Chapter 1 – Introduction to accounting

Accounting: is recording, evaluation, analysis and interpretation of financial information for

various users.
Accounting deals with budget and tax management.

Differences between bookkeeping and accounting

- Bookkeeping deals with recording of financial transactions while accounting is the

recording, analysis and interpretation of accounting data for various users.
- Accounting follows the rules set by either the GAAP or IGRS while bookkeeping does
not follow any of these rules.
-

Branches of accounting

Financial accounting
Cost accounting
Management accounting
Tax accounting
Auditing

Users of accounting information and the importance of financial information to each of

them

There are several users of financial information namely;

- The government – the government need financial information to calculate the amount of
tax payable to them from the profits generated by the businesses.

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 - Business owners – to determine if the business is generating enough profit from its
operations or not and make necessary adjustment if it is not profitable enough.
- Investors – to see if they will get returns for their investment if the eject money into the
business.
- Employees – for bargaining purposes, if business is making enough profit, they can
negotiate salary increment or get to see if their jobs are secure enough by business
making profit.
- Managers – for decision making purposes such as budgeting, pricing etc. and to drive the
business into making profit.
- Customers – to negotiate price cuts or discounts and to determine if the business will
continue to exist in future and offer them goods and services.
- Creditors – to determine if the business will be able to pay for the goods, they obtain
from them on credit.
- Banks/Financial institutions – to find out if the business is credit worthy and will be
able to repay the loans offered to them by these institutions.
- Accountant, auditors and financial analyst – for preparation and interpretation of
financial statements.

Consistency: fundamental concept which requires a company to consistently apply the same
accounting methods practices for one year to another.
- A principle that states a business should maintain the same accounting method throughout
the accounting periods so that the users are able to make meaningful conclusions from the
financial information.

Time interval concept: the process of dividing the life of the business into distinct and shorter
periods such as months, quarters and yearly for the purpose of reporting financial information.
- Businesses should report their financial positions, state of operations and cashflows at
regular intervals.

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Comparability: it allows users of financial information to compare financial information across
different periods and between different companies.
- An extent at which the information provided in the financial statements is comparable
across different firms and time periods.

Prudence: Ensures that the company is not over valued by preventing the income and the assets
from being overstated in the company’s reporting.
- The simple concept is that the company accounts should show what it has really earned
along with what it owes and owns rather than just calculations that are formally and
legally correct.

Substance Over Form Concept: Accounting principle is more focused on the true nature of the
transaction and not just the legal form that could be used to mislead the company’s readers and
investors. The simple concept is that the company accounts should show what it has really
earned along with what it owes and owns rather than just calculations that are formally and
legally correct.

Importance

The following points reflect the importance of substance over form are –

 It helps companies in their critical financial reporting.

 The accounting concept majorly helps in taxation and is worldwide appraised for it.
 It helps in complete disclosure, especially with sale and purchase agreements and revenue
recognition.
 When companies report transactions parallel to their economic substance, the accounting
principle helps in maintaining consistency for better decision-making.
 It reduces the risk of exploitation; companies cannot take unfair advantage or benefit
from loopholes and must present their economic reality.
 It restricts firms from using complex legalities to hide their true economic nature and
induces accurate financial reporting.

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Business Entity concept: The business entity concept states that the business is separate from the
owner(s) of the business. Therefore, the accounting records for even the simplest business, the
sole trader, must be kept separate from the personal affairs of the owner or owners.

There are basically three types of business entity:

 sole trader
 partnership
 limited company.

The principles of double-entry accounting apply to all forms of business organization, as well as
not-for-profit organizations.

Money Measurement Concept?

Accounting deals with facts measurable in monetary values, any transaction without a monetary
value is not an accounting transaction.

This concept states that businesses should only record transactions that can be expressed in
money. Transactions, activities, characteristics, and events that cannot be ascribed a current
monetary value must be excluded from the financial statements.

What is money measurement with examples?

It is an accounting principle that ensures that only transactions with a current monetary value are
recorded on the financial statements. There are many examples of transactions that may be
recorded including the payment of taxes, purchases from suppliers, and sales to customers.

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Time Interval

The time period principle is the concept that a business should report the financial results of
its activities over a standard time period, which is usually monthly, quarterly, or annually.
Once the duration of each reporting period is established, use the guidelines of Generally
Accepted Accounting Principles or International Financial Reporting Standards to record
transactions within each period.

Reasons for the Time Period Principle

The time period principle is rigorously enforced, because a high degree of consistency is
needed in reporting financial statements. By following this principle, your organization can
produce financial statements that are comparable to the results reported for prior years. This
is needed by investors, lenders, and others who read the financial statements, and who may
want to conduct multi-period analyses.

Going Concern Principle

The going concern principle is the assumption that an entity will remain in business. This
assumption allows you to defer the recognition of some expenses to later periods (such as
depreciation), when a business will presumably still be in operation.

Matching Principle

The matching principle states that you should record all expenses related to a revenue-
generating transaction at the same time that you recognize the revenue. This is the
foundation for the use of accrual accounting.

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Materiality Principle

The materiality principle states that you should include all transactions in the financial
statements if their omission would otherwise influence the decisions of a person using the
financial statements.

Conservatism Principle

The conservatism principle states that you should recognize expenses and liabilities as soon
as possible, even if there is some uncertainty about them, whereas you should delay the
recognition of revenues and assets until you are certain of them. This tends to yield more
conservative reporting of profits and losses.

PRINCIPLES OF ACCOUNTING

Ethical issues in accounting

The Ethical Responsibilities of Accountants: Accountants have a fiduciary duty to act in the best
interests of their clients, employers, and the public. The following ethical responsibilities guide
their professional conduct:

Integrity: Accountants must be honest, truthful, and free from conflicts of interest. They should
accurately represent financial information, avoiding any form of manipulation or
misrepresentation.

Objectivity: Accountants must exercise impartiality and avoid any bias that could compromise
their professional judgment. They should base their decisions on factual evidence and analysis,
considering the long-term interests of stakeholders.

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Professional Competence: Accountants should maintain and enhance their professional
knowledge and skills to provide accurate and reliable financial information. Staying updated with
evolving accounting standards and regulations is essential for ethical decision-making.

Confidentiality: Accountants must maintain strict confidentiality regarding client information

unless required by law or with the client’s permission. This helps protect the interests of clients
and maintains trust in the profession.

Professional Behavior: Accountants should adhere to professional codes of conduct, treat

colleagues and clients with respect, and act in a manner that upholds the reputation of the
profession.

The Significance of Integrity and Transparency: Maintaining integrity and transparency in

financial practices holds significant importance for both accountants and the organizations they
serve. Here are some key reasons:

Trust and Reputation: Ethical behavior enhances trust between accountants, organizations, and
stakeholders. Trust is the foundation for healthy relationships, investor confidence, and
sustainable business growth.

Compliance with Laws and Regulations: Ethical accounting practices ensure compliance with
laws and regulations, such as the Generally Accepted Accounting Principles (GAAP) or
International Financial Reporting Standards (IFRS). Compliance helps prevent legal issues and
financial penalties.

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The accounting equation

The financial position of a business is expressed in the statement of financial position, which is
more commonly called the balance sheet. The financial position of a business is represented by:

 assets (what the business owns)

 liabilities (what the business owes)
 owner’s capital (the monetary value of the owner’s investment in the business).

Questions

What is the accrual basis of accounting?

What are accruals?
What is the cost of goods sold?
What is owner's equity?
What is a capital expenditure versus a revenue expenditure?
What is the matching principle?
What is the difference between the cash basis and the accrual basis of accounting?

Accounting equation

What is accounting equation?

First let’s Recap on the definition of accounting

Accounting can also be defined as the recording of financial transaction (in monetary terms),
reporting the results of such transactions and drawing up the financial statement for decision
making.

Accounting equation is the foundation for every transaction that we are going to encounter in
accounting. There are certain things that you will look into and you will get to see the

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relationship they have to this equation and it is an important aspect of accounting. For instance,
when you look at the statement of financial position (balance sheet), trial balance, the income
statement and the statement of cash flows you will fully see their relationship to the accounting
equation. Understanding this equation is therefore important for all accountants for it is the
foundation on which accounting is based.
The accounting equation is the simple defined as:

Assets = Owner’s Equity + Liabilities

What you own Interest of the owners What you owe
in the business

Examples Examples Examples

Vehicles Capital/Shareholder’s equity loans
Equipment (e.g., computers) Drawings trade payables/creditor
cnt
Furniture Income Bank
overdraft
Machinery Expenses
Land/Buildings
Bank//Cash
Debtors Control/Trade receivables
Inventory/Stock/Merchandise

The accounting equation in action

Remember the dual aspect/concept of accounting when dealing with the accounting equation
which states that every transaction of accounting has to be recorded twice or each
transaction involve at least two accounts.

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Which means for your accounting equation every transaction will affect at least two items
including those transactions in a contra entry or transactions which affect both bank account and
cash account at the same time.

Examples;

i) The owner invested in the business by depositing P20 000 cash.

ii) Bought inventory on credit P5 000.
iii) Paid telephone account by cheque P200.
iv) Bought goods by cheque P600
v) Paid a supplier P4 000 in settlement of account.
vi) Bought stationery by cheque P3 550.
vii) The owner drew a business cheque of P3000 for his personal use.
viii) The tenant paid P1 800 monthly rental to the company.
ix) The owner contributed a vehicle worth P15 000 to the business

Answers to this activity - Example 1.

Assets = Capital + Liabilities

i) + P20 000 (bank) + P20 000 (capital)
ii) + P5000 (stock) + P5000
(inventory)
iii) – P200 (telephone) + P200 (telephone)
iv) + P600 (inventory)
- P600 (bank)
v) – P4000 (cash) - P4000 (creditor)
vi) + P3550 (stationery) - P3550 (stationery)
vii) - P3000 (bank) - P3000 ((drawings)
viii) + P1800 (cash) - P1800 (rent)
ix) + P15000 (vehicle) + P15000 (capital)

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DEBIT AND CREDIT
Understanding debit and credit - Knowing what to Debit and what to Credit

Let us start with the double entry principle of accounting. Read it from above.
To understand debit and credit please remember the acronym DEAD CLIC

What does DEAD CLIC stands for?

DEAD CLIC

DEBIT CREDIT
Expenses Liabilities
Assets Income
Drawings Capital

This acronym applies to all of these items only when they increase and when the decrease it is
vice versa of what is stated above. Which means expenses, assets and drawings are credited
when they decrease, while liabilities, income and capital are debited when they decrease.

Examples;

i) The owner invested in the business by depositing P20 000 cash.

ii) Bought inventory on credit P5 000.
iii) Paid telephone account by cheque P200.
iv) Bought goods by cheque P600
v) Paid a supplier P4 000 in settlement of account.
vi) Bought stationery by cheque P3 550.
vii) The owner drew a business cheque of P3000 for his personal use.

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 viii) The tenant paid P1 800 monthly rental to the company.
ix) The owner contributed a vehicle worth P15 000 to the business

Financial statements

The income statement (The statement of comprehensive income)

- It is the statement that shows the change in the equity (assets) of the business/firm/ entity.
It shows the financial performance of the entity over a specific period of time (income
earned and expenses incurred).

The statement of financial position (balance sheet)

- It shows the entity financial position at a given time (assets, capital and liabilities).

The cash flow statement (the statement of cash flows)

- It shows entity movement in cash over a specific period of time.

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