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Module 1ModuleModuleModule 111 An Introduction to Accounting and the Accounting Equationthe Accounting Equation Omar ElKheshen – kheshen@gmail.com 1
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This module introduces you to accounting and the accounting equation Learning Objectives 1. The value to various groups in society of a knowledge of accounting 2. The role of accounting in management 3. The need for, and use of, accounting information in decision making within any organization 4.4. The accounting equationThe accounting equation 5. The basic layout of the profit and loss account (income statement), the balance sheet and the cash flow statement 6. The distinction between financial accounting and management accounting Omar ElKheshen – kheshen@gmail.com 2
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Agenda 1.1 Approaching Accounting 1.2 The Reality of Accounting 1.3 What Accounting Is 1.4 Focus on Profit-Seeking Businesses 1.5 Who Are the Users of a Company’s Accounting Information? 11..66 For what Sort of Decisions Do these Users Value Accounting Information?For what Sort of Decisions Do these Users Value Accounting Information? 1.7 Common Information Requirements among Users 1.8 The Accounting Equation 1.9 The Accounting Statements Do-It-Yourself Example 1.10 Sole Trader versus MBA 1.11 Accounting: The External and Internal Functions Omar ElKheshen – kheshen@gmail.com 3
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Students often prefer to avoid accounting since it is misperceived as boring, methodical, and highly numerical – fortunately, it is far from that! Accounting Misconceptions Non-Intuitive Requires the mastery of rules from the outset, unlike marketing, economics and OB Highly Mathematical Deals exclusively with numbers Involves extensive precision and accuracy, both of whichInvolves extensive precision and accuracy, both of which Focused on PrecisionFocused on Precision require a highly developed mathematical mind Requires Long Studies Accountants must spend many years studying accounting to acquire their professional qualifications Stereotyped as being humorless, repetitive and Dull and Boring unimaginative Luckily, accounting is none of the above! Omar ElKheshen – kheshen@gmail.com 4
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Agenda 1.1 Approaching Accounting 1.2 The Reality of Accounting 1.3 What Accounting Is 1.4 Focus on Profit-Seeking Businesses 1.5 Who Are the Users of a Company’s Accounting Information? 11..66 For what Sort of Decisions Do these Users Value Accounting Information?For what Sort of Decisions Do these Users Value Accounting Information? 1.7 Common Information Requirements among Users 1.8 The Accounting Equation 1.9 The Accounting Statements Do-It-Yourself Example 1.10 Sole Trader versus MBA 1.11 Accounting: The External and Internal Functions Omar ElKheshen – kheshen@gmail.com 5
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Accounting is a a series of processes and techniques that identify, measure and communicate economic information to be used in decision-making Accounting: Is a Service Function Must Be Identified, then Measured Accounting is not an end Some economic events are easy It provides information to to identify and to measure decision-makers Others are easy to identify but not to measure Economic events have to be properly measured to haveproperly measured to have accurate profit figures Deals with Economic Information Is a Communication Device Organizations have a bewildering Accounting helps decision makers range of information reach their objectives Accounting confines itself to Accountants should communicate economic information and precise, up to the point and clear processes it into money value accounting information to them Omar ElKheshen – kheshen@gmail.com 6
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Agenda 1.1 Approaching Accounting 1.2 The Reality of Accounting 1.3 What Accounting Is 1.4 Focus on Profit-Seeking Businesses 1.5 Who Are the Users of a Company’s Accounting Information? 11..66 For what Sort of Decisions Do these Users Value Accounting Information?For what Sort of Decisions Do these Users Value Accounting Information? 1.7 Common Information Requirements among Users 1.8 The Accounting Equation 1.9 The Accounting Statements Do-It-Yourself Example 1.10 Sole Trader versus MBA 1.11 Accounting: The External and Internal Functions Omar ElKheshen – kheshen@gmail.com 7
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Accounting is a universally applicable management tool employing universally applicable principles What do the following persons have in common? The chairman of a A chief executive in The Chancellor of the football club the local brewery Exchequer A financial controller The senior partner of The medical director of a universityof a university a law firma law firm of a hospiceof a hospice They are all concerned with the raising and spending of money and the control of scarce resources through budgets The detailed accounting procedures applicable to each of these individuals are fairly complex, we will focus primarily on the profit-seeking manufacturing sector Omar ElKheshen – kheshen@gmail.com 8
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The profit-seeking private sector, and more specifically the manufacturing industry, is our scope of focus in this course Reasons behind this selection Lots of people invest in profit-seeking private companies even non-for- 1 profit organizations Increasing privatization adopts techniques and performance measures 2 of the private sectorof the private sector Manufacturing industry setting is the easiest and the most applicable in 3 conveying accounting rules and principals Omar ElKheshen – kheshen@gmail.com 9
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Agenda 1.1 Approaching Accounting 1.2 The Reality of Accounting 1.3 What Accounting Is 1.4 Focus on Profit-Seeking Businesses 1.5 Who Are the Users of a Company’s Accounting Information? 11..66 For what Sort of Decisions Do these Users Value Accounting Information?For what Sort of Decisions Do these Users Value Accounting Information? 1.7 Common Information Requirements among Users 1.8 The Accounting Equation 1.9 The Accounting Statements Do-It-Yourself Example 1.10 Sole Trader versus MBA 1.11 Accounting: The External and Internal Functions Omar ElKheshen – kheshen@gmail.com 10
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A company’s accounting information can be of use to internal users and/or external users Internal Users External Users Directors Shareholders Senior Executives Analysts Managers Creditors Employees Tax Authorities Trade Unions The Public They need accounting to base their decisions on adequate and truthful information Omar ElKheshen – kheshen@gmail.com 11
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Agenda 1.1 Approaching Accounting 1.2 The Reality of Accounting 1.3 What Accounting Is 1.4 Focus on Profit-Seeking Businesses 1.5 Who Are the Users of a Company’s Accounting Information? 11..66 For what Sort of Decisions Do these Users Value Accounting Information?For what Sort of Decisions Do these Users Value Accounting Information? 1.7 Common Information Requirements among Users 1.8 The Accounting Equation 1.9 The Accounting Statements Do-It-Yourself Example 1.10 Sole Trader versus MBA 1.11 Accounting: The External and Internal Functions Omar ElKheshen – kheshen@gmail.com 12
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Each category of accounting users has a different purpose in reviewing company accounts Questions Asked by Different Users of Accounting Information Has the company been employing its resources in the most effective way to maximize the profit earned for our shareholders? Is it maximizing shareholder value? Directors Has the company been a good corporate citizen? Have all our industrial processes been friendly to the environment? If not, how much is being spent on improving the flawed processes?processes? Are we managing our money efficiently? Senior Is our manager remuneration scheme sufficiently rigorous to executives promote effort and commitment while at the same time being competitive with other multinationals? Omar ElKheshen – kheshen@gmail.com 13
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Each category of accounting users has a different purpose in reviewing company accounts (Continued) Would it be cheaper to make a component ourselves or buy it in Managers from an outside supplier? Are all our lines profitable? How much should we claim in the next wage round? Employees What are the security and prospects of employment in this company? Should we buy (or sell or hold) shares in this company? Shareholders How much dividend has been paid last year compared with profits earned? Should we advise shareholders and potential shareholders to buy Analysts or sell or hold shares in the company? Is the performance of the company this year superior to its competitors? Omar ElKheshen – kheshen@gmail.com 14
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Each category of accounting users has a different purpose in reviewing company accounts (Continued) Should we advise a switch of holding to a company with a more promising prospect? Creditors Should we extend our credit to this company, or should we press to recover our debts? In the longer term will the company be able to supply us with business? Tax How much tax can we expect to receive from the company? Authorities Is the company fulfilling its obligations to society by, for instance, The Public minimizing environmental pollution, or by abiding by international guidelines for trading in Third World countries? Omar ElKheshen – kheshen@gmail.com 15
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Agenda 1.1 Approaching Accounting 1.2 The Reality of Accounting 1.3 What Accounting Is 1.4 Focus on Profit-Seeking Businesses 1.5 Who Are the Users of a Company’s Accounting Information? 11..66 For what Sort of Decisions Do these Users Value Accounting Information?For what Sort of Decisions Do these Users Value Accounting Information? 1.7 Common Information Requirements among Users 1.8 The Accounting Equation 1.9 The Accounting Statements Do-It-Yourself Example 1.10 Sole Trader versus MBA 1.11 Accounting: The External and Internal Functions Omar ElKheshen – kheshen@gmail.com 16
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Accounting is not all about profitability and liquidity ratios, but rather about understanding and interpreting accounting information Professional Terminology "Profits" Profitability Answers to all previous questions require knowledge of: "Cash Position" Liquidity This course is designed to assist managers in: Understanding Answering All Preparing the Mechanics of Questions Posed Interpreting Accounting Accounting Information the Accounting by Various Information Process Interest Groups Omar ElKheshen – kheshen@gmail.com 17
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Agenda 1.1 Approaching Accounting 1.2 The Reality of Accounting 1.3 What Accounting Is 1.4 Focus on Profit-Seeking Businesses 1.5 Who Are the Users of a Company’s Accounting Information? 11..66 For what Sort of Decisions Do these Users Value Accounting Information?For what Sort of Decisions Do these Users Value Accounting Information? 1.7 Common Information Requirements among Users 1.8 The Accounting Equation 1.9 The Accounting Statements Do-It-Yourself Example 1.10 Sole Trader versus MBA 1.11 Accounting: The External and Internal Functions Omar ElKheshen – kheshen@gmail.com 18
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The accounting recording system is based on the “Accounting Equation” that expresses the relationship between resources & funds used to acquire them Accounting Equation Assets = Owner’s Equity + Liabilities OrOr Assets - Liabilities = Owner’s Equity The accounting equation is a collection of balances after each transaction has been completed and recorded Omar ElKheshen – kheshen@gmail.com 19
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A simple example will show how this equation works by examining a series of actions through a period of time Action 1 An individual commences his business on 1 January with €20,000 cash. Assets = Owner’s Equity + Liabilities +20,000 (Cash) +20,000 Action 2 Out of these cash resources he purchases plant and equipment for €12,000. Assets +8,000 (Cash) = Owner’s Equity + Liabilities +20,000 + 12,000 (Plant) Omar ElKheshen – kheshen@gmail.com 20
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