7.1. The Accounting Machine Flashcards
What is accounting…
The process of identifying, measuring and communicating economic information to permit informed judgement by the users.
A body of knowledge:
- Accounting principles, regulations and applicable laws.
- Accounting standards.
- Financial information.
A technical process:
- The mechanics of what accountants do (i.e. credits and debits).
- The technicalities of the job.
Accounting acts as a series of activities which convert inputs to outputs.
Financial accounting…
Focuses on providing information to external parties.
The primary output is financial statements that must follow set laws from Companies Act 2006.
Financial accounts therefore have legal and capital market accountabilities.
Is designed to provide a faithful representation of the financial position and performance of a company.
Transactions…
Take place in the market, including sales, purchases of raw materials, hiring labour, renting real estate and purchasing resources.
Transactions have a market price, assumed to be fair value.
Transactions are less problematic.
Events…
Take place outside the market, including the accumulation of inventories, depreciation of assets, accidental loss and theft.
Events do not have a market price, accountants must therefore use judgement.
Events are more problematic:
- It is difficult to value inventory levels and value depreciation.
Two concepts of accounting…
Money measurement: only financially measurable transactions and events should be treated as inputs.
Accounting entity: businesses are treated as independent and separate from their owners. Therefore, only transactions and events that are directly related to the business should be considered.
Transaction processing system (TPS)…
- Identifies and captures relevant transactions (sales records, receipts, bills, payments) and events and records legal evidence these occured.
- Classifies transactions and events into criteria, such as sales, purchases, wage payments.
- Records the transactions and events in relevant files / databases according to the double entry bookkeeping rule.
Decision support system (DSS)…
Generates reports and statements for legal, tax and audit regulation purposes.
The output can then be communicated to the relevant user who can analyse and interpret it for specific purposes
Three financial statements…
Income statements:
- Profit and loss account, demonstrates the performance over time.
- Contains all the income, expenses and profit / loss details.
Statements of financial position:
- Balance sheet, shows the performance at one time.
- Contains information about assets, liabilities, capital and equity.
Statement of cash flows:
- Shows liqudity changes, detailing cash inflow and outflow over time.
Assets…
Something owned by the company, can be controlled and used to create future benefit.
Non-current (fixed): long-term assets such as buildings and equipment.
Current: short-term assets such as stock / inventory.
Liabilities…
Something that is owed.
Long-term liabilities: long-term debt obligations such as loans.
Current: short-term liabilities, such as an overdraft or unpaid bill.
Capital / equity…
Investment from shareholders.
Contributed capital: funds invested by the shareholders and owners.
Earned capital: accumulated profits that are reinvested into assets.
Income…
Revenue received for the sale of goods and services.
The value paid by the customers for products sold or services supplied.
Businesses recognise income when transactions occur.
Expenses…
The cost of day-to-day business operations.
Expenses are an item that is used up in the production of income.
Accounting equation…
Assets = liabilities + capital + (income - expenses)
