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2015 John Wiley & Sons, Ltd, Accounting for Managers, 5th ed., 9780470777640, Ch 3 2
makes a profit and its human capital is increased when employees become better trained.
3.2 This Background Paper for <IR> explores the six categories of capital identified by the IIRC, which are
The plurality of the Capital concept in
depicted in Figure 1. Together, these capitals are the basis of an organizations value creation. As shown, the
capitals are not entirely independent. The exact nature of their interaction is a function of organizational focus
contemporary organizations
and beliefs. While most organizations rely on all capitals to an extent, some dependencies will be relatively
minor or so indirect that they are immaterial for reporting purposes.
Business events
occur during the 4
stages of the cash
cycle
FINANCING
INVESTING
OPERATING
RETURNING
2015 John Wiley & Sons, Ltd, Accounting for Managers, 5th ed., 9780470777640, Ch 3 4
The cash cycle - Financing
(OWNERS ) (LENDERS)
EQUITY LIABILITIES
CASH
2015 John Wiley & Sons, Ltd, Accounting for Managers, 5th ed., 9780470777640, Ch 3 5
The cash cycle - Investing
CASH
LABOR, MATERIALS,
FIXED ASSETS
OVERHEAD,ETC.
INVENTORY
2015 John Wiley & Sons, Ltd, Accounting for Managers, 5th ed., 9780470777640, Ch 3 6
The cash cycle - Operating
ACCOUNTS
CASH RECEIVABLE
SG&A
INVENTORY REVENUE
2015 John Wiley & Sons, Ltd, Accounting for Managers, 5th ed., 9780470777640, Ch 3 7
The cash cycle Returning
CASH
2015 John Wiley & Sons, Ltd, Accounting for Managers, 5th ed., 9780470777640, Ch 3 8
The cash cycle: general overview
EQUITY LIABILITIES
TAXES
ACCOUNTS
CASH RECEIVABLE
INVENTORY REVENUE
2015 John Wiley & Sons, Ltd, Accounting for Managers, 5th ed., 9780470777640, Ch 3 9
The financial performance of
the business
n If we could measure financial performance at the end of the
lifecycle of the business, then we should have:
Accounts
2015 John Wiley & Sons, Ltd, Accounting for Managers, 5th ed., 9780470777640, Ch 3 11
Forms of transactions
n On Cash
Bank (receipts, payments)
n On Credit
Debtors (customers who owe money to the
business)
Creditors (suppliers to whom the business
owes money)
2015 John Wiley & Sons, Ltd, Accounting for Managers, 5th ed., 9780470777640, Ch 3 12
Account and the Chart of Accounts
2015 John Wiley & Sons, Ltd, Accounting for Managers, 5th ed., 9780470777640, Ch 3 13
Types of accounts
n Assets
Things the business owns [investments: e.g. fixed;
inventory (products, materials, WIP); debtors; bank]
n Liabilities
Debts the business owes (creditors; loans; bank
overdraft)
n Income
Revenue generated from the sale of goods/services
n Expenses
Costs incurred in producing goods/services
2015 John Wiley & Sons, Ltd, Accounting for Managers, 5th ed., 9780470777640, Ch 3 14
Types of Accounts
(Investments)
( financing)
Liabilities
Expense
Income
Assets
Account
Bank
Equipment
Inventory
Creditor
Wages
Debtors
Sales
Cost of Sales
Advertising
2015 John Wiley & Sons, Ltd, Accounting for Managers, 5th ed., 9780470777640, Ch 3 15
Types of accounts &
the two basic accounting equations
The worth created by
business in the year
Income vs
Expenses
Profit = Income Expenses
Positive Negative
components components
Assets vs
Capital = Assets Liabilities
Liabilities
Positive Negative
The owners total amount of elements elements
(accounting) value of the business at
the end of the year
Not all the transactions affect Income or
Expenses and have a profit effect
2015 John Wiley & Sons, Ltd, Accounting for Managers, 5th ed., 9780470777640, Ch 3 16
Examples of transactions and their
effect on accounts and profit
2015 John Wiley & Sons, Ltd, Accounting for Managers, 5th ed., 9780470777640, Ch 3 17
Examples of transactions and their
effect on accounts and profit
2015 John Wiley & Sons, Ltd, Accounting for Managers, 5th ed., 9780470777640, Ch 3 18
Business events, transactions and the accounting
system: an overview
Business is conducted through a series of Business events
2015 John Wiley & Sons, Ltd, Accounting for Managers, 5th ed., 9780470777640, Ch 3 20
Summary of business transactions in a ledger
Capital Assets Liabilities Income Expense
Advertising 1000
Advertising 1000
Bank 16000
Advertising -1000
Install new equipment for -25000
Investment by the owner 50000
Pay supplier for goods -9000
Pay weekly wages -3000
Receive payment 4000
Capital 50000
Investment by the owner 50000
Cost of Sales 4000
Deliver goods from stock 4000
Creditor 6000
Pay supplier for goods -9000
Receive stock of goods for 15000
Equipment 25000
Install new equipment for 25000
Inventory 11000
Deliver goods from stock -4000
Receive stock of goods for 15000
Sales 9000
Sell goods to customer from stock 9000
Wages 3000
Pay weekly wages 3000
Debtor 5000
Receive payment -4000
Sell goods to customer from stock 9000
2015 John Wiley & Sons, Ltd, Accounting for Managers, 5th ed., 9780470777640, Ch 3 21
Inside the accounting machine
2015 John Wiley & Sons, Ltd, Accounting for Managers, 5th ed., 9780470777640, Ch 3 22
Inside the accounting machine
The fundamental accounting rule of
double entry bookeeping
n In recording transactions in the accounting system, double entry
bookeeping rules work in a way that each transaction involves at least
two accounts. Variations of value are recorded in the opposite sides of
each of the accounts involved (balance of accounts)
Asset/Expense account Liabilities/Capital/Income account
(+) Increase of value (-) Decrease of value (-) Decrease of value (+) Increase of value
n This way, the sum of the values of transactions recorded in the left side
of all the accounts is always equivalent to the sum of the values of
transactions recorded in the right side of all the accounts
23
2015 John Wiley & Sons, Ltd, Accounting for Managers, 5th ed., 9780470777640, Ch 3
Inside the accounting machine
Bank Capital
50,000 50,000
2015 John Wiley & Sons, Ltd, Accounting for Managers, 5th ed., 9780470777640, Ch 3 24
Inside the accounting machine
Inventory Creditors
15,000 15,000
2015 John Wiley & Sons, Ltd, Accounting for Managers, 5th ed., 9780470777640, Ch 3 25
Inside the accounting machine
Debtors Sales
9,000 9,000
2015 John Wiley & Sons, Ltd, Accounting for Managers, 5th ed., 9780470777640, Ch 3 26
The two basic accounting equations
Income vs
Expenses
Profit = Income Expenses
Positive Negative
components components
Assets vs
Capital* = Assets Liabilities
Liabilities
Positive Negative
elements elements
*or Equity
2015 John Wiley & Sons, Ltd, Accounting for Managers, 5th ed., 9780470777640, Ch 3 27
Accounting Equation of Capital: example
Capital = Assets Liabilities
Assets = Liabilities + Capital
Income
Expenses
Profit = Income Expenses
Income Statement
Assets
Liabilities
Capital = Assets Liabilities
Balance Sheet
Financial reports
2015 John Wiley & Sons, Ltd, Accounting for Managers, 5th ed., 9780470777640, Ch 3 29
Financial reports
2015 John Wiley & Sons, Ltd, Accounting for Managers, 5th ed., 9780470777640, Ch 3 30
From the ledger to Financial reports
Capital Assets Liabilities Income Expense
Advertising 1000
Advertising 1000
Bank 16000
Advertising -1000
Install new equipment for -25000
Investment by the owner 50000
Pay supplier for goods -9000
Pay weekly wages -3000
Receive payment 4000
Capital 50000
Investment by the owner 50000
Cost of Sales 4000
Deliver goods from stock 4000
Creditor 6000
Pay supplier for goods -9000
Receive stock of goods for 15000
Equipment 25000
Install new equipment for 25000
Inventory 11000
Deliver goods from stock -4000
Receive stock of goods for 15000
Sales 9000
Sell goods to customer from stock 9000
Wages 3000
Pay weekly wages 3000
Debtor 5000
Receive payment -4000
Sell goods to customer from stock 9000
Total 50000 57000 6000 9000 8000
2015 John Wiley & Sons, Ltd, Accounting for Managers, 5th ed., 9780470777640, Ch 3 31
From the ledger to Financial reports
2015 John Wiley & Sons, Ltd, Accounting for Managers, 5th ed., 9780470777640, Ch 3 32
From the ledger to Financial reports
50,000(Owners
2015 John Wiley &original investment)
Sons, Ltd, Accounting for Managers, 5th+ 1,000
ed., (Profit)
9780470777640, Ch 3 33
Financial reports: Income Statement
Income Profit = Income Expenses
Expenses
Income Statement
Income 9,000
Less expenses:
Cost of goods sold 4,000
Wages 3,000
Advertising 1,000 8,000
Profit 1,000
Matching Principle: income is
recognized when it is earned and
expenses when they are incurred, rather
34
than on a cash basis
2015 John Wiley & Sons, Ltd, Accounting for Managers, 5th ed., 9780470777640, Ch 3
Financial reports: Balance Sheet (1)
Assets Capital = Assets Liabilities
Liabilities Assets = Liabilities + Capital
Balance Sheet
Assets Liabilities + Capital
Equipment 25,000 Creditors 6,000
Inventory 11,000 Capital
Debtors 5,000 Owners original
Bank 16,000 investment 50,000
+ profit for period 1,000
Total capital 51,000
Total liabilities
Total assets 57,000 plus capital
2015 John Wiley & Sons, Ltd, Accounting for Managers, 5th ed., 9780470777640, Ch 3
57,000
35
Financial reports: Balance Sheet (2)
Assets Capital = Assets Liabilities
Liabilities Assets = Liabilities + Capital
2015 John Wiley & Sons, Ltd, Accounting for Managers, 5th ed., 9780470777640, Ch 3 38
Financial reports: Income Statement
(including depreciation) Matching Principle: income
is recognized when it is
earned and expenses when
they are incurred, rather than
Income Statement on a cash basis
Income 9,000
Less expenses:
Cost of goods sold 4,000
Depreciation 5,000
Wages 3,000
Advertising 1,000 13,000
Loss 4,000
Earnings management:
when companies smooth
their reported performance to
satisfy the expectaction of 39
2015 John Wiley & Sons, Ltd, Accounting for Managers, 5th ed., 9780470777640, Ch 3
stockholders
Financial reports: Balance Sheet
(including depreciation)
Balance Sheet
Assets Liabilities
Equipment 20,000* Creditors 6,000
Inventory 11,000 Capital
Debtors 5,000 Owners original
Bank 16,000 investment 50,000
- loss for period 4,000
Total capital 46,000
Total liabilities
Total assets 52,000 plus capital 52,000
* (25,000 5,000)
2015 John Wiley & Sons, Ltd, Accounting for Managers, 5th ed., 9780470777640, Ch 3
40
Points to remember
n Sales are based on the selling price
n Cost of sales are based on the purchase cost of
the goods sold (or cost of services supplied)
n Profit is not equal to cash flow
Capitalizing assets
Working capital (debtors, creditors, inventory
& bank)
Matching (or accrual) principle
n Profit is an addition to the owners Capital
n Loss is a deduction to the owners Capital
2015 John Wiley & Sons, Ltd, Accounting for Managers, 5th ed., 9780470777640, Ch 3 41
The limitation of financial accounting in
relation to cost concepts
n Accounting consider only financial costs
Human, social and environmental costs are also relevant
n Financial accounting produces reports based on line
items (resource input, e.g. materials, labour)
Many other relevant cost objects for decision making:
n Output (Product/Service)
n Process (e.g. customer order processing)
n Area of responsibility (department or cost centre)
2015 John Wiley & Sons, Ltd, Accounting for Managers, 5th ed., 9780470777640, Ch 3 43
Recording Financial
Transactions and the
Principles of Accounting