Mastering Accounting

Most people associate accounting with the world of business. To see what it involves we can divide it into three parts.

The last chapter demonstrated how any transaction will have two effects on a balance sheet. You should now be able to identify which assets and/or sources of finance are affected by different transactions. In this chapter we will introduce a more efficient way of recording transactions than redrafting a balance sheet after each one. This will be done by means of ledger accounts. You will learn the principles of double entry book-keeping which will enable you to keep a simple set of ledger accounts.

The last chapter introduced the principles of double-entry book-keeping and applied them to assets and sources of finance. In this chapter we will apply these rules to the asset, stock. Then we will consider how to deal with transactions involving expenses and incomes.

The last two chapters concerned the rules of double-entry book-keeping and the application of these rules to a variety of transactions. In this chapter we are going to look at a simple way of making a preliminary check on the accuracy of the entries made in the ledger. We will do this by balancing the accounts and then drafting a trial balance. We will start, however, by demonstrating how the folio column in the ledger can be used to provide a reference system for all the double entries. Such a system helps to speed up the process of checking that all the double entries have been completed correctly.

In this chapter we will see how the contents of a ledger can be subdivided into a number of sections. We will then deal in some detail with one of these subdivisions — the cash book.

In this chapter we are going to look at the main sources of information from which entries are made in the ledger and cash book. Then we will examine the way in which some details may be kept in subsidiary books known as journals. These help to reduce the amount of detail needed in the ledger.

In the chapter we are going to examine two very important matters. The first involves the money in the bank and the second concerns the personal accounts of debtors and creditors. Control is really a function of management aacounting and as such might seem beyond the scope of this book. Our task here, therefore, will be to take an introductory look at the idea of control. It is assumed you are fully acquainted with the cash book and the divisions of the ledger which were looked at in Chapter 5.

The main theme of the remainder of this book can be summed up by one word: profit. It is something of vital importance to all businesses. In this chapter we will examine concepts which are essential to understanding how to measure profit and we will deal with the method of measurement. In the remaining chapters with particular problems relating to its measurement.

We have now covered the whole process involved in keeping a set of financial accounts — from opening a ledger and keeping track of transactions there and in the journals to preparing the final accounts at the end of the period. In the remaining chapters we will consider the reasons why certain adjustments have to be made to the information recorded in our books. We will also see how these adjustments can be made. In addition we will take the opportunity of giving you some additional practice preparing the final accounts. This chapter will cover the adjustments which arise because payments and receipts of money do not always occur in the financial period to which the expenditure or income relates.

In this chapter we are going to look at an adjustment involving debtors. It will enable the true amount of bad debts for a period to be included in that period’s profit and loss account. In addition the asset ‘debtors’ will be shown at its proper value in the balance sheet. There are two methods of book-keeping that can be used and both of these will be illustrated. When you have mastered the process of providing for bad debts and recording the recovery of debts previously written off as bad, there will be an opportunity to gain extra practice in the preparation of final accounts.

In this chapter we are going to look at the way in which capital expenditure on a fixed asset can be spread over the life of the asset. This is done so that a fair amount of the expense can be recorded each year in the profit and loss account and a truer, more up-to-date valuation of the asset can be shown in the balance sheet. Two methods of book-keeping will be considered because both are encountered in examination questions. Before you begin this chapter you are advised to reread section 3.8 on depreciation in Chapter 3 and section 8.2 on capital expenditure in Chapter 8.

John Jones started in business as a self-employed plumber five years ago after completing his apprenticeship. He began with a small amount of money which he had saved, and worked long hours to build up contacts and establish a very good reputation for high quality work. After three years he was doing very well, in fact too well! He was having difficulty coping with the number of jobs he was getting, never mind dealing with the paperwork and VAT and trying to spend some time with his family. So he employed Kevin Crane to help him with the practical work. Kevin was an excellent worker — bright, hardworking and easy to get on with. He was also an expert on central heating systems, an area in which John had not got involved. With Kevin’s help, John’s business had continued to grow steadily but now, two years later, Kevin tells John that he wants to leave to set up his own business.

‘Of course I’ve heard of limited liability companies. I’m dealing with them all the time. Many of my suppliers are companies, my bank is and some of my customers are. But why should my business become one? What makes them so special?’

So far you have studied various aspects of the accounts of sole traders, partnerships and limited companies — different types of ownership of businesses. All of these have been involved in trading, i.e. the buying and selling of finished goods, as their method of operation. This type of business activity is very common and familiar to us all when shopping, whether it be at the local newsagent’s, supermarket or large store. However, other firms have to supply the goods which these traders sell. Many of Britain’s largest and best known companies, such as GEC, ICI, Rover Group, Plessey, BP and Unilever, are mainly involved in this different business activity of manufacturing goods and then selling them. Overall, manufacturing firms account for approximately 20% of people employed and so constitute an important sector of the economy. The main characteristic of such manufacturing firms is that they obtain raw materials and components and convert them into finished products ready for sale. This work will obviously be reflected in the accounts which will, therefore, be slightly different to those which you have previously seen and prepared.

It is time now to broaden our view of accounting. So far we have concentrated on the mechanics of accounting — the way in which accounts are prepared and presented. But consider the view taken by John Slater, managing director of Slater’s Stores Ltd:

I have to pay my accountant/auditor a large fee to prepare and approve my company’s accounts. What a waste of money! I don’t understand them, so the business doesn’t benefit. The only people that do are the taxman and the VAT man! OK by law I have to prepare them for the shareholders, but they are me and my wife. The only other person who gets a copy is the Registrar of Companies, but I don’t suppose he’s interested.

It is vital that the information contained in accounts is understood and used. There is little point in preparing them otherwise. In this chapter we will consider the various groups of people who may want to use a company’s accounts and the tools of analysis used to help them make sense of the figures in those accounts. This is a very important chapter in your studies as it begins to show how accounts are used in the business world and how it is possible to understand what they mean.

‘These should keep you happy. You’ve made a good profit over the past year.’ Chris Tompkins, auditor of Mather Machines Ltd had just given a set of the company’s finalised accounts to Mike Mather, managing director.

The research and development and marketing departments of Sportstuffs Ltd had made their presentation of a new product idea to the managing director, Chris Disley.

Vic Ganby had built up a thriving business. He had left the army in 1980 and used all of his capital to buy a small garage. He began by doing all the work himself — serving petrol, repairing and maintaining cars, and the paperwork. He built up a reputation for excellent service and quality workmanship. His business expanded rapidly. He extended the workshop and bought the building next door, turning it into a showroom for new car sales. He then bought two other garages in the area and a hire car business. His company now employed over 200 people and Vic appeared to be doing very well.