This document provides an introduction to accounting. It defines accounting as identifying, measuring, and communicating economic information to allow for informed decisions. The purpose of accounting is to provide standard financial information to assess profit/loss, asset value, cash flows, debts owed/due, and financial health. There are two main branches - financial accounting which records transactions and prepares financial statements, and management accounting which provides internal information to aid decision making. Key users of accounting information and their needs are also outlined.
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2. The Nature, Purpose and Scope of Accounting
• What is accounting?
• Accounting can be defined as ‘the process of identifying, measuring,
and communicating economic information to permit informed
judgements and decisions by users of the information’
• The managers of businesses want to know whether they are making
profits or not, how much they owe to different stakeholders and how
much the business is owed. The purpose of accounting is, therefore,
to provide the information required by presenting it in standard and
logical form.
3. Accounting has many objectives, including letting people and
organizations know:
• if they are making a profit or a loss;
• what their business is worth;
• what a transaction was worth to them;
• how much cash they have;
• how wealthy they are;
• how much they are owed;
• how much they owe to someone else;
• enough information so that they can keep a financial check on the
things they do.
However, the primary objective of accounting is to provide information
for decision making.
4. Accounting has many objectives, including letting people and
organizations know:
• if they are making a profit or a loss;
• what their business is worth;
• what a transaction was worth to them;
• how much cash they have;
• how wealthy they are;
• how much they are owed;
• how much they owe to someone else;
• enough information so that they can keep a financial check on the
things they do.
However, the primary objective of accounting is to provide information
for decision making.
5. • There are two main strands (branches) of accounting:
• Financial accounting – this comprises the two key stages of:
(a) Bookkeeping (the recording of day-to-day business transactions)
(b) Accounts preparation – These financial statements summarize
the business transactions for a period, normally one year.
• Management accounting – management accounting is defined as ‘the
application of professional knowledge and skill in the preparation and
presentation of accounting information in such a way as to assist
management in the formulation of policies and in the planning and
control of the operations of the undertaking’. It aims to provide
information in a form that aids decision making in a business
organisation
STRANDS (BRANCHES) OF ACCOUNTING
6. The Differences Between Financial Accounting
and Managerial Accounting
ATTRIBUTE FINANCIAL ACCOUNTING MANAGEMENT ACCOUNTING
Format Financial accounts are supposed to be in
accordance with a specific format by IAS
so that financial accounts of different
organizations can be easily compared.
No specific format is designed for
management accounting systems.
Planning and Control Financial accounting helps in making
investment decision, in credit rating.
Management Accounting helps
management to record, plan and
control activities to aid decision making
process
Internal Vs External Users A financial accounting system produces
information that is used by all parties, the
external and Internal, to the organization,
such as shareholders, bank and creditors.
A management accounting system
produces information that is used
within (internal) an organization, by
managers and employees.
7. Focus Financial accounting focuses
on history.
Management accounting
focuses on future & Present
Reporting frequency
and duration
Well-defined - annually, semi-
annually, quarterly
As needed - daily, weekly,
monthly.
Optional Preparing financial accounting
reports are mandatory
especially for limited
companies.
There are no legal
requirements to prepare
reports on management
accounting.
Legal/Rules Drafted according to GAAP –
General Accepted Accounting
Procedure.
Drafted according to
management suitability
8. Users of Accounting Information and
Their Respective Needs
• The users of the accounting information are the stakeholders
interested in the financial information of businesses though with
different needs.
• A stakeholder is any person that has an interest in a business
organization or will be impacted by the organization’s decisions.
Stakeholders can include individuals, groups of people or
organizations that are affected by the business organization. The
possible users of accounting information include:
9. OWNERS
• The owners of sole trader or partnership will be interested in how the
business is doing, for example any profit or loss and the extent of
monies owed to the business by trade receivables and monies owed
by the business to trade payables.
• Owners will be able to take whatever money they want from the
business in the form of drawings. Shareholders are those who have
invested money in the company and are considered owners of the
business. The company will be run by a team of managers, and the
shareholders require the managers to account for the “stewardship”
of the business – so how the shareholders’ funds have been used.
10. INVESTORS
• Banks and other lending institutions require to know if the business is
likely to be able to repay loans and to pay the interest charged.
Currently available accounts of a business may be several months old
and not show an up-to-date position. In these cases, the lender will
ask for cash flow forecasts to show what will happen in the business.
Therefore, accounting techniques have to be flexible and adaptable to
meet users’ needs.
11. MANAGEMENT
• The board of directors require up-to-date, in depth information so
that they can plan for the long term, medium future of the business.
Management will compare results with past decisions and forecasts.
As other levels of management will require access to different types
and detail of accounting information managers will need to see
financial information about areas of the business for which they are
responsible.
12. EMPLOYEES
• Employees must be assured of the future outlook and job security of
their employment. They also need to see the financial position of the
business and how that may affect their pay levels. For example,
claiming pay rises or performance-related pay.
13. PROSPECTIVE OWNERS/BUYERS
• Any individual entering into an established partnership – e.g. those
thinking of buying shares in a company or making a takeover bid for
an existing business – will want to know the financial viability of the
business, the price of the ownership, the share price/asking price for a
takeover. This must be fair and in consideration of the current financial
position and the business’s future prospects.
14. Business contacts (customers, suppliers and
competitors):
• These are suppliers to who the business owes money. This may be for
goods and services bought on credit – trade payables, and for
customers who owe money for goods and services received on credit –
trade receivables.
• Financial information provided by the businesses should not adversely
affect the financial failure of another. Competitors may compare their
own results with those of other similar businesses. They need to ensure
they are performing as well-or better-than their competitors.
15. GOVERNMENT
• All businesses have to submit their accounts to determine their
liability for taxation. The government’s primary source of revenue to
fund public spending is through businesses liability for taxation.
16. Characteristics of Useful Accounting Information
• These are the attributes/qualities that make the information provided
in the financial statements to be more meaningful to the users. The
demand for accounting information by investors, lenders, creditors,
etc., creates fundamental qualitative characteristics that are desirable
in accounting information. The qualitative characteristics of
accounting information are important because they make it easier for
both company management and investors to utilize a company’s
financial statements to make well-informed decisions.
17. Qualitative characteristics of accounting
information
• Relevance refers to how helpful the information is for financial
decision-making processes. In other words, the information must have
a purpose why it’s being produce and must meet the needs of the
users. For accounting information to be relevant, it must possess:
• 1. Confirmatory value – Provides information about past events
• 2. Predictive value – Provides predictive power regarding possible
future events
18. Verifiability
Verifiability is the extent to which information is reproducible given the
same data and assumptions. For example, if a company owns
equipment worth $1,000 and told an accountant the purchase cost,
salvage value, depreciation method, and useful life, the accountant
should be able to reproduce the same result. If they cannot, the
information is considered not verifiable.
19. • Timeliness
•
• Timeliness is how quickly information is available to users of
accounting information. The less timely (thus resulting in older
information), the less useful information is for decision-making.
Timeliness matters for accounting information because it competes
with other information. For example, if a company issues its financial
statements a year after its accounting period, users of financial
statements would find it difficult to determine how well the company
is doing in the present.
20. • Understandability
• Understandability is the degree to which information is easily
understood. In today’s society, corporate annual reports are in excess
of 100 pages, with significant qualitative information. Information that
is understandable to the average user of financial statements is highly
desirable. It is common for poorly performing companies to use a lot
of jargon and difficult phrasing in its annual report in an attempt to
disguise the underperformance.
• Understandability depends on two factors:
• (a) The way in which the information is presented; and
• (b) The capabilities of the users
21. Comparability
• Comparability is the degree to which accounting standards and policies are
consistently applied from one period to another. Financial statements that
are comparable, with consistent accounting standards and policies applied
throughout each accounting period, enable users to draw insightful
conclusions about the trends and performance of the company over time. In
addition, comparability also refers to the ability to easily compare a
company’s financial statements with those of other companies.
• The financial statements should enable users to make comparison of an
entity over time to identify trends in its performance and financial position.
They should also enable the users to compare and evaluate the relative
performance and financial position of different entities. Therefore,
consistency is required.
22. • Materiality
• Information is material to the financial statements if its misstatement
or omission may reasonably be expected to influence the economic
decisions of users. Financial statements need to include all material
information and immaterial information need not be shown in the
financial statements. As to whether information is material will
depend on the size and nature of the item being judged in the
particular circumstances.
23. Reliability
• Information provided by the financial statements must be dependable
(trustworthy).
• Information is reliable when:
• (i) it is faithfully presented - the users can depend on it as faithfully
representing what it purports to represent or what could be reasonably
expected to represent (faithfully presentation)
• (ii) it is neutral - free from deliberate or systematic bias (neutrality)
• (iii) it is free from material error
• (iv) it is complete within the context of materiality; and
• (v) it is prudent - in conditions of uncertainty, a certain level of caution has
been applied in exercising judgment and making the necessary estimates
(prudence)
24. Accounting Concepts
• In order to maintain uniformity and consistency in preparing and
maintaining books of accounts, certain rules or principles have been
evolved. These rules/principles are classified as concepts and
conventions. These are foundations of preparing and maintaining
accounting records.
• ➢ Accounting Concept refers to the basic assumptions and rules and
principles which work as the basis of recording of business
transactions and preparing accounts.
25. The following are the various accounting concepts that have been discussed
in the following sections:
• Business entity concept
• Going concern concept
• Prudence Concept
• Historical cost concept
• Duality aspect concept
• Accrual concept/Matching concept
• Realisation Concept
• Substance Over Form
26. 1. Business entity concept:
• This concept assumes that, for accounting purposes, the business
enterprise and its owners are two separate independent entities.
Thus, the business and personal transactions of its owner are
separate. For example, when the owner invests money in the
business, it is recorded as liability of the business to the owner.
• Similarly, when the owner takes away from the business cash/goods
for his/her personal use, it is not treated as business expense. Thus,
the accounting records are made in the books of accounts from the
point of view of the business unit and not the person owning the
business. This concept is the very basis of accounting.
27. 2. The going concern concept
• This concept states that a business firm will continue to carry on its
activities for a foreseeable future - indefinite period of time. Simply
stated, it means that every business entity has continuity of life. Thus,
it will not be dissolved in the near future.
• This is an important assumption of accounting, as it provides a basis
for showing the value of assets in the balance sheet; For example, a
company purchases a plant and machinery of K.100,000.00 and its life
span is 10 years. According to this concept every year some amount
will be shown as expenses and the balance amount as an asset.
28. 3. Historical Cost Concept:
• Historical cost concept states that all assets are recorded in the books
of accounts at their purchase price (cost), which includes cost of
acquisition, transportation and installation and not at its market
price. It means that fixed assets like building, plant and machinery,
furniture, etc are recorded in the books of accounts at a price paid for
them.
29. 4. Duality Concept (Dual Concept):
• Dual aspect is the foundation or basic principle of accounting. It provides the very basis of
recording business transactions in the books of accounts. This concept assumes that every
transaction has a dual effect, i.e. it affects two accounts in their respective opposite
sides. Therefore, the transaction should be recorded at two places.
• It means, both the aspects of the transaction must be recorded in the books of accounts.
For example, goods purchased for cash has two aspects which are (i) Giving of cash (ii)
Receiving of goods. These two aspects are to be recorded. Thus, the duality concept is
commonly expressed in terms of fundamental accounting equation :
• Assets = Liabilities + Capital
• The above accounting equation states that the assets of a business are always equal to the
claims of owner/owners and the outsiders. This claim is also termed as capital or owners
equity and that of outsiders, as liabilities or creditors’ equity.
• The knowledge of dual aspect helps in identifying the two aspects of a transaction which
helps in applying the rules of recording the transactions in books of accounts. The
implication of dual aspect concept is that every transaction has an equal impact on assets
and liabilities in such a way that total assets are always equal to total liabilities.
30. 5. Realisation Concept:
• This concept states that revenue from any business transaction should be
included in the accounting records only when it is realised. The term
realisation means creation of legal right to receive money.
• Selling goods is realization whilst receiving order is not.
• In other words, it can be said that: Revenue is said to have been realised
when cash has been received or right to receive cash on the sale of goods
or services or both has been created.
• In short, the realisation occurs when the goods and services have been sold
either for cash or on credit. It also refers to inflow of assets in the form of
receivables.
31. 6. Accrual Concept:
• This concept is also known as the “matching” principle. The concept states that revenue
should be recognised when it is earned and not when money is received. This means
that revenue should be matched against expenditure when calculating profit.
• The accrual concept under accounting assumes that revenue is realised at the time of
sale of goods or services irrespective of the fact when the cash is received. For example,
a firm sells goods for MWK55,000 on 25th March 2005 and the payment is not received
until 10th April 2005, the amount is due and payable to the firm on the date of sale i.e.
25th March 2005. It must be included in the revenue for the year ending 31st March
2005.
• Similarly, expenses are recognised at the time services provided, irrespective of the fact
when actual payment for these services are made. For example, if the firm received
goods costing MWK.20000 on 29th March 2005 but the payment is made on 2nd April
2005 the accrual concept requires that expenses must be recorded for the year ending
31st March 2005 although no payment has been made until 31st March 2005 although
the service has been received and the person to whom the payment should have been
made is shown as creditor.
• In brief, accrual concept requires that revenue is recognised when realised and expenses
are recognised when they become due and payable without regard to the time of cash
receipt or cash payment.
32. 7. Substance Over Form
• Substance over form is an accounting concept which states that the
economic substance of transactions and events must be recorded in
the financial statements rather than just their legal form in order to
present a true and fair view of the affairs of the entity.
• When the legal form of a transaction differs from its real substance,
accountants should show the transaction in accordance with its real
substance which is basically how the transaction affects the economic
situation of the business. For instance, assume that a business bought
a car on hire purchase
33. 8. Prudence concept
• The prudence concept states that accountants should always exercise
caution when dealing with uncertainty while at the same time
ensuring that financial statements are neutral such that assets or
income are not overstated and liabilities or expenses are not
understated
34. 9. Consistency Concept:
• The concept of consistency means that accounting methods once adopted
must be applied consistently in future. Also same methods and techniques
must be used for similar situations for similar items.
• It implies that a business must refrain from changing its accounting policy
unless on reasonable grounds. If for any valid reasons the accounting policy
is changed, a business must disclose the nature of change, the reasons for
the change and its effects on the items of financial statements.
• Consistency concept is important because of the need for comparability,
that is, it enables investors and other users of financial statements to easily
and correctly compare the financial statements of a company.