Introduction to Accounting

Unit 1 : The Nature of Accounting and

Accounting Equation

Objectives

After you have studied this chapter, you should:

Know what accounting isKnow who are the main users of accounting

informationUnderstand what is meant by assets,

liabilities and capitalUnderstand the accounting equationCommon accounting terminologyTypes of businessTypes of financial statements

What is Accounting? Accounting is the language of

business.

Accounting can be defined as “the process of identifying, measuring, and communicating economic information to permit informed judgments and decisions by users of information.

Accounting is the art of recording, classifying,

and summarising money transactions and events

The history of AccountingAccounting began because

people needed to

Record business transactionsKnow if they were being

financially successfulKnow how much they owned and

how much they owed

Accounting comprises 4 main activitiesRecording Classifying Summarising: (when preparing

The Profit and Loss Account, and The Balance Sheet)

Interpretation

The branches of Accounting

Accounting

Book-keepingFinancial

accounting and reporting

Management accounting

Cost book-keeping

What is bookkeeping?Bookkeeping is the process of

recording data relating to accounting transactions in the accounting books.

Bookkeeping is the mechanical task involving the collection of basic financial data.

These data are entered in special records known as books of account and then extracted in the form of a trial balance.

The purpose of accountingIt is to provide information to the

management by using the data recorded by book-keeping and converting it into financial statements.

Balance sheetProfit and loss accountCash flow statement

Types of business

Sole trader

•Capital put in by the owner•Business is run by the proprietor•Usually small retail establishments•Unlimited liability

Partnership

•Capital contributed by all partners•Each partner acts as the principal and agent of the firm•Profits or losses at the end of the year are shared in the agreed ratio•Usually professionals like doctors, lawyers, accountants, etc

Company•Capital contributed by the public, who are joint owners of the company•Can be public or private •Separate legal entity•Ownership and management is usually separate•No limit to the maximum amount of members•Accounts must be prepared and audited yearly under the company's act

The main users of accounting information

Accounting

information

Investors

Lenders

Employees

Suppliers

Public

Governments

Customers

The objectives of financial statementsProvide information on the financial

position of the business at the start of the period.

Provide information on the financial of the business at the end of the period.

• Show the analysis of the changes during the period.

The financial stability of the business.

• Indicate the future prospects of the business.

Users of financial statementsInternal groups The management and the

employeesEmployees; their interest: Employment stabilityWage negotiationManagement; their interest: all aspects (Performance)

Users of financial statementsExternal groups

InvestorsLenders Suppliers CustomersGovernmentGeneral Public

The Accounting Equation:

Resources supplied by the owner = Resources in the business

Capital = AssetsCapital = Assets – LiabilitiesAssets = Capital + LiabilitiesResources: what they are= Resources:

who supplied them (Assets) (Capital+

Liabilities )

The Accounting Equation:

The concept of a Balance Sheet is based on the accounting equation, which is:

Assets = Liabilities + Owner’s equity

TerminologyBusiness entity. The owner is

separate from the business as such we record business transactions in the business books.

Any transactions carried out by the owner outside of the business are not reflected in the books of the business.

Business transaction. Any event that affects the business e.g. purchase of goods for resale, payment of business expenses, etc.

Business transaction can be for cash or on credit.

Cash transaction means that cash was paid or received in exchange for goods and services.

Credit transaction means that goods or services were rendered or received for which the payment will be received/paid later.

TerminologyCapital. Any value introduced by

the owner into the business. This value can be represented by cash and assets.

Drawings. Any value withdrawn by the owner from the business for personal use. This value can be cash and goods.

TerminologyDebtors. Customers to whom

goods have been sold or services have been provided for which they not yet paid.

Creditor. Suppliers from whom the business have purchased goods or acquired services for the business has not yet paid.

Trading Accounting. This is a statement which is used to compute gross profit .

Terminology

Profit and loss account This is a statement used for computing net profit.

Balance sheet. A statement which shows what a business owes and own at a particular point of time.

AssetsAssets. Any item of value owned

and used by the business to carry out its trade.

They can be subdivided into a) Current Assets, fluctuating

day to day b) Fixed assets, used by the

business over a long period of time .

Liabilities. These are amounts owed by the

business to outsiders. They can be subdivided into

a) Short term liabilities .

b) Long term liabilities.