FUNDAMENTALS OF

ACCOUNTING I
CHAPTER ONE:
INTRODUCTION TO ACCOUNTING AND BUSINESS
1.1 The nature of business

Definition I
 Business is a socio-economic activity that

satisfies human needs and wants by

providing goods and services for profit to
maintain and improve quality of life.
 . Goods are tangible items manufactured by businesses,

such as laptops
1.1 The nature of a business

 . Services are intangible offerings of businesses that

can’t be held, touched, or stored. Eg. . Physicians,
lawyers, hairstylists, car washes, and airlines
 1.2 Types of business organization in Ethiopia

 Definition - A business organization is an

economic entity which is engaged in converting
basic inputs into products (provision of service)
for sale at profit to customers.
 1.2 Types of business organization in Ethiopia

Types of business organizations - based on the

type of activities they perform or are engaged in
to generate income, business organizations
may be divided in to three:
 1.2 Types of business organization in
Ethiopia

Service - an enterprise that renders professional

and technical services. E.g.
banks, telecommunication and transportation
companies.
Merchandising - an enterprise that buys and
resells finished goods to customers. E.g.
Stationery shops, retail and wholesale stores,
supermarkets, etc.
1.2 Types of business organization in
Ethiopia

 Manufacturing - an enterprise that buys and

converts raw materials into finished products
for sale to other businesses (merchandising)
or direct to consumers. E.g. textile and
cement factories, wood- and metal-work
shops, etc.
1.2 Types of business organization in Ethiopia

 Forms of business organizations - Three

different legal forms of businesses:
1.2 Types of business organization in Ethiopia

 Sole proprietorship - an enterprise owned by

one person and usually operated and
managed by the same person. The sole
proprietorship form of business is not a
separate legal entity from its owner. The life
of a sole-proprietorship usually depends up
on the life of the owner.
1.2 Types of business organization in Ethiopia

Partnership - an enterprise owned by two/more

persons called partners and the partners are
usually engaged in operations and management
of the organization.
1.2 Types of business organization in Ethiopia
 . Like the sole proprietorship form of
business, partnership is not legally separate
from its owners .
 The life of a partnership usually depends up

on the admission of new partner/s or

withdrawal of existing partner/s
1.2 Types of business organization in Ethiopia

Corporation - an enterprise owned usually by

three/more persons called shareholders or
stockholders.
The unique feature of a corporation is that
 It is a legal entity usually referred to as an

artificial person which is solely responsible

for its act and debt.
1.2 Types of business organization in Ethiopia

. Its life does not depend on the admission or

withdrawal of shareholder/s.
Assignment 1
Write down the advantage and disadvantage of
i. Sole proprietorship
ii. Partnership
iii. corporation
 1.3The Role of Accounting
Accounting is defined as a process identifying measuring, recording
and communicating economic events of an organization (business or
non –business) to interested users of the information.
Identifying - collecting recordable economic activities
Measuring - This involves determining whether the
economic activities bring changes (increase/decrease)
Recording- effects of economic activities on A,L,C,R,and
E
It is the language of business
 1.4 The profession of
accounting
I) Public Accounting
ii)Private Accounting or
iii) Not – for – profit Accounting
 1.4 The profession of
accounting
i) Public accounting
 A major portion of public accounting

practice is involved with Auditing.

 CPA examines the financial statements of

companies and expresses opinion as to the

fairness of presentation
 ii) Private Accounting
private accountant involved in one of the
following activities:-
 Cost Accounting: Determining the cost of

producing specific products.

 Budgeting: Assisting management in

quantifying goals concerning revenues,

costs of goods sold, and operating
expenses.
 ii) Private Accounting
 General Accounting: recording daily
transactions and preparing financial
statements and related information.
 Accounting information systems: designing

both manual and computerized data processing

systems
ii) Private Accounting
 Tax Accounting: preparing tax returns (forms
to be filled by a company and returned to a
taxing authority) and engaging in tax
planning for the company.
 Internal Auditing: reviewing a company’s

operations to determine compliance with

management policies and evaluating
efficiency of operations.
iii) Not for Profit Accounting

 Not - for-profit organizations need sound

financial reporting and control.
 Donors to such organizations want

information
1.5 An overview of International
Financial Reporting Standards
Definition

International Financial Repot Standard (IFRS)

is a set of accounting standards developed by an
independent, not- for-profit organization called
the International Accounting Standards Board
(IASB
IFRSs refers to the entire body of IASB

pronouncements, including standards and

interpretations approved by the IASB .
1.5 An overview of International
Financial Reporting Standards
 IASB has amended some IASs and has
proposed to amend others
 IASB has replaced some IASs with new

International Financial Reporting Standards

(IFRSs)
1.5 An overview of International
Financial Reporting Standards
Framework for the preparation and presentation of Financial Statements

 IFRS 1 First-time Adoption of International Financial Reporting Standards

 IFRS 2 Share –based payment
 IFRS 3 Business Combinations
 IFRS 4 Insurance contracts
 IFRS 5 Nun-current Assets Held for Sale and Discontinued Operations
 IFRS 6 Explorations for and Evaluation of Mineral Assets
 IFRS 7 Financial Instruments .Disclosures
 IFRS 8 Operating Segments
 IFRS 9 Financial Instruments
 IFRS 10 Consolidated Financial Statements
 IFRS 11 Joint Arrangements
 IFRS 12 Disclosure of interests in Other Entities
 IFRS 13 Fair Value Measurement
International Accounting Standards

 IAS 1 Presentation of Financial

Statements
 IAS 2 Inventories
 IAS 3 Consolidated Financial
Statements-Originally issued 1976,
effective 1 Jan 1977
 IAS 4 Depreciation Accounting-
Withdrawn in 1999, replaced by
IAS16,22 AND 38
 International Accounting
Standards
 IAS 5 Information to be Disclosed in
Financial Statement- Originally
issued October 1976, effective 1 Jan
1997
 IAS 6 Accounting Responses to
changing prices. Superseded by IAS
15, which was withdrawn Dec.2003
 IAS 7 Statement of Cash Flows
International Accounting
Standards
 IAS 8 Accounting Policies ,Changes in
A accounting Estimates and Errors
 IAS 9 Accounting for Research and
Development Activities. Superseded by
IAS 38 EFFECTIVE 1/7/99
 IAS 10 Events after the Reporting Period
International Accounting
Standards

IAS 11 Consultation Contracts

IAS 12 Income Taxes
IAS 13 Presentation of current Assets and Current
Liabilities-superseded by IAS 1
IAS 14 Segment Reporting
IAS 15 Information Reflecting the Effects of
changing prices –withdrawn Dece.2003
IAS 16 Property, Plant and Equipment etc…
1.6 OVER VIEW OF FINANCIAL
REPORTING REQUIRMENTS IN
ETHIOPIA AND AABE
Accounting and accounting rules in Ethiopia
 Accou nting and accounting rules in

Tax Year: The fiscal year runs from the 8 July to

the 7 July of the following calendar year.
Accounting Standards: The Financial Report
Proclamation of Ethiopia - issued in 2014 -
requires companies including banks to follow
IFRS standards in their financial statement
presentation.
Accounting Regulation Bodies:
Accounting and Auditing Board of Ethiopia (AABE
)
 Accounting and
accounting rules in
Ethiopia
Accounting Reports: The annual report has to include a
balance sheet, a profit and loss account and a cash flow
statement.
Publication Requirements: Any reporting entity shall submit
its financial report to the Accounting and Auditing Board of
Ethiopia, within the schedule set by the Board itself.
 Accounting and accounting
rules in Ethiopia
Professional Accountancy Bodies: Ethiopian
Professional Association of Accountant and
Auditors .
Certification and Auditing: The auditing
standards to be used by auditors in Ethiopia shall
be the International Standards for Auditing
issued by the International Federation of
Accountants.
 Financial Reporting Requirements in Ethiopia

IFRS 1 is regularly updated to address first –time adoption issues.

IFRS1 requires companies to:
a) Identify the first IFRS financial statements
b) Prepare an opening SFP(statement of financial position) at the
date of transition to IFRS;
C) Select accounting policies the comply with IFRS effective at the
end of the first IFRS reporting period and apply those policies
retrospectively to all periods presented in the first IFRS financial
statement (SENE30, 2009/10/11E.C). These accounting policies
are used in the opening IFRS effective at earlier dates.
The entity does not apply different versions of IFRS effective at
earlier dates.
 ]
Financial Reporting Requirements in Ethiopia

Estimates in the opening IFRS, SFP must be

consistent with estimates made at the same date
under previous GAAP even if further information
is now available (in order to comply with IAS 8).
d) Consider whether to apply any of the
optional exemptions from retrospective
application;
e) Apply mandatory exceptions from
retrospective application;
f) Make extensive disclosures to explain the
transition to IFRS.
 1.7 Accounting Elements,
Business Transactions and
Accounting Equation
Elements of Financial Statements - are items that
are recorded in the accounting records and then
reported on commonly called financial statements of a
business entity reports. The elements of financial
statements include assets, liabilities, capital, revenue
and
expenses.
 1.7 accounting Elements and
Accounting Equation
Assets - are resources owned/controlled by an economic
entity and with the potential to provide future benefits
to the business. E.g. building, land, vehicle, money,
office machine
 1.7 accounting Elements
Liabilities - obligations/debts of a business that arise as a
result of borrowing and/or buying goods and services on
credit. E.g. Accounts Payable , Salary Payable , Utility
Payable , Bank Loan Payable .
Capital - refer to resources contributed by or that belong
to the owner/s of a business entity.
 Capital may include direct investment of resources by

owner/s and profit generated from business operations

that are accumulated over time or not withdrawn by
the owner/s for personal use.
 1.7 accounting Elements

Revenues - refer to money or other assets received in

exchange for goods and services sold to customers. Eg.
Sales ,Fees Earned Interest Income , Rent/Royalty Income ,
Commission Income
 1.7 accounting Elements
Expenses - refer to goods and services consumed/used in
operating or carrying on day-to-day activities of a business.
Eg. Supplies Expense , Utility Expenses, Wages/Salary
Expenses Interest Expense , Rent/Royalty Expense
 Accounting Equation
Accounting Equation - is a mathematical expression
that shows the relationship between assets, liabilities
and capital of a business.
 Accounting Equation
Resources = Equities/Claims to Resources

Resources contributed or invested by owner/s and those

resources supplied by creditors

Assets = Liabilities + Owner's Equity

 Accounting Equation

Assets-Liabilities=Owner's Equity
Business Transaction and
its Effect
on Accounting
Equation
 Business Transaction
Business Transactions - are economic activities of a
business that bring monetary changes in its assets,
liabilities, capital, revenues and expenses and should be
recorded in the accounting records of the business.
. They include buying and selling goods and services and
collecting and paying money.
 Business Transactions
Business transactions may be categorized as external
and internal transactions.
External transactions - refer to exchanges of goods
and services between a business organization and an
outside party such as individuals and/or other
organizations.
E.g. buying telephone services from ETC
 Business Transactions
Internal transactions - refer to consumptions of goods
and services within a business entity, which do not
affect external party.
E.g. use of previously purchased stationery materials,
 Effects of Business Transaction
Business transactions affect one or more elements of
the accounting equation.
Below are sample transactions and their effects on
the elements of the
financial statements.
Collections of resources from
 Owner/s in the form of investment, increase both

assets and capital

Creditor/s in the form of credit/loan, increase both

assets and liabilities

Customer/s in exchange for goods and services sold

to them, increase both assets and revenues

 Effects of Business Transaction
Consumptions of goods and services such as
Previously purchased supplies, stationery materials and fuel,

increase expenses and decrease assets

Utility, housing and employee services for which money is

not yet paid, increase both expenses and liabilities

Money taken out of business by the owner for personal use

called withdrawals, decrease both assets and capital

 1.8 Financial Statements

Definition - financial statements are reports prepared

by a business to provide financial information about its
economic affairs to users for decision making.
Business organizations prepare four basic financial
statements: income statement, statement of changes in
owner’s equity (capital), balance sheet and statement
of cash flows.
 1.Balance Sheet
Balance Sheet – is used to provide information about
amounts and types of assets a business owns and
amounts and types of resources contributed by its
owner/s and creditor/s.
It is prepare on a specific date, usually at the end of a

month or a year.
 Balance Sheet
There are two forms of a balance sheet: report and
account.
Report form - lists assets first followed by liabilities
and capital in report writing form
Account form - lists assets on the left side and
liabilities and capital on the right side of the balance
sheet
 2.Income Statement
Income Statement - is used to provide information
about financial performance of a business over time.
 The statement summarizes the revenues earned and

expenses incurred in a specific period of time such as a

month or a year.
 3.Statement of Changes in Owner’s
Equity
Statement of Changes in Owner’s Equity - is a
summary of changes (increases and decreases) in
owner’s equity that have occurred during a specific
period of time such as a month or a year.
The statement includes beginning and ending capital

balances, additional investment, withdrawal and net

income/loss.
 4.Statement of Cash Flows
Statement of Cash Flows - is used to provide
information about sources and uses of cash over a
specific period of time such as a month or a year. Cash
flows are classified based on the activities of an
organization: operating, investing and financing.
 Statement of Cash Flows
Operating activities - refer to cash activities of a business
that are entered into determination of net income/loss.
Investing activities - refer to cash activities of a business
that involve acquisition and sale of relatively long-term
assets
 Statement of Cash Flows

Financing activities - refer to cash activities of a business

that affect equities of owner/s and long-term creditors of
the business.
 Example1.1

On January 3, 2013, Ato Alemu, an ex-manager of the

CBE Bishoftu Branch, established his own consultancy
business. He named his business "AH Consultancy
Services".
 Example1.1
The objective of the business is to render financial
consultancy services to clients on a fee basis. The
following business activities occurred during the
first month of operations of the business (January
3 to January 31, 2013).
 Example1.1
1.Alemu deposited $20,000 cash in a bank account
in the name of his business - AH Consultancy
Services. He has $250,000 cash in his personal bank
account with Dashen Bank and $50,000 cash in a safe
deposit box at his residence.
2.Alemu transferred furniture worth $30,000 from
his home for office purposes by AH Consultancy
Services. He also has extra home furniture,
residential house and personal car worth
$620,000, $800,000 and $360,000, respectively.
 Example1.1
3.Alemu purchased office supplies worth $5,000
from various suppliers agreeing to pay the sum
in the near future. Two-fifth of the supplies will
be used for personal purposes while the
remaining is for use by AH. Three-fifth of the
liability is arranged to be settled from business
cash sources.
 Example1.1
4.AH received $20,000 cash for consultancy
services it rendered to a cash client.
5.AH paid $3,000 cash for advertising aired
through ETV.
6.AH forecasted that services fees in the next
two weeks will amount to $5,000.
7.AH received $10,000 additional cash
investment from Alemu - its owner.
 Example1.1
8.AH rendered consultancy services worth
$15,000 to clients promising to pay in the
near future.
9.AH sold one of the furniture invested by its
owner for $5,000 cash. The furniture had a
recorded value of $5,000.
 Example1.1
10.AH collected $5,000 cash from clients who
received services in item-8 above.
11.AH paid $2,000 cash to suppliers on credit.
12.AH purchased a used car for business
purposes. The business paid $8,000 cash
for the car.
 Example1.1
13.AH borrowed $4,000 cash from
Dashen Bank. The loan is repayable
over ten months.
14.AH employed an accountant and a
secretary for monthly salary of
$1,200 and $700, respectively.
 Example1.1
15.AH incurred and paid for the following
expenses
Wages.................. $6,000
Rent..................... 4,500
Utilities..................... 1,200
Others...................... 800
 Example1.1
16.AH determined that cost of supplies
remained on hand at the end of the
current month total $1,300.
17.AH paid $450 cash to Dashen Bank
consisting of $400 principal and $50
one month interest on the loan due in
January.
18.AH paid its owner $5,000 cash for
personal uses (to pay house utility
expenses).
 :
Required

a) Analyze the above transactions in terms of

their effect on the elements of financial
statement.

b) Prepare financial statements for the business for the

month of January 2013.
 
Chapter 1

The End