Sheet
4. Statement of Comprehensive Income
The statement of cash flows answers one question the other four financial statements do
not: how did the company generate, and spend, its cash?
Measurement of Cash Flows
Cash flows are defined to include both cash (monies in checking accounts and bank savings
accounts) and cash equivalents. Cash equivalents include:
 Money market funds
 Highly-liquid investments with original maturities of less than 3 months,
such as bank certificates of deposit and U.S. Treasury bills.
Classification of Cash Flows
The Statement of Cash Flows shows cash inflows and cash outflows, organized into three
different business activities. These three business activities are summarized below.
Name of activity
Accounts analyzed
What the activity presents
Operating
Operating assets
The net cash flows generated, or
activities
and liabilities.
used, by the business in their core
These include
operations. We will use the indirect
most current
method of presenting operating
asset and liability activities. This method reconciles net
accounts.
income to net cash flow from
operating activities.
Investing
Long-term assets The cash inflows and outflows from
activities
sales and purchases of long-term
assets, such as equipment, patents,
and long-term investments.
Financing
Long-term
The cash inflows and outflows from
activities
liabilities and
issuance of debt; repayment of debt;
stockholders’
issuance of stocks; dividends paid;
equity.
and stock repurchases.
Noncash Investing and Financing Activities
Businesses sometime engage in transactions not affecting cash. For example, a business can
purchase equipment by issuing a long-term note payable to the vendor. In this case, cash is
not affected, and this transaction would not be reported in the body of the statement of
cash flows. This transaction, referred to as a noncash investing and financing activity, would
instead be disclosed either at the bottom of the statement of cash flows or in a note to the
financial statements.
CASH FLOWS FROM OPERATING ACTIVITIES
Using the indirect method of reporting operating activities
Nearly all companies report operating activities using the indirect method. This is because
the indirect method is easier to compute—although you may disagree after completing the
homework!
(In class, we will go over a skeleton format that will be much easier to remember than the
more formal one shown below.)
The following template should prove helpful to you in preparing the operating activities of
the statement of cash flows using the indirect method.
Net Income
$XXX
Adjustments to reconcile net income to net cash
provided by operating activities
Decrease in operating assets **
X
Increase in operating liabilities +
X
Increase in operating assets **
(X)
Decrease in operating liabilities +
(X)
Depreciation Expense
X
Loss on sale of assets or debt retirement
X
Gain on sale of assets or debt retirement (X)
Net Cash Provided by Operating Activities
$XXXX
**Examples: A/R, Inventory, prepaid assets, and trading securities.
+ Examples: A/P, accrued liabilities, and unearned rent; excludes dividends payable.
If the indirect method is used, income taxes paid and interest paid must be disclosed in a
footnote to the financial statements.
For example, assume Michelle Company reported the following for its most recent fiscal
year:
Net income, $200,000
Depreciation expense, $50,000
Increase in accounts receivable, $10,000
Decrease in merchandise inventory, $2,000
Increase in prepaid expenses, $1,000
Decrease in accounts payable, $9,000
Increase in wages payable, $3,000
Loss on sale of equipment, $1,000
The operating activities would report the following, using the indirect method:
Cash flows from operating activities
Net income
$200,000
Adjustments to reconcile net
income to net cash provided by
operating activities
Increase in accounts receivable
(10,000)
Decrease in merchandise inventory
2,000
Increase in prepaid expenses
(1,000)
Decrease in accounts payable
(9,000)
Increase in wages payable
3,000
Depreciation expense
50,000
Loss on sale of equipment
1,000
Net cash provided by operating activities
CASH FLOWS FROM INVESTING ACTIVITIES
$236,000
Investing activities include cash inflows from:
 Sale of long-term assets
 Sale of investments (except trading securities)
 Collections of notes receivable
Investing activities include cash outflows from:
 Purchase of long-term assets
 Purchase of investments (except trading securities)
 Loaning cash to others
Obtaining the data for the investing activities section involves three steps:
1. Calculate the increase or decrease in the long-term asset accounts
2. Reconstruct the changes in the accounts
3. Report their effects in the investing activities
As an example, assume the balance of Equipment for Michelle Company was $100,000 at the
beginning of the year, and $120,000 at the end of the year. We can say Equipment increased
by $20,000 during the year.
However, a detailed reconstruction of Equipment revealed the following:
Equipment, beginning of year
$100,000
Purchases of equipment
30,000
Sales of equipment
(10,000)
Equipment, end of year
$120,000
The equipment sold had an original cost of $10,000 and accumulated depreciation of $4,000,
so its book value was $6,000. Assuming the equipment was sold for $5,000, a loss of $1,000
on sale of equipment was incurred.
The investing activities section for Michelle Company would report the following:
Cash flows from investing activities
Cash received from sale of equipment $5,000
Cash paid for purchase of equipment
Net cash used in investing activities
(30,000)
(25,000)
The loss on sale of equipment of $1,000 would be added to net income in operating
activities.
CASH FLOWS FROM FINANCING ACTIVITIES
Financing activities include cash inflows from:
 Issuing stock
 Issuing debt
Financing activities include cash outflows from:
 Purchasing treasury stock
 Retiring stock by purchase
 Debt payments
 Dividend payments
For example, if a company issued stock for $50,000 but repaid debt of $20,000, the financing
activities section would report the following.
Cash flows from financing activities
Cash received from issuing stock
$50,000
Cash paid to retire debt
(20,000)
Net cash provided by financing activities
30,000
PROVING CASH BALANCES
After preparing the operating, investing and financing activities of the statement of cash
flows, one final step remains. We must report the beginning and ending balances of cash and
cash equivalents, and prove that the net change in cash is explained by summing the
operating, investing, and financing activities.
Assume the beginning of year cash balance for Michelle Company was $100,000, and the end
of year cash balance was $341,000. The net increase in cash would be $241,000. Michelle
Company’s statement of cash flow, once completed, would appear as follows.
Cash flows from operating activities
Net income
$200,000
Adjustments to reconcile net
income to net cash provided by
operating activities
Increase in accounts receivable
(10,000)
Decrease in merchandise inventory
2,000
Increase in prepaid expenses
(1,000)
Decrease in accounts payable
(9,000)
Increase in wages payable
3,000
Depreciation expense
50,000
Loss on sale of equipment
1,000
Net cash provided by operating activities
Cash flows from investing activities
Cash received from sale of equipment $5,000
Cash paid for purchase of equipment
(30,000)
Net cash used in investing activities
Cash flows from financing activities
Cash received from issuing stock
$50,000
Cash paid to retire debt
(20,000)
Net cash provided by financing activities
Net increase in cash
Cash and cash equivalents at prior year-end
Cash and cash equivalents at current year-end
$236,000
(25,000)
30,000
241,000
100,000
$341,000
The cash and cash equivalents balance at current year-end must agree with the balance for
cash and cash equivalents reported on the balance sheet.
CLASSIFICATION OF ACCOUNTS
The classification of accounts and rules of debit and credit based on such classification are
given below:
Personal Accounts:
Accounts recording transactions relating to individuals or firms or company are known as
personal accounts. Personal accounts may further be classified as:
(i) Natural Person’s personal accounts: The accounts recording transactions relating to
individual human beings e.g., Paul’s a/c, Philip’s a/c, Mary’s a/c are classified as natural
persons’ personal accounts.
(ii) Artificial Persons’ Personal accounts: The accounts recording transactions relating to
limited liability companies, bank, firm, institution, club, etc., MTN; M/s Sahoo & Sahoo; Hans
College; Facebook Club are classified as artificial persons’ personal accounts.
(iii) Representative Personal Accounts: The accounts recording transactions relating to the
expenses and incomes are classified as nominal accounts. But in certain cases (due to the
matching concept of accounting) the amount, on a particular date, is payable to the
individuals or recoverable from individuals. Such amount (i) relates to the particular head of
expenditure or income and (ii) represent persons to whom it is payable or from whom it is
recoverable. Such accounts are classified as representative personal accounts e.g., “wages
outstanding account”, pre-paid Insurance account, etc.
Real Accounts: The accounts recording transactions relating to tangible things (which can be
touched, purchased and sold) such as goods, cash, building, machinery etc., are classified as
tangible real accounts.
Whereas the accounts recording transactions relating to intangible things (which do not have
physical shape) such as goodwill, patents and copy rights, trade marks etc., are classified as
intangible real accounts.
Nominal Accounts: The accounts recording transactions relating to the losses, gains,
expenses and incomes e.g. Rent, salaries, wages, commission, interest, bad debts etc., are
classified as nominal accounts.
Let us consider the following example to illustrate how the rules of debit and credit are
applied in practice:
Rs.
5.7 JOURNAL
Journal is a book which lists accounting transactions of a business other than cash, before
posting them to ledgers. The journal is currently only used to a limited extent to cover item
outside the scope of other accounting books. Let us understand the mechanism of recording
business transaction in a journal.
5.8 CASH BOOK
All business dealings ultimately resolve themselves into cash transactions; therefore,
recording of cash transactions in a separate book becomes necessary. To keep record of all
receipts and payments of money in business, cash book is maintained.
Cash book with regard to the nature of business and the manner in which the cash is dealt
with. Money receipts are entered on debit side and payments are shown on the credit side.
There are three distinct types of Cash Book, and each business could get its cash book ruled
in a manner as would suit its own requirements. Thus the Cash Book may be ruled so as to
possess.
– Cash and Discount columns only on both sides or
– Cash, Bank and Discount columns on both sides or
– Bank and Discount columns only on both sides.
5.9 PRINCIPAL BOOK: LEDGER
A ledger is a group of accounts. Most of us have probably seen a bound book with the word
‘ledger’ printed on the cover. All the accounts of a small business/industry could be entered
in a ledger in concerned accounts in a summarized and classified form.
From the journal a trader cannot know his total cash, purchases, amount spent under each
head of expense and amount earned under each head of income. The journal will not tell him
what he owes to his creditors and what his customers owe to him. Such classified
information can be got only by opening ledger accounts for every kind of transaction.
Every ledger has two sides namely debit and credit. Left hand side is debit and right hand
side is credit. Each side of the ledger has columns on date, particulars, journal folio and
amount- In the particulars column of the debit side the name of the account from which
benefit is received is recorded and on the credit side, the name of the account to which
benefit is given is recorded. The words ‘To’ and ‘By’ are affixed to the name of the amount
entered on debit and credit sides respectively.
If a business is not able to accommodate all its accounts in one ledger it can have more than
one ledger. Business may have an ‘accounts receivable ledger’ an ‘accounts payable ledger’
and a ‘general ledger’ each containing the group of accounts suggested by the title. The
ledger is not necessarily a bound book, it may consist of a set of loose leaf pages, a set of
punched cards, or if computerized a set of impulses on a magnetic tape. No matter what its
form may be, the essential character of the account and the rules for making entries to it
remain exactly the same.
(i) Ledger Posting:
Transferring the entries from the journal or a subsidiary book to the ledger is known as
posting. Posting the ledger from journal is easy as the transactions in the journal are already
classified into debit and credit. However, the following points must be noted while posting
the ledger.
– For the same person or expense only one account should be opened.
– Cash and credit sales should be posted to Sales Account and cash and credit purchases to
Purchase Account.
– The word Debit as Dr. and Credit as Cr. should not be omitted.
– Date and folio columns should not be left blank.
(ii) Balancing of Ledger Accounts:
At periodic intervals, the debit and credit sides of individual ledger accounts are totaled and
balance of each account indicated. If the total of the debit side of any account is more than
the credit side, there will be a debit balance and, if the credit side is more than the debit side
there will be credit balance.
With the help of the illustration which we took for recording journal entries, let us see how
the ledger postings and balancing will be done.
Based on the illustration the following accounts need to be opened in ledger.
FINAL ACCOUNTS
The final accounts of a business consists of the Manufacturing Account, Trading Account,
Profit and Loss Account and Balance Sheet.
Before we look into the process of preparing final accounts we must understand the meaning
and importance of Trial Balance.
The Trial Balance
The trial balance is simply a list of names of the accounts, and the balances in each account
as at a given moment of time, with debit balances in one column and credit balances in
another column. The preparation of trial balance serves two principal purposes (i) it shows
whether the equality of debits and credits has been maintained and (ii) it provides a
convenient transcript of the ledger record as a basis for making adjustments and closing
entries for preparation of final accounts.
When the total debits equal total credits, it does not mean that there has been no error in
recording the transactions.
Entries may have been omitted entirely; they may have been posted to the wrong accounts;
off-setting errors may have been made; or the transactions may have been analyzed
incorrectly.
For example when a debit for purchase of a truck is made incorrectly to an expense account,
rather than correctly to a fixed assets account, the total of the trial balance is not affected.
Nevertheless, errors that result in unequal debits and credits are common, and the existence
of such errors is revealed when a trial balance does not balance, that is when the debit
column does not add to the same total as the credit column.
A trial balance may be prepared at any time. A pre-adjustment trial balance is one prepared
after the original entries for the period have been posted, but prior to the adjusting and
closing process. A post-closing trial balance is prepared after the closing process.
(i) Manufacturing Account:
When a concern is engaged in both production and selling activities it will have to open a
manufacturing account in the general ledger. The manufacturing account is prepared in the
following manner.
Manufacturing Account is balanced by adding debit side and finding the excess of debit over
credit. The excess of debit over credit will indicate the cost of manufacturing of the finished
goods. This balancing figure will be inserted in the credit side of the Manufacturing Account
preceded by the word ‘By cost of manufacturing’ during the period transferred to Trading
Account and the same figure will also be written on the debit side of a ‘Trading Account’ to
be opened in General Ledger. In the Trading Account this figure will be preceded by the word
‘To cost of production transferred from the Manufacturing Account’. Thus Manufacturing
Account is closed and the cost of production of finished goods during the period is
transferred to the Trading Account. The debit balance of (a) opening stock of finished goods,
(b) purchase less returns, (c) nominal accounts representing cost incurred in connection with
purchase of materials/goods, like carriage inward on such purchase etc. will then be cleared
by crediting these accounts and debiting the Trading Account.
(ii) Trading Account
When a concern is engaged in trading activities only, there will be no Manufacturing
Account. The Trading Account on its debit side will show certain entries regarding opening
stock (of saleable goods), purchase less returns and expenses relating to purchase viz.
freight, duty, carriage inward etc.
The credit balance of sales account (less the debit balance of sales return accounts) will then
be transferred to Trading
Account by debiting the former account and crediting the latter account.
The excess of credit total of trading account over the debit total is called the gross profit. This
amount is computed and an entry is passed by debiting this amount to Trading Account
(preceded by the word ‘To Gross Profit transferred to Profit and Loss Account’) and crediting
the Profit and Loss Account (preceded by the word ‘By Gross Profit, brought over from
Trading Account’). The Trading Account .thus indicates the gross result from selling of the
goods.
(iii) Profit and Loss Account
At this stage Profit and Loss Account stands credited with gross profit. The Profit and Loss
Account also stands adjusted with some of the adjustment entries like bad debts,
depreciation, insurance, rent etc. All the debit and credit balances lying in different nominal
accounts are then transferred to Profit and Loss Account. The debit balances are closed by
entering the respective word ‘By Profit and Loss Account’. The respective amounts are also
entered on the debit side of the Profit and Loss Account preceded by the words To ...............
. The credit balances of nominal accounts are similarly closed by passing debit entries to the
respective nominal accounts preceded by the word ‘To Profit and Loss Account’. In the credit
side of the “Profit and Loss Account” the corresponding credit entries are inserted preceded
by the word ‘By ...................’.
Thus, the Profit and Loss Account on its credit shows Gross
Profit and items of miscellaneous incomes and on its debit shows Gross Loss and expenses
incidental to carrying of the business and arising in course of running the business. The
excess of credit side over the debit side is known as net profit and the excess of debit side
over the credit side is known as net loss. The net profit or net loss is transferred to Capital
Accounts) in case of proprietary or partnership business and to an account called Profit and
Loss Appropriation Account in case of corporate business.
Pro-forma of Profit & Loss Account
Profit and Loss Account of M/s …….………………….. for the year ending ………………………..
(iv) The Balance Sheet
A balance sheet shows the financial position of an organization as on a specified moment of
time; in fact it is sometimes called a statement of financial position. It is therefore a status
report, rather than a flow report.
After Trial Balance is prepared; adjustments entries passed, and revenue accounts drawn up,
all the nominal accounts will stand closed. The accounts still remaining open in the general
ledger will represent either personal accounts or real accounts. The balance remaining after
the preparations of
Trading and Profit and Loss Account in the Trial Balance represents either assets or liabilities
existing on the date of the closing of the accounts. When they are arranged in a proper
manner, the resultant statement is called ‘Balance Sheet’.
The balance sheet is a statement of position and strictly speaking not a part of double entry
system of book keeping.
No transfer of ledger accounts balances is therefore necessary.
Only the relevant particulars are extracted from the general ledger. The balance sheet is
prepared on a certain date and not for a period. Therefore, it is true only on the date of its
preparation and not on any other day. Secondly, the total of liabilities including capital must
be equal to total of assets, otherwise it means that the double entry system of book keeping
has not been followed properly in respect of all the transactions.
A balance sheet represents the assets of the business, whether fixed or current or fictitious,
on the right hand side and liabilities, whether owned or borrowed, on the left hand side.
The balance sheet of an organization can be prepared in the following format:
Proforma of Balance Sheet
5.11 APPLICATION OF COMPUTERS AND INFORMATION
TECHNOLOGY TO ACCOUNTING AND FINANCIAL
MANAGEMENT
Business Accounting and Financial Management are crucial management functions in every
enterprise. Whether you manage a small department, a major division, big company, small
company or your micro enterprise, you work with numbers every day. Numbers are the
language of business and industrial enterprises. Use of computers in general and electronic
spread sheet in particular can economically and effectively replace traditional tools of
accounting like ledger pager, stubby pencils, worn-out erasers, desktop calculators etc. Use
of computer and spread sheet in today’s complex business can take you ahead in speed,
accuracy and capability.
Computer application in accounting and financial management can help you in transaction
recording, financial planning, analysis, and forecasting. Best of all, it gives you a method of
examining the implications of endless “What if ?” situations - the tough alternatives you face
in running your business profitably. Computer software developing companies have
developed a large number of accounting and financial management software’s.
A brief account of some of the important soft wares available in India is given below. The
basic function of these softwares are to enter the transactions and the rest of things i.e.
posting, balance calculation is done by these software. This software can prepare the trail
balance, cash book, balance sheet and profit and loss account.
1. Tally
2. Easy
3. Visipak
4. Fact
5. Fast
6. Ex 3.0
5.12 SUMMARY OF ACCOUNTING PROCESS
(i) The first and the most important part of the accounting process is the analysis of
transactions, i.e. the process of deciding which account or accounts should be debited, which
should be credited, and in what amounts, in order to reflect events in the accounting
records. This requires judgment.
(ii) Next comes the purely mechanical step of journalizing original entries that is, recording
the result of the analysis.
(iii) Next to journalizing is ledger posting. Posting is the process of recording transactions in
the ledger accounts, exactly as specified by the journal entries. This is another purely
mechanical step.
(iv) At the end of the accounting period Judgement is involved in deciding on the adjusting
entries, and these are journalized and posted in the same way as original entries.
(v) The closing entries are journalized and posted. This is also a purely mechanical step.
(vi) Finally, the financial statements are required to be prepared. This requires judgment and
knowledge. The accuracy of financial statements will depend upon the quality of judgment
made as suggested in steps (i) and (ii)