AcFn 2011 Ch 1 FC Final (2).pptx

Fundamentals of Accounting I-AAUSC, AAUSC, 2021
SEEK WISDOM, ELEVATE YOUR EXCELLENCE & SERVE HUMANITY
AcFn 2011
Chapter One
Introduction to Accounting & Business

Ch1: Introduction to Accounting and
Business
Outline
– The nature of a business
– Types of business organizations in Ethiopia
– The role of accounting in business
– The profession of Accounting
– Overview of International Financial Reporting Standards
(IFRS)
– Overview of Financial Reporting Requirements in Ethiopia
and AABE
– The accounting equation and elements of the equation
– Business transactions and financial statements
Fundamentals of Accounting I-AAUSC,
AAUSC, 2021

..Ch1: Introduction to Accounting and
Business
Chapter Objectives
After studying this chapter, you should be able to:
1. Explain what accounting is.
2. Identify the users and uses of accounting.
3. Understand why ethics is a fundamental business concept.
4. Explain accounting standards and the measurement principles.
5. Explain the monetary unit assumption and the economic
entity assumption.
6. State the accounting equation, and define its components.
7. Analyze the effects of business transactions on the
accounting equation.
8 Understand the four financial statements and how they
are prepared.
AAUSC, 2021

Business
The Nature of Business
A business is an organization in which basic
resources (inputs), such as materials and labor,
are assembled and processed to provide goods
or services (outputs) to customers.
Businesses come in several types and sizes,
(Small shops, Supermarkets, Laundry, Hotels,
Garage, educational institutions, banks,
insurance and so on)
AAUSC, 2021

Business
Activity:
Write 5 business activities/organizations that
you know.
AAUSC, 2021

…Ch1: Introduction to Accounting and
Business
…The Nature of Business
Organizations can be classified in various forms:
Based on objective:
Profit making/ Not for Profit organizations
Based on Function:
Service giving, Merchandising, Manufacturing, Farming ..
Based on Ownership, there are three common forms
of businesses:
1.Sole Proprietorship,
2.Partnership
3.Corporation (Share Company)
AAUSC, 2021

Proprietorship Partnership Corporation
 Owned by two or
more persons
 Often retail and
service-type
businesses
 Generally
unlimited
personal liability
 Partnership
agreement
 Ownership
divided into
shares
 Separate legal
entity organized
under corporation
law
 Limited liability
 Generally owned
by one person
 Often small
service-type
businesses
 Owner receives
any profits,
suffers any
losses, and is
personally liable
for all debts
LO 5 Explain the monetary unit assumption
and the economic entity assumption.
AAUSC, 2021
Forms of Business Ownership
…Ch1: Introduction to Accounting and Business

Business
…The Nature of Business
Regardless of the objective, size, function and
form of ownership, all organizations are
required to keep records showing their
financial activities. This implies the fact that
accounting is needed in all types of
organizations.
 So what is Accounting? Why it is needed in all
organizations?
AAUSC, 2021

Business
Activity: (Homework)
1. Write forms of business organizations as
stated in Commercial code of Ethiopia
1960.
2.List and briefly describe 10 organized
business activities in your sub-city in light
of the commercial code.
AAUSC, 2021

LO 1 Explain what accounting is.
Accounting is the process of identifying, measuring, recording,
classifying, communicating and interpreting the reports.
Accounting consists of three basic activities - it
 identifies,
 records, and
 communicates
the economic events of an organization to interested users.
What is Accounting?
AAUSC, 2021
Business

Three Activities
Illustration 1-1
The activities of the
accounting process
The accounting process includes
the bookkeeping function.
What is Accounting?
LO 1 Explain what accounting is.
AAUSC, 2021
Business

Book Keeping
 It is the recording part of
accounting
 It is purely clerical in
nature
 It is performed by Book-
keepers or account clerks
Accounting
• It is wider than book-keeping.
• It includes activities such as
designing the system of book
keeping (recording), it
includes preparation and
interpretation of financial
reports.
• It is performed by
Accountants
• Accountants are more
qualified than book keepers,
they review the work of book
keepers
AAUSC, 2021
Difference between Bookkeeping & Accounting

……What is Accounting?
Accounting is the language of business – it
can be viewed as an information system that
identifies, measures, and communicates
financial information about economic
entities to interested persons.
Accounting mainly deals with information
that is quantitative in nature.
Business
AAUSC, 2021

 The Nature of Accounting can be summarized as
follows:
 Accounting is
a service activity
a descriptive/analytical discipline
 an information system
Accounting as a service activity:
 As a service activity, it provides interested parties
(users) with quantitative financial information that
helps them to make various decisions
Business
AAUSC, 2021

Accounting as a descriptive/analytical
discipline:
It identifies mass of events and transactions that
characterize economic activity (purchases, sales,
collections, payments etc).
Through measurement, classification, and
summarization, it reduces those data to relatively
few, highly significant, and interrelated financial
reports.
AAUSC, 2021

Accounting as an information system
It is a system with 3 parts Input-Processing-Output:
 It collects raw data as an input (invoices, receipts),
then
 It processes the input (recording, classifying,
summarizing)
 Finally provides output in the form of financial
statements and communicates economic information
about business enterprise or other entity to a wide
variety of users to assist them in making decisions .
•
AAUSC, 2021
Business

……Ch1: Introduction to Accounting and
Business
AAUSC, 2021
What is the Role of Accounting in
Business?
The Role of Accounting in business is to
provide financial information to
managers for use in operating the
business. In addition, accounting provides
information to other users in assessing the
economic performance and condition of
the business.

Business
AAUSC, 2021
Who are users of Accounting
Information?
Users of accounting information
are parties that are interested to
know about the financial activities
of the organization to make
various decisions

Users of accounting information can be broadly
classified into two categories;
Business
Users of Accounting
Information
Internal Users External Users
AAUSC, 2021

Management
Human
Resources
Taxing
Authorities
Labor
Unions
Regulatory
Agencies
Marketing
Finance
Investors
Creditors
Customers
Internal
Users
External
Users
Who Uses Accounting Data
LO 2 Identify the users and uses of accounting.
AAUSC, 2021

Common Questions Asked User
1. Can we afford to give our
employees a pay raise? Human Resources
2. Did the company earn a
satisfactory income?
3. Should any product lines be
eliminated?
4. Is cash sufficient to pay dividends
to shareholders?
5. What price for our product will
maximize net income?
6. Will the company be able to pay
its debts?
Investors
Management
Finance
Marketing
Creditors
Who Uses Accounting Data
LO 2 Identify the users and uses of accounting.
AAUSC, 2021

Business
…….Internal users:
- Include Top executives, management, and
administrators within organizations. ( Managers at
different levels)
– Purpose: They need financial information to plan and
control operations
– Type of report & frequency- They need detailed and
frequent information
– These group of users have access to company
information
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Business
2. External Users
• Include Shareholders, Banks, Creditors, Investors,
suppliers, government
• Purpose: They need financial information about
entire company’s financial performance (Profit/loss),
financial position (resources and sources) and cash
flow
• Type of report: periodic report showing
aggregate/company wide information in the form of
general purpose financial statements
• They do not have access to company information
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QUESTIONS ASKED BY EXTERNAL USERS
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• Fundamental relationships in the decision-
making process:
Event
Accountant’s
analysis &
recording
Financial
Statements
Users
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Business
How Accounting Evolves to its Current Stage?
Evolution of Accounting
• Similar to other fields of study, Accounting has
evolved to meet the increasing needs of the
society
• As organizations increase in type, size and
complexities, the demand for financial
information has also increased
• Accounting has developed new concepts and
principles to meet these demands
AAUSC, 2021

Business
….Evolution of Accounting
• Primitive Accounting
– The oldest accounting record was the one that was
found in Babylonia in around 3600 B.C.
– Primitive accounting deals with limited aspect of
transactions
– There was no systematic recording
• Modern Accounting
– Modern accounting for business was developed in
response to the needs of Italian commercial orgs.
AAUSC, 2021

Business
…Evolution of Accounting
• Modern accounting was started with
the invention of a system of recording
known as “Double Entry Accounting
System”, a complete recording system
• This system was invented in 1494 in
Italy by an Italian Monk and
mathematician named Pacioli.
AAUSC, 2021

• Double Entry system provides a set of integrated reports
showing
1. The profit or loss (operation result) of a given
business for a certain period (Income statement)
2. The resources/assets/properties of a given business and the
sources of the finance to acquire these resources. (Statement
of Financial Position/Balance sheet)
• The invention of double entry accounting system is considered
to be the most important stage in the development of
accounting. In spite of the tremendous development in the
profession since 1494, the basic elements of the double entry
remains unchanged and it continues to this date.
AAUSC, 2021

Business
Influential factors for the Development of
Accounting
• The Industrial Revolution;
• The formation of Corporate forms of
organizations;
• The development of Public Accounting;
• The Government influence through tax
regulation and others.
AAUSC, 2021

Forensic Accounting
Uses accounting, auditing, and
investigative skills to conduct
investigations into theft and
fraud.
Government
Careers with the tax
authorities, law enforcement
agencies, and corporate
regulators.
Private Accounting
Careers in industry working in
cost accounting, budgeting,
accounting information
systems, and taxation.
LO 9 Explain the career opportunities in accounting.
Public Accounting
Careers in auditing, taxation,
and management consulting
serving the general public.
The ACCOUNTING Profession/CAREER OPPORTUNITIES
AAUSC, 2021

The following are considered to be the building
blocks of accounting
1. Ethics
2. Accounting Standards (IFRS)
3. Measurement Principles & Assumptions
STUDY OBJECTIVES 3, 4 & 5
AAUSC, 2021
The Building Blocks of Accounting

1. Ethics In Financial Reporting
LO 3 Understand why ethics is a fundamental business concept.
Standards of conduct by which one’s actions are judged as
right or wrong, honest or dishonest, fair or not fair, are
ethics.
 Recent financial scandals include: Enron (USA),
Parmalat (ITA), Satyam Computer Services (IND), AIG
(USA), and others.
 Effective financial reporting depends on sound ethical
behavior.
..The Building Blocks of Accounting
AAUSC, 2021

Overview of International Financial Reporting Standards (IFRS)
 Accounting practices are guided by accounting standards
 These standards guide accountants on how to record and report
financial transactions.
 Application of accounting standards/principles standardize
accounting reports and standardization makes financial reports
more useful since it adds the quality of comparability to these
statements
 These standards are the result of continuous research and studies
of accounting scholars and practitioners; and are subject to change
and modification depending on the development and complexity
of the information need of the business and society.
AAUSC, 2021
2. Accounting Standards
…The Building Blocks of Accounting

…The Building Blocks of Accounting
The Standard-setting effort and the Development of IFRS
 Many countries have made tremendous effort in developing their own
accounting standard to guide the accounting and reporting practices in
their homeland
Eg. USA, Great Britain, France, Germany, Canada, and Italy
 As businesses globalize, the existence of these different standards
have created difficulty for both preparers and users of accounting
information.
 At present most countries agree to use one set of international
accounting standards. Because today’s companies view the entire
world as their market- Multinational corporations.
….. …Ch1: Introduction to Accounting and
Business
Fundamentals of Accounting I-AAUSC, AAUSC, 2021

International Financial Reporting Standards (IFRS)
LO 4 Explain accounting standards and the measurement principles.
Financial Accounting Standards Board (FASB)
http://www.fasb.org/
International Accounting Standards Board (IASB)
http://www.iasb.org/
Generally Accepted Accounting Principles (GAAP)
….The Building Blocks of Accounting
Accounting Standards setters
AAUSC, 2021
FASB and IASB recognize that global markets will best be served if
only one set of standard is used, IFRS.

Business
Overview of IFRS
What are International Financial Reporting Standards
(IFRS) ?
 IFRS Standards are a globally recognized set of standards for
the preparation of ﬁnancial statements by business entities.
 IFRS Standards prescribe:
 the items that should be recognized as assets, liabilities, income
and expense;
 how to measure those items;
 how to present them in a set of ﬁnancial statements; and
 related disclosures about those items.
AAUSC, 2021

…Ch1: Introduction to Accounting
and Business
• ….The Building Blocks of Accounting
IFRSs are issued by International Accounting Standards Board
(IASB.)
The term IFRS comprises:
IFRS issued by IASB;
IAS issued by (International Accounting Standards
Committee) IASC; and
Interpretations issued by the Standing Interpretations
Committee (SIC) and the International Financial
Reporting Interpretations Committee (IFRIC) of the IASB
 130+ countries already use IFRS.
AAUSC, 2021

From IAS to IFRS
International Accounting
Standards Committee (IASC)
1973
2000
Standards Board (IASB)
2001
Future
Standards (IAS)
International Financial Reporting Standards (IFRSs)
IFRS
IAS (41) IFRS (17) IFRIC(21)
SIC (32)
AAUSC, 2021

• ..The Building Blocks of Accounting
Measurement Principles:
• IFRS generally uses one of two measurement principles,
the historical cost principle and Fair Value principle
• Cost Principle – or historical cost principle, dictates that
companies record assets at their cost.
• Fair Value Principle – states that assets and liabilities
should be reported at fair value (the price received to sell
an asset or settle a liability).
AAUSC, 2021

Example on Measurement Principle
Assume ABC Co. Purchased a Machine.
 Date of Purchase: January 1,2019, at Br 150,000
 Price listed by seller ……………..… Br180,000
 Buyer’s initial offer to buy at……... Br 120,000
 Assessed value for property taxes…Br190,000
 Market Value on December 31, 2019… Br 250,000
1. At what amount should ABC Co. record this Equipment on its
accounting records on January 1,2019?
a) by Cost principle b) by Fair value principle
2. At what amount should ABC Co. report this Equipment on its
accounting records on December 31,2019?
a) by Cost principle b) by Fair value principle
Solution:
AAUSC, 2021

Monetary Unit – include in the accounting records only
transaction data that can be expressed in money terms.
Economic Entity – requires that activities of the entity be
kept separate and distinct from the activities of its owner and
all other economic entities.
 Proprietorship.
 Partnership.
 Corporation.
LO 5 Explain the monetary unit assumption
and the economic entity assumption.
Forms of Business
Ownership
Assumptions
AAUSC, 2021

..Ch1: Introduction to Accounting and
Business
The Monetary Unit Assumption
• In accounting money is used as a measurement unit due to this, all
transactions are recorded in terms of money.
• Money is both the common factor of all business transactions and
the only feasible unit of measurement that can be used to achieve
uniform financial data. However, the use of money as a
measurement unit has the following limitations:
1. It limits financial statements to report only quantifiable events.
Qualitative events affecting the performance of a business are not
reported because of the problem of quantification. For example,
effect on profit of the death of an excellent business manager is not
included in financial statement.
2. It ignores the effect of inflation since it assumes money as a stable
unit of measurement.
AAUSC, 2021

Business
The Business Entity/Economic Entity Assumption
 An Economic entity /Business entity can be any organization
or unit in society. It is an economic unit which enters into
business transactions that must be recorded, summarized &
reported. It can be profit making/not for profit.
 As per this assumption, a business organization is considered to
be separate from owners and creditors who supplied asset and
from other businesses;
 Each business organization should keep a separate accounting
records showing the activities of the business; Financial events of
the business should not be mixed with either of these parties, and
it should be kept separately.
AAUSC, 2021

Business
• Application of business entity concept enables
users to have accurate information about how well
the entity is doing.
The following are not violations of this assumption:
1. Withdrawal of assets by owners for personal use
recorded as owners withdrawals, not as a
business expense
2. Combining the financial statements of different
businesses to have an overall view/aggregate
figure
AAUSC, 2021

• Frequency of reporting
An entity is required to present a complete
set of financial statements at least
annually.
• Accrual method of accounting
It is a method of accounting in which
transactions are recorded in the periods in which
the events occur.
AAUSC, 2021

Accrual Basis of Accounting
Revenue is recorded in the
period it is earned
regardless of collection
In December 2019 ABC Co.
rendered Service :
 on cash: Br 100,000
 on account/on credit: Br
200,000 (it was collected in
Feb. 2020)
Total Revenue of Br 300,000
is reported in December
2019
Cash Basis of Accounting
Revenue is recorded in the
period of cash collection.
 In December 2019 ABC Co.
rendered Service :
 on cash: Br 100,000
on account/on credit: Br
200,000 (it was collected in
Feb. 2020)
Only Revenue of Br 100,000 is
reported in December 2019 and
Br 200,000 is reported in 2020
AAUSC, 2021
Accrual Vs Cash Basis of Accounting
Companies prepare financial statements based on Accrual Basis

Accrual Basis of Accounting
Expense is recorded in the
period it is incurred
regardless of payment
 In December2019 ABC Co.
incurred Expenses as
follows:
 paid in cash: Br 50,000
 incurred but not paid Br
80,000 (it was paid in Jan.
2020)
Total expense of Br 130,000 is
reported in December 2019
Cash Basis of Accounting
Expense is recorded in the
period of cash payment.
 In December2019 ABC Co.
incurred Expenses as follows:
 paid in cash: Br 50,000
 incurred but not paid Br 80,000
(it was paid in Jan. 2020)
Only Expense of Br 50,000 is
reported in December 2019 and
Br 80,000 is reported in 2020
AAUSC, 2021
Accrual Vs Cash Basis of Accounting

..Ch1: Introduction to Accounting and Business
Which one is realistic, Accrual or Cash Basis?
Which method do companies use?
Accrual method is considered to be realistic in
measuring the operation results of the business in
terms of net income and net loss since it matches
efforts with accomplishments (revenues are
reported in the period efforts to generate revenues
are exerted).
IFRS requires companies to prepare financial
statements based on Accrual Basis

AAUSC, 2021

..Ch1: Introduction to Accounting and Business
The application of IFRS in Ethiopia
As per the Report on Observance of Standards and Codes
(ROSC) in 2007, there was no accounting standard in
Ethiopia.
The absence of one set of accounting standard in the
country, financial statements depict limited information for
users which indicates the existence of urgent need for
Ethiopia to have a uniform standard.
Since most of the countries in the world are following
IFRS, Ethiopia should not isolate itself.
Consequently, the government of Ethiopia issued a proclamation
called “Financial Report Proclamation of Ethiopia: 847/2014” and
Council of Ministers Regulation 332/2014.
AAUSC, 2021

The application of IFRS in Ethiopia…
Accounting and Audit Board of Ethiopia (AABE)
established and took responsibility to guide and
dictate the implementation of IFRS
Objectives of AABE:
 To promote high quality reporting of financial and
related information by reporting entities
 Promote highest professional standards among
auditors and accountants
 Promote high quality of accounting & auditing
services
 Ensure the accounting profession is used in public
interest
 Protect the professional independence of
accountants & auditors
AAUSC, 2021

Assets Liabilities Owner’s Equity
= +
The accounting equation and elements of the equation
The Accounting Equation: The foundation of accounting system.
The accounting (balance sheet) equation is an equation that expresses the
following relationships:
Resources Sources of the resources
=
Equity = Creditors equity + Owners equity
AAUSC, 2021

Assets Liabilities Equity
= +
Provides the underlying framework for recording and summarizing
economic events.
Applies to all economic entities regardless of size.
The Basic Accounting Equation
LO 6 State the accounting equation, and define its components.
AAUSC, 2021

Assets
economic events.
 Resources a business owns.
 Provide future services or benefits.
 Cash, Inventory, Equipment, etc.
Assets
Liabilities Equity
= +
AAUSC, 2021

economic events.
Liabilities
Assets Liabilities
= + Equity
 Claims against assets (debts and obligations).
 Creditors - party to whom money is owed.
 Accounts payable, Notes payable, etc.
AAUSC, 2021

economic events.
Ownership claim on total assets.
Referred to as residual equity.
Share capital-ordinary and retained earnings.
Equity
Assets Liabilities Equity
= +
AAUSC, 2021

Revenues result from business activities entered into for the purpose
of earning income.
Generally results from selling merchandise, performing services,
renting property, and lending money.
Illustration 1-7
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Expenses are the cost of assets consumed or services used in the
process of earning revenue.
Common expenses are salaries expense, rent expense, interest
expense, property tax expense, etc.
Illustration 1-7
AAUSC, 2021

Dividends are the distribution of cash or other assets to shareholders.
 Reduce retained earnings
 Not an expense
Illustration 1-7
AAUSC, 2021

Classification
Classify the following items as issuance of shares, dividends,
revenues, or expenses. Then indicate whether each item
increases or decreases equity.
1. Rent expense
2. Service revenue
3. Dividends
4. Salaries expense
Effect on Equity
Expense Decrease
Revenue Increase
Equity Decrease
Expense Decrease

Transactions are a business’s economic events
recorded by accountants.
 May be external or internal.
 Not all activities represent transactions.
 Each transaction has a dual effect on the
accounting equation.
LO 7 Analyze the effects of business transactions on the accounting equation.
Using the Accounting Equation
AAUSC, 2021

Illustration: Are the following events recorded in the
accounting records?
Event
Purchase
computer.
Criterion Is the financial position (assets, liabilities, or equity)
of the company changed?
Discuss
product
design with
customer.
Pay rent.
Record/ Don’t
Record
Illustration 1-8
AAUSC, 2021

Illustration 1-9
Expanded accounting equation
Transaction Analysis
AAUSC, 2021

LO 7
Transaction (1). Investment by Shareholders. Ray and Barbara Neal
decides to open a computer programming service which he names
Softbyte. On September 1, 2014, they invest €15,000 cash in exchange for
€15,000 of ordinary shares.
Illustration 1-10
AAUSC, 2021

LO 7
Illustration 1-10
Transaction (2). Purchase of Equipment for Cash. Softbyte purchases
computer equipment for €7,000 cash.
AAUSC, 2021

LO 7
Illustration 1-10
Transaction (3). Purchase of Supplies on Credit. Softbyte purchases
for €1,600 from Acme Supply Company computer paper and other supplies
expected to last several months. The purchase is on account.
AAUSC, 2021

LO 7
Illustration 1-10
Transaction (4). Services Provided for Cash. Softbyte receives €1,200
cash from customers for programming services it has provided.
AAUSC, 2021

LO 7
Illustration 1-10
Transaction (5). Purchase of Advertising on Credit. Softbyte receives a
bill for €250 from the Daily News for advertising but postpones payment
until a later date.
AAUSC, 2021

LO 7
Illustration 1-10
Transaction (6). Services Provided for Cash and Credit. Softbyte
provides €3,500 of programming services for customers. The company
receives cash of €1,500 from customers, and it bills the balance of €2,000
on account.
AAUSC, 2021

LO 7
Illustration 1-10
Transaction (7). Payment of Expenses. Softbyte pays the following
expenses in cash for September: store rent €600, salaries and wages of
employees €900, and utilities €200.
AAUSC, 2021

LO 7
Illustration 1-10
Transaction (8). Payment of Accounts Payable. Softbyte pays its €250
Daily News bill in cash.
AAUSC, 2021

LO 7
Illustration 1-10
Transaction (9). Receipt of Cash on Account. Softbyte receives €600 in
cash from customers who had been billed for services [in Transaction (6)].
AAUSC, 2021

LO 7
Illustration 1-10
Transaction (10). Dividends. The corporation pays a dividend of €1,300
in cash.
AAUSC, 2021

Companies prepare four financial statements :
Statement of
Financial
Position
Income
Statement
Statement of
Cash Flows
Retained
Earnings
Statement
LO 8 Understand the four financial statements and how they are prepared.
Financial Statements
AAUSC, 2021

Net income will result during a time period when:
a. assets exceed liabilities.
b. assets exceed revenues.
c. expenses exceed revenues.
d. revenues exceed expenses.
Question
AAUSC, 2021

Net income is needed to determine the
ending balance in retained earnings.
LO 8
Illustration 1-11
Financial statements and
their interrelationships
AAUSC, 2021

The ending balance in retained earnings is
needed in preparing the balance sheet
Illustration 1-11
LO 8
AAUSC, 2021

The balance sheet and income statement are
needed to prepare statement of cash flows.
Illustration 1-11
LO 8
AAUSC, 2021

Which of the following financial statements is prepared as
of a specific date?
a. Statement of financial position.
b. Income statement.
c. Retained earnings statement.
d. Statement of cash flows.
Question
AAUSC, 2021

Chapter 1
The End
Any
AAUSC, 2021

AcFn 2011 Ch 1 FC Final (2).pptx

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