The 30 Day MBA Read Online Free PDF Page A

every indication of wanting to buy again. Most of us know quite different salespeople who can ‘anticipate’ the most unlikely volume of sales. In accounting, income is usually recognized as having been earned when the goods (or services) are dispatched and the invoice sent out. This has nothing to do with when an order is received, how firm an order is or how likely a customer is to pay up promptly. It is also possible that some of the products dispatched may be returned at some later date – perhaps for quality reasons. This means that income, and consequently profit, can be brought into the business in one period and has to be removed later on.
    Obviously, if these returns can be estimated accurately, then an adjustment can be made to income at the time. So the ‘sales income’ figure that is seen at the top of a profit and loss account is the value of the goods dispatched and invoiced to customers in the period in question.
    The accrual concept
    The profit and loss account sets out to ‘match’ income and expenditure to the appropriate time period. It is only in this way that the profit for the period can be realistically calculated. Suppose, for example, that you are calculating one month’s profits when the quarterly telephone bill comes in. The picture might look like Table 1.2 .
    TABLE 1.2    Example of a badly matched profit and loss account
Profit and loss account for January, year 20XX
$/£/€
Sales income for January
4,000
Less telephone bill (last quarter)
800
Profit before other expenses
3,200
    This is clearly wrong. In the first place, three months’ telephone charges have been ‘matched’ against one month’s sales. Equally wrong is charging anything other than January’s telephone bill against January’s income. Unfortunately, bills such as this are rarely to hand when you want the accounts, so in practice the telephone bill is ‘accrued’ for. The figure (which may even be absolutely correct if you have a meter) is put in as a provision to meet this liability when it becomes due.
    Accounting conventions
    These concepts provide a useful set of ground rules, but they are open to a range of possible interpretations. Over time, a generally accepted approach to how the concepts are applied has been arrived at. This approach hinges on the use of three conventions: conservatism, materiality and consistency.
    Conservatism
    Accountants are often viewed as merchants of gloom, always prone to take a pessimistic point of view. The fact that a point of view has to be taken at all is the root of the problem. The convention of conservatism means that, given a choice, the accountant takes the figure that will result in a lower end profit. This might mean, for example, taking the higher of two possibleexpense figures. Few people are upset if the profit figure at the end of the day is higher than earlier estimates. The converse is never true.
    Materiality
    A strict interpretation of depreciation (see above) could lead to all sorts of trivial paperwork. For example, pencil sharpeners, staplers and paperclips, all theoretically items of fixed assets, should be depreciated over their working lives. This is obviously a useless exercise and in practice these items are written-off when they are bought.
    Clearly, the level of ‘materiality’ is not the same for all businesses. A multinational might not keep meticulous records of every item of machinery under £1,000. For a small business this may represent all the machinery it has.
    Consistency
    Even with the help of those concepts and conventions, there is a fair degree of latitude in how you can record and interpret financial information. You should choose the methods that give the fairest picture of how the firm is performing and stick with them. It is very difficult to keep track of events in a business that is always changing its accounting methods. This does not mean that you are stuck with