YARDSTICK

INTERNATIONAL
COLLEGE
YIC ONLINE program

1
Financial and
Managerial
Accounting
Course leader : Kirubel Asegdew (Asst. prof.)

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CHAPTER
ONE
Introduction to Accounting and Business

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Chapter:1
Learning Objectives
After studying this chapter, you should be able to:
● Explain business and distinguish its types.
● Explain the concept of accounting.
● Identify the users and uses of accounting.
● Identify the different characteristic of Financial and Managerial Accounting
● Explain the about the IFRS setting Body.
● Explain accounting standards and the measurement principles (IFRS).

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1.1. The nature of a business

What is a business?
● A business is the activity of making one’s living or making money by
producing or buying and selling products (goods and services).
● The objective of most businesses is to maximize profits.
● But some organization operate with an objective other than to maximize
profit.
E.g. governmental units

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Types of Business
What is a business?
● Manufacturing businesses: change basic inputs into products that are
sold to individual customers.
E.g. Coca-cola, Sony, Nike, General Motors

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Cont.…
● Merchandising businesses: also sell products to customers. However,
rather than making the products, they purchase them from other
businesses.
E.g. Wal-Mart, Amazon.com

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Cont.…
● Service businesses: provide services rather than products to customers.
E.g. Air Lines, Hospitals, Bus

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Forms of Business Organizations
● There are three types of business organizations
○ Proprietorship
○ Partnership
○ Corporation

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Cont.…
● Proprietorship is owned by one individual and usually managed by the
owner.
Advantage
Abebe’s
● Ease in organizing
● Low cost of organizing
Disadvantage
● Limited source of financial
resources
● Unlimited liability

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Cont.…
● Partnership is owned by two or more individuals.
Advantage
● More financial resources than a
Abebe & Marta’s
proprietorship.
● Additional management skills.
Disadvantage
● Unlimited liability.

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Cont.…
● Corporation is organized under state or federal statutes as a separate
legal entity.
Advantage
A & M, Inc.
● The ability to obtain large amounts
of resources by issuing stocks.
● Limited liability
Disadvantage
● Double taxation.

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 What is Accounting?
Accounting consists of three basic activities - it
● Identifies,
● Records, and
● Communicates
the economic events of an organization to interested users.

LO 1 Explain what accounting is. 13

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What is Accounting?
Three Activities

The accounting process includes

the bookkeeping function.

LO 1 Explain what accounting is. 15

 Who Uses Accounting Data
Internal External
Users Human Taxing Users
Resources Authorities
Labor
Finance Unions
Customers
Management
Creditors

Marketing Regulatory
Agencies Investors

LO 2 Identify the users and uses of accounting. 16

1.4. The profession of Accounting
Accountants engage in either:
● Private Accounting: Accountants employed by a business firm or NFP
organization.
● They are frequently called management accountants or may be referred
to as industrial or cost accountants.
● Public accounting: Accountants and their staff who provide services on a
fee basis.
○ A major portion of public accounting practice is involved with
Auditing.

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 Different types of Accounting
Financial Accounting
It’s primarily concerned with
the recording & reporting of
economic data and activities for
a business to external parties.
Helps to know how well the
business is running.
Managerial Accounting
It uses both financial
accounting and estimated data
to aid management in running
day-to-day operations and in
planning future operations.
Helps to know how to run
business
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Different types of Accounting
Distinction between financial and management accounting

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Financial Statements and Financial Reporting

Essential characteristics of accounting are:

1. The identification, measurement, and communication of financial
information about
2. Economic entities to
3. Interested parties.

LO 1 20
 Objective of Financial Reporting
Objective: Provide financial information about the reporting entity that is
useful to
● Present and potential equity investors,
● Lenders, and
● Other creditors
in making decisions about providing resources to the entity.

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 Objective of Financial Reporting
General-Purpose Financial Statements
○ Provide financial reporting information to a wide variety of users.
○ Provide the most useful information possible at the least cost.

Equity Investors and Creditors

○ Investors and creditors are the primary user group.

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 Objective of Financial Reporting
Entity Perspective
● Companies viewed as separate and distinct from their owners
(shareholders).

Decision-Usefulness
● Investors are interested in assessing
1. the company’s ability to generate net cash inflows and
2. management’s ability to protect and enhance the capital providers’
investments.

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Standard-Setting Organizations
Main international standard-setting organization:
● International Accounting Standards Board (IASB)
✔ Issues International Financial Reporting Standards (IFRS).
✔ Standards used on most foreign exchanges.
✔ IFRS used in over 149 countries.
✔ Two organizations that have a role in international standard-setting
are the International Organization of Securities Commissions (IOSCO)
and the IASB.

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 QUESTION TIME
Which organization(s) has(have) the
responsibility of standard-setting?

A. The Financial Accounting Standard Board

B. The International Organization of Securities Commissions
C. The International
CREDITS: This Accounting Standard
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Both IFRS and including
IOSCO icons by Flaticon, infographics &
images by Freepik

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Conceptual Framework
Conceptual Framework establishes the concepts that underlie financial
reporting.

Need for a Conceptual Framework

● Rule-making should build on and relate to an established body of
concepts.
● Enables IASB to issue more useful and consistent pronouncements over
time.

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 Conceptual Framework
Development of a Conceptual Framework
Presently, the Conceptual Framework is comprises of the following.
• Chapter 1: The Objective of General Purpose Financial Reporting
• Chapter 2: The Reporting Entity (not yet issued)
• Chapter 3: Qualitative Characteristics of Useful Financial Information
• Chapter 4: The Framework, comprised of the following:
● Underlying assumption—the going concern assumption;
● The elements of financial statements;
● Recognition of the elements of financial statements;
● Measurement of the elements of financial statements; and
● Concepts of capital and capital maintenance.

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Conceptual Framework
Overview of the Conceptual Framework

Three levels:
● First Level = Objectives of Financial Reporting
● Second Level = Qualitative Characteristics and Elements of Financial
Statements
● Third Level = Recognition, Measurement, and Disclosure Concepts.

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 ASSUMPTIONS PRINCIPLES CONSTRAINTS
1. Economic entity 1. Measurement 1. Cost
2. Going concern 2. Revenue recognition
Third level
3. Monetary unit 3. Expense recognition The "how"—
4. Periodicity 4. Full disclosure implementation

5. Accrual

QUALITATIVE OBJECTIVE ELEMENTS

CHARACTERISTICS Provide information 1. Assets
1. Fundamental about the reporting 2. Liabilities
Second level entity that is useful Second level
Bridge between qualities 3. Equity
to present and Bridge between
levels 1 and 3 2. Enhancing 4. Income levels 1 and 3
potential
qualities 5. Expenses
equity investors,
lenders, and other
creditors in their
capacity as capital
providers.
First level
The "why"—purpose of accounting 29
Basic Objective
“To provide financial information about the reporting entity that is useful to
present and potential equity investors, lenders, and other creditors in making
decisions about providing resources to the entity.
● Provided by issuing general-purpose financial statements.
● Assumption is that users need reasonable knowledge of business and
financial accounting matters to understand the information.

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Fundamental Concepts
Qualitative Characteristics of Accounting Information
IASB identified the Qualitative Characteristics of accounting information that
distinguish better (more useful) information from inferior (less useful)
information for decision-making purposes.

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Qualitative Characteristics

ILLUSTRATION 2.2
Hierarchy of Accounting
Qualities

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 Relevance

ILLUSTRATION 2.7
Conceptual Framework for
Financial Reporting

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 Qualitative Characteristics
Fundamental Quality—Relevance

To be relevant, accounting information must be capable of making a

difference in a decision.
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 Qualitative Characteristics
Fundamental Quality—Relevance

Financial information has predictive value if it has value as an input to predictive

processes used by investors to form their own expectations about the future.

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 Qualitative Characteristics
Fundamental Quality—Relevance

Relevant information also helps users confirm or correct prior expectations.

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 Qualitative Characteristics
Fundamental Quality—Relevance

Information is material if omitting it or misstating it could influence decisions that

users make on the basis of the reported financial information.
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Faithful Representation

ILLUSTRATION 2.7
Conceptual Framework for
Financial Reporting

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 Qualitative Characteristics
Fundamental Quality—Faithful Representation

Faithful representation means that the numbers and descriptions match what
really existed or happened.
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Qualitative Characteristics

Fundamental Quality—Faithful Representation

Completeness means that all the information that is necessary for faithful
representation is provided.
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Qualitative Characteristics

Fundamental Quality—Faithful Representation

Neutrality means that a company cannot select information to favor one set of
interested parties over another.
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Qualitative Characteristics

Fundamental Quality—Faithful Representation

An information item that is free from error will be a more accurate (faithful)
representation of a financial item.
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Qualitative Characteristics
Enhancing Qualities

Information that is measured and reported in a similar manner for different

companies is considered comparable.
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Qualitative Characteristics
Enhancing Qualities

Verifiability occurs when independent measurers, using the same methods,

obtain similar results.
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Qualitative Characteristics
Enhancing Qualities

Timeliness means having information available to decision-makers before it

loses its capacity to influence decisions.
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Qualitative Characteristics
Enhancing Qualities

Understandability is the quality of information that lets reasonably informed

users see its significance.
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Basic Elements

ILLUSTRATION 2.7
Conceptual Framework for
Financial Reporting

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Basic Elements

Elements of Financial Statements

A resource controlled by the entity as a result of
Asset
past events and from which future economic
benefits are expected to flow to the entity.
Liability

Equity

Income

Expenses
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Basic Elements

Elements of Financial Statements

Asset
A present obligation of the entity arising from
past events, the settlement of which is expected
Liability
to result in an outflow from the entity of
resources embodying economic benefits.
Equity

Income

Expenses
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Basic Elements

Elements of Financial Statements

Asset

Liability
The residual interest in the assets of the entity
Equity after deducting all its liabilities.

Income

Expenses
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Basic Elements

Elements of Financial Statements

Asset

Liability
Increases in economic benefits during the
Equity accounting period in the form of inflows or
enhancements of assets or decreases of
Income liabilities that result in increases in equity, other
than those relating to contributions from equity
participants.
Expenses
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Basic Elements

Elements of Financial Statements

Asset

Liability

Equity Decreases in economic benefits during the

accounting period in the form of outflows or
Income depletions of assets or incurrences of liabilities
that result in decreases in equity, other than
those relating to distributions to equity
Expenses participants.
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Basic Elements

Elements of Financial Statements

These concepts explain how companies should recognize, measure, and
report financial elements and events.
Recognition, Measurement, and Disclosure Concepts
ASSUMPTIONS PRINCIPLES CONSTRAINTS
1. Economic entity 1. Measurement 1. Cost
2. Going concern 2. Revenue recognition
3. Monetary unit 3. Expense recognition
4. Periodicity 4. Full disclosure
5. Accrual

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Assumptions

Economic Entity – company keeps its activity separate from its owners and
other business unit.
Going Concern - company to last long enough to fulfill objectives and
commitments.
Monetary Unit - money is the common denominator.
Periodicity - company can divide its economic activities into time periods.
Accrual Basis of Accounting – transactions are recorded in the periods in
which the events occur.

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Basic Principles of Accounting

● Measurement Principles
○ Historical Cost is generally thought to be a faithful
representation of the amount paid for a given item.
○ Fair value is defined as “the price that would be received to sell
an asset or paid to transfer a liability in an orderly transaction
between market participants at the measurement date.”

IASB has given companies the option to use fair value as the basis for
measurement of financial assets and financial liabilities.

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The Basic Accounting Equation

Assets Liabilities Equity

= +

Provides the underlying framework for recording and summarizing economic

events.
Applies to all economic entities regardless of size.

LO 6 State the accounting equation, and define its components. 56

The Basic Accounting Equation

Assets Liabilities Equity

= +

Provides the underlying framework for recording and summarizing economic

events.
Assets
● Resources a business owns.
● Provide future services or benefits.
● Cash, Inventory, Equipment, etc.

LO 6 State the accounting equation, and define its components. 57

The Basic Accounting Equation

Assets Liabilities Equity

= +

Provides the underlying framework for recording and summarizing economic

events.
Liabilities
● Claims against assets (debts and obligations).
● Creditors - party to whom money is owed.
● Accounts payable, Notes payable, etc.

LO 6 State the accounting equation, and define its components. 58

The Basic Accounting Equation

Assets Liabilities Equity

= +

Provides the underlying framework for recording and summarizing economic

events.
Equity
● Ownership claim on total assets.
● Referred to as residual equity.
● Share capital-ordinary and retained earnings.

LO 6 State the accounting equation, and define its components. 59

 QUESTION TIME
Which one of the following cannot be
considered as an asset by Sodere Resort Hotel?
A. Hippopotamus in the river which is sometimes used for
photographic operation in which the revenue goes to the
hotel.
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D. swimming pools in the resort
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The Basic Accounting Equation

Revenues result from business activities entered into for the purpose of
earning income.
Generally results from selling merchandise, performing services, renting
property, and lending money.
LO 6 State the accounting equation, and define its components. 61
The Basic Accounting Equation

Expenses are the cost of assets consumed or services used in the process of
earning revenue.
Common expenses are salaries expense, rent expense, interest expense,
property tax expense, etc.
LO 6 State the accounting equation, and define its components. 62
The Basic Accounting Equation

Dividends are the distribution of cash or other assets to shareholders.

● Ownership claim on total assets.
● Reduce retained earnings
● Not an expense
LO 6 State the accounting equation, and define its components. 63
Using the Accounting Equation

Transactions are a business’s economic events recorded by accountants.

● May be external or internal.
● Not all activities represent transactions.
● Each transaction has a dual effect on the accounting equation.

LO 7 Analyze the effects of business transactions on the accounting equation. 64

 Using the Accounting Equation
Illustration: Are the following events recorded in the accounting records?
Purchase Discuss product
Event computer. Pay rent.
design with customer.

Is the financial position (assets, liabilities, or equity) of the

company changed?
Criterion

LO 7 Analyze the effects of business transactions on the accounting equation. 65

Using the Accounting Equation
Transaction Analysis

LO 7 Analyze the effects of business transactions on the accounting equation. 66

Transaction Analysis
Transaction (1). Investment by Shareholders. Alex and Bely decides to open a
computer programming service which they names Softbyte. On September 1,
2019, they invest €15,000 cash in exchange for €15,000 of ordinary shares.
Illustration 1-10

LO 7 Analyze the effects of business transactions on the accounting equation. 67

Transaction Analysis
Transaction (2). Purchase of Equipment for Cash. Soft byte purchases
computer equipment for €7,000 cash. Illustration 1-10

LO 7 Analyze the effects of business transactions on the accounting equation. 68

Transaction Analysis
Transaction (3). Purchase of Supplies on Credit. Softbyte purchases for €1,600
from Acme Supply Company computer paper and other supplies expected to
last several months. The purchase is on account.
Illustration 1-10

LO 7 Analyze the effects of business transactions on the accounting equation. 69

Transaction Analysis
Transaction (4). Services Provided for Cash. Soft byte receives €1,200 cash
from customers for programming services it has provided. Illustration 1-10

LO 7 Analyze the effects of business transactions on the accounting equation. 70

Transaction Analysis
Transaction (5). Purchase of Advertising on Credit. Softbyte receives a bill for
€250 from the Daily News for advertising but postpones payment until a later
date. Illustration 1-10

LO 7 Analyze the effects of business transactions on the accounting equation. 71

Transaction Analysis
Transaction (6). Services Provided for Cash and Credit. Softbyte provides
€3,500 of programming services for customers. The company receives cash
of €1,500 from customers, and it bills the balance of €2,000 on account.

Illustration 1-10

LO 7 Analyze the effects of business transactions on the accounting equation. 72

Transaction Analysis
Transaction (7). Payment of Expenses. Softbyte pays the following expenses
in cash for September: store rent €600, salaries and wages of employees
€900, and utilities €200.

Illustration 1-10

LO 7 Analyze the effects of business transactions on the accounting equation. 73

Transaction Analysis
Transaction (8). Payment of Accounts Payable. Softbyte pays its €250 Daily
News bill in cash.

Illustration 1-10

LO 7 Analyze the effects of business transactions on the accounting equation. 74

Transaction Analysis
Transaction (9). Receipt of Cash on Account. Softbyte receives €600 in cash
from customers who had been billed for services [in Transaction (6)].

Illustration 1-10

LO 7 Analyze the effects of business transactions on the accounting equation. 75

Transaction Analysis
Transaction (10). Dividends. The corporation pays a dividend of €1,300 in cash.

Illustration 1-10

LO 7 Analyze the effects of business transactions on the accounting equation. 76

 QUESTION TIME
A company keeps its economic activity separate and
distinct from its owners and any other business unit.
This statement represents_______
A. Going concern assumption
B. Monetary unit assumption
C. Economic entity
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77
Financial Statements
Companies prepare four financial statements :

Statement
Retained Statement
Income of
Earnings of Cash
Statement Financial
Statement Flows
Position

LO 8 Understand the four financial statements and how they are prepared. 78
Financial Statements
Net income is
needed to
determine the
ending balance in
retained earnings.

LO 8 79
Financial Statements
The ending balance
in retained earnings
is needed in
preparing the
balance sheet

LO 8 80
Financial Statements
The balance sheet
and income
statement are
needed to prepare
statement of cash
flows.

LO 8 81
Transaction Analysis

● Assume That On November 1, 2010 Ato Aymen And His Colleagues Begin A
Business That Will Be Known As Net Solutions. The First Phase Of Their Business
Plan Is To Operate Net-Solutions As A Service Business That Provides Assistance
To Individuals And Small Businesses In Developing Web Pages And In
Configuring And Installing Application Software. They Expect This Initial Phase Of
The Business To Last One To Two Years. During This Period, They Will Gather
Information On The Software And Hardware Needs Of Customers. During The
Second Phase Of The Business Plan, They Plan To Expand Net Solutions Into A
Personalized Retailer Of Software And Hardware For Individuals And Small
Businesses.
● Each Transaction During Net Solutions’ First Month Of Operations Is Described In
The Following Paragraphs. Show The Effect Of Each Transaction On The
Accounting Equation:
82
Cont…

Transaction a Aymen deposits $25,000 in a bank account in the name of Net

Solutions.
Transaction b Net Solutions exchanged $20,000 cash for land.
Transaction c During the month, Net Solutions buying supplies for $1,350 and
agreeing to pay the supplier in the near future.
Transaction d During its first month of operations, Net Solutions provided
services to customers, earning fees of $7,500 and receiving the amount in
cash. This amount is called revenue.
Transaction e Spent cash or used up other assets are called expenses. The
expenses paid during the month were as follows: wages, $2,125; rent, $800;
utilities, $450; and miscellaneous, $275.

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Cont…

Transaction f Net Solutions pays $950 to creditors during the month.

Transaction g At the end of the month, the cost of the supplies on hand (not
yet used) is $550.
Transaction h At the end of the month, paid dividend of $2,000 for
shareholders.

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End of Chapter One

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