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Understanding Accounts New Welcome to the Financial Management module on Understanding Accounts. This module is part of a series of e-learning modules designed to foster and develop the financial management skills of people working in global health. Each module will offer an opportunity to learn from experienced managers and to engage in learning activities that are designed to apply the skills and concepts to your own professional setting. 1 This e-learning module was produced by the University of Washington Department of Global Health, based on content from the Financial Management Essentials Handbook developed by Mango. Mango is an award-winning UK charity whose mission is to strengthen the financial management and accountability of Non Governmental Organizations around the world by providing innovative, high-quality, in-person trainings, consultancy and recruitment services. This module provides an overview of the basic content, but not the full experience of attending one of Mango’s practical and participatory training courses, where the motto is “Taking the Fear out of Finance”. A library of Mango’s own publications, as well as information about their services and their Open Training program can be found at the Mango website. We encourage you to visit this resource of information on financial management and accountability. 2 When you have completed this lesson, you’ll be able to explain why it is important for an organization to keep accounts. You will be able to describe the different methods used to keep track of financial transactions and you will understand which accounting records your organization should keep. You will be able to define key financial accounting concepts and terminology. Finally you will be able to describe the financial statements which are prepared from the accounts. 3 Accounts are records. Keeping accounts means devising appropriate methods for storing financial information so that the organization can show how it has spent its money and where the funds came from. Why it is important to keep accounts? Good financial records are the basis for sound financial management of your organization. Well-documented accounts help an organization by providing information and credibility. Accounts frequently satisfy a legal requirement and provide the information necessary for effective planning. All organizations need to keep records of their financial transactions so that they can access information about their financial position, including: a summary of INCOME & EXPENDITURE and how these are allocated under various categories, the OUTCOME of all operations – surplus or deficit, net income or net expenditure, and ASSETS and LIABILITIES –what the organization owns and owes to others. Accurate accounts demonstrate that an organization is scrupulous in their handling of money – keeping accurate financial records promotes integrity, accountability, and transparency and avoids suspicion of dishonesty. There is often a statutory obligation to keep and publish accounts. Donor agencies sometimes require audited accounts as a condition of grant aid. 4 Although financial accounting information is historical, it will help managers to plan for the future and understand more about the operations of the organization. With information spanning two or three years, it is possible to detect trends. 4 Records can be kept in a manual format (as in hardback books of accounts) or in a computerized format with one of the many accounting programs available. Regardless of whether you keep accounts on a computer or with pen and paper, you will need to choose which of the two methods you will use to keep accounts: cash accounting or accruals accounting. They differ in a number of ways but the crucial difference is in how they deal with the timing of the two types of financial transactions, cash and credit. Cash transactions have no time delay since the trading and exchange of monies takes place simultaneously. Credit transactions are different in that they involve a time lag between the contract and payment of money for the goods or services. You will soon see how the method we choose to record transactions (either cash accounting or accruals accounting) will produce different financial information. It is important that managers know the method of keeping accounts to better understand financial reports. Let’s look a little more closely at the method of Cash Accounting so you can see how it works, what information it provides and what it may not provide. 5 Cash accounting is the simplest way to keep accounting records and does not require advanced bookkeeping skills to maintain. When using a cash accounting system, payment transactions are recorded in a Bank (or Cash) Book as and when they are made and incoming transactions are recorded as and when they are received. The system takes no account of time lags and any bills which might be outstanding. The system does not automatically maintain a record of any money owed by or to the organization. The system also cannot record non-cash transactions such as a donation in kind or depreciation. The records produce a Receipts and Payments Account for a given period. This simply shows the movement of cash in and out of the organization and the cash balances at any given time. 6 Accruals accounting is more advanced and requires accounting skills to maintain. Expenses are recorded in the General Ledger as they are incurred, rather than when the bill is actually paid; and income is recognized as it is earned, for example, when an invoice is issued, rather than when received. By recognizing financial obligations when they occur, not when they are paid or received, this overcomes the problem of time lags, giving a truer picture of the financial position. The system can deal with all types of transactions and adjustments. The system automatically builds in up-to-date information on assets and liabilities. These records provide an Income and Expenditure Account summarizing all income and expenditure committed during a given period; and a Balance Sheet which demonstrates, amongst other things, moneys owed to and by the organization on the last day of the period. 7 Accruals accounting involves ‘double entry’ bookkeeping which refers to the dual aspects of recording financial transactions. ‘Double Entry’ bookkeeping recognizes that there are always two parties involved: the giver and the receiver. The dual aspects are referred to as debits and credits. Outgoing payments, or expenditures, are debits. Incoming transactions are credits. 8 In summary, Cash accounting is single-entry, handles all transactions as cash transactions, results in a record of receipts and payments, is recorded in a bank (or cash) book, requires only basic bookkeeping skills, cannot account for non-cash transactions, does not account for assets and liabilities, and produces a receipt and payment report. Accruals accounting uses a ‘double entry’ bookkeeping system accounting for debits and credits, handles cash and credit transactions, results in a record of income and expenditures, is recorded in a general (or nominal ) ledger, requires advanced bookkeeping skills, can account for non-cash transactions, accounts for assets and liabilities, and produces an income and expenditure report with a balance sheet. 9 Before we said that there are two methods to keep accounts. In fact we can add another approach. Many organizations adopt a hybrid approach: they use the cash accounting basis during the year and then convert (often with the help of the auditor) the summarized figures at the year-end (or more frequently) to an accruals basis for the final accounts and audit. This includes keeping separate books to record and identify accruals and prepayments, and unspent grants and capital purchases during the accounting period. 10 Now that we have a better understanding of why account records are important, and we know the different methods for keeping track of transactions (cash, accrual and hybrid) let’ delve into HOW you can keep good accounts. Every organization needs to keep accounting records, but WHICH accounting records are right for your organization? For a small organization with few financial transactions, a simple bookkeeping system is all that is needed. As an organization grows and takes on a number of projects and different sources of funding, its reporting requirements, and therefore its financial systems, will become more sophisticated. First we will consider the implementation of a basic Cash Accounting system, before looking at a full bookkeeping system necessary to implement an Accruals Accounting system. Every system, regardless of sophistication will require the handling of two main categories of records: Supporting Documentation and Books of Accounts. 11 Accounting records fall into two main categories: Supporting Documents and Books of Accounts. Every organization should keep files of the following original documents to support every transaction taking place: • Receipts or vouchers for money received • Receipts or vouchers for money paid out • Invoices – certified and stamped as paid • Bank paying-in vouchers stamped and dated when money is taken to the bank • Bank statements • Journal vouchers – for one-off adjustments and non-cash transactions. With these documents on file it will always be possible to construct a set of accounts. Other useful supporting documents include: • Payment Vouchers (PVs) • Local Purchase Orders (LPOs) and • Goods Received Notes (GRNs) The minimum requirements for books of accounts are: Bank (or Cash) Book for each bank account and a Petty Cash Book. For organizations with salaried staff, valuable equipment and significant levels of stock, the following records, where relevant, may also be kept as part of a full bookkeeping system: • General (Nominal) Ledger • A journal or Day Book 12 • A Wages Book • An Assets Register • And a Stock Control Book 12 It is important to maintain supporting documents in the form of receipts or vouchers for all financial transactions. These should be cross-referenced to the books of accounts and filed in date or numerical order. Receipts can explain when transactions take place, how much money was transacted, with whom the transaction took place, and for what purpose.
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