IPAM-USL 2023/24

INSTITUTE OF PUBLIC ADMINISTRATION AND MANAGEMENT

UNIVERSITY OF SIERRA LEONE
FACULTY OF ACCOUNTING & FINANCE
DEPARTMENT OF ACCOUNTANCY
COURSE : APPLIED ACCOUNTING YEAR ONE (1)
SEMESTER : SECOND SEMESTER
MODULE : FINANCIAL ACCOUNTING
LECTURE NOTE ONE : INTRODUCTION TO ACCOUNTING &
FINANCIAL ACCOUNTING INFORMATION
LECTURERS:
Mr. Albert Beah (076 727 588, abeah@ipam.edu.sl)

LEARNING OBJECTIVES

After you have studied this chapter, you should be able to:

• explain what accounting is about

• briefly describe the history of accounting
• explain the relationship between bookkeeping and accounting
• list the main users of accounting information and what accounting information they are
interested in
• present and explain the accounting equation
• explain the relationship between the accounting equation and the layout of the balance
sheet
• explain the meaning of the terms assets, capital, liabilities, debtors, and creditors
• describe how accounting transactions affect the items in the accounting equation
• draw up balance sheets after different accounting transactions have occurred

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INTRODUCTION TO ACCOUNTING

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ACCOUNTING HISTORY
How humans invented this thing called accounting (a brief history)
Everyone needs an accountant, or so the saying goes. But why would that be? Accounting’s
history can be traced back thousands of years to the cradle of civilisation in Mesopotamia and is
said to have developed alongside writing, counting and money. The early Egyptians and
Babylonians created auditing systems, while the Romans collated detailed financial information.
Some of the first accountants were employed around 300 BC in Iran, where tokens and
bookkeeping scripts were discovered. Around the first millennium the Phoenicians invented an
alphabetic system for bookkeeping, while the ancient Egyptians may have even assigned
someone the role of comptroller.
Accounting began because people needed to:

• Record business transactions,

• Know if they were being financially successful, and
• Know how much they owned and how much they owed.
Italian roots
The father of modern accounting is Italian Luca Pacioli, who in 1494 first described the system
of double-entry bookkeeping used by Venetian merchants in his Summa de Arithmetica,
Geometria, Proportioniet Proportionalita. While he was not the inventor of accounting, Pacioli
was the first to describe the system of debits and credits in journals and ledgers that is still the
basis of today's accounting systems.
With the onset of the industrial revolution in 1760, there was a proliferation of companies and
the need for more advanced accounting systems. The development of corporations also created
larger groups of investors, and more complex structures of ownership, all requiring accounting
systems to adapt.
Scotland modernises accounting
The modern profession has its roots in Scotland in the mid-1800s when the Institute of
Accountants in Glasgow petitioned Queen Victoria for a Royal Charter, so accountants could
distinguish themselves from solicitors, as for a long-time accountant had belonged to
associations of solicitors, which would offer accounting in addition to a firm’s legal services. In
1854 the institute adopted ‘chartered accountant’ for its members, a term and demarcation that
still carries legal weight globally today.
The petition was signed by 49 Glaswegian accountants, and it argued that the accounting
profession had long existed in Scotland as a distinct profession of great respectability and that
the small number of practitioners had been rapidly increasing. The petition further highlighted
the varied skills required to be a professional accountant – in addition to mathematical skills, an

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accountant needed to be acquainted with general legal principles, as they were often employed
by the courts to give evidence on financial matters – as they still are today.
Industrial revolution
By the mid-1800s, the industrial revolution in Britain was well underway and London was the
financial center of the world. With the growth of the limited liability company and large-scale
manufacturing and logistics, demand surged for more technically proficient accountants capable
of handling the growingly complex world of global transactions.
The increasing importance of accountants helped to transform accounting into a profession, first
in the UK and then in the US. In 1904 eight people formed the London Association of
Accountants to open the profession to a wider audience of people than was available through the
UK’s older associations. After several name changes the London Association of Accountants
adopted the name the Association of Chartered Certified Accountants (ACCA) in 1996.
Importance of ethics
It’s not all been plain-sailing for the accountancy profession. The 21st century has seen some
dubious actions by accountants causing large-scale scandals. The Enron scandals in 2001 shook
the accounting industry, for example. Arthur Andersen, one of the world’s largest accounting
firms at the time, went out of business. Subsequently, under the newly introduced Sarbanes-
Oxley Act, accountants now face harsher restrictions on their consulting engagements. Yet
ironically, since Enron and the financial crisis in 2008, accountants have been greatly in demand,
as corporate regulations have increased and more expertise is required to fulfil reporting
requirements.
DEFINITION OF KEY TERMS & ACCOUNTING

Account - A record of financial transactions over a period of time, such as money paid, received,
borrowed or owed Please send me your account or a detailed or an itemised account.

Accountability - The fact of being responsible to someone for something, e.g. the accountability
of directors to the shareholders

Accountable - Referring to a person who has to explain what has taken place or who is
responsible for something (NOTE: You are accountable to someone for something.)

Accountancy - The work of an accountant, they are studying accountancy or they are
accountancy students.

Accountancy Bodies - Professional institutions and associations for accountants’ accountancy

profession

Accountancy Profession - The professional bodies that establish entry standards, organise
professional examinations, and draw up ethical and technical guidelines for accountants

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Accountant - A person who keeps a company’s accounts or deals with an individual person’s
tax affairs, A person who advises a company on its finances, A person who examines accounts
etc.

Accounting - The work of recording money paid, received, borrowed, or owed accounting
methods accounting procedures an accounting machine

American Accounting Association (AAA) defines accounting as "the process of identifying,

measuring, and communicating economic information to permit informed judgments and
decisions by users of the information. A bit of a mouthful really, but what it means is that
accounting involves deciding what amounts of money are, were, or will be involved in
transactions and then organizing the information obtained and presenting it in a way that is
useful for decision making.

TYPES OF BUSINESS

A business can be organized in one of several ways;

• Sole Trader: A business owned and controlled by one person or an individual

• Partnership: A business owned and controlled by two or more people
• Company: A business owned by many people and operated by many people (though not
necessarily the same).
TYPES OF ACCOUNTING/BRANCHES OF ACCOUNTING

Accounting is a vast and dynamic profession and is constantly adapting itself to the specific and
varying needs of its users. Over the past few decades, accountancy has branched out into
different types of accounting to cater for the diversity of needs of its users.

Financial Accounting

Financial accounting is the process of producing information for external use usually in the form
of financial statements. Financial Statements reflect an entity’s past performance and current
position based on a set of standards and guidelines known as GAAP (Generally Accepted
Accounting Principles). GAAP refers to the standard framework of guideline for financial
accounting used in any given jurisdiction. This generally includes accounting standards (e.g.
International Financial Reporting Standards), accounting conventions, and rules and regulations
that accountants must follow in the in the preparation of the financial statements.

Management Accounting

Management accounting produces information primarily for internal use by the company’s
management. The information produced is generally more detailed than that produced for
external use to enable effective organization control and the fulfillment of the strategic aims and
objectives of the entity. Information may be in the form budgets and forecasts, enabling an

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enterprise to plan effectively for its future or may include an assessment based on its past
performance and results. The form and content of any report produced in the process is purely
upon management’s discretion.

Cost accounting is a branch of management accounting and involves the application of various
techniques to monitor and control costs. Its application is more suited to manufacturing concerns.

Auditing

External auditing is the action of a company providing financial documents to a third party for
financial feedback. In this instance, a third party is a reliable source in describing if a company's
financial statement is a representation of GAAP. External auditing is conducted by a Certified
Charted Accountant.

Internal auditing determines the effectiveness of internal accounting processes. An internal

auditor can review employee departmental responsibilities, management policies and approval
procedures on related projects. In turn, they provide useful feedback that can help a company to
become more profitable and efficient. Qualifications for internal auditors will vary as this is an
internal role. An accountant can become a Certified Internal Auditor (CIA), and some public
companies and governmental agencies may require their internal auditors to hold this
certification.

Forensic Accounting

Forensic accounting is the use of accounting, auditing and investigative techniques in cases of
litigation or disputes. Forensic accountants act as expert witnesses in courts of law in civil and
criminal disputes that require an assessment of the financial effects of a loss or the detection of a
financial fraud. Common litigation where forensic accountants are hired include insurance
claims, personal injury claims, suspected fraud and claims of professional negligence in a
financial matter (e.g. business valuation).

Tax Accounting

As the name implies, tax accounting refers to accounting for the tax related matters. It is
governed by the tax rules prescribed by the tax laws of a jurisdiction. Often these rules are
different from the rules that govern the preparation of financial statements for public use (i.e.
GAAP). Tax accountants therefore adjust the financial statements prepared under financial
accounting principles to account for the differences with rules prescribed by the tax laws.
Information is then used by tax professionals to estimate tax liability of a company and for tax
planning purposes.

Governmental/Public Accounting

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Also known as public accounting or federal accounting, governmental accounting refers to the
type of accounting information system used in the public sector. This is a slight deviation from
the financial accounting system used in the private sector. The need to have a separate
accounting system for the public sector arises because of the different aims and objectives of the
state owned and privately owned institutions. Governmental accounting ensures the financial
position and performance of the public sector institutions are set in budgetary context since
financial constraints are often a major concern of many governments. Separate rules are followed
in many jurisdictions to account for the transactions and events of public entities.

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FINANCIAL ACCOUNTING

Financial Accounting

1. The form of accounting in which financial reports are produced to provide investors or other
external parties with information on a company’s financial status.

2. The process of classifying and recording a company’s transactions and presenting them in the
form of profit and loss accounts, balance sheets and cash flow statements for a given accounting
period

3. The type of accounting which covers the recording, identifying, measuring, summarizing and
communicating economic information of a business to permit informed judgments and decisions
by users of the information.
Financial Accountant

Financial Accountant is a qualified accountant, a member of any Institute of Financial

Accountants, who advises on accounting matters or who works as the financial director of a
company

IMPORTANCE OF FINANCIAL ACCOUNTING

• It helps to prevent fraudulent practices of the business

• It helps to determine the income and expenditure of the business
• It helps to determine the asset and liabilities of a business
• It helps to make good decision through the financial data of a business
• It provide permanent record of all transactions
• It helps to determine profitability, liquidity and risk of a business

BOOKKEEPING & FINANCIAL ACCOUNTING

Book-keeping is a part of financial accounting and is concerned with the recording of monetary
transactions in a regular and systematic which is often routine and clerical in nature, whereas
financial accounting performs other functions as well, viz., measurement and communication,
besides recording.

LIMITATIONS OF FINANCIAL ACCOUNTING

Financial accounting permits alternative treatments

No doubt, accounting is based on concepts and it follows "generally accepted accounting

principles", but there exist more than one principle for the treatment of any one item. This
permits alternative treatments within the framework of generally accepted accounting principles.

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For example, the closing stock of a business may be valued by any one of the following methods:
FIFO (First-in-first-out); LIFO (Last-in First-out); Average price, Standard price etc.,
Application of different methods will give different results but the methods are generally
accepted. Therefore, the results are not comparable.

Financial accounting is influenced by personal judgments

In spite of the fact that convention of objectivity is respected in accounting but to record certain
events estimates have to be made which requires personal judgment. It is very difficult to expect
accuracy in future estimates and objectivity suffers. For example, in order to determine the
amount of depreciation to be charged every year for the use of fixed asset it is required to
estimate (a) future life of the asset, and (b) scrap value of the asset. Thus, in accounting we do
not determine but measure the income. In other words, the income disclosed by accounting is not
authoritative but approximation.

Financial accounting ignores important non-monetary information

Financial accounting takes into consideration only those transactions and events which can be
described in monetary terms. The transactions and events, however important, if non-monetary
in nature are ignored i.e., not recorded. For example, extent of competition faced by the business,
technical innovations possessed by the business, loyalty and efficiency of the employees etc. are
the important matters in which management of the business is highly interested but accounting is
not tailored to take note of such matters. Thus, any user of financial information is, naturally,
deprived of vital information, which is of non-monetary character.

Financial accounting does not provide timely information

Financial accounting is designed to supply information in the form of statements (Balance Sheet
and Profit and Loss Account) for a period, normally, one year. So the information is, at best, of
historical interest and only postmortem analysis of the past can be conducted. The business
requires timely information at frequent intervals to enable the management to plan and take
corrective action.

USERS OF ACCOUNTING INFORMATION

Management
Management needs detailed information in order to control their business and plan for the future.
Budgets will be based upon past performance and future plans. These budgets will then be
compared with actual results. Information will also be needed about the profitability of
individual departments and products. Management information must be very up to date and is
normally produced on a monthly basis.
Investors

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Investors and potential investors are interested in their potential profits and the security of their
investment. Future profits may be estimated from the target company’s past performance as
shown in the income statement. The security of their investment will be revealed by the financial
strength and solvency of the company as shown in the statement of financial position. The largest
and most sophisticated groups of investors are the institutional investors, such as pension funds
and unit trusts.
Employees
Employees and trade union representatives need to know if an employer can offer secure
employment and possible pay rises. They will also have a keen interest in the salaries and
benefits enjoyed by senior management. Information about divisional profitability will also be
useful if a part of the business is threatened with closure.
Lenders
Lenders need to know if they will be repaid. This will depend on the solvency of the company,
which should be revealed by the statement of financial position. Long-term loans may also be
backed by ‘security’ given by the business over specific assets. The value of these assets will be
indicated in the statement of financial position.
Government
Government agencies need to know how the economy is performing in order to plan financial
and industrial policies. The tax authorities also use financial statements as a basis for assessing
the amount of tax payable by a business.
Suppliers
Suppliers need to know if they will be paid. New suppliers may also require reassurance about
the financial health of a business before agreeing to supply goods.
Customers
Customers need to know that a company can continue to supply them into the future. This is
especially true if the customer is dependent on a company for specialised supplies.
Competitors
Competitors wish to compare their own performance against that of other companies and learn as
much as possible about their rivals in order to help develop strategic plans.
Public
The public may wish to assess the effect of the company on the economy, local environment and
local community. Companies may contribute to their local economy and community through
providing employment and patronising local suppliers. Some companies also run corporate

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responsibility programmes through which they support the environment, economy and
community by, for example supporting recycling schemes.
QUALITATIVE CHARACTERISTICS OF USEFUL FINANCIAL INFORMATION
FUNDAMENTAL CHARACTERISTICS
The Conceptual Framework states that financial information is only useful if it is:
• Relevant
• a faithful representation of an entity’s transactions.
Relevance
Relevant information will make an impact on the decisions made by users of the financial
statements. Relevance requires management to consider materiality. An item is material if
omitting, misstating or obscuring it would influence the economic decisions of users.
Faithful representation
A faithful representation of a transaction would represent its economic substance rather than its
legal form. A perfectly faithful representation would be: Complete, Neutral and Free from error.
ENHANCING CHARACTERISTICS
In addition to the two fundamental qualitative characteristics, there are four enhancing
qualitative characteristics of useful financial information:
Comparability – investors should be able to compare an entity’s financial information year-on-
year, and one entity’s financial information with another.
Timeliness – older information is less useful.
Verifiability – knowledgeable users should be able to agree that a particular depiction of a
transaction offers a faithful representation.
Understandability – information should be presented as clearly and concisely as possible.

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ACCOUNTING INFORMATION SYSTEMS

Accounting information systems, or AIS, is the system by which a company collects, stores and
processes its financial and accounting data. Many AIS are now built to integrate with other
departments such as connecting the hiring process in Human Resources to the payroll function of
a newly hired employee. This flow-through process helps minimize the manual entry of
information.

How an accounting system contributes to providing useful information

The main features of an accounting system and how it helps in providing information to the
business are as follows:

In a computerised system all information about the business transactions can be quickly
accessed. This will help in decision making.

• It provides details of transactions of the business in the relevant accounts.

• When the accounts are closed off the balances for each outstanding account are determined.
This will give the value of assets and liabilities in the business.
• It gives a summary of outstanding balances.
• This summary can then be used for the preparation of financial statements.

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FINANCIAL ACCOUNTING INFORMATION

(ACCOUNTING EQUATION)

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FINANCIAL ACCOUNTING INFORMATION (ELEMENT & COMPONENT)

The purpose of financial accounting information is to provide information to users about an
entity’s: Assets, Liabilities, Equity, Income and Expenses.
This information is provided in:

• a statement of financial position (Balance Sheet)

• statements of financial performance (Profit or Loss account)
• Other statements, such as statements of cash flows, statement of changes in equity, and
notes to accounts.
THE ACCOUNTING EQUATION
By adding up what the accounting records they say belongs to a business and deducting what
they say the business owes, you can identify what a business is worth according to those
accounting records. The whole of financial accounting is based upon this very simple idea. It is
known as the accounting equation.
It can be explained by saying that if a business is to be set up and start trading, it will need
resources. Let’s assume first that it is the owner of the business who has supplied all of the
resources. This can be shown as: Resources supplied by the owner = Resources in the
business
In accounting, special terms are used to describe many things. The amount of the resources
supplied by the owner is called capital. The actual resources that are then in the business are
called assets. This means that when the owner has supplied all of the resources, the accounting
equation can be shown as: Capital = Assets
Usually, however, people other than the owner have supplied some of the assets. A liability is
the name given to the amounts owing to these people for these assets. The accounting equation
has now changed to: Capital = Assets − Liabilities
It can be seen that the two sides of the equation will have the same totals. This is because we are
dealing with the same thing from two different points of view – the value of the owners’
investment in the business and the value of what is owned by the owners.
Asset = Capital + Liability
Capital = Asset - Liabilities
Liability = Asset - Capital
The accounting equation is expressed in a statement called the Statement of financial position or
balance sheet.

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BALANCE SHEET / STATEMENT OF FINANCIAL POSITION

The balance sheet shows the financial position of an organization at a point in time. In other
words, it presents a snapshot of the organization at the date for which it was prepared.
Note: the balance sheet is not an account. Its only shows the balance remaining in the books. It
shows the asset and liabilities of the business for a particular period. The elements of balance
sheet are Asset, Liabilities and Capital.
Pro – form:
Shift A
Statement of Financial Position as At 31st December 2022
Asset:
Fixed Asset / Non-Current Asset:
Le
Tangible:
Building xxx
Land xxx
Furniture and fitting xxx
Plant and machinery xxx
Intangible:
Good will xxx
Patent xxx
royalty xxx
Copy right xxx

Investment (Neither a tangible nor an intangible asset) xxx

xxx
Current Asset:
Closing stock / Inventory xxx
Debtors / Receivables xxx
Prepayment / Prepaid xxx
Bills Receivable xxx
Income accrued xxx
Bank / cash xxx xxx
Total asset xxx

Capital / Equity &Liabilities

Capital xxx
Net profit xxx
xxx
Long Term Liabilities / Non-Current Liabilities
Debenture xxx

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Loan xxx
Mortgage xxx xxx

Short Term Liabilities/Current Liabilities

Creditors / payables xxx
Accruals / Owings / Outstanding / Due xxx
Bills payable xxx
Income in Advance xxx xxx
Total equity/capital and liabilities xxx

ASSET
These are things or properties owned and controlled by the business. Example; Land and
building, cash / Bank, Prepayment, closing stock, debtors, motor vehicles, motor van, furniture
and fittings, land, office building, Good will, patent right, Copy right etc. it is divided into two
which are as follows;

Fixed Asset / Non-Current Asset

These are things or properties owned by the business that can last for a long period of time. They
are not easily turned into cash. Example; Land and building, motor vehicles, motor van, furniture
and fittings, land, office building etc.

Current Asset
These are asset that could be turned into cash easily. Example closing stock, debtors, bills
receivable, cash in hand, cash at bank etc.

LIABILITIES
These are debts owed by a business. Liabilities include amounts owed by the business for goods
and services supplied to the business and for expenses incurred by the businesses that have not
yet been paid for. They also include funds borrowed by the business. It is sub divided into the
following;

Long Term Liabilities / Non-Current Liabilities

These are debts owed by the business for a long period. i.e. more than one year. Example
includes; loan, debenture mortgage etc.

Short Term Liabilities/Current Liabilities

These are debts owed for a short period. i.e. not more than one year. Examples include; creditors,
accruals, arrears etc.

CAPITAL

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Capital is a type of liability; it is the money/items produced by the owner/owners of a business to

start up a business. It is the resources supplied by the owner.
Capital is often called the owner’s equity or net worth. It comprises the funds invested in the
business by the owner plus any profits retained for use in the business less any share of profits
paid out of the business to the owner.
PRACTICE QUESTIONS
1. Complete the gaps in the following table:
Assets Liabilities Capital
Le Le Le
(a) 12,500 1,800 ?
(b) 28,000 4,900 ?
(c) 16,800 ? 12,500
(d) 19,600 ? 16,450
(e) ? 6,300 19,200
(f) ? 11,650 39,750

2. Complete the gaps in the following table:

Assets Liabilities Capital
Le Le Le
(a) 55,000 16,900 ?
(b) ? 17,200 34,400
(c) 36,100 ? 28,500
(d) 119,500 15,400 ?
(e) 88,000 ? 62,000
(f) ? 49,000 110,000

3. Which of the items in the following list are liabilities and which of them are assets?
(a) Loan to C Shirley (d) Computers
(b) Bank overdraft (e) we owe a supplier for goods
(c) Fixtures and fittings (f) Warehouse we own

4. State which of the following are wrongly classified:

Assets Liabilities
Loan from C Smith Stock of goods
Cash in hand Debtors
Machinery Money owing to bank
Creditors Motor vehicles ‘

5. Bammy Wise is setting up a new business. Before actually selling anything, he bought a
van for£4,500, a market stall for £2,000 and a stock of goods for £1,500. He did not pay
in full for his stock of goods and still owes £1,000 in respect of them. He borrowed

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£5,000 from C Fox. After the events just described, and before trading starts, he has £400
cash in hand and £1,100 cash at bank. Calculate the amount of his capital.

6. Sia is starting a business. Before actually starting to sell anything, he bought fixtures
for£1,200, a van for £6,000 and a stock of goods for £2,800. Although he has paid in full
for the fixtures and the van, he still owes £1,600 for some of the goods. B Rub lent him
£2,500. After the above, Flint has £200 in the business bank account and £175 cash in
hand. You are required to calculate his capital.

7. Draw up Alma’s balance sheet from the following information as at 31 December 20X8:
£
Capital 7,200
Debtors 1,200
Van 3,800
Creditors 1,600
Fixtures 1,800
Stock of goods 4,200
Cash at bank 300

8. Draw up Janet’s balance sheet as at 30 June 20X6 from the following items:
£
Capital 10,200
Equipment 3,400
Creditors 4,100
Stock of goods 3,600
Debtors 4,500
Cash at bank 2,800

9. Amara has the following items in her balance sheet as on 30 April 20X8: Capital
£18,400; Creditors £2,100; Fixtures £2,800; Car £3,900; Stock of goods £4,550; Debtors
£2,780; Cash at bank £6,250; Cash in hand £220.
During the first week of May 20X8
(a) She bought extra stock for goods £400 on credit.
(b) One of the debtors paid her £920 by cheque.
(c) She bought a computer by cheque £850.
You are asked to draw up a balance sheet as on 7 May 20X8 after the above transactions have
been completed.

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