Yunivarsiitii Naannoo Oromiyaa: Oromia State University

YUNIVARSIITII NAANNOO OROMIYAA
Oromia State University
04/11/2023 By Teshome Kankuse 1

Course Intermediate financial Accounting I
Academic Year 2013
Year of entry 2012
04/11/2023 By Yonas G. 2
UNIT 1:
DEVELOPMENT OF ACCOUNTING
PRINCIPLES AND PROFESSIONAL
PRACTICE
Introduction
With the increasing size and complexity of business
enterprises and the increasing economic role of
government, the responsibility placed on
accountants is greater today than ever before.
If accountants are to meet this challenge, they must
have a logical and consistent body of accounting
theory to guide them.
This theoretical structure must be realistic in terms of
 The economic environment and
 Its designed to meet the needs of users of financial
statements
04/11/2023 By Yonas G. 4
Financial statements and reports prepared by
accountants are vital to the successful working
which used by
 society
 mangers
 Economists
 investors
 business executives
 labor leaders
 bankers, and
 government officials
04/11/2023 By Yonas G. 5
These groups are making increased use of
accounting as a base for forecasting future economic
trends. Accounting communicates financial
information about an economic entity to interested
persons. This characteristic has described
accounting for hundreds of years.
1.1 THE ENVIRONMENT OF ACCOUNTING
Like other human activities and disciplines,
accounting is largely a product of its environment.
The environment of accounting consists of social –
economic – political - legal conditions, restrictions
and influence that vary from time to time.
As a result, accounting objectives and practices are
not the same today as they were in the past.
Accounting theory has evolved to meet changing
demands and influences. As economic entities
continued to increase in size and complexity, and
the interested persons increased so greatly in
number and diversity.
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So accounting had developed new concepts and
techniques to meet the ever increasing needs
for financial information. The financial statements
are expected to present fairly, clearly, and
completely the economic facts of the existence and
operations of the enterprise.
In preparing financial statements, accountants are
confronted with the potential dangers of
 Bias
 Misinterpretation
 Inexactness and
 Ambiguity
04/11/2023 By Yonas G. 8
Financial Reporting Environment
• In order to minimize these dangers, the accounting

profession has attempted to develop a set of
standards that is generally accepted and universally
practiced.
With out these standards, each enterprise would
have to develop its own standards, and readers of
financial statements would have to familiarize
themselves with every company's accounting and
reporting practice. As a result it would be almost
impossible to prepare statements that could be
compared.
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Objective of Financial Reporting
Provide financial information about the reporting
entity that is useful to
– present and potential equity investors,
– lenders, and
– other creditors in making decisions about providing
resources to the entity.

USERS OF ACCOUNTING INFORMATION
The basic assumptions that underlie current

accounting practice have evolved over many years
in response to the needs of various users of
accounting information. Organizations set up an
accounting information system to help them and
others make better decisions.
The accounting system serves the information needs

of various kinds of users (Stakeholders).
04/11/2023 By Yonas G. 12
The information that a specific user needs depends
on the kind of decision that user makes. The
difference in decisions divides the users in to two
broad groups: the internal users and external users.
Internal users:- This include those who are to be
found with in the organization such as management
personnel and lobur leaders of a business
enterprise. They used accounting information for
 Either planning and controlling current operations
and
 Formulating long range plans and making major
business decisions.
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External users:- This involves those who are used
an accounting information such as stockholders,
bondholders, potential investors, bankers and other
creditors, financial analysts, economists, labor
unions, and numerous governmental agencies which
are to be found out side of the organization.
For the purposes of study and practice, the
discipline of accounting is commonly divided into
the following areas or subsets: financial accounting,
managerial (cost) accounting, tax accounting, and
not- for- profit (public sector) accounting
Management accounting relates to internal
measurement and reporting; it includes the
development of detailed current information helpful
to all level of management (Internal users) in
decision making designed to achieve the goal of the
enterprise.
In contrast, financial accounting is directly related to

external reporting because it provides investors and
other outsiders with the financial information they
need for decision making
04/11/2023 By Yonas G. 15
`1.2 Conceptual framework (FASB Vs IFRS)
A Conceptual framework is like a constitution: it is a
coherent system of interrelated objectives and
fundamentals that can lead to consistent standards
and that prescribes the nature, function, and limits of
financial accounting and financial statements.
Many have considered the board’s real contribution

and even its continued existence to depend on the
quality and utility of the conceptual framework
.
To be useful, standard setting should build on and
relate to an established body of concepts and
objectives. A soundly developed conceptual
framework should enable the FASB to issue more
useful and consistent standard in the future.
Over the years, numerous organizations,
committees, and interested individuals developed
and published their own conceptual frameworks.
But no single framework was universally accepted
and relied on in practice. Perhaps the most
successful was the Accounting principles Board
statement NO.4, "Basic Concepts and Accounting
Principles
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I F R S Insights
Similarities with FASB
The IASB has recently completed its conceptual
framework, whereas the FASB has not. However,
many of the concepts that are covered in the new
IASB conceptual framework are consistent with the
FASB current framework and related standards.
• The objective of financial reporting and the
qualitative characteristics of useful financial
information are essentially the same between the two
frameworks.
04/11/2023 By Yonas G. 18
Both frameworks have similar measurement
principles, based on historical cost and fair value
concepts. The mixed model (historical cost and fair
value) is same in the two frameworks. In 2011, the
Boards issued a converged standard on fair value
measurement so that the definition of fair value,
measurement techniques, and disclosures are the
same between G A A P and I F R S when fair value
is used in financial statements

Differences
a. The IASB gives more emphasis to stewardship in
its conceptual framework. The framework indicates
that users need information about the resources of
the entity not only to assess an entity’s prospects for
future cash inflows but also to determine how
effectively and efficiently management has
discharged their responsibilities to use the entity’s
existing resources (i.e., stewardship).
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b. In other words, the IASB conceptual framework
explicitly discusses the need to provide information
related to stewardship of an entity’s resources as
well as the need for information to help users
understand the prospects for future net cash inflows
to the entity.
c. The concept of prudence is introduced to support
the principle of neutrality in relation to the purpose
of faithful representation. Prudence is defined as the
exercise of caution when making judgments under
conditions of uncertainty. As an example, prudence
means that revenues are not overstated, and
expenses are not understated.
04/11/2023 By Yonas G. 21
d. Although both G A A P and I F R S are increasing
the use of fair value to report assets, at this point I F
R S has adopted it more broadly. As examples, under
IFRS, companies can apply fair value to property,
plant, and equipment; natural resources; and, in
some cases, intangible assets.
The monetary unit assumption is part of each
framework. However, the unit of measure will vary
depending on the currency used in the country in
which the company is incorporated.
I F R S makes an explicit assumption that financial
statements are prepared on an accrual basis.
The IASB also clarified two other concepts, these are;
measurement uncertainty and substance over form.
The framework indicates that measurement
uncertainty does not prevent information from being
useful. However, in some cases the most relevant
information may have such a high degree of
uncertainty that the most useful information is that
which is slightly less relevant but is subject to lower
measurement uncertainty.
04/11/2023 By Yonas G. 23
The economic entity assumption is also part of each
framework although some cultural differences result
in differences in its application. I F R S defines a
reporting entity as one that is required to (or chooses
to) prepare financial statements.
A reporting entity does not need to be a legal entity; it

could be a portion of an entity or a combination of
entities. G A A P uses a different definition (more
aligned with legal entities).
04/11/2023 By Yonas G. 24
In the revised conceptual framework, the I A S B has
introduced two new qualitative characteristics:
prudence and substance over form. Also, the I A S B
is making modifications to other parts of its
conceptual framework by revising the definitions of
a number of the basic elements.
The I A S B is also introducing updated on such items

as measurement, classification of income and
expense, recognition of assets and liabilities, and the
reporting entity.
By Teshome Kankuse
04/11/2023 25
.
Memorandum entitled Conceptual Framework for
Financial Accounting and Reporting:
Elements of Financial Statement and Their
Measurement. It set forth the major issues that must
be addressed in establishing a conceptual framework
that would be a basis for setting
accounting standards and for resolving financial
reporting controversies. Since the publication of that
document, the FASB has issued six Statements of
Financial Accounting Concepts (SFAC) that relate
to financial reporting for business enterprises. They
are;
04/11/2023 By Yonas G. 26
1. Statement of Financial Accounting Concepts
(SFAC) No 1. “Objectives of Financial Reporting
by Business Enterprises” presents the goals and
purpose of accounting.
2. Statement of Financial Accounting Concepts No 2.
“Qualitative Characteristics of Accounting
Information," Examines the characteristics that
make accounting information useful.
04/11/2023 By Yonas G. 27
3. Statement of Financial Accounting Concept No.3.
“Elements of Financial Statements of Business
Enterprises," Providing definition of items in
financial statements, such as assets, liabilities,
revenues and expenses.
4. Statement of Financial Accounting Concepts No.5.
"Recognition and Measurement in Financial
Statement of Business Enterprises," sets forth
recognition and measurement criteria and guidance
on what information should be formally
incorporated in to financial statements and when.
04/11/2023 By Yonas G. 28
5. Statement of Financial Accounting Concepts No.6.
“Elements of Financial Statements", replaces
statement of Financial Accounting Concept No.3
and expands its scope to include not-for –profit
organizations.
The conceptual framework for financial accounting
can be presented pictorially as presented below.

At the first level, the objectives identify the goals
and purpose of accounting and are the building
blocks for the conceptual framework.
At the second level are the qualitative characteristics
that make accounting information useful and the
elements of financial statements (assets, Liabilities,
and so on).
At the final or third level are the measurement and
recognition concepts used in establishing and
applying accounting standards. These levels are
explained in the following sections.
04/11/2023 By Yonas G. 30
• Third level: The "how” implemen Third level: The
Recognition and "how”
Measurement concepts implementation
Qualitative Elements
characteristics of
of accounting financial Second Level:
information statement Bridge between
level 1 and 3
Objectives of
Financial
Reporting b
First level: The "Why"-
goals and Purposes of
accounting

Fundamental concepts
Between these two levels it is necessary to provide
certain conceptual building blocks that explain the
qualitative characteristics of accounting information
and define the elements of financial statement.
These conceptual building blocks form a bridge
between
 the why of accounting (the objectives) and
 the how of accounting (recognition and
measurement).
.

1.3 Objectives of Financial Reporting and
financial statements
Basic Objective
To provide financial information about the reporting
entity that is useful to present and potential equity
investors, lenders, and other creditors in making
decisions about providing resources to the entity
The objectives of financial reporting and financial
statements are derived from the needs of external
users of accounting information.
Financial statements often intended to serve all
external users often are called general - purpose
financial statements.
04/11/2023 By Yonas G. 33
The FASB issued SFAC No.1, “Objectives of
Financial Reporting by Business Enterprises," to
establish the objectives of general purpose external
financial reporting by business enterprises.
This concept defines the target audience as those
who
a. Lack the authority to prescribe the information they
want and must rely on the information
management communicates to them.
b. Have a reasonable understanding of business and
economic activities and are willing to study the
information with reasonable diligence
04/11/2023 By Yonas G. 34
There for Objectives of Financial Reporting and
financial statements may presented as follows
1. Financial reporting should provide information that
is useful to present and potential investors and
creditors and other users in making rational
investment, credit, and similar decisions are as
follows;
2. Financial reporting should be helpful to current and
potential investors and creditors and other users in
assessing the amount, timing, and uncertainty of
future cash flows such as dividends or interest
payments.
04/11/2023 By Yonas G. 35
3. Financial reporting should provide information
about the economic resources of an enterprise, the
claims to those resources, and the effects of
transaction, events, and circumstances that change
recourses and claims to those resources.
4. Financial reporting should provide information
about how management of an enterprise has
discharged its stewardship responsibility to owners
for the use of enterprise resources entrusted to it.
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Qualitative Characteristics of Accounting
Information
The FASB identified the qualitative
characteristics of accounting information that
distinguish better (more useful) information
from inferior (less useful) information for
decision-making purposes.
04/11/2023 By Yonas G. 37
This provides
how does one decide whether financial reports
should provide information?
 how much a firm's assets cost to acquire?
 how much they are currently worth ( current value
basis)?
In addition, the FASB has identified certain constraints (cost -
benefit and materiality) as part of the conceptual frame
work.
04/11/2023 By Yonas G. 38
Qualitative Characteristics
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Decision makers (users) and understandability
Decision makers vary widely in
 the type of decision they make,
 the methods of decision making they employ,
 the information they already possess or can obtain
from other sources, and
 their ability to process the information.
Consequently, for information to be useful there must
be a connection (linkage) between it and the users
and the decisions they make.
04/11/2023 By Yonas G. 40
This link, understandability, is the quality of
information that permits reasonably informed
users to perceive its significance.
Understandability of financial statements,

however, depends not only on the accountant's
skills and abilities to comprehend hat
information. In this regard, a user's ability could
vary from being simplistic to expert.
04/11/2023 By Yonas G. 41
Primary qualities: Relevance and Reliability
Relevance and reliability are the two primary qualities
that make accounting information useful for decision
making. As stated in FASB concepts statement No.2.
“the qualities that distinguish 'better' (more useful)
information from 'inferior ' (less useful) information are
primarily the qualities of relevance and reliability, with
some other characteristics that those qualities imply.“
A. Relevance
To be relevant, accounting information must be
capable of making difference in decision. If certain
information has no bearing on a decision, it is irrelevant
to that decision. Relevance can be evaluated according
to three qualitative criteria:-
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Fundamental Quality—Relevance
To have relevance, accounting information must be

capable of making a difference in a decision.
Financial information has predictive value if it has value as

an input to predictive processes used by investors to form
their own expectations about
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the future.
By Teshome Kankuse 44
Relevant information also helps users confirm or

correct prior expectations.
Information is material if omitting it or misstating it

could influence decisions that users make on the
basis of the reported financial information.
By Teshome Kankuse
04/11/2023 46
.
Timeliness- for information to be relevant, it must be
available to decision makers before it loses its
capacity to influence their decision. Outdated
information is irrelevant for the decision at hand.
• Predictive value- accounting information should be
helpful to external decision makers by increasing
their ability to make predictions about the outcomes
of future vents.
• Feedback value- accounting information should be
helpful to external decision makers who are
confirming past predictions or make updates,
adjustments, or corrections to predictions
B. Reliability
Reliability means that users can depend on
accounting information to represent the underlying
economic conditions or events that it purports to
represent. Accounting information is reliable if it is
reasonably free from error and bias and faithfully
represents what it purports to present.
Reliability of information is a necessity for
individuals who have neither the time nor the
expertise to evaluate the factual content of
financial statements. Like relevance, reliability
must meet three qualitative criteria
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Representational faith fullness
Accounting information should present what it
purports to represent and should ensure that the
selected method of measurement has been used
without error or bias. This attributes is some
times called validity.
• The numbers and descriptions should represent
what really existed or happened.
• For example, if NIB International Bank reports
an income of birr 50 million when it had an
actual income of birr 35 million, then the
statements are not a faithful representation.
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Faithful Representation
Faithful representation means that the numbers

and descriptions match what really existed or
happened.
Completeness means that all the information that

is necessary for faithful representation is provided.
Neutrality means that a company cannot select

information to favor one set of interested parties
over another.
An information item that is free from error will be a

more accurate (faithful) representation of a financial
item.
Verifiability- is demonstrated when independent
measures, using the same measurement method,
obtain similar results. For example, would several
independent auditors come to the same conclusion
about a set of financial statements? If outside parties
using the same measurement methods arrive at
different conclusions, then the statement are not
verifiable. Auditors could not render an opinion on
these statements.

Neutrality – Accounting information must be
free from bias regarding a particular view
point, predetermined result, or particular party.
Factual, truthful, unbiased information must be
the overriding consideration. Preparers of
financial statement must not attempt to induce
a predetermined outcome or a particular mode
of behavior (such as to purchase a company's
stock.)
04/11/2023 By Yonas G. 55
Conservatism: Although not a qualitative
characteristic of accounting information,
conservatism is a concept that may be discussed
with reliability.
It is a policy of “playing safe”. Many accounting

measurements do not have a single" correct
answer"; when alternatives exist, a choice must be
made among these alternative assumptions under
conditions of uncertainty.
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• The concept of conservatism holds that when
reasonable support exist for alternative accounting
methods and for different measurement techniques,
accountants should select the method or technique
with the least favorable effect on net income and
financial position in the current accounting period.
• Business transactions should be recorded in such a

manner that profits are not overstated.
Conservatism is applied as follows:
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• If there is a choice between two acceptable asset
values, the lower figure is selected. Accordingly,
inventories are values at the lower of cost or net
relatable value.
• Contingent loss is recognized if the loss is probable
and the amount can be reasonably estimated.
• Contingent gain is not recognized but disclosed only.
Conservatism is synonymous with prudence. Prudence

is the desire to exercise care and caution
when dealing with uncertainties in the measurement
process.
Secondary Qualities: Comparability and
consistency
This involve qualitative characteristic that used
different acceptable methods by an enterprise in
different year, or by different companies in a given
year, would make comparison of financial results
difficult.
Consequently, in order to enhance the usefulness of
accounting reports, the qualities of comparability
and consistency are components of the conceptual
framework. They are considered to be secondary in
our hierarchy to the qualities of relevance and
reliability.
04/11/2023 By Yonas G. 59
Information about an enterprise is more useful if it
can be compared with similar information about
other enterprises and with similar information about
the same enterprise at other points in time.
Comparability
Information that has been measured and reported in
similar manner for different enterprises in a given
year, or for the same enterprise in different years is
considered comparable. Thus, comparability is a
characteristic of relationship between two pieces of
information rather than of a particular piece of
information itself.
Comparability enables users to identify the real
similarities and differences in economic phenomena
because these similarities and differences have not
been obtained by the use of non comparable
financial statements. Comparability of the financial
statements of a business enterprise from one
accounting period to the next is essential if
favorable and unfavorable trends in the enterprise
are to be identified. If the financial statements for
the current accounting period show larger earnings
than for the preceding period, the user assumes that
operations have been more profitable.

04/11/2023 By Yonas G. 61
However, if a material change in the accounting
principle has occurred, the reported increase in
earnings could have been caused solely by the
accounting change, rather than any improvement in
the underlying business activity. Therefore, these
statements are not comparable.
Comparability of financial statements of different
enterprises with in the same industry enables users
make valid evaluation of alternatives in resource
allocation decisions. For example, if NIB
international Bank capitalizes its marketing costs, but
Abyssinia Bank expenses these costs, it is more
difficult to compare and evaluate the financial results
of these two companies.
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NIB international Bank may report a higher net income
because it capitalized its marketing costs. Therefore, a
valid evaluation can be made only if comparable
information is available.
Consistency
When an entity applies the same accounting
treatments to similar events, from period to period, the
entity is considered to be consistent in its use of
accounting standards. The consistent application of
accounting principles for a business enterprise is
needed in order that the financial statements of
successive periods will be comparable.
By Teshome Kankuse
04/11/2023 63
.
The presumption that an entity should not change
an accounting principle may be overcome only if
the enterprise justifies the use of an alternative
acceptable accounting principle on the basis that
it is preferable.
The nature of and justification for a change in
accounting principle and its effect on income
should be disclosed... The justification for the
change should explain why the newly adopted
accounting principle is preferable.
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Constraints
In providing information with the qualitative
characteristics that makes it useful, two overriding
constraints must be considered:
(1) the const benefit relationship and
(2) materiality.
Cost Benefit Relationship
Users assume that information is a cost free
commodity. But preparers and providers of accounting
information know that it is not. Therefore, the cost-
benefit relationship must be considered. The cost of
providing the information must be weighted against the
benefits that can be derived from using the information
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• Obviously the benefit should exceed the costs.
In order to justify requiring a particular
measurement or disclosure, the benefits
perceived to be derived from it must exceed
the costs perceived to be associated with it
( the benefit derived from the information
should exceed the cost incurred in obtaining
the information).
04/11/2023 By Yonas G. 66
cost-benefit analysis involves several kinds, including
 costs of collecting and processing,
 costs of disseminating,
 costs of auditing,
 costs of potential litigation,
 costs of disclosure to competitors, and
 costs of analysis and presentation.

Benefits accrue to preparers
o in terms of greater management control and access to capital
and to users
o in terms of allocation of resources, tax assessment, and rate
regulation.
But benefits are generally more difficult to quantify than are
costs.
2. Materiality
The constraint of materiality relate to an items impact on the
firm's overall financial operations.
An item is material if its inclusion or omission would influence
or change the judgment of a
reasonable person. It is immaterial and, therefore, irrelevant if it
would have no impact on a
decision
04/11/2023 maker. By Yonas G. 68
In short, it must make a difference or it need not be
disclosed. The point involved here is one of relative
size and importance.
 If the amount involved is significant when
compared with the other revenue and expenses,
assets and liabilities, or net income of the entity,
sound and acceptable standards should be followed.
 If the amount is so small that is quite unimportant
when compared with other items, application of a
particular standard may be considered of less
importance.
Company A Company B
Sales $ 10,000,000 $ 100,000
Costs and expense 9,000,000 90,000
Operation Income $ 1,000,000 $ 10,000
Unusual gain $ 20,000 $ 5,000

During the period in question, the revenues and
expenses and, therefore, the net incomes of
company A and company B have been proportional.
Each has had an unusual gain. In looking at the
abbreviated income figures for company A, it does
not appear significant whether the amount of the
unusual gain is set out separately or merged with the
regular operating income.
It is only 2% of the net income and, if merged,
would not seriously distort the net income figure.
Company B has had an unusual gain of only 5,000,
but it is relatively much more significant than the
larger gain realize by A.
• For company B, an item of 5,000 amounts to
50% of its net income, obviously, the inclusion of
such an item in ordinary operating income would
affect the amount of that income materially. Thus
we see the importance of the relative size of an
item in determining its materiality
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1.5 Elements of Financial Statements
An important aspect of developing any theoretical structure is
the establishment and definition of the basic elements or
items to be included in the structure.
At present, accounting uses many terms that have peculiar and
specific meanings. These terms constitute the language of
business or the jargon of accounting.
SFAC No. 6, which replaced SFAC NO.3, defines the ten
interrelated elements that are most directly related to
measuring the performance and financial status of an
enterprise as follows:
Assets:
 Probable future economic benefits obtained or controlled by
a particular entity as a result of past transactions or events
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 To qualify as assets, there are three characteristics to
be fulfilled
 Have future economic benefits (be capable of
producing profits).
 Be under managements control ( can be freely
deployed or disposed of)
 Result from past transaction ( the transaction or
event giving rise to the entity’s right to, or control
of, the benefit has already occurred)

Liabilities
Liabilities are Probable future sacrifices of economic
benefits arising from present obligations of a
particular entity to transfer assets or provide
services to other entities in the future as a result of
past transactions or events.
To qualify as liabilities, obligations must:
Require transfer of assets having future economic
benefit.
Specify to whom the asset must be transferred (the
terms, parties, and conditions under which asset
transfers will take place must be specified).
Result from past transactions.
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Equity is Residual interest in the assets of an entity that
remains after deducting its liabilities. While equity in
total is a residual, it includes specific categories of item,
for example, type of share capital, contributed surplus
and retained earnings.
Investment by owners
Increases in net assets of a particular enterprise resulting
from transfers to it from other entities
of something of value to obtain or increase ownership
interests (or equity) in it.
Assets are most commonly received as investment by
owners, but that which is received may also
include services or satisfaction or conversion of liabilities
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the enterprise. By Yonas G. 76
Distribution to owners
Decreases in net assets of a particular enterprise resulting
from transferring assets, rendering services, or incurring
liabilities by the enterprise to owners.
. They are characterized as:
1. Cash dividend payments or declarations
2. Transfer of assets to owners
3. Liquidating distribution (asset sale proceeds)
4. Conversion of equity ownership to liabilities.

Comprehensive Income
Change in equity (net assets) of an entity during a
period from transactions and other events and
circumstances from non owner sources. It includes
all changes in equity during a period except those
resulting from investments by owners and
distribution to owners
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Revenues
Inflows or other enhancements of assets of an
entity or settlement of its liabilities (or a
combination of both) during a period from
delivering or producing goods, rendering
services, or other activities that constitute the
entity’s ongoing major or central operations.
 delivering or producing goods,
rendering services, or
other activities that constitute the entity on going
major or central operations
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The two essential characteristics of a revenue
transaction are
a. It arises from the company's primary earning
activity (main stream business lines) and not from
incidental or investment transactions (assuming
that the entity is a non investment company).
b. It is recurring
By Teshome Kankuse
04/11/2023 80
.
Expenses
Outflows or other using up of assets or
incurrence of liabilities (or a combination of
both) during a period from delivering or
producing goods, rendering services, or
carrying out other activities that constitute the
entity’s ongoing major or central operations.
delivering or producing goods,
rendering services, or
carrying out other activities that constitute the
entity's on going major or central operations.
04/11/2023 By Yonas G. 81
The essential characteristic of an expense is that it
must be incurred in conjunction with the company's
revenue-generating process. Expenditures that do
not qualify as expenses must be treated as assets
(future economic benefit to be derived), as losses
(no economic benefit), or as distribution to owners.
Gains
Increases in equity (net assets) from peripheral or
incidental transactions of an entity and from all
other transactions and other events and
circumstances affecting the entity during a period
except those that result from revenues or
investments by owners.
04/11/2023 By Yonas G. 82
Losses
Decreases in equity (net assets) from peripheral or
incidental transactions of an entity and from all
other transactions and other events and
circumstances affecting the entity during a period
except those that result from expenses or
distributions to owners.
1.6 Generally Accepted Accounting Principles
Generally Accepted Accounting Principles are broad
guidelines, conventions, rules, and
• procedures of accounting. GAAP is also used by
CPAs in their audit reports to indicate whether the
 Business enterprise being audited has prepared its
financial statements in acceptable manner, so that
they may be compared with
 Prior year’s statements and
 To some extent with the statements of other
enterprises.
The most authoritative sources of GAAP in recent
years have been the statement issued by
 Securities and Exchange Commission (S E C)
 American Institute of Certified Public Accountants
(A I C P A)
 Financial Accounting Standards Board (FASB)
04/11/2023 By Yonas G. 84
In the following sections we will discuss a number
of fundamental accounting principles and concepts
which are considered as GAAP.
a. BUSINESS ENTITY PRINCIPLE
Because economic activity is carried on by various
legal and economic entities, accounting results are
summarized in terms of these entities. Accounting
deals with specific, identifiable business entities,
each considered an accounting unit separate and
apart from its owners and other entities.

Under the separate entity assumption all accounting records
and reports are developed from the viewpoint of a single entity,
regardless of the form of the organization. The assumption is
that an individual’s transactions are distinguishable from those
of the business he or she might own. For example the personal
residence of a business owner is not considered as an asset of
the business, even though the residence and the business are
owned by the same person.
The activities of an enterprise should be kept separate and

distinct from any other business unit so that it would be
possible to know how the business is doing. For example, if the
activities and elements of East African Bottling Company
could not be distinguished from those of MOHA Soft Drinks
Factory, then it would be impossible to know which company
outperformed
04/11/2023 the other. By Yonas G. 86
b. CONTINUIY OR GOING - CONCERN
PRINCIPLE
Under this principle, the business entity in question
is expected not to liquidate, but to continue
operations for the foreseeable future. That is, it will
stay in the business for a period of time sufficient to
carry out contemplated operations, contracts and
commitments. Generally accountants assume that
business entity will continue to exist indefinitely.

Present value is determined by discounting all
future payments on a promissory note at the current
fair rate of interest. This requirement for discounting
receivables and payables to their present value
applies principally to notes; it is not applicable to
receivables and payables arising from transactions
with customers or suppliers that are due within one
year or less

e. MATCHING PRINCIPLE
• The matching principle means that after the revenue
(accomplishment) for an accounting period has been
determined, the cost (effort) associated with the revenue
must be deducted from the revenue to measure net
income. The term matching refers to the close
relationship that exists between certain costs and the
revenue recognized as a result of incurring those costs.
• The matching of business enterprises expenses (or

expired costs) with its revenue for an accounting period
is the primary activity in the measurement of the results
of an enterprise’s operations for that period.
04/11/2023 By Yonas G. 89
All expenses incurred during the relevant period may
not be related to that period alone. Expenses relating
to the previous period of the subsequent period
might have been incurred during the period under
reference. Likewise, the entire amount of revenue
received may not be of the current period.
• In the matching concept, only those expenses
pertaining to the current accounting period must be
matched against the revenue relating to the same
period. For example, expenditures for advertising
attract customers and generate sales.
04/11/2023 By Yonas G. 90
• The outlay for advertising is one of the
expenses to be deducted from the revenue of
the accounting period. Similarly, the
recognition of doubtful accounts expense
illustrates the importance of the accounting
period in the matching of expenses and
revenue. Doubtful accounts expense is caused
by selling goods or services on credit to
customers who fail to pay their bills.
04/11/2023 By Yonas G. 91
• MONETARY PRINCIPLE
• The monetary principle states that money is the
common denominator or a useful standard
measuring unit for reporting the effects of business
transactions. It is used as a common denominator
through out the accounting process.
• As per this principle, only transactions that can be
measured in terms of money are recorded in the
books of account. The basic purpose of using money
is to maintain an element of uniformity among
diversity. An event or transaction that cannot be
expressed in terms of money cannot be recorded in
the books of accounts.
• DISCLOSURE PRINCIPLE
• The disclosure principle requires that financial statements
be complete in the sense of including all information
necessary to users of the statements. If the omission of
certain information would cause the financial statements
to be misleading, disclosure of such information is
essential.
• All the accounting statements must be prepared honestly
and must contain all relevant and material information.
But it does not mean that business sectors and similar
matters must be made public. It only implies that the
public financial statements must fully disclose the true
and fair view of the state of affairs of the concern for a
particular period or on a particular date.
04/11/2023 By Yonas G. 93
• The concept of disclosure applies not only
transactions and events that have occurred during
the accounting period covered by the financial
statements, but also to material subsequent events
that occur after the balance sheet date but before the
financial statements are released. Such events are
disclosed in the note to the financial statements.
04/11/2023 By Yonas G. 94
1.7. CASH FLOWS AND INCOME MEASUREMENT
In the preceding discussion, we have seen that accountants
assume a business enterprise has a continuous existence. Its
earnings and related operating activities are continuous.
However, financial reports are produced for a specific period
of time.
Cash inflows and outflows are closely related to revenues and

expenses of an enterprise. So in measuring earnings, how
should revenues and expenses should be reported? Should
they be reported on the basis of cash flows and outflows or on
the basis of transactions that have present and future cash
consequences? This section clearly explains and contrasts the
cash basis of accounting with the accrual basis of accounting.
04/11/2023 95
By Teshome Kankuse
1.4.1 ACCRUAL BASIS OF ACCOUNTING
• Accrual basis of accounting is a system of accounting
that requires an event that alters the economic status of
the firm as represented in its financial statements be
recorded (recognized) in the period in which the event
occurs rather than in the period cash changes hands.
• When this system is used, revenues are reported in the
income statement when they are earned and expenses are
reported in the income statement when they are incurred,
without regard to the timing of cash receipts or payments.
When we say revenues are earned, it means the service is
rendered or the items are sold, and when we say expenses
are incurred, it means that employees are engaged or
services are used or items are consumed.
04/11/2023 By Yonas G. 96
• Under the accrual basis of accounting, the
accounting records are adjusted periodically to
ensure that all assets and liabilities (and thus
revenue and expenses) are correctly stated. That is,
the accrual basis of accounting is inline with the
matching principles therefore net income under this
method is determined as realized revenue minus
incurred expenses.
04/11/2023 By Yonas G. 97
1.4.2. CASH BASIS OF ACCOUNTING
The cash basis of an accounting system is an
accounting system based on the timing of cash
payments and receipts. Under this system, revenue
is recorded only when cash is received and expenses
are recorded only when cash is paid. The
determination of income thus rests on the collection
of revenues and the payment of expenses, rather
than on the realization of revenue and the incurring
of expenses. Use of the cash basis of accounting is
not compatible with the matching principle.
04/11/2023 98
By Teshome Kankuse
• Consequently, financial statements prepared under
the cash basis of accounting do not present the
financial position or operating results of an
enterprise in conformity with GAAP.
• However, in any business enterprise in which the

purchase, production, or sale of merchandise is a
significant factor, these transactions must be
reported on an accrual basis. For example, when
merchandise is sold on credit, the revenue must be
recognized immediately
04/11/2023 By Yonas G. 99
The cost of goods sold must reflect purchases on
credit and inventories on hand, whether paid for or
not. Thus, for a merchandising enterprise the
revenue from sales, the cost of goods sold, and the
gross profit on sales will be the same under the
accrual basis of accounting as under the modifies
cash basis of accounting.
The following illustration shows the impact of the

different bases of accounting on financial reporting
04/11/2023 By Yonas G. 100

• Assume that a contractor begins business in period 1
and agrees to construct a building to an insurance
company for birr 100,000. During period 1, the
contractor incurred costs of birr 50,000 on credit in
constructing the building and delivered the
completed building to the client in the same year. In
period 2, the contractor collected the contract price
of birr 100,000 from the insurance company. In
period 3, the contractor paid his creditors birr
50,000 due.
• On the basis of the above data, the contractor's net
incomes for each period under accrual and cash
basis of accounting are as follows:
04/11/2023 By Yonas G. 101
Periods
Cash basis of 1 2 3 Total
accounting
Cash receipts 0 100,000 0 100,000
Cash disbursements 0 0 50,000 50,000
Net income 0 100,000 (50,000 50,000

)
Accrual basis of
accounting
Revenues 100,000 - - 100,000
Expense 50,000 - - 50,000
Net Income
04/11/2023 50,000 0
By YBy Teshome Kankuse 0 50,000 102
• From the above, you can observe that accrual accounting
and cash basis of accounting differ in the timing of net
income. However, accrual basis of accounting is superior to
cash basis of accounting from the view point of the
definitions of financial statement elements
Additional illustration is given below to show you how to
restate from one basis of accounting to another basis of
accounting. In this case, we are going to convert a cash
basis to accrual basis of accounting.
• During year 6, Rahel collected from her clients $200,000
and paid $90,000 for operating expenses, resulting in a
cash basis net income of $110,000 (200,000 - 90,000).
Rahel's fees receivable, accrued liabilities, and short term
prepayments on January 1 and on December 31, year 6,
were as follows:
04/11/2023 By Yonas G. 103
Jan, 1, year 6 Dec, 3 year 6
Fees $ 26,000 50,000

receivable
Accrued 10,000 6,000

liabilities
Short-term 8,000 3,000

prepayments

• Note that the revenue from fees under the cash basis
does not include the fees receivable Dec. 31, which
were realized in year 5. Therefore, this amount is
added to the cash collected in the restatement of
revenue from fees to the accrual basis of accounting.
Because fees receivable on January 1 were realized
in year 5 and collected in year 6, this amount is
subtracted from cash collections in the restatement
of revenue from fees to accrual basis of accounting.

It is because the
 accrued liabilities on Dec 31, year 6 represent expenses
incurred in year 6 that will be paid in year 7 and
 the amount of short term prepayment on January 1, year 6
represents services paid for in year 5 that were consumed in
year 6.
The amount of accrued liabilities on
 January 1, year 6, represents expenses of year 5 paid for in
year 6, and
 the amount of short-term prepayments on December 31, year
6, represents cash out lays in year 6 for services that will be
consumed in year 7.
Therefore, both amounts are deducted from the amount of
cash paid to restate the operating expenses for year 6 to the
accrual
04/11/2023
basis of accounting.By Yonas G. 106
Rahel Yohannes, Lawyer
Working paper to restate Income Statement From
Cash Basis to Accrual Basis of Accounting
For Year Ended December 31, Year 6
Income statement Adjustments to restate to Income
under cash basis of statement under
accounting
accrual basis of accounting accrual basis of
accounting
Add Deduct
Revenue from fees received in cash…….. 200,000 26,000
Add: Fees receivable, Dec. 31 224,000

Year 6 …………………………….. 50,000
Less: Fees receivable, Jan.1 Year 6...........
Operating expenses paid in cash……….. 90,000

Add: Accrued liabilities, Dec. 31,
Year 6 …………………………. 6,000
Short-term prepayments Jan 1,
Year 6 ………………………… 8,000 10,000 91,000
Less: Accrued Liabilities, Jan 1 year 6 …. 3,000

Short term prepayments Dec.31,
Year 6 ………………………..
Net income under cash basis of
accounting…………………………… 110,000
Net income under accrual basis of 133,000
Generally Accepted Accounting Principles
• Generally Accepted Accounting Principles are
broad guidelines, conventions, rules, and
procedures of accounting. The term GAAP has
long been used in financial accounting. This term is
also used by CPAs in their audit reports to indicate
whether the business enterprise being audited has
prepared its financial statements in acceptable
manner, so that they may be compared with prior
year’s statements and to some extent with the
statements of other enterprises.

.
• Although a body of generally accepted accounting
principles has long been recognized, no complete
list of such principles exists. The most authoritative
sources of GAAP in recent years have been the
statement issued by the FASB, the opinions issued
by the APB, the Accounting Research Bulletin
issued by the AICPA Committee on Accounting
Procedures, and Financial Reporting Releases issued
by SEC. In the following sections we will discuss a
number of fundamental accounting principles and
concepts which are considered as GAAP
04/11/2023 By Yonas G. 109

• BUSINESS ENTITY PRINCIPLE
• Because economic activity is carried on by various
legal and economic entities, accounting results are
summarized in terms of these entities. Accounting
deals with specific, identifiable business entities,
each considered an accounting unit separate and
apart from its owners and other entities. A
corporation and stockholders are separate entities
for accounting purposes. Also, partnership and sole
proprietorships are treated as separate from their
owners, although this assumption does not hold true
in a legal sense.
04/11/2023 By Yonas G. 110
• Accounting deals with specific, identifiable
business entities, each considered an accounting
unit separate and apart from its owners and other
entities. Under the separate entity assumption all
accounting records and reports are developed from
the viewpoint of a single entity, regardless of the
form of the organization.
• The assumption is that an individual’s transactions
are distinguishable from those of the business he or
she might own.

• For example the personal residence of a business
owner is not considered as an asset of the business,
even though the residence and the business are owned
by the same person.
• The activities of an enterprise should be kept separate
and distinct from any other business unit so that it
would be possible to know how the business is doing.
• For example, if the activities and elements of East

African Bottling Company could not be distinguished
from those of MOHA Soft Drinks Factory, then it
would be impossible to know which company
outperformed the other.
04/11/2023 By Yonas G. 112
b. continuity or going - concern principle
• Under this principle, the business entity in question
is expected not to liquidate, but to continue
operations for the foreseeable future.
• That is, it will stay in the business for a period of
time sufficient to carry out contemplated operations,
contracts and commitments. Generally accountants
assume that business entity will continue to exist
indefinitely.
04/11/2023 By Yonas G. 113

• Revenue realization principle
• The revenue realization principle deals with the
point of time at which the revenue is considered as
earned. It asserts that revenue is realized when
goods are transferred or services are rendered to a
customer.
• Revenue is not realized when an order is received
from a customer. The realization of revenue takes
place only on the execution of that order. Likewise,
an advance collection from customers is not treated
as revenue earned.

c. Valuation principle
• Realization, which is a key principle in income
measurement, forms the basis for distinguishing methods of
valuation used in the reporting of assets and liabilities in
the balance sheet
• A general class of assets called monetary assets usually is
carried in the balance sheet at amounts closely
approximating current value. Examples of monetary assets
are cash, certificates of deposit, short-term investments,
and receivables.
• All these assets represent current purchasing power.
Promissory notes receivables and notes payables that are
non-interest bearing, or that have an unrealistically low rate
of interest, are not to be valued at face amount, but at their
present
04/11/2023
value. By Yonas G. 115
• Present value is determined by discounting all future
payments on a promissory note at the current fair rate of
interest. This requirement for discounting receivables and
payables to their present value applies principally to notes;
it is not applicable to receivables and payables arising from
transactions with customers or suppliers that are due within
one year or less
d. Matching principle
• The matching principle means that after the revenue
(accomplishment) for an accounting period has been
determined, the cost (effort) associated with the revenue
must be deducted from the revenue to measure net income.
The term matching refers to the close relationship that
exists between certain costs and the revenue recognized as
a04/11/2023
result of incurring those costs.
By Teshome
.
Kankuse 116
• The matching of business enterprises expenses (or
expired costs) with its revenue for an accounting
period is the primary activity in the measurement
of the results of an enterprise’s operations for that
period.
• All expenses incurred during the relevant period
may not be related to that period alone. Expenses
relating to the previous period of the subsequent
period might have been incurred during the period
under reference. Likewise, the entire amount of
revenue received may not be of the current period.
04/11/2023 By Yonas G. 117

• Monetary principle
• The monetary principle states that money is
the common denominator or a useful standard
measuring unit for reporting the effects of
business transactions.
• It is used as a common denominator through
out the accounting process. As per this
principle, only transactions that can be
measured in terms of money are recorded in
the books of account.
04/11/2023 By Yonas G. 118

The basic purpose of using money is to maintain
an element of uniformity among diversity. An event
or transaction that cannot be expressed in terms of
money cannot be recorded in the books of accounts.
The basic purpose of using money is to maintain
an element of uniformity among diversity.

DISCLOSURE PRINCIPLE
The disclosure principle requires that financial
statements be complete in the sense of including all
information necessary to users of the statements. If
the omission of certain information would cause the
financial statements to be misleading, disclosure of
such information is essential. All the accounting
statements must be prepared honestly and must
contain all relevant and material information. An
event or transaction that cannot be expressed in
terms of money cannot be recorded in the books of
accounts.
04/11/2023 By Yonas G. 120
• The concept of disclosure applies not only
transactions and events that have occurred
during the accounting period covered by the
financial statements, but also to material
subsequent events that occur after the balance
sheet date but before the financial statements
are released. Such events are disclosed in the
note to the financial statements.
04/11/2023 By Yonas G. 121

1.7. CASH FLOWS AND INCOME MEASUREMENT
In the preceding discussion, we have seen that
accountants assume a business enterprise has a
continuous existence. Its earnings and related
operating activities are continuous. However,
financial reports are produced for a specific period
of time.

Cash inflows and outflows are closely related to
revenues and expenses of an enterprise. It is used to
measure
How should revenues and expenses should be
reported?
Should they be reported on the basis of cash flows
and outflows or on the basis of transactions that
have present and future cash consequences?
This section clearly explains and contrasts the cash
basis of accounting with the accrual basis of
accounting.
04/11/2023 By Yonas G. 123
1.7.1 ACCRUAL BASIS OF ACCOUNTING
Accrual basis of accounting is a system of
accounting that requires an event that alters the
economic status of the firm as represented in its
financial statements be recorded (recognized) in the
period in which the event occurs rather than in the
period cash changes hands.
• When this system is used, revenues are reported in
the income statement when they are earned and
expenses are reported in the income statement when
they are incurred, without regard to the timing of
cash receipts or payments.
04/11/2023 By Yonas G. 124
• When we say revenues are earned, it means the
service is rendered or the items are sold, and when
we say expenses are incurred, it means that
employees are engaged or services are used or items
are consumed.
Under the accrual basis of accounting, the
accounting records are adjusted periodically to
ensure that all assets and liabilities (and thus
revenue and expenses) are correctly stated.
That is, the accrual basis of accounting is inline with
the matching principles therefore net income under
this method is determined as realized revenue minus
incurred expenses.
04/11/2023 By Yonas G. 125
1.4.2. CASH BASIS OF ACCOUNTING
The cash basis of an accounting system is an
accounting system based on the timing of cash
payments and receipts. Under this system, revenue
is recorded only when cash is received and expenses
are recorded only when cash is paid. The
determination of income thus rests on the collection
of revenues and the payment of expenses, rather
than on the realization of revenue and the incurring
of expenses.

Use of the cash basis of accounting is not compatible
with the matching principle. Consequently,
financial statements prepared under the cash basis
of accounting do not present the financial position
or operating results of an enterprise in conformity
with GAAP.
• However, in any business enterprise in which the
purchase, production, or sale of merchandise is a
significant factor, these transactions must be
reported on an accrual basis. For example, when
merchandise is sold on credit, the revenue must be
recognized immediately.
04/11/2023 By Yonas G. 127
• The cost of goods sold must reflect purchases on
credit and inventories on hand, whether paid for or
not. Thus, for a merchandising enterprise the
revenue from sales, the cost of goods sold, and the
gross profit on sales will be the same under the
accrual basis of accounting as under the modifies
cash basis of accounting.
04/11/2023 By Yonas G. 128

• The following illustration shows the impact of the
different bases of accounting on financial reporting
Assume that a contractor begins business in period 1
and agrees to construct a building to an insurance
company for birr 100,000. During period 1, the
contractor incurred costs of birr 50,000 on credit in
constructing the building and delivered the
completed building to the client in the same year. In
period 2, the contractor collected the contract price
of birr 100,000 from the insurance company. In
period 3, the contractor paid his creditors birr
50,000 due. On the basis of the above data, the
contractor's net incomes for each period under
accrual and cash basis of accounting are as follows
04/11/2023 By Yonas G. 129
:
Period
Cash basis of 1 2 3 Total

accounting
Cash receipts 0 100,000 0 100,000
Cash disbursements 0 0 50,000 50,000
Net income 0 100,000 (50,000 50,000

)
Accrual basis of
accounting
Revenues 100,000 - - 100,000
Expense 50,000 - - 50,000
Net Income 50,000 0 0 50,000

From the above, you can observe that accrual
accounting and cash basis of accounting differ in
the timing of net income. However, accrual basis
of accounting is superior to cash basis of
accounting from the view point of the definitions
of financial statement elements.
Additional illustration is given below to show you
how to restate from one basis of accounting to
another basis of accounting. In this case, we are
going to convert a cash basis to accrual basis of
accounting.
04/11/2023 By Yonas G. 131

During year 6, Rahel collected from her clients
$200,000 and paid $90,000 for operating expenses,
resulting in a cash basis net income of $110,000
(200,000 - 90,000). Rahel's fees receivable, accrued
liabilities, and short term prepayments on January 1
and on December 31, year 6, were as follows:
Jan,1,year 6 Dec, 3 year 6
Fees receivable $ 26,000 50,000

Accrued 10,000 6,000
liabilities
Short-term 8,000 3,000
prepayments
04/11/2023 By Yonas G. 133
Note that the revenue from fees under the cash basis
does not include the fees receivable Dec. 31, which
were realized in year 5. Therefore, this amount is
added to the cash collected in the restatement of
revenue from fees to the accrual basis of accounting.
Because fees receivable on January 1 were realized
in year 5 and collected in year 6, this amount is
subtracted from cash collections in the restatement
of revenue from fees to accrual basis of accounting.
It is because the

Accrued liabilities on Dec 31, year 6 represent expenses
incurred in year 6 that will be paid in year 7 and the
amount of short term prepayment on January 1, year 6
represents services paid for in year 5 that were
consumed in year 6.
The amount of accrued liabilities on
 January 1, year 6, represents expenses of year 5 paid for
in year 6, and
 the amount of short-term prepayments on December 31,
year 6, represents cash out lays in year 6 for services
that will be consumed in year 7.
• Therefore, both amounts are deducted from the amount
of cash paid to restate the operating expenses for year 6
to the accrual basis of accounting.
04/11/2023 By Yonas G. 135
• End of chapter one
04/11/2023 By Yonas G. 136

The PIP will be submitted to the Council of
Ministers for reviews, revision, and approval.
The PIP will then be sent back to MOFED for
the necessary changes.
The revised PIP would then be forwarded to

the Office of the Prime Minister, which in turn
will present it to the parliament for reviews,
revision, and approval. The approved PIP will
then is circulated to public bodies and frame
the upcoming year’s capital budget.
04/11/2023 137
Stage No 3: Annual Fiscal Plan
The third stage of planning is the preparation of
the Annual Fiscal Plan. As defined in the financial
regulations, the fiscal plan is principally an exercise
in estimating the upcoming fiscal year resources
and expenditures.
The financial regulation does not mention the role

of the fiscal plan in setting the overall ceiling for
expenditures and setting the split between federal
expenditures and regional subsidies.
04/11/2023 138
• Budgeting involves different tasks on the
expenditures and revenues sides of
government finance. On the side of
expenditure, it deals with the determination
of the total deals with the determination of
the total size of the budget (i.e total amount
of money for the year), size of outlays on
different functions, and the magnitude of
outlays on various activities; on the revenue
side, it involves the determination of the size
of the overall revenue and foreign aid.
04/11/2023 By Yonas G. 139

In a federal system, constitutionally recognized
levels of government can formulate their own
economic, social and development strategies
and determine their expenditure preferences.
This is because they are constitutionally
recognized jurisdictions having the respective
autonomy to impose tax and to spend on
expenditure needs.
04/11/2023 By Yonas G. 140

It should be noted that both the autonomy
and accountability principles are applicable to
both levels of governments. This financial
autonomy of both expenditure allocations and
the budgetary processes in Ethiopia broadly
follow government policies.
04/11/2023 By Yonas G. 141

For instance, the budget proclamations show
that the greater share of the federal budget is
being devoted to roads, agriculture, capacity
building and grant subsidies to regions.
According to the recently introduced

'Sustainable Development and poverty
Reduction Programme' (SDPRP), the budget
allocation is expected to intertwine with the
political and economic processes of the
strategies indicated in the document.
04/11/2023 142
Accordingly, it should focus on agriculture and
food security projects, capacity building in the
public sector, decentralization towards wereda
and municipal governance, education, health
and roads. In this regard, regional autonomy
will be limited.
04/11/2023 By Yonas G. 143

However, their discretion is broader in the process
of allocating recurrent and capital budgets and in
prioritizing other expenditures.
But, regions may show huge variations in their

performance capacities, and in the expenditure
evaluation and control mechanisms.
04/11/2023 144
Furthermore, budgeting also address the issue
of the budget deficit (i.e. the excess of outlays
over domestic revenues), and its financing.
Budgeting is not solely a matter of finance in

the narrow sense. Rather it is an important
part of government’s general economic policy.
04/11/2023 By Yonas G. 145

Budget is not only a description of fiscal
policies and financial plans, rather it is a strong
instrument in engineering and dynamiting the
economy and its main objectives are to devise
tangible directives and implement the long
term, medium term, and annual
administrative and development programs”.
04/11/2023 By Yonas G. 146

Budget structures are the formats that organize
budget data. Budget data could be classified in
different ways and for different purposes.
In the early days, for instance, budget classification

basically focused on providing a better
understanding of the intentions and purposes of
government for which funds were planned and to
be spent.
04/11/2023 147
Later on, the budget structures started to be
influenced largely by the issue of
accountability. That is in addition to providing
information on what the government
proposed to do, the budget structures indicate
the full responsibility of the spending agency.
04/11/2023 By Yonas G. 148

To this end the budget head or classification of
the budget are mostly mapped to each
spending agency. This should not, however,
imply unnecessarily extended and detailed
structure (or mapping). The first classification
of the budget is between revenue and
expenditure.
04/11/2023 By Yonas G. 149

i. Revenue Budget
Revenue Budget represents the annual
forecast of revenues to be raised by
government through taxation and other
discretionary measures.
The amount of revenues raised in this way

differ from country to country both in
magnitude and structure, mainly due to the
level of economic development and the type
of the economy.
04/11/2023 By Yonas G. 150
In Ethiopia, the revenue budget is usually
structured into three major headings such as;
a. ordinary revenue,
b. external assistance, and
c. capital revenue.
Hence, the funds expected from these three

sources are proclaimed as the annual revenue
budget for the country. The revenue budget is
prepared by the Ministry of Finance and Economic
Development (MoFED) for the federal government
and by Finance Bureaus for regional governments.
04/11/2023 151
a. Ordinary revenues include both tax and not
tax revenues. the tax revenues being direct
taxes (personal income tax, rental income tax,
business income tax, agricultural income tax,
tax on dividend and chance wining, land use fee
and lease) and indirect taxes (excise tax on
locally manufactured goods, sales tax o locally
manufactured goods, service sales tax, stamps
and duty); and taxes on foreign trade (customs
duty on imported goods, duty and tax on coffee
export).
04/11/2023 152
b. Non tax revenues include charges and fees;
investment revenue; miscellaneous revenue (e.g.
gins); and pension contribution. The second
major item in revenue budget is external
assistance. It includes: cash grants, these are
grants from multilateral and bilateral donors for
different structural adjustment programs; and
technical assistance in cash and material form.
04/11/2023 153
c. capital revenue. This could be from
domestic (sales of movable properties and
collection of loans), external loan from
multilateral and bilateral creditors mostly for
capital projects, and grants in the form of
counterpart fund.
04/11/2023 By Yonas G. 154

B. Expenditures Budget:
Government expenditures for administration and
developmental activities are handled through the
expenditures budget. These expenditures are
categorized into recurrent and capital
expenditures.
04/11/2023 By Yonas G. 155

Recurrent budget which covers the current
expenditures financed in principle by taxation
( more broadly by domestic revenue from
tax and non tax sources), and
Capital budget which covers the acquisition of

newly produced assets in the economy
financed through external borrowing and
grants.
04/11/2023 By Yonas G. 156

The acceptance to this category of
expenditures is related to the general change
in the perception of deficit. Prior to the 1930s,
budget deficits were considered to be at fault
and indicate bad financial management.,
however, over the years the cardinal rule of
balanced budget was changed in favor of
cyclical budget, and functional finance.
04/11/2023 By Yonas G. 157

This change in the rule of budgeting, in turn,
resulted in several approaches to measuring
and understanding the deficit. Some of the
concepts that were developed include:
04/11/2023 By Yonas G. 158

I. the public debt concept of deficit,
II. the net worth concept of deficit,
III. the overall deficit, and
IV. the concept of domestic deficit.
04/11/2023 By Yonas G. 159

To illustrate these four approaches of
measuring deficit, we can employ a simplified
budget balance given in Table -1 below:
04/11/2023 By Yonas G. 160

Table-1: A Simplified Budget Balance
Revenues Expenditures
A. Tax and Non Tax C. Recurrent Expenditure

Revenues
B. Net Borrowing D. Capital Expenditure
A+ B C+D
04/11/2023 By Yonas G. 161

The public debt concept of deficit defines budget
deficit as the difference between revenue (A) and
recurrent expenditures (C) and capital
expenditures (D)
This measure A-(C+D) is equal to net borrowing

(B), and the budget is considered to be balanced
if net borrowing remains unchanged from
previous years or is equal to zero.
04/11/2023 162
This approach illustrates, the understanding
prior to 1930s, which emphasized balanced
budget as a prudent fiscal policy.
04/11/2023 By Yonas G. 163

The emergence of active fiscal policy: The emergence
of active fiscal policy (i.e. government could borrow
as long as that liability is matched by an increase in
assets) right after the depression led to the
development of the net worth concept of deficit.
Referring to the Table above, the net worth is defined

as the difference between recurrent expenditures
and revenues (C-A), which is equal to the excess of
net borrowing over capital expenditures (B-D) this
measure of deficit requires the division of
expenditures into current and capital budgets, with
the latter being financed by borrowing.
04/11/2023 164
overall deficit The concept of the overall deficit has
several connotations and methods construction.
The common practice is to put revenues,
expenditures, and borrowing as distinct groups as
in Table 2 below.
Each budget category may then be related

economic activity being computed as a ratio of
GDP, which then becomes a first approximation
and an important single measure of the impact of
government fiscal operations.
04/11/2023 165
Table- 2: The Overall Budget Deficit
The Overall Budget Deficit
A. Revenues
Tax revenues
Non Tax revenues
Grants
B. Expenditures
Recurrent Expenditures
Capital Expenditures
C. Overall Deficit (A-B)
D. Financing
1. Foreign Debt
2. Domestic Debt
Non Bank Borrowing
Commercial Banks
Central Bank
166
The domestic balance concept is a family of
the overall budget deficit. The basic argument
being, in countries that had large revenues,
expanded incomes from government
expenditures placed strains on the domestic
economy and spurred inflationary pressures.
04/11/2023 By Yonas G. 167

In such cases, budget surpluses will have an
expansionary effect. Under such
circumstances the overall budget deficit or
surplus measure would be misleading to guide
government policy.
04/11/2023 By Yonas G. 168

In fulfilling the requirements of oil producing
countries and others in similar circumstances,
the technique of splitting the domestic balance is
the component of the overall balance from which
external budget transactions have been
excluded.
04/11/2023 By Yonas G. 169

In practice three criteria have been in use to
define budget into capital and recurrent. These
are
 sources of finance,
 object of expenditure, and
 nature of activity.
Capital budgets were originally defined by

western governments by the source of finance,
i.e., capital expenditures are financed from loan
not current revenue.
04/11/2023 By Yonas G. 170
The object of expenditure refers to the
particular activities to be performed with that
budget like, formation of fixed assets, study
and design, salaries of civil servants, etc.
The nature of activity, refers to whether the

activity is short term (i.e. project) or on going
(that may not terminate in a specific period),
and objective specific.
04/11/2023 By Yonas G. 171

In Ethiopia the definition of recurrent and capital
budgets follow some combination of these
criteria. That is:
1. Recurrent budget is to be covered by domestic
revenue from tax and non-tax sources. But the
economy could borrow to meet its capital
budget.
2. The financial proclamation 57/1996 and financial
regulations 17/1997 defined capital budget
based on the object for expenditure. Accordingly
capital budget equals capital expenditure which
equals fixed assets and consultancy services.
04/11/2023 172
3. Short-term activities that are project in nature
are included in capital budget while those
activities that are recurring and continuous in
nature are put in the recurrent budget. In some
instances activities with a very long life period
have been entertained in the capital budget.
04/11/2023 173
Since fiscal year 1994/95 efforts have been
exerted to identify many such projects that
have been categorized under recurrent budget
(projects in Education, health and Agriculture
sectors).
04/11/2023 By Yonas G. 174

The Expenditure Budget includes the following two
types of Budgets:
a. Recurrent Budget, and
b. Capital Budget.
a. Recurrent Budget:
To common practice, it includes budget
expenditures which involves recurrent in nature
like salaries of civil servants
04/11/2023 175
The recurrent budget is structured by implementing
agencies (public bodies) under four functional
categories of;
 administrative and general services,
 economic services
 social services and
 other expenditures.
All public bodies then fall under one of these

functional categories. The budget hierarchy will
then be down to sub agencies.
04/11/2023 176
b. Capital Budget:
Financial proclamation 57/1996 defined
capital expenditure as “an outlay for the
acquisition for improvements to fixed assets,
and includes expenditures made for
consultancy services.”
Financial regulations 17/1997 further provided

a detailed definition of capital expenditures to
mean:
04/11/2023 By Yonas G. 177

I. The acquisition, reclamation, enhancement as
laying out of land exclusive of roads, buildings or
other structures;
II. The acquisition, construction, preparation
enhancement or replacement of roads, buildings
and other structures;
III. The acquisition, installation or replacement of
movable plant, machinery and apparatus,
vehicles and vessels;
04/11/2023 178
iv. The making of advances, grants or other
financial assistance to any person towards
him/her on the matters mentioned in (a) to
(c) above or in the acquisition of
investments; and
v. The acquisition of share of capital or loan
capital in any body corporate;
vi. Any associated consultancy costs of the
above.
04/11/2023 By Yonas G. 179

Capital budget could thus broadly be described
as an outlay on projects that result in the
acquisition of fixed assets and the provision of
development services (Ministry of planning and
Economic Development, 1993:4).
It should therefore be need that, capital budget as

a wider coverage than simple outlays in fixed
investments, since it includes expenditure on
development services like agricultural research
and transfer payments related to a project.

04/11/2023 180
• The capital budget is presented under three
functional groups viz.,
 economic development,
 social development, and
 general development.
Economic development includes production

activities (agriculture, industry, etc.), economic
infrastructure facilities (mining, energy, road etc.),
commerce, communication, and so on.
04/11/2023 181
Social development includes education,
health, urban. Development, welfare and so
on.
General development include services like

cartography, statistics, public and
administrative buildings, and the like.
04/11/2023 By Yonas G. 182

• End both section
04/11/2023 By Yonas G. 183

Experience of the Ethiopian government
The experience of the Ethiopian government is

presented in the following table. Consolidated
national budget in ETB million
04/11/2023 By Yonas G. 184

2002/03 2003/04 2004/05
Revenue total 15703 17918 20147

Direct tax 3010 3431 3930
Indirect tax 5233 7476 8468
Non-tax revenue 2906 3010 3184
Grants 4554 4002 4565
Expenditure total 20517 20520 24803
Recurrent expenditure 13549 11977 13235
Capital expenditure 6313 8271 11343
Special programs 655 272 224
Budget deficit -4815 -2602 -4655
Source: Adapted from MoFED

04/11/2023 185
• Week end
04/11/2023 By Yonas G. 186

The budget process (Cycle) in Ethiopia
The FDRE Constitution calls for the
governments at all times to promote the
participation of the people in the formulation
of national development policies and
programmes, and to support the initiative of
the people in their development endeavors
(Article 89(6)).
04/11/2023 By Yonas G. 187

• The overall approach of the Constitution is to
provide a meaningful devolution or delegation
of power to the lower levels of administration.
This is to enable the people to participate
directly in the local administration (Article
50(4)).
04/11/2023 By Yonas G. 188

The need for devolution of power also entails
the autonomy to decide on the budgetary
allocation based on local expenditure needs
Which is reversing the strict observance of the
hierarchical budgetary relationship.
04/11/2023 By Yonas G. 189

The FDRE Constitution also requires that the
states shall determine all financial expenditure
necessary to carry out all responsibilities and
functions assigned to them by law (Article 94 (1)).
However, the expenditure performance of states
is, among other things, dependent upon the
ability to draw up and administer their budgets.
04/11/2023 By Yonas G. 190

The independent budgeting process actually began
in most of the states in the 1993/94 fiscal year. To
understand this budgeting process, we have to
remind ourselves how state governments are
organized at least for the purpose of the budgeting
system.
The State Council (legislature), the state

administration and the judiciary are established at
the state level.
04/11/2023 191
The state administration, the highest executive
organ, consists of sector bureaus which are
also organized at the zonal, wereda and keble
level.
The sector bureaus are the major actors in the

states' budgeting and spending activities. The
weredas have a 'wereda council' and a
'wereda administration‟.
04/11/2023 By Yonas G. 192

The budgeting process after 2002/03 fiscal year
involved the coordination of several channels
which ultimately make up the state‟s budget.
This coordination involved a 'bottom-up

information flow before the final amount was
determined at the regional level. The bottom-up
process refers to the process in which the budget
was consolidated at the regional level by taking
into consideration the requests from the wereda
and zone levels.
04/11/2023 193
Dimensions of budgeting process in Ethiopia
The budgeting process in general had two
dimensions such as;
 Identification of priorities and goals and
 Managing funds in order to fulfill these goals.
In the process of identifying priorities and goals, the

major activity was to gather the budget needs of
each administrative office. All the information about
their needs was finally consolidated at the regional
level and is approved by the state council.
04/11/2023 194
Information includes
 A draft request indicating the plan,
 The amount, the activities and
 The budget ceiling.
Information flow began at the wereda level,

where the wereda sectoral offices plan and
send the budget request to the bodies
concerned. This information flow took
directions: horizontal and vertical flows.
04/11/2023 By Yonas G. 195

The vertical information flow had two channels
which is
 The flow from a sector office at lower level to the
office at the higher level and
 A flow of consolidated information from the wereda
council to the zonal administration and
 From the zones (the aggregate of report of several
weredas) to the regional council.
04/11/2023 196
For example, in the education sector
information flow from the wereda education
bureau to the zonal education bureau. Zonal
education bureau then consolidate the
information gathered from all wereda bureaus
accountable to it and finally transfer it to the
regional education bureau.
04/11/2023 By Yonas G. 197

In a similar fashion, the regional education
bureau gather and collect dated information
from all zonal education bureaus. Finally, each
sector bureau at the regional level consolidate
the information gathered, and specified the
implementation of capital and recurrent
budgets.
04/11/2023 By Yonas G. 198

The horizontal information flow existed at three
levels such as the wereda, the zonal and the local
levels.
A horizontal information flow existed at the wereda

level when all sector offices at woreda level
prepare their plans and the budget request, and
send them to the wereda council.
04/11/2023 199
This flow of Information was designed to be
facilitated through a wereda development
committee (within the council) mandated with
the power to review, consolidate and adjust
the plans, and to submit the budget request,
together with its own proposal, to the wereda
council for approval.
04/11/2023 By Yonas G. 200

However, horizontal information flow was not as
effective as planned for the reason that the weredas
had no financial autonomy to decide, and because
of the shortage of skilled manpower and Even the
planning office was not available in many weredas.
Further, the wereda council did not have the

minimum amount of manpower to prepare its own
budget request and not cabale to review the
reports of the sector offices and requests of the
sector offices to the zonal administration.
04/11/2023 201
The final step was followed by the regional planning
and economic development bureau to aggregate
the entire budget request submitted by all zonal
sector offices and other government agencies. Its
duty was to evaluate the information in light of the
zonal and regional economic development goals.
04/11/2023 202
The information gathered from sectoral offices and
the budget request from the wereda council
created the zonal budget divided into recurrent.
and capital budgets. Here the aggregates of the
recurrent and capital budget requests made up
the zonal developmental plan.
04/11/2023 203
The recurrent budget was then passed to the
regional finance bureau, whereas the capital budget
was sent to the regional planning bureau.
The final regional budget was consolidated by two

separate bureaus the regional finance bureau
consolidate the regional recurrent budgets, and on
and the planning and economic development
bureau consolidate the regional capital budgets.
04/11/2023 204
Common features of the budgeting process in the
regions
There were some common features of the
budgeting process in the regions.
 First, the amounts requested for a particular year
were measured in light of the budget performance
of the previous year.
If there were under spending, a budget amount has
chance of being approved, unless there were
convincing reasons for the under spending and the
strategies for a better performance in the new
budget year.
04/11/2023 205
 Second, priority was given to recurrent
expenditures (salaries, supplies, administrative
costs) rather than to capital expenditure. Most of
the recurrent costs were permanent costs. It was
also easy to verity, i.e., the spending in the
previous year helped to determine the amount
requested for the next year.
04/11/2023 206
Normally, it was only after the recurrent budget has
been set that the remaining amount is allocated
for capital expenditure.
This, of course, did not apply to the budget whose

source was either foreign assistance or loans. The
allocation of the fund from these sources was
dependent upon the nature of the agreement
(bilateral or multilateral), but mostly it goes
towards capital expenditure.
04/11/2023 207
 Third, the regional budgeting process was and still
mainly carried out to reallocate the funds that
came from the federal government. Thus, the
consolidated budgets of the regions depend on the
amount of grants rather than the expenditure need
of the level of government.
The imbalance between the expenditure needs

and the available fund resulted in budget cut-offs,
or shitting finance from one sector to the other
depending on the reason appreciated by the
regional government.
04/11/2023 208
Normally, the state councils have the authority
to evaluate whether the budget requests were
in accordance with the general development
strategy and the activity of the planned
projects.
04/11/2023 By Yonas G. 209

The post-2002/03 fiscal year budgetary procedures
aim to reverse the trends of the previous years and
focus on the autonomy of local governments
(weredas).
According to new approach, in principle, the

weredas receive general grants but the budgetary
process which allocates recurrent and capital
budgets is only approved at the wereda council.
04/11/2023 210
This approach intends to address the major
drawbacks of the preceding period;
 weak local participation,
 the broader financial and administrative
autonomy of zonal administrations, and
 the possible fragmentation or break up of regional
government.
04/11/2023 211
Budgeting from the initial stage of forecasting
the annual revenues and expenditures to the
final stage of approval of the annual budget by
the Council of Peoples Representatives passes
through a sequential and an iterative process.
04/11/2023 By Yonas G. 212

This budgeting process includes:
 Preparation of the macro-economic and fiscal
framework;
 Revenue forecast and determination of
expenditure budget ceiling:
 allocation of expenditure budget between
Federal and Regional governments;
 allocation of Federal government expenditure
budget between recurrent and capital
budgets:
04/11/2023 By Yonas G. 213

 budget call and ceiling:
 budget review by MoF and MoED;
 Budget hearing and defense:
 Review and recommendation:
 Submission of the budget to the council of
Ministers:
 Submission of the budget to the Council of
Peoples’ Representatives:
 Notification and publication of the budget; and
 Allotment.
04/11/2023 By Yonas G. 214

Stages of budget process
The budget process thus includes all these stages,
which obviously are sequential (one after the
other) which may involves three phases:
 analyzing,
 fitting, and
 implementing.
The analysis phase involves assembly and
integration of financial data which might include
processes from formulation of macro-economic and
fiscal framework to the allocation of expenditure
budget between Federal and Regional governments
04/11/2023 215
The fitting phase which involves the process of
prioritizing activities to fit with policy and reducing
a budget to a ceiling referring to the budgeting
processes which might range from the processes of
allocation of Federal government expenditures
budget between recurrent and capital budget down
to the submission of the budget to the council of
peoples’ Representatives.
04/11/2023 216
The implementing phase which involves
distribution and allocation of fund, i.e. the
notification and publication of the budget,
allotment and the monitoring processes.
04/11/2023 By Yonas G. 217

Budget being a one-year plan prepared for the
coming fiscal year it requires a time schedule
(deadlines) for each and every processes should
strictly be adhered to. The time schedule is usually
handled through the budget calendar. In effect the
budget calendar is the major instrument to manage
the budgetary process..
04/11/2023 218
Thus far we don’t have an authoritative and binding
budget calendar that could force all public bodies
involved in the process f budgeting. The only dates
proclaimed by law are the final approval and
notification dates of the budget.
04/11/2023 219
Financial proclamation 57/1996 states that
“the budget appropriation shall be approved
by the council of peoples Representatives by
sine 30th and all public bodies shall be notified
by Hamle 7.
04/11/2023 By Yonas G. 220

The MoF and MFED will notify the spending
public bodies well ahead of time about the
important deadlines, the budget ceiling and
other information through the budget circular.
the budgeting process usually took between
six to eight months, and the MoF and MoED
will release the budget circular around
November to December
04/11/2023 By Yonas G. 221

• End for the week
04/11/2023 By Yonas G. 222

• The budgetary process at the federal level
• The budget processes at the Federal level
follows sequential and iterative the steps. Let
us briefly explain these steps one by one here
under:
•
•
04/11/2023 By Yonas G. 223

• Step one - Macro-Economic and Fiscal
Framework:
• The preparation of the macro-economic and
fiscal framework is basically a component of
the recently initiated public investment
program (PIP).
04/11/2023 By Yonas G. 224

• It is a planning practice and as stated in
Ministry of Economic Development, the
macro-economic and fiscal framework
determines the overall level of
government expenditures based on
policies related to the role of
government in the economy, government
deficits, and priorities for resource
allocation between regions and sectors.
For the Federal government the
framework is a three years forecast and
will be updated each year.
04/11/2023 By Yonas G. 225
• Step Two- Determination of Federal
Government Expenditure and Subsidy to
• Regional Governments:
• After the revenue and expenditure of the
government are estimated through the fiscal
framework, the PMO will decide on the shares
of Federal government expenditures and
subsidies Regional governments. it is known
that, following the decentralization policy,
Regional governments took grants from the
Federal government in the form of subsidy.
04/11/2023 By Yonas G. 226
• Once the amount of subsidy is known, the allocation among
regions is determined on the basis of a formula. Initially the
formula was composed of five parameters (population, level
of development, revenue generating capacity, utilization
capacity, and land area). At present, however, the formula
takes account of three parameters: population, the level of
development, and revenue generating capacity of each
region which are given a relative weight of 60%, 25% and
15% respectively. This allocation will first be prepared by
MoED, then reviewed by the PMO and finally approved by
the Council of peoples’ Representatives.
04/11/2023 By Yonas G. 227

• Step three: Allocation of Federal Expenditure
between Recurrent and Capital Budget
• The practice in the allocation of recurrent and capital
budget is to consider the latter as a residual. That is,
first the amount of budget necessary to cover such
recurrent expenditures like pensions, debt servicing,
wages and non-wage operating costs will be
determined. The balance will then be allotted to
capital expenditures. This will be performed by the
PMO in consultation with MoF and MoED.
04/11/2023 By Yonas G. 228
• Step Four - Budget Call and Ceiling Notification:
• This includes two items. They are:
• a). Recurrent budget: MoF will release the budget ceiling to the
line ministries in a budget call. The budget call provides each
ministry such information as the macro-economic environment,
an aggregate recurrent budget ceiling, and priorities to budget.
•
• b). Capital Budget: MoED issues detailed capital budget
preparation guidelines to spending public bodies along with the
ceilings provided to each line institution. MoED will set the
ceiling for each sector.
04/11/2023 By Yonas G. 229

• Step Five - Budget Review by MoF and MoED:
• Recurrent Budget:
• Prior to a formal budget hearing, spending public bodies will submit their budget
proposals to the MoF-Budget Department. In consultation with spending public bodies,
MoF will prepare an issue paper on Major issues at each head level in the proposed
budget. Here, spending public bodies can submit above the ceiling but need to have a
compelling justification
• 2. Capital Budget:
• The sector departments of MoED review the capital budget requests from different public
bodies. At this stage projects will be screened. If there exist a discrepancy between the
respective sector department and the public body, a series of discussions will be held to
reach agreement. After such a process the various sector departments of MoED will
submit their first round recommendation to the Development Finance and Budget
Department of MoED. Then it will be consolidated and prepared for the capital budget
hearing and defense.
04/11/2023 By Yonas G. 230

• Step Six - Budget Hearing and Defense:
• Recurrent Budget:
• Spending public bodies defend their budget submission in a
formal hearing with the MoF. The issue paper will be the basis
of the hearing. The hearing focuses on policies, programs and
cost issues, when necessary it might involve discussion down
to line item. Spending public bodies could also challenge the
ceiling. Presenting the hearing will be ministers and/or vice
ministers, heads of public bodies and the MoF.
•
04/11/2023 By Yonas G. 231

• Capital Budget:
• Spending public bodies will be called to defend their projects to a budget
hearing convened by the PMO which will be chaired by the prime
Minister or the deputy Prime Minister or the their economic advisers. The
hearing customarily includes a review of status of the project,
implementation capacity of the institution, compatibility with the
countries development strategy and policy, cost structure, and regional
distribution. A project description will be presented which includes
objectives of the project, main activities of the project, status of the
project, total cost, past performance of the project, source of finance, and
whether the project is accepted or rejected by MoED. On the basis of the
discussion the respective sector departments of MoED in consultations
with the spending public body will further refine the capital projects.
04/11/2023 By Yonas G. 232

• Step Seven - Review and recommendation:
• Recurrent budget:
• After the hearing is over, the budget committee of the MoF will review
the discussion and make a recommendation. If there is an increase (over
ceiling) this will go to the PMO for approval.
•
• Capital budget:
• After the hearing and defense with the PMO and MoED, sector
departments of MoED will give a final recommendation to the
development finance and budget department of MoED. This will then be
compiled and put in appropriate formats for submission to the council of
ministers.
04/11/2023 By Yonas G. 233

• Step Eight: Submission to the council of Ministers:
• At this stage the two budgets (recurrent and capital) will be consolidated, and MoF
will prepare a brief analysis of the total budget.
• Recurrent budget:
• The recommended budget will be submitted to the deputy Prime Minister for
economic affairs. This will first be reviewed by ministers and vise ministers in
economic affairs, and then presented to the Prime Minister along with a brief. The
Prime Minister may or may not make amendments and then the budget will be
sent to the council of Ministers for discussion.
• Capital Budget:
• A brief analysis of the capital budget will be prepared by MoED on the final
recommended budget and, along with the consolidated capital budget, will be
submitted to the council of ministers. MoED will defend the budget in the council.
The council of ministers may make some adjustment and the draft capital budget
will pass the first stage of approval.
04/11/2023 By Yonas G. 234

• Step Nine - Submission to the Council of
• Once approved by the council of ministers, the
Prime Minister will present both the recurrent
and capital budget to the council of peoples’
representatives. The budget will then be
debated based on the recommendation of the
budget of the committee.
04/11/2023 By Yonas G. 235

• Step Ten - Notification and Publication:
• The approved budget will then get the legal status through the publication in the
‘Negaret gazeta.’ Spending public bodies will then formally be notified of their approved
budget by line items from MoF and MoED for recurrent and capital budgets,
respectively. MoF will notify spending public bodies through Form 3/1. Likewise, MoED
will inform through Form 3/2. Both Forms will be copied to the Treasury Department of
the MoF which disburse funds to spending public bodies. Until Form 3/1 is released
spending public bodies are authorized to spend one-twelfth of the previous year’s
budget with no provision for new expenditures (e.g. new staff posts) in the case of
recurrent budget. For capital budget spending public bodies are authorized to use
approved budget for ongoing projects even when Form 3/2 is not released.
• The final stage of the budgetary process is to request spending public bodies to prepare
adjusted work plan and cash flow for the approved budget. The adjusted work plan and
cash flow will be verified by MoF-for the recurrent budget-and by MoED-for the capital
budget, and then will be sent to the treasury Department of the MoF.
04/11/2023 By Yonas G. 236

• Step Eleven - Supplementary Budget:
• In the course of the budget year
supplementary (additional) budget will be
proclaimed when necessary, following almost
the same process as the initial budget
preparation. Likewise budget reallocation will
be made mainly based on performance.
04/11/2023 By Yonas G. 237

• The budgetary process at the regional level
• It is quite difficult to present the budget process at the Regional level in the
way discussed for Federal Budgeting. At present the budget process
followed by regions is not uniform. Hence, let us discuss the process of
budgeting in a more general terms with out referring to a particular region.
• The process is more or less a mirror image of the Federal budget process.
In place of MoF the Regional Finance Bureau (RFB) is responsible for the
preparation of the recurrent budget. While the Regional planning and
Economic Development bureau (RPEDb) is responsible for the capital
budget. At the higher level the Regional council is the one responsible for
the appropriation of the region’s budget. One significant deviation is, the
regional budget process starts at the woreda level and goes up to Zone and
Region levels.
04/11/2023 By Yonas G. 238

• 1. Pre-ceiling Budgeting:
• Pre-ceiling budgeting is the budgeting practice at the woreda and zone levels before
the region receives its subsidy/grant from the Federal government. The process is as
follows: the woreda prepares a budget with no indicative or final ceiling from the Zone
or the Region. The Finance Office will consolidate the budget of the sectoral offices
and submit to the woreda council. The woreda executive committee will then form a
budget committee to review the budget. This budget will be sent to the zone through
two channels: one, the woreda counsel submit the budget to the zone executive
committee,: second, the woreda sectoral offices send to the zone sectoral
departments. The zone executive committee will then form a budget committee that
will be chaired by the head of the Finance Department, to review the woredas’ and
zones’ budget proposal.
• In passing the budget to the region it will again be through two channels. The zone
executive committee submits to the Region executive committee and the zone sectoral
departments will submit to the region sectoral bureaus. The sectoral bureaus then
prepare a budget submission to the Region Finance Bureau.
04/11/2023 By Yonas G. 239

• 2. Post-ceiling Budgeting:
• Following the notification of the subsidy from the Federal
government, the regional public expenditure envelope will
be determined based on the Federal subsidy, local revenue
and local borrowing. Once the expenditure envelope is set,
then it will be split up between recurrent and capital
expenditures. The practice is similar to the Federal
government, i.e. the allocation begins with recurrent
expenditures and the balance of the envelope will be
reserved for capital expenditures.
•
04/11/2023 By Yonas G. 240

• After this stage, different regions fallow different
approaches to allocate recurrent expenditure
between salary and organization and management,
and to allocate capital expenditure among the
different sectors. In some regions the budget will be
prepared up to line items at the region level, where
as in some regions a lump sum will be allotted to
zones that will be in turn allocated to woredas,. At
last, the budget will be published in the region’s
‘Negarit gazeta’.
04/11/2023 By Yonas G. 241
• 4.3 Budgetary Documents
• Budgetary information presented to the parliament should include all the elements needed to
assess government’s fiscal policy and its future impact. The budgetary document should contain
most or all of the following information:
 Medium-term macroeconomic and fiscal projections.
 A statement of budget policies and fiscal policy objectives.
 Ministry or agency narrative statement explaining the sectoral activities to be funded, their
objectives and expected results.
 Revenue and expenditure estimates, measured in gross terms even when appropriation are
calculated on a net basis. These estimates should cover all central government revenues and
expenditure including special funds and accounts, if any
 Authorizations for forward commitments, if any
 Financing from external sources, grants and loans
 A statement of contingent liabilities resulting from state guarantees of third party debts and
estimates of payments likely to be required under those guarantees during the budget year.
 A statement of major identifiable fiscal risks
 A statement of tax expenditures.
04/11/2023 By Yonas G. 242

• 4.4. Budget Deficit
• A budget is considered as surplus or deficit
according to the position of the revenue
accounts of the government. Thus a surplus
budget is one in which revenue receipts exceed
expenditure charged to revenue account
regardless of the gap in capital accounts; while
a deficit budget is one in which expenditure is
greater than current revenue receipts.
04/11/2023 By Yonas G. 243
• Budget deficit is the excess of total expenditure
over total revenue of the government.
• The deficit financing denotes the direct addition
to gross national expenditure through budget
deficits whether the deficits are on revenue or
capital accounts”. It implies that the expenditure
of the government over and above the aggregate
receipt of revenue account and capital account is
treated as budget deficit of the government.
04/11/2023 By Yonas G. 244

• The meaning of deficit financing is different in different
countries. In western countries, the budget gap, that is
covered by loans is called deficit financing because, if
the government borrows from the banks rather than
from individuals the idle funds will be activated and
there will be an increase in the total public expenditure
and thus there will automatically be an deficit financing
has been used in a different sense,. Here it is used to
denote the direct addition to gross national
expenditure as a result of budget deficit.
04/11/2023 By Yonas G. 245

• Thus deficit financing can be defined as “the
financing of a deliberately created gap between
public revenue and public expenditure”. The
government of Ethiopia has used deficit financing
for acquiring funds to finance economic
development. When the government cannot
raise enough financial resources through taxation,
it finances its developmental expenditure through
borrowing from the market or from other sources.
04/11/2023 By Yonas G. 246

• 4.4.1. Methods of Financing Deficit:
• There are four important techniques through
which the Government may finance its budgetary
deficits. They are as follows:
• 1. Borrowing from central bank
• 2. The running down of accumulated cash balances
• 3. The government may issue new currency
• 4. Borrowing from market or from external
sources.
04/11/2023 By Yonas G. 247
• Under the first method, government borrows from central bank as per budgetary
policy. In the second source, government spends from available cash balance,. In the
third measure, government issues new currency for financing deficit. The last method
is that government borrows from internal and external sources to finance its deficit.
• 4.4.2. Objectives of Deficit Financing:
1. Deficit financing has generally been used as a method of meeting the financial needs
of the government in times of war, when it is considered difficult to mobilize
adequate resources.
2. Keynes advocated deficit financing as an instrument of economic policy to overcome
conditions of depression and to raise the level of output and employment.
3. The use of deficit financing has also been considered essential for financing economic
development especially in under developed countries.
4. Deficit financing is also advocated for the mobilization of surplus idle and unutilized
resources in the economy.
04/11/2023 By Yonas G. 248

• 4.4.3. Effects of Deficit Financing:
• Deficit financing has both positive and negative effects in the economy as under:
• 1. Inflationary rise in prices: The most serious disadvantage of deficit finance is the inflationary rise of
prices. Deficit financing increases the total volume of money supply. Unless there is proportional increase
in production this can lead to inflation. When deficit financing goes too far it becomes self-defeating.
There was inflationary pressure during the decade due to deficit financing.
• 2. Effects on distribution of wealth and income: The real income of wage earners gets reduced and that
of entrepreneurs/ businessmen increased, leading to distribution of wealth in favour of business class
• 3. Faster growth: Country is able to implement the developmental plans through deficit financing thereby
attaining faster growth.
• 4. Change in pattern of Investment: Deficit financing leads to encouragement for investment in certain
fields like construction, luxury consumption inventory holding and speculation. This may lead to
investment in undesirable fields.
• 5. Credit creation in banks: Inflationary forces created by deficit financing are reinforced by increase credit
creation by banks.
• Among various fiscal measures, deficit financing has been assigned an important place in financing
developmental plan and various developing countries including Ethiopia resort to deficit financing to meet
budgetary gaps.
04/11/2023 By Yonas G. 249

• 4.4.4. Deficit financing in Ethiopia:
• Deficit financing in Ethiopia was mainly resorted to enable the
Government of Ethiopia to obtain necessary resources for the plans. The
levels of outlay laid down were of an order, which could not be met only
by taxation or through a revenue surplus. The gap in resources is made
up partly through external assistance. But when external assistance is not
enough to fill the gap, deficit financing has to be undertaken. The targets
of production and employment in the plans are fixed primarily with
reference to what is considered as the desirable rate of growth for the
economy. When these targets cannot be achieved through resources
obtained from taxation and external borrowing, additional resources have
to be found. Deficit financing is the easier option. It is important to
emphasis the fact that deficit financing cannot create real resources
which do not exist in the economy.
04/11/2023 By Yonas G. 250

• 4.5 Categories of Revenues to Government:
• The revenues of the Government can be classified
into two ways. They are:
• 1. On the basis of mode of collection and
• On the basis of nature of revenue.
• Let us see these classifications one by one here
under:
• 4.5.1. Revenue on the Basis of Mode of Collection:
• It can be shown with the help of the following chart:
04/11/2023 By Yonas G. 251
04/11/2023 By Yonas G. 252
Steps in planning cycle
Planning cycle has three steps
• Stage No 1: Multi-year planning
• Stage No 2: Multi-year programming
and
• Stage No 3: Annual Fiscal Plan
04/11/2023 By Yonas G. 253

Stage 1: Multi-year planning
Multi-year planning is based on Macro-
Economic and Fiscal Framework /MEFF/
Provides a three-year forecast of
concepts such as;
Economic growth and the domestic
product
04/11/2023 By Yonas G. 254

public sector expenditure and source
of finance
The allocation between the federal
government expenditure and total
subsidies to regions and administrative
council
04/11/2023 By Yonas G. 255

An allocation between capital and
recurrent expenditure for the
federal government
An allocation of capital expenditure
between federal public bodies
The MOFED is responsible for the
preparation of Macro-Economic and
Fiscal Framework
04/11/2023 By Yonas G. 256
Stage 3: Annual Fiscal Plan
• The third stage of planning is the
preparation of the Annual Fiscal
Plan. As defined in the financial
regulations, the fiscal plan is
principally an exercise in estimating
the upcoming fiscal year resources
and expenditures.
04/11/2023 By Yonas G. 257
stage 2. Multi-year programming
Second stage of planning cycle

begins.
The second stage is the preparation
of PIP, which involves financial
programming using IPFs
The IPF provides a public body with
a three-year planning program its
capital expenditure.
04/11/2023 By Yonas G. 258
This requires public bodies to
prioritize their capital expenditure
into three categories of projects:
Ongoing, Approved, and Planned.
The public bodies will prepare the
PIP and MOFED will co-ordinate the
preparation and the consolidation
of the PIP
04/11/2023 By Yonas G. 259

Revenue Budget
• Budgeting involves different tasks on the
expenditures and revenues sides of
government finance. On the side of
expenditure, it deals with the determination
of the total with determination of the total
size of the budget which is;
04/11/2023 By Yonas G. 260

 total amount of money for the year
size of outlays on different functions, and
 the magnitude of outlays on various
activities
on the revenue side,
This involves the determination of the size
of the overall revenue and foreign aid.
04/11/2023 By Yonas G. 261
• It represents
 the annual forecast of revenues to be
raised by government through taxation
and other discretionary measures,
the amount of revenues raised this way
differ from country to country both in
magnitude and structure mainly due to
the level of economic development and
the type of the economy.
04/11/2023 By Yonas G. 262

• In Ethiopia, the revenue budget is usually
structured into three major headings. These
are
 ordinary revenue,
external assistance, and
capital revenue.
04/11/2023 By Yonas G. 263

• Hence, the funds expected from these
three sources are proclaimed as the
annual revenue budget for the country.
• The revenue budget is prepared by the
Ministry of Finance and Economic
Development (MoFED) for the federal
government and by Finance Bureaus for
regional governments.
04/11/2023 By Yonas G. 264

• End
04/11/2023 By Yonas G. 265

• Expenditures Budget:
• Government expenditures for administration and
developmental activities are handled through the expenditures
budget. These expenditures are categorized into recurrent and
capital expenditures. This categorization gained acceptance
since the Great Depression of the 1930s. the recurrent budget
which covers the current expenditures is financed in principle
by taxation ( more broadly by domestic revenue from tax
and non tax sources), and the capital budget which covers the
acquisition of newly produced assets in the economy is
financed through external borrowing and grants.
04/11/2023 By Yonas G. 266

• The acceptance to this categorization of
expenditures is related to the general change
in the perception of deficit. Prior to the 1930s,
budget deficits were considered to be
reprehensible and indicate bad financial
management. Over the years, however, the
cardinal rule of balanced budget was changed
in favor of cyclical budget, and functional
finance.
04/11/2023 By Yonas G. 267
• This change in the rule of budgeting, in turn,
resulted in several approaches to measuring
and understanding the deficit. Some of the
concepts that were developed include:
1. the public debt concept of deficit,
2. the net worth concept of deficit,
3. the overall deficit, and
4. the concept of domestic deficit.
04/11/2023 By Yonas G. 268

• To illustrate these four approaches of
measuring deficit, we can employ a simplified
budget balance given
Revenues Expenditures
A. Tax and Non Tax C. Recurrent Expenditure

Revenues
B. Net Borrowing D. Capital Expenditure
A+ B C+D
04/11/2023 By Yonas G. 269

• The public debt concept of deficit defines
budget deficit as the difference between
revenue (A) and recurrent expenditures (C)
and capital expenditures (D) this measure A-
(C+D) is equal to net borrowing (B), and the
budget is considered to be balanced if net
borrowing remains unchanged from previous
years or is equal to zero. This approach
illustrates, the understanding prior to 1930s,
which emphasized balanced budget as a
prudent fiscal policy.
04/11/2023 By Yonas G. 270
04/11/2023 By Yonas G. 271
Budgeting cycle
It involves determination of the expenditures and
revenues of government .
Revenue Budget
Represents the annual forecast of revenues to
be raised by government
The revenue budget is usually structured into
three major headings:
 Ordinary revenue,
include both tax and not tax revenues.
04/11/2023 By Yonas G. 272

cont.
External assistance,
• It includes: cash grants, these are
grants from multilateral and bilateral
donors for different structural
adjustment programs; and technical
assistance in cash and material form
04/11/2023 By Yonas G. 273

Capital revenue.
• The third item is capital revenue
includes domestic (sales of movable
properties and collection of loans),
external loan from multilateral and
bilateral creditors mostly for capital
projects, and grants in the form of
counterpart fund.
04/11/2023 By Yonas G. 274

The budgetary process at the federal level
• Step one - Macro-Economic and Fiscal

Framework
• Step Two- Determination of Federal Government
Expenditure and Subsidy to Regional
Governments:
The PMO will decide on the shares of Federal
government expenditures and subsidies Regional
governments
04/11/2023 By Yonas G. 275

• Step three: Allocation of Federal Expenditure
between Recurrent and Capital Budget
resource is allocation of recurrent and capital
budget
• Step Four - Budget Call and Ceiling
Notification:
• Step Five - Budget Review by MoF and MoED:
• Step Six - Budget Hearing and Defense:
• Step Seven - Review and recommendation:
• Step Eight: Submission to the council of
Ministers
04/11/2023 By Yonas G. 276
• Step Nine - Submission to the Council of
• Step Ten - Notification and Publication:
• Step Eleven - Supplementary Budget
04/11/2023 By Yonas G. 277

Chapter Five:
Monitor Budget
Outcomes
04/11/2023 By Yonas G. 278

Monitor Budget Outcomes
• Organizations monitor and evaluate
actual results against approved budgets
to guide current and future decision-
making and hold managers accountable
for performance
• Budgeting may be the most important
responsibility of a government legislator
or manager
04/11/2023 By Yonas G. 279
Cont.
• Who monitors the budget

The Executive
The Legislature
The Citizens
Civil society
04/11/2023 By Yonas G. 280

Key processes to effectively manage
approved budgets include
• Monitoring and reporting against
internal budgets
• Revising the internal budget through a
controlled and coordinated process
• Forecasting to manage gaps between
budget estimates and actual results
• Reviewing and improving internal
budget processes
04/11/2023 By Yonas G. 281
. the budget in
The Executive monitors
the following ways:
Using Regulations, circulars and directives
issued to accounting officers
Financial laws prescribing procedures for
awarding contracts
Office of Auditor General which scrutinizes
and audits government expenditure.
Appropriate government agencies
responsible for monitoring projects
executed by government
04/11/2023 By Yonas G. 282
The Legislature monitors the budget
in the following ways
Establish Various committees of the
legislature oversee the activities of
ministries
By hearing The legislature receives and
scrutinizes audit report from the office
of Auditor General
04/11/2023 By Yonas G. 283

The Citizens monitors the budget in the following
ways
Analyzing budget estimates to determine the
extent to which they reflect the needs of the
people
whether resources are allocated equitably
among various sectors/ sections of the country.
Ensuring that they receive budgeted and
allocated resources and services.
Monitoring compliance of government’s
ministries
04/11/2023 By Yonas G. 284
Other method of monitoring budg
 Integration of planning, budgeting, and
performance measurement
 Analyze and explain budget variances
 Managerial tools to improve performance
Customer Relationship Management
 Service Efforts and Accomplishments (SEA
Activity-based Costing
Balanced Scorecards
04/11/2023 By Yonas G. 285

Why we monitor government budget
It is a civic duty for all citizens to monitor

government budget
To identify specific projects and activities which
government plans to carry out in a year.
To ensure that these projects and activities are
actually carried out according to specifications
in the budget.
To determine weaknesses in the budget
process,
04/11/2023 By Yonas G. 286
To determine the level of performance of
government in terms of delivery of
services promised the people.
To provide data and information by which
the people could demand accountability
from government.
To enhance transparency of government
and build public confidence in the budget
process
04/11/2023 By Yonas G. 287

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YUNIVARSIITII NAANNOO OROMIYAA

Oromia State University

04/11/2023 By Teshome Kankuse 1

• In order to minimize these dangers, the accounting

04/11/2023 By Teshome Kankuse 11

The basic assumptions that underlie current

The accounting system serves the information needs

In contrast, financial accounting is directly related to

Many have considered the board’s real contribution

04/11/2023 By Teshome Kankuse 19

A reporting entity does not need to be a legal entity; it

The I A S B is also introducing updated on such items

04/11/2023 By Teshome Kankuse 29

04/11/2023 By Teshome Kankuse 31

04/11/2023 By Teshome Kankuse 32

Understandability of financial statements,

To have relevance, accounting information must be

Financial information has predictive value if it has value as

Relevant information also helps users confirm or

Information is material if omitting it or misstating it

Faithful representation means that the numbers

Completeness means that all the information that

Neutrality means that a company cannot select

An information item that is free from error will be a

04/11/2023 By Teshome Kankuse 54

It is a policy of “playing safe”. Many accounting

• Business transactions should be recorded in such a

Conservatism is synonymous with prudence. Prudence

04/11/2023 By Teshome Kankuse 67

Sales $ 10,000,000 $ 100,000

Costs and expense 9,000,000 90,000

Operation Income $ 1,000,000 $ 10,000

Unusual gain $ 20,000 $ 5,000

04/11/2023 By Teshome Kankuse 70

04/11/2023 By Teshome Kankuse 74

04/11/2023 By Teshome Kankuse 77

04/11/2023 By Teshome Kankuse 85

The activities of an enterprise should be kept separate and

04/11/2023 By Teshome Kankuse 87

04/11/2023 By Teshome Kankuse 88

• The matching of business enterprises expenses (or

Cash inflows and outflows are closely related to revenues and

• However, in any business enterprise in which the

The following illustration shows the impact of the

04/11/2023 By Yonas G. 100

Cash disbursements 0 0 50,000 50,000

Net income 0 100,000 (50,000 50,000

Expense 50,000 - - 50,000

Fees $ 26,000 50,000

Accrued 10,000 6,000

Short-term 8,000 3,000

04/11/2023 By Teshome Kankuse 104

04/11/2023 By Teshome Kankuse 105

Revenue from fees received in cash…….. 200,000 26,000

Add: Fees receivable, Dec. 31 224,000

Operating expenses paid in cash……….. 90,000

Less: Accrued Liabilities, Jan 1 year 6 …. 3,000

04/11/2023 By Teshome Kankuse 108

04/11/2023 By Yonas G. 109

04/11/2023 By Teshome Kankuse 111

• For example, if the activities and elements of East

04/11/2023 By Yonas G. 113