FAC1501

LEARNING UNIT 1

THE NATURE AND

PURPOSE OF
FINANCIAL ACCOUNTING

Introductory Financial
Accounting
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2 OVERVIEW

Learning outcomes ................................................................................................................................ 2

Key concepts ......................................................................................................................................... 2
Assessment criteria ............................................................................................................................... 3
1.1 Introduction...................................................................................................................................... 3
1.2 What is financial accounting? .......................................................................................................... 3
1.3 The objective of financial accounting............................................................................................... 4
1.4 The nature of financial accounting................................................................................................... 4
1.5 International Financial Reporting Standards (IFRSs) ...................................................................... 5
1.6 The objective of financial statements .............................................................................................. 5
1.7 Users of financial statements .......................................................................................................... 5
1.8 Exercises and solutions................................................................................................................... 7
Self-assessment .................................................................................................................................... 8
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LEARNING OUTCOMES

After studying this learning unit, you should be able to

define financial accounting
explain the objective of financial accounting
explain the nature of financial accounting
list the steps involved in the financial accounting cycle
explain the difference between financial accounting and bookkeeping
explain the acronym IFRSs
identify the users of financial accounting information in the financial statements and the reasons
why they need the financial information

KEY CONCEPTS

Transaction
Financial accounting
Objective of financial accounting
Financial accounting cycle
Bookkeeping
International Financial Reporting Standards (IFRSs)
Users of financial statements

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ASSESSMENT CRITERIA
explained.
The nature and objective of financial accounting are explained.
The specific and general functions of financial accounting are explained.
The processing of basic transactions is explained.
The meaning of International Financial Reporting Standards (IFRSs) and its
application to the preparation and presentation of financial information are
explained.
The overall objective of financial statements to meet the needs of the users of
financial information is explained.
Information useful to the users of financial information is determined according
needs.

1.1 INTRODUCTION
Every day all over the world, literally millions of transactions take place. A transaction is an action
where money is paid and in return an item or service, that the buyer needs, is obtained. Think about
buying a loaf of bread something that most of us do daily. For us as individuals, it is quite easy to
remember what transactions we concluded for a particular day, but for a big entity, it would be
impossible to know what transactions took place during a day if proper records were not kept. It would
even become impossible for an individual to remember what transactions were concluded a month
ago if he/she does not have a proper recordkeeping system in place.

1.2 WHAT IS FINANCIAL ACCOUNTING?

Financial accounting can be defined as the orderly and systematic identification and recording of the
monetary values of financial transactions of an individual or business entity, and the reporting of the
results of these transactions by way of the preparation and presentation of financial statements to
enable the users to use the information obtained in these financial statements as a basis for decision
making. Financial accounting is a specialised method used to communicate financial information about
an entity and its activities to those persons or entities that have an interest in the activities of the entity.

Financial accounting is a process that involves three activities, namely:

Identification selecting those events that are evidence of economic activity (transactions) relevant
to the particular entity.
Recording the monetary value of the economic events (transactions) to provide a permanent
history of the financial activities of the entity. Recording consists of keeping a chronological diary
of measured events in an orderly and systematic manner. Recording implies that economic events
are also classified and summarised.
The third activity encompasses the communication of the recorded information to interested users.
The information is communicated through the preparation and distribution of accounting reports,
the most common of which are known as financial statements, that consist of
- a statement of financial position
- a statement of profit or loss and other comprehensive income
- a statement of changes in equity
- a statement of cash flows
- notes, comprising of a summary of significant accounting policies and other explanatory notes

An entity does not necessarily refer to business entities. It can also refer to an educational institution,
a religious institution, or a private household.

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NOTE:
Do not be concerned if you do not understand all the terminology on the following few pages, as
they will all be explained in learning units 1 and 2.

1.3 THE OBJECTIVE OF FINANCIAL ACCOUNTING

The objective of financial accounting is to enable the users of financial information to ascertain readily
what the financial results and financial position of the entity is. With this statement we mean:

(a) Did the entity trade at a profit or loss?

(b) What was the income of the entity and what were the expenses incurred in producing that income?
(c) How much does the entity owe to other entities?
(d) How much do customers owe to the entity?
(e) What is the nature and amount (in value) of the various kinds of property and other assets the
entity possesses?
(f) (equity)?

1.4 THE NATURE OF FINANCIAL ACCOUNTING

Financial accounting functions as an information system: far-reaching decisions are taken based on
the results reported in financial statements and business transactions must be measured, classified,
summarised, and recorded continuously. We call these actions the financial accounting cycle. This
cycle is demonstrated in the following diagram.

TRANSACTION
DATA

INPUT record on

SOURCE
DOCUMENTS

prepare

SUBSIDIARY
JOURNALS

post to
update

PROCESSING GENERAL SUBSIDIARY

LEDGER LEDGERS

extract

TRIAL
BALANCES

prepare

ANALYSIS DECISION MAKING

OUTPUT FINANCIAL
AND BY
STATEMENTS
INTERPRETATION MANAGEMENT

Diagram 1.1: The financial accounting cycle

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Financial accounting is the systematic recording of the financial transactions of an entity in such a
manner that any information required by the entity is readily available. The systematic recording of
the financial information is called a financial accounting cycle, which consists of the elements listed
in diagram 1.1.

The processing stage entails the recording of transactions, and this process is known as
bookkeeping. The goal of the input stage and the processing stage is to prepare financial
statements.

1.5 INTERNATIONAL FINANCIAL REPORTING STANDARDS (IFRSS)

It would be problematic if each entity kept individualised records of its transactions as this would make
it difficult to compare the performance of an entity with those of other similar entities. To prevent this
from happening, the financial accounting profession has standardised the way in which entities are
required to keep record of their transactions.

In South Africa, the recording and reporting of financial information are governed by international
financial reporting standards as set by the Financial Reporting Standards Council (FRSC) in South
Africa. The purpose of these financial accounting standards will, to a great extent, ensure that the
same type of transaction is recorded by different entities in the same way.

This will eventually ensure that the financial statements of different entities conducting the same
type of business are
those prepared in previous years.

In South Africa, we must comply with the International Financial Reporting Standards (IFRSs), which
financial

1.6 THE OBJECTIVE OF FINANCIAL STATEMENTS

The objective of financial statements is to provide information about the financial position,
performance, and changes in the financial position of an entity that is useful to a wide range of users
in making economic decisions.

1.7 USERS OF FINANCIAL STATEMENTS

Financial statements are prepared and presented at least once a year and are directed towards the
common information needs of a wide range of users.

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The following categories of users, and their need for accounting information, have been identified:

User Information needs

Clients to assess the ability of the entity to continue as a going concern.

Employees to assess the ability of their employer to provide stable employment and
remuneration.

Government to regulate activities of the enterprise, compile statistics and determine

resource allocation and tax policies.

Investors to assess the risk and return on an investment in the enterprise.

Lenders to assess the ability of the enterprise to pay interest on a loan and to
repay loans.

Suppliers and other to assess the ability of the enterprise to pay amounts owing.
trade payables

Management planning, that is determining future actions to be taken;

or
exercising control, that is evaluating the current situation and taking
corrective steps.

Although employees are part of the organisation, they do not have the same, unlimited access to the
accounting records of the entity.

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1.8 EXERCISES AND SOLUTIONS

3 REQUIRED
Answer the following questions:
(a) What is a transaction?
(b) How will you define financial accounting?
(c) What is the objective of financial accounting?
(d) What is the nature of financial accounting?
(e) List the steps in the financial accounting cycle.
(f) What does bookkeeping entail?
(g) What does IFRSs stand for?
(h) List the categories of users of financial accounting information.
(i) Name the reasons why management need financial accounting information.
(j) What is the objective of financial statements?

4 SOLUTIONS

(a) A transaction is an action where money is paid and, in return, an item or service that the buyer
needs is obtained.
(b) Financial accounting is the orderly and systematic identification and recording of the monetary
values of financial transactions of an individual or business entity, and the reporting of the
results of these transactions by way of the preparation and presentation of financial statements
to enable the users to use the information as a basis for decision making.
(c) The objective of financial accounting is to enable the users of financial information to ascertain
readily what the financial results and financial position of the entity is.
(d) The nature of financial accounting:
to identify events that are evidence of economic activity relevant to the particular entity;
to record the monetary value of economic events to provide a permanent history of the
financial activities of the entity; and
to communicate the recorded information to interested users.
(e) The steps in the financial accounting cycle:
Transactions source documents journals general ledger and subsidiary ledgers trial
balances final accounts and financial statements.
(f) Bookkeeping is the systematic recording of transactions.
(g) IFRSs stands for International Financial Reporting Standards.
(h) The categories of users of financial accounting information:
clients
employees
government
investors
lenders
suppliers and other trade payables
management
(i) Information to be used for decisions directed at
planning, that is determining future actions to be taken; or
exercising control, that is evaluating the current situation and taking corrective steps.
(j) The objective of financial statements is to provide information about the financial position,
performance, and changes in the financial position of an entity that is useful to a wide range of
users in making economic decisions.
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5 SELF-ASSESSMENT
After you have worked through this learning unit, are you able
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to
define financial accounting?
explain the objective of financial accounting?
explain the nature of financial accounting?
list the steps involved in the financial accounting cycle?
explain what the acronym IFRSs stands for?
list the users of financial statements?
explain what information different users of financial
statements will be interested in?
explain the main objective of financial statements?

If you have marked all , you may continue to the next learning unit.

If you have marked any , you have to revise that specific section.

If you have marked any , you have to re-study that specific section.