Accounting Management

What is bookkeeping and what is accounting?

Bookkeeping - involves the identification and recording of economic events only and is therefore just one part of the accounting process.

Accounting can be defined as the orderly and systematic identification and recording of the monetary values of economic transactions of an individual entrepreneur (person) or a business enterprise (entity or institution), the reporting on the results of these transactions and the provision of financial information by submitting financial statements, which information is used as a basis for decision making. Accounting, therefore, includes bookkeeping.

Generally Accepted Accounting Practice (GAAP)

The International Accounting Standards Board (IASB) approved the Framework for the Preparation and Presentation of Financial Statements (hereafter referred to as the Framework). The purpose of the framework is mainly to assist national standard-setting bodies, preparers of financial statements, auditors and users, in preparing and presenting financial statements for external use.

The Accounting Practice Board (APB) is the standard-setting body in South Africa. The main object of this body is the establishment, recognition and acceptance of what the Board considers to be Generally Accepted Accounting Practice (GAAP).

The statements on accounting practice, issued by SAICA (South Africa Institute of Chartered Accountants), are denoted by the prefix AC, followed by three digits. AC 100 deals, for example, with the Preface to Statements of General Accepted Accounting Practice, and IAS 1 (AC 101) deals with Presentation of Financial Statements. 

Approach to setting accounting standards:

In the setting of standards, the accounting practices that are desirable are identified. This narrows the difference and variety of available accounting practices. It does not, however, attempt to prescribe a rigid uniformity of the production of an inflexible set of rules for all circumstances. 

Fair presentation:

The most important requirement of the Companies Act is that the financial statements must reveal a fair presentation. The set standards help to achieve both comparability and fair presentation. Only in exceptional cases is a deviation from GAAP permitted.

Application of statements of GAAP:

It will always be necessary to bear in mind the overriding requirements of fair presentation. Two considerations affect the application of GAAP, in particular, situations (AC 100.11.)

1. Substance over form: Transactions and other events should be accounted for and presented in accordance with their substance and financial reality and not merely with their legal form.

2. Materiality: Financial transactions should disclose all items which are material enough to affect evaluations or decisions.

The requirements of the Companies Act and Schedule 4 thereto are taken into account in the preparation of GAAP. Some entities may be required to prepare financial statements which comply with other statutes.

The function of accounting:

The function of accounting is to provide financial information to all interested parties on the results of the economic activities of a particular individual or institution. Most financial information is information expressed in monetary terms (money value). Economic activities include all activities (transactions) that use or consume resources (assets) to create new value. 

A trading entity purchases merchandise which is then sold at a price higher than the purchase price and other related costs. The difference between the purchase price and costs on the one hand, and the higher selling price on the other, is called a profit. The financial results of economic activities have, therefore, two aspects:

1. The value added to the net worth of a person or an entity during a particular period, and

2. The accumulated net worth of that person or entity.

In terms of paragraph 8 of IAS 1 (AC 101), a set of financial statements must consist of:

• Balance sheet
• Income statement
• Statement of changes in equity
• Cash flow statement, and
• Notes, comprising a summary of significant accounting policies and other explanatory notes.

The entity concept:

An entity is an economic unit whose financial results are determined on its own. In practice, all economic activities are undertaken by a single person, group of persons in partnership, a business undertaking or group of business undertakings, for which it is necessary to report separately on the finances thereof. In the medical practice every practice number, if it is a one-man practice or group practice or a company each one will have their own entity depending on the Practice number. 

The purpose, status and scope of the accounting framework:

The Framework sets out the directives and concepts that underlie the preparation and presentation of financial statements. 

The Framework is concerned with general purpose financial statements, which are prepared at least annually.

Financial statements form part of the process of financial reporting. 

The Framework applies to the financial statements of all commercial, industrial and business reporting entities, whether in the public or the private sector.

The nature of and the need for financial information:

The main function of information is to support decision making. Financial information supplied by the accounting process is primarily used for decisions directed at planning or at exercising control. In planning decisions, financial information is used in determining future actions to be taken, often based on what happened in the past. 

Control decisions entail using financial information to evaluate the results of financial activities. The most important control function of financial information is the provision of accountability and stewardship. 

Users of financial information:

The users of financial statements include, according to paragraph 9 of the Framework, present and potential inventors, employees, lenders, suppliers and other trade creditors, customers, governments and their agencies and the public. Each user uses the information disclosed in the financial statements in order to satisfy particular needs, which may include (Framework .9.):

• Investors: These are the providers of Capital. They need the information to decide whether they should invest (buy shares), hold or withdraw (sell shares).
• Employees: Employees are interested in information about the stability and profitability of the business. 
• Lenders: Lenders need the information to determine whether their loans and the interest on the loans will be paid on due dates.
• Suppliers and other trade creditors: These users need information that will assure them that amounts owed to them will be paid when due.
• Customers: They want to know if the business will continue to exist, especially when they are involved n a long time or when they are dependant on the entity.
• Government and their agencies: They are interested in the allocation of resources and, therefore, in the activities of the entity.
• Public: Members of the public are affected in several ways. Entities often contribute to the local economy by employing people and supporting local suppliers.

Published financial statements are based on the information used by management about the financial position, performance and changes in equity and the cash flows of the entity. (Framework. 11.).

The objectives of financial statements:

Statements largely disclose the financial effects of past events and do not necessarily provide non-financial information (Framework .13.).  

Financial performance, changes in equity, financial position and cash flow statements:

Financial Performace:

The financial results of an entity consist of economic activities which are measured in two ways: firstly the financial performance for a particular period and, secondly, the financial position at a particular point in time.

The financial performance reflects the profit made or the loss incurred by the entity over a specific period of time. The financial performance is reported in an income statement.

 Changes in Equity:

In terms of paragraph 8(c) of IAS1 (AC 101), information regarding any changes in the equity of an entity must be reported in a statement particularly formatted to show the changes in the equity of an entity.

This statement also forms a "link" between the income statement (reflecting the profit for the financial period) and the balance sheet (reflecting the capital or equity) of the entity.

Financial position:

The financial position is usually determined at the end of the period, that is, after the financial performance for that period has been determined in the income statement. The financial position reflects the net worth of the entity at a specific point in time.

The financial position of an entity is affected by (Framework .16.):

• The economic resources it controls
• financial structure
• liquidity
• solvency
• capacity to adapt to changes in the environment in which it operates.

Cash flow statements:

The ability to generate cash will eventually determine whether the entity will be able to meet its commitments, such as the ability to pay its employees, suppliers and interest, the ability to repay loans and to make distributions to its owners.

Cash equivalents are short-term investments which can easily be withdrawn (converted into cash) without any meaningful risk of changes in value. 

The cash flow statement reflects inflows and outflows of cash during the financial period. 

The accounting process:

The accounting process comprises the methods and procedures for the identification, recognition, measurement and recording of financial transactions and events that change the financial results and position of an entity. This includes the processing, presentation, interpretation and use of the information supplied and which is a result of the economic transactions related tot he particular entity.

Recognition is a process of deciding whether an element or item is valid and that it should be included in the accounts of the entity.

Measurement is the process of determining what, monetary amounts are to be disclosed for each item in the financial statements.

The design of the accounting records and accounting system is very important as the information recorded is processed in the accounting records by collecting it, classifying it, sorting it and summarising it into a format in which it will serve as useful information.

The domains of accounting:

Accounting can be divided according to the nature of the information it provides, thus: 

• Financial accounting, and
• Management accounting

Financial accounting deals primarily with external users of financial information. Financial accounting caters the formal financial statements (income statement, statement of changes in equity, balance sheet and cash flow statement as well as notes to the statements) which contain financial information regarding the entity as a whole.

Management accounting caters mainly for internal users of financial information of the entity. Internal users require a wide variety of financial information in order to manage the entity on a day-to-day basis. Management accounting produces reports regarding specific aspects of the entity;'s business according to the needs of the various internal users.

Summary:

A set of financial statements of an entity comprises

(a) an income statement (to report on financial performance), 

(b) a statement of changes in equity (to report on such changes), 

(c) a balance sheet (to report on the financial position of the entity) and 

(d) a cash flow statement. 

Accounting is a specialised means of communication.