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With the establishment of any business, one of the essential steps is the development of a dependable accounting system. In many instances, the system is designed in-house and installed by a member of the entity's own accounting department, although the system may be developed by an outside source such as a public accounting firm or management consultant. Alternatively, a commercially available software package may be purchased. Whichever approach is taken, the development of an accounting system must be revised frequently to accommodate a larger volume of transactions and changes in the nature of those transactions. The installation of an accounting system consists of three steps, which is system analysis, system design and system implementation.
1. System analysis
The objective of the systems analysis phase is to gather facts that provide a thorough understanding of business's information requirements and the sources of information. A study of the organization and how it functions is performed to determine the best combination of personnel, forms, record, procedures and equipment.
In existing systems, much of the information required for systems analysis may be available in the form of an operating manual or accounting manual. Any deficiencies in procedures and data processing method currently in use should be corrected during analysis phase.
2. System design
A new system is developed or improvements are made to an existing system in the SYSTEM DESGIN phase based on the facts gathered through systems analysis. An existing system may require minor amendments only, or it could be completely replaced with a new system for instance a more computerized system. A team approach using accountants, managers, engineers, computer experts and other specialists is often required in the design of an accounting system.
The design must include a consideration of the personnel required to operate the system, the source documents needed to record transactions, the accounting record and procedures to be used to process data, job descriptions for personnel, the reports to be prepared for interested parties and any automated features of the system. The basic concern in the design phase is to develop an accounting system with the most efficient flow of information, given the funds committed to the system and the information requirements involved. A fundamental part of design phase is the development of reliable internal control.
2. Systems implementation and review
Systems implementation and review is the final phase in the development or revision of an accounting system. This step involves the implementation of the decisions made during the design phase. The source documents, record and equipment chosen must be purchased. The personnel needed to operate the system must be selected, trained and supervised closely to ensure that they understand how the system should function. An accounting manual should be prepared as a formalized description of the procedures required to transform economic data into useful information.
When an existing system is being revised, the old system often is operated in parallel to the new one until management is certain that the new system is reliable. Any new accounting system should be tested thoroughly to be certain that its output is compatible with the desired result, and modifications made when necessary. Major reviews are usually accomplished gradually rather than all at once to help ensure reliable data flows.
-Understanding information requirements and sources of information
-Determining personnel requirements, source documents, accounting record and procedures, reports and reports format.
Systems implementation and review
-Implementing systems, training staff, preparing accounting manual, test-runs, evaluation and review.
Accounting cycle steps
1. Transactions are analyzed and recorded in the journal
The first step in the accounting cycle is to analyze and record transactions in the journal using the double-entry accounting system. Transactions are analyzed and journalized using the following steps:
Carefully read the description of the transaction to determine whether an asset, liability, owner's equity, revenue, expense, or drawing account is affected
For each account affected by the transaction, determine whether the account increases or decreases.
Determine whether each increase or decrease should be recorded as debit or a credit, following the rules of debit and credit.
Record the transaction using a journal entry
2. Transactions are posted to the ledger
Periodically, the transactions recorded in the journal are posted to the accounts in the ledger. The debit and credits for each journal entry are posted to the accounts in the order in which they occur in the journal. Journal entries are posted to the account using the following 4 steps.
The date is entered in the date column of the account
The amount in entered into the debit or credit column of the account
The journal page number is entered in the Posting Reference column .
The account number is entered in the Posting Reference column in the journal.
3. An unadjusted trial balance is prepared
An unadjusted trial balance is prepared to determine whether any errors have been made in posting the debits and credit to the ledger. The unadjusted trial balance does not provide complete proof of the accuracy of the ledger. It indicates only that the debits and the credits are equal. This proof is of value, however, because errors often affect the equality of debits and credits. If the two totals of a trial balance are not equal, an error has occurred that must be discovered and corrected
4. Adjustment data are assembled and analyzed
Before the financial statements can be prepared, the accounts must be updated. The four types of accounts that normally require adjustment include prepaid expenses unearned revenue, accrued revenue, and accrued expenses. In addition, depreciation expense must be recorded for fixed assets other than land.
5. An optional end-of-period spreadsheet(worksheet) is prepared
Although an end-of-period spreadsheet(work sheet) is not required, it is useful in showing the flow of accounting information from the unadjusted trial balance to the adjusted trial balance and financial statements. In addition, and end-of-period spreadsheet is useful in analyzing the impact of proposed adjustments on the financial statements.
6. Adjusting entries are journalized and posted to the ledger
Each adjusting entry affects at least one income statement account and one balance sheet account. Explanations for each adjustment including any computations are normally included with each adjusting entry.
7. An adjusted trial balance is prepared
After the adjustments have been journalized and posted, and adjusted trial balance is prepared to verify the equality of the total of the debit and credit balances. This is the last step before preparing the financial statements. If the adjusted trial balance does not balance, an error has occurred and must be found and corrected.
8. Financial statements are prepared
The most important outcome of the accounting cycle is the financial statements. The income statement is prepared first, followed by the statement of owner's equity and then the balance sheet. The statements can be prepared directly from the adjusted trial balance, the end-of-period spreadsheet, or the ledger. The net income or net loss shown on the income statement is reported on the statement of owner's equity along with any additional investments by the owner and any withdrawals. The ending owner's capital is reported on the balance sheet and is added with total liabilities to equal total assets.
9. Closing entries are journalized and posted to the ledger
Four closing entries are required at the end of an accounting period. These four closing entries are as follows:
Debit each revenue account for its balance and credit Income Summary for the total revenue.
Credit each expense account for its balance and debit Income Summary for the total expenses
Debit Income Summary for its balance and credit the owner's capital account.
Debit the owner's capital account for the balance of the drawing account and credit the drawing account.
The closing entries are normally identified in the ledger as "Closing."In addition, a line is often inserted in both balance columns after a closing entry is posted. This separates next period's revenue, expense, and withdrawal transactions from those of current period.
10 A post-closing trial balance is prepared
A post-closing trial balance is prepared after the closing entries have been posted. The purpose of the post-closing trial balance is to verify that the ledger is in balance at the beginning of the next period. The accounts and amounts in the post-closing trial balance should agree exactly with the accounts and amounts listed on the balance sheet at the end of the period.
Journalising is the process of recording financial transactions by using the rules of debit and credit. Cash book, sales day book, purchases day book, returns inwards day book, return outwards day book are each devoted to a particular form of transaction. For example, all credit sales are in the sales day book. To trace any of the transactions entered in these five books would be relatively easy, as we know exactly which book of original entry would contain the information we are looking for. The other items which do not pass through these five books are much less common, and sometimes much more complicated. It would be easy for a bookkeeper to forget the details of these transactions if they were made directly into the ledger accounts from the source documents and, if the bookkeeper left the business, it could be impossible to understand such bookkeeping entries.
What is needed is a form of diary to record such transactions, before the entries are made in the double entry accounts. This book is called the journal. For each transaction it will contain:
The name of account(s) to be debited and the amounts
The name of account(s) to be credited and the amounts
A description and explanation of the transaction(narrative)
A folio/Posting Reference to the source documents giving proof of
Typical Uses Of The Journal
Some of the main uses of the journal are listed below. It must not be thought that this is a complete list.
The purchase and sale of fixed assets on credit.
Writing-off bad debts.
The correction of errors in the ledger accounts.
Opening entries. These are the entries needed to open a new set of books.
Adjustments to any of the entries in the ledger.
Steps of journalising :
The date of the transaction is entered into the date column.
The title of the account to be debited is recorded at the left-hand margin under the description column, and the amount to be debited is entered into the debit column.
The title of the account to be credited is listed below and to the right of the debited account title, and the account to be credited is entered into the credit column.
A brief description maybe entered below the credited account.
The folio/Posting reference column is left blank when the journal entry is initially recorded. By using the preceding steps above, an example is illustrated as below.
The layout of the journal :
Step 2Credit Amount
Step 32013 Jan 1
Invested in InstantFlow
The following is a useful method for analysing and journalizing transactions:
Carefully read the description of the transaction to determine whether an asset, a liability, an owner's equity, revenue, an expense, or a drawing account is affected.
For each account affected by the transaction, determine whether the account increases or decreases.
Determine whether each increase or decrease should be recorded as a debit or a credit, following the rules of debit and credit.
Record the transaction using a journal entry.
Advantages of Recording Transactions in Journal
All business transaction is recorded down in journal in one place on the time and date basis.
On the basis of receipts or bill, transactions are recorded down, so we can check the reliability of each journal entries with bills.
The chance to avoid any particular transaction is minimized because in journal, transactions are recorded date basis.
Accountant writes every journal entry's narration bellow of that journal entry, so other auditor can know what the reason of that journal entry is.
Every transaction is recorded after two accounts is analysed on the basis of double entry system, so the chance of mistake in journal is minimized.
The use of journal makes fraud by bookkeepers more difficult.
It is the basis of posting in ledger accounts. With making of journal, accountant cannot make ledger accounts.
If mistake is found in ledger, we can correct it with the help of journal or rectify journal entry in journal.
All opening journal entries, closing journal entries and all other transactions which are not recorded in any other subsidiary books will be recorded in journal.
Every type of accounting software needs a journal. By their automatic processing, it enabling auto system of posting journal entries, but accountant must feed journal entries in journal and other specific vouchers of journal.
USERS OF FINANCIAL REPORTS *roles & function of external financial reports
External financial statements
External financial statements are prepared by companies to report their business information to the observer outside, including lender, suppliers and investors too. A company's external financial statements don't have much difference from its internal accounting in many cases; other times, the difference might be substantial. The matter is that the external documents illustrate a clear, complete and precise picture of the particular company's financial condition.
Objective of financial report
There is a set of objectives of financial reporting by business enterprises are identified by the accounting profession. Financial reporting should provide information that:
Is useful to present and potential investors and creditors and other users in making rational investment, credit, and similar decisions. The information should be comprehensible to those who have a reasonable understanding of business and economic activities and are willing to study the information with reasonable diligence.
Helps present and potential investors, creditors, and other users assess the amounts, timing, and uncertainty of prospective cash receipts from dividends or interest and the proceeds from the sale, redemption, or maturity of securities or loans. Since investors' and creditors' cash flows are related to enterprise cash flows, financial reporting should provide information to help them.
Clearly portrays the economic resources of an enterprise, the claims to those resources (obligations of the enterprise to transfer resources to other entities and owners' equity), and the effects of transactions, events, and circumstances that change its resources and claims to those resources.
In brief, the objective of it is (1) useful in investment and credit decisions, (2) useful in assessing cash flow prospects, (3) about company resources, claims to those resources, and change in them.
The emphasis on "assessing cash flow prospects" does not mean that the cash basis is preferred over the accrual basis of accounting. Information based on accrual accounting generally better indicates a company's present and continuing ability to generate favourable cash flows than do information limited to financial effects of cash receipts and payments.
The objective of accrual-basis accounting is to ensure that a company records events that change its financial statements in the periods in which the events occur, rather than only in the periods in which it receives or pay cash. Using the accrual basis to determine net income means that a company recognizes revenues when it earns them rather than when it receives cash. Similarly, it recognizes expenses when it incurs them rather than it pays them. Under accrual accounting, a company generally recognizes revenues when it makes sales. The company can then relate the revenues to the economic environment of the period in which they occurred. Over the long run, trends in revenues and expenses are generally more meaningful than trends in cash receipts and disbursements.
A publicly traded company must publish four external financial statements which are: a statement of cash flows, an equity statement, an income statement and a balance sheet.
Some financial statements are prepared on regular basis at equal intervals whereas some are communicated to people outside the entity and some are meant only for management. Usually financial statements refer to either a complete set of general purpose financial statements or a statement included in the complete set of general purpose financial statements. And due the same reason whenever the term financial statement is used, it is often assumed that a report is about entity's financial position, financial performance, cash flows or fluctuations in equity.
Financial statement is usually used forÂ allÂ orÂ anyÂ of the following statements:
Statement of financial position
Statement of Comprehensive Income or Income Statement
Statement of Cash Flows
Statement of Changes in Equity
Financial statements are one of such reports that are prepared on regular basis as specific entities are required to do so according to applicable laws.
Corporate leadership understands that a resource-rich business generally attracts external financiers, especially those with a long-term investment strategy. Consequently, senior managers purchase strategic assets to beef up the company's balance sheet, also known as a statement of financial position. Assets such as cash and accounts receivable, also called short-term resources, help a firm remain solvent and effectively manage its day-to-day activities. Other balance sheet items include equity, long-term assets and corporate debts. Long-term assets, or fixed resources, include equipment and land. Corporate debts, such as bonds payable and notes due, enable businesses to fund operating activities and stand out in the competitive battlefield.
A collective anxiety may grip a company if it posts mediocre or negative results over a long period. To curb the losing streak, senior managers may step up pressure on salespeople to increase revenues and smartly woo customers. An external income statement tells investors, and the public, how a business remains financially afloat, the blockbuster products it relies on to generate revenue and which operating processes cost the firm money. Simply put, this accounting statement includes corporate expenses and revenues to arrive at a net profit or loss.
Investors know that no business is immune to liquidity problems, and they sift through a company's cash-flow statement to make sure the firm has the cash needed to fuel its commercial ambitions. Financiers also review this accounting report to find out where the company gets the money it uses in operating activities. A statement of cash flows includes liquidity information about operating, investing and financing activities.
Also known as a statement of shareholders' equity, an equity report provides such elements as the amount of dividends paid out, the company's retained-earnings balance and any profits or losses from operations. Retained earnings are profits the firm has chosen to reinvest in its existing businesses.
Financial statements must be understood by readers who have "a reasonable knowledge of business and economic activities or accounting." There are different kinds ofÂ users of financial statements which may be inside or outside the business.Â .Â
Classification of Users of Financial Statements
The various users of financial statements are classified and detailed as follows:Â
1. Internal UsersÂ
Internal users of financial statements are those who have direct bearing with the organization, for instance:
Managers and Owners
The managers and owners need the financial reports essential to make business decisions in order for the smooth operation of the organization. So to have a more comprehensive view of the financial position of an organization, with the information supplied in the financial statements, financial analysis is performed. The financial statement is used to formulate contractual terms between the company andÂ other organizations.
The financial reports or the financial statements are of immense use to the employees of the company for making collective bargaining agreements. Such statements are used for discussing matters of promotion, rankings and salary hike.
2. External Users
The external users comprise of:
Investors who use the financial statements to assess the financial strength of a company are basically the external users of financial statements. This will aid them to make a better investment decisions.
The users of financial statements are also the different financial institutions like banks and other lending institutions who decide whether to help the company with working capital or to issue debt security to it.
The financial statements of different companies are also used by the government to analyse whether the tax paid by them is accurate and is in line with their financial strength.
The vendors who extend credit to a business require financial statements to assess the creditworthiness of the business.
General Mass and Media
The common people as well as media also make part of the users of financial statements.
In the case studyâ€¦
Brief List of Users of Financial Statements
Existing equity investors and lenders, to monitor their investments and to evaluate the performance of management.
Prospective equity investors and lenders, to decide whether or not to invest.
Investment analysts, money managers, and stockbrokers, to make buy/sell/hold recommendations to their clients.Â
Rating agencies (such as Moody's, Standard & Poor's, and Dun & Bradstreet), to assign credit ratings.
Major customers and suppliers, to evaluate the financial strength and staying power of the company as a dependable resource for their business.
Labour unions, to gauge how much of a pay increase a company is able to afford in upcoming labour negotiations.
Boards of directors, to review the performance of management.
Management, to assess its own performance.
Corporate raiders, to seek hidden value in companies with under-priced stock.
Competitors, to benchmark their own financial results.
Potential competitors, to assess how profitable it may be to enter an industry.
Government agencies responsible for taxing, regulating, or investigating the company.
Politicians, lobbyists, issue groups, consumer advocates, environmentalists, think tanks, foundations, media reporters, and others who are supporting or opposing any particular public issue the company's actions affect.
Actual or potential joint venture partners, franchisors or franchisees, and other business interests who need to know about the company and its financial situation
Financial ReportÂ is a set of documents of the financial activities of a business, person, or other entity by government agencies at the end of an accounting period.
Financial ReportÂ generally contains summary of accounting data for that period, with background notes, forms, and other information.Â
Interpretation of Financial report:Â
Financial reportsÂ deal with umpteen numerical values due to which it's a bit tough to interpret this. But by calculating ratios the interpretation can be made easier. The usefulness of taking the ratio is to compare not only the past performances with the current one but also with other's business performance whatever may the figure be. Howbeit, ratios will not be able to give exact answer but they are a useful indicator to show the company's financial condition.Â
The gross margin ratio is very useful to depict the profit and loss of the company. By taking the ratio of gross margin and sales revenue the gross margin ratio is calculated. Another useful ratio is the profit ratio which shows the net income. This information is highly confidential to the company and is not allowed to leak outside because it can help the competitor to change their business strategy.Â Financial reportÂ is usually been made after a quarter or the completion of one year.Â Different Types of Financial Reports: