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 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 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 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 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 .

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. are recorded in the General 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 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 . 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, 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 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.

Apart from being required by the external auditor to support the audit trail, certified receipts also provide protection to those handling money. Mislaid or incomplete records can result in suspicion of mismanagement of funds.

Keep separate files for receipts for money coming into the organization and money going out. Mark invoices ‘paid’ with the date and check number to prevent their fraudulent re-use by an unscrupulous person. Well-maintained files provide invaluable information to the organization such as the trends in price increases, details of equipment purchased, past discounts, etc.

13 The Bank Book – or Cash Book or Cash Analysis Book – is the main book of account for recording bank transactions (otherwise known as ‘cash’ transactions). It is normal to maintain a separate Bank Book for each bank account held as this makes it easier to reconcile each account at the end of the month.

With a manual (paper based) Bank Book, receipts are usually entered on the left side and payments on the right and each page is ruled into columns. The number of columns required will depend on the type and volume of transactions. Each transaction is entered on one line of either the Receipts page or the Payments page in date order. The column headings prompt you to enter key information – for example, date, check number, payee, description, amount, category of transaction, etc. The columns are totalled at the end of each page or accounting period.

The columns under the Categories header are analysis columns and include the main categories of income and expenditure as identified in your and your budget. These are what make the Bank Book such a useful record. They allow you to sort and summarize transactions by budget category which in turn helps to compile financial reports quickly and easily.

14 The Bank Book should be checked with the bank’s records – the bank statement – at least once a month. This is called the . The purpose of this process is to make sure that the organization’s own records agree with the bank’s records and to pick up any errors made by the bank or the organization.

A bank reconciliation involves taking the closing bank statement balance for a particular date and comparing it to the closing Bank Book balance for the same date. If there is a difference between these two closing balance figures, the difference must then be explained.

In practice, there will almost always be a difference because of timing delays, such as: • Money paid into the bank which is not yet showing in the bank’s records. • Checks issued to a supplier but not yet banked by the supplier. • Bank charges and bank interest which get added to the bank statement by the bank periodically. • Errors either made by the bank or when recording entries in the Bank Book.

15 This table summarizes the reconciliation process and actions to take when discrepancies are discovered.

For example, if the cash book reflects a payment to a supplier, but the bank statement does not, it is important to look for the transaction in the bank statement next month and contact the supplier if the transaction is older than two months.

Take a few moments to familiarize yourself with this table.

16 Petty cash records are kept in a similar way to the Bank Book records. As both sets of figures will eventually have to be combined to produce financial reports, it makes sense to set out the books in a consistent manner.

The Petty Cash Book can either be kept in a loose leaf or bound book format. It does not however, require more than one column on the Receipts side because the only money that is paid into petty cash is the float reimbursement and therefore not attributable to other categories. The Petty Cash Book may require fewer analysis columns for payments because petty cash will not usually be used to pay for larger items such as salaries, office rent, etc.

There are two ways of keeping petty cash: the fixed float or imprest system; and the variable or non-imprest system.

With the fixed float or imprest system you have a fixed float of, say, $50 and when the cash balance gets low, you top up the float by exactly the same amount that you have spent since the float was last reimbursed.

With the variable float, or non-imprest method, cash is drawn from the bank in round sums as required.

17 With the fixed float or imprest system you have a fixed float – an established amount - of, say, $50 and when the petty cash is reconciled on a daily, weekly or monthly basis, you add exactly the same amount that you have spent since the float was last reimbursed.

In this example of a 50 dollar fixed float, the balance after $34.60 was spent is $15.40. The float amount is 50 dollars. 50 minus 15.40 is $34.60. Therefore, $34.60 is added to the balance.

An advantage of this system is that at any time you count the petty cash plus receipts, they should always add up to the fixed float amount. Also, it is much easier to incorporate petty cash spending into the accounts as the reimbursement check is entered in the analyzed Bank Book.

18 The variable float, or non-imprest method, is more complicated and time consuming. With the variable float method, cash is drawn from the bank in round sums as required.

When using the non-imprest method an extra column is added in the Bank Book headed ‘petty cash withdrawn’. When reconciling this float you will have to add up all the petty cash withdrawals since the last reconciliation and add on the cash balance brought forward to get a total of the cash float for the period. This total should then be the same as the total spent since the last reconciliation plus the remaining petty cash.

19 Organizations requiring a full bookkeeping system use a series of (books of account), depending on the activities of the organization. The is a central record which pulls together basic bookkeeping information from the main working books of account (Bank/Cash Book, Petty Cash Book, Sales and Purchase Ledgers). It is used to sort basic financial information and is especially useful when an organization has several projects and different donors requiring different reports. The General Ledger (sometimes called the Nominal Ledger) has one page for each category of income, expenditure, assets and liabilities and information is ‘posted’ from the other accounting books into each category. The General Ledger plays a central role in the double-entry bookkeeping system and is the basis for the , the starting point for preparation of financial statements. Other elements in a full-bookkeeping system include: • A Sales ledger and a sales day book (if you have sales) • A Purchase ledger and purchase day book • A Stock ledger • And a Journal

These, together with the Bank/Cash Book and Petty Cash Book are the day-to-day working accounts books. It is possible to set up a General Ledger without these additional ledgers; the choice will depend on the activities of your organization. The Journal is used to record unusual, one-off transactions which cannot be recorded easily in other books of accounts. These will include non-cash transactions (such as

20 depreciation and donations), adjustments and corrections. A journal entry follows the rules of double entry and will always include entries to at least two accounts. For example, a donation-in-kind in the form of rent-free office space would be recorded as income under ‘Donations’ and expenditure under ‘Office Rent’.

Employers have a statutory duty to maintain records of all wages paid and deductions made and failure to do so could result in a heavy fine. Be sure to familiarize yourselves with the arrangements of your own Department of Taxes and get hold of the latest tax deduction tables.

Larger organizations should also keep a separate Wages Book, which brings together all information on staff salaries and deductions. This helps facilitate the year-end reconciliation or available as add-ons to accounting software packages.

20 The Trial Balance is simply an arithmetic check on the accounts maintained using the Double Entry method of accounting. It is also the basis for the preparation of accruals-based financial statements.

At the end of an accounting period – usually monthly – all the accounts categories having a balance in the General Ledger are listed on a summary sheet to form a Trial Balance. Providing no errors have crept in during the recording and summarizing stages, the total of debit balances on the list will equal the total of the credit balances.

21 Now let’s talk about how this all fits together. This diagram shows how the Trial Balance is the final stage of the accounting process – the result of recording, classifying and summarizing the many different transactions that take place in an organization. Take a few moments to familiarize yourself with this process.

22 Financial statements are a product of the financial accounting process. They are a summary of all the transactions for a specified period that show the financial position of an organization.

Financial statements can cover any period of time – for example, a month, a quarter or one year. The annual financial statements are used as the basis for an annual external audit.

The simplest of all financial statements is the Receipts and Payments report. This is a summary of the Cashbook and includes details of cash balances at the start and end of the reporting period.

The other two main reports relevant to organizations are the Income and Expenditure report and the Balance Sheet.

To download an example of the Receipts and Payment report, an Income and Expenditure Report, and a Balance sheet, click the “Attachments” link above.

When you are ready, click the forward button to continue.

23 The Income and Expenditure Report (or Account) is the equivalent of the Profit and Loss Account for not-for profit organizations. It is produced either from a Trial Balance where the accruals-based system of accounting is used; or it is based on a Receipts and Payments account with adjustments for loose ends like depreciation, accruals and prepaid items.

It records as a summary: • all categories of income and expenditure which belong to that year; • all income not yet received but belonging to that financial year; such as Training Fees (receivables) • all payments not yet paid but belonging to that financial year; such as Telephone and Fax.

Income items usually appear first in a list down the page, followed by the summary of expenditure items. The difference between total income and total expenditure, often called the outcome, appears on the bottom line and is expressed either as:

• ‘excess of income over expenditure’ where there is a surplus; or • ‘excess of expenditure over income’ where there is a deficit.

This excess figure is then included on the Balance Sheet under the heading Accumulated Funds. Note that there should be an accompanying Balance Sheet for

24 the same date that the Income and Expenditure Account is prepared for.

24 The balance sheet is a list of all the assets and liabilities on one particular date and provides a ‘snapshot’ of the financial position of an organization.

The purpose of a Balance Sheet is to assess the financial position – or ‘net worth’ – of an organization at a given date. If the organization ceased operating at that date and all of its assets were converted into cash, and all of its debts were paid off, then what was left over would be what the organization was ‘worth’.

The Balance sheet has two parts. One part records all balances on assets accounts; the other records all balances on liabilities accounts plus the income and expenditure account balance. The Balance Sheet will either be presented with the Assets listed on the left and the Liabilities presented on the right of the page, or more commonly nowadays, listed down the page with Assets presented first then Liabilities deducted from them as used in this example.

25 Other important terms to understand are Liquidity and Working Capital.

The term liquidity is used to describe how easy or otherwise how difficult it is for assets to be turned into cash. So money held in a bank account is deemed to be very liquid, while money tied up in fixed assets like a building is clearly not liquid at all.

Working Capital is the same as net current assets, that is, the short-term assets remaining if all immediate debts were paid off. These are the funds that the organization has available as a cushion or safety net for running the organization’s operations.

26 Capital expenditure, such as that on buildings, computer equipment and vehicles, is expenditure which covers more than one accounting period and retains some value to the organization.

Depreciation is the way that deal with the cost of wear and tear on fixed assets. It allows the original cost of the item to be spread over its ‘useful life’.

The amount calculated for depreciation is shown as an in the accounts and deducted from the previous value of the . As it is a non-cash transaction, depreciation is entered in the accounts using a journal entry.

There are several methods used to calculate the cost of depreciating assets, but the two most commonly used are: Straight Line method and Reducing Balance method

In the Straight Line method the amount to be depreciated is spread evenly over a pre- arranged period.

For example, a computer purchased for 1,000 US Dollars expected to last for 4 years will be depreciated at 250 US Dollars per year for 4 years. At the end of 4 years the computer will have a zero net book value – in other words, it will have no value as far as the accounts are concerned. In reality, it may have a second hand market value.

27 The Reducing Balance method fixes a percentage reduction in value so that the item loses more value in the earlier years.

For example, a car is purchased for 10,000 US Dollars. It is decided to depreciate it at the Net Book Value over 4 years – that is, by 25% per year. This table shows how the equipment is depreciated over its useful life (figures are rounded to nearest dollar). Note that when using this method, the asset is never completely written off. At the end of the 4th year it will still have a residual value. In this example, the car will be valued in the accounts at 3,164 US Dollars. This recognizes that the item may have a resale value when it comes to replacing it.

27 Some costs cover more than one project or activity. In this case, it is important to identify which activities the costs should be charged to.

There are two types of shared costs: • Those that are truly direct costs and belong to two or more projects • Those that are truly indirect costs that must to be shared across all projects in the organization.

For truly direct project costs – for example, the cost of using a shared vehicle for project activities – these must be allocated according to actual use to the relevant project cost center. It is best to make the allocation when the transaction is entered into the accounting records.

For truly indirect costs – for example, central support costs such as the central office running costs or the annual audit fee – these must be apportioned in a fair and justifiable way across all cost centers.

Central support costs are often shared between cost centres in a pre-arranged ratio. This is commonly entered in the accounting records or at the end of the reporting period by making one adjustment entry.

The decision on how to apportion costs between cost centers can be based on

28 different criteria according to what is known as the cost driver, for example: • Full-time equivalent (FTE) staff • Number of cost centers • Size of each project budget • Project staff costs • And amount of space used by a department.

There is no hard and fast rule for apportioning central support costs to projects. It should however be logical, transparent and consistently applied.

28 To recap what we covered in today’s lesson: You should now have a better understanding and awareness of why it is important for an organization to keep accounts.

You should be able to describe the different methods used to keep track of financial transactions and understand which accounting records to keep.

You should be able to define key financial accounting concepts and terminology. As well as describe the financial statements which are prepared from the accounts.

29 Congratulations! You have reached the end of the module. Please take this time to revisit any of the content we covered today

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