Section 5.

2: The Accounting
Function, Planning And
Controlling Business Activity

HTTPS://WWW.YOUTUBE.COM/WATCH?V=WR2OFTI_URG
 Explain the role of the accounting function in the planning and control of business activity
 distinguish between various kinds of costs, explaining their nature and significance (fixed
vs variable, direct vs indirect, unit, average, marginal and total costs)
 Recognize and use the following concepts:
 income, expenses, gross profit, net profit, capital employed, employment of capital, owner’s
equity, drawings, assets (non-current and current), liabilities, working capital
 Explain the difference between profit and cash
 Use and interpret simple quantitative accounting data, in particular the financial
statements (Income Statement and Statement of Financial Position) of a business,
 calculating performance ratios (return on capital employed, gross profit margin (%), net profit
margin (%)), liquidity ratios (current ratio, quick/liquid ratio, rate of inventory turnover) and the
solvency ratio
 Distinguish between retained profit and spendable cash (use calculations if needed)
 Identify and explain the users of financial statements
 The Accounting function is NB! For business as money is needed for all the other
functions.
 If no money is available- none of the functions will be performed.
 ACCOUNTING FUNCTION:
 Prepares budgets for the whole business
 Records all financial transactions
 Collect all the data and presents it in the final accounts
 Analyses the profitability of investment projects
 Decides on the most appropriate methods of finance
 Keeps control of the cash flow

FINAL ACCOUNTS: ACCOUNTS PRODUCED AT THE END OF THE FINANCIAL YEAR

GIVING DETAILS OF THE PROFIT/LOSS MADE OVER THE YEAR AND THE WORTH OF THE
BUSINESS.
1) Forecast the money that different activities will need:
 The firm forecast its financial needs by working out a budget for all the activities
 All the budgets of all the activities are put together to get the total budget of the firm.
 When the financiers have a total budget they can estimate how much money will be needed
2) Source of finance:
 In order to get the money that they need, the finance department must look at different
sources and compare the advantages & disadvantages of each source to find the best source.
3) Financial Control:
 Finance department need to take care that no more money is spent than the amount
budgeted for.
 They must also see to it that they get the income that they have expected
 Financial control is very important to ensure that the budget will balance at the end of financial
period
4) Investment decisions:
 It is their task to invest any surplus money in the business in the
most profitable way.
 The financiers have to look at different ways to invest the
money so that they can make the most profit possible.

5) Business costs:
 Cost are necessary expenditures that must be made in order
to run a business.
Cost include:
 Rent
What are the costs of producing a
 Insurance product?
 Bank charges Wat are the costs of marketing a product?

 Raw materials used

 Management salaries
 Variable Indirect
Fixed costs Direct costs
costs costs

Unit cost/
Marginal
Total costs average
cost
cost
Fixed costs: (overhead cost)
 Cost which do not vary with the number of items sold/produced. They have to be paid
whether they are selling goods/not.
Indirect costs
 Costs which cannot be directly related / identified with a particular
product/department.
Variable costs:
 Cost vary with the number of items sold/produced.
Direct cost
 They can be directly related to the particular product.
 E.g. Direct cost of production of sport shoes- raw materials & labour cost
 Total cost:
 Fixed cost and variable costs combined
Unit Cost/ average cost per unit:
 Cost of producing one item
𝑇𝑜𝑡𝑎𝑙 𝑐𝑜𝑠𝑡
𝑡𝑜𝑡𝑎𝑙 𝑜𝑢𝑡𝑝𝑢𝑡
Marginal costs:
 The extra costs a business incur by producing one more unit of
output.
 Extra DIRECT COST of making an additional unit

https://www.youtube.com/watch?v=f640XIT7ZgA

Activity 6.5 Pg. 96 (3rd ed)

 Raw materials
 Rent
 Water & electricity
 Wages based on time rate
 Insurance
 Raw materials (variable)
 Rent (fixed)
 Water & electricity (variable)
 Wages based on time rate (variable)
 Insurance (fixed)
 The fall in the value of a fixed asset over time.

 Money which a business receives on a day-to-day basis for

e.g. selling goods/services. Also include sales revenue, rent
income, current income.

 Money spent to pay for operating expenses in order to do

business. (Telephone, W&E)
 Profit made when sales revenue is greater than the cost of goods sold.

 Money left after cost have been deducted from sales revenue.

 When owner withdraw/takes money or goods from the business for personal use.

 Contribution made by the owner to the business in the form of funds/ non-current assets.

 Possessions of a more permanent nature, not involved in trading but essential to earn income.
 E.g. investments in other companies, intellectual property (e.g. patents), and property, plant and
equipment. Noncurrent assets appear on a company's balance sheet.
• MONEY THAT IS READILY AVAILABLE AND KEPT
IN THE BUSINESS FOR A SHORT PERIOD OF TIME.
• CURRENT ASSET.

SPENDABLE CASH:
Money spent on day-to-day expenses which
does not involve the purchase of long-term
assets.

• DIFFERENCE BETWEEN INCOME AND EXPENSES.

WHEN INCOME EXEED EXPENSES.

RETAINED PROFIT:
Profit reinvested back into a company after
deducting tax and payments to owners
(dividends)
Ploughed back profit
 FINANCIAL ACCOUNTS:

INCOME STATEMENT OF
STATEMENT FINANCIAL
POSITION

Tell us about the:

1)Performance of the company
2)Financial strength of the
company
 At the end of the financial year the business want to know how
much profit/loss it made during that year.
 The profit and loss account records the revenue, cost and profit of a
business over a period.

Divided into 3:
1. Trading account
2. Profit and loss section
3. Appropriation account
1) TRADING ACCOUNT:
 1st step in calculating profit/loss
 In the trading account the amount earned through sales/services
less the cost of goods sold-is used to calculate the GROSS PROFIT.
 This means that profit made from trading before expenses are taken
into consideration.

Sales revenue/turnover: total income received from the sale of goods during a
financial year.
Cost of goods: is total cost of goods that is sold during a period of time.
Gross Profit: difference between the sales revenue and the cost of goods sold
COST OF SALES= (OPENING STOCK+PURCHASES)-CLOSING STOCK
GROSS PROFIT=. SALES REVENUE-COST OF GOODS SOLD

Sales: N$ 23 000
Stock purchased during year: N$ 14 200
Stock at the beginning of the year: N$ 8 000
Stock on hand at the end of the year: N$16 000

Calculate the following

i. Cost of goods sold
ii. Gross profit

Act 7.1-2
GROSS PROFIT ACTIVITY Pg.111
2) PROFIT AND LOSS SECTION:
 In this account one take the gross profit earned from trading, add
all other income and then deduct all the expenses that have
been paid to keep the business running.

Net profit= (Gross Profit + income)-operating

expenses

Expenses include:
• Water and electricity
• Monthly telephone expense
• Insurance
• Wages and salaries
• Depreciation (fall in the value of fixed assets over time)
 3) APPROPRIATION ACCOUNT:
 Last part of the profit and loss account.
 It shows how the profits after tax of the business are
distributed between owners (as dividends in a
company) and retained profits.

Dividends:
• Share of profits paid to the shareholders as a return of their
investment made.
Retained profit:
• Profit after all deductions (including dividends)- ploughed
back into the company.
 A: B:
1) Net Profit a) Cost of producing OR buying of goods that are sold by the
business.
2) Gross Profit b) Profit made after all costs have been deducted from sales
revenue
3) Cost of goods sold c) (OPENING STOCK+PURCHASES)-CLOSING STOCK
4) Retained profit d) Difference between the sales revenue and the cost of goods
sold

5)Dividends e)Sales- Cost of goods

6) Formula for Gross Profit f) Show how the profits/ dividends after tax of the business are
distributed between owners and shareholders or kept as retained
profits.
7) Formula for Net Profit g) Share of profits paid to the shareholders as a return of their
investment made
8) Formula for Cost of goods h) total income received from the sale of goods during a financial
sold year.

9) Appropriation Account i) Profit after all deductions and reinvested into company.
10) Sales Revenue j) (Gross Profit + income)-operating expenses
 FINANCIAL STATEMENT THAT GIVES A SUMMARY OF THE FINANCIAL
POSITION/ WORTH OF THE BUSINESS.
 Shows the value of a business assets and liabilities at a particular time.
 ASSETS- ITEMS OF VALUE WHICH ARE OWNED BY THE BUSINESS
(FIXED/CURRENT)
• Land, buildings, equipment, vehicles (fixed)= MORE THAN A YEAR
• Cash, stock and debtors (current)= ONLY HELD FOR SHORT PERIODS
 LIABILITIES- ITEMS OWED BY BUSINESS (long term/ current)
• Long term loan (mortgage, BANK LOAN)
• Overdraft and creditors (suppliers)- current liabilities
 Shareholders Fund:
 Total sum of money invested into the business by the
owners of the company (shareholders)
Money is invested in 2 ways:

RESERVES:
SHARE CAPITAL: • Retained profits from current and
• Money put into the business previous years.
when shareholders buy newly • Profit is owned by the shareholders
issued shares. but has not been paid out to them
as dividends
• It is kept in the business.
CAPITAL EMPLOYED:
 Total long term liabilities plus the capital owned (owners equity) of
the business which has been used to pay for the net assets

Capital employed= Shareholders Fund/ owner’s equity + Long-term

liabilities
Therefore capital employed= net assets
EMPLOYMENT OF CAPITAL:
 Total of capital must correspond with the total of capital employed.
 The total of employment of capital reflects how the capital employed was used in the
business over the financial year.
Employment of capital = (Fixed assets + Investments +(current assets-current liabilities) OR
Employment of capital = Fixed Assets+ working capital

WORKING CAPITAL/ NET CURRENT ASSETS:

 Pay short-term debts, if business cannot pay debts, the creditors would force the
business to stop trading.
 Current assets and liabilities change all the time.

Working Capital= Current Assets-Current Liabilities

START- UP CAPITAL:
 Finance needed to begin a new business to pay for fixed & current assets before
trading can begin.
 Gross Profit
margin

ROCE

Profitability
Net Profit
margin

Return Net
Assets
Ratios

Current Ratio
Way of using numbers to
look at how well/ badly a
business is doing) Liquidity
Acid test ratio

Stock Turnover
Solvency ratio
Ratio
 Assess how successful the management has been at
converting sales revenue into gross profit and net profit.
 How efficiently a firm generates profit and value for
shareholders.

PERFORMANCE OF THE COMPANY

PERFORMANCE OF THE MANAGEMENT
Performance Ratios/ Profitability Ratios:

𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑝𝑟𝑜𝑓𝑖𝑡 𝑜𝑟 𝑛𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡

Return on Capital Employed/ (ROCE) (%) =
𝑐𝑎𝑝𝑖𝑡𝑎𝑙 𝑒𝑚𝑝𝑙𝑜𝑦𝑒𝑑
 Info from the balance sheet is needed to calculate this ratio
 The higher the result, the more successful the managers were in
making net profit from each dollar invested.
• Net profit will be lower than gross
profit- all the current expenses of
𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡 the business have been
Gross Profit Margin(%)= x 100 deducted from gross profit to get
𝑆𝑎𝑙𝑒𝑠 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟
net profit.
 Info found in Income Statement • Higher the result-more successful
the owners/ managers are in
making a gross profit from sales.
𝑁𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡 • Higher the results for net profit=
Net Profit Margin (%)= more successful the owners were
𝑆𝑎𝑙𝑒𝑠 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 at controlling expenses.
 𝑁𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡
 Return on net assets= x 100
𝑁𝑒𝑡 𝑎𝑠𝑠𝑒𝑡𝑠

 How well a company and its management are using

assets in to generate net profit.
 High ratio result indicates that management is making
more net profit out of each dollar invested in assets.
Liquidity Ratios:
 Measure of short term financial health of the business.
 Not concerned with profit but with working capital
 If they don’t have enough working capital, they can’t settle their short term debts.
Current Assets
Current Ratio:
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
 Accountants recommend a result of (1.5-2)
 E.g. ABC- 2:1 and DEF- 1:1
 ABC is in a more liquid position because they have twice as many current assets as
current liabilities.
 For every $1 short term debt it has $2 of current assets to pay for them.
 Low current ratio might lead to corrective management to increase the cash held by
the business. (sell redundant assets/ take out long term loan)
 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠−𝑆𝑡𝑜𝑐𝑘
Acid Test Ratio:
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠

 Inventories (stock) have not yet been sold so by eliminating

the stock, the business will get a clearer picture of the firm’s
ability to pay short term debts.
 Inventory= less liquid (not easily converted to cash)
 How quickly can cash be found if a business is in trouble?

𝐶𝑜𝑠𝑡 𝑜𝑓 𝑆𝑎𝑙𝑒𝑠
Stock Turnover Ratio:
𝑆𝑡𝑜𝑐𝑘
 Solvency Ratio
𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠
Solvency Ratio=
𝑇𝑜𝑡𝑎𝑙 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠

 Aim for a result of 1 or higher. Anything

below suggest the business is INSOLVENT
(Firm cannot pay long term loans) and the
firm will have cash flow problems
1) Shareholders:
 They have interest in knowing how big a profit/loss the company makes.
 Want to know if the business is worth more at the end of the year than it was in the beginning.
2) Creditors:
 Businesses (banks/ suppliers) which have lent money to the company.
 They want to study the accounts to see if the company can repay their debt.
3) Government:
 Want to check profits and tax paid
 If the company is making a loss, workers will be retrenched, increasing the unemployment rate
of the country.
4) Other companies:
 Managers of other companies may be considering a bid to take over the company
 Want to compare performances