Book 1: Introduction To Accounting

B124
Book 1
Introduction to accounting
Written by Jonathan Winship
Fundamentals of accounting
This publication forms part of the Open University module B124 Fundamentals of accounting. Details of this and other
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1.1
Contents
Introduction to B124 5
Introduction to Book 1 8
Learning outcomes 9
Chapter 1 The purpose of accounting 10
1.1 Bookkeeping and accounting 10
1.2 The development of double-entry accounting 16
1.3 The three main functions of accounting 18
1.4 Financial and management accounting 21
Answers to activities 24
Summary 27
Chapter 2 Accounting transactions and cycles 28
Introduction 28
2.1 Manual and computerised accounting information systems 28
2.2 Source documents in accounting 29
2.3 Transaction cycles for cash and credit transactions 33
2.4 The accounting cycle 33
Summary 36
Chapter 3 The skills, knowledge and ethics required for
accounting 37
Introduction 37
3.1 The role of the accountant in business 37
3.2 Professional accounting skills and knowledge 38
3.3 The fundamental ethical principles of professional accounting 42
Summary 49
Chapter 4 Essential numerical skills for accounting 50
Introduction 50
4.1 Use of BODMAS and brackets 51
4.2 Use of calculator memory 52
4.3 Rounding 53
4.4 Fractions 54
4.5 Ratios 55
4.6 Percentages 56
4.7 Negative numbers and the use of brackets 57
4.8 The test of reasonableness 59
4.9 Table of equivalencies 60
4.10 Manipulation of equations and formulae 61
Summary 67
Chapter 5 Essential spreadsheet skills for accounting 68
Introduction 68
5.1 What is a spreadsheet? 67
5.2 What are the typical features of worksheets within a
spreadsheet? 67
5.3 How can spreadsheet skills be developed? 68
5.4 What are the limitations of using spreadsheets? 68
5.5 How has the use of spreadsheets evolved in accounting over
the past 40 years? 69
Summary 70
Book summary 71
Self-assessed questions 72
Solution to self-assessed questions 73
References 76
Acknowledgments 77
Introduction to B124
Welcome to B124 Fundamentals of accounting. Proper accounting is crucial
for the prosperity and even survival of every organisation. Our complex
economic system depends on accurate, trustworthy and relevant financial
records and reports. While this module focuses on the accounting required
for a sole trader, the skills and knowledge you will learn are of central
importance for accounting in any organisation, whether for-profit, not-for-
profit or governmental.
There are two main reasons why B124 concentrates on the accounting
needed for sole traders:
. Sole traders or sole proprietorships still comprise the majority of for-

profit businesses in the UK (White, 2012, p. 2).
. The accounting required for sole traders tends to be more
straightforward than other enterprises and thus are a better starting point
for accounting students.
An essential skill of accounting, and one that is covered in detail in B124,
is double-entry bookkeeping. The well-known quote from German writer
and scientist Goethe is as apt today as it was over 200 years ago:
What advantages are conferred on the trader by double-entry

bookkeeping! It is one of the finest inventions of the human spirit, and
every good manager should introduce it in his administration.
(Goethe, 1795/1977, p. 40)
Many students on B124 will be studying the module as a first year option in
a degree in business management. This module is particularly useful for
management students because it deals at length with preparing financial
reports, as well as all the different types of underlying records that fit
together to form the double-entry accounting system. As Goethe understood,
such a system is essential for the management of any organisation.
Management students will also benefit from other accounting material in
B124 that focuses on effective financial planning, control and decision-
making in any organisation.
5
Book 1: Introduction to accounting
The aim of B124 is to give you a clear and well-structured guide over eight
units to the fundamentals of accounting. Each unit will include printed
study material in the related book and online study material in the relevant
session on the B124 website.
Unit 1: Introduction to accounting will explain the purpose and principal
functions of double-entry bookkeeping and accounting. It will introduce the
importance of accounting information systems, both manual and
computerised, for sound record keeping. Without such record keeping, no
organisation can fulfil its legal and social obligations and make informed
financial decisions. Unit 1 will also cover the skills, knowledge and ethics
required of professional accountants in today’s world. A crucial expectation
of accountants in such an environment is that they have good skills in
numeracy and spreadsheets. The final two sections of this book will thus
focus on developing your skills in these two key areas.
Unit 2: Essentials of double-entry bookkeeping will introduce the key
principles of the double-entry system based on the accounting equation. It
will show how the two main financial statements: the balance sheet and
the income statement, are produced from individual, separate accounts
maintained by the enterprise.
Unit 3: Accrual accounting explored will look at the way these accounts are
used to record a wide range of transactions. This unit will also explain in
detail how the double-entry system is the basis of accrual accounting
which gives much more useful information than the more straightforward
cash accounting. Without accrual accounting, no organisation is able to
properly understand and report its financial performance or position.
Unit 4: Control over the ledgers examines the records kept by accountants
that underpin the accounts. Such records are known as books of original
entry. An important aspect of this unit is to explain how accounts are
monitored, controlled and corrected by means of bank reconciliations.
Unit 5: Preparing financial statements will develop your knowledge of the
end-of-period adjustments introduced in Units 2–4 and which are needed
for accrual accounting. By the end of the unit you should be able to prepare
a detailed income statement and a balance sheet for a sole trader. You will
be tested on your ability to do this in both your third tutor-marked
assignment (TMA 03) and your exam. Unit 5 will also explain how useful
accounting information can be derived from incomplete records and how to
prepare simple manufacturing accounts.
Unit 6: Essentials of cost and management accounting will explain how the
double-entry system can be used for management accounting as well as
financial accounting purposes. The unit will also introduce the basic
concepts and principles of cost and management accounting that are needed
to properly run any organisation. A feature of this unit will be an
explanation of the difference between a manual and a computerised
accounting system.
Unit 7: Management accounting applications will consider some basic
management applications, applying the concepts and principles of
management accounting introduced in Unit 6. The unit includes case studies
of businesses, demonstrating how management accounting information and
6
analysis can assist managers in improving the performance of an

organisation.
The final unit, Unit 8: Exam preparation workbook, contains material that
will not be assessed. The purpose of Unit 8 is to help you revise the module
content and to prepare you for the examination.
7
Introduction to Book 1
This first book of B124 will help you understand the role of accounting and
the diverse skills required of accountants. It will explain how double-entry
accounting evolved to answer four fundamental financial questions:
. What are the resources of the enterprise?

. What are the claims of the owners, credit suppliers and lenders of these
resources?
. How much profit or loss did the enterprise make?
. How did the enterprise obtain and use its cash?
All users of financial information, both inside and outside the organisation,
want the answers to these questions because they give fundamental
information about the financial performance and position of the enterprise.
This book will explain the key differences between financial accounting,
which is targeted at those outside the business, and management accounting,
which focuses on the financial information that managers need to make
effective decisions.
Book 1 will also explain the importance of keeping proper financial records
in order to manage transaction and accounting cycles effectively.
Accountants have a responsibility to keep accurate financial records and to
produce financial statements that are timely, but also relevant and reliable.
This book will look in detail at the skills, knowledge and ethics required to
be a professional accountant. Finally, it will help students to understand the
importance of having both numerical and spreadsheet skills. You will be
given a number of activities to help develop these vital skills.
Book 1 consists of five chapters

Chapter 1 explains the purpose of bookkeeping and accounting and
how double-entry accounting evolved to meet the financial information
needs of a wide range of users.
Chapter 2 covers the importance of record keeping and other control

measures to ensure that transaction and accounting cycles are
managed effectively.
Chapter 3 deals with the skills, knowledge and ethics required for an
effective and responsible accountant.
Chapter 4 illustrates the importance of numerical skills for both financial

and management accounting and provides a number of activities to
improve these skills.
Chapter 5 focuses on the importance of spreadsheets in presenting,

manipulating and analysing financial information. You will be given a
8
Introduction to Book 1
number of simple spreadsheet activities to improve your spreadsheet

skills.
Learning outcomes
After studying Book 1 you should be able to:
. understand and explain the purpose and role of accounting within

business management
. understand and explain the three main functions of accounting
. understand and describe the main source documents and data sources
used for identifying and recording financial transactions
. understand and explain the nature of the transaction cycle and the
accounting cycle in the context of financial record keeping
. understand the skills, knowledge and ethics required for accounting
. apply the essential numerical skills for financial and management
accounting
. use spreadsheets to present and manipulate financial information.
9
Chapter 1 The purpose of

accounting
Introduction
By the end of this chapter you should be able to:
. understand and explain the purpose and role of bookkeeping and

accounting
. explain the difference between profit and cash flow
. understand the main functions of a double-entry accounting system
. describe and analyse the difference between financial and management
accounting.
In this chapter you will learn about the central purpose of accounting: to
use the double-entry accounting system to communicate relevant and
reliable financial information to a wide range of users.
1.1 Bookkeeping and accounting
An economic event is Bookkeeping is the process of identifying and recording transactions and
any change in value of other economic events affecting an enterprise in a systematic way. From
an economic resource or ancient times, rulers, investors and owners of enterprises have needed to
the transfer of control of
rely on financial records kept by bookkeepers. Such records have little value
such a resource from one
party to another. unless they are accurate and trustworthy.
Accounting is broader than bookkeeping and refers to the process of
classifying, interpreting, summarising and reporting on transactions and
other economic events. This is done in order to generate useful information
from the many different types of purchases and sales that are individually
recorded by bookkeepers.
An example of useful information is a daily sales report for a particular
product in order to determine if an advertising campaign has made any
difference to sales. By producing such a report, the raw material or sales
transaction data recorded by the bookkeeper is organised into a meaningful
form that will help the accountant or other user to decide if sales for the
relevant period has changed as a result of the advertising.
The responsibility of accountants is to prepare reports that contain useful
information for a range of decision makers and stakeholders inside and
outside the business.
1.1.1 The characteristics of good quality information

There are four key characteristics which make information useful to users
(Bentley, 1998):
10
Chapter 1 The purpose of accounting
. Relevance – Information is relevant if it helps users make decisions.

(Relevance also implies timeliness: information must be available when
a decision needs to be made.)
. Reliability – Information is reliable if it is free from material error and
bias.
. Comparability – Accounting information must be comparable with
similar information produced by similar organisations and with
information produced by the same organisation for different time
periods.
. Understandability – Information should be expressed as clearly as
possible, and in a form that the anticipated users can understand.
The International Accounting Standards Board (IASB) has developed a
conceptual framework for financial reporting that sets out the concepts that
underlie the preparation and presentation of financial statements for external
users (IASB, 2010).
Box 1.1 The IASB and the international accounting

rules
The International Accounting Standards Board (IASB) is an
independent, private-sector body that develops and approves
International Financial Reporting Standards (IFRSs). IFRSs are,
essentially, the rules that govern modern accounting. Most countries in
the world are increasingly using IFRSs.
In its conceptual framework the IASB identifies two fundamental

characteristics that underlie useful financial information. The first is
‘relevance’ and the second is ‘faithful representation’. Relevance is defined
as having ‘predictive or confirmatory value’ (IASB, 2010, p. 18) and
faithful representation is defined as ‘complete, neutral and free from error’
(IASB, 2010, p. 19). While the IASB regards these as the two fundamental
or ‘qualitative characteristics’ of useful information, it asserts that such
usefulness is ‘enhanced if it is comparable, verifiable, timely and
understandable’(IASB, 2010, p. 17).
The qualities of ‘useful information’ referred to above are sometimes
explained in different ways. Three qualities that have not been referred to
yet but which are also widely regarded as useful are that:
. the benefit of any information does not exceed the cost

. information should be easy to use and understand
. any information meets user needs.
Although no list of the qualities of useful information can ever be
exhaustive, the following activity should help you to understand eight
qualities of useful information that you should know.
11
Activity 1.1 The qualities of useful information

Spend approximately 10 minutes on this activity. You will find the answers to all
activities in the books of B124 at the end of each relevant chapter.
In the table below, use an arrow to join each of the qualities of useful
information in the first column with its correct explanation in the second
column.
Eight qualities of useful Which sentence best explains the

information identified quality?
Relevant Information should come from trusted
sources.
Reliable The cost of producing, understanding
and using information should be less
than the benefit generated from its use.
Accurate Users of information have different
needs (e.g. sometimes a summary is
required, not a detailed report).
Up-to-date Information that is capable of or
suitable for comparison.
Benefit exceeds cost Information should not be too long, and
should be clearly presented in an
appropriate form (e.g. email, printed
report, audio-visual presentation).
Meets user needs As far as possible, information should
be free from errors.
Easy to use and understand Information needs to be timely if it is to
be used effectively.
Comparable Information should be what is needed
for effective decision-making.
It is vital that all stakeholders and decision makers in an organisation get

financial information that is useful. Although all eight qualities above are
important, their relative importance depends on the particular situation.
When there is an urgent deadline, for example, it might be more important
for an effective financial report that information is up-to-date rather than
being 100% accurate.
A prime role of accountants is thus to convert all financial transaction data
into useful information. They also have to appropriately estimate, record
and communicate financial events such as depreciation (which will be
explained fully in Book 3). Such an event is not recorded by bookkeepers
as a transaction, but needs to be taken into account to give a complete
answer to four crucial financial questions that will be discussed in the next
section. Only in answering these fundamental questions is the accountant
able to generate reports that meet the varying information needs of different
stakeholders.
12
1.1.2 The four fundamental financial questions

Users of financial information, both inside and outside organisations, want
answers from accountants to the following four fundamental financial
questions:
Question 1: What does an enterprise own, i.e. what are its assets?
Question 2: What does an enterprise owe, i.e. what are its liabilities?
Question 3: How did the enterprise perform, i.e. what is its profit or loss?
Question 4: How did the enterprise obtain and use cash, i.e. what is its cash
flow?
All the assets and liabilities of a business are summarised in a primary
financial report called a balance sheet, also known as the statement of
financial position. Such a report, as well as the underlying accounting
records, give the answers for the first two fundamental accounting questions
above.
In Units 2 and 3 you will learn double-entry bookkeeping, the accounting
system that keeps track of all assets and liabilities in double-entry records
that are used as the basis of the balance sheet. At this stage it is more
important that you develop a good understanding of the difference between
assets and liabilities.
Activity 1.2 Understanding assets and liabilities

Spend approximately 10 minutes on this activity.
In the table below, state whether the following items are assets or liabilities.
Item Asset or liability

Buildings
Overdraft
Receivables
Mortgage
Inventory
Patent
Payables
Machinery
The answer to the third fundamental question: ‘What is its profit or loss?’ is
provided by the income statement, which is the second primary financial
report. This report gives summary totals of all the income and expense
items in a business that have been aggregated from the underlying double-
entry bookkeeper records. (This key aspect of double-entry accounting will
be explained in detail in Units 2–4.) If total income is greater than total
expenses then this positive difference is referred to as a profit. If total
13
income is less than total costs then this negative difference is referred to as
a loss.
An important aspect of double-entry accounting is that income and expenses
are recognised when they occur (and not when cash is paid or received) and
then reported in the financial period to which they relate. Consider a credit
sale that occurs in the annual accounting period ending 31 December 2016
but payment is only received from the customer the following year. Such a
sale is recognised and reported in the accounting period in which it takes
place whether or not cash has been received by the end of the period.
In larger companies, the cash flow of an enterprise (the fourth fundamental
question) is summarised in a cash flow statement which, like the income
statement and balance sheet, is governed by international accounting rules.
Such a report summarises the cash coming in and out of a business
according to a set format. Such a statement is compulsory for larger
companies to publish but is not required for sole traders, the focus of B124.
Box 1.2 What exactly is a sole trader?

A sole trader or sole practitioner is a person who owns a business on
their own. Such a person may use a trading name, i.e. Paula Savraz
trading as Milton Keynes Dog Grooming Services, but their customers
and suppliers are always trading with them as individuals. Because a
sole trader trades on their own, they are personally responsible for any
debts the business incurs. If the business does not generate enough
cash to pay business invoices as they fall due, the sole trader’s
personal assets may have to be used to pay them. Sole traders are the
simplest form of business organisation. Although generally small, they
can grow over time and have a number of employees.
Because this module only deals with all the accounting required for sole
traders, it will not explain the cash flow statement. Instead, you will learn
14
in Unit 4 about the cash book which records all receipts and payments of
money including all changes in the bank balance.
Stop and reflect

What is the difference between the cash made or lost in a period and
the profit or loss in the same period?
The amount of cash any business has made or lost in a period is

simple to calculate. It is merely the difference in cash held at the
beginning and the end of that period. If the cash position is greater at
the end of the period than the beginning, then the business has
generated a positive cash flow. If less, then the result will be a negative
cash flow. The profit or loss made in the same period is all income
earned less all expenses incurred in generating that income. (It is
important to recognise that ‘all income’ and ‘all expenses’ include cash
as well as credit transactions.) If total income is greater than total
expenses in a period, then a profit has been made regardless of
whether a positive or negative cash flow has occurred. If less, a loss
has been suffered irrespective again of whatever may have happened
to the cash position of the enterprise.
It is widely known that profit is the difference between total income and
total expenses in a business. What is less well-known is that the overall
accounting value of a business is the difference between total assets and
total liabilities as recorded in the balance sheet. This overall value is known
as the net assets, net worth or capital of the business.
Capital in accounting is If a sole trader business is large enough it may employ an accountant to
also known as owner’s keep accurate and up-to-date accounting records, of which one would be the
interest or equity. owner’s capital. This capital represents the owner’s investment in a business
and is thus commonly known as owner’s interest. Often a sole trader is not
able to afford an in-house accountant, however, and is only able to keep
incomplete accounting records. In this case, as you will learn in Unit 5, it
needs to employ someone with sufficient accounting skills at the end of
each financial period (usually annually) to use whatever records are
available to produce the balance sheet and the income statement.
In the next section you will learn about the importance of accounting
properly for capital in a business.
1.1.3 Capital in accounting

Every enterprise starts with no money. It needs the owner to put in capital –
their own or borrowed cash – to get the business going. Other assets, such
as inventory (goods) to be sold to customers, are then bought for future
financial benefit.
Businesses need to separate out the money put into the business by the
owner from the liabilities it incurs which need to be repaid. As you have
15
learned, the money ‘owing’ to the owners is known as capital. (More

accurately described as accounting capital, it needs to be distinguished
from economic capital which you will learn about in Unit 6.)
Box 1.3 Accounting records and the business entity

concept
Some businesses, such as sole traders, have no separate legal
existence from the owner or owners. All the debts of the business are
their personal debts and, unlike a limited company, they have
unlimited liability for honouring these debts. In spite of this they must
always keep the accounting records of the business separate from their
own personal affairs. This is known as the business entity concept
and is as relevant to a small sole trader as it is to a multinational
company.
If a business makes a profit, then the capital figure in the balance sheet
increases by the same amount. Should a loss be made, then the capital
figure decreases to the extent of the loss. (The actual mechanics of how a
proft is determined in the income statement, and how the capital figure is
increased in the balance sheet will be explained in Unit 2.)
Income statements and balance sheets report on the past financial
performance and position of an organisation respectively. These reports are
normally required by the tax officials in a country and are thus expected to
follow certain formats and principles. This legal requirement states in the
UK that financial statements, including those submitted for sole traders
'True and fair' means (Income Tax Act, 2007), should be ‘true and fair’ (p. 491). In the USA the
that financial statements equivalent legal requirement is that they should be a ‘faithful presentation’
are accurate, complete of the underlying accounting records.
and not misleading in
any way. The financial reports that accountants produce today are based on a double-
entry system of accounting that was developed by merchants in Italy over
600 years ago.
1.2 The development of double-entry

accounting
Bookkeeping and accounting have been around for thousands of years. The
Romans used simple but effective accounting records to determine taxes due
from their citizens.
Merchants in medieval Italy, however, discovered that they needed to keep
more detailed records than the custom for their time (Gleeson-White, 2012).
As a result of greatly expanding trade, such businessmen often needed to
borrow money in order to purchase goods in faraway countries. It became
crucially important for them not to lose track of the money they owed as it
would be many centuries before western society allowed bankruptcy
16
protection for sole traders and limited liability for companies. Instead, a
system of double-entry accounting came to be widely used by such
merchants from the 14th century. This drastically reduced mistakes in
accounts and allowed businesses of all types to flourish in the years to
come.
Since its first use in Italy in the 14th century, the double-entry system of
accounting has facilitated the extraordinary growth of all types and sizes of
businesses, initially in Venice where merchants pioneered its use, and then,
in time, throughout the world. The speed and global reach of modern
business would not now be possible without computerised double-entry
accounting.
The first person to describe the existing system of Venetian double-entry
accounting was the monk and mathematician, Luca Pacioli (1445-1517)
(Gleeson-White, 2012). In November 1494 Pacioli published The Collected
Knowledge of Arithmetic, Geometry, Proportion and Proportionality.
Although the book only contained a small part on accounting, its effect on
global business marked a revolution and ensured Pacioli’s place in history
as the ‘Father of Accounting’ (Figure 1.1). The rules of double-entry set out
in this book form the basis of double-entry accounting today.
Figure 1.1 Luca Pacioli, the 'Father of accounting'
17
Box 1.4 The unlimited liability of Italian medieval

merchants
The Italian businessmen who first used double-entry accounting were
sole traders or partners, not today’s limited liability companies. This
meant they were personally liable for all debts they incurred. If their
businesses did not have the assets to meet the claims of creditors, the
merchants had to meet such claims from their personal assets. Such a
prospect made it essential for them to develop an accounting system
that was accurate and reliable.
Pacioli’s genius was to understand the whole system of accounting that had
evolved by the 15th century in the northern city states of Italy and to
explain it systematically and clearly. The same essential principles are used
in computerised accounting today.
In the next section you will learn about the financial information that true
and fair accounting provides in order to achieve three main objectives:
stewardship, control and management planning and decision-making.
1.3 The three main functions of

accounting
The users of accounting information may be broadly divided into those who
are internal and those who are external to the organisation. Each user will
have different information requirements. Of the four fundamental financial
questions that accounting exists to answer, different users want different
financial information needs met. The owner of a sole trader, for instance, is
particularly interested in what the business owns and what it owes in order
to know the overall capital of the business and, perhaps, the available
resources, especially cash. By contrast, the government is more interested in
knowing the profit or loss of a business to determine what tax may be due.
The next activity should help you to understand how different users have
different reasons for wanting accounting information.
Activity 1.3 User information needs

Sarah has sole ownership of a business, Olney Glazing Services, that she
leaves to a manager, Peter, to run because she has a full-time job. Peter is
given a fixed salary plus a bonus that is calculated as a percentage of the
profit. The business has three other reliable employees and a small number
of long-standing customers and suppliers.
Peter has managed and developed the business over a number of years and
now has a very good relationship with the business’s customers and
18
suppliers. The customers have come to rely on a three-year guarantee of the

goods they purchase as well as good after-sales service if there are any
problems. The main suppliers currently give the business three months credit
to make any necessary payments.
In the name of the business, Sarah needed to take out a long-term loan in
order to properly fund and establish Olney Glazing Services. This non-
current liability has been recently increased.
. In the table below, state in the second column whether the identified user
of accounting information is internal or external.
. In the third column, the information needs identified have been
deliberately put in the wrong row. Use an arrow to join each user with the
most correct and relevant information need.
User Internal/External Information needs

Owner Information about job security and
prospects, in comparison with conditions in
other organisations
Manager Information about the prospects of the
business remaining a supplier
Employee Information on taxable profit
Bank lender Information to inform their own business
strategies
Suppliers Information to make decisions to improve
profitability and to safeguard the assets of
the business
Customers Information on the financial return of an
investment in order to hold managers to
account
Government Information about the likelihood of being
paid, and future growth/survival prospects
Competitors Information about the capacity of the
business to make repayments and pay
interest on loans
1.3.1 Stewardship
Historically, a steward was an agent or manager who looked after money
and/or resources on behalf of the owner. Part of the steward’s responsibility
was to provide accurate and up-to-date financial information so that the
owner, who was often absent, could have a reliable record of how their
resources were managed. Accountants today use their skills and knowledge
to help managers, such as Peter in Activity 1.3, to keep proper records and
to report on the assets they have been entrusted with.
Peter is accountable for how he has managed the business, and has to face
the consequences of any poor decisions he has made. As most of her own
time is committed to her own full-time job, Sarah is reliant on properly
19
documented evidence, such as accounting records and reports, to confirm

that Peter has properly managed her business as her steward.
Sarah is also like a steward although she is the owner of the business. Her
primary accountability is to the government as a business owner who is
liable for any tax that is due. She is also accountable to the bank lender and
the suppliers in terms of meeting the obligations of the business to them as
creditors. Sarah is acutely aware that she is personally liable for all debts
incurred by Olney Glazing Services because it is just the trading name of a
sole tradership. This is likely to make Sarah very conscious of her
vulnerability if anything adverse happens to the business.
It will thus be in Sarah’s interest to ensure that proper accounting records
and reports are maintained in her business to meet her tax and other legal
obligations and to maximise the future financial prospects of her business.
Sarah needs a properly controlled accounting information system in order to
achieve this. This need to achieve control over accounting records and
reports in order that they are relevant and reliable is the second function of
accounting and will be examined in the next section.
1.3.2 Control
Accountants understand different things by the word control. In Unit 6 you
will learn that one meaning of control refers to the various ways that a
business is managed to ensure that financial plans and targets are achieved.
Control in this context means that if management activities and operations
do not go according to plan then corrective actions are taken if possible.
This is known as management accounting control and its purpose is to
ensure that all operations of the business are efficient and effective.
Control as an overall function of accounting has a different meaning. In this
sense it means that the accounting information system is designed to ensure
that fit-for-purpose accounting records and reports are maintained.
The double-entry system that you will learn about in detail from Units 2-4
evolved to ensure that accountants could exercise proper control over the
underlying records to ensure that the resultant reports were relevant and
reliable.
In Unit 4 you will learn about particular controls to ensure that financial
records are correct. One such accounting control is a bank reconciliation to
ensure that the amount of cash reported on the balance sheet (and the
balance in the cash book or cash account) is the correct amount.
A second accounting control is to have two distinct systems of record
keeping to track all credit suppliers and customers in a business. The one
system involves keeping separate up-to-date, accurate records of the
individual accounts of credit suppliers and customers, while the other
system involves keeping an aggregate record of all the accounts for credit
suppliers and credit customers, each in one combined account.
If, for example, the total of all balances for each individual credit customer
account is different from the summary account that gives an overall balance
for total receivables in the business, then this needs to be investigated
20
because an error has been made somewhere. You will develop a better
understanding of this accounting control when you look at practical
examples in Unit 4.
While accounting information is important for the purposes of stewardship
and control, it is also important to support management planning and
decision-making. This is the third major function of accounting.
1.3.3 Management planning and decision-making

Inside any modern organisation, managers want to exploit the benefits of a
double-entry accounting system to get relevant financial information as
quickly as technology permits. Inefficient use of time leads to increased
costs and delays in delivering useful information. Knowing, at a glance if
possible, accurate up-to-date costs and revenues is crucial to managing
effective and efficient enterprises of any size.
Stop and reflect

Why do modern computer systems help management decision-making?
Today, computers allow all financial and other relevant records to be

accurately and almost instantaneously processed, interrogated and
summarised in order to produce whatever management reports are
needed. Relevant, reliable and real-time information is an extremely
useful resource for effective management decision-making.
An important aspect of management decision-making is making plans for

future business activities and operations. For example, if a business has
evidence that demand for a product is on an upward trend it may plan to
increase production of this good. This will involve careful analysis of the
costs involved as well as the most appropriate selling price. Unit 6 will
look at business and product costs in detail and their relevance for planning
and decision-making.
It is common practice today to make a distinction between the internal
accounting required for improved management control, planning and
decision-making, known as management accounting, and more traditional
financial accounting. This important distinction will be studied in the next
section.
1.4 Financial and management accounting

Financial accounting is principally concerned with preparing financial
statements (income statements, balance sheets, cash flow statements) for
external users such as those providing funds (shareholders, lenders), credit
suppliers, tax authorities and so on.
21
These statements will also be of interest to managers of an organisation, but

they will not be sufficient for managers’ planning, decision-making and
control needs in the day-to-day running of an organisation. For this, much
more detailed and more frequent accounting information is required.
Providing such information and analysis is the function of management
accounting.
This area of accounting covers cost accounting and all areas of management
decision-making such as setting the price of a good for sale, deciding on the
cost of a manufactured good and deciding what type of budget best suits a
business.
By contrast, outside users of financial information, such as capital providers,
taxation officials and business lenders, want summarised financial
information that should be thoroughly checked before the business makes it
available. For a sole trader, the smallest type of business, this checking
process is done by the owner or, if the business is large enough, an internal
employee or external accountant. Preparing financial statements for external
users takes much time, experience and knowledge and, for larger private
companies and all public companies, involves a detailed checking process
by specially trained independent accountants known as auditors. The area
of accounting that is targeted primarily at those outside of the business is
called financial accounting.
Box 1.5 Using the same accounting record for all

accounting purposes
It is important to note that the different routines of ‘management’ and
‘financial’ accounting do not mean that different accounting records
must be kept. The different routines involve the same underlying
accounting data but organised, summarised and communicated in
rather different ways.
In the next activity you will have an opportunity to develop a better

understanding of the difference between financial and management
accounting.
Activity 1.4 Understanding the differences between financial and

management accounting
In the following table, there are six aspects of accounting in the first column
that are different for financial accounting compared to management
accounting. Using the information already given to you about the two types
of accounting, try to complete the following table. The first row has been
done for you. (Use a quick internet search if you find it helpful.)
22
Financial accounting Management accounting
Chief purpose The production of The production of detailed

summarised financial and up-to-date informal
statements by managers as a reports by managers to
formal report of their decide and plan activities and
stewardship responsibility. to control them.
Viewpoint
Timing of
information
Regulatory
authority
Accuracy level
Auditing
requirement
All managers benefit from good quality and properly prepared financial
A business unit is part of information. Sometimes the manager of a business unit (department or
an organisation that is division) in a larger organisation is expected to give a monthly report of
independent to a varying how the resources entrusted to him or her are being used. This is, as you
degree.
will recall, the stewardship function of accounting. Such a manager might
have to be responsible for a monthly balance sheet and income statement
and will need to have good financial accounting skills even if they do not
prepare the accounts. The next activity will help you to understand why this
is so.
Activity 1.5 Why managers benefit from understanding double-

entry accounting
You are one of the shop managers in a business that owns five shops. You
are expected to take full responsibility for both costs and sales in your shop.
At the end of every month the internal business accountant prepares an
income statement and a balance sheet to show how your shop has
performed for that month. You are expected to check and sign these reports
before they are sent to the business owner.
You have a good knowledge of double-entry accounting compared to the

manager of another shop in the business with the same responsibility. How
might this benefit the quality of the financial reports from your shop?
Sometimes a manager needs to exercise a stewardship function as in the

activity above. This is where a knowledge of financial accounting is
important. Units 2–4 will teach you the core financial accounting knowledge
you will need whether you are a preparer or a user of financial reports such
as a manager.
Often, however, managers need to use the same financial data in the
bookkeeping records to make specific decisions such as working out how
much of a certain product to sell and at what price. A properly skilled
23
manager should normally be able to make informed and correct decisions

and not rely on an accountant. In this case, such a manager needs to
understand the core management accounting knowledge that will be covered
in Units 6 and 7.
Even managers who have good levels of competence in both financial and
management accounting often need to rely on the deeper and more diverse
knowledge and skills of professional accountants. This will be discussed in
more detail in the third chapter of this book. In the next chapter we will
examine the crucial matter of keeping reliable and relevant accounting
records within an accounting information system. An essential skill of
professional accountants is to have an advanced understanding of double-
entry accounting information systems, both manual and computerised.
Answers to activities
Activity 1.1 The qualities of useful information

The correct explanation for each quality of information is given below. As
with every activity in this module see how the correct answer compares
with your own and then make sure you understand the correct answer.
Quality required Explanation

Relevant Information should be what is needed for
effective decision-making.
Reliable Information should come from trusted
sources.
Accurate As far as possible, information should be free
from errors.
Up-to-date Information needs to be timely if it is to be
used effectively.
Benefit exceeds cost The cost of producing, understanding and
using information should be less than the
benefit generated from its use.
Meets user needs Users of information have different needs
(e.g. sometimes a summary is required, not a
detailed report).
Easy to use and understand Information should not be too long, and
should be clearly presented in an appropriate
form (e.g. email, printed report, audio-visual
presentation.)
Comparable Information that is capable of or suitable for
comparison.
Activity 1.2 Understanding assets and liabilities

Buildings and machinery are assets that are common in a business. A
patent, which is an exclusive right to make, use or sell an invention for a
specified period, is a less common asset. While buildings and machinery are
tangible assets, a patent is classified as an intangible asset. Receivables
refers to the total money owed to a business by credit customers and is
24
thus an asset. Inventory are goods for sale in a business and are thus assets
that are owned.
All the other items are liabilities. An overdraft is when a bank balance is
negative and the customer owes the bank a sum of money. A mortgage is a
loan agreement secured on a business premise, for instance, in which the
lender can take possession of the premise if the borrower fails to pay back
the loan as agreed. Payables is the total money owed by a business to
credit suppliers of goods or services.
Activity 1.3 User information needs

User Internal/External Information needs
Owner External Information on the financial return of an
investment in order to hold managers to
account
Manager Internal Information to make decisions to improve
profitability and to safeguard the assets of
the business
Employee Internal Information about job security and
prospects, in comparison with conditions in
other organisations
Bank lender External Information about the capacity of the
business to make repayments and pay
interest on loans
Suppliers External Information about the likelihood of being
paid, and future growth/survival prospects
Customers External Information about the prospects of the
business remaining a supplier
Government External Information on taxable profit
Competitors External Information to inform their own business
strategies
Each user above wants the accounting information that best assists them to
achieve their own particular aim. Sarah, for example, as the owner of the
business and the main external user of accounting information, wants to
hold her manager, Peter, to account for his performance in running the
business on her behalf.
By contrast, Peter wants accounting information to show that he has made
decisions that have improved profitability and better protected the assets of
the business. Peter’s responsibility as a manager is to be a good steward of
Sarah’s business and to keep sound accounting records and reports. This is
known as the stewardship function of accounting and is the first main
function of accounting.
25
Activity 1.4 Understanding the differences between

financial and management accounting
Financial accounting Management accounting

statements by managers as a reports by managers to
formal report of their decide and plan activities and
stewardship responsibility. to control them.
Viewpoint Gives information about past Gives comparative, up-to-
performance. Only available date and forward-looking
several months after period information about
end. performance.
Timing of Normally annually, but Normally prepared on a
information depending on type of monthly basis, but can
business may be every three sometimes be required at
or six months as well. very short notice.
Regulatory Financial statements need to Financial reports can be in
authority be presented according to any form needed.
the requirements of
government and the
appropriate accounting
regulators.
Accuracy level Need to be thoroughly Accuracy, while always
checked in order to be as important, may need to be
accurate as possible. compromised in order that
information is up to date and
relevant.
Auditing Required for certain Not required.
requirement enterprises such as public
companies and larger
registered charities.
Activity 1.5 Why managers benefit from understanding

double-entry accounting
By understanding how the underlying figures, as kept in the double-entry
records, are aggregated at the month end in the balance sheet and the
income statement, you will be able to see exactly where these summary
figures come from. This makes you more likely to be able to detect any
errors or fraud in the monthly reports. Any figure that may look odd in the
report can be quickly traced back to the original records as a check. You
will also be able to challenge any judgements or estimates that the
accountant has made because you will have a good understanding of the key
underlying accounting concepts and principles. Such knowledge also makes
the accounting figures more meaningful to you as a manager in terms of
acting upon them more effectively.
26
Summary
Bookkeeping is the process of recording financial transactions and other
economic events in a systematic and chronological way. Accounting is
broader than bookkeeping and refers to the process of classifying,
summarising, presenting and interpreting financial transactions and other
economic events. Users of financial information want answers to the
following four fundamental financial questions:
Question 1: What does an enterprise own, i.e. what are its assets?
Question 2: What does an enterprise owe, i.e. what are its liabilities?
Question 3: How did the enterprise perform, i.e. what is its profit or loss?
Question 4: How did the enterprise obtain and use cash, i.e. what is its cash
flow?
The two principal financial statements that summarise the information
contained in the accounting records are the balance sheet and the income
statement.
Double-entry accounting allows all the information contained about an
enterprise’s assets (including cash), liabilities and profit or loss to be traced
back, quickly and accurately, to original transactions and financial events.
Such an accounting system also ensures that the three main functions of
accounting: stewardship, control and management planning and decision-
making are properly supported.
The same double-entry system can be used for the purposes of financial and
management accounting. Today, computers allow financial records to be
accurately and almost instantaneously processed, interrogated and
summarised in order to produce whatever financial and management reports
are needed.
27
Chapter 2 Accounting transactions

and cycles
Introduction
. describe the three parts of an accounting information system, whether

manual or computerised
. understand and explain the main source documents used for identifying
and recording financial transactions
. describe the difference between cash and credit transaction cycles
. understand and explain accounting cycles and how they differ from
transaction cycles.
Double-entry bookkeeping evolved to meet the financial information needs
of a wide range of users. It became the basis of accounting information
systems that could be relied upon anywhere in the world and whatever the
size of the organisation and the technology available.
2.1 Manual and computerised accounting

information systems
In the course of B124 you will develop a good understanding of the
accounting information system as illustrated in Figure 2.1 below. Such an
accounting information system can be manual or computerised. Source
documents, either in paper or electronic form, serve as the ‘input’ for such
a system. In Section 2.2 you will learn about the importance of keeping
accurate and clear source documents for every transaction. In Unit 2 you
will start to gain an understanding of the manual double-entry accounting
process that allows all the many transactions input into the system to be
summarised in ledger accounts and then to emerge as useful information in
the form of the balance sheet and the income statement. The same
principles you will learn in a manual accounting system also apply to a
computerised one.
Accounting information system
Input Process Output
Source documents Double-entry accounting Financial statements
(recorded in books (summarised records in (Income statement

of original entry) ledger accounts) & Balance sheet)
Figure 2.1 The accounting information system
28
Chapter 2 Accounting transactions and cycles
Although financial statements are the main output of the double-entry

system, as indicated in Figure 2.1, it is important to realise that the same
Units 2–4 focus on the system can also be used to produce management accounting reports.
‘input’ and ‘process’ of
double-entry accounting. The following activity will ask you to summarise the importance of an
Unit 5 on the ‘output’ of effective accounting information system.
financial statements.
Activity 2.1 The importance of an effective accounting

information system
In your own words, as concisely but clearly as possible, outline the main
reasons why all businesses need to have a fit-for-purpose accounting
information system.
Every accounting information system needs appropriately recorded and filed

source documents.
2.2 Source documents in accounting

A source document is the original record that substantiates every transaction
entered into the accounting system of a business. Each transaction involves
two sides of an exchange: a supply of a good or service and a reciprocal
consumption or use. (This dual nature of every transaction also helps to
explain the double-entry system of accounting introduced in detail in
Unit 2.) Suppliers and consumers or customers need to keep different source
documents that show the same original information in case there is a query
or dispute over any aspect of a purchase or the relevant payment.
Source documents should contain all relevant details because they are a
critical part of an audit trail. An audit trail gives a step-by-step recording
of a transaction from the original or source document to its final
presentation in a summary financial report. A reliable and easy to follow
audit trail provides objective evidence of proper record keeping in a
business.
Source documents make it difficult for cash or other resource items in a
business to be misappropriated or stolen because they provide proof that a
transaction has actually occurred.
These source documents are also required by government tax officials and,
for UK sole traders, they need to be kept and accessible within the business
records for at least five years after the tax period to which they relate.
It is easiest to understand the main source documents in the example of
simple retail business.
Example: source documents of Havelock sole trader

Tina Havelock owns a small furniture retailer, ‘Havelock’. She buys her
furniture on credit from a small number of furniture manufacturers or
29
wholesalers, and sells the furniture on to a larger number of cash and credit
customers.
Source documents for a credit purchase

Tina is considering the purchase of five desks of the same design from one
of her suppliers, KeyOffice. She emails the supplier and asks for a purchase
quotation for these desks.
Upon receiving the quote in writing she decides it is acceptable and so

sends a purchase order in response. Such an order expresses Tina’s
intention to buy but does not mean there is a contract of sale between her
and the seller.
The purchase order only becomes such a contract when the seller confirms
the contract in a sales confirmation email. (The supplier’s confirmation
expresses their intention to sell and can also be regarded as their sales
order. Such a sales order will be needed for the supplier’s own accounting
records.)
Tina then waits for the desks to be delivered to her shop. When they arrive,
she will also receive a three-part document from the supplier that she will
sign if she is satisfied with both the delivery and the accompanying
paperwork. Each part of the document has the same information about the
contents of the delivery and each has the same unique serial number.
The first part of the document is a goods delivery note (GDN) that confirms
the information in the purchase order. Once signed by Havelock as correct,
this document will go back to the warehouse of the supplier to confirm the
delivery. (The supplier will use this document to update their own accounting
and inventory records.)
The second part of the document is an invoice, which states the amount due
to the supplier and the terms of the payment required (within 30 days). This
document goes to the person responsible for keeping accounting records
and is duly recorded.
30
The third part of the three-part document is a goods receipt note (GRN)
that is kept by the person at Havelock responsible for recording furniture
received. This note is checked and signed as correct by the responsible
person. A copy of the GRN should be made, and sent to the accounts
department. (The person responsible for furniture storage needs their own
copy to keep an accurate inventory record.) On receiving this copy of the
GRN the accounts department verifies the invoice earlier received as correct
and due for payment.
At the end of each month an account’s receivable statement (or just an

account statement) is sent by a supplier, such as KeyOffice, to Havelock
giving the current amount due, the relevant invoice outstanding and a
reminder of the terms of payment.
Havelock then makes payment within 30 days by direct online bank transfer
into the supplier’s bank account. The source document for this payment is a
bank transfer form with the relevant unique invoice number. (Havelock used
to send payments by cheque in the post but stopped doing this for all
suppliers a number of years ago.)
Upon receiving payment within the agreed terms KeyOffice and other
suppliers acknowledge payment in an email that Havelock files as a receipt
or proof of payment.
Figure 2.2 gives a summary and a chronology of all the source documents
involved in the complete transaction of the credit purchase by Havelock of
the five desks, from the price quotation to the receipt sent by KeyOffice for
the payment. The arrows indicate whether a source document goes from the
supplier to the customer or vice versa. The one double-header arrows
indicates that a document received externally is copied and the original is
sent to the internal accountant and not back to the supplier.
Source document Source document
Direction
Price quotation Purchase order
Sales confirmation
Goods delivery note
(GDN)*
Invoice*
Goods receipt note

Supplier (GRN)* Customer
(KeyOffice) (Havelock)
Signed GDN
Signed GRN
Accounts
receivable statement
Bank transfer form
Receipt
Figure 2.2 Source documents needed for the complete transaction of a credit
purchase
*Different parts of a three-part document
31
Source documents for a cash sale

Most of Havelock’s customers are cash buyers. The source documents
needed for the audit trail for a cash transaction cycle are much more
straightforward.
A customer normally uses a trolley to carry a desk to the purchase counter.

The cash sale then takes place and is recorded on a cash register. This
machine prints out a cash register slip, which is given to the customer as a
receipt of sale.
The cash register keeps a running total of all cash sales and at the end of
the day produces a sales report that is printed out in duplicate. These
duplicate reports serve as the relevant source documents. One copy is given
to the person responsible for recording sales transactions for the day while
the other is given to the person responsible for keeping a record of furniture
inventory. The first copy is used for the accounting records while the second
is kept for the inventory records.
The transaction cycle

The time taken from the price quotation to the receipt for payment is the
transaction cycle illustrated in Figure 2.3. In the case of the credit transaction
above, it can take up to 30 days. The transaction cycle for a cash sales
transaction is much quicker and simpler, as Figure 2.3 reveals.
Initiation of
transaction
Exchange of good for cash

New ownership of good or promise of cash
Cash sale
(via credit given)
Credit
sale
Figure 2.3 Transaction cycle
From the example above you can see that far fewer source documents are
needed for a simple cash sale than a more complicated credit purchase. No
purchase quotations, purchase orders, or three-part goods received notes, for
instance, would be needed for the former. All such documents are
unnecessary given the customer’s actions in simply taking the desk to the
till and paying for it.
While the source documents needed for a cash sale are still important for
proper accounting and inventory records, those for a much more
complicated credit purchase need more care and thought in order to save
time and money.
A purchase quote is expected to have certain information. Other source
documents, such as purchase orders and invoices, would have other
information as required. Such information might be VAT registration
numbers, as applicable, or a unique purchase order or invoice number. An
important aspect of keeping good records is that source documents are
32
properly cross-referenced as a control measure and also if there is a query.

This is why the three-part document in the example has a unique sequential
number that appears on each of the three parts of the document.
In the next section we will look at the key differences between a credit
transaction cycle and a cash transaction cycle.
2.3 Transaction cycles for cash and credit

transactions
A transaction cycle, as illustrated in Figure 2.3, starts with the order of a
product or service, and ends with the exchange of the good or service for
payment. In the case of a cash transaction, as in the cash sale in our
example, the whole transaction cycle could take as little as a minute.
A cash transaction is recorded as a receipt by the seller and as a payment
by the buyer. Cash transactions do not give rise to liabilities for either the
seller or the buyer. In the case of a credit transaction, the transaction cycle
takes as long as the seller is willing to extend credit to the buyer. This
could be the 30 days in our example, but it could also be six months or
longer. For a credit transaction, the transaction cycle lasts from the moment
a buyer places an order to the moment the seller receives payment for the
goods or services delivered.
It is common practice for many businesses to buy and sell on credit.
Therefore, transaction cycles could take weeks or months to be completed.
In the case of large-scale construction projects they could even take years.
Retail businesses, such as Havelock, often buy their inventory on credit and
sell their goods for cash. Credit enables businesses to increase their sales
and purchases faster than they would be able to do on a cash basis. On the
other hand, the advantage of cash sales and purchases is that a business
does not run the risk that its customers will not pay their invoices or that it
will not be able to pay its credit suppliers.
While proper recording of source documents is important, it is also essential
that the many transactions that are individually recorded are periodically
summarised and presented in a form that serves a particular purpose. It
could be to see what sales are achieved by a business over a month or what
liabilities exist at a financial year end. The double-entry process which
starts with recording transactions (see Units 2–4) and ends with useful
information in financial statements (see Unit 5) is known as the accounting
cycle.
2.4 The accounting cycle

The accounting cycle, as illustrated in Figure 2.4, is a process that starts
when a transaction is first recorded and ends at the time that the financial
statements are prepared. For financial accounting purposes it is normally
once a year when an annual income statement and balance sheet have to be
33
presented as a formal external report that meets certain legal requirements

and has to be in a certain format. Such annual financial statements for sole
traders in the UK, in order to meet their legal responsibilities, need only to
be submitted in a summary form in a tax return, paper or electronic, as
determined by the tax authorities. (For purposes of stewardship, a more
detailed statement might need to be presented to the owner of a sole
proprietorship and perhaps to any lender.)
1
Recording of transactions
in books of original entry
3 2
Financial statements Summary totals recorded in
(also other reports as required) double-entry ledger accounts
Figure 2.4 Accounting cycle
Box 2.1 The way the accounting cycle is taught in

B124
In Unit 2, you will learn about how each type of asset, liability, income
and expense item has its own ledger account. The running total or
balance on these separate accounts are aggregated to prepare the
balance sheet and the income statement. In Unit 3 you will learn more
about recording transactions in these accounts (Step 2 in Figure 2.4)
according to fundamental double-entry rules. Once you understand the
essentials of double-entry bookkeeping you will be introduced to the
range of books of original entry (Step 1 in Figure 2.4) in Unit 4 because
they will make more sense at this stage of your learning. Unit 5 will
focus on financial statements (Step 3 in Figure 2.4) while in Units 6 and
7 you will learn about management accounting reports that are based
on the same underlying double-entry records (also Step 3 in
Figure 2.4).
The external statements for public companies, by contrast, need to follow

more complicated legal requirements and accounting regulations because
they are publicly available. The main reason that such care has to be taken
in presenting these statements is that they are used by the public to make
investment decisions. Because a year is too long for investors to wait for
financial information about a public company, such companies in Europe are
expected to provide an interim report – normally after six months – as well
as a final one. In the USA such interim reports are expected every three
months. The interim reports, whether in Europe or the USA, should be seen
as shorter accounting cycles within the annual financial reporting cycle.
For management accounting purposes, management reports can be produced
whenever the need arises. By convention this is normally monthly but there
is no set legal requirement or expected format because they are not for
external use. Such reports focus on producing information that management
34
decides is most useful. It could be sales and costs broken down into
different regions or products in order to decide which region or product
needs more investment. It could be a monthly report that compares the
current budgeted sales and costs with the actual figures.
In the next activity, you will gain a better understanding of accounting
cycles and how they differ from transaction cycles.
Activity 2.2 The difference between transaction and accounting

cycles
Which of the following statements are untrue?
1 Transaction cycles are shorter than accounting cycles.

2 The accounting cycle starts before the transaction cycle.
3 The credit transaction cycle can involve individual as well as aggregated
transactions.
4 The accounting cycle ends with the annual financial statements.
Activity 2.1 The importance of an effective accounting

information system
An appropriate accounting information system keeps track of where money
comes from and how it is spent, and also how the value of other resources,
as well as all debts, changes over time. It is required by law. Such a system
is also needed for effective decision-making and planning. It helps to keep
control of goods and property owned by a business. Finally, an effective
accounting information system is essential as the basis for ‘true and fair’
financial statements that are accepted by all users.
Activity 2.2 The difference between transaction and

accounting cycles
All of the statements are untrue as will be explained.
1 Transaction cycles can be longer or shorter than accounting cycles. It
depends on the type of transaction or accounting cycle. In the case of
constructing a building the transaction cycle may take several years. An
accounting cycle to produce a monthly management report needs to take
a maximum of a month. Only in the case of a cash transaction cycle,
which can take as little as a minute, is the transaction cycle definitely
shorter than the accounting cycle.
2 The credit transaction cycle starts with the price quotation. This is an
earlier stage than the related accounting cycle, which would start with
the recording of the information in the invoice.
35
3 The credit transaction cycle only deals with individual transactions from
the price quotation to the receipt of payment. The accounting cycle
involves individual transactions to record individual invoices and
payments but also aggregated transactions to record summary totals for
the different categories in the income statement and the balance sheet.
4 The accounting cycle does not necessarily end with the annual financial
statements. Although this is normally the main purpose of the financial
accounting cycle, in management accounting the relevant accounting
cycle is usually a month.
Summary
All but the smallest businesses use an accounting information system that
involves:
. an input stage – recording of source documents

. a processing stage – using the double-entry accounting method
. an output stage – producing the financial statements, and any
management accounting reports needed.
A source document is the original record that substantiates each financial
transaction entered into the accounting system of a business. Such
documents should contain all relevant details because they are a critical part
of an audit trail.
The time taken to complete a credit transaction cycle is from the price
quotation to the receipt of payment stage. A cash transaction cycle can take
as little as a minute.
The accounting cycle is a process that starts when a transaction is first
recorded and ends at the time that the financial statements are prepared. For
financial accounting purposes it is normally once a year while for
management accounting purposes it is generally completed monthly.
36
Chapter 3 The skills, knowledge and ethics required for accounting
Chapter 3 The skills, knowledge

and ethics required for accounting
Introduction
. explain what it means to be a professionally qualified accountant

. understand and explain the skills and knowledge required for accounting
. understand and explain the ethics required for accounting
. be able to identify straightforward ethical threats.
Although all managers should have sound general financial and management
accounting skills, the accounting profession has developed expertise in
more specialised areas. This chapter will look briefly at a number of roles
assumed by accountants in today’s business world. Because the focus of
B124 is on the accounting required for sole traders, particular attention will
be paid to the work that accountants perform for these businesses. Many
owners of sole trader businesses have limited accounting skills and are thus
reliant on the skills, knowledge and ethics of professionally qualified
accountants.
3.1 The role of the accountant in business

Professionally qualified accountants develop a wide range of skills and
knowledge that equip them for a diverse range of business careers. These
include tax advice, auditing, business advice and management and IT
consulting. Less well-known services include more specialised roles such as
forensic accounting and being an insolvency practitioner.
Insolvency is a financial condition experienced by a business when it can no
longer meet its financial obligations when they become due. In most
countries, including the UK, it is a criminal offence to trade whilst
knowingly insolvent. Insolvency practitioners are appointed to protect the
creditors of the insolvent individual or business and, if possible, to rescue
the business. When sole traders become insolvent they are normally
described as becoming bankrupt. By convention companies are described as
insolvent not bankrupt.
Self-employed accountants that offer their services to the public perform a
number of different services for sole traders. This is especially true for such
businesses that are not big enough to afford their own in-house accountant.
The external accountant for these sole traders will often describe their role
as being a ‘business adviser’ because it encompasses a number of roles.
The first role of such an accountant is to do the tax return for the sole
trader. This is a valuable function that not only meets the legal obligation of
the business but also offers opportunities to minimise and delay tax
liabilities.
37
In order to do a tax return the accountant will have to establish the financial
position of the business at the end of the relevant accounting period in
which a tax liability falls due. As you will learn in Unit 5 it takes some
skill and knowledge to establish such a financial position – normally
reported in a balance sheet – from the incomplete records that are often
kept by sole traders who do not have an in-house accountant.
Often an external accountant will offer management accounting services to
a sole trader as well as finalising the end-of-period balance sheet and
income statement. Such services may involve producing monthly
management reports as well as different types of budgets.
Because qualified accountants undergo an extensive amount of initial
education as well as continuous professional development, sole traders often
depend on their accountant for developing their business strategy as well as
meeting all their legal obligations. An important aspect of being a qualified
accountant is to have extensive knowledge of commercial law as well as
risk assessment.
Because the external accountant is so integral to the success of most sole
traders, it is crucial that the business owner has confidence in the ethics and
integrity of their accountant. Later in this chapter we will discuss the
importance of following a transparent ethical framework for professionally
qualified accountants.
In the next section we will look in more detail at the term ‘accountant’, the
importance of the chartered accounting qualification and the skills and
knowledge required of professionally qualified accountants.
3.2 Professional accounting skills and

knowledge
In most countries, including the UK, certain professionals, such as doctors
and lawyers, have legal protection associated with their status. Only
properly qualified and regulated doctors and lawyers can call themselves by
these terms. The term ‘accountant’ does not have the same legal protection
in the UK. Anyone can set themselves up as an accountant and trade as
such. The only areas of accounting that are restricted to professionally
qualified, registered and inspected accountants are audit and insolvency.
Not only is there no required qualification to practise as an accountant in
the UK and a number of other countries, but there are a number of
accounting qualifications that are neither recognised by the government nor
by financial institutions such as banks. Because of this, an important
distinction has emerged in the UK and many other countries between
professionally qualified accountants and all other accountants.
Qualified accountants in the UK are members of one of the six professional
accountancy bodies that have received a Royal Charter. These bodies are
thus known as chartered accountancy bodies and comprise the following:
. The Association of Chartered Certified Accountants (ACCA)
38
. The Institute of Chartered Accountants of Scotland (ICAS)

. The Institute of Chartered Accountants in England and Wales (ICAEW)
. The Institute of Chartered Accountants in Ireland (ICAI)
. The Chartered Institute of Management Accountants (CIMA)
. The Chartered Institute of Public Finance and Accountancy (CIPFA).
The first five bodies cater for both the private and the public sector, while
the last (CIPFA) specialises in the public sector. Professionally qualified
accountants in many former British colonies such as Canada, India,
Australia and South Africa are also known as chartered accountants. As in
the UK, such accountants are accountable to professional bodies that have
websites you may want to explore. Professionally qualified and regulated
accountants in the USA are known as certified public accountants.
In the next two chapters you will develop your understanding of two key
skills required for every level of work in accounting. The first of these
skills is numerical and the second is spreadsheet focused.
There are a number of other important skills that accountants should
develop. The first of these is communication.
3.2.1 Communication skills for accountants

It is not always appreciated how important communication skills are in
accounting. No matter what type of accounting role is undertaken the ability
to communicate effectively is essential.
The next activity should develop your appreciation of communication in
accounting.
Activity 3.1 The importance of communication in accounting

What type of communication skills do you think an accountant should have,

and why?
3.2.2 General skills and abilities of accountants

Over and above numerical, spreadsheet and communication skills there are a
number of other equally important skills and abilities that an effective
accountant should develop.
The next activity will highlight these skills.
Activity 3.2 The general skills and abilities of effective

accountants
In the following table, use an arrow to join each skill or ability in the first
column with its correct explanation in the second.
39
Skills and abilities Explanation

Organisation The ability to be honest, transparent and to not
manipulate others.
Critical thinking The ability to identify a problem or a potential
problem.
Time management The ability to be a role model and to do strategic
thinking and planning.
Adaptability The skill to assess your own performance and
others in order to continually improve.
Monitoring The ability to keep track of responsibilities and to
fulfil all duties.
Openness The ability to change effectively in response to a
dynamic environment.
Problem awareness The ability to use intuition, logic and reasoning to
identify the alternative approaches to solving
problems.
Risk management The ability to arrange things or actions in a correct
order according to stipulated rules.
Leadership The ability to effectively anticipate problems,
situations or events.
Information ordering The skill to manage your own time as well as those
you work with.
Being proactive The ability to identify, assess, prioritise and
effectively manage risk.
3.2.3 The knowledge required of accountants

A central requirement of accountants is that they have an in-depth
knowledge of financial and management accounting principles and practices.
Allied to this is a good understanding of economic analysis for management
decision-making.
Accountants are also expected to understand the nature and purpose of
financial markets, banking and the analysis and reporting of financial data.
An advanced knowledge of mathematics is not needed, only a sound grasp
of arithmetic and a basic understanding of algebra and statistics.
It is important that accountants have a good understanding of administration
and management. In particular, accountants should develop a good
understanding of strategic planning, resource allocation, production methods
and leadership.
Knowledge of relevant law and the regulatory environment is vital for every
accountant. This includes understanding all relevant laws and legal codes,
court procedures and all relevant government and professional regulations
and rules.
As a key part of the job of a modern accountant is to help run a business or
to work alongside managers and owners as a business adviser, knowledge of
human resource management and customer service is also important. The
former is concerned mainly with the recruitment, selection, training and
motivation of staff while the latter deals with knowing the principles and
practices for providing effective customer service.
40
Of particular relevance for accountants who work alongside sole traders is

the ability to offer advice about the effective management of credit
customers and suppliers, as well as how to deal with lenders, especially
when applying for bank loans.
A growing area of required knowledge for modern accountants is
information technology. This might involve being able to use integrated
accounting packages as well as advanced features of spreadsheets. All
accountants should be familiar with word processing programs as well as
how to manage computer files and records.
3.2.4 Understanding and applying strategic

management
Fully qualified accountants should be expected to have the skills and
knowledge to practise effective strategic management. Strategic
management is the continuous process of determining, implementing and
evaluating decisions that enable an organisation to achieve its long-term
objectives.
An important part of strategic management is to be able to analyse the
macro-environment in which a business operates in order to respond to
opportunities and to maximise the competitive strengths and advantages of
the business.
The most widely used tool for analysing the external environment of a
business is the PESTLE framework and it is widely taught to management
and accounting students. The expanded form of PESTLE denotes P for
Political, E for Economic, S for Social, T for Technological, L for Legal
and E for Environmental. When helping to manage the strategy of any
business in any industry, the accountant should always have an overview of
the different aspects of the business environment.
Political: The extent to which a government influences the national
economy or the industry in which a business operates. Political factors
include tax policies, government regulations, trade tariffs, etc. that may
affect the business environment.
Economic: The aspects of a national economy’s performance that directly
impacts a business both in the long and short term. Economic factors
include inflation rate, interest rates, foreign exchange rates, foreign
investments and economic growth rates.
Social: This relates to the social environment of the business and concerns
matters like cultural trends, demographics and buying trends.
Technological: This refers to innovations in technology that may affect the
operations of a business and its industry.
Legal: The business environment is affected by laws and the regulatory
environment especially in areas such as employer responsibilities and
employee rights, safety standards and consumer protection.
Environmental: This includes such factors as climate, weather, geographical
location, global changes in climate, environmental/green issues. Some
41
industries such as agriculture, energy extraction, and manufacturing are

more affected than others.
In the next activity you will apply your understanding of PESTLE to a short
case study.
Activity 3.3 Understanding the business environment

Read the following case study about an imaginary company and then do a
PESTLE analysis of the relevant business environment.
You are the accountant and financial manager of a business, TTE

(Today’s Telecommunication Electronics), that manufactures
telecommunication electronics.
TTE has its main office and production facility in Omega, a

prosperous country with a well-developed political system. The
government in Omega has recently promoted the
telecommunications industry by providing grants and tax
incentives. As a result of increasing social and environmental
concerns, the government has also recently tightened up on
legislation reducing carbon emissions and improved health and
safety standards.
The telecommunications sector in Omega is extremely competitive

and innovative. This has led to a rapidly increasing use of social
networking and telecommunication networks. Employees with skills
in these areas are able to command high salaries and tend not to
stay in any one business long.
Most of the employees involved in production are members of a

union and there are minimum wage laws in Omega.
Omega is recovering slowly from a downturn in its domestic

economy while employment costs remain high. The major market
for Omega is a country, Alpha, whose currency has recently
depreciated against the currency of Omega.
In the next section we will look at a very important aspect of the

responsibility of professionally qualified accountants: maintaining high
standards of professional ethics.
3.3 The fundamental ethical principles of

professional accounting
According to the International Ethics Standards Board for Accountants
(IESBA), which is supported by the International Federation of Accountants
42
(IFAC), all professional accountants are required to comply with the

following fundamental principles:
Integrity
A professional accountant should be straightforward and honest in all
professional and business relationships.
Objectivity
A professional accountant should not allow bias, conflict of interest or
undue influence of others to override professional or business
judgements.
Professional competence and due care
A professional accountant has a continuing duty to maintain
professional knowledge and skill at the level required to ensure that a
client or employer receives competent professional service based on
current developments in practice, legislation and techniques. A
professional accountant should act diligently and in accordance with
applicable technical and professional standards when providing
professional services.
Confidentiality
A professional accountant should respect the confidentiality of
information acquired as a result of professional and business
relationships and should not disclose any such information to third
parties without proper and specific authority unless there is a legal or
professional right or duty to disclose. Confidential information
acquired as a result of professional and business relationships should
not be used for the personal advantage of the professional accountant
or third parties.
Professional behaviour
A professional accountant should comply with relevant laws and
regulations and should avoid any action that discredits the profession.
(IFAC, 2006, pp. 5–6)
The next activity should help you to apply your understanding of these
fundamental ethical principles.
Activity 3.4 Professional ethics of accountants

In the following table, each statement in the first column violates one
particular fundamental ethical principle. Write this fundamental principle in
the second column.
43
Statement Fundamental principle violated

An accounting practice advertises in a
local newspaper that it will beat the fee of
any tax return service offered by other
accounting practices in the area.
An accountant uses information gained
from a client to give free advice to an
accounting student. He receives no
financial or other reward for this advice.
An accountant is an auditor of a company
of which he is also a shareholder. He
deliberately withholds this information.
An accountant has not been able to
acquaint herself with the latest accounting
standards and other relevant technical
knowledge as she runs a very busy
practice.
An accountant is approached by a close
family member to do an audit for them.
The accountant has the technical
knowledge and experience to conduct this
audit.
Related to the professional ethical principles of integrity, professional

behaviour and objectivity is the obligation to treat people fairly and
decently and without prejudice or the need to stereotype.
In the next activity you will develop your ability to understand and discuss
prejudicial and stereotypical perspectives.
Activity 3.5 Understanding and dealing with stereotypes and

prejudices
Read the material below and answer the questions that follow.
Historically, the role of a professionally qualified accountant was perceived to

be straightforward. He (rarely a she) was seen as simply a human ‘bean
counter’. (The root word in accountant is ‘count’ hence this limited view of
accounting.) Regarded as always prudent and objective, ‘he’ was relied
upon to provide the plain financial information that the cold, clear logic of
double-entry accounting could provide.
A man past middle age, spare, wrinkled, intelligent, cold, passive,

non-committal, with eyes like a cod-fish, polite in contact, but at
the same time, unresponsive, cold, calm and damnably composed
as a concrete post or plaster-of-paris cast; a human petrification
with a heart of feldspar and without charm of the friendly germ,
minus bowels, passion, or a sense of humour.
(Black, 2005, p. xiii of preface)
44
The old stereotype of a traditional chartered accountant in the well-known

quote above still persists.
1 Explain why the above quote is a very limited stereotype of a modern

professionally qualified accountant.
2 What is the danger of using stereotypes when dealing with people in a
business situation?
An important part of your study of B124 is to consider how any new

knowledge or skills help you in your present or future work situation. The
next ‘Stop and reflect’ exercise should help you to think through the
vocational implications of learning about what is involved in qualifying and
practicing as a professional accountant.
Stop and reflect

In this chapter you have learned about the skills, knowledge and ethics
required to be a professionally qualified accountant. How might this
learning influence your present and future work situation?
If you currently have any type of managerial role you will probably need
to work alongside accountants or financial managers (invariably trained
accountants) who work with you to prepare financial reports for your
area of responsibility. It is likely that such colleagues will also help you
to set and manage your area budget. Knowing more about the expected
skills, knowledge and ethics of such accountants will help you to work
more constructively with them.
It may be that your better understanding of what it means to be a

professional accountant has motivated you to start the process of
qualifying as one. Knowing what is involved should help you to plan
more effectively to achieve this work and life goal. Alternatively, this
chapter may have helped you to decide to develop a career in more
general management. If this is the case you will still need to work
alongside qualified accountants. It may be that they are the financial
manager or director who you report to or to whom they report. It could
45
also be that they serve as external auditors or management consultants

for your organisation.
In the next chapter we will focus on the essential numerical skills required
for accounting. Although the modern accountant needs a wide skill set and
knowledge base, these more traditional skills remain very important.
Activity 3.1 The importance of communication in

accounting
Being able to communicate effectively both in writing and verbally are key
requirements of being an accountant. It is very important to be able to
convey sometimes complex information simply and clearly. The following
activities also need good communication skills:
Active listening – an accountant must give full attention to what a client or
a colleague is saying, knowing when and how to ask appropriate questions,
and when not to interrupt.
Written comprehension – an accountant should be able to read and
understand information and ideas presented in writing.
Social awareness – an accountant should be able to analyse the behaviour of
others, such as customers or colleagues, and to understand why they are
reacting in a certain manner.
Activity 3.2 The general skills and abilities of effective

accountants
The correct explanation for each skill or ability is given below. See how the
correct answer compares with your own and then make sure you understand
the correct answer.
Skills and abilities Explanation

Organisation The ability to keep track of responsibilities and to
fulfil all duties.
Critical thinking The ability to use intuition, logic and reasoning to
identify the alternative approaches to solving
problems.
Time management The skill to manage your own time as well as those
you work with.
Adaptability The ability to change effectively in response to a
dynamic environment.
Monitoring The skill to assess your own performance and
others in order to continually improve.
Openness The ability to be honest, transparent and to not
manipulate others.
46
Problem awareness The ability to identify a problem or a potential

problem.
Risk management The ability to identify, assess, prioritise and
effectively manage risk.
Leadership The ability to be a role model and to do strategic
thinking and planning.
Information ordering The ability to arrange things or actions in a correct
order according to stipulated rules.
Being proactive The ability to effectively anticipate problems,
situations or events.
Activity 3.3 Understanding the business environment

Political: TTE is based in a stable, prosperous country where the
government values and encourages telecommunication technology by
providing grants and tax incentives. The government has recently
strengthened laws reducing carbon emissions and improving health and
safety standards. There are minimum wage laws in Omega.
Economic: The economy of Omega is still recovering from a downturn. The
depreciating currency of Alpha, the major market for TTE, is making TTE’s
products more expensive in the Omega currency.
Social: The increasing use of social networking and telecommunication
networks in Omega is likely to increase the market for telecommunication
electronics. There is widespread social awareness of environmental issues
such as the need to reduce carbon emissions. A feature of Omega society, at
least in this industry, is union membership.
Technological: The telecommunications sector in Omega is extremely
innovative. The rapid take-up of social networking and telecommunication
networks implies a growing market in these emergent technologies and
greater demand for TTE’s products.
Legal: The business environment in Omega is strongly affected by laws
relating to employer responsibilities and employee rights such as minimum
wages, recognition of unions and health and safety. Recently, laws have
been passed reducing carbon emissions.
Environmental: Green issues have an increasing relevance to businesses in a
country such as Omega. The desire to control carbon emissions, as
mentioned in the case study, is likely to be matched by increasing pressure
for a business like TTE to recycle as much as possible. This is likely to
increase the cost of manufacture for TTE but offers the business an
opportunity to improve its reputation amongst its stakeholders.
47
Activity 3.4 Professional ethics of accountants

Statement Fundamental principle violated
An accounting practice advertises in a Professional behaviour
local newspaper that it will beat the fee
of any tax return service offered by
other accounting practices in the area.
An accountant uses information gained Confidentiality
from a client to give free advice to an
accounting student. He receives no
financial or other reward for this
advice.
An accountant is an auditor of a Integrity
company of which he is also a
shareholder. He deliberately withholds
this information.
An accountant has not been able to Professional competence and due
acquaint herself with the latest care
accounting standards and other
relevant technical knowledge as she
runs a very busy practice.
An accountant is approached by a Objectivity
close family member to do an audit for
them. The accountant has the
technical knowledge and experience to
conduct this audit.
An important aspect of the professionalism of qualified and regulated

accountants is that they should perform their services in the public interest.
The professionalism and ethics of accountants, especially auditors, is
increasingly challenged in the modern world in which there have been a
number of accounting scandals. The most important of these scandals was
the case of Enron in the early 21st century. Accounting fraud, both within
the organisation as well as involving the auditors, played a part in the
collapse of this company which at its height was the biggest energy
company in the world. There is now a great deal of pressure on today’s
chartered accountants to act professionally and ethically and to be able to
explain and defend all their actions.
Activity 3.5 Understanding and dealing with

stereotypes and prejudices
1 Today, a chartered accountant is as likely to be a women as a man.
People of all different types of backgrounds and personality types
become professional accountants. Such professionals need to be flexible,
socially competent and to work with a range of different people in a
range of different situations. Such a business professional would thus
benefit from having ‘charm’ and a ‘sense of humour’. Although
preparing and auditing financial statements remains a part of being an
accountant, the reality is that accountants, especially at the ‘chartered’
level are more likely to be business leaders, advisers or consultants.
While it is still important for a professional accountant to be prudent and
48
objective when making financial evaluations, a much wider skill set and
knowledge base is required than suggested in the quote above.
2 The first danger of using stereotypes in a business situation is that you
may easily offend someone. A stereotype, such as that of an accountant
in the quote above, can be viewed as a prejudice that reveals the
ignorance and bias of the person using it. The second danger is that by
prejudging people in a business situation you are likely to not take
advantage of their varying skills, knowledge and experience for your
mutual business benefit. Mutually respectful business relationships
should be based on integrity, objectivity and appropriate business
behaviour.
Summary
Fully qualified accountants in the UK and in the former British colonies are
also known as chartered accountants. Such accountants need to achieve
rigorous entry requirements as well as ongoing monitoring and professional
development. It is important for professional accountants to have a wide
skill set and knowledge base. Numerical and spreadsheet skills are just two
areas of expertise that should be continually developed.
The fundamental ethical principles of professional accountants are integrity,
objectivity, professional competence and due care, confidentiality and
professional behaviour. An important aspect of ethical behaviour is to be
aware of common stereotypes and prejudices but not to allow them to affect
your treatment of people.
49
Chapter 4 Essential numerical

skills for accounting
Introduction
. understand and use the correct order of operations

. understand and use calculator memory
. understand and use the following: rounding, fractions, ratios, percentages
and negative numbers
. understand and use the test of reasonableness and the table of
equivalencies
. understand, use and manipulate equations and formulae.
Expertise in mathematics is not required to succeed as an accountant. The
core skill needed is the confidence and ability to add, subtract, multiply and
divide, as well as to use decimals, fractions and percentages. Competent
accountants should be able to do mental calculations as well as use a
calculator to perform these numerical skills.
An important skill in accounting is the ability to manipulate simple
equations. In Book 2 you will be introduced in detail to the accounting
equation, which is the foundation of the double-entry system of accounting.
Being able to understand and express the accounting equation in different
forms is crucial to understanding and preparing the principal financial
statements (the income statement and the balance sheet).
The material in this section covers the basic numeracy skills from
multiplication and division, through to decimals, percentages, fractions and
negative numbers. It expects that you will use a calculator for most of the
activities but you are also encouraged to use mental calculations. In the
modern world, the assumption is that we use calculators to save the tedious
process of working out calculations by hand or mentally. The danger, of
course, is that you may use a calculator without understanding what an
answer means or how it relates to the numbers operated upon. For example,
if you calculate that 8% of £20 is £160 (which can easily happen if either
you forget to press the percent key or it is not pressed hard enough), you
should immediately notice that something is very wrong.
Using a calculator requires certain skills in understanding what functions
the buttons perform and in which order to carry out the calculations. Your
need to study this material is dependent on your mathematical background.
If you feel weak or rusty on basic arithmetic or maths, you should find this
material helpful. The directions and symbols used will be those found on
most standard calculators. If you find any of the instructions contained in
this material do not produce the expected answer, please look at the
instructions for your calculator and amend the instructions in this chapter so
that they match those for your own calculator.
50
Chapter 4 Essential numerical skills for accounting
There are four basic operations between numbers, each of which has its
own notation:
Addition 7 + 34 = 41
Subtraction 34 – 7 = 27
Multiplication 21 x 3 = 63, or 21 * 3 = 63
Division 21 ÷ 3 = 7, or 21 / 3 = 7
The next section will examine the application of these operations and the
correct presentation of the results arising from them.
4.1 Use of BODMAS and brackets

When several operations are combined, the order in which they are
performed is important. For example, 12 + 21 x 3 might be interpreted in
two different ways:
add 12 to 21 and then multiply the result by 3
multiply 21 by 3 and then add the result to 12.
The first way gives a result of 99 and the second a result of 75. We need
some way of ensuring that only one possible interpretation can be placed
upon the formula presented. For this we use BODMAS, which gives us the
correct sequence of operations to follow so we always get the right answer:
(B)rackets
(O)rder
(D)ivision
(M)ultiplication
(A)ddition
(S)ubtraction
According to BODMAS, multiplication should always be done before
addition. Therefore, 75 is actually the correct answer to the equation above.
(‘Order’ may be an unfamiliar term to you in this context but it is merely
an alternative for the more common term, ‘power’ which means a number is
multiplied by itself one or more times. The ‘power’ of one means that a
number is multiplied by itself once, i.e. 2 x 1, 3 x 1, etc., the ‘power’ of
two means that a number is multiplied by itself twice, i.e. 2 x 2, 3 x 3, etc.
In mathematics, however, instead of writing 3 x 3 we write 32 and express
this as three to the ‘power’ or ‘order’ of 2.)
Brackets are the first term used in BODMAS and should always be used to
avoid any possibility of ambiguity or misunderstanding. A better way of
writing 12 + 21 x 3 is thus 12 + (21 x 3). This makes it clear which
operation should be done first.
51
12 + (21 x 3) is thus done on the calculator by keying in 21 x 3 first in the

sequence:
Calculator
21 X 3 + 12 =
The next activity will test your ability to use brackets properly.
Activity 4.1 Use of BODMAS

Complete the following calculations.
(a) (13 x 3) + 17
(b) (15 / 5) – 2
(c) (12 x 3) / 2
(d) 17 – (3 x (2 + 3) )
(e) (13 + 2) / 3 – 4
(f) 13 x (3 + 17)
4.2 Use of calculator memory

A portable calculator is an extremely useful tool for a bookkeeper or an
accountant. Although computers normally provide computer applications,
there is no substitute for the convenience of a small, portable calculator or
its equivalent in a mobile phone or tablet.
When using the calculator, it is safer to use the calculator memory (M+ on
most calculators) whenever possible, especially if you need to do more than
one calculation in brackets. The memory calculation will save the results of
any bracket calculation and then allow that value to be recalled at the
appropriate time. It is always good practice to clear the memory before
starting any new calculations involving its use. (Consult your own
calculator manual for its method of storing any calculation in memory as
well as its instructions for clearing memory.)
Box 4.1 The memory function in a scientific

calculator
The scientific calculator memory is particularly useful for more complex
calculations in accounting. Such a calculator has a number of different
memories of which the ‘M’ memory is the most commonly used in
accounting calculations. Like most calculators, the ‘M’ memory is
accessed using the M+ key. Only the most basic calculator is needed
for B124 but a scientific calculator should be strongly considered for
any future study in accounting. The key features of the memory function
52
in a scientific calculator will be explained if you progress to the Level 2

Open University module in management accounting.
Activity 4.2 Use of calculator memory

Use the memory on your calculator to evaluate each of the following:
(a) 6 + (7 – 3)
(b) 14.7 / (0.3 + 4.6)
(c) 7 + (2 x 6)
(d) 0.12 + (0.001 x 14.6)
4.3 Rounding
For most business and commercial purposes the degree of precision
necessary when calculating is quite limited. While engineering can require
accuracy to thousandths of a centimetre, for most other purposes tenths will
do. When dealing with cash, the minimum legal tender in the UK is one
penny, or £00.01, so unless there is a very special reason for doing
otherwise, it is sufficient to calculate pounds to the second decimal place
only.
However, if we use the calculator to divide £10 by 3, we obtain
£3.3333333. Because it is usually only the first two decimal places we are
worried about, we forget the rest of them and write the result to the nearest
penny of £3.33.
This is a typical example of rounding, where we only look at the parts of
the calculation significant for the purposes in hand.
Consider the following examples of rounding to two decimal places:
1.344 rounds to 1.34
5.5555 rounds to 5.56
6.9966 rounds to 7.00
7.7754 rounds to 7.78
Rule of rounding
If the digit to round is below a 5, round down. If the digit is 5 or above, round up.
53
Activity 4.3 Use of rounding

(a) Round the following numbers to two decimal places:

(i) 0.5678
(ii) 3.9953
(iii) 107.356427
(b) Round the same numbers as above to three decimal places:

(i) 0.5678
(ii) 3.9953
(iii) 107.356427
4.4 Fractions
So far we have thought of numbers in terms of their decimal form,
e.g. 4.567, but this is not the only way of thinking of, or representing,
numbers. A fraction represents a part of something. If you decide to share
out something equally between two people, then each receives a half of the
total and this is represented by the symbol ½.
A fraction is just the ratio of two numbers: 1/2, 3/5, 12/8, etc. We get the
corresponding decimal form 0.5, 0.6, 1.5 respectively by performing
division. The top half of a fraction is called the numerator and the bottom
half the denominator, i.e. in 4/16, 4 is the numerator and 16 is the
denominator. We divide the numerator (the top figure) by the denominator
(the bottom figure) to get the decimal form. If, for instance, you use your
calculator to divide 4 by 16 you will get 0.25.
A fraction can have many different representations. For example, 4/16, 2/8,
and 1/4 all represent the same fraction, one quarter or 0.25. It is customary
to write a fraction in the lowest possible terms. That is, to reduce the
numerator and denominator as far as possible so that, for example, one
quarter is shown as 1/4 rather than 2/8 or 4/16.
If we have a fraction such as 26/39 we need to recognise that the fraction
can be reduced by dividing both the denominator and the numerator by the
largest number that goes into both exactly. In 26/39 this number is 13 so
(26/13) / (39/13) equates to 2/3.
We can perform the basic numerical operations on fractions directly. For
example, if we wish to multiply 3/4 by 2/9 then what we are trying to do is
to take 3/4 of 2/9, so we form the new fraction:
3/4 x 2/9 = (3 x 2) / (4 x 9) = 6/36 or 1/6 in its simplest form.
In general, we multiply two fractions by forming a new fraction where the
new numerator is the result of multiplying together the two numerators, and
the new denominator is the result of multiplying together the two
denominators.
54
Addition of fractions is more complicated than multiplication. This can be

seen if we try to calculate the sum of 3/5 and 2/7. The first step is to
represent each fraction as the ratio of a pair of numbers with the same
denominator. For this example, we multiply the top and bottom of 3/5 by 7,
and the top and bottom of 2/7 by 5. The fractions now look like 21/35 and
10/35 and both have the same denominator, which is 35. In this new form
we just add the two numerators.
(3/5) + (2/7) = (21/35) + (10/35)
= (21 + 10)/35)
= 31/35
Activity 4.4 Use of fractions

(a) Convert the following fractions to decimal form (rounding to three

decimal places) by dividing the numerator by the denominator on your
calculator:
(i) 125/1000
(ii) 8/24
(iii) 32/36
(b) Perform the following operations between the fractions given:

(i) 1/2 x 2/3
(ii) 11/34 x 17/19
(iii) 2/5 x 7/11
(iv) 1/2 + 2/3
(v) 3/4 x 4/5
4.5 Ratios
Ratios give exactly the same information as fractions but expressed in a
different form. Accountants make extensive use of ratios in assessing the
financial performance of an organisation.
A supervisor’s time is spent in the ratio of 3:1 (spoken as ‘ three to one’)
between Departments A and B. (This may also be described as being ‘in the
proportion of 3 to 1’.) Her time is therefore divided 3 parts in Department
A and 1 part in Department B.
There are 4 parts altogether and:
3/4 time is in Department A
1/4 time is in Department B
If her annual salary is £24,000 then this could be divided between the two
departments as follows:
Department A 3/4 x £24,000 = £18,000
55
Department B 1/4 x £24,000 = £6,000
Activity 4.5 Use of ratios

A company has three departments that make use of the canteen. Running
the canteen costs £135,000 per year and these costs need to be shared out
among the three departments on the basis of the number of employees in
each department.
Dept Number of employees

Production 125
Assembly 50
Distribution 25
How much should each department be charged for using the canteen?
4.6 Percentages
Percentages also indicate proportions. They can be expressed either as
fractions or as decimals:
45% = 45/100 = 0.45
7% = 7/100 = 0.07
Their unique feature is that they always relate to a denominator of 100.
Percentage means simply ‘out of 100’ so 45% is ‘45 out of 100’, 7% is ‘7
out of 100’, etc.
A business is offered a loan to a maximum of 80% of the value of its
premises. If the premises are valued at £120,000 then the company can
borrow the following:
£120,000 x 80% = £120,000 x 0.80 = £96,000.
Fractions and decimals can also be converted to percentages. To change a
decimal to a percentage you need to multiply by 100:
0.8 = 80%
0.75 = 75%
To change a percentage to a decimal you need to divide by 100:
60% = 0.6
3% = 0.03
To convert a fraction to a percentage it is necessary to first change the
fraction to a decimal:
4/5 = 0.8 = 80%
3/4 = 0.75 = 75%
56
If a machine is sold for £120 plus VAT (value added tax – an indirect tax in
the UK you will learn about in Book 3) at 20% then the actual cost to the
customer is:
£120 + (20% of 120) = £120 + (0.20 x 120) = £144
Alternatively, the amount can be calculated as:
£120 x (100% + 20%) = £120 x (1.00 + 0.20) = £120 x 1.20 = £144
If the machine were quoted at the price including VAT (the gross price) and
we wanted to calculate the price before VAT (the net price), then we would
need to divide the amount by (100% + 20%) = 120% or 1.2. The gross
price of £144 divided by 1.2 would thus give the net price of £120. This
principle can be applied to any amount that has a percentage added to it.
For example, a restaurant bill is a total of £50.40 including a 12% service
charge. The bill before the service charge was added would be:
£50.40 / 1.12 = £45.00
Activity 4.6 Use of percentages

(a) Convert the following to percentages

(i) 0.9
(ii) 1.2
(iii) 1/3
(iv) 0.03
(v) 1/10
(vi) 1 1/4
(b) A company sells its product for £65 per unit. How much will it sell for if
the customer negotiates a 20% discount?
(c) If a second product is sold for £36.18 including 20% value added tax,
what is the net price before tax?
4.7 Negative numbers and the use of

brackets
Numbers smaller than zero (shown to the left of zero on the number line
below in Figure 4.1) are called negative numbers. We indicate they are
negative by enclosing them in brackets as shown in Figure 4.1.
(7) (6) (5) (4) (3) (2) (1) 0 1 2 3 4 5 6 7
Negative numbers Positive numbers

Figure 4.1 The number line
You may be used to seeing negative numbers indicated by the use of a

minus sign ‘–’. However, because accountants conventionally use brackets
57
to make it more obvious that a value is negative; this is the convention we

adopt on B124. Negative numbers can be manipulated just like positive
numbers and the calculator can deal with them with no difficulty as long as
they are entered with a ‘–’sign in front of them.
Rules of negative numbers

The rules for using negative numbers can be summarised as follows:
Addition and subtraction
Adding a negative number is the same as subtracting a positive
50 + (–30) = 50 – 30 = 20
Subtracting a negative number is the same as adding a positive
50 – (–30) = 50 + 30 = 80
Multiplication and division
A positive number multiplied by a negative gives a negative
20 x –4 = –80
A positive number divided by a negative gives a negative
20 / –4 = –5
A negative number multiplied by a negative gives a positive
–20 x –4 = 80
A negative number divided by a negative gives a positive
–20 / –4 = 5
Try to confirm the above rules for yourself by carrying out the following
exercise either manually or by means of a calculator.
Activity 4.7 Use of negative numbers in maths operations

Calculate each of the following. (In this activity we will assume the
convention that if a number is in brackets it means it is negative.)
(a) (2) x (3)

(b) 6 – (8)
(c) 6 + (8)
(d) 2 x (3)
(e) (8) / 4
(f) (8) / (4)
58
Box 4.2 Important note about use of brackets

Always remember that while a single number in brackets means that it
is negative, the rule of BODMAS means that brackets around an
‘operation’ between two numbers, positive or negative, means that this
is the first operation that should be done. The answer for a series of
operations in an example such as 12 + (–8 – 2) would thus be 2
according to the rules of BODMAS and negative numbers. It should be
also noted that if 12 + (–8 – 2) was given as 12 + ( (8) – 2) the answer
would still be 2 as (8) is just another way of showing –8.
4.8 The test of reasonableness

Applying a test of reasonableness to an answer means making sure the
answer makes sense. This is especially important when using a calculator
because it is surprisingly easy to press the wrong key.
An example of a test of reasonableness is if you use a calculator to add 36
to 44 and arrive at 110 as an answer. You should know immediately that
there is a mistake somewhere because two numbers under 50 can never total
more than 100.
When using a calculator it is always a good idea to perform a quick
estimate of the answer you expect. One way of doing this is to round off
numbers. For instance if you are adding 1,873 to 3,982 you could round
these numbers to 2,000 and 4,000 so the answer you expect from your
calculator should be in the region of 6,000.
Test your ability to perform the test of reasonableness by completing the
following short multiple choice quiz. Do not calculate the answer either
mentally or by using an electronic calculator, but try to develop a rough
estimate for what the answer should be. Then determine from the choices
presented to you which makes the most sense, i.e. the choices that are most
reasonable.
Activity 4.8 Use of test of reasonableness

Choose the correct answer purely on what appears to be most reasonable.
1 126 / 7 =
(a) 180
(b) 0.18
(c) 18
2 17 x 26 =
(a) 44.2
59
(b) 442
(c) 4,420
3 6,460 / 760 =
(a) 85
(b) 0.85
(c) 8.5
4 330 x 8.4 =
(a) 277.2
(b) 2,772
(c) 27,772
5 269 + 378 =
(a) 547
(b) 757
(c) 647
6 562 – 268 =
(a) 194
(b) 294
(c) 394
4.9 Table of equivalencies

The next activity in developing your numerical skills required for
accounting is to give you practice in converting between percentages,
decimals and fractions. It is a very useful numerical skill to be able to know
or to work out quickly the equivalent between a number given in percentage
form and in other forms.
Activity 4.9 Use of equivalencies

Fill in the correct answers for the gaps in table below. The first one is done
for you. Answers required in decimals should be rounded off to two decimal
points. Answers required in fractions should be written in the lowest possible
terms.
Percentage Decimal Fraction

1% 0.01 1/100
2%
0.05
1/10
20%
0.25
60
33.33%
0.5
2/3
75%
1.0
2/1
4.10 Manipulation of equations and

formulae
An equation is a mathematical expression that shows the relationship
between numbers through the use of the equal sign. An example of a simple
equation might be 3 + 2 = 5.
An equation could also be in the form of £5,000 – £2,000 = £3,000 to
express mathematically the accounting fact that Sales of £5,000 minus Costs
of £2,000 equals a Profit of £3,000. (An important aspect of mathematics,
but not of accounting, is that £5,000 – £2,000 = £3,000 can be simplified as
5 – 2 = 3). Another well-known use in accounting of an equation is the
accounting equation (Assets = Capital + Liabilities) which you will
explore in more detail in the next unit.
The simple equation of 3 + 2 = 5 is true as long as each of the three
numbers does not change. If one number is hidden, as long as the other two
numbers are known in our example, then the hidden third number can be
worked out easily. For example, if ‘3’ is hidden in 3 + 2 = 5, we know that
this number must be 3 in order to make the equation true.
A special type of equation is an algebraic equation where a letter, say ‘x’
represents a number, i.e. in x + 2 = 5, ‘x’ represents 3 in order to make the
equation true.
Algebraic equations are solved by manipulating the equation so that the
letter stands on its own. This is achieved in the equation x + 2 = 5 by the
following two steps.
x=5–2
x=3
The principal rule of manipulating equations is whatever is done to one side
of the equal sign must also be done to the other as was shown in step 1
above i.e.:
x = 5 – 2 is achieved by subtracting 2 from both sides of the equation x + 2
= 5, i.e.
x+2–2=5–2
x=3
Manipulating an equation to get the algebraic letter to stand on its own
involves ‘undoing’ the equation by using the inverse or opposite of the
61
original operation. In the example of x + 2 = 5, the operation of adding 2

must be undone by subtracting 2 from either side of the equal sign.
The following table shows a number of examples of how equations are
manipulated to solve the correct number for the algebraic letter.
Operation Inverse Equation Manipulation to solve

algebraic letter
add 7 subtract 7 a+7=9 a+7–7=9–7
a=2
subtract 5 add 5 b–5=6 b–5+5=6+5
b = 11
multiply divide by 3 (or multiply cx3= c x 3 / 3 = 18 / 3
by 3 by 1/3) 18 c=6
divide by multiply by 6 d/6=2 d/6x6=2x6
6 d = 12
An equation such as a x 3 = 12 can also be expressed as a3 = 12 or 3a =

12, i.e. if an algebraic letter is placed directly next to a number in an
equation it means that the letter is to be multiplied by the number. (By
convention, the number is always put before the letter, i.e. 3a not a3).
The correct number for the algebraic letter ‘a’ in the equation 3a = 12 will
be obtained thus:
3a = 12
3a / 3 = 12 / 3
a=4
Box 4.3 Manipulation of accounting equation

The accounting equation states that Assets (A) = Capital (C) +
Liabilities (L). Such an equation, which can also be abbreviated as A =
C + L, can be stated in financial terms for a particular sole trader at a
particular time:
£50,000 of Assets (A) = £40,000 of Capital (C) + £10,000 of Liabilities

(L)
3 + 2 = 5 can be expressed as 3 = 5 – 2 as well as other ways by

manipulating this equation. How can the accounting equation for our
sole trader above be expressed in different forms?
C + L = A or £40,000 + £10,000 = £50,000
C = A – L or £40,000 = £50,000 – £10,000
L = A – C or £10,000 = £50,000 – £40,000
A – L = C or £50,000 - £10,000 = £40,000
62
A – C = L or £50,000 – £40,000 = £10,000
Manipulating or rearranging formulae involves the same process as

manipulating or rearranging equations.
In the formula S = D / T, S is the subject of the formula. (This simply
means that S stands on its own and is determined by the other parts of the
formula. By convention the subject is always placed on the left-hand side of
the equal sign, although S = D / T means the same as D / T = S).
To rearrange or manipulate an equation, the formula S = D / T can also be
manipulated to make D or T the subject.
S=D/T
D / T = S (turning the formula around)
D = S x T (multiplying both sides of the formula by T)
Or, from D = S x T
D / S = T (dividing both sides of the formula by S)
T = D / S (turning the formula around)
Box 4.4 Important note about formulae

A formula is simply an equation that states a fact or rule such as S = D
/ T or Speed is equal to Distance divided by Time. The accounting
equation you will learn about in the next unit, although always
described as an ‘equation’ by convention, could be more accurately
described as the ‘accounting formula’.
Activity 4.10 Use of equations and formulae

(a) Solve the following algebraic equations:

(i) c + 9 = 11
(ii) a – 15 = 21
(iii) d x 7 = 63
(iv) b / 13 = 13
(b) Rearrange the formula h = 3dy – r to make:

(i) r the subject
(ii) y the subject
63
Activity 4.1
(a) 56
(b) 1
(c) 18
(d) 2 (Did you enter the expression in the inner brackets, i.e. (2 + 3) first?)
(e) 1
(f) 260
Activity 4.2
(a) 10
(b) 3
(c) 19
(d) 0.1346
Activity 4.3
(a)
(i) 0.57
(ii) 4.0
(iii) 107.36
(b)
(i) 0.568
(ii) 3.995
(iii) 107.356
Activity 4.4
(a)
(i) 0.125
(ii) 0.333
(iii) 0.889
(b)
(i) 1/3
(ii) 187 / 646 = 11/38 (if top and bottom both divided by 17)
(iii) 14/55
(iv) 7/6 or 1 1/6 (intermediate step is 3/6 + 4/6)
(v) 12/20 simplified to 3/5 (12 ÷ 4 / 20 ÷ 4 = 3/5)
64
Activity 4.5
Production (125 / (125 + 50 + 25)) x £135,000 = £84,375
Assembly (50 / (125 + 50 + 25)) x £135,000 = £33,750
Distribution (25 / (125 + 50 + 25)) x £135,000 = £16,875
Activity 4.6
(a)
(i) 90%
(ii) 120%
(iii) 33.33%
(iv) 3%
(v) 10%
(vi) 125% (i.e. 100 x 1.25)
(b) £65 x (1 – 0.2) = £52
(c) £36.18 / 1.2 = £30.15
Activity 4.7
(a) 6
(b) 14
(c) (2)
(d) (6)
(e) (2)
(f) 2
Activity 4.8
1 c. 18
2 b. 442
3 c. 8.5
4 b. 2,772
5 c. 647
6 b. 294
Activity 4.9
Percentage Decimal Fraction
1% 0.01 1/100
2% 0.02 1/50
5% 0.05 1/20
10% 0.1 1/10
20% 0.2 1/5
65
25% 0.25 1/4

33.33% 0.33 1/3
50% 0.5 1/2
66.67% 0.67 2/3
75% 0.75 3/4
100% 1.0 1/1
200% 2.0 2/1
Activity 4.10
(a)
(i) c = 2
(ii) a = 36
(iii) d = 9
(iv) b = 169
(b)
(i)
h = 3dy – r
h + r = 3dy
r = 3dy – h
(ii)
h = 3dy – r
h + r = 3dy
3dy = h + r
y = (h + r) / 3d (Did you remember to use brackets?)
Summary
A competent accountant should have the confidence and ability, both
mentally and using a calculator, to be able to add, subtract, multiply and
divide, as well as use decimals, fractions and percentages. Completing
tables of equivalencies is a good way of practicing converting between
percentages, decimals and fractions. All accountants should be able to
manipulate simple equations and formulae. The most important equation in
accounting is the accounting equation, which states that assets (A) = capital
(C) + liabilities (L).
66
Chapter 5 Essential spreadsheet skills for accounting
Chapter 5 Essential spreadsheet

skills for accounting
Introduction
. understand and explain the purpose of spreadsheets

. describe and explain the typical features of a worksheet
. describe how spreadsheet skills can be further developed
. understand the limitations of using spreadsheets.
Spreadsheets need to be used in many of the tasks required of bookkeepers
and accountants. Almost all numerical accounting problems can be solved
using a spreadsheet – indeed the term has been borrowed from accounting.
Being able to produce and use effective spreadsheets is a core skill of any
bookkeeper or accountant in today’s world. Only basic level spreadsheet
skills are required for B124. You are, however, strongly encouraged to
develop these skills. Spreadsheets can be used whenever numerical data
needs to be presented, calculated, analysed and manipulated. This can vary
from a quick calculation using one cell in one worksheet to long and
complex financial statements involving a number of worksheets that are
linked.
5.1 What is a spreadsheet?

A spreadsheet is an electronic file consisting of a number of worksheets.
Worksheets are often described as pages of a spreadsheet. Each worksheet
can be seen as an electronic table divided into horizontal rows and vertical
columns. The most widely used spreadsheet is Microsoft Excel.
5.2 What are the typical features of

worksheets within a spreadsheet?
A typical worksheet includes three data types: labels (column and row
headings), numerical values and formulae or calculations. The three basic
types of data in a worksheet can be summarised in the table below:
The three basic types of data in a worksheet
Data types Examples Descriptions

Label Name or May or Product Z12 Any text
Constant 3 or 2.89 or –9.8 Any number
Formula = 5 + 3 or = 3 * (9 – 5) Maths equation
67
5.3 How can spreadsheet skills be

developed?
Information on using Excel is freely available in the comprehensive Help
menu on Excel, on the Microsoft website and on many other websites.
Simply putting a question on Excel directly into a search engine such as
Google or Yahoo often gets a quick, clear answer. Other ways to learn the
features of Excel more fully would be to buy or borrow from the library
any of the many books on learning Excel. Finally, training programs will
help you learn the more advanced features of Excel.
Stop and reflect

The best way for students to improve their spreadsheet skills is to use
spreadsheets as much as possible. What personal and family activities,
financial and non-financial, might benefit from a spreadsheet?
You might use a spreadsheet for the following:
. budgets
. tax returns
. producing your own bank statement to make sure an external bank
statement is correct
. checking credit card statements
. checking mortgage statements
. phone and address lists
. calorie counts
. cost analyses and comparisons.
5.4 What are the limitations of using

spreadsheets?
Spreadsheets normally only display the underlying formula of the active cell
in the formula bar above the Row headings. It is, however, possible to see
all the formulae for all the relevant cells in a worksheet. This enables you
to see how the worksheet works in detail. In Excel this can be done in at
least the following two ways:
1 Press Ctrl + ` (the latter is the key above the Tab key on the keyboard).
Press Ctrl + ` again to get the standard display with the formulae
hidden.
68
Chapter 5 Essential spreadsheet skills for accounting
2 On the Formulas tab, click Show Formulas in the Formula Auditing

group to display the formulas in your worksheet. Click Show Formulas
again to get the standard display with the formulae hidden.
A further limitation of spreadsheets is that it can be easy and tempting to
quickly create spreadsheets that are obscure and unintelligible to anyone
other than the creator. It is, therefore, a good idea to make sure spreadsheets
are clear and logical and can be easily understood by others without any
explanation. Finally, the presence of errors may not be obvious, creating a
dangerous over confidence in calculation results.
Spreadsheets have been used extensively in this module because they are a
very effective financial tool used by accountants in their day-to-day work.
They can be used whenever financial data needs to be recorded, analysed,
summarised and presented. Spreadsheets, however, have limitations in
computerised accounting which have largely been solved by the use of
integrated accounting packages that you will be introduced to in Unit 6.
Unit 6 will also examine the benefits of an integrated accounting package.
5.5 How has the use of spreadsheets

evolved in accounting over the past 40
years?
When spreadsheets first appeared in the late 1970s they were swiftly
adopted by accountants and accounting software developers. They used
them as the basis for computerised accounting systems, which were capable
of producing income statements and balance sheets from original data
entries (Figure 5.1). As will be shown in B124, spreadsheets can be set up
as computerised accounting systems. However, spreadsheets are seldom
used now as the basis for accounting systems despite their proven ability to
record, summarise and present financial data. Spreadsheets are still widely
used by accountants but much more so in the area of data calculation and
analysis than in other uses, such as the recording of transactions.
Before learning how a computerised double-entry accounting system works,
it is important to understand a manual system because it gives a clearer
picture of every step that is involved. (The same core principles and
concepts underpin any double-entry accounting system, whether manual or
computerised.) A manual double-entry accounting system will thus be
explained in detail in Units 2–5 where you will be shown, step-by-step, how
every expense and sales transaction, whether for cash or credit, is ultimately
reflected in both the income statement and the balance sheet.
69
Figure 5.1 A young Bill Gates and the famous computer spreadsheet, Excel
Summary
A spreadsheet is an electronic file consisting of a number of worksheets.
The three basic types of data in a worksheet are labels (i.e. text), values
(i.e. numbers) and formulae (i.e. maths equations). The most important
advantage of a spreadsheet is that it allows the user to easily change the
source data and have all related calculations immediately updated. A
powerful feature of spreadsheets is that one worksheet can be linked to
another. Linked spreadsheets can be used as the basis of a double-entry
accounting system. Such an accounting system has limitations that have
been addressed by modern integrated accounting packages.
70
Book summary
Book summary
You have now reached the end of Book 1.
In Chapter 1 you learned about the purpose of bookkeeping and accounting
as well as the development of double-entry accounting. You also learned
about the difference between financial and management accounting and the
three major functions of double-entry accounting.
In Chapter 2 you learned about the main source documents used for
identifying and recording financial transactions. This chapter also explained
the difference between cash and credit transaction cycles and the key
differences between accounting cycles and transaction cycles.
In Chapter 3 you learned about the skills and knowledge required for the
professional accountant. An important obligation of such a professional is to
understand and practice five fundamental ethical principles.
In Chapter 4 you learned about the essential numerical skills needed for
accounting. An important aspect of such a skill is to be able to convert
accurately and quickly between fractions, ratios and percentages.
In Chapter 5 you learned the purpose of spreadsheets and the typical
features of a worksheet. This chapter also explained the limitations of using
spreadsheets as well as how you can further develop your spreadsheet skills.
71
Self-assessed questions
It is important that you attempt to answer the question yourself first and only then
check the suggested solutions, which are in the next section.
SAQ 1
(a) Explain the concept of stewardship in accounting.
(b) Identify and briefly explain a stewardship role that you are undertaking
at the moment in your personal, social or working life. What would you
do to improve your performance in this role?
SAQ 2
Discuss five aspects of financial accounting which distinguish it from
management accounting.
SAQ 3
(a) Read the case study below about an imaginary small accounting practice
and answer the question that follows.
Peta Lee is a junior in a small accounting practice. She has only
recently been appointed to this training position and is keen to make as
good impression as possible. Although she is a keen fan of a local
rugby team, Glampin RFC, she is determined to keep this quiet as the
partners of the practice appear to be extremely enthusiastic and
committed football fans.
A partner has now asked Peta if she is interested in rugby because the
practice would like her to assist with preparing the final accounts for
Glampin. Peta replied that, although she was not interested in rugby, she
would be prepared to help with the accounts.
When Peta needed to visit the rugby club she discovered that the club
treasurer was someone she had got to know well from being a
supporter. Peta feels this should not affect her work performance so has
decided not to disclose her familiarity with the treasurer. At this stage
Peta also feels too embarrassed to admit her interest in rugby and her
keen support for Glampin to the accounting practice partner.
Required
Criticise the behaviour of Peta, clearly identifying the two fundamental
ethical principles of professional accounting she has most obviously
failed to meet.
72
(b)
(i) Outline at least ten items of information that should be
included in a sales invoice that is given to a credit customer by
a retailer. Assume that the retailer is VAT registered.
(ii) The retailer in b (i) has a computerised accounting system.
What items of information included in your answer to b (i)
may help the retailer to track any customer queries or payment
delays. How would this be done?
Solution to self-assessed questions
SAQ 1 solution
(a) Historically, a steward was an agent or manager who looked after
money and/or resources on behalf of the owner. Part of the steward’s
responsibility was to provide accurate and up-to-date financial
information so that the owner, who was often absent, could have
reliable records of how their resources were managed. Accountants
assist stewards in providing financial information relating to resources
stewards control, but do not own. The idea of stewardship now has a
wider meaning. It means that accountants are expected not just to
follow all legal requirements in financial reporting but also in every way
that a business conducts itself. This also involves proper care and
control over all the assets of the business.
(b) It is not possible to give a solution to this question as the answer should
apply knowledge of good stewardship to a unique, personal situation. In
explaining how stewardship performance can be improved, the answer
could include following the seven qualities of useful information and
the five fundamental ethical principles of professional accountants.
SAQ 2 solution
(a) The table below could be used as the basis of a discussion about any
five aspects of financial accounting that distinguish it from management
accounting.
Aspect Financial accounting Management accounting

statements by owners or reports for owners and
managers as a formal report managers to decide and plan
of their stewardship activities and to control them.
responsibility.
Perspective Gives information about past Gives comparative and up-to-
performance. Only available date information about
several months after period performance.
end.
73
Timing of Normally annually, but Normally prepared on a

information depending on type of monthly basis, but can
business may be every three sometimes be required at
or six months as well. very short notice.
Regulatory Financial statements need to Management reports can be
authority be presented according to in any form needed.
the requirements of
government and the
appropriate accounting
regulators.
Accuracy level Need to be thoroughly Complete accuracy may need
checked in order to be as to be less important than
accurate as possible. making sure information is up
to date and relevant.
Auditing Required for certain Not required.
requirement enterprises such as public
companies and larger
registered charities.
SAQ 3 solution
(a) The fundamental principles that Peta has breached in the case study are
integrity and objectivity.
Peta has not been straightforward and honest in her professional and
business relationship with the partners of her accounting practice. She
continually denies the truth of her interest in rugby even when it means
that she may have a conflict of interest in working with the treasurer
she knows well. Peta’s lack of integrity has clearly undermined her
work performance.
Peta has allowed a bias that football fans such as the partners may hold
it against her that she is a rugby supporter. This bias seems to override
her professional judgement. Peta’s lack of objectivity is also apparent
from her familiarity with the rugby club treasurer that she is failing to
disclose. This familiarity may potentially undermine her ability to
perform her work role properly.
(b)
(i) A sales invoice for a credit customer should include the
following information as a minimum:
◦ the name and address of the supplier

◦ the name and address of the customer
◦ the invoice date
◦ the invoice number
◦ the VAT registration number
◦ the delivery note number (if already delivered)
◦ the customer’s account number
◦ the details of the goods
◦ the details of the price (including VAT)
◦ the terms of delivery
◦ the terms of payment
74
◦ payment instructions including the supplier’s bank account

details
(ii) The invoice number and the customer’s account number should
both be unique sequential numbers or alphanumeric digits. This
makes it much easier to find information as required in a
computerised record keeping system. It could be useful when
the customer queries an invoice as by just inputting the unique
number into the system all related details of the invoice will be
instantly and correctly pulled up. The customer’s unique
account number could be entered into the accounting system to
get an instant and up-to-date report of the details of any unpaid
invoices including the time in days since the invoice. This
computer-generated report could be linked to a customer
statement report in order to send out an appropriate reminder,
perhaps by email, within seconds.
75
References
Bentley, T. J. (1998) Managing Information: Avoiding Overload, London:
Chartered Institute of Management Accountants, Kogan Page.
Black, G. (2005) Introduction to Accounting and Finance, London: Pearson
Education Limited.
Gleeson-White, J. (2012) Double Entry: How the Merchants of Venice Created
Modern Finance, New York: W. W. Norton & Company.
Goethe, J. (1795/1977) Wilhelm Meister's Years of Apprenticeship, trans. H. M.
Waidson, London: Calder.
IASB (2010) The Conceptual Framework for Financial Reporting, London:
IASB publications.
IFAC (2006) International Federation of Accountant’s Ethics Committee Code
of Ethics for Professional Accountants. Available at https://www.ifac.org/
system/files/publications/files/ifac-code-of-ethics-for.pdf (Accessed: 8
October 2015).
Income Tax Act (2007) Income Tax Act 2007, Part 16, Chapter 1, Section 997.
Available at http://www.legislation.gov.uk/ukpga/2007/3/pdfs/
ukpga_20070003_en.pdf (Accessed: 30 September 2015).
White, S. (2012) ‘Business population estimates for the UK and regions 2012’,
Department for Business, Innovation and Skills Statistical Release. Available at
https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/
80247/bpe-2012-stats-release-4.pdf (Accessed: 30 September 2015).
76
Acknowledgements
Acknowledgements
Book 1 Cover image: © The Art Archive / Alamy Stock Photo
Page 5 © traveler1116/iStockphoto.com
Figure 1.1 © The Art Archive/Alamy Stock Photo
Page 30 © hanhanpeggy/iStockphoto.com
Page 71 Taken from flickr.com and used under Creative Commons 2.0 (c)
Microsoft Sweden https://creativecommons.org/licenses/by/2.0/
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B124

Written by Jonathan Winship

The Open University, Walton Hall, Milton Keynes MK7 6AA

ISBN 978 1 4730 04405

. Sole traders or sole proprietorships still comprise the majority of for-

What advantages are conferred on the trader by double-entry

analysis can assist managers in improving the performance of an

. What are the resources of the enterprise?

Book 1 consists of ﬁve chapters

Chapter 2 covers the importance of record keeping and other control

Chapter 4 illustrates the importance of numerical skills for both ﬁnancial

Chapter 5 focuses on the importance of spreadsheets in presenting,

number of simple spreadsheet activities to improve your spreadsheet

. understand and explain the purpose and role of accounting within

Chapter 1 The purpose of

. understand and explain the purpose and role of bookkeeping and

1.1 Bookkeeping and accounting

1.1.1 The characteristics of good quality information

. Relevance – Information is relevant if it helps users make decisions.

Box 1.1 The IASB and the international accounting

In its conceptual framework the IASB identiﬁes two fundamental

. the beneﬁt of any information does not exceed the cost

Activity 1.1 The qualities of useful information

Eight qualities of useful Which sentence best explains the

It is vital that all stakeholders and decision makers in an organisation get

1.1.2 The four fundamental ﬁnancial questions

Activity 1.2 Understanding assets and liabilities

Item Asset or liability

Box 1.2 What exactly is a sole trader?

Stop and reﬂect

The amount of cash any business has made or lost in a period is

1.1.3 Capital in accounting

learned, the money ‘owing’ to the owners is known as capital. (More

Box 1.3 Accounting records and the business entity

1.2 The development of double-entry

Figure 1.1 Luca Pacioli, the 'Father of accounting'

Box 1.4 The unlimited liability of Italian medieval

1.3 The three main functions of

Activity 1.3 User information needs

suppliers. The customers have come to rely on a three-year guarantee of the

User Internal/External Information needs

documented evidence, such as accounting records and reports, to conﬁrm

1.3.3 Management planning and decision-making

Stop and reﬂect

Today, computers allow all ﬁnancial and other relevant records to be

An important aspect of management decision-making is making plans for

1.4 Financial and management accounting

These statements will also be of interest to managers of an organisation, but

Box 1.5 Using the same accounting record for all

In the next activity you will have an opportunity to develop a better

Activity 1.4 Understanding the differences between ﬁnancial and

Financial accounting Management accounting

Chief purpose The production of The production of detailed

Activity 1.5 Why managers beneﬁt from understanding double-

You have a good knowledge of double-entry accounting compared to the

Sometimes a manager needs to exercise a stewardship function as in the

manager should normally be able to make informed and correct decisions

Activity 1.1 The qualities of useful information

Quality required Explanation