Table Of ContentA ONE-YEAR ACCOUNTING
COURSE
IN TWO PARTS
PART I
BY
TREVOR GAMBLING
Faculty of Commerce and Social Science,
University of Birmingham
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PREFACE
ABOUT this book.
'Accounting', as opposed to the financial management of a business, is
one of the most simple arts known to mankind, but anyone who has studied
the subject will know that it is one which gives very great difficulty to many
beginning students. In part this phenomenon is due to the inborn 'figure-
blindness' which makes the handling of large masses of numerical data so
distasteful to a great many people; nevertheless, the initial presentation of
the technique to a beginning class can affect their enthusiasm and ability
throughout their careers. This book is the outcome of the author's experience
over a number of years of teaching accounting to students during which he
can claim to have used most of the generally accepted teaching methods.
These suffer from two shortcomings: firstly, they tend to present the subject
in a vacuum, unrelated to their other studies or experience, or even to its
own historical development. To counteract this an attempt has been made
here to present a broad picture of the whole field—cost accounting, mechani
zation and the history of accounting are introduced at a very early stage and
no opportunities are lost to tie the text in with parallel work whether in
commercial practice, economics or statistics. The other danger in learning
accounting is the loss of interest which inevitably follows if students become
conscious of their slow rate of progress; if the object of the training is that
the student should be able to keep the books, by hand, of a trading company,
close study of the minutiae of the technique can hardly be avoided, but in
the great many instances where these are not required, a less detailed approach
will be entirely adequate.
In particular there is a whole class of people who require general instruc
tion in accounting practice because they may be assumed to be suitable
material for general management positions at a later date, who seem scarcely
to be served by existing texts at all. These are typically, but by no means
exclusively, the students of the professional engineering institutes, and in
recent years these bodies have shown an increasing desire to extend their
members' understanding of financial problems. It was the needs of this latter
class of student which led the author to conceive this book in two volumes
that are parallel rather than consecutive. Part I contains a general descrip
tive course which has been written with the engineering student in mind,
although it might be quite satisfactory for ONC students or the senior forms
at technical and commercial schools. It will be found that Part II contains
similar chapter headings as the first part, and both parts are meant for use
vii
VÜi PREFACE
together by those who require a degree of expertise in the practical applica
tion of accounting techniques.
The books' of an enterprise contain only a part of the body of economic
information needed to manage it or even to let it operate as a system. How
ever, they comprise the only formal information systems which most enter
prises possess, and thus they are the basis from which all management
exercises must start. Those who use accounting data without understanding
the principles underlying the techniques by which it was gathered and
classified are likely to find their most elaborate analyses vitiated by unwise
choice of basic input.
Birmingham T. E. G.
CHAPTER 1
INTRODUCTION
ACCOUNTING is classed as one of the social sciences; primarily these may be
thought of as consisting of economics, economic history, political science
and sociology, but to them it is usual to add accounting and also statistics.
These last two subjects are sometimes referred to as 'quantitative methods'
and represent the tools by which a social scientist records and marshalls the
facts upon which he is working. Once the facts have been recorded in this
way, it will be seen that the record itself is capable of being used experi
mentally within certain limits. Such methods are of practical use in business
affairs also; this is not surprising, since the businessman and the social
scientist are both concerned with similar problems.
The Function of an Accountant in an Industrial Society
Before launching into the basic techniques of accounting, it will be helpful
to give a little thought to just where they are likely to be applied and for what
purposes. Some phenomena are capable of being handled physically and can
thus themselves be the subject of visual examination and test, but others are
either so large or so minute that their properties can best be observed through
the form of a diagram. The construction of a component such as a car's
gearbox is apparent either from dismantling it or by examining an engineer's
drawing which is a fairly straightforward pictorial representation of its parts;
the molecular construction of the metals from which it is manufactured is
not verifiable by visual inspection, however, and the diagrams which metal
lurgists and physicists commonly draw to illustrate these are very definitely
symbolic rather than pictorial. Other phenomena may be capable of pictorial
representation, but sheer bulk or perhaps multiplicity of instances will make
it impossible for the human mind to appreciate its nature in this way; eco
nomic problems are of this type. If one wished to record the financial position
of a large company at any point in time, it would no doubt be possible to
photograph every piece of equipment in its works or offices and every un
paid bill which it owed or had owing to it. The results would be interesting,
but so voluminous that one would be hard put to it to reach any firm con
clusions about the concern at all. The reason for this difficulty in comprehen
sion is clear from this highly simplified example:
3 turret lathes -f 1 typewriter — a gas bill = what ?
1
2 A ONE-YEAR ACCOUNTING COURSE PART I
Before any attempt can be made to understand a proposition of this sort
it is necessary to formulate it in a homogenous symbolism which enables the
relationships between the various items to be expressed in a logical way. In a
highly developed society money is used not only as a medium of exchange
but as a store of value and a measure of economic worth as well, and it is
this latter use of the currency which provides the basic symbols of many
economic diagrams or 'models'. The example given above can then be
re-written:
3 turret lathes* f 1 typewriter! fgas bull {Money value*]
worth - + J worth L - £of8 of the firm I
£450 1 £20 J I J £462 J
The precise sum to be set down as the 'value' or 'worth' of an asset is itself
frequently a matter in dispute, as will be seen in later chapters, but readers
should appreciate that since there are conventions which are generally accept
ed in arriving at values of this sort, semantic difficulties which arise because
the symbolism used is defective under extreme circumstances do not invalidate
the system as a method of conveying ideas.
Accounting is essentially the presentation of complex economic situations
or histories in the form of conventional mathematical models, and beginners
will do well to cling fast to the fact that accounts have no meaning at all if
divorced from the underlying economic reality which they portray. A diagram
of the molecular structure of a material does not affect the physical structure
of the material itself, although it may suggest possible improvements in
ingredients or manufacture in the future. Similarly, no accountant or business
man should imagine that a rearrangement of the figures was in any way an
adjustment of the underlying facts.
The basis of the accountant's skill lies in his mastery of this symbolic
model-making, and this might be a good point at which to emphasize one
aspect of the teaching of accounting in which the author is at variance with
some other writers. A good deal of time is often devoted to attempts to
explain the logic which is supposed to lie behind the symbolism used:
accounting in the modern sense was developed for very limited purposes
some six or seven centuries ago and has only recently been expanded to the
full system which we use today, and such explanations are rather in the
nature of rationalization of an existing and essentially irrational convention.
This argument will be developed in the next chapter. However, the accoun
tant's work is not confined to the preparation of accounts. Indeed it is likely
that the greater part of the time of a qualified accountant will be spent out
side this immediate technique with the result that it would hardly be a fair
introduction to the subject of accountancy if no mention was to be made of
these ancillary duties.
In view of the widespread and socially valuable services which the account-
INTRODUCTION 3
ing profession renders and their subject's place amongst the social sciences,
it is surprising that the popular 'image' of an accountant is of a Dickensian
figure seated at an old-fashioned desk and engaged in the manual writing-up
of a big leather-bound book. In fact, at the present time companies of any
size will usually record the vast majority of their transactions mechanically
(see Chapter 3). As a result, the common complaint of trainee accountants
(and their instructors) is rather of a lack of sufficient 'practical book-keeping'
experience to obtain the facility in that art necessary to direct or carry out
the more idiosyncratic parts of the work which are still done manually.
An unfortunate result of this misapprehension is that when a school-
leaver or graduate expresses an ambition to become an engineer, a dentist or
a parish priest, he has a faulty but basically reasonable idea of what his
duties are likely to be; an entrant into accountancy, however, commonly
has no such understanding. A qualified accountant is valued primarily as (i)
a legal adviser, and (ii) a financial adviser, and only secondarily as (iii) an
expert in book-keeping. The development of this concept was as follows.
(1) An obvious extension of the model-making was to include investiga
tions as to whether the accounts, once prepared, were a reasonably accurate
picture of the underlying reality and followed the generally accepted con
ventions for their preparation; at the same time considerations could be given
as to whether the preparation of the accounts and the conduct of the business
disclosed by them conformed with the law relating to such matters. This is
known as auditing, and the accountant performing the duty is known as an
auditor; it is a very ancient practice, antedating the development of modern
accounting, indeed the latin root of the word implies listening, listening to
the verbal account of a steward to his master at a time when one or both
parties were unable to read or write. Sometimes the auditor may be employed
by the management of the company as a member of its staff, when he is known
as the 'internal' auditor, but in most countries it is also customary to appoint
an independent firm of accountants to make these investigations at regular
intervals. Particularly in the case of limited companies and other corporate
bodies, where the interests of creditors and shareholders may from time to
time conflict with those of the management, the appointment of an indepen
dent auditor is required by law and therefore he is often referred to as the
'statutory' auditor. The techniques of auditing and the legal framework in
which it operates is a separate subject and one which lies outside the terms of
this book, but it will be seen that this 'security' aspect of accounting probably
preceded its use in the management and control of the business. Indeed, a
very simple economic unit, such as a one-man taxi service, could get along
without any model-making of this sort at all, but such a 'sole trader' is
supposed to keep some records to convince interested parties, usually the
Inland Revenue authorities, of the reasonable accuracy of his returns, etc.
(2) In most developed countries the Government raises a large portion of
4 A ONE-YEAR ACCOUNTING COURSE PART I
its revenue from a tax which is based on the income of the taxpayer. Where the
income is not of a fixed nature, such as a rent or salary, but is in fact the
profits of a business enterprise, the Inland Revenue authorities have some
interest in the accuracy of the accounts and the principles upon which they
are compiled. Because the accountant will already be familiar with much of
the ground to be covered either as auditor or the original author of the
accounts, the preparation of the taxation computations upon which the
demands, or assessments, are based will normally be entrusted to the
accountant. Many professional accountants devote a major proportion of
their time to this aspect of their profession; each country produces a sub
stantial body of statutory and case law applicable to this type of work and,
once again, 'taxation' is a separate subject in the studies of most would-be
accountants but one which will not be covered in this book.
(3) Because of his knowledge of his client's affairs as their auditor and tax
adviser, the accountant is frequently called upon to act as a consultant upon
a variety of financial problems, and this requires of him a sound grasp of
company law and most other aspects of mercantile and industrial law.
Wherever a legal problem involves figure work, the accountant is to be found;
acting as the liquidator of a company which is going out of business or as
trustee of a bankrupt, where it is necessary to distribute the proceeds of the
sale of property amongst those who are entitled to it; acting, usually with a
solicitor, as trustee of a deceased person's estate or trust fund; or perhaps
with a banker, over the flotation of a new company. He may be called upon
to make an investigation into the financial affairs of a company by a govern
ment agency, a bank or a prospective purchaser, or alternatively by the
company itself because they believe that the accountant's professional skill
may discover some way in which their business could be carried on more
efficiently. This latter aspect of the accountant's 'consultancy' practice
requires of him an up-to-date knowledge of clerical organization and methods,
office machinery, design of forms and so on. The knowledge which the
accountant uses here goes some little way beyond the basic technique of
book-keeping; Chapter 3 contains the elementary principles of mechanized
accounting, and something will be said of the basic paper work of industry
and commerce in the latter part of this chapter and also in Chapter 8, but in
general, 'commercial practice' is a separate subject in accountancy, and thus
outside the main concern of this book.
(4) Readers will have noticed that the preceding paragraphs have not, in
most instances, made it clear whether the accountant referred to was an
independent practitioner or an employee (or director) of the concern. This
was deliberate because, except in the case of the statutory audit of a company,
the tasks described can be as effectively carried out internally as externally.
However, unless a firm is an extremely large and complex one, it is unlikely
that it will be able to provide enough specialized work in some of these fields;
INTRODUCTION 5
as a result it will usually be found best policy to use the services of a practising
firm of accountants. One final point: medicine and the law are 'registered
professions', which means that it is an offence against the criminal code to
draw up legal documents or treat diseases for payment unless one possesses
certain recognized professional qualifications. Accountants are active in
their professional capacities over almost the whole field of industry, commerce
local government and central government, with the result that it would be
rather onerous in some cases if any attempt were to be made to define the
work of an accountant for the purpose of making it a registered profession.
Since they are not registered in this way, it is necessary sometimes to use the
term 'qualified accountant' to distinguish members of professional bodies
from those who carry out the duties of an accountant without formal quali
fication. Although some degree of integration is currently being discussed,
the principal bodies of accountants currently to be found in the United
Kingdom are:
(a) The chartered accountants (designatory letters FCA, ACA, or in
special circumstances FSAA and AS A A). There are separate institutes
established for England and Wales, Scotland (where the designatory
letters are CA only) and in Ireland, and the members of these bodies
are one of the two groups specifically entitled to audit the accounts of
public companies. However, not all members are in independent
practice; some are employed by other practising accountants, and
many hold positions in industry and commerce.
(b) The certified accountants (designatory letters FACCA, AACCA) are
the other body authorized under the Companies Act (§ 161) to act as
auditors to public companies. However, it would be true to say that the
majority of the members are in industry and one of the distinctions
between this body and the chartered accountants is that they do their
training as registered students in approved employment under the
supervision of a qualified accountant in industry or in practice, whereas
chartered accountants have to enter into formal 'articles' (which are
in similar terms to an engineering apprentice's indentures) with a
practising chartered accountant in England or Wales.
(c) The Institute of Cost and Works Accountants (FCWA and ACWA), as
their name implies, are mainly concerned with the accounting problems
of industry and are not commonly to be found dealing with the more
legalistic aspects of accountancy. Obviously the vast majority of the
members are employed by industrial concerns, but a number are in prac
tice as independent consultants in industrial aspects of accounting.
There are a number of other, usually rather smaller, bodies which require
their members to pass examinations before admitting them to membership.
Mention should be made of the chartered secretaries and the corporate
6 A ONE-YEAR ACCOUNTING COURSE PART I
secretaries, whose duties commonly extend far beyond those laid down by
law as those of a company secretary, and comprise the commercial and
office management aspects of accounting. All bodies impose a code of
professional ethics on their members, who are liable to be excluded from
membership if evidence of their professional shortcomings can be proved to
a disciplinary committee. The profesional bodies are now encouraging the
development of a number of post-qualification courses; notably the Certifi
cate in Management Information of the Chartered Accountants, and the
Joint Diploma in Management Accounting.
The Basic Documentation of Industry and Commerce
One further preliminary matter remains. Accounting is the technique of
recording economic facts in a symbolic form, but, except in the case of a very
small business, it is neither possible nor even desirable for the records to be
prepared simultaneously with the transaction. It is preferable that items
should be entered up in the books of the business by a specialist member of
the staff, and it will be found more efficient to group a number of similar
items together to be dealt with at one time; this is an example of the advan
tages of the specialization of labour in general, such as can be seen in the
mass production of a large batch of identical articles on a production line.
This method of operation makes it essential that some record should be
prepared at the time of the transaction from which the book-keeping staff
can 'write up' their records. In practice this is not entirely unproductive
labour because most of these transactions involve another party besides the
firm itself, whether an employee, a supplier or a customer; both trade custom
and convenience usually require the passing of some documentary evidence
of the transaction between the two parties, so either the original or a carbon
copy or counterfoil is automatically available to both for use in their respec
tive accounts.
The accounts prepared on the basis of these original documents are not
capable of being more accurate than the documents themselves, and in
Chapter 8 some time will be devoted to the consideration of a typical 'stock-
control' system. One of the major objectives of this quite elaborate set of
procedures is to ensure that nothing leaves or enters the premises without
the fact being recorded and further, of course, that nothing is paid for unless
the full procedure has been observed. A full system of this sort involves a
good number of internal documents which will be described in the appropriate
place, but it is necessary to say a word or two about some others at this
point because this will make it somewhat easier to understand what is going
on when a start is made on double-entry theory in the next chapter.
(1) The invoice (Fig. 1). This is a document sent by a supplier to his customer
to record the details of some goods supplied or service rendered, usually on a
particular day. Notice that this document gives the name of the supplier, his
