INTRODUCTION

Accounting as the "art of recording, classifying, and summarizing 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 ’’

This definition captures the various aspects that make-up the accounting process as follows:

i) Recording of transactions and events in books of original entry.

ii) Classifying transactions through the process of posting from the books of original entry
to the different accounts in the ledger.
iii) Summarizing the results periodically in financial reports.
iv) Interpreting the results of the business operation through the analysis of financial
statements or reports
OR

Accounting or accountancy is the measurement, processing, and communication of financial and

non financial information about economic entities such as businesses and corporations

BOOKKEEPING AND ACCOUNTING

Bookkeeping is an activity within the broader activities of accounting. It is mainly concerned

with the recording of routine business transactions on a day to day basis. A bookkeeper may be
responsible for keeping all or some of the records of a firm.

Accounting on the other hand, is concerned not only with the recording function but also with
other activities including the designing of the accounting system itself. Accountants are
responsible for preparation of financial reports and statements, as well as in the analysis and
interpretation of the reports. Accountants usually supervise the work of bookkeepers, and are
expected to have acquired a level of training and qualification commensurate to this position

BRANCHES OF ACCOUNTING

• Financial accounting (or financial reporting). 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),

• Management accounting (or Managerial accounting). Produces information

primarily for internal use by the management. The kinds of financial and other
reports which management accounting offers are aimed to help management in
 planning and controlling business operations, and in decision making. The data is
processed and converted into reports for managers and other decision-makers.
E.g. pricing ,budgeting

• Cost accounting. Is a branch of management accounting and involves the application of

various techniques to monitor and control costs. Its application is more suitable to
manufacturing concerns

• Government accounting (or Public sector 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 different aims and objectives of
the state owned and private owned institutions. Government accounting ensures the
financial position and performance of 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

• Taxation: This is a division of accounting which involves collecting, recording,

summarising and interpretation of financial information for tax purposes only. It is
related to the determination of taxable incomes of different entities using various tax laws
as required by the tax authorities of different nations.

• Auditing: This is a division of accounting which involves independent examination of

financial statements of the client’s entity to determine as to whether the financial
statements present a true and fair view of the entity’s financial undertakings.

THE OBJECTIVES OF ACCOUNTING/ NEED FOR ACCOUNTING INFORMATION

Accounting has many objectives; including letting people and organizations know:
 if they are making a profit or a loss;
 what their business is worth;
 what a transaction was worth to them;
 how much cash they have;
 how wealthy they are;
 how much they are owed;
 how much they owe to someone else;
 Enough information so that they can keep a financial check on the things they do.

However, the primary objective of accounting is to provide information for decision making to
the primary users.
Assignment two individual

a) Identify and explain users of accounting information

b) Explain accounting conventions

ACCOUNTING CONCEPTS, PRINCIPLES AND CONVENTIONS

ACCOUNTING PRINCIPLES

Principles is a fundaments truth that is always accepted, in accounting, principles relate to an

accepted guidance or method

As we have been seen above, various parties such as shareholder’s, banks, suppliers etc. are
interested in financial statements of the organization. If there is no uniformity in the principles
followed by different organization in preparation of financial statements, nobody will be in a
position to interpret the financial statements and draw any conclusions

To overcome those certain standards principles for preparation of financial statements are given.
In accounting terminology we use the words “International Accounting Standards (IAS),
International Financial Reporting Standards (IFRS) Or Generally Accepted Accounting
Practices (GAAP)

ACCOUNTING CONCEPTS

An accounting Concepts refers to the basic ideas, assumptions, rules and principles which work
as the basis of recording of business transactions and preparing the financial statements. It’s
based on theoretical nature.

The main objective is to maintain uniformity and consistency in accounting records. These
concepts constitute the very basis of accounting. All the concepts have been developed over the
years from experience and thus they are universally accepted rules.

Business entity

This concept states that the business exists separately and distinct from its owners. Its books of
accounts and records should reflect only those transactions which pertain to the firm and should
not include personal transactions and activities of the owner. If the owner buys a new pair of
dress shoes it is incorrect to record this in a firm's books of account as a business expense.

 Business Entity: Business owners and business itself are two things different

 The business entity concept implies that the affairs of a business are to be treated as being
quite separate from the non-business activities of its owner(s).
 The items recorded in the books of the business are, therefore, restricted to the transactions of
the business. No matter what activities the proprietor(s) get up to outside the business, they
are completely disregarded in the books kept by the business.

The only time that the personal resources of the proprietor(s) affect the accounting records of
a business is when they introduce new capital into the business, or take drawings out of it.

Going concern

The going concern concept assumes that business

(i) will continue in its operations for at least the next 12 months
(ii) does not have any intention or need to close down its operations
(iii) does not have intention or need to curtail materially, the scale of its operations

 Going concern: all business should be in the business for long time or under indefinite
period

 Examples where the going concern assumption should be rejected are:

 If the business is going to close down in the near future;

 Where shortage of cash makes it almost certain that the business will have to cease
trading;

 Where a large part of the business will almost certainly have to be closed down
because of a shortage of cash.

Accrual

Revenue should be recognized when earned rather than when cash is collected, and expenses
should be recognized when goods and services are consumed regardless of when they are paid
for.

 Accrual basis: whether the amount is received or not must be recorded; expenses and
income whether they are not paid or received, but the accounting treatment should be
recorded to the accounting period in which they are made.

Unit of measure

Also known as the money measurement concept and states a position that accounting is more
concerned with activities capable of being measured in monetary terms. Therefore, money is
used as a unit of measure in recording and reporting all transactions of the business. Events and
attributes that cannot be reliably measured in monetary terms are therefore, not a major concern
of accounting. An example of such an attribute being motivation and commitment of employees.
Also inherent in this concept is the assumption that currency will remain stable in value.
 Money measurement: all business transactions can be transferred to money (convert in
terms of money)

Historical Cost

Assets of a business must be recorded at their original cost. Cost is determined through an arms-
length transaction with an independent supplier and in most cases this is the most objective
figure to use as long as the going concern assumption holds.

The historical cost concept: It means that assets are normally shown at cost price, and that this is
the basis for valuation of the asset.

 Cost concept(historical-cost): non-current assets should be recorded in original value then

less depreciation if any

Dual aspect concept

This states that there are two aspects of accounting, one represented by the assets of the business
and the other by the claims against them. The concept states that these two aspects are always
equal to each other.

Every business transaction should be shown in two accounting aspects (double entries and
accounting equation)

Accounting Period

Although a business is assumed to continue to exist indefinitely, its life can be broken into
periods of time, usually twelve months, during which results can be measured. The significance
of this concept is that users do not have to wait until cessation of business to determine profit or
loss.

 Accounting period: is the time when ascertainment of profit/loss made (measurement of

profit/loss is made)

Matching Concept

In determining profit or loss at all times, revenues should be matched against expenses incurred
in the process of generating that revenue in the same period. It is necessary to recognize all the
revenue/income earned during a period regardless of when money is received. In the same way,
all expenses incurred by the business should be included regardless of when money is paid for
them. It is evident that the accrual and matching principles are closely connected.

 Matching concept: all expenses should be matched together with the income so as to yield
the profit/loss of the business. It applied when preparing final accounts.
ACCOUNTING TERMINOLOGY

ASSETS

Is 'a resource controlled by the entity as a result of past events and from which future economic
benefits are expected to flow to the entity OR Is something the business owns or controls. An
example is if a business sells goods on credit then it has an asset called a debtor. The past event
is the sale on credit and the resource is a debtor. This debtor is expected to pay so that economic
benefits will flow towards the firm i.e. in form of cash once the customers pays.

Assets are classified into two main types:

i) Non-current assets (formerly called fixed assets).

ii) Current assets.

Non-current assets are acquired by the business to assist in earning revenues and not for resale.
They are normally expected to be in business for a period of more than one year.

Major examples include:

 Land and buildings

 Plant and machinery

 Fixtures, furniture, fittings and equipment

 Motor vehicles

Current assets are not expected to last for more than one year. They are in most cases directly
related to the trading activities of the firm. Examples include:

• Inventory of unsold goods (also called 'stock')

• Trade receivables (the amounts owed to the business by customers, also called 'debtors')

• Prepayments (amounts paid in advance for items such as rent)

• Bank balances (cash in the bank - also called 'cash-equivalents')

• Cash balances (cash held by the business, but not in the bank).
LIABILITIES

Are present obligations of the entity arising from past events, the settlement of which is expected
to result in an outflow from the entity of resources embodying economic benefits'. An example is
when a business buys goods on credit, then the firm has a liability called creditor. The past event
is the credit purchase and the liability being the creditor the firm will pay cash to the creditor and
therefore there is an out flow of cash from the business.

Liabilities are also classified into two main classes.

i) Non-current liabilities (or long term liabilities)

ii) Current liabilities.

Non-current liabilities are expected to last or be paid after one year. This includes long-term
loans from banks or other financial institutions.

Current liabilities last for a period of less than one year and therefore will be paid within one
year. Examples include:

• Trade payables (the amounts owed by the business to suppliers of goods, also known as
'creditors')
• Accruals (amounts owing for expenses such as electricity, where the bills have not yet been
received)
• Bank overdrafts.

CAPITAL

Capital is also sometimes referred to as 'equity' or 'ownership interest', that is, the value which
the owner or owners have invested in their business. The Framework defines Equity as 'the
residual interest in the assets of the entity after deducting all its liabilities'.

INCOME

Is simply the event that result in money flowing into the business. The definition of income
encompasses both revenue and gains. Revenue arises in the course of the ordinary activities of an
entity and is referred to by a variety of different names including sales, fees, interest, dividends,
and royalties and rent. Gains include, for example, those arising on the disposal of non-current
assets

EXPENSES
Is the money spent or cost incurred in an entity's efforts to generate revenue .The definition of
expenses encompasses losses as well as those expenses that arise in the course of the ordinary
activities of the entity. Expenses that arise in the course of the ordinary activities of the entity
include, for example, cost of sales, wages and depreciation. Losses include, for example, those
resulting from disasters such as fire and flood, as well as those arising on the disposal of non-
current assets

ACCOUNTING EQUATION

In its simplest form, the accounting equation states that Total Assets equal Total Capital. Total
capital is made up all funds which finance all resources or assets of a business. Total assets of a
business are financed by the owner who injects capital. Often, the owner is unable to finance all
activities of a business single-handedly, particularly for large businesses. Some other parties who
do not have ownership interest also finance activities of a business by extending credit and loans.
These are known as liabilities. Total capital therefore, consists of liabilities and owner's equity.

The accounting equation can at this stage be expressed as:

• Assets = Liabilities + Owner’s Equity

• Non-current Assets + (Current Assets) = Capital + (Current Liabilities+ Non-current
Liabilities)
• Assets = Liabilities + Owner's Equity + (Revenues - Expenses)
• Assets = Liabilities + Owner's Capital + (Revenues - Expenses) – Drawings
• Assets + Expenses + Drawings = Liabilities + Owner's Capital + Revenues

Example 1

a) Owner puts shs. 50,000 cash to start business

b) Firm buys lorry for cash shs. 10,000
c) Firm borrows shs. 30,000 from a bank
d) Firm buys shs. 20,000 stock on credit from a supplier
Example 2

The example may be extended to consider the following independent cases:

(a) All of the stock was sold for shs. 20,000 cash.
(b) All of the stock was sold on credit for shs. 20,000.
(c) All of the stock was sold for shs. 30,000 cash.
DOUBLE-ENTRY SYSTEM

Accounting entries are made on the left side and right hand sides of an account. When an
amount is entered on the left side, the account is said to be debited, and when an amount is
entered on the right side the account is said to be credited. The difference between the total
debits and total credits is the balance of the account. The balance may be either a debit balance if
the debit side exceeds the credit side; or a credit balance if the credit side exceeds the debit side.
When the total debits equal the total credits, the account is said to have nil or zero balance.

The words "debit" and "credit" should not be confused with "increase" or "decrease". Certain
accounts may increase when debited and other accounts may increase when credited depending
on the type of account involved.
For the double entry to be reflected in the accounts, every debit entry must have a corresponding
credit entry.
The transactions affecting these accounts are posted in the account as debit entry and credit entry
to complete the double entry

When we make a debit entry we are either:

(i) Increasing the value of an asset.
(ii) Reducing the value of a liability.
(iii) Reducing the value of capital.

When we make a credit entry we are either:

(i) Reducing the value of an asset.
(ii) Increasing the value of a liability.
(iii) Increasing the value of capital.

Accounting for Sales, Purchases, Incomes and Expenses

Sales:
This is the sale of goods that were bought by a firm (the goods must have been bought with the
purpose of resale). Sales are divided into cash sales and credit sales.

When a cash sale is made, the following entries are to be made.

i. Debit cash either at bank or in hand.
ii. Credit sales account.
For a credit sale:
i. Debit debtors/ Accounts receivable account.
ii. Credit sales account.
A new account for sales is opened and credited with cash or credit sales.
Purchases:
Buying of goods meant for resale. Purchases can also be for cash or on credit.

For cash purchases:

i. Debit purchases.
ii. Credit cash at bank/cash in hand

For credit purchases, we:

i. Debit purchases.
ii. Credit creditors for goods.

Incomes:
A firm may have other incomes apart from that generated from trading (sales). Such incomes
include:
 Rent
 Bank interest
 Discounts received.

When the firm receives cash, from these incomes, the following entries are made:
i. Debit cash in hand/at bank.
ii. Credit income account.

Each type of income should have its own account e.g. rent income, interest income.
Incomes increase the value of capital and that is the reason why they are posted on the credit side
of their respective accounts.

Expenses:
These are amounts paid out for services rendered other than those paid for purchases. Examples
include:
 Postage and stationery
 Salaries and wages
 Telephone bills
 Motor vehicle running expenses.
 Bank charges.

When a firm pays for an expense, we:

i. Debit the expense account.
ii. Credit cash at bank/in hand.
Returns Inwards and Returns Outwards.

Returns Inwards: These are goods that have been returned by customers due to various reasons
e.g.
i. They may be defective/damaged,
ii. Being of the wrong type.
iii. Excess goods being delivered.

Goods returned may relate to cash sales or credit sales. For the goods returned in relation to cash
sales and cash is refunded to the customer the following entries are made:
i. Debit returns – inwards
ii. Credit cashbook.
For goods returned that relate to credit sales; no cash has been given to customer, the following
entry is to be made.
i. Debit returns inwards.
ii. Credit debtors.

Returns Outwards: These are goods returned to suppliers/creditors. They may be for cash
purchases or for credit purchases. For cash purchases a cash refund given to the firm by the
supplier,
i. Debit the cashbook (cash at bank/hand).
ii. Credit returns outwards.
For credit purchases and no refund has been made:
i. Debit creditors.
ii. Credit returns outwards

Illustration 1
From the following transactions find out the nature of account and also state which account
should be debited and which account should be credited:
(1) Salary paid
(2) Interest received
(3) Machinery purchased for cash
(4) Building sold
(5) Outstanding salary
(6) Received cash from Ramesh
(7) Proprietor introduced capital
(8) Dividend received
(9) Commission paid
(10) Furniture purchased for cash
Accounting for drawings, discounts allowed and discounts received.
Drawings
The owner makes drawings from the firm in various ways:
i) Cash or bank withdrawals
When the owner withdraws money from the business we debit drawings and credit cashbook
(cash in hand or cash at bank).
ii) Taking goods for own use and
When the owner takes out some of the goods for his own use, we debit drawings and credit
purchases.
iii) Personal expenses, paid by the business
Here we debit the drawings and credit expense account
Taking some of the other assets from the business e.g. motor vehicles or using part of the
premises.
Sometimes the owner may take over some of the assets of the business e.g. vehicle or converting
business premises into living quarters or not paying into the business cash collected personally
from the customers.
When this happens we debit drawings and credit the relevant asset e.g. motor vehicles, premises
or some building or even debtors.

Discounts
Discounts received.
A discount received is an allowance by the creditors to the firm to encourage the firm to pay the
amount dues within the agreed time. It is an amount deducted from the invoice price.
When a discount is given by the supplier then we debit creditor’s account and credit discounts
received e.g. A. Ltd sells some goods on credit to B Ltd. ₤1,000 under the terms of sale, B Ltd,
will receive a discount of 5% if they pay the amount due within one month. B decides to take up
the offer and pays the amount within the given time. B will record the transaction as follows.
Debit: Creditor – A Ltd
Credit: Discounts Received

Discounts Allowed
These are the allowances made by a firm on the amounts receivable from the customers to
encourage prompt payment. The amounts deducted from the sales invoice. In the previous
example when A Ltd issued the discount and was taken up by B the entries will be:
i. Debit - discount allowed
ii. Credit - debtors - B Ltd.
Example 1.
Given the following information, you are required to journalize and enter the transactions,
completing the double entry in the books for the month of May 2012.
May 1 Started business with £2,000 in the bank.
“2 Purchased goods £175 on credit from M Rooks.
“3 Bought furniture and fittings £150 paying by cheque.
“5 Sold goods for cash £275.
“6 Bought goods on credit £114 from P Scot.
“ 10 Paid rent by cash £15.
“ 12 Bought stationery £27, paying in cash.
“ 18 Goods returned to M Rooks £23.
“ 21 Let off part of the premises receiving rent by cheque £5.
“ 23 Sold goods on credit to U Foot for £77.
“ 24 Bought a motor van paying by cheque £300.
“ 30 Paid the month’s wages by cash £117.
“ 31 The proprietor took cash for himself £44.

FINANCIAL STATEMENTS
A) FINANCIAL STATEMENTS FOR PROFIT ORGANIZATION

Financial statements for profit organization have the following components:

(i) Statements of profit or loss and other comprehensive income
(ii) Statement of financial position
(iii) Statements of changes in equity
(iv)Statements of cash flows
(v) Notes to the financial statements

In our level will study the Statements of profit or loss and other comprehensive income and
Statement of financial position

Example 1
From the following trial balance of P Boones draw up a trading and profit and loss account for
the year ended 30 September 2012, and a balance sheet as at that date.
Dr Cr
£ £
Stock 1 October 2011 23,680
Carriage outwards 2,000
Carriage inwards 3,100
Returns inwards 2,050
Returns outwards 3,220
Purchases 118,740
Sales 186,000
Salaries and wages 38,620
Rent 3,040
Insurance 780
Motor expenses 6,640
Office expenses 2,160
Lighting and heating expenses 1,660
General expenses 3,140
Premises 50,000
Motor vehicles 18,000
Fixtures and fittings 3,500
Debtors 38,960
Creditors 17,310
Cash at bank 4,820
Drawings 12,000
Capital 126,360

332,890 332,890
Closing stock was valued at £ 29,460