This free course, Financial accounting and reporting , serves as an introduction to financial accounting, introducing the basic terminology, purpose and different types of accounting. You will learn about what accounting is, the purposes for which accounting information is used, how to distinguish between management and financial accounting, the components of accounting information, and the main financial reports in which this information is presented to its users.
You will also have a clear understanding of how accountants act as processors and purveyors of information for decision making, of the needs of those who use accounting information, and of the role performed by accountants. Accounting does not exist for its own sake or in a vacuum: there must be a reason why accounting is being done. This course is also meant to enable you to understand the relevance of the course to your own career. For example, if you are thinking about becoming a professionally qualified accountant or studying business or management, or using knowledge of accounting in your own work situation or your own business.
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This OpenLearn course provides a sample of level 2 study in Business & Management .
After studying this course, you should be able to:
define bookkeeping and accounting
explain the general purposes and functions of accounting
explain the differences between management and financial accounting
describe the main elements of financial accounting information – assets, liabilities, revenue and expenses
identify the main financial statements and their purposes.
First of all, you need to be aware of some of the basic terminology in this subject area. There are several different terms in common use under the general umbrella of accounting and they are often used by people interchangeably without distinguishing the meanings of these terms. Some of the most important are considered in this section, namely bookkeeping , accounting and reporting .
Bookkeeping is the process of recording transactions in the financial records of a business entity. Before transactions are recorded, they need to be classified according to their type so that similar items can be recorded in the same record or account . For example, a business entity will keep records of sales and purchases of goods or services, each classified according to their nature. Originally records detailing similar types of transactions were kept together in a book or ledger, with one or more pages dedicated to a particular kind of transaction, for example, sales of specific goods. Therefore, records often are collectively referred to as the ‘books’ of a business.
Bookkeeping goes back many hundreds, even thousands, of years. It began because people needed to record business transactions as a means of keeping track of who owed them money and to whom they owed money, and of knowing whether businesses were financially successful or not. For many years, bookkeeping was based on common sense – businesses recorded the data they considered necessary in order to obtain the information they required. ‘Bookkeeping’ as a term is used to denote not only recording transactions in the way described here, but also frequently as an abbreviation for double-entry bookkeeping , a particular system of recording transactions devised about 500 years ago, and first written about by an Italian monk called Luca Pacioli. Today, double-entry bookkeeping remains the most widespread method of bookkeeping.
It is the job of the bookkeeper to maintain the books of a business and keep them up to date. This is done by ensuring that transactions are recorded in a timely and logical manner, either chronologically, as they occur, or by dealing with like items in batches, for example, recording all sales of a particular good in a defined period of time (day, week or month, according to the needs of a business). Recording may be done manually using paper and pen, but it is now more commonly done by using a computerised bookkeeping or accounting program.
Recording items in individual accounts (see above) is also referred to as posting , and a computer program can ensure that all necessary records are completed quickly and accurately (provided that data have been entered correctly, of course!).
Arguably the need felt by the Sumerian civilisation in Mesopotamia to keep account of livestock was also the origin of writing, as this account was recorded. The concept of ‘wealth’ is much older than that of ‘money’. Livestock was often regarded as an indication of wealth – which is still the case in some developing countries. Anyone who has read Alexander McCall Smith’s The No. 1 Ladies’ Detective Agency , set in Botswana in recent years, will recall that Mma Ramotswe was bequeathed a herd of 180 prime cattle by her father, who had regarded them as an investment.
As a result of posting transaction details to individual accounts in this way, each account will show a history or list of transactions that have occurred, so the management of a business can keep track of them individually. It can also track movements (increases and decreases in the volume of transactions recorded) over a period of time (e.g., to monitor sales of a new product). Businesses also need to know how well they are faring in all aspects, and the existence of accounts enables them to draw up a formal report to show this. The list of monetary transactions in an individual account can be totalled so, for example, the total sales of a good in a particular period can be determined. This totalling of individual accounts also may reveal that one side of a double-entry account exceeds another in value. This enables a balance to be calculated. The individual account balances for all accounts are then listed in a separate document, which is known as a trial balance . The process of balancing off individual accounts and drawing up a trial balance is an important part of determining whether a business has made a profit or loss overall.
Imagine a business recorded what it had sold, to whom, the date it was sold, the price at which it was sold, and the date it received payment from the customer, along with similar data concerning the purchases made by the business.
What information do you think that the business could produce from these data? Take ten minutes or so to type your answer.
These data would enable the business to know how much it had sold and how much it had purchased, how much cash it had received and paid, how much was owing to it and how much was owed by it (both in respect of any individual customer or supplier and in respect of the overall business transactions), and whether it was making a profit or a loss over a particular time period. It might also be possible to compare how much had been sold to the customer and purchased from the supplier with amounts sold and purchased previously.
Accounting is a process which identifies, organises, classifies, records, summarises and communicates information about economic events, usually, but not exclusively, in monetary terms. While accounting is often considered as including bookkeeping as well, it is much wider than bookkeeping. It may also be regarded as a transformative process in that it turns the raw data recorded in bookkeeping into useful information. Data lack meaning until they have been processed into meaningful information. What good is it to know that a book cost a bookshop £10? Those data will only become information when they are combined with something else that enables you to assess them within a relevant context, such as how much the book would have cost had the bookshop bought it from a different supplier or how much profit the bookshop made when it sold the book to a customer.
The communication aspect of accounting involves the reporting of information about a business to interested parties, such as owners and managers. Results of all transactions over a period of time need to be summarised, presented and interpreted in order to assess a business’s performance and its financial position at a given date. The period of time for which results are calculated is referred to as an accounting period or period of account . An accounting period can be any length of time, and the length may be determined by the reason for which a set of results is required, for example, to provide management with information, to support an application for a bank loan, etc. Commonly, however, an accounting period is of a year’s duration, and however often businesses produce sets of results, they will always produce an annual set of results, as these are required for specific purposes, such as for taxation or, in the case of companies, filing with a regulatory authority. Only in certain well defined circumstances will sets of results for periods other than a year be accepted for these specific purposes. For example, the first accounting period for companies in the UK must be more than six months, but no more than 18 months.
The date on which an annual accounting period ends is referred to as the business’s accounting reference date or closing date . For UK business entities, this date can be any date in the year and does not have to coincide with a calendar year, though this is not necessarily the case elsewhere. The form in which results are presented is usually twofold: a calculation of the business’s overall profit or loss for its accounting period, referred to as an income statement or profit and loss statement/account ; and a statement of financial position as at the end of the accounting period, also called a balance sheet. In this course we will use the terms ‘income statement’ and ‘balance sheet’. The income statement and balance sheet together are often referred to as the financial statements or set of accounts .
The different names for the different parts of financial statements have arisen as a result of different customs, rules and regulations over the years, when we look especially at the impact of the International Accounting Standards Board (IASB) and the introduction of International Accounting Standards (IASs) and International Financial Reporting Standards (IFRSs) . ‘Profit and loss account’ was for many years a common term, but it was felt to be less than precise, particularly when, for example, it was used by entities which did not have a profit motive, such as charities. IAS 1, the international accounting standard which deals with the presentation of financial statements, therefore, introduced the term ‘income statement’, which can be more universally applied. At the same time, it suggested the replacement of another, much older term, ‘balance sheet’, by the term ‘statement of financial position’. IAS 1, however, did not make adoption of the new terms mandatory. ‘Income statement’ has been widely adopted, but not ‘statement of financial position’. While many professional accounting training manuals use the latter, it is not yet widely used by businesses, which still continue to use the term ‘balance sheet’. In this course, we therefore use the terms ‘income statement’ and ‘balance sheet’. In addition to widespread use, the term ‘balance sheet’ is also useful when learning accounting as it helps remind you that a balance sheet itself should ‘balance’, that is, both halves/sides should add up to the same figure, and that certain individual account balances will be included there.
Although businesses produce formal income statements and balance sheets for, and at the end of, accounting periods, they can do so at any time, and often produce them more regularly to help managers monitor and control business activities and make decisions, as mentioned above. This adds further dimensions to accounting, as it helps look to the future, rather than focusing on transactions that have already occurred, and in this sense accounting has a management function, as a part or sub-set of the wider management information system (MIS) of a business. In this context, accounting is sometimes referred to as an accounting information system (AIS) or in short, accounting system .
Earlier it was mentioned that it might not be very useful to know only that a book cost a bookshop £10. What other data do you think could be used in order to convert the data about the cost of the book into information? Take ten minutes or so to think about this and type your answer.
You may have suggested any of the following:
These are all good answers, and there are probably many others. In each case, they provide the means of assessing something:
Information is data processed for a purpose. Once data have been converted into information, you can then use that information to help you make a decision, which will require the exercise of judgement. You cannot take meaningful decisions with data. This process can be expressed as follows:
Decision = Purpose + Information + Judgement
Note that while the bookkeeper will record data, it is the accountant who (as the definition of ‘accounting’ suggests) will convert data into information which serves a purpose, that is, is useful. To be useful, information must be timely, relevant, complete and of good quality. It can only possess these qualities if the underlying data have been recorded properly.
The main purpose of accounting is to provide financial information to managers and owners of businesses (as we have already seen) and a variety of other interested parties. This financial information fulfils different objectives, namely stewardship, accountability, planning and decision making and control, as discussed in the next sections.
Persons who run or manage businesses are not always those who have invested money and/or resources in the business. They manage money and/or resources which are owned by others, and act as stewards (or agents ) on behalf of owners (sometimes called principals ). The concept of stewardship places an obligation on stewards to provide financial information relating to the resources which they control, but do not own (see Figure 2 below).
Arrows denote flow of resources, information and directions of responsibility.
Accountability is connected to the idea of stewardship (though it is a wider concept as it may extend to other stakeholders or society in general). Stewards are obliged to give to owners of businesses an account of how they have managed resources. This may be discharged in part by the provision of financial information, such as an income statement and balance sheet. However, the idea of ‘accountability’ also carries with it the notion of acting responsibly and being able to justify one’s actions and, therefore, prepared to suffer the consequences of irresponsible and unjustifiable actions.
Business managers need to have financial information to enable them to make plans for future business activities and operations. For example, if a business plans to sell 120,000 units of a good it manufactures in the next year, it will need to know the quantity and price of raw materials required to make 120,000 units, the number of staff required and the hours each staff member can work and their rate of pay, the type and number of machines required, etc. There will, of course, be other costs associated with production. Such information is typically derived from on-going business activities and experience and reported financial information, combined with knowledge of future price increases for raw materials, wages and other known costs. Planning of this kind can be very difficult in practice if a business is aiming to increase or decrease production of an existing good, and becomes even more difficult in the case of producing any good which the business has not produced before.
Accounting information can also be used for the purposes of control. Business managers need to monitor activities and operations to see whether they are proceeding according to plan. In the example in Section 2.3 of planning to manufacture and sell 120,000 units of a good, a business may have planned to sell the units evenly over a year, that is, 10,000 units per calendar month. Therefore, the business will need accounting information on a monthly basis to see whether this target is being achieved. If it is not, then the business will need to find out why, and take corrective action if possible. The type of corrective action will depend on the problem that has been identified. Different problems can have the same overall effect. For example, if sales were ‘down’ in any given month, it might be the case that trade was more seasonal than anticipated and there might be compensating higher sales in other months. It might also have been the case that a sales representative for a particular area had been away on sick leave, which would also result in lower sales. Equally, a production problem could have prevented sufficient goods being manufactured for sale – perhaps being caused by machines breaking down or suppliers’ inability to deliver raw materials when needed. It is also possible that sales in a given month might be ‘up’ on what was forecast – which could also cause problems if it continued in the longer term, as the business may have resources that are inadequate to meet an unanticipated higher demand. Regular provision of accounting information (in this example, for sales and production) is essential for control purposes.
How do you think a shareholder in a company can be assured that the financial statements give a true and fair view of how the directors have been running the company? Take ten minutes or so to type your answer.
The shareholder would primarily look at the externally audited financial statements for the accounting period ended most recently. You might have been thinking along the lines of the shareholder asking someone to undertake an independent investigation into the financial statements and (by implication) into the directors’ management activities. You would have been right, because this is what external auditing involves. An external auditor is an independent, external person or firm appointed formally by the shareholders to write a report to them on the externally reported financial results of a company (as shown in its financial statements) and on its management.. There are also internal auditors , who might do a similar job, but report to internal committees within a firm.
From Section 2, it is clear that accounting information has a number of different purposes, governed by the needs of those using it. This brings us to consider different types of accounting, namely financial accounting and management accounting, as the purposes fulfilled by accounting information generally fall under one or the other heading. It is important to note that this does not mean that any different types of books or records need to be kept. It is just that the information produced from the books and records organises, classifies, summarises and communicates information according to the perspectives and needs of the users, as Table 1 below shows.
|Financial accounting||Management accounting|
|Chief purpose||Production of summarised income statements and balance sheets by managers as a formal report on the stewardship of resources entrusted to them but should also, in the case of public companies, help interested parties (such as investors) make decisions. Depending on the type of the business entity, documents may be publicly available.||Production of detailed and up to date information used by managers to plan activities and control them. This information is not publicly available, but is internal to the entity producing it.|
|When information is prepared||Annually, at the end of an accounting period, but, depending on the type of business entity, may be every three or six months as well.||Normally prepared on a monthly basis.|
|Governed by||Legal requirements and often mandatory accounting regulations* and/or conventions which may also dictate a required format (though this depends on the legal form of an entity).||Management needs only – with no legal requirement to produce anything in any format, or anything at all. Information is produced in the format management deems most useful, e.g., by operating unit or product line, to record and monitor sales (by product, region, etc.), costs of production methods or products.|
|Perspective||Gives information about past performance, and might in practice be outdated by the time summarised documents are produced.||Comparative and up to date. While a given month’s results are provided, these are usually accompanied by a total for all months to date and comparative figures for a prior year (as well as for planned activities in the month and period to date).|
Which of the following statements is untrue?
Take ten minutes or so to type your answer.
All statements are true, though in the case of Statement 2, it does depend on the extent to which financial or management accounts may contain estimated figures, which are appropriate in certain circumstances, as you will learn later. Remember that all accounting information is produced from the same records – but at different times and for different purposes. It should all be of similar quality. Note that, in respect of Statement 3, while management accounts are not audited, not all financial statements are either, hence the subtle use of the phrase ‘may be audited’ in respect of financial statements. The requirement for audit is determined by the type of organisation and its size.
Section 1.2 told you that results of all business transactions over a period of time need to be summarised, presented and interpreted in order to assess a business’s performance and its financial position at a given date, in the form of an income statement and balance sheet. It was emphasised in Section 3 that the presentation of financial accounting information is governed by a combination of legal requirements and accounting regulations and conventions. Different types of business entities are governed by different requirements. However, one of the rationales underlying the preparation of income statements and balance sheets is to turn raw financial data into useful information, and this is achieved in part by organising, classifying and presenting data in particular ways to make them meaningful. Here we shall look at some conventional ways of doing this.
An income statement is a summarised financial statement which shows how well or badly a business is faring. An example of an income statement is shown in Figure 3. This is an income statement for a hypothetical sole trader (here called Mr Schmidt).
|Less: Cost of goods sold|
|Less: Closing inventory||Total (12,000)|
|Lighting and heating expenses||2,800|
|General expenses||Total 800|
|Net profit||Total 9,400|
Figure 3 Example of an income statement
As its name suggests, an ‘income statement’ includes all the income generated by a business in its accounting period. This is usually derived from the sales of its products and services, which are first listed from individual accounts on to the trial balance and then added up together. Income derived from sales may be referred to by a number of different terms, such as turnover or sales (sometimes sales turnover ), sales revenue or just revenue . However, income may be derived from other sources, and the source may be denoted in the terminology used to describe it. If a business derives income from a bank account in the form of bank interest, for example, this too will be included in the income statement. It will be shown separately from income arising from sales and will be called ‘bank interest receivable’ or something similar. However, perhaps rather unhelpfully for persons learning about accounting for the first time, ‘revenue’ can also be used as a general term to mean any sort of income, and if so used, could include ‘bank interest’ as well. There is no hard and fast rule about how the terms ‘income’ or ‘revenue’ are used. They are both very common terms, and you will see both used in this course.
In acquiring or making products for sale, or delivering services to customers, however, a business will have laid out some of its own resources (most commonly, money). For example, if a business makes a product, it will need to buy in raw materials, pay wages to employees making the product, and pay for electricity (for example) used in the manufacturing process. Likewise all such items are listed from individual accounts on to the trial balance and then added up together, with like items grouped together. For example, raw materials will be added together, as will energy items, wages, etc. The term costs or expenses is often used here to denote these types of items. Some accounting textbooks differentiate between these terms, but you will find them used interchangeably without distinction of meaning, and we do not differentiate between them in this course. Often terms used in accounting are also used in every day life with no reference to their financial meanings and this contributes to the overall lack of precision. For example, it is common to speak of someone ‘paying the price’ for something, such as committing a misdemeanour.
An income statement shows the total costs subtracted/deducted from total income. If there is an excess of total income over total costs, this is referred to as a profit (sometimes called a surplus , if the entity, like a charity, does not have a profit motive). If total costs exceed total income, then a loss or deficit (the latter is often used by non-profit-making entities) is said to arise – hence the alternative name for an income statement of ‘profit and loss account’. By organising, classifying and presenting income and expenses in this way, the income statement makes them into meaningful information because by calculating a profit or loss it becomes possible to determine how well or poorly a business is performing.
You will see that Mr Schmidt has separated his costs into those that relate to items that he has sold and the rest, and it shows two different kinds of profit. You will learn all about this later in this course, so do not worry if there are things here that you do not understand. Note also that the accounting convention used here puts figures to be deducted in round brackets. This is widely used, especially in the UK, but you should be aware that not every country uses it.
As the income statement groups together like items of income and deducts like items of costs to show a profit or loss for an accounting period, the balance sheet also groups together like items to show the financial position of an entity at the end of its accounting period. It is rather like a ‘snapshot’ of the entity at that moment in time. Determining a financial position is something that individual people frequently do as well, and involves sorting out what, as a person, you own and what is of value to you, often in terms of money and things like houses, cars, jewellery, furniture, etc. These types of things are called assets and the term means much the same in an accounting context as well. Determining a financial position also involves sorting out what, as a person, you might owe to other people – by way of things like mortgages, loans, credit card bills, unpaid bills for utilities, etc. These are called liabilities . If the value of your assets exceeds your liabilities, you could (in theory, at least) sell your assets, realise cash and settle your liabilities.
Assets and liabilities have been carefully defined by the International Accounting Standards Board (IASB). Assets are resources controlled by a business as a result of past events and from which future economic benefits are expected to flow to the business. They might be things the business owns, like machinery.
Businesses try to establish a financial position in a similar way at the end of an accounting period. They may have various assets, such as land and buildings, plant and machinery and vehicles, which they use to carry out business, manufacture goods and deliver them, and which they intend to keep for a long time. These are referred to as non-current assets or fixed assets . ‘Fixed’ here does not necessarily imply that assets are immovably fixed in one place (though many kinds of these assets often are); rather, it implies ‘lasting’. Many non-current assets, such as land and buildings, plant and machinery and vehicles, etc., are also referred to as tangible assets in that they have a physical form and can be ‘touched’ (the basic meaning of the word ‘tangible’). It follows that there are also intangible assets which are things that cannot be ‘touched’, such as patents , copyrights , trademarks , etc., though their existence may be confirmed by some kind of documentation. Businesses may also have items which they have bought to use in manufacturing, such as raw materials, but have not yet used. These will be used up in the course of manufacturing, and are often referred to as inventory or stock . They form one of another category of assets known as current assets , which either stay with a business entity for only a short time, or change over time. They perform a different role in the business from non-current assets. A business will not have exactly the same type or amount of raw materials in stock at the end of every accounting period, but will keep buying in materials as and when required, as it continues to manufacture and sell goods, so from one accounting period end to another, these items will not be the same. Businesses may also have stocks of finished items, which have not yet been sold, or stocks of items which are only partly finished ( work in progress ).
Other types of current assets are cash and amounts due from customers who have not paid for goods sold to them, referred to as trade receivables (' receivables ' for short and sometimes also referred to as trade debtors ).
Businesses also have liabilities in a similar way to individuals. They buy from suppliers, and may not pay for goods immediately, so at the end of an accounting period may owe money for such goods, referred to as trade payables (' payables ' for short and also sometimes referred to as trade creditors ) or for utilities such as gas, electricity or telephone charges. Businesses also borrow money from banks or other lenders to start or continue business. Also, owners of businesses invest their own money in business, most often when business commences. Money, resources or assets put into a business by owners are referred to as owner’s interest , equity or, commonly, as capital , though this latter word can be used to mean other things as well. As money, resources and assets will eventually be repayable to a business’s owners, this may also be regarded as a type of liability. Generally, liability items are classified by reference to when they need to be paid. Those due more than a year after the end of the accounting period are referred to as non-current liabilities (or long-term liabilities ). Those due within a year or less are called current liabilities . Amounts due in respect of trade payables will be current liabilities as such amounts are often due within three months or less, whereas loans may not be repayable for several years.
Liabilities are present obligations of a business arising from past events, the settlement of which is expected to result in an outflow from the business of resources embodying economic benefits. They might be sums of money owed to lenders, for example, who have loaned money to a business, and who will need to be repaid in due course.
At the end of an accounting period, all assets and liabilities are listed from individual accounts on to the trial balance and then added up together, with like items grouped together. There are two ways of showing assets and liabilities on a balance sheet – using either a horizontal format or a vertical format . A horizontal format lists all the assets on the left-hand side and all the liabilities on the right. As a result of the manner in which transactions are recorded using double-entry bookkeeping, the total of assets always equals the total of liabilities. This is why a statement of financial position is commonly called a ‘balance sheet’, that is, both sides (or halves) add up to the same amount. A vertical format often shows capital in the ‘bottom’ half, and in the ‘top’ half shows assets with liabilities deducted from them (current liabilities, for example, are deducted from current assets to show net current assets or liabilities). This is often referred to as the net assets approach . It is also possible to show all assets in the top half and all liability (or credit) balances in the bottom half (which is now possible under the international accounting approach ) Any entity could, in theory, produce a balance sheet in either format, as it is just a matter of presentation. The vertical balance sheet (i.e., using the net assets approach) is common in the UK, but different countries have different rules. It would not, for example, be permitted in France, although other countries with specific regulations may require it for certain types of entities. Examples of a horizontal and vertical balance sheet are shown in Figures 4 and 5 below – again for Mr Schmidt, the hypothetical sole trader whose income statement you looked at previously, in Figure 3.
|Fixtures and fittings||18,000||Cash introduced||25,000|
|Current assets||Net profit for the year||9,400|
|Trade receivables||5,800||Current liabilities|
|Cash at bank and in hand||2,300||Trade payables||8,200|
|Total 53,600||Total 53,600|
Figure 4 Example of a horizontal balance sheet
|Fixtures and fittings||18,000|
|Cash at bank and in hand||Total 2,300|
|Trade payables||Total (8,200)|
|Net current assets||Total 11,900|
|Net assets||Total 29,900|
|Retained earnings||Total 11,000|
|Add: Net profit for the year||Total 9,400|
|Less: Drawings||Total (15,500)|
Figure 5 Example of a vertical balance sheet, following the net assets approach
Again, do not worry if there are things here that you do not understand, such as drawings or why these are included in the horizontal balance sheet with assets, as these will be explained later (though drawings are simply a withdrawal of capital by the owner(s)). You will see in the above balance sheets that both show the profit of £9,400, as per the income statement in Figure 3, included with the capital elements.
Classify the following items as income, a cost/expense, an asset or a liability:
a machine for manufacturing widgets
The correct answer is c.
This is a tangible non-current asset – used for carrying out business and likely to be kept for a long time.
air conditioning used in a factory
The correct answer is b.
This is a cost/expense – a utility needed to keep machinery and employees at an appropriate temperature while they work. If the actual air conditioning plant itself is implied by the words ‘air conditioning’ (rather than what the plant actually does) then this would be a tangible non-current asset, likely to be used and kept for a long time.
sales of 1,000 widgets for cash to Mr Mohammad, a customer
The correct answer is a.
This is a sale to a customer, generating sales revenue (income).
£3,000 borrowed from the bank
The correct answer is d.
This is a loan, which will have to be paid back. It is a liability, and whether it is classified as current or long-term will depend on the date of repayment.
a heap of metal on the yard, to be used for manufacturing widgets
The correct answer is c.
This is raw material to be used in manufacturing so is inventory. Hence, it is a current asset.
£4,000 owed to Pyron Ltd for the metal on the yard
The correct answer is d.
This is money owed for material to be used in the business, so it represents a trade payable, and would be a current liability.
a Toyota Lexus car, used by an employee, but owned by his/her employer, Yen Ltd
The correct answer is c.
This is a non-current asset. This is because it is used in the business for transporting the employees (it may be what is called a ‘pool’ car, that is, it is available to a variety of employees). It is important to note that the car is owned by the employee’s company, not the employee. Therefore, the car would be one of the company’s non-current assets.
£10,000 of personal savings used by someone starting up a business
The correct answer is d.
This is money introduced to do business – therefore, it is capital which may be regarded as a particular type of liability, in that it will eventually be repayable to the owner.
To summarise from the previous discussions, the financial statements comprise:
The income statement or profit and loss statement, which shows income, less costs/expenses for an accounting period. Where income exceeds expenses, a profit or surplus arises. Where costs/expenses exceed income, a loss or deficit arises.
The balance sheet, which is a ‘snapshot’ of assets and liabilities at a moment in time – the end of the accounting period. The end of the accounting period is also often referred to as the ‘accounting reference date’, ‘balance sheet date’ or ‘closing date’.
To the above, we must also add:
The cash flow statement . There is a requirement for certain business entities, namely companies, to provide a cash flow statement to show movements in cash over the period covered by the income statement. This cash flow statement is considered by entities required to provide it as a third financial statement in addition to the income statement and balance sheet. The cash flow statement will be discussed later in this course when you learn about company financial statements, and examples will be given there.
If you look at any income statement and/or balance sheet for an entity, you will find that they are generally accompanied by a set of notes to the financial statements which provide further information, explanation or analyses, which are more conveniently shown separately from the main statements.
‘Profit’ and ‘cash’ are not the same thing, although profit commonly becomes cash in time. It is important for a business to generate both – profit to stay in business in the longer term and cash to be able to pay bills and liabilities as they fall due.
This Openlearn course has provided an introduction to some of the basics of accounting. You have learned the basic terminology of bookkeeping and accounting, the general purposes and functions of accounting and the differences between the two sorts of accounting (financial accounting and management accounting). You should also now be able to describe the different elements of financial information, such as income/revenue, costs/expenses, assets and liabilities, as well as identify the main financial statements (income statement, balance sheet and cash flow statement) and their purposes.
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This free course was written by Professor Jane Frecknall-Hughes.
This OpenLearn course provided a sample of level 2 study in Business & Management.
Except for third party materials and otherwise stated (see terms and conditions ), this content is made available under a Creative Commons Attribution-NonCommercial-ShareAlike 4.0 Licence .
The material acknowledged below is Proprietary and used under licence (not subject to Creative Commons Licence). Grateful acknowledgement is made to the following sources for permission to reproduce material in this course:
1.1.1: Portrait of Luca Pacioli (c. 1445–c.1514). © The Bridgeman Art Library
Every effort has been made to contact copyright owners. If any have been inadvertently overlooked, the publishers will be pleased to make the necessary arrangements at the first opportunity.
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This free course is adapted from a former Open University course called 'Financial accounting (B291)' .