It is has questions and answers to practice on and tackles financial statements and interpreting them , capital budgeting and investment appraisal , cash budgets and more.
SOME BASICS IN ACCOUNTING
(The formats may vary slightly from what’s in your module guide but the information below is
made available to assist you if you require foundational knowledge for Unit 2 of the module
guide. This information was taken from a module guide that I wrote for Mancosa.)
1. CLASSIFICATION OF FINANCIAL INFORMATION
The classification of the vast array of financial information requires a system of accounts. An
accountant may use a computerised system or a manual system. Our approach is to explain manual
accounting procedures but the knowledge gained can be applied to any type of automated
accounting system. Any system must provide for five types of accounts, namely:
■ Assets
■ Liabilities
■ Equity
■ Income
■ Expenses
Asset, equity and liability accounts are used to determine the financial position of an entity by
preparing a statement of financial position (balance sheet).
Income and expense accounts are used to determine the financial performance (profitability of the
entity) by means of a statement of comprehensive income (income statement).
The record in which increases or decreases in any item in the financial statements are noted, is called
a ledger account or simple an account. The entire collection of accounts is called a ledger.
The relationship:
Assets = Equity + Liabilities
is called the accounting equation. Whilst the assets show what the entity owns, the equity and
liabilities shows who supplied the finance and how much each group supplied. Everything that is
owned by the entity is funded by either the owners or creditors. Thus the total claims of the owners
plus the claims of the creditors equal the total assets of the entity. That is why the total assets will
always balance the equity and liabilities in the statement of financial position.
When business events that involve money (called transactions) take place, the flow of accounting
information is summarised in the illustration below:
,Figure 1-2 The flow of information through the accounting system
A business transaction takes place.
A business document is prepared or received.
Information is recorded in journals.
Posting to ledger accounts take place by means of debits and credits.
Financial statements are prepared at the end of the accounting period.
2. SUMMARISING FINANCIAL INFORMATION IN THE FINANCIAL STATEMENTS
The financial information of an enterprise is summarised in financial reports called financial
statements. The following is an overview of the typical financial statements viz. statement of
comprehensive income, statement of financial position and cash flow statement. (Statement of
changes in equity is excluded from this discussion.)
2.1 Statement of Comprehensive Income (Income Statement)
This statement provides a summary of the financial performance (profitability) of an entity for a period
of time, by matching income earned to expenses incurred to obtain that income. Income results
from economic benefits flowing to the entity because of various transactions with third parties, other
than the owners of the entity. Expenses are decreases in economic benefits in the form of outflows
or depletion of assets. The following is an example of a statement of comprehensive income of a
sole proprietorship:
,Santana Traders
STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 28 FEBRUARY 20.14
R
Sales 1 262 000
Cost of sales (700 000)
Gross profit 562 000
Other operating income 62 000
Rent income 60 000
Discount received 2 000
Gross operating income 624 000
Operating expenses (313 850)
Wages 123 000
Bank charges 4 000
Packing materials 37 000
Advertising 18 000
Rates 7 000
Bad debts 2 800
Discount allowed 1 000
Stationery 19 000
Water and electricity 9 000
Insurance 11 500
Telephone 9 900
Depreciation 40 000
Other operating expenses 31 650
Operating profit/Earnings before interest and tax 310 150
Interest income 0
Interest expense (12 000)
Net profit for the year 298 150
Sales reflect the amount that an entity earns through selling products that it has purchased or
, manufactured.
Cost of sales is the cost of the merchandise/goods sold to customers.
Gross profit is the difference between sales revenue and cost of sales.
Other operating income refers to income, other than sales, generated during ordinary activities of
an entity.
Gross operating income is the sum of the gross profit and other operating income. Operating
expenses are the costs of resources used as part of the operating activities during a financial period
and are not directly associated with specific goods and services. Operating expenses include selling
expenses, general and administrative expenses.
Earnings before interest and tax (Operating profit) is the difference between the gross profit and
operating expenses. Interest expense and interest income must be disclosed separately on the
face of the statement of comprehensive income after operating profit.
Arithmetically, the net profit (or loss) is the difference between income and expenses. Net profit will
only result if the income exceeds expenses.
The statement of comprehensive income of a company will also include company tax (second last
entry in the statement) before the earnings after interest and tax (EAIT) is determined.
2.2 Statement of Financial Position (Balance Sheet)
The purpose of this statement is to reflect the financial position of an entity on a particular date by
reflecting its assets, equity and liabilities. The following is an example of a statement of financial
position of a sole proprietorship:
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