DEPARTMENT OF ACCOUNTING

UNIVERSITY OF JAFFNA- SRI LANKA

Programme Title : Bachelor of Engineering Technology
Course Unit : CST307NT2: Fundamentals of Financial Accounting
Handout : 01 – Introduction to Accounting
Prepared by : Mr. A. Ajanthan
Issued on : 02nd of August, 2019

Learning Objectives:
After you have studied this chapter, you should be able to:
 explain what accounting is about
 identify the different activities of accounting
 explain the relationship between bookkeeping and accounting
 outline the history of accounting
 identify the different users of accounting and;
 identify the major types of accounting

Introduction
Accounting plays an important role in recording transactions. It is a discipline that
provides important financial information to a wide range of users in making economic
decisions about the allocation of their economic resources. Through accounting, all
business transactions are recorded at the end of the financial year the results of the
business is assessed in the form of final accounts on the basis of some accepted
principles, rules and guidelines.

Definition of accounting
Different organisations have identified the definition of accounting as follows:
“Accounting is the process of identifying, measuring, and communicating economic
information to permit informed judgements and decisions by users of the
information”. - American Accounting Association (AAA)

“Accounting is the art of recording, classifying and summarising in a significant

manner and in terms of money, transactions and events which are in part at least, of a
financial character, and interpreting the results thereof".
- American Institute of Certified Public Accountants (AICPA)

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Accounting consists of three basic activities — it identifies, records, and communicates
the economic events of an organization to interested users. Let’s take a closer look at
these three activities.

Activities / Functions of Accounting

 As a starting point to the accounting process, a company identifies the economic
events relevant to its business.
Example: Sale of snack chips by PepsiCo, sale of iPods by Apple, the provision of
cell phone services by AT&T, and the payment of wages by Facebook.
 Once a company like PepsiCo identifies economic events, it records those events in
order to provide a history of its financial activities. Recording consists of keeping a
systematic, chronological diary of events, measured in rupees and cents. In
recording, PepsiCo also classifies and summarizes economic events.
 Finally, PepsiCo communicates the collected information to interested users by
means of accounting reports. The most common of these reports are called financial
statements.
A vital element in communicating economic events is the accountant’s ability to analyze
and interpret the reported information. Analysis involves use of ratios, percentages,
graphs, and charts to highlight significant financial trends and relationships. Illustration
1.1 summarizes the activities of the accounting process.

Illustration 1.1: Accounting Activities

Objectives of Accounting
The main objectives of accounting are to:
 ascertain the results of business transactions (profit or loss) within a given period.
 ascertain the true financial position of an entity at the end of the financial period.
 provide necessary information to the users (i.e. interested parties of accounting
information).

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The sub objectives are to:
 to keeping systematic record
 to portray the liquidity position
 to protect business properties and satisfy the requirements of law

Bookkeeping / Recordkeeping
Until about one hundred years ago all accounting data was kept by being recorded
manually in books, and so the part of accounting that is concerned with recording data is
often known as bookkeeping. Nowadays, although handwritten books may be used
(particularly by smaller organisations), most accounting data is recorded electronically
and stored electronically using computers. The CIMA definition of book-keeping is
Recording of monetary transactions, appropriately classified, in the financial records
of an entity. - CIMA, Official Terminology, 2005

Accounting and Bookkeeping

People often fail to understand the difference between accounting and bookkeeping.
Bookkeeping is the process of recording financial transactions and keeping financial
records. Mechanical and repetitive bookkeeping is only a small, but important, part of
accounting. Accounting, on the other hand, includes the design of a financial information
system that meets the user’s needs. The basic differences between accounting and
bookkeeping are given below;
Bookkeeping Accounting
The primary duty of an It involves the preparation of trial
accountant is to identify the balance, income statement and
Scope or
financial transactions and then balance sheet through classified
area
record the said transactions data on the basis of accepted
systematically in the books. accounting principles.
It includes the design of a financial
Bookkeeping is mainly information system that meets the
concerned with the recording of user’s needs. The major goals of
Objective
the financial data or events accounting are analysis,
measurable in terms of money. interpretation and use of
information.
It may be performed even by a
Performer of It is performed by persons having
clerk having no skilled
the job skilled knowledge of accounting.
knowledge of accounting.
Accountancy begins where
Stage It is the primary stage
bookkeeping ends.
It is a clerical job done regularly It is an analytical and a systematic
Nature of job
and chronologically. job done in a consistent manner.

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 It doesn’t require any special It requires special skills and
Skills used skill. It is a mechanical regular knowledge of accounting and
job. accepted rules of accounting.

Example: Bookkeeper of a shoe store keeps the day-to-day records as to how many
shoes are sold and what bills need to be paid; accountant analyzes this data to
evaluate the profitability and health of the business.

Development or Evolution or History of Accounting

Accounting, which has been known as the “language of business”, was first emerged in
the year of 1494 with the contribution made by Luca Pacioli’s book called “Summa
Summa de Arithmetica, Geometria, Proportioni et Proportionalita (Everything about
Arithmetic, Geometry and Proportion)”. Because of this publication, the impact on
accounting was so great and he is known as the “Father of Accounting”. His system
included most of the accounting cycle as we know it today.

Luca Pacioli was born about 1445 at Borgo San Sepulcro in Tuscany, Frater Luca
Bartolomes Pacioli acquired an amazing knowledge of diverse technical subjects –
religion, business, military science, mathematics, medicine, art, music, law and
language. He accepted the popular belief in the inter-relatedness of these widely varying
disciplines and in the special importance of those, such as mathematics and accounting,
which exhibit harmony and balance.

Users of Accounting Information

Accounting is often called the language of business because all organisations set up an
accounting information system to communicate date to help people make better
decisions. Illustration 1.2 shows that the accounting information system serves many
kinds of users who can be divided into two groups: external users and internal users.

Illustration 1.2: Users of accounting information

Internal users

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Internal users of accounting information are managers who plan, organize, and run the
business. These include marketing managers, production supervisors, finance directors,
and company officers. In running a business, internal users must answer many important
questions, as shown in Illustration 1.3.

Illustration 1.3: Questions that asked by internal users

To answer these and other questions, internal users need detailed information on a
timely basis. Managerial accounting provides internal reports to help users make
decisions about their companies.

External users
External users are individuals and organizations outside a company who want financial
information about the company. The two most common types of external users are
investors and creditors. Investors (owners) use accounting information to decide whether
to buy, hold, or sell ownership shares of a company. Creditors (such as suppliers and
bankers) use accounting information to evaluate the risks of granting credit or lending
money. Illustration 1.4 shows some questions that investors and creditors may ask.

Illustration 1.4: Questions that asked by external users

Financial accounting answers these questions. It provides economic and financial

information for investors, creditors, and other external users. The information needs of
external users vary considerably. Taxing authorities, such as the Internal Revenue
Department, want to know whether the company complies with tax laws. Regulatory

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agencies, such as the Securities and Exchange Commission, want to know whether the
company is operating within prescribed rules. Customers are interested in whether a
company like Cargill’s will continue to honor product warranties and support its product
lines. Labor unions want to know whether the owners have the ability to pay increased
wages and benefits.

Types of Accounting
According to the different users of accounting information, accounting has two important
divisions.

Accounting

Financial Accounting Management Accounting

[Preparation of information about [The provision of relevant
the past transactions of an entity information that will assist and
in a manner that will enable support all levels of management to
external users to make economic plan, control, and make decisions in
decisions is financial accounting] order to fulfill their responsibilities is
management accounting]

Financial Accounting Process

Accounting Accounting Accounting

Inputs Functions Outputs
Collecting, Trading account,
Transactions classifying, Statement of
recording, analysing, Comprehensive
and
interpreting and income and
Events communicating Statement of
financial position

Figure 1.2: Financial accounting process

Management Accounting Process

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 Inputs Process Outputs
Budgeted
Historical Planning, statements,
information and accounting ratios,
budgeting
common activity
budgeted and analysis, marginal
information controlling cost information and
information for
investment decisions.

Figure 1.3: Management accounting process

Differences between Financial Accounting and Management Accounting

Financial Accounting Management Accounting

Uses historical information only
Provides information for internal and
external users.
Information is provided for a specific
period of time.
Following accounting concepts, rules
and regulations.
Uses historical and budgeted information
Information is provided only for internal
users.
Provides information as and when required
by management.
Accounting concepts, rules, and regulations
and standards are not relevant.

EXERCISE QUESTIONS
1) What do you mean by “accounting”.
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2) List-out the objectives/purposes of accounting.
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3) What is the relation between accounting and recordkeeping?
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4) Who are the internal and external users of accounting information?

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 ………………………………………………………………………………………………
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5) Give three reasons why accounting is an important subject for non-accountants
to study.
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6) Genesis Company performs the following accounting tasks during the year.
________Analyzing and interpreting information.
________Classifying economic events.
________Explaining uses, meaning, and limitations of data.
________Keeping a systematic chronological diary of events.
________Measuring events in dollars and cents.
________Preparing accounting reports.
________Reporting information in a standard format.
________Selecting economic activities relevant to the company.
________Summarizing economic events.
Accounting is “an information system that identifies, records, and communicates
the economic events of an organization to interested users.”
Instructions
Categorize the accounting tasks performed by Genesis as relating to either the
identification (I), recording (R), or communication (C) aspects of accounting.

7) Indicate whether each of the five statements presented below is true or false.
a) The three steps in the accounting process are identification, recording, and
communication ………………
b) Bookkeeping encompasses all steps in the accounting process ………………
c) Accountants prepare, but do not interpret, financial reports ………………
d) The two most common types of external users are investors and company
officers ………………
e) Managerial accounting activities focus on reports for internal users ………………

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