Introduction to Accounting Concepts

Principles
of Accounts
COURSE INTRODUCTION
Introduction to
Accounting
Concepts, the Accounting Cycle and Business
Organization
Definition and Purpose of Accounting
● Accounting is a system of collecting,
organizing, reporting and interpreting
information about those activities of
businesses that can be described in
money terms.
● These activities are called transactions.
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● Transactions involve an exchange of value between a business
and another party. For example, most businesses sell or
exchange goods or services for money with which they buy
other goods and services.
● These transactions result in a change in the business financial
condition.
● From the section above we know that users are interested in a
business financial position and how transactions cause changes
in that position.
● Let us note that, other features of the business which users
need to know about since they may contribute to profit, for
example, a reputation for excellent service will not be recorded
in accounting.
● So accounting has its limitations.
● The main purpose of accounting, therefore,
is the provision of financial information
for decision-making by users.
● For financial information to be useful for
decision-making, it must have certain
qualities.
● Accounting information must be relevant to
the user’s needs and the user must find it
reliable and consistent.
● When the user receives relevant and
reliable information, genuine comparisons
can be made between periods of operation
and among similar firms, and decisions can
be made in planning and controlling
business activities.
.
Concepts and Purpose of Accounting
It is important for those individuals responsible for
the success of businesses to know:
● Whether a profit is being made, because this is the main reason
for having a business—is the business profitable?
● Whether there are sufficient funds to meet all the commitment of
the business on time—is the business liquid?.
● That they are making the best use of the funds that have been
invested in the business—is the decision-making sound?
Users and their needs
Some people believe that the world revolves around
businesses, large and small. Some of us are
involved in the business directly and some of us look
on from outside having no direct financial interest.
We are:
Internal Users
1. owners and investors of businesses;
2. managers and other employees (including our
labour unions);
External Users
3. lenders (for example, banks, suppliers) and other
creditors;
4. regulators such as the tax authorities and other
government agencies;
5. advisors about businesses such as stockbrokers
and financial reporters;
6. customers and the general public/local community.
7. potential investors who wants a good return on
their investment
Users and their needs (Category 1:
Internal Users)
Owners
● Is my business making a profit?
● How much is my share in that profit?
● How does my profit level compare with the profits of
similar companies?
● Are the values of my resources increasing?
● What are the chances that my business will survive and
grow?
(Category 1: Internal Users)
Managers
● Am I meeting my responsibility to owners in terms of achieving
profits, expanding the business, safeguarding resources?
● Do we have enough money coming in to meet our obligations
to lenders, creditors and workers?
● Are our stock items selling fast enough?
● Are expenses rising faster than our revenues?
Employees and their representatives
● Can the business afford to pay acceptable wages and salaries?
● Is there potential for growth and therefore a future for me with
this business?
(Category 2: External Users)
Investors and financial advisors
● Should I invest (advise investment) in this business?

● Is this business making profits and how does the profit
level compare with the profits of similar companies?
● How much has the business shared out to owners
recently?
● Are the values of the resources increasing? What are the
chances that the business will survive and grow?
Government regulators
● How much tax will this business be able to
contribute to the national account?
● Is this business meeting its obligations to the
public, for example, national insurance
contributions?
Lenders and creditors

● Will this business be able to pay its debts to me,
for example, interest on time?
● Should I take the risk and provide goods or
services on credit?
Traditional vs Emerging Careers in Accounting
The provision of accounting information relies

on the work of two different groups of
individuals—bookkeepers and accountants—
whose responsibilities are summarized in the
following tables on the next two slides
Job Main responsibility Examples
Book-keeping The recording of financial • Preparing accounts by entering and

information, particularly posting transactions
transactions, in a systematic • Preparing trial balances
way • Checking the records for accuracy
• Preparing payroll and inventory records
• Assisting the work of the accountant(s)
Accounting The selecting, classifying, • Preparing financial statements

and summarizing of financial • Preparing budgets
data in ways that provide • Supervising the work of bookkeepers
owners of business and • Analyzing financial statements
others with useful • Making recommendations and providing
information to help them advice on how to improve performance
assess performance and • Preparing tax assessments
make informed decisions
The following table gives examples of both traditional and
emerging careers in bookkeeping and accounting
Job Traditional careers Emerging careers
Book-keeping • Accounts recievable clerk • Bookkeeping software specialist

• Payroll clerk • Payroll software operative
• General ledger clerk
Accounting • Accounts manager • Accounting software developer

• Tax accountant • Environment accountant
• Internal auditor • E-commerce specialist
• Management accountant
Ethical Principles and Accounting
● Ethics is about moral principles and standards of
behavior .
● In accounting it is vital that clients can have complete
trust in their accountant, since the accountant has
access to so much information that is both confidential
and sensitive.
● Accountantants are required to abide by certain ethical
principles to demonstrate honesty and fairness and to
ensure trust is maintained
● The ethical principles of accounting are summarized in
the next slide.
● Integrity— straightforward and honest in all relationships
● Objectivity— avoid bias, conflicts of interest or undue
influence when making professional judgements
● Professional competence and due care— updating
knowledge and skills in order to deliver deligent
services to clients
● Confidentiality— avoiding the disclosure or use of
information to others without expressed permission
● Professional Behavior— adopting the highest standards of
the proffesion by complying with legal requirements and
regulations
Maintaining ethical Principles requires strength of
character and courage. Where there is a failure to apply
ethical principles the following consequences could
arise:
● Law suits
● Loss of Job
● Loss of integrity/reputation
● Fines
● Imprisonment
Key Accounting Principles, Concepts,
Conventions
● The accounting system we use to record the activities of
business was basically invented in the fifteenth (15th) century
by Luca Pacioli, an Italian mathematician.
● It involves the collection and recording of financial information.
Pacioli recognized that for a business to gain something, some
other thing must be given up.
● This became the major rule or principle underlying the system
accounting.
● It is called the dual aspect principle.
● It states that: in every transaction, giving of value and
receiving of value occurs.
Key Accounting Principles, Concepts,
Conventions
● For example, a firm might pay cash to acquire a
delivery van. In effect, “cash” gave value and
“delivery van” received value of the same amount.
● Pacioli showed that at least two records or
accounts must be opened to show the matching
change.
● In accounting practice this is called the double
entry rule. Presently accounts are drawn in a T-
shape as shown on the next slide.
Account Format
● In line with the double entry rule, an entry on the DEBIT or left
hand side of one account is matched by an entry on the right
hand or CREDIT side of another account.
Key Points
1. The major underlying principle of accounting is the dual aspect
principle. In practice the double entry rule is applied.
2. In every transaction, one party receives value and another
party gives value.
3. (a) An ACCOUNT is a record or history of a business’
transactions as it affects one aspect of the business.
(b) DEBIT means LEFT HAND SIDE OF AN ACCOUNT.
(c) CREDIT means RIGHT HAND SIDE OF AN ACCOUNT.
(d) TRANSACTIONS are business activities where there are
exchanges of value between a firm and another “person” or
entity.
Key Accounting Principles (Prudence)
● When provided with accounting information, users can make
comparisons, can plan and manage their businesses.
● However, there is always some uncertainty in arriving at some
monetary values.
● Accountants need to estimate certain figures in preparing
accounting statements.
● However, they cannot be overconfident or unrealistic about the
future prospects of the business.
● For example, can the accountant be certain that all persons will
pay their debts? Therefore, accountants apply the prudence
concept. Conservatism, another name for prudence, is
expressed very simply.
Example
● Sarah Cattrick, the managing partner of Sweety Biscuits
Enterprises, has decided to offer credit facilities to her
customers who were required to pay in cash before. She
expects that would increase current sales of $20 000 by 10%.
However, she realized that she would have to run the risk that
a few customers may not pay their debts of $1 200.
1. Should Sarah report Sales of $22 000 in anticipation of the
10% increase?
2. Should Sarah report a figure for debtors that is decreased by
$1 200.
The answer is “No” to Q 1. as she is anticipating a gain or
profit and “Yes” to Q 2. as she prudently anticipates a loss.
Key Accounting Principles
(Consitency)
• It is especially important that when accountants make choices
about methods of estimating and accounting procedures, that
they stay with those methods.
• These methods should only be changed for very good reasons.
• Users will find it easy to compare the performance of the firm
from year to year if the principles of accounts applied in
reporting remain unchanged.
• This is called the consistency concept. It can be expressed
as follows:
(Consistency)
Example
● The new owner of Gregory’s Welding Supplies wants the firm to
re-value inventory by finding a new average cost every time new
items were bought and applying it to the items on the shelves.
The accountant disagrees and wants to continue using the
current method that values inventory based on actual cost of the
items in stock.
● QUESTION: Which accounting concept will influence the final
decision on method to be used to value inventory?
● The principle that supports the accountant is the principle
that a firm is expected to be consistent in the use of
methods such as the method to be used to value inventory.
Key Accounting Principles (Accrual)
● One significant task of the accountant is the calculation of profit. Profit

is the difference between the earnings (revenue) of the business
through activities such as sales and the costs incurred to create those
earnings (expenses). Today few businesses receive all their revenue in
cash immediately and fewer still pay all their expenses in cash right
away. Those businesses which operate in cash use the cash basis of
accounting. Other businesses accrue their revenues and expenses.
● The accounts will show when the revenue was earned, that is,
recognized even if it is collected in a period before or a period after.
Similarly, expenses may have been incurred in one period but paid in
another. This is called the accrual basis of accounting. To take it a
step further, in any one period, accountants must match revenue with
the expenses incurred in earning it. This is called the matching
concept. Let us look at a simple example.
Key Accounting Principles (Accrual)
Example
● Chris Adams, a small building contractor has just one
employee, a mason. The mason is paid $20 per hour. Last
month a client paid $2000 for the labour on a small job. By the
end of the month, only three-quarters of the work was
completed. The mason worked 60 hours on the job but Adams
has paid him for only 50 hours by the end of the month. He will
need ten more hours to complete the job.
(Accrual vs Cash)
CASH BASIS
Month 1: Revenue collected $2000 Expense paid $1000 ($20 x 50hrs)
Cash difference $1000
Month 2: Revenue collected $0 Expense paid $400 ($20 x 20hrs)
Cash difference $400
ACCRUAL BASIS
Month 1: Revenue earned $1500 Expense incurred $1200 ($20 x 60hrs)
Profit $ 300
Month 2: Revenue earned $500 Expense incurred $ 200 ($20 x 10hrs)
Profit $ 300
Chris Adams accounts for the revenue when it is earned, $1 500 in month 1;
$500 in Month 2 and matches the appropriate amount of expenses, $1 200 in
Month 1 and $200 in Month 2.
(Separate Entity)
● The last principle to be discussed is the separate entity
principle. An accountant must treat a business as if it was a
legal person in its own right.
● The transactions of the business are the only ones to be
recorded in the business accounting books. In the eyes of the
accountant, the owner is simply one more interested party
whose needs can be met by good accounting records.
● In other words, the separate entity principle says:
What belongs to the business belongs to the
business and what belongs to the owner belongs
to the owner and the two should not be confused
in the accounts.
(Separate Entity)
Example
● John Barclay, a teacher and plumber, cannot understand why
his accountant warns him about treating his business’ affairs as
an extension of his personal activities. John cannot understand
why he should not use the business bank account to pay his
doctor’s bill or put his income from his teaching job into the
business bank account.
The accountant points out that the accounting records
must separate his activities from the business’
activities if a true picture of the business profitability
and financial condition is to be seen.
Types of business organizations
Businesses are organizations that provides goods and/or
services in order to make a profit. There are a number of ways
of classifying businesses. All businesses can be classified by
what they do, for example:
● Provide raw materials through farming, mining, fishing etc.
● Manufacturing goods, turning raw material into finish products
● Sell goods to the general public (retailers) or to others
businesses (wholesalers)
● Provide services for businesses and the general public
You may also think about businesses in
terms of who owns them. You are
expected to be familiar with the general
features of five types of business
organizations based on their owners and
be able to compare each with the other.
Let us look carefully at the table below:
Types Ownership Source of Reason for business venture-advantages,
startup disadvantages
capital
Sole One owner Private • started up to make a profit (profit motive)
trader or savings or
• profit belongs to the one owner
proprietor sources
• easy to start with small amounts of capital
• quick decision-making and hands-on
supervision
• capital and management expertise restricted
to owner’s efforts
• owner has unlimited liability for business debts
• business often dies when owner retires or dies
Partnership Two – Private • access more capital and usually more
Twenty savings or profit
owners sources • losses shared among partners
from each • easy to start but should have legally
partner in binding agreement
varying • may have specialized expertise for
amounts decision-making
• business may or may not die with partner
or change of ownership
• profits must be shared as per agreement
or Partnership Act 1890
• partners may bind each other to bad
contracts
• partners generally have unlimited liability
for business debts
Limited liability Limited or Regular • shareholders provides funds
Companies unlimited purchasing of needed to establish and run the
(Corporations) shareholders shares by company
shareholders • owners are rewarded with
and investors some of the profits made by the
company if successful
• owners carry a responsibility for
the debts of the company that
is limited to the amount they
have invested
• Owners are not at risk of losing
their private funds if things go
wrong, unlike sole traders and
partners
Co-operative Limited or Regular ● service or help to members
unlimited purchasing through low interest loans and
membership of shares other services, for example,
by each education and training
member
● sharing of any profits
(dividends) as set out in bye-
laws and statutes
● may have inexperienced
management
● needs to attract new
members all the time
● great risks for shareholders
since loans may be
unsecured
Non-profit Limited Regular ● service or help to self and
organizatio members payment of others
n (club or or subscriptions ● occasional profits ploughed
society) subscriber back into organisation
s with ● may have inexperienced
common management
aim ● needs to have members
pay subscriptions regularly
or carry out profit making
activities
Financial statements
● Financial statements summarize and report on how a
business has used its owner’s resources over a stated
period of time. The three basic financial statements are given
below.
Name of statement Purpose

INCOME STATEMENT Shows the sources of business revenue
(also called the Trading (income) and the expenses incurred to
and Profit and Loss make that revenue. The result is either
Account) business profit (surplus) or loss (deficit).
INCOME & Records the surplus or deficit made by a co-

EXPENDITURE operative society
ACCOUNT
Name of statement Purpose
STATEMENT OF Shows the value of what the business owns

FINANCIAL POSITION (assets) and what it owes to others
(Balance sheet) (liabilities). One special amount owed
belongs to owners who provide the business
with financing (capital).
CASH FLOW Shows the sources of money flowing into the
STATEMENT business and the uses to which that money
was put.
● The Balance Sheet and the Income Statement will be looked at
later on in greater detail.
● To be able to create these statements, the business
undertakes a sequence of six repetitive steps called the
accounting cycle.
● These steps are repeated in the same order during a specific
period of time usually over twelve months called the financial
or accounting year.
You should be aware that these terms summarize a number of tasks that have to be performed. For example, there are as many as nine source
documents to be analyzed and a firm may use as many as seven different journals and six ledgers in steps one, two and three. Furthermore, a
number of other activities take place other than these major steps, for example, errors in the records have to be corrected.
The accounting cycle
The major steps in the accounting cycle are as follows:
1. collect documents which become the source of information;
2. record transactions in the first set of books called journals;
3. record (called “post”) information from journals into a second
set of books called ledgers;
4. prepare a summary of all the similar information into a format
called the Trial Balance;
5. change figures from the ledger to account for additional
information; expense accounts (accruals & Prepayments),
revenue accounts, depreciation, provision for bad debts etc.
6. prepare financial statements (for example, balance sheet,
income statement, cash flow statement) that summarizes all
the information for the period.
Role and impact of technology on the
accounting process
● Many small businesses carry out the accounting cycle
manually. They use a manual accounting system
(MAS).
● For example, information from documents is entered by
hand into journals and posted manually into ledgers.
● The chance that errors will be made increases with
every step. This is especially true as computations
become too complex for adding machines and ordinary
cash registers.
Role and impact of technology on the
accounting process
● As the business grows, owners/managers recognize that
there are tremendous benefits to be gained from the use
of technology, in particular a Computerized Accounting
System (CAS).
● When persons think about technology, they often think
about desktop or micro-computers. However a
computerized accounting system consists of both
equipment or hardware and programs or software.
Computer hardware
● Computer hardware consists of not only central

processing units (CPUs), monitors, printers and scanners
but also other specialized pieces of equipment developed
for special purposes.
● For example, banks use automated banking machines
and debit and credit cards which allow for almost
instantaneous changes in customer accounts while the
automatic scanning registers at retailers checkout points
update information on inventory.
Computer software
● Computer programs have been written to perform all the steps
in the accounting cycle. In addition, there are programs for
other business functions such as collecting customer
information, sending bills to customers and preparing the
payroll.
● All of these packages of instructions are called applications
software.
● A wide variety of these are available, including Sage,
Quickbooks, Peachtree Accounting and Microsoft Dynamics
● These make use of databases and spreadsheets.
● A database is an organized set of information or files that
allows accountants to find and change information easily and
generate reports with specific purposes.
Computer hardware
● A spreadsheet is a table-like form with numbered rows and
columns which allows quick and easy manipulation and
analysis of accounting information and its presentation in the
form of charts and graphs.
● Special reports on any area of the business accounts, for
example, before and after figures, can be generated whenever
needed. The opportunities for errors and irregularities are
greatly reduced. There is a reduced chance of decision-
making based on poor or limited information.
Features of Accounting Software
● Automatic processing: Once data is inputted all other processes are
automatic
● Integration of functions: All accounting functions are packaged in on
software (inventory records, invoices, and payroll records).
● Management information: Can be presented with more information
such as debtors account balances (detailed info)
● Inventory control: Records can be automatically updated every time
there is a purchase, sale or return of goods.
● Credit control: Records of debtors can show how much is owed and for
how long the debt has been outstanding.
● Payroll: Software can produce all the needed information for wage and
salary calculations
● Management reports: Software can produce trial balances,
income statements, balance sheet, ratio analysis and audits.
Advantages of CAS over MAS
I. Greater accuracy due to automation of processes
II. Greater speed because updating and calculations are carried
out virtually instantaneously
III. Easier access to information using computer software to find
particular details
IV.More information available to help with management and

decision making
V. Reduction in staffing costs may be possible because record

keeping is mainly automatic
Disadvantages
I. Capital expenditure: There could be a heavy initial outlay on
computer equipment and software programs as well as
additional costs for frequent updates at different intervals.
II. Training costs: Staff will need support in using new equipment
and software programs, and skills will periodic require updating.
III. Risk of data loss: System can ‘crash’, and security of data can
be serious issue.
IV.Maintaenance and support costs: Businesses have to invest
in technical support to ensure systems provide continual
service.
V. Period of transaction: It is sensible to run old (manual),

systems alongside new computerised systems at least for a
time to ensure that everything works as it should
Key points
● The use of computers has done a lot to reduce the amount of

work needed to produce accounting information in a useful
form.
● The flexibility of the computerized system accommodates a
variety of users and their changing information needs.
● However, you must remember that the same steps are carried
out as in a manual system, it is only that the information is no
longer visible.
Key points
● The two main categories of users of accounting information are
internal (owners, managers, employees) and external
(investors, creditors and government regulators) to the
business.
● Users are concerned to varying degrees about profits, cash
flows, business efficiency and the ability of the firm to survive
over a long period.
● Accounting is a system of collecting information about business
transactions, organizing it into accounts, reporting in financial
statements and interpreting information.
● Transactions are business activities where there are
exchanges of value between a firm and another “person” or
entity.
Key points
● An account is a record or history of a business’ transactions as
they affect aspects of the business.
● Financial statements summarize and report on how a business
has used its owner’s resources over a stated period of time.
● The main purpose of accounting is the provision of relevant and
reliable financial information for interpretation and comparison
by users who need to make planning, controlling and investing
decisions.
● Accounting uses principles, concepts and conventions to
ensure relevance and reliability. Some key ones are the dual
aspect principle, the prudence concept (conservatism), the
consistency concept, the matching concept (based on the
accrual basis of accounting) and the separate entity principle.
Key points
● There are five types of business organizations: sole trader,
partnership, corporation, co-operative and non-profit
organizations which differ in several ways but which make
common use of accounting information.
● Accounting information go through six steps in a pattern called
the accounting cycle.
● Firms may use a manual accounting system where information
from documents is entered by hand into the accounts and
eventually composed into financial statements or they may use
a computerized accounting system which electronically
processes accounting information with the use of databases
and spreadsheets.
Conclusion
● You will appreciate by now that a lot goes into creating
and using an accounting system.
● Designers of accounting systems must produce special
forms and documents, select methods and procedures,
describe the tasks of different jobs in the accounts
department, ensure that controls are built in to prevent
theft and fraud, order special processing equipment and
train and supervise employees.
Conclusion
● All this work is for the benefit of users, both internal and
external, from many different organization types but who
all need reliable and relevant information to support their
decision-making.
● This is the purpose of accounting and that purpose is
strengthened by the application of generally accepted
principles, concepts and conventions.

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Introduction to Accounting Concepts

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Principles

● Should I invest (advise investment) in this business?

Lenders and creditors

The provision of accounting information relies

Book-keeping The recording of financial • Preparing accounts by entering and

Accounting The selecting, classifying, • Preparing financial statements

Book-keeping • Accounts recievable clerk • Bookkeeping software specialist

Accounting • Accounts manager • Accounting software developer

● One significant task of the accountant is the calculation of profit. Profit

Name of statement Purpose

INCOME & Records the surplus or deficit made by a co-

STATEMENT OF Shows the value of what the business owns

● Computer hardware consists of not only central

IV.More information available to help with management and

V. Reduction in staffing costs may be possible because record

V. Period of transaction: It is sensible to run old (manual),

● The use of computers has done a lot to reduce the amount of

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