UNIVERSITY OF TECHNOLOGY, JAMAICA

SCHOOL OF BUSINESS ADMINISTRATION

FUNDAMENTALS OF ACCOUNTING
WHAT IS ACCOUNTING?

Accounting plays an important role in our economic and social system. Sound decisions made by individuals,
businesses, governments and other entities are essential for efficient distribution and use of the nation's scarce
resources. To make such decisions, these groups must have reliable information provided by the accounting
system. Accounting can therefore be defined as the process of identifying, measuring and communicating
economic information to permit informed judgments and decisions by users of that information.

ACCOUNTING AS AN INFORMATION SYSTEM

Accounting is often called the "Language of Business". This language can be viewed as an information system
that provides essential information about the financial activities of an entity to various individuals or groups for
their use in making informed judgments and decisions. As such, accounting information is composed
principally of financial data about business transactions, expressed in monetary terms.

An accounting information system is therefore the full components that, together, comprise all the inputs,
storage, and transformation processing, collating and reporting of financial transactions. It is in effect the
infrastructure that supports the production and delivery of accounting information.

OBJECTIVES OF ACCOUNTING

Accounting has many objectives, included in these are letting people and organizations know:

 if they are making a profit or loss

 what their business is worth
 how much cash they have
 how wealthy they are
 how much they are owed
 how much they owe to someone else
 what a transaction was worth to them

However, the primary objective of accounting is to provide information for decision-making.

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ACCOUNTING INFORMATION AND TYPES OF BUSINESS ORGANISATIONS

Success in business requires making countless decisions, and decisions require financial information.

Forms of Business Users and Uses of Business Activities Communicating with

Organizations Financial Information Users
Sole proprietorship Internal users Financing Statement of Profit or
Loss
Partnership External Users Investing
Statement of Financial
Corporation Operating Position

Statement of Changes in
Equity

Statement of cash flows

FORMS OF BUSINESS ORGANISATONS

If you seek to start your own business one of your first decisions is what organizational form your business will
have. There are three basic choices - sole proprietorship, partnership, or corporation.

A business owned by one person is a sole proprietorship. A business owned by more than one person is a
partnership. A business organized as a separate legal entity owned by shareholders is a corporation or limited
company.

You will probably choose the sole proprietorship. It is simple to set up and gives you control over the business.
Small owner-operated businesses such as barber shops, law offices, and auto repair shops are often sole
proprietorships, as are farms and small retail stores.

Another possibility is for you to join forces with other individuals to form a partnership. Partnerships often are
formed because one individual does not have enough economic resources to initiate or expand the business, or
because partners bring unique skills or resources to the partnership. You and your partners should formalize
your duties and contributions in a written partnership agreement. Partnerships are often used to organize retail
and services-type business, including professional practices (lawyers, doctors, architects, and certified public
accountants).

As a third alternative, you might organize as a corporation. As an investor in a corporation you receive shares or
stocks to indicate your ownership claim. Buying stock in a corporation is often more attractive than investing in
a corporation because shares of stock are easy to sell (transfer ownership). Selling a proprietorship or
partnership interest is much more involved. Also, individuals can become stockholders by investing relatively
small amounts of money. Therefore, it is easier for corporations to raise funds. Successful corporations often
have thousands of stockholders, and their stock is traded on organized stock exchanges like the New York Stock
Exchange and the Jamaica Stock Exchange. Many businesses may start as sole proprietorships or partnerships
and eventually incorporate.

Other factor to consider in deciding which organisational form to choose is legal liability. If you choose a sole
proprietorship or partnership, the proprietors and partners are personally liable for all debts of the business
(unlimited liability); corporate stockholders are not. In other words the stockholders in a corporation have no
personal liability; hence the term limited liability corporations.

Advantages Disadvantages

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Sole Proprietorship Simple to establish Unlimited liability

Owner controlled Raising capital is limited

Less statutory regulations Life of business is limited

Partnerships Simple to establish Unlimited liability

Shared control High risk of disagreements

Broader skills and resources Decision making may take longer

Corporations Easier transfer of ownership Expensive to establish

Easier to raise funds Affairs of the company are public

No personal liability Reporting may be complex

Although the combined number of proprietorships and partnerships in Jamaica may be greater than the number
of corporations, the revenue produced by corporations is much larger. Most of the largest enterprises in Jamaica
are corporations. This course however, is concerned primarily with the sole proprietorships.

USERS AND THE USES OF FINANCIAL INFORMATION

The purpose of financial Information is to provide inputs for decision making. Accounting is the information
system that identifies, records, and communicates the economic events of an organization to interested users.
Users of financial reports are an entity’s existing and potential investors, lenders and other creditors. Those
users must rely on financial reports for much of the financial information they need. Many people have an
interest in knowing about the ongoing activities of the business. These people are users of accounting
information. Users can be divided broadly into two groups - internal users and external users.

INTERNAL USERS

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

 Is cash sufficient to pay the bills?

 What is the cost of producing each unit of output?
 Can we afford to give employees an increase in salary?
 Which production line is the most profitable?

To answer these questions, you need detailed information on a timely basis. For internal users, accounting
provides internal reports, such as financial comparisons of operating alternatives, projections of income from
new sales campaigns, and forecasts of cash needs for the next year. In addition, summarized financial
information is presented in the form of financial statements.

EXTERNAL USERS
,

There are several types of external users of accounting information. Investors (owners) use accounting
information to make decisions to buy, hold, or sell stock. Creditors such as suppliers and bankers use
accounting information to evaluate the risks of granting credit or lending money. Some questions that may be
asked by investors and creditors about a company are:

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  Is the company earning satisfactory income?
 How does the company compare in size and profitability with competitors?
 Will the company be able to pay its debts as they fall due?

The information needs and questions of other external users vary considerably: Taxing authorities, such as the
Inland Revenue Service want to know whether the company complies with the tax laws. Regulatory agencies,
such as the Jamaica Stock Exchange will want to know whether the company is operating within the prescribed
rules.

The International Accounting Standards Board (IASB) Framework lists the following users and their
information needs:

a) Investors: The providers of risk capital and their advisers are concerned with risk inherent in and the
return provided by their investments. They need information to help them determine whether they
should buy, hold or sell. Shareholders are also interested information which enables them to assess the
ability of the enterprise to pay dividends.

b) Lenders: Lenders are interested in information that enables them to determine whether their loans and
related interest will be paid when due.

c) Suppliers and other trade creditors: Suppliers and other trade creditors are interested are interested in
information that enables them to determine whether amount owing to them will be paid when due.
They are also concerned amount giving future credit.

d) Customers: Customers have an interest in information about the continuance of an enterprise,

especially when they have a long term involvement with, or are dependent on, the enterprise.

e) Employees: Employees and their representative groups are interested in information about the stability
and profitability of their employers. They are also interested in information which enables them to
assess the ability of the enterprise to provide remunerations, retirement benefits and employment
opportunities.

f) Government: Government and their agencies are interested in the allocation of resources and,
therefore, the activities of enterprises. They also require information in order to regulate the activities
of enterprise, determine taxation policies and as the basis for national Income and similar statistics.
g) Public: Enterprises affect members of the public in a variety of ways. For example, enterprises may
make a substantial contribution to the local economy in many ways including the number of individual
they employ and their patronage to local suppliers. Financial statements may assist the public by
providing information about the trends and recent developments in the prosperity of the enterprise and
the range of its activities.

While financial statements cannot satisfy all the information needs of its users, there are needs which are
common to all users and which can be satisfied.

BUSINESS ACTIVITIES

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All businesses are involved in three types of activities

1. Financing Activities: It takes money to make money. A business enterprise must have a source or
sources of funds to finance its operations. Funding may come in the form of:

a. Loans/Short term credit from suppliers

b. Issue of shares/equity
c. Bank overdraft

2. Investing Activities: Once the company has raised money through financing activities, it will then use
the money in investing activities. Investing activities involve the purchase of those resources an
enterprise needs in order to operate. During the early stages of the enterprise's life it must acquire many
resources. These may include motor vehicles, buildings, furniture, computers and machinery. Resources
owned or controlled by an enterprise are called assets.

3. Operating Activities: Once a business or enterprise has the assets it needs to get started then it can begin
its operations. The business will seek to generate revenues and will in the process incur expenses.

In accounting language revenues arise from different sources and are identified by various names,
example, sales revenue, service revenue and interest revenue. Expenses are the cost of assets consumed
or assets used up in the process of generating revenues. Expenses take many forms and are identified by
various names depending on the type of asset consumed or service used. Examples include wages,
insurance premiums, depreciation, interest expense and rent expense. At the end of the operating or
accounting period expenses must be matched against revenues to determine the profit or loss for the
period. If revenues exceed expenses a profit will be earned; however if expenses exceed revenues a loss
will be incurred and reported.

COMMUNICATING WITH USERS

Assets, liabilities, expenses and revenues are of interest to users of accounting information. For business
purposes, it is customary to arrange this information in the format of four different financial statements; these
form the backbone of financial accounting. The results on some statements are used as input on other
statements, the statements are interrelated.

1. To show how profitable the enterprise was during the period a Statement of Profit or Loss would be
prepared. Expenses are matched against revenues to determine the profit or loss for the period.

2. To present a picture at any particular point in time of the assets owned by a business and the liabilities
owned by it a Statement of Financial Position would be prepared. In other words the statement of
financial position is a list of the assets and liabilities of the enterprise.

3. To indicate how much of previous income was distributed to you and the other owners of the business in
the form of dividends, and how much was retained in the business to allow for future growth, you would
present a Statement of Changes in Equity.

4. And finally, of particular interest to your bankers and other creditors, a Statement of Cash Flows would
be presented to show from what sources the enterprise obtained cash during the year and how the cash
was used.

This course will be concerned primarily with the Statement of Profit or Loss and the Statement of Financial
Position.

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UNIVERSITY OF TECHNOLOGY, JAMAICA
SCHOOL OF BUSINESS ADMINISTRATION
FUNDAMENTALS OF ACCOUNTING
Please note that it is the personal responsibility of each student to ATTEMPT the questions on the tutorial sheet
BEFORE going to tutorial. Your tutors are there to ASSIST you NOT do the problems for you. Thank you for
your co-operation.

Tutorial Sheet 1 (Some test 1 questions)

1. All of the following characteristics relate to partnership EXCEPT:

a. Owned by at least two individuals
b. Jointly responsible for loss
c. Decision making is quick
d. Profits are shared

2. Which is not one of the three forms of business organization?

a. Sole proprietorship
b. Creditorship
c. Partnership
d. Corporation

3. Net Profit will result during a time period when:

a. Assets exceed liabilities
b. Assets exceeds revenues
c. Expenses exceed revenues
d. Revenues exceed expenses

4. Which is not a one of the three primary business activities?

a. Financing
b. Advertising
c. Operating
d. Investing

5. Which statement about users of accounting information is incorrect?

a. Management is considered an internal user
b. Taxing authorities are considered external users
c. Present creditors are considered external users
d. Regulatory authorities are considered internal users

6. Which financial statement gives a listing of the enterprises assets, liabilities, and stockholder’s equity?
a. Statement of profit or loss
b. Retained earnings statement
c. Statement of Financial Position
d. Statement of Cash Flows

7. In which business activity would the enterprise be spending money on acquiring new equipment?

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 a. The investing section
b. The operating section
c. The financing section
d. None of the activities

8. On the death of a shareholder of a company, the company will continue.

a. True
b. False

9. Match each of the following forms of business organisation with a set of characteristics: Sole
Proprietorship (SP), Partnership (P), Corporation (C)

a. P Shared control, increased skill and resources, longer decision making process
b. SP Simple to set up, control maintained with founder, unlimited liability
c. C Easier to transfer ownership and raise funds, no personal liability

10. Who are the internal users of accounting data? managers who plan, organize, and run a business
How does accounting provide relevant data to the internal users? Financial comparisons of operating
alternatives, projections of income from new sales campaigns, forecasts of cash needs for the next year,
and summarized financial information.
Internal users of accounting information are managers who plan, organize, and run a business
For internal users, accounting provides internal reports, such as financial comparisons of operating
alternatives, projections of income from new sales campaigns, and forecasts of cash needs for the next
year. In addition, summarized financial information is presented in the form of financial statements.

11. Who are the external users of accounting data? Give examples
Investors (owners)
Creditors such as suppliers and bankers

12. What are the three main business activities, for each activity listed give an example.
Financing Activities- issue of shares/ equity
Investing Activities- motor vehicles, buildings, furniture, computers and machinery. Resources owned
or controlled by an enterprise are called assets.
Operating Activities- sales revenue, service revenue and interest revenue

13. Listed here are some items that can be found on the financial statements of a sole trader. Indicate in
which financial statement(s) each item would appear.

a. Service revenue- equipment

b. Equipment- balance sheet
c. Net Loss- profit or loss
d. Advertising Expense- profit or loss
e. Wages payable- balance sheet
f. Insurance- profit or loss
g. Depreciation- profit or loss
h. Motor Vehicle-
i. Debtors- balance sheet
j. Stationery- profit or loss
k. Insurance- profit or loss
Shareholder’s Equity/Capital- balance sheet

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 14. As an accounting student, explain the four (4) differences between a sole trader and corporation

Sole trader
Simple to establish, Unlimited liability

Owner controlled, Raising capital is limited

Less statutory regulations, Life of business is limited

Corporation
Easier transfer of ownership, Expensive to establish

Easier to raise funds, Affairs of the company are public

No personal liability, Reporting may be complex

15. “Accounting is ingrained in our society and is vital to our economic system” Do agree? Explain.