UNIVERSITY OF LUSAKA

EC130/ BPS120/ED120/HRM160 PRINCIPLES OF FINANCIAL ACCOUNTING

INTRODUCTION TO FINANCIAL ACCOUNTING

1.0 What is accounting?

Accounting is defined as the process of recording, classifying, summarizing and communicating
financial information to the users of financial statements.

Frank wood defines accounting as the process of identifying, measuring and communicating
economic information to permit informed judgments and decisions by users of the information.

1.1 The definition consists of the following elements

 Recording the transactions of a business to provide information for day-to-day

management. For example sales to customers on credit must be recorded so that
statements of account can be sent to the customers and the money due collected.
 Classifying information of the business, similar transactions are classified together.
 Summarizing the transactions of a period to provide information about the performance
and position of a business to interested parties.
 Communicating information to the owners of the business as well as others entitled to
receive the information.

1.2 Financial Accounting and Management Accounting

Definitions

 Financial Accounting: is mainly concerned with the production of financial

statements to users outside the business though of course the records from which
the statements are prepared are essential for the day-to-day running of the
business also.

 Management Accounting: is an integral part of management, it is concerned

with identifying, presenting and interpreting information used for;

 Formulation of strategy
 Planning and controlling the activities
 Decision taking
 Optimizing the use of resources

1
1.3 Management Accounting and Financial Accounting Contrasted

Financial accounting Management accounting

It is a legal requirement to prepare financial
accounts, publish them and keeping a record of
them.
Financial accounting information is prudently
computed in accordance with the legal and
accounting requirements.
Financial accounts are mainly historical
records.
Financial accounts are concerned with profits
The cost of record keeping is a necessity
Keeping records of management accounts is
not mandatory
Information from management accounts should
be computed as per management requirements
provided it is relevant
Management accounts are concerned with
predictions.
Management accounts are concerned with cash
flow, profit and business management
generally.
The cost of record keeping needs to be justified

NOTE: differences between management and financial accounting are not limited to the ones
stated above.

1.4 Financial Accounting comprises two stages

1) The recording of day-to-day business transactions is referred to as Book-Keeping

2) From the book-keeping records accounts and financial statements are prepared and these
statements summarize the performance of the business- usually over the period of one
year.

1.5 Financial Management and Auditing

Definitions

 Financial Management: Covers all the functions concerned in attempting to

ensure that financial resources are obtained and used in the most effective way to
secure attainment of the objectives of the organization.

 Auditing: may be external or internal

o An external audit: is the examination of, and expression of opinion on,

the financial statements of a business entity.
o An internal audit: is a review of operations and records, sometimes
continuous, undertaken within a business by specially assigned staff.

2
2.0 The Purpose of Accounting

The purpose of accounting is to provide information to users of the financial statements. The
needs for accounting information differ from one user to another.

3.0 Users of Financial statements

They are the stakeholders who have an interest in the information contained in the financial
statements. The stakeholders have each their own different area of interest in the financial
statements. They are classified as follows, with a summary of their needs, but they are not
limited to the list below.

3.1 Government

o Government agencies use accounting information to collect statistical information to

reveal trends within the economy.
o Government through the Zambia Revenue Authority will use accounting information to
determine the tax liability of the business entities.

3.2 Banks and Other lending Institutions

Lending institutions use accounting information to determine whether the business has the ability
to repay loans and the interest charged.

The disadvantage is that accounting information may not show up-to-date financial position and
performance of the company, hence lenders will ask for cash flow forecasts. This illustrates why
accounting techniques have to be flexible and adaptive to meet user’s needs.

3.3 Competitors

Competitor will use their own results with other companies provided, they do not disclose
information harmful to their business. At the same time may not wish to hide information which
would put them above other companies.

3.4 Board of Directors

The board of directors want up-to-date in depth information so that it can draw up long term,
medium term and short term plans. Compares results with its past decision and forecasts. The
information the board requires is much more detailed and is published.

3.5 Shareholders and Potential Shareholders

As investors in the company, shareholders require managers to be accountable to them for the
performance of the business. They are said to be the owners of the business. While potential
shareholders use accounting information to assess the viability of the company before they can
acquire shares in it.

3
3.6 Financial Analysts

Financial analysts advising investors such as unit trust, insurance companies, mining companies
and pension’s authorities are among the users of accounting information, for the purpose of
advising their clients on various financial matters.

3.7 Employees and Trade Unions Representatives

Employees use accounting information to assess the potential performance of the business. This
information is important to the employees, who wish to discover whether the company can offer.

o Safe employment.
o Promotion through growth over a number of years.

Trade unionists use profits in calculations and claims for higher wages or better conditions.

3.8 Customers

Customers use accounting data to assess the viability of a company, so as to determine if a

contract can be placed with the company.

3. 9 The General Public

It is a legal requirement for the company to publish its financial statements; hence the general
public has access to the published information, through the press.

4.0 Responsibility for the preparation of financial statements

The boards of directors or management as agents of the business entities are entrusted with the
responsibility of preparing financial statements.

5.0 Business Entities

5.1 Types of Business Entities

1) Sole trader: a business entity normally operated by one person.

2) Partnership: a business jointly owned and run by several people.
3) Company: a company is formed using contributions from a number of people called
shareholders or members. They own the business, but they do not participate in its
management.

5.2 Legal personality

Unlike a sole trader or partnership a company is legal person distinct from its owners. A
company can own property, can be sued and sue just like any natural human beings.

4
 5.3 Limited liability

Unlike a sole traders or partnership companies have limited liability. This means that in
case of winding up creditors of the company will not go to the extent of sequestrating
personal belongings of share holders to recover the debts. The creditors will only be
allowed to repossess property registered in the name of the company.

A limited liability partnership like a company also has limited liability and is distinct
from its owners.

4.4 Types of Companies

Public limited Companies Private limited Companies

 Are listed on the stock exchange
 Must have the word “public limited
company” abbreviated to “Plc” at the
end of the name
 The maximum number of members is
unlimited
 The minimum number of members is
seven
 Are not list on the stock exchange
 Must have the word “limited”
abbreviated to “Ltd” as the last word of
their name
 Can have a maximum of fifty members
 The minimum number of members is
two, though some companies have
single shareholders.

6.0 Availability of Accounting Information

a. Sole Traders and Partnerships

Sole traders and Partnership have their financial statements completely private and are not
seen by anyone other than the sole traders or partners unless they choose to show them to a
third party, for example a bank manager in support of loan application.

b. Private and Public Companies

In the case of public and private companies

o Financial statements are first of all published

o Each shareholder is entitled to a copy
o They have to be lodged with the Registrar of companies

7.0 References

1 AT Foulks Lynch Ltd, (1997), Financial accounting, National Accounting Technicians.

2 Frank Wood & Alan Sangster, (2005), Business Accounting, Tenth Edition.