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Learning Outcomes

After studying this chapter you will be able to

Explain the meaning of accounting
Appreciate the need of accounting
Perceive the development of accounting
Name the parties interested in accounting
Explain the different branches of accounting
Explain the meaning of certain key terms

Systematic process of measuring the
economic activity of a business
To provide useful information to those who
make economic decisions.
Accounting information is used in many
different situations.


Importance of Accounting

is a
system that



that is




Accounting Activities





Need of Accounting
Language of business

Bankers use accounting information when
deciding whether or not to make a loan.
Stockbrokers and other financial advisers base
investment recommendations on accounting
Government regulators use accounting
information to determine if firms are complying
with various laws and regulations.

Development of Accounting
1494 and 1775- Age of stagnation
Accounting is a function of economic (and
social) development .There was practically no
economic development . Naturally , there was no
progress in accounting practices and ideas.

Growth of accounting Knowledge

Accounting knowledge ( principles , practices ,
systems) has grown much over the period of
about 200 years from (1775-2000).
The proprietary owners were more interested in
knowing their capital (Assets Liabilities).

(1850-1900): Period of development of

accounting principles and assumptions
1- Growth of corporations led the development
of separate entity assumption .
2. There was greater emphasis on income
rather than on balance sheet . So it led to
development of accounting concepts of
income and the periodicity assumption.
3- A company was regarded as going concern;
and assets were valued at original cost less

4- The revenue principles , the cost principles

and the matching principles began to be
applied in the construction of income
5- Inventory and fixed assets began to be
valued at historical cost due to stewardship

1-As for development of this period , stewardship
reporting did not remain all that significant
around 1950 . Cost accounting and
management accounting developed during this
period .
2- Tax accounting , advising and planning were
3- Auditing techniques , standerds and guidelines
were issued by the professional bodies.

1- Accounting developed as a Full-fledged
information system.
2- Many new theoretical concepts were tested
and put to practice . A long descriptive
approach ,the normative approach to
development of an accounting theory was
also regarded as useful .
3- Various accounting standards boards and
committees were set up to issue statements
of concepts and standards in many countries.

4- International accounting was developed to

harmonize accounting techniques and practices
in member-countries.
5- Non-monitory information also began to be
reported in annual statement.
6- The application of computers has
revolutionized accounting system and
techniques .information system, information
technology (IT), E-commerce, management
- Accounting is now becoming a multiple model
(pattern) science.


Financial Accounting
The functions of financial accounting are
concerned with that of bookkeeping, i.e.
maintenance of records of costs, debtors,
and creditors, etc.
As per the company law requirements, the
company has to maintain the accounts for
their adoption by the shareholders in the
Annual General Meeting.

Limitations of Financial Accounting

Financial accounting doesnt aims at
continuous reporting of financial data
Financial accounts will not reveal the data by
jobs, process, products, etc.
It provides only historical data, and it would be
too late for any corrective action.
It does not provide data for adequate control
over materials, labour, and overheads.
In financial accounting, there are no systems to
set predetermined estimates, standards, or

Users of Accounting Information

1. Equity investor group, including existing and potential
2. The loan creditor group, including existing and
potential holders of debentures and loan stock, and
providers of short-term secured and unsecured loans
and finance.
3. The employee group, including existing, potential and
past employees.

4. The analyst-adviser group, including financial analysts

and journalists, economists, statisticians, researchers,
trade unions, stockbrokers and other providers of advisory
services such as credit rating agencies.
5. The business contact group, including customers, trade
creditors and suppliers and, in a different sense, business
rivals competitors, and those interested in mergers,
amalgamations and takeover.
6. The government, including tax authorities, departments
and agencies concerned with the supervision of
commerce and industry, and local authorities.
7. The public, including taxpayers, ratepayers, consumers
and other community and special interest groups such as
political parties, consumer and environmental protection
societies and regional pressure groups.

Classification of Accounts
Asset: Items that a business or individual
owns or are owed.
Liability: A debt or obligation.
Revenue: Amounts earned by delivering
goods or services to customers.
Expenses: The daily costs incurred in running
a business.
Capital: The owner's or owners' rights to
assets of a business.



Proprietor or Owner

The amount of money or moneys worth
invested or introduced by the proprietor
into his business at the time of the
commencement of the business is called
Capital is total assets minus total liabilities.

Net Worth Or Net Assets

Net worth or net assets means the excess
of the total assets of a business over its
total liabilities at any particular point of
In short, it means owners capital.

Drawing refer to cash, goods or any other
asset withdrawn by the proprietor from his
business for his personal, private or
domestic use or purpose.

Assets means resources, things or rights
of value owned by a business undertaking.
Assets are also defined as properties and
possessions owned by a business which
benefit future period or periods.

Assets include:
(a) Physical or real properties or things called
tangible assets like lands, buildings, Plant &
machinery, etc
(b) Rights in certain things or certain rights
having money value called intangible assets,
such as Goodwill, Patent rights, trade marks
and copyrights possessed by a business.
(c) Debts or amounts due to a business from
others, such as sundry debtors, bills
receivable, accrued incomes, etc.


Liabilities means claims of outsiders

against a business concern which bind
the business concern to others.
In short, liabilities are outsiders equity.
Examples of liabilities:
- loans borrowed
- deposits accepted
- bank loan
- bank overdraft
- sundry creditors etc


A debtor is a person who owes money to

the business . He owes money to the
business because he has received some
benefit from the business.
A debtor constitutes an asset for the
A debtor may be: (a) a trade debtor,
(b) a loan debtor,
(c) a debtor for an asset sold on credit or
(d) a debtor for the service rendered on


The amount of a business transaction due

from a person (i.e., debtor) to the business
is called a debt.
Book debt is the amount due to the
business from a debtor as per the books of
Good debt: fully recoverable debt.
Bad debt: A debt which is irrecoverable.
Doubtful debt: A debt, the realization or
recovery of which is uncertain or doubtful.
It is the possible loss to the business.

A creditor is a person to whom the business
owes money.
A creditor constitutes a liability for the
A creditor may be
(a) a trade creditor,
(b) a loan creditor,
(c) a creditor for an asset purchased on
credit and
(d) an expense creditor

Solvent: A businessman is said to be

solvent when he is able to pay his
liabilities in full. In other words, a
businessman is regarded as solvent,
when his assets exceeds his liabilities.
Insolvent: A businessman is said to be
insolvent when he is not able to pay his
liabilities in full.

Goods: refer to merchandise, commodities,

products, articles or things in which a trader
Purchases: Goods purchased by a
business are called purchases.
-The purchases of goods may be cash
purchases or credit purchases.
- Goods returned by a business to its
suppliers out of the purchases already
made are called purchases returns,
returns outwards or returns to suppliers.

Sales: Goods sold by a business are

called sales.
Sales Returns: Sold goods returned by
customers are called sales returns/returns
inwards or returns from customers.

Inventory: Inventory or stock refer to the

stock of finished goods held for sale in the
ordinary course of business, or
the stock of raw materials and work-inprogress held for consumption in the
production of finished goods for sale, or
stock of consumable stores like cotton
waste, grease, lubricant, etc. held for use
in the factory.

Expenses are the costs incurred in
connection with the earnings of revenue.
E.g. Cost of goods sold or services
rendered, administration or office
expenses, selling and distribution
expenses, maintenance expenses,
financial expenses, etc

Loss: refers to money or moneys worth

given up without getting any benefit in
e.g. loss of goods by fire, loss of cash by
theft, loss of machinery in accident etc.
Revenue : is the earning of a business
from the sale of goods or from the
rendering of services to customers during
an accounting period. It also includes
other earnings like interest and dividends,
rent, discount etc.

Gain: refers to revenue which is not

generated through routine or regular
business activities.
Profit: is the excess of revenues over the
expenses of a given period of time, usually
a year.