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CLE - CREATIVE LEARNINGEXERCISE

CLE 21 A ONE DAY PROGRAM IN ACCOUNTING

LANGUAGE & PRACTICE

Learn to Communicate withAccounting Staff

PART D - LECTURE/CASE SESSIONTEXT WITH AUDIO TO FOLLOW

DRAFT MAY 2006

Dr Bob Boland and Prof. Patricia Nuq and Mr. Anthony HarrisCopyright RGAB/AH 2006/4

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LEARNING OBJECTIVES

Using UK, USA and IAS terminology, the key learningobjectives of this one day program on confident

communication with accountants, are to:a. Use and absorb accounting language without effort.b. Apply the language to basic accounting concepts.c. Relate the concepts to current accounting practice.d. Communicate effectively with all accounting staff.e. Motivate further study in the future..

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LEARNING MATERIALS

The variety of active learning materials includes::

Audio - Alert Focus (David Wark) (20 minutes)Audio - Learning Reinforcement (20 minutes).

Text - Basic CLE sessions with text and frames (180minutes)Text - Simple Glossary for continuous referenceText - Quiz to measure learning achieved (60 minutes)

Powerpoint - Mini-AGL in Basic Finance (240 minutes)Powerpoint/audio - Lecture/case session (45 minutes)

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CUSTOMIZATION The program can be adapted for different learning groups

e.g. managers, staff, trainees, students etc, in eachparticular business or educational organization.

The UK, USA and IAS terminology are all related and easyto learn.

The initial timetable to test the program in one day (or twohalf days) could be as follows. Then the program can be

customized for each specific organization.

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TIMETABLE

Pre-course learning (45 minutes)Course learning:

1, Introduction 09.00 09.202. Audio - Alert Focus 09.20 - 09.40

3. Basic CLE Chapter 3 09.40 - 10.404. Coffee break 10.40 - 11.005. Lecture/case Session (first time) 11.00 11.456. Basic CLE - Chapters 4 - 5 11.45 - 13.007. Break lunch break (end half day) 13.00 14.008. Glossary Session 14.00 - 14.30

9. Lecture/case Session (reinforced) 14.30 15.1510. Coffee break 15.15 15.3011. Quiz & Feedback Session 15.30 16.0012. Post-course reinforcement 16.00 16.30.

Post-course learning: (240 minutes)

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SUMMARY OF CHAPTERS COVERED

CHAPTER i Introduction to Accounting

CHAPTER II Accounting Reports

Set 1 Have we made a profit?

Set 2 What is our financial position?

Set 3 Business transactions

CHAPTER III The Balance Sheet

Set 4 Assets

Set 5 Liabilities

Set 6 Owners equity

CHAPTER IV The Income statement

Set 7 Accounting Periods

Set 8 Sales and gross profitSet 9 Net income

Set 10 Statement of retained earnings

CHAPTER V The Package of Accounting Reports

Set 11 A summary of everything

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DEDICATION

As qualified UK/USA professional accountants, wedesigned this program to be amusing, and dedicate itto the memory of all those dedicated hard working

accountants (and auditors), who have always beenthe respected traditional the honest men in thetough game of business, but have been sometimesrelegated to the relatively humble job ofscorekeepers.

In revenge the accountants keep the score, in such acomplex way, that nobody other than skilledaccountants, can know what the score really is ...was ... or will be ...

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DEDICATION

We believe that the program will provide you with confidence,humour and motivation to learn well, about the wonderful worldof accounting, which started with a book on debits and creditsin 1425 ... and is still progressing.

However we still put our trust in the Professional Accountantsand Auditors who always try to serve us well, and in the newincreasingly powerful GAAP - Generally Accepted AccountingPrinciples and the even more powerful IAS - InternationalAccounting Standards, as the hopes of the future.

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DEDICATION

Note:

The original AGL/ASS/CLE materials have been used by over100,000 managers in seven languages in 30 countries aroundthe world.

In 2005, we felt bold enough to make this new version, whichadds humour and relaxation, to give confidence, to motivateand to anchor the learning, and make it fun!

Other one day programs will include: Cost Accounting &

Control, Planning & Budgetary Control, and DCF for CapitalInvestment Analysis and Basic Finance Management.

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Chapter 1 INTRODUCTION TOACCOUNTING

Read quickly through Chapter 1.

Study it detail when you have completed the

whole program.

The fun bits of the program are in heavy typeand have a grain of truth in them like themetaphorical stories

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Accounting Language

Accounting has been called the language of business and,like any language, it can never express our thoughts withabsolute precision and clarity.

Our task of learning this language is complicated by thefact that many of the words used in accounting meanalmost, but not quite, the same as they mean in everydaylife. You must learn to think of words in the accounting,rather than their popular, meaning.

In this program we have used a standard set of accountingterms. Although certain other terms are also commonlyused in practice.

However, frequent repetition and writing of the standard

accounting terms reinforces your basic grasp of theaccounting language.

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Rules and Principles

In any language there are some rules or principles that aredefinite and some others that are not definite. The latter area matter of opinion or style.

Accountants have different opinions just as grammarians havedifferent opinions. In this program we have tried to describethe elements of good accounting practice and to indicate someof the areas where there are differences of opinion as to whatconstitutes good practice.

As language changes to meet the needs of communication in asociety, so accounting changes to meet the needs of business.We have presented what we feel is currently regarded as goodpractice in accounting.

Question: What is more important in accounting, peanuts (small

money) or coconuts?

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Answer:

Coconuts are important!!

Leave the peanuts to the monkeys!

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GAAP (USA) & IAS

International Accounting Standards are the hope of the future forreliable financial reporting internationally.

At this time (2005) some countries simply still use the poor taxlaw as their accounting standard (France, Germany, Switzerland).

Some countries have few enforceable accounting standards (Africa,India, China, Russia etc.) and few really independent professionalauditors. So do not believe the figures!!

Thus GAAP & IAS become essential for reliable financialaccounting and reporting.

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Uncertainty

Accounting encompasses the facts about a businessthat can be expressed in money.

However, many important business facts, like thehealth of the managers, the morale of the workers,the state of the market, etc., cannot be expressedin money.

Accounting must necessarily therefore provide onlya limited picture of a business.

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Even when a fact may be expressed in money, theamount of money may be difficult to estimate

accurately.

We must rely upon the judgment of the accountantto choose the most appropriate alternative

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Again, many business transactions may be incomplete at the end of anaccounting period and it can then be difficult to determine whether aprofit has or has not been realized.

For example, does a business actually realize a profit, when it: buys goods for resale receives a customers order delivers the goods to a customer the customer pays for the goods?

The accountant must decide these alternatives and he normally choosesto treat the profit as realised when the goods are shipped.

Question: What is estimated in accounting?

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Answer: Almost everything- but very very carefully!

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Conservatism

In the past, management has accepted accounting as anecessary evil that is not useful for day-to-day businessdecisions.

The practices of accounting have arisen from businessactivities over a long period of time and to avoid a falseimpression to management, accountants tend to be ultraconservative and to understate rather than overstatethe financial position of a business

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UNFORGETTABLE STORY TO ANCHOR THE LEARNING

An economist died and was carried by angels to heaven. St Mathew,the tax collector, greeted him and took him on a tour beyond thePearly Gates.

Off in the distance, the economist spotted an imposing wall beyond amoat filled with menacing creatures.

"What's beyond the wall?" he whispered.

"Oh that," replied St Matthew. "That's where we put the Chartered

and Certified Accountants ... they think they're the only oneshere."

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Accounting practices try to take profits only when theyare reasonably certain, and yet by contrast to providefor losses as soon as they are known or anticipated.

An attitude of conservatism however, could lead us tomis-statement of the financial position of a business.

By contrast Good Accounting tries to present a trueand fair view of a business, in accordance with good

accounting standards.

Question: Why did the accountant cross the road?

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Answer:

To open up a very profitable tax/consultingpractice on the other side!

(now almost forbidden !!)

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Consistency and Comparability

Accounting figures become significant, not inthemselves, but when they are compared withother figures for a similar, previous period,budget estimate, or even another business.

The accountant, therefore, despite the problemsof uncertainty and conservatism, tries to beconsistent in his judgment so that the figures heproduces are comparable from one period toanother.

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The Accounting Period

The basis of all profit is the period (accounting period) duringwhich the profit is realised. Thus 100 a week is not the sameas 100 for a whole year.

Again, the financial position of a business is related to aparticular date.

Thus the picture at January 1st may not be the same as thepicture as at June 30th.

The accounting period and the date, therefore, are vitalinformation which affect the significance of an accountingreport.

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The Cost Concept

Accounting generally values assets at cost and notat their resale values.

Otherwise accounting reports would show a businessto make a profit by simply buying goods for resaleand not by actually selling them.

There are two exceptions to this general principle:

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Where it is known that goods purchased for resalewill fetch less than their cost.

We then value the goods at resale (market value)thereby recognizing the loss, and

Where goods are purchased for retention and use

in the business and not for resale (fixed assets),we shall value them at cost (not market value).

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This cost of the fixed assets will be depreciated overthe working life of the assets.

Depreciation allocates the cost over the working life; itdoes not attempt to value the assets at their resalevalue.

The market value of all fixed assets is too difficult andcomplicated to calculate at every accounting date and istherefore not normally used in accounting.

ACCOUNTING

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ACCOUNTING

CASE:1- GLADSTONE BAG COMPANY

Old established company has a policy of payingall suppliers before time and never borrowinganything from anyone.

Management is convinced that this is the wayto do business and good financial management.

Do you agree?

ACCOUNTING

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ACCOUNTING

CASE 1 ANSWER

Paying suppliers before time is never justified. Payearly to get discount. Otherwise don't pay untilrequired to pay.

Company probably has excessive equity.

Failure to use equity and debt. Is not goodfinancial management.

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LEARNING PATTERNS

LANGUAGE

R & P = IASUNCERTAINTY

CONSERVATISM

C & C

ACCOUNTING PERIOD

COST CONCEPT

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Set 1 HAVE WE MADE A PROFIT

The income statement (or profit and loss account)of a business relates to a specific accountingperiod.

It matches sales against cost of sales andexpenses, to compute a figure of profit for the

accounting period.

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CHAPTER II Accounting ReportsSet 1 HAVE WE MADE A PROFIT


A business owner was interviewing people for a division manager position.He wanted a practical manager who could answer the simple question"How much is 2+2?".

The engineer pulled out his slide rule came up with: "It lies between 3.98and 4.02".

The Mathematician said "In two hours I can demonstrate it equals 4 witha short proof".

The Attorney stated "In the case of Svenson vs. the State, 2+2 was

declared to be 4." The Trader asked "Are you buying or selling?"

The Accountant looked at the business owner, then got out of his chair,went to see if anyone was listening at the door and pulled the curtains.Then he returned to the business owner, leaned across the desk andsaid in a low voice "What would you like it to be, Sir?"

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Set 1 HAVE WE MADE A PROFIT

Profit realised is not the same as cash received.

Sales, less cost of sales and expenses equalsprofit.

Sales equals cost of sales, plus expenses, plusprofit

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CHAPTER II Accounting ReportsSet 1 HAVE WE MADE A

PROFITLEARNING PATTERNSS - C - E = P

ACCOUNTING PERIOD

C + E + P = SALES

CASH v CREDIT

MATCHING - S v C & E

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CHAPTER II Set 2WHAT IS OUR FINANCIAL POSITION?

The balance sheet presents a financial picture of a businessand lists the assets, liabilities and owners equity of thebusiness at a specific date. It is not the same as a incomestatement.

Valuable things owned by a business such as cash,receivables, inventory, prepaid expenses and buildings areassets.

Accounts payable, other payables and mortgage loans areliabilities.

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The owners equity of a business consists of the originalinvestment (capital stock) plus the profits earned and

accumulated in the business.

Assets are generally recorded at cost or lower and not attheir market or resale prices.

Assets less liabilities equal owners equity or net worth.Assets equal liabilities plus owner's equity.

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The company owner is dying and calls in his lawyer and his accountant.The owner says "I am dying and I want take my money with me. At myfuneral please put these envelopes in my grave". So at the funeral,the lawyer and the accountant put the envelopes in the grave.

In the car on the way home the lawyer felt bad and tells the accountantthat he had opened the envelope, found one hundred thousand in cashand took fifty thousand out, as his justifiable fee, but he now he feltbad about it.

The accountant responded "How could you have disregarded a dying man's

last request with a fee of 50%? You should be ashamed of yourself, Ileft my personal check for the full amount.

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Financial health can be easily determined with the LAPPsystem which compares key ratios against budget andindustry averages, for:

Liquidity & Gearing -measured by: quick ratio,current ratio, equity: debt ratio.

Activity - measured by: sales/assets,, cost of goodssold/ Inventory, days of payables, days ofreceivables.

Profitability - measured by: gross profit/sales, netincome/sales, net income/owners equity.

Potential - in terms of: sales orders, products,

markets, facilities, finance, contingencies,mana ement etc.

CHAPTER IISet 2

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Case 3: WILLIAMS BANK

Client with large loan sends monthly reports to its bank

six to eight weeks late because "the auditors are in.and no information is available for two months".

Reasonable?

CHAPTER II Set 2

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CHAPTER II Set 2WHAT IS OUR FINANCIAL

POSITION?

Case 3 Answer:

Do not accept that the auditors are responsible; insistupon regular timely reports.

The poor hardworking honest auditors are so oftenused as an excuse to expedite payment or delayinformation on poor financial results.

Don't blame then ... please but ... if the business goesbankrupt ... sue them!

CH PTER 2

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CHAPTER II Set 2WHAT IS OUR FINANCIAL

POSITION?LEARNING PATTERNS

A = L + OECA & FA & OA

CURRENT = ONE YEAR

CA = C + AR + I + PPFA = COST - AD

CL & LTLOE = CS (SC) +AP (RE)

SHARES - O or PCA CL = WC

L A P P

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CHAPTER II Set 3BUSINESS TRANSACTIONS

Transactions may be for cash or for credit. In a credittransaction, a liability is incurred but cash istransferred later as a separate transaction.

All transactions have a dual aspect and thereby affecttwo items on a balance sheet.

Accounting conventions recognise transactions atparticular times.

For example, sales transactions are generally recognisedwhen the goods leave the sellers premises, whereaspurchase transactions are normally recognised whenthe goods are received by the buyer.

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Case 4: LATE CHRISTOPHER COMPANY

Company owned by its executives seeks a small loan fromthe bank.

Bank insists that in addition to normal company security.each executive should sign an unlimited indefinite personal"joint and several guarantee" to me bank for the loan. Isthis reasonable?

Should they agree?

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Case 4 Answers:

Normal for banks to require personal guarantees when they lend money tocompanies owned by their own executives.

However, ensure that the guarantees are for specific limited amounts overspecific time periods.

Avoid unlimited indefinite guarantees.

NOTE : To avoid total loss of all personal assets to aguarantee one unlimited guarantor gave everything he

owned to his wife but then she left him and ran off withthe chief salesman so I guess you have to be careful withguarantees

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LEARNING PATTERNS

DUAL EFFECT OF T

CASH - IN/OUT NOW

CREDIT RECEIVABLES (DEBTORS) NOWOR

PAYABLES (CREDITORS) NOW

AND CASH IN/OUT LATER

CHAPTER III S t 4

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CHAPTER III Set 4THE BALANCE SHEET -

ASSETS Valuable things owned by a business that have ameasurable cost are assets. Assets are normallyclassified as: fixed, current or other.

Fixed assets are acquired for long-term use andfor physical use in the business. They appear in thebalance sheet at cost less depreciation. This is notthe re-sale value of the assets.

Fixed assets are treated as long-term costs, andthe cost allocated by depreciation over the workinglife of the fixed assets.

Land, buildings, plant, machinery, equipment,furniture and fixtures etc. acquired for use (NOT

RE-SALE) are normally treated as fixed assets.

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CHAPTER III Set 4

THE BALANCE SHEET - ASSETSUNFORGETTABLE STORY TO ANCHOR THE LEARNING

An accountant was walking on the countryside when

he found a shepherd who had a lot of sheep.

Accountant to the shepherd: Listen, these sheepare your ASSETS !. I can calculate how many

sheep you have". Remember the story ?

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CHAPTER III Set 4THE BALANCE SHEET - ASSETS

Valuable things owned by a business that have a measurablecost are assets. Assets are normally classified as: fixed,current or other.

Fixed assets are acquired for long-term use and for

physical use in the business.

They appear in the balance sheet at cost less depreciation.This is not the re-sale value of the assets.

Fixed assets are treated as long-term costs, and the costallocated by depreciation over the working life of the fixedassets.

Land, buildings, plant, machinery, equipment, furniture andfixtures etc. acquired for use(NOT RE-SALE) are normally

treated as fixed assets.

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Current assets consist of cash, or assets to be convertedinto cash, or to be used up in the operating process duringthe normal operating cycle of the business.

This normal operating cycle is generally one year.

Cash, marketable investments, inventory, prepaid expensesetc. are current assets.

Inventory is valued at the lower of cost or market value and

notits re-sale price.

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Other assets include patents, trade investments, goodwilletc. which do not come within the above definitions.

Goodwill is only recorded to the extent that it has beenactually purchased for cash or shares.

Patents are amortised over their working life.

Trade investments are recorded at cost not re-sale value.

Assets are sometimes classified as tangible or intangible.

Literally tangible means able to be physically touched.

Current and fixed assets are normally tangible whereas otherassets are normally, but not always, intangible.

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Case 5: Gillie Golf

Bank requires company to submit financial forecasts tojustify application for substantial bank loans.

Company insists that the position is so uncertain thatforecasts would not be useful.

What to do?

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Case 5 Answers:

Forecasts are especially necessary when the financialposition is so uncertain.

Suggest alternative forecasts of high, low andprobable estimates, so as to give some idea of therange of risk.

Financial forecasts are always useful as part offinancial decision-making.

But they are no substitute for good business intuition ...

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CHAPTER III Set 4

THE BALANCE SHEET - ASSETSLEARNING PATTERNS

A = L + OECA & FA & OA

CURRENT = ONE YEAROA + G + P + R&D

FA = COST AD

FA L + B + E

QA = C + R + MICA = C + R + I + PP + MI

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CHAPTER III Set 5 - LIABILITIES


An accountant appears at Saint Peter's gate. SaintPeter starts asking him all the usual questions

required to get into heaven.

Remember the story ?

CHAPTER III Set 5 -

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LIABILITIES

Liabilities are claims by creditors against theassets of a business. They are not owners claims.

Secured creditors, such as for mortgage loans,have a prior claim to a specific asset or even aprior claim to all of the assets.

Current liabilities are due for payment within oneyear whereas long-term liabilities are not due forpayment within one year.

Deferred income tax is calculated on the profit ofthe current year, but is not due for payment untila future date.

Income tax currently payable, however, is normally

shown as a current liability.

CHAPTER III Set 5

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CHAPTER III Set 5 -LIABILITIES

The working capital of a business is the currentassets less current liabilities.

The working capital ratio or current ratiorelates these two classifications, and indicates thecash position of the business over one year

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CHAPTER III Set 5 -

LIABILITIES Case 6: Melville Holdings:

Management insists that to achieve increased sales,the inventory and receivables must increasesubstantially.

What can be done to manage inventory and

receivables?

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CHAPTER III Set 5 - LIABILITIES Case 6 Answers:

Rapidly increasing sales will probably require inventoryexpansion ahead of the sales. They almost always

increase ... inventory and receivables and thus workingcapital ...

Managing the inventory investment by: operationsresearch, better purchasing, getting suppliers to holdinventory until required with JIT etc.

Manage receivables by: credit control, customerselection, factoring, credit terms, quicker billing,expediting, customer research, settling claims quickly,getting deposits etc.

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CHAPTER III Set 5 -

LIABILITIESLEARNING PATTERNS

CREDIT NOT CASH PAYABLES (CREDITORS)

CL = AP + AE + BANK + IT

QL = AP + AE

ACCRUALS INCOME TAXCL ONE YEAR

LTL ONE YEAR PLUS

MORTGAGE LTLSECURED v UNSECURED

CHAPTER III Set 6 OWNERS

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CHAPTER III Set 6 - OWNER SEQUITY

Assets less liabilities of a company equal theowners equity of the company.

This equity represents the original investment of

the stockholders plus any profits of the businessthat have been left to accumulate in the businessand not paid back to stockholders.

Authorized capital stock is the shares availablefor sale by the company. When issued (sold) the

shares become issued capital stock.

CHAPTER III Set 6 - OWNERS

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A doctor is explaining to her patient thatthe patient only has six months to live.

The patient responds: "But doctor isn'tthere anything I can do?"

Remember the story ?


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The nominal value of shares is the face value.

If sold for more than the face value, thedifference represents a share premium.

This share premium is not a profit but a capitalreserve and cannot normally be paid back tostockholders as dividend.


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Shares may be of various kinds.

Preference shares entitle the holder to a fixed percentageof the nominal value of the shares, as a dividend each year.

Such dividends may be cumulative or non-cumulative.

Ordinary shares do not entitle the holder to receive a fixeddividend but merely to dividends from the profits afterpreference dividends have been paid.


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Retained earnings may sometimes be set aside as a generalreserve in the business and not used for dividends.

However both retained earnings and general reserve can bemade available for dividends if the directors of a company orthe stockholders so decide.

All profits and reserves available for dividend may be calledRevenue Reserves.

Capital stock, capital reserve and revenue reserves make upthe owners equity or stockholders claims against the assets of

a company.

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CHAPTER III Set 6 - OWNERS EQUITY

Case 7: ELIZA COMPANY

The next year draft financial budget forecast

indicates a doubling of sales but a stable inventoryand stable receivables, and a gross profitincreasing from 32 to 35%.

Is this a reasonable expectation Why?

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CHAPTER III Set 6 - OWNERS EQUITY

Case 7 Answers:

a. The underlying assumptions do not seem to be consistentwith "normal" financial expectations. When you doublesales in one year, you normally need the support of a

higher inventory investment. Has this already been made?Can the unchanged inventory levels be justified by specialstudies?

b. Similarly receivable levels would be higher unless sales aremainly for cash. With a competitive market, it would seemthat doubling sales and increasing the gross profit increaseby 3% would be difficult

c. Overall: the budget seems to be over-optimistic; check itout with the industry averages to see if other companies areachieving similar results?

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CHAPTER III Set 6 - OWNERSEQUITY

LEARNING PATTERNS

A = L + OE

CA & FA & OACURRENT = ONE YEARCA = C + AR + I + PP

FA = COST - AD CL & LTLOE = CS (SC) +AP (RE)

SHARES - O or P

CA CL = WC

CHAPTER III S t 6 OWNERS

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CHAPTER III Set 6 - OWNERSEQUITY


The new chief accountant of a very successful oldmajor departmental store with good reliable annualprofit record (NP/OE of over 20%), discoveredthat the company land downtown in the city, wasvalued in the balance sheet at cost in 1846.

Remember what happened to him?

CHAPTER IV THE INCOMESTATEMENT (P & L)

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STATEMENT (P & L)

Set 7 - ACCOUNTING PERIODS

In the income statement we match sales, costs andexpenses for a specific period of time and compute the netincome of a business for the accounting period.

At the beginning and end of each accounting period wenormally prepare a balance sheet to show the financialpicture of the business at each date.

The changes in these two financial pictures are explained inthe income statement.

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CHAPTER IV Set 7 - ACCOUNTINGPERIOD

Profits increasethe owners equity of a business whereas lossesreducethe owners equity.

Owners equity is the difference between assets and liabilities.

Thus any increase or decrease in owners equity is reflected in allor any of the assets and liabilities and not just in the cash balance.

The income statement and balance sheet both reflect accruals ofprofits and losses whether or not they have actually been realisedin cash.

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Case 8: ZONDI COMPANY

Company's profit is low this year and management

seeks to manipulate it higher to avoid complaintsfrom the shareholders.

What methods could the company consider whichare in accordance with accepted accounting

principles? (seven methods)

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Case 8 Answers:

To be "creative" (manipulate) for a higher profit:

a. Make high (less conservative) inventory values.b. Capitalise heavy maintenance as a fixed or deferred

asset.c. Depreciate fixed assets over longer "horizons"

(working lives) certified by engineers.d. Defer advertising, R & D and other expenses.e. Keep accruals and reserves to the minimum.f. Release reserves into profits and ....

g. Charge losses to restructuring reserve or accumulatedprofits.h. Acquire profitable subsidiaries and consolidate.i. Sell fixed assets and investments a profit and take

it in the income statement.

Note: But don't do it ... unless you REALLY have to ...

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LEARNING PATTERNS

MATCHING S & C & E FOR AN AP

BS OPENING BS CLOSING

IS & RE TO CONNECT TWO BS

UNCERTAINTY AT END OF AP USE IAS!!

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CHAPTER IV Set 8SALES AND GROSS PROFIT

The income statement is sometimes divided into two parts:computation of gross profit (in the Trading Account) andthe computation of net income.

The trading account matches sales and cost of goods

actually sold, to compute gross profit. Cost of goods soldis not the same as total goods purchased, since some goodsmay be left in inventory.

Gross profit does not take into account the overheadexpenses of the business.

Cost of sales, equals opening inventory plus purchases, lessclosing inventory.

Sales less cost of sales equals gross profit. A gross profitpercentage of 31% means that for every 100 of sales wemake a gross profit of 31. Thus the goods we sold actuallycost us 69.

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Gross profit does not take into account theoverhead expenses of the business.

Cost of sales, equals opening inventory plus

purchases, less closing inventory. Sales less cost of sales equals gross profit. A

gross profit percentage of 31% means that forevery 100 of sales we make a gross profit of 31.Thus the goods we sold actually cost us 69.

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Case 9: HOLMES WATSON COMPANY

Profit will be well over budget and company wishes toreduce the profit disclosed this year, so as to keep "alittle in hand for the future".

Chief Executive suggests acquiring another company,which is losing money, and then consolidating the figures.Is this acceptable?

What alternatives available?

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Case 9 Answers:

"Creativity" of the profit this year could be achieved byacquiring a loss company; but other methods may be less risky:

a. Reduce the inventory value by being more conservative.

b. Set up reserves and accruals for every conceivable loss.

c. Postpone the sale of a fixed asset (at a profit) or sellit sooner (if it makes a loss).

d. Charge all losses to income statement and not to reserve.

continuing

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continuing

e. Expense small fixed assets (and even larger ones).

f. Reduce the working life (horizon) of fixed assets so as

to increase the annual depreciation

g. Write to the lawyer to find out about possible legalliabilities for damages or claims; accrue for them inthe books.

h. Write down the value of investments or any assets which are

overvalued and charge the loss against profits.

Note: But don't tell anyone ... if asked ... call it "being realistic"!

CHAPTER IV Set 8

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SALES AND GROSS PROFIT

LEARNING PATTERNS

S C E = P

S COS = GP

OI + P - CI = COS = CGS

S SD SR = NET S

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E 9NET INCOME

The net income of a business is the final profitafter matching and deducting all relevant costsand expenses for the accounting period.

Gross profit less operating expenses (selling,administrative and general) equals the operatingprofit which is the profit from the normalbusiness operations of the period.

Operating profit less non-operating expensessuch as interest, loss on disposal of fixedassets etc, equals profit before taxes. Thisincludes both normal and abnormal profits of

the period.

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NET INCOME

Profits before taxes, less the reserve for future incometax (based on the profit) equals net income.

A net income percentage of 4% on sales means that onevery 100 of sales the business makes a net income of 4

during the accounting period.

A net income percentage of 8% on owners equity, meansthat in the accounting period, there is a net income of 8on every 100 of owners equity.

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NET INCOME

Case 10: OUALO COMPANY

Due to sale of an investment, the company sufferedmajor loss this year, which will upset shareholders

and cause the share price to fall.

No capital reserve available but company buildingsare undervalued.

What can be done to avoid showing a loss thisyear? (seven alternatives)

CHAPTER IV Set 9

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NET INCOME

Case 10 Answers:

Try to sell another asset at a profit, or revaluethe buildings in the books and credit the differencein value to capital reserve; then charge the loss onthe sale of the investment to capital reservethereby not reducing the profit of the year.

Make a note in the financial statements to indicatethe charge to reserve and explain fully that it

"avoids distorting the figures for the year".

Add some paragraphs and pictures in the AnnualReport of the company on the critical need formore and more "transparency" in businessreporting ...

CHAPTER IV S t 10

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CHAPTER IV Set 10STATEMENT OF RETAINED EARNINGS

Profits of a business increase the owners equity. Theyincrease the account Retained earnings.

Dividends paid to stockholders reduce the owners equity andthe account Retained earnings.

The balance of retained earnings (accumulated profit)represents profit earned but left in the business and not paidto stockholders.

Losses reduce the amount of retained earnings.

If losses and dividends exceed the profits, the balance ofretained earnings becomes a deficit which reduces ownersequity.

The statement of retained earnings is sometimes called theprofit and loss Appropriation account.

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Case 11 PROFELD COMPANY

Company needs more credit from suppliers toprovide substantial financing.

Requests guidelines as to how creditors may be"stretched" (seven ideas).

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Case 11 Answers:

1. Pay each supplier a little regularly and keep himhappy with extra orders" promise.

2. Insist that as an old and loyal customer. suppliermust give better credit terms.

3. Tell supplier that his competitors are offeringlonger credit terms.

4. Place large orders on condition that extra creditterms are granted.

Contimnuing

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CHAPTER IV Set 10STATEMENT OF RETAINED

EARNINGSContinuing

5. Ask supplier to supply copy invoices and thus delaypayment.

6. Query the prices and amounts thus delay payment.

7. Take unreasonable discounts and take time negotiating soas to complicate the account thereby making difficult toexpedite.

8. Pay the wrong amount on invoices and statementsthereby confusing the supplier accounting system.

9. Use peanut disputes to delay paying for coconuts

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LEARNING PATTERNSACCUMULATED PROFITS

AP = ONE YEARUNCERTAINTY

S CGS = GPCGS = OI + P CI = COS

INVENTORY C or lower MVGP OE = OP

OE = S & A & G expenseOP NOE = PBTPBT IT = NP (NI)

RE: OB + NP DIVI. = CB

CHAPTER V Set 11THE PACKAGE OF ACCOUNTING

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THE PACKAGE OF ACCOUNTINGREPORTS

In the package of accounting reports the balancesheets present a true and fair view of thefinancial position of a business at the beginning andend of the accounting period.

The income statement presents a true and fairview of the results of operations during theaccounting period.

The balance sheets do not reflect the re-sale or

break up value or actual worth of a business.

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REPORTS

They reflect the cost, or cost less depreciation, ofthe assets held by the business as a going concern.

Balance sheets at the beginning and end of theaccounting period are related by the statement ofretained earnings.

The statement shows how much of the profitearned was distributed to stockholders and howmuch was left to accumulate in the business.

CHAPTER V Set 11

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Accounting reports, based upon accounting principles andconventions, try to present a true and fair view of abusiness despite the problem of uncertainty and theproblem of transactions which are incomplete at the end ofthe accounting period.

The figures depend very largely upon the judgement of theaccountant.

Many alternative balance sheet presentations (withimportant notes attached) may be used to display the same

basic balance sheet data.

CHAPTER V Set 11

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When the CEO is going to make a big loss this yearwhat should he do to survive?

Remember the story what can he do ?


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K FREPORTS

Determine the financial health of a company, with theLAPP system of financial analysis.

In LAPP, compare key ratios against industry averagesand budget, as follows:

Liquidity & Gearing -

Quick ratio (1.5 to 1) - QA:QL

Current ratio (2 to1) - CA:CL

E:D ratio (2 to1) - E:D.


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REPORTS

Activity:

Sales/assets

Cost of goods sold/inventory

Days of payables:Payables/purchases X 365 days

Days of receivables:Receivables/sales X 365 days


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REPORTS

Profitability:

Gross profit/sales X 100%

Net profit/sales X 100%

Net profit/owners equity X 100%.


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REPORTS

Potential:

Sales orders Products Markets Facilities Finance Contingent liabilities. lawsuits etc Management etc.


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REPORTS


A balloonist lands in a random field and asks a manout walking his dog "Where am I?"

The man replies "You are three feet in front of mein the middle of a field

"You must be an accountant!" retorts the balloonist


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REPORTS

"How did you know that?" the man asksincredulously.

Reply: "Easy. What you just told me is 100%accurate but absolutely useless!"

Accountant replied: "So you must be a Manager."

The balloonist is amazed and says "That's

absolutely right! How ever could you tell?"


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REPORTS

Accountant then adopted a gentle professional smileand tone saying:

"Because you don't know where you are, you don'tknow where you are going, and you are exactlywhere you were 10 minutes ago, but somehow youblame me

And now, you even pretend that it is all myfault!"


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Case 12: POTTER PRODUCTION

Financial director insists that he needs Euro500,000 loan from the bank for working capital.

What seven alternatives could be investigated?


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Case 12 Answers:

Seven alternatives to a bank loan are as follows:

1. Reduce investment in inventory. receivables and cash.2. Stretch the suppliers.3. Factor receivables.4. Get suppliers to hold the inventory and deliver and

invoice as required.5. Lease rather than buy fixed assets.

6. Get long term loan or mortgage.7. Expedite receivables with better credit policies,

discounts and credit control. Reduce cash reserves.Get customer deposits.

...ANCHOR THE LEARNING ... IN YOUR

MIND FOR EVER HOORAY!!!

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MIND FOR EVER ... HOORAY!!! A STANDARD AUDITORS REPORT

We have examined the accompanying balance sheet of ABC and itssubsidiaries as of December 31, 2004, and the related income andcash flow statements for the year then ended.

We conducted our audit in accordance with International Standards ofAuditing. These require that we plan and perform the audit to obtainreasonable assurance about whether the financial statements are free

of material misstatements. As audit includes examining on a test basis,evidence supporting the amounts and disclosures in the financialstatements. An audit also includes assessing the accounting principlesused and significant estimates made by management, as well asevaluating the overall financial statement presentation. We believethat our audit provides a reasonable basis for our opinion.

In our opinion the financial statements fairly present in all materialrespects, the financial position of the ABC Group as of December 31,2004, and of the results of its operations and is cash flows for theyear then ended in accordance with International AccountingStandards.

Signed XXX & YYY Chartered and Certified Accountants, February 15, 2005


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LEARNING PATTERNS

GAAP & IAS (M) = CREATIVITY

BS DATE

IS PERIOD

L A P PLIQUIDITY & GEARING

QA:QL & CA:CL & E:D

ACTIVITY

S/A & CGS/I & DAYS OF R & P

PROFITABILITY

GP/S & NP/S & NP/OE

POTENTIAL- ORDERS, MARKETS, PRODUCTS, FINANCE,

MANAGEMENT, CONTINGENCIES


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LANGUAGE & PRACTICELearn to Communicate with Accounting Staff

Materials covered in the lecture/casesection.

Chapter 1 Introduction to Accounting


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Set 1 Have we made a profit?

Set 2 What is our financial position?

Set 3 Business transactions


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CHAPTER III The Balance Sheet

Set 4 Assets

Set 5 Liabilities

Set 6 Owners equity

CLE 21 A ONE DAY PROGRAM IN

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ACCOUNTING LANGUAGE & PRACTICELearn to Communicate with Accounting Staff

CHAPTER IV The Income statement

Set 7 Accounting Periods

Set 8 Sales and gross profit

Set 9 Net income

Set 10 Statement of retained earnings

CHAPTER V The Package of Accounting Reports


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END OF LECTURE/CASE SESSION

CHECK AGAIN ON EACH CASE STUDY AND BE SURE

TO DEVELOP YOUR OWN PERSONAL

INSTINCTIVE ACCOUNTING REACTIONS

WHICH WILL SERVE YOU WELL IN THE FUTURE.

AND ABOVE ALL LEARN TO COMMUNICATE

AND GET THE BEST OUT OF YOUR ACCOUNTING STAFF!

GOOD LUCK!

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