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FINANCIAL ACCOUNTING

LECTURE NOTES BY MR.S. NDHLOVU


TOPIC 1
INTRODUCTION TO FINANCIAL ACCOUNTING
LEARNING OBJECTIVES
After you have studied this chapter, you should be able to:
• Define financial accounting
• Identify types of businesses
• Explain the objectives of financial accounting
• List the main users of accounting information and what accounting
information they are interested in

INTRODUCTION TO FINANCIAL ACCOUNTING cont’d
What is Accounting?
• Accounting is the business language.
• It is the process of identifying, measuring, recording,
summarizing economic information and finally communicating it
to interested parties (users).

• ANALYSIS OF DEFINITION
• Process mean accounting has steps and procedures of doing things.
• Identifying means accounting is only concerned with activities or
transactions relating to the business.
INTRODUCTION TO FINANCIAL ACCOUNTING cont’d
• Measuring means that all activities related to the business should be
stated in monetary terms.
• Recording is the aspect of writing down business transactions in
accounting books. This is called BOOK KEEPING.
• Summarizing means analyzing all recorded information in categories
and preparing financial statements such as Income Statement,
Statement of Cash flows, Balance Sheet etc.
• Financial statements should be provided to any body interested for
assessment and decision making (communication).
INTRODUCTION TO FINANCIAL ACCOUNTING cont’d
TYPES OF BUSINESS ENTITY
What is a business?
• A business can be defined variously to suit one’s requirements
• It can be defined as any legal activity carried out with a view to making
profit or
• It is “a person, firm, company or other organization which produces
goods or provides some kind of services usually for the purpose of
making profits.”
• Therefore, a business of whatever size or nature exist to make a profit.
• Business is categorized into three main types; namely:
INTRODUCTION TO FINANCIAL ACCOUNTING cont’d
(1) SOLE TRADER

• This is the type of business owned and operated by one person, perhaps
employing one or two assistants and controlling their work.

• The sole trader, as an individual will provide the resources and skills to
operate the business.

• Maintaining accounting records in a sole trader may vary from basic to


complex as some sole trader may grow very big.
INTRODUCTION TO FINANCIAL ACCOUNTING CONT’D
Advantages of being a sole trader
• It is very simple to start the business; there are no legal formalities
• You make all the decisions without having to consult any other
person
• You enjoy all the profits
• You have total control over the business
• Less stringent reporting obligations compared with other business
structures(no need to make financial accounts publicly available).
INTRODUCTION TO FINANCIAL ACCOUNTING CONT’D
Disadvantages of being a sole trader
• The owner is personally liable for all debts(unlimited liability)
• Personal property may be vulnerable for debts and other business
liabilities
• A sole trader may not have sufficient money to start a business hence
depends really on personal savings and overdrafts
• A sole trader may not provide all the management expertise.
• The business may lead to long working hours without the normal
employee recreation leave and other benefits
• Issues of continuity may rise, if the owner is seriously ill or dies.
INTRODUCTION TO FINANCIAL ACCOUNTING cont’d
(2)PARTNERSHIP

• This is a type of business where two or more persons put their


resources together to carry on business for the purpose of making
profits. There is a limit as to the number of partners depending on
the type of business to be carried on. However for professionals such
as accountants, lawyers, medical practitioners etc. there is no limit
on the number of partners.
INTRODUCTION TO FINANCIAL ACCOUNTING cont’d

Advantages of partnership

• More capital can be raised to start the business

• Division of roles and responsibilities and an increased skill set

• Sharing of risk and losses between more people

• Less stringent reporting obligations compared with other business


structures(no need to make financial accounts publicly available
unless the partnership has the limited liability partnership status
INTRODUCTION TO FINANCIAL ACCOUNTING cont’d
Disadvantages of partnership
• One partner does not have a sole control of the business as other
partners may overrule one partner’s decision.
• Slower decision making due to the need for consensus
between/among partners
• The partners are liable for the debts of the business
• Issues of continuity of the business may rise in an event that a
partner or partners die or seriously fall ill.
INTRODUCTION TO FINANCIAL ACCOUNTING cont’d
(3) Limited Liability Companies
• A company is a formal association of persons for business purposes
and is legally incorporated under company law. The members in
company are known as shareholders.
• A limited liability company is a company that is legally separate from
its owners, and can confer various rights and duties. if the company
goes into liquidation because of debts, each member will only lose the
cost of his shares i.e. amount contributed in the business and no more.
• In other words, the shareholders are only responsible for the amount
paid for their shares, not for the company’s debts.
INTRODUCTION TO FINANCIAL ACCOUNTING cont’d
Advantages of Limited liability company
• The liability of the owners of a company for the debts it incurs is
limited to the amount they have agreed to subscribe for shares
• It can be easier to raise large sums of money
• The company can be professionally managed by directors
• A limited liability company has a separate legal identity from its
shareholders. So a company continues to exist regardless of the
identity of its owners
• Shares can be easily transferred from owner to another
INTRODUCTION TO FINANCIAL ACCOUNTING cont’d

Disadvantages of a limited liability company


• Limited liability companies have to publish financial statements. This means that
anyone (including competitors) can see how well or badly the company is doing
• The financial statements of limited liability companies have to comply with legal
and accounting requirements or standards
• The financial statements of larger limited liability companies have to be audited
• Share issues are regulated by laws e.g. shares capital can not easily be reduced
• It is more expensive to start such kind of business as it requires more capital
• More documents are required in setting such kind of business e.g. articles of
association, memorandum of association, certification incorporation etc.
INTRODUCTION TO FINANCIAL ACCOUNTING cont’d
OBJECTIVES OF ACCOUNTING

• To keep systematic records: Accounting is done to keep systematic record of financial


transactions. The primary objective of accounting is to help us collect financial data and to
record it systematically to derive correct and useful results of financial statements.

• To ascertain profitability: With the help of accounting, we can evaluate the profits and losses
incurred during a specific accounting period. With the help of a Trading and Profit & Loss
Account, we can easily determine the profit or loss of a firm.

• To ascertain the financial position of the business: A balance sheet or a statement of affairs
indicates the financial position of a company as on a particular date. A properly drawn
balance sheet gives us an indication of the class and value of assets, the nature and value of
liability, and also the capital position of the firm. With the help of that, we can easily
ascertain the soundness of any business entity.
INTRODUCTION TO FINANCIAL ACCOUNTING cont’d
OBJECTIVES OF ACCOUNTING CONT’D
• To assist in decision-making: To take decisions for the future, one requires
accurate financial statements. One of the main objectives of accounting is
to take right decisions at right time. Thus, accounting gives you the
platform to plan for the future with the help of past records.

• To fulfill compliance of Law: Business entities such as companies, trusts,


and societies are being run and governed according to different legislative
acts. Similarly, different taxation laws (direct indirect tax) are also
applicable to every business house. Everyone has to keep and maintain
different types of accounts and records as prescribed by corresponding
laws of the land. Accounting helps in running a business in compliance
with the law.
INTRODUCTION TO FINANCIAL ACCOUNTING cont’d
OBJECTIVES OF ACCOUNTING CONT’D
• To make information available to various users.
• To protect business properties.
• To ascertain the cost of production and selling price.
• To control expenditure of business.
• To calculate the amount due to and due from others

IMPORTANCE OF ACCOUNTING INFORMATION


• It serves as a historical record.
• It facilitates the preparation of financial statements.
• It supplies information to interested persons
• It helps the management in taking important business decisions.
• It facilitates comparative study of the performance of business over different
periods.
INTRODUCTION TO FINANCIAL ACCOUNTING cont’d
IMPORTANCE OF ACCOUNTING INFORMATION CONT’D
• It provides evidence in case of disputes.
• It helps to forecast the future.
• It provides information for judging the efficiency of business
• It is useful in getting loans.
• It helps in valuation of good will.
• It helps in controlling expenses.
• It helps in controlling employees.
• It helps in prevention and detection of errors and frauds.
INTRODUCTION TO FINANCIAL ACCOUNTING CONT’D
USERS OF ACCOUNTING INFORMATION AND THEIR INTEREST
The following are some of main users of accounting information.
(i) Managers of the company: Managers are people appointed by owners of
the company to supervise the daily activities of the company. They need
accounting information to make effective decisions.
(ii) Shareholders of the company i.e. the company’s owners, want to assess
how well the management is performing. They want to know how profitable
the company’s operations are and how much profit they can afford to withdraw
from the business for their own use.
Shareholders are interested in profits and security of their investment. They
need to look at accounting information to access profitability of the company
and will make decisions such as retaining their investment in the company or
invest it somewhere else.
INTRODUCTION TO FINANCIAL ACCOUNTING cont’d

USERS OF ACCOUNTING INFORMATION CONT’D


(iii) Trade Contacts: These are suppliers who provide goods and services to
company on credit and customers who purchase goods and services provided
by the company. Suppliers want to know about the company’s ability to pay its
debts while customers need to know that the company is a secure source of
supply and is in no danger of having to close down.
(iv) Lenders
• Lenders provide finance to companies in form of loans which could be short or
long term.
• Their main concern is on whether a company will be able to pay interest on
loans and also eventually repay the loan itself.
INTRODUCTION TO FINANCIAL ACCOUNTING cont’d
USERS OF ACCOUNTING INFORMATION CONT’D
(v) Government and their agencies: these are interested in the allocation of
resources and therefore in the activities of business entities. They also
require information in order to provide basis national statistics.
(vi) Tax authorities: these would want to know about the business profits in
order to assess the tax payable by the company, including sales taxes.
(vii) Employees and trade union representatives: Employees are workers in a
company. Their concern is job security and better conditions of services.
• These people will need accounting information as a basis for negotiating for
improved salaries and conditions of services. Accounting information may also
disclose that the company is threatened with closure and employees will have
to make a decision of staying or not.
INTRODUCTION TO FINANCIAL ACCOUNTING cont’d
USERS OF ACCOUNTING INFORMATION CONT’D
(viii)The public: People in general want accounting information because
enterprises affect them in many ways. For instance the general public would be
interested in seeing whether the company employs the locals as well as giving
supplies contracts to them. The public also get concerned on issues of
environment such as pollution.

(x) Financial analyst and advisers: These are specialists in economic trends. They
need accounting information in order to advise their clients on best investment
options and generally to inform the public on financial matters. For example, a
stockbroker need information to advise investors while a credit agency would
information to advise potential suppliers of goods and services to a company.
INTRODUCTIONT TO FINANCIAL ACCOUNTING CONT’D

• ACCOUNTING PROCESS OR CYCLE

• This the process and procedure to be completed to prepare financial


statements( Income Statement, Balance Sheet etc.). Each time the financial
statements are prepared, the accounting cycle has to be completed.

• The following are stages in accounting cycle:


INTRODUCTION TO FINANCIAL ACCOUNTING cont’d

1. Collecting and Analyzing Accounting Documents


• It is a very important step in which you examine the source documents and analyze
them. For example, cash, bank, sales, and purchase related documents. This is a
continuous process throughout the accounting period.

2. Journalizing and Posting to the ledger


• Journalizing is recording the information from source documents into journal or books
of prime entry. These entries in the journal are then aggregated and posted into
appropriate account in the ledger.
INTRODUCTION TO FINANCIAL ACCOUNTING cont’d

3. Preparation of Trial Balance

• As the name suggests, a trial balance is a summary of all the


balances of ledger accounts irrespective of whether they carry
debit balance or credit balance. Since we follow double entry
system of accounts, the total of all the debit and credit balance
as appeared in trial balance remains equal. Usually, you need to
prepare trial balance at the end of the said accounting period.
INTRODUCTION TO FINANCIAL ACCOUNTING cont’d

4. Preparation of Financial Statements


• Financial statements are the set of statements like Income
and Expenditure Account or Trading and Profit & Loss
Account, Cash Flow Statement, Balance Sheet or Statement
of Financial Affairs. It is from the trial where we get
information to prepare to prepare the financial statements.