Federal University Lokoja

Department of Economics

100 Level First Semester 2013/2014 Academic Session

Econ 103: Basic Accounting

Olatinwo Olabanji A. (MSc.)

Ibrahim Muye Y. (MSc.)

Lesson Note I: NATURE AND SIGNIFICANCE OF ACCOUNTING AND BOOK-

KEEPING

Accounting is as old as money itself”. In the early ages, commercial activities were based on barter

system which meant record keeping was not a necessity. The Industrial Revolution of 19th century

along with rapid rise in population, paved the way for the development of commercial activities,

mass production and credit terms. Thus recording of business transaction has become an

important feature of modern businesses. In recent years with the change in technologies and

marketing along with stiff competition and globalization accounting system has undergone

remarkable changes. Today when accounting is mentioned, it extend beyond the traditional record

keeping and preparation of final accounts (statement of comprehensive income and statement of

financial position) encompassing all aspects of financial management including auditing, cross-

border transactions, mergers and acquisitions and investment planning using sophisticated

processes and electronic application platforms.

Conceptual Meaning and Purpose of Accounting and Book-Keeping

Accounting is concerned basically with “accountability” or “stewardship”. The underlying purpose

of accounting is to provide financial information about an economic entity, the management of its

resources and its obligation to owners and other third parties. In essence, it is about making

providing owners and interested third parties with report on the activities and profitability of the

operations of economic entity. This information is provided, periodically, to shareholders and

others connected with the organization to enable them decide the extent to which they want to

continue to associate with the organization. The need for accounting is more pronounced in a

business where a lot of finance, risk, and energy have been involved. Financial information is

needed to plan and control the finance and operation of a business. Thus, Accounting may be

defined as the science and the art of systematically recording, presenting, and interpreting the

financial facts of an individual or enterprise. It can also be defined as the art of recording,

classifying, summarizing and analysing financial transactions of a business However, a more

comprehensive definition is given by the American Accounting Association which defines accounting as

“the process of identifying, measuring and communicating economic information to permit

informed judgements and decision by users of the information”.

The process of accounting as per the definition above is given below:

input process output

The definition above is a functional one highlighting the roles of the accountant to the business

enterprise and the society. Below, each process is explained in brief.

i. Identifying: Identifying the business transactions from the source documents.

ii. Recording: The next function of accounting is to keep a systematic record of all business

transactions, which are identified in an orderly manner, soon after their occurrence in the

journal or subsidiary books.

iii. Classifying: This is concerned with the classification of the recorded business transactions

so as to group the transactions of similar type at one place, i.e. in ledger accounts. In order

to verify the arithmetical accuracy of the accounts, trial balance is prepared.

iv. Summarising: The classified information available from the trial balance is used to prepare

profit and loss account and balance sheet in a manner useful to the users of accounting

information.

v. Analysing: It establishes the relationship between the items of the profit and loss account

and the balance sheet. The purpose of analysing is to identify the financial strength and

weakness of the business. It provides the basis for interpretation.

vi. Interpreting: It is concerned with explaining the meaning and significance of the

relationship so established by the analysis. Interpretation should be useful to the users, so

as to enable them to take correct decisions.

vii. Communicating: The results obtained from the summarised, analysed and interpreted

information are communicated to the interested parties.

Need and Importance of Accounting

When a person starts a business, whether large or small, his main aim is to earn profit. He receives

money from certain sources like sale of goods, interest on bank deposits etc. He has to spend

money on certain items like purchase of goods, payment of salary, payment for rent expenses, etc.

These activities take place during the normal course of his business. He would indeed be keen at

the year end, to know the progress of his business. Business transactions are numerous, that it is

not possible to recall from memory how the money had been earned and spent. At the same time,

Business

transactions

(monetary value)

Identifying Recording Classifying Summarising Analysing Interpreting Communicating

Information

to users

if he had documented his incomes and expenditures, he can readily get the necessary information.

Consequently, the details of the business transactions have to be recorded in a clear and systematic

manner to get answers easily and accurately for the following questions at any time he likes.

i. What has happened to his investment?

ii. What is the result of the business transactions?

iii. What are the earnings and expenses?

iv. How much amount is receivable from customers to whom goods have been sold on credit?

v. How much amount is payable to suppliers on account of credit purchases?

vi. What are the nature and value of assets possessed by the business concern?

vii. What are the nature and value of liabilities of the business concern?

viii. What is the obligation of the business to government, i.e. how much is the tax liability of

the entity?

ix. Is the business solvent enough to settle all its obligations when they fall due?

These and several other questions are answered with the help of accounting. The need for

recording business transactions in a clear and systematic manner is the basis which gives rise to

Book-keeping

Book-keeping

Book-keeping is that branch of knowledge which tells us how to keep a record of business transactions. It is the recording phase of accounting. It is the classification and recording of business transactions in the books of account. It is often clerical and routine therefore it tends to be repetitive. It is important to note that only those transactions related to the business which can be expressed in terms of money are recorded. The activities of book-keeping include recording in the journal, posting to the ledger and balancing of accounts. R.N. Carter defines thus: “Book-keeping is the science and art of correctly recording in the books of account all those business transactions that result in the transfer of money or money‟s worth”. The objectives of book-keeping are

i. To have permanent record of all the business transactions. ii. To keep records of income and expenses in such a way that the net profit or net loss may

be calculated. iii. To keep records of assets and liabilities in such a way that the financial position of the

business may be ascertained. iv. To keep control on expenses with a view to minimise the same in order to maximise profit. v. To know the names of the customers and the amount due from them. vi. To know the names of suppliers and the amount due to them. vii. To have important information for legal and tax purposes.

Book keeping involves a number of process and they are below:

(a) The classification of business transactions using source documents; (b) Recording of classified transactions in appropriate subsidiary books or books of prime

entry; (c) Posting of entries from subsidiary books to the ledger; and (d) Extraction of ledger balances at the end of the period to prepare the Trial Balance.

History of Accounting

As have been mentioned earlier, 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.

Accounting is known to have existed in one form or another since at least 3,500 BC (records exist which indicate its use at that time in Mesopotamia). There is also reasonable evidence of accounting being practised in ancient times in Egypt, China, Greece, and Rome. In England, the

‘Pipe Roll’, the oldest surviving accounting record in the English language, contains an annual description of rents, fines and taxes due to the King of England, from 1130 to 1830.

However, it was only when Lucia Pacioli wrote about it in 1494 or, to be more precise, wrote about a branch of accounting called, „bookkeeping‟ that accounting began to be standardised and recognised as a process or procedure.

No standard system for maintaining accounting records had been developed before this because the circumstances of the day did not make it practicable for anyone to do so – there was little point, for example, of anyone devising a formal system of accounting if the people who would be required to „do‟ accounting did not know how to read or write.

One accounting scholar (A. C. Littleton) suggested that seven key ingredients which were required before a formal system could be developed existed when Pacioli wrote his treatise:

1. Private property: The power to change ownership exists and there is a need to record the transaction.

2. Capital: Wealth is productively employed such that transactions are sufficiently important to make their recording worthwhile and cost-effective.

3. Commerce: The exchange of goods on a widespread level. The volume of transactions needs to be sufficiently high to motivate someone to devise a formal organised system that could be applied universally to record transactions.

4. Credit: The present use of future goods. Cash transactions, where money is exchanged for goods, do not require that any details be recorded of who the customer or supplier was. The existence of a system of buying and selling on credit (i.e. paying later for goods and service purchased today) led to the need for a formal organised system that could be applied universally to record credit transactions.

5. Writing: A mechanism for making a permanent record in a common language. Writing had clearly been around for a long time prior to Pacioli but it was, nevertheless, an essential element required before accounting could be formalised.

6. Money: There needs to be a common denominator for exchanges. So long as barter was used rather than payment with currency, there was no need for a bookkeeping system based upon transactions undertaken using a uniform set of monetary values.

7. Arithmetic: As with writing, this has clearly been in existence far longer than accounting. Nevertheless, it is clearly the case that without an ability to perform simple arithmetic, there was no possibility that a formal organised system of accounting could be devised.

c. Users of financial statements and their information needs

d. scope and the range of accounting services provided to organizations