CHAPTER ONE

ACCOUNTING CAREERS AND CONCEPTS

1.1 INTRODUCTION

Throughout their lives, people make many important decisions to make living. The study of
accounting is the most useful knowledge in making both business and financial decisions.
Accounting information is used by every profit seeking business organization that has economic
resources such as money, machinery, equipment and buildings. While accounting has been called
language of business, it also serves as the language that provides financial information about not
– for – profit organizations such as governments, churches, charities, fraternities and hospitals.
This text concentrates on the use of accounting as it relates to the business firm.

1.2 ACCOUNTING DEFINED

Managers and owners of business organizations need good financial information to make good
business decision. Orderly records of a business financial activities are called accounting
records.
records. Accounting is the process of identifying, measuring and communicating financial and
economic information to permit informed judgments and decisions by the users of the
information.

Specifically, the accounting process (also called accounting cycle) consists of the following
group of functions.
1. Accountants observe many events and identify and measure in financial terms those
events considered evidence of economic activity.
2. The economic events are recorded, classified in to meaningful groups, and summarized
for conciseness.
3. Accountants report on a business activity by preparing financial statements and special
reports. Often accountants are asked to interpret these statements and reports for various
groups such as management and creditors.

1.3 JOB OPPORTUNITIES IN ACCOUNTING.

Accounting is an old profession. Records of business transactions have been prepared for
centuries. However, only during the last half-century has accounting been accepted as a
profession with the same importance as medical and legal professions. Today several millions
are employed in accounting and accounting related fields all over the world. Typically,
accounting jobs can be grouped in to four major categories.

a) Accountants: Persons who plan, summarize, analyze, and interpret financial information.
They also prepare various accounting reports and assist owners and managers in making
financial decisions. Accountants also supervise the work of other accounting workers,
which includes checking the accuracy of recorded financial information.
b) Bookkeepers:
Bookkeepers: Persons who do general accounting works plus some summarizing and
analyzing work. In some businesses, bookkeepers may supervise accounting clerks. In
small to medium size businesses, bookkeepers may also help owners and managers
interpret accounting information. Bookkeepers in small firms may do additional general
office work. Many businesses require that bookkeepers have filling and typing skills.
These two office skills are needed for storing accounting records and preparing
accounting reports.

c) Accounting clerks:
clerks: Persons who record, sort and file accounting information. Some
businesses have large quantity of day-to-day accounting tasks to be done. These
businesses will not want their highly trained accountants and bookkeepers doing the
routine work. Instead, accounting clerks are assigned to do these day-to-day routine
accounting tasks. Accounting clerks job titles often show the accounting records on
which they work. For example, a clerk working inventory records is sometimes known as
inventory clerk.

d) General office clerks:

clerks: General office clerks generally do some works related to
accounting. For example, a secretary may be in charge of a small cash fund. A typist may
file accounting reports.

1.4 DIFFERENCE BETWEEN ACCOUNTING AND BOOKKEEPING

Accounting is often confused with bookkeeping. Bookkeeping is a mechanical process that

records a routine economic activity of a business. Accounting includes bookkeeping but goes
well beyond it in scope. Accountants analyze and interpret financial statements, conduct audit,
design accounting systems, prepare special business and financial studies, prepare forecasts and
budgets and provide tax services. However, bookkeeping, mostly deals with routine accounting
works like general accounting works, summarizing, sorting and filing accounting records.

1.5 FORMS OF BUSINESS ORGANIZATIONS

Accountants frequently refer to a business organization as an accounting entity or a business

entity. A business entity is any business organization, such as grocery store or supermarket that
exists as an economic unit. For accounting purposes, each business organization has an existence
separate from its owners, creditors, employees, customers, and other businesses. This separate
existence of the business organization is known as business entity concept. Thus, in the
accounting records of the business entity, the activity of each business should be kept separate
from other businesses and the personal financial activities of the owner.

As you will see in the discussion that follows on the three forms of business organization- sole
proprietorship, partnerships, and corporations- the business entity concept applies to all forms of
businesses. Thus, for accounting purposes, all three business forms are separate from other
business entities and from their owners.

1.5.1 Sole Proprietorship

A sole proprietorship is an unincorporated business owned by an individual and often managed
by the same individual. Sole proprietorship; include physicians, lawyers, electricians, and other
people who are in business for themselves. Many small service-type businesses and retail
establishments are sole proprietorship. No legal formalities are necessary to organize such
businesses, and usually only a limited investment is required to begin operations.

In a sole proprietorship, the owner is held solely responsible for all debts of the business. For
accounting purpose, however, the business is a separate entity. Thus the financial activities of the
business, such as the receipt of fees from selling services to the public, are kept separate from the
personal financial activities of the owner. For example, the owner's personal house or car
payment should not be entered in financial records of the business.
1.5.2 Partnership
A partnership is an unincorporated business owned by two or more persons associated as
partners. The business is often managed by the same persons. Many small retail establishments
and professional practices, such as dentists, physicians, attorneys and other professional firms,
are organized as partnerships.

Partnerships are created by a verbal or written agreement. A written agreement is preferred

because it provides a permanent record of the terms of the partnership. Included in the agreement
are such terms as the initial investment of each partner, the duties of each partner, the means of
dividing profits or losses between the partners each year, and the settlement to be made up on the
death or withdrawal of a partner. Each partner may be held liable for all the debts of the
partnership and for the actions of each partner with in the scope of the business. However, as
with in the sole proprietorship, for accounting purposes, the partnership is a separate business
entity.

1.5.3 Corporation
A corporation is a business incorporated under the law of the country and owned by a large
number of persons. Almost all large businesses are corporations. The corporation is unique in
that it is a legal business entity. The owners of the corporation are called stockholders or
shareholders. They buy shares of stock, which are unit of ownership in the corporation. The
personal assets of the owners are protected from the creditors of the corporation that is the
owners have limited liability.

The stockholders do not directly manage the corporation; they elect a board of directors to
represent their interests. The board of directors selects the officers such as the president and vice
presidents who manage the corporation for the stockholders.

1.6 TYPES OF BUSINESS ACTIVITIES PERFORMED BY BUSINESS

ORGANIZATIONS.

The forms of business entities discussed in the previous section are classified according the type
of ownership of the business entity. We can also group business entities by the type of business
activity they perform
 1. Service companies
Service companies perform services for a fee. This group includes companies such as accounting
firms, law firms, repair shops and many others.

2. Merchandising companies
Merchandising companies purchase goods that are ready for sale and sell them to customers.
Merchandising companies include such companies as auto dealership, clothing stores, and
supermarkets.

3. Manufacturing companies
Manufacturing companies buy materials, convert them into products, and then sell the products
to other companies or final consumers. Example of manufacturing companies are cloth
manufactures, auto manufacturers and flour factories.

1.7 USERS OF ACCOUNTING INFORMATION

An accounting information system provides data to help the decision making process of
individuals outside the business as well as inside the business. The decisions of individuals
outside the business are affected in some way by the performance of the business, while
decision-makers inside the business are responsible for the performance of the business.

There are several different groups of external users of accounting information. Each group has
different interests in the company and wants answer to different questions. The groups and some
of their possible questions are:

(a) Owners: Has the company had satisfactory income on its total investment? Should
additional investment be made in this company?
(b) Creditors and lenders: Should a loan be granted to the company? Will the company be
able to pay its debts as they become due?
(c) Employees and their unions: Does the company have the ability to pay increased wages?
Is the company financially able to provide permanent employment?
(d) Customers: Does the company offer useful products at fair prices? Will the company
survive long enough to honor its product warranties?
(e) Government units:
units: Is the local public utility charging a fair rate for its services?
 (f) General Public: Is the company providing useful products and gainful employment for
citizens without causing serious environmental problems?

Accounting information system also provides data to help the decision making process of
individuals inside the business (also called internal users). Managers are internal users of
accounting information. The kind of information used by managers range from broad, long-range
planning data to detail explanations of why actual costs varied from estimated cost. The purpose
of accounting information system is to generate information that a manager can use to make
sound internal decisions such as financial decisions, resource allocation decisions, production,
and marketing decisions.

1.8 ACCOUNTING CONCEPTS

Accounting professionals are guided by accounting concepts. The ten concepts described in this
unit are commonly accepted by all professional accountants. The following are accounting
concepts, which are used through this material.

1. Business entity concept

Business financial information is recorded and reported separately from the owner’s personal
financial information. This concept assumes that each business has an existence separate from its
owners, creditors, employees, customers, other interested parties, and other businesses.

The owner of the business may also own a personal houses and car. However, business financial
records should not include information about the owner’s personal belongings. That is, a
business exists as an entity separate from its owners.

2.Going concern (continuity)

Financial statements are prepared with the expectation that a business will remain in operation
indefinitely.

Any business is started with every expectation that it will be successful. Owners expect to
continue operating their business well into the future. This concept states that an entity will
continue to operate indefinitely unless strong evidence indicates that the entity will terminate.
3. Accounting period cycle
Changes in financial information are reported for a specific period of time in the form of
financial statements.

Accounting records are summarized periodically and reported to business owners and managers.
The reports or statements are prepared to cover a specific period of time. The period of time may
cover a month, quarter of a year, six months, or a year.

4. Objective evidence
Each transaction is described by a business document that proves the transaction did occur.
A business transaction should be recorded only if it actually occurred. The amount recorded must
be accurate and true. Nearly all business transactions result in the preparation of a business
paper. For example, checks are prepared for cash payments. Receipts are prepared for cash. Sales
slips are prepared for items sold. One way to check the accuracy of specific accounting
information is to look at the business paper giving details of the transaction. Most accounting
entries are supported by business forms.

5. Unit of Measurement (Money measurement)

All business transactions are recorded in a common unit of measurement such as Birr or Dollar
instead of physical or other units of measurement.

The use of a particular monetary unit provides accountants with a common unit of measurement
to report economic activity. Without a monetary unit it would be impossible to add such items as
buildings, equipment and inventory on a balance sheet.

6. Realization of Revenue
“Revenue from business transactions is recorded at the time goods or services are sold.”
Revenue is the inflow of assets from the sale of goods and services to customers, measured by
the amount of cash expected to be received from customers. But when to record revenue is a
crucial question because some businesses sell goods or services for cash only, and other
businesses sell goods or services on one date and receive payment from customers on a later
date. The general answer to the previous question provided under the revenue realization
principle is that revenue should be earned and realized before it is recognized (recorded.)
7. Matching Expenses with Revenue
“Revenue from business activities and expenses associated with earning that revenue are
recorded in same accounting period".

The logic underlying this principle is that when economic resources are used, some one wants to
know what was accomplished and at what cost. Every evaluation of economic activity will
involve matching benefits with sacrifice.

8. Historical cost
“The actual amount paid or received is the amount recorded in accounting records.”
For example, Habesha Co. bought a computer for Br. 8,000. The current selling price of the
computer is Br. 10,000.
9. Adequate disclosure
"Financial statements should contain all information necessary for a reader to understand a
business financial condition."

All users need a business’s financial information. All financial information must be reported if
good business decisions are to be made. A financial statement with incomplete information is
similar to a book with missing pages.

10. Consistent Reporting

In the preparation of financial statements, the same accounting concepts are applied in the same
way in each accounting period.

Consistency generally requires that a company use the same accounting principles and reporting
practices through time. This concept prohibits indiscriminate switching of principles or methods,
such as changing inventory methods every year. However, consistency does not prohibit a
change in accounting principles if the information needs of financial statement users are better
served by the change.