INTRODUCTION TO FINANCIAL ACCOUNTING Session 01 Certificate in Business Management (CBM)
Session Outline • Definition of Accounting • Objectives of Accounting • Users of Accounting Information • Book-keeping vs. Accounting • Accounting Process • Source Documents and Prime Entry Books • Qualitative Characteristics of Accounting Information • Accounting Concepts/ Principles • Elements of Accounting • Types of Financial Statements
DEFINITION OF ACCOUNTING “The process of identifying, measuring and communicating economic information to permit informed judgments and decisions by users of the information.“ American Accounting Association [AAA]-1941
OBJECTIVES OF ACCOUNTING Primary Objective: To provide information for decision making Other Objectives: – To keep systematic records – To ascertain profitability – To ascertain the financial position of a business – To comply with laws and regulations
USERS OF ACCOUNTING INFORMATION
USERS OF ACCOUNTING INFORMATION User Interests Investors Profitability/ Security Management Financial progress and the status Employees Job security/ Pay and benefits Lenders Repayment capacity Government Employment creation/ Tax payable Suppliers Financial health/ Liquidity Customers Business stability Public Local welfare/ Environmental concerns (CSR) Competitors Benchmarking
PRACTICE QUESTION • List four (4) users of accounting information and briefly explain their information needs.
BOOK KEEPING VS. ACCOUNTING • Book-keeping is the process of recording data relating to accounting transactions in the accounting books. • Accounting is concerned with the uses which accountants might make of the bookkeeping information given to them.
ACCOUNTING PROCESS Financial Source Prime Entry General Trial Statements Documents Books Ledger Balance
SOURCE DOCUMENTS • Contains details regarding a business transaction. • Used to verify that transactions have actually occurred, and is proof for such. • Usually contains the description of the business transaction, the date of the transaction, monetary values and an authorising signature. • Important to the accountants, who uses the information on the document as a source to record transactions.
Books of Prime Entry Transaction Type Source Document Sales Journal Credit Sales Sales Invoice Purchases Journal Credit Purchases Purchase Invoice Return Inwards Journal Returns Inwards Credit Notes Return Outwards Journal Returns Outwards Debit Notes Cash Book Receipts and Payments of Cash and Cheques Cheque Counterfoils, Paying in slips, Till Rolls Petty Cashbook All small Cash Transactions Petty Cash Vouchers General Journal All transactions not recorded elsewhere Everything else not covered by above
QUALITATIVE CHARACTERISTICS • Accounting information must comply with qualitative characteristics. • These are the attributes that make information useful for both external and internal users. • Clear and understandable information is needed for quality decision making. • If users cannot understand the information; it is considered as a waste of resources.
QUALITATIVE CHARACTERISTICS 1. Understandability • Classifying, characterising and presenting information clearly and concisely makes it understandable. • To understand accounting information, users are assumed to have a reasonable knowledge of business activities. • Information on complex issues if relevant, should not be eliminated, even though it is difficult for an average user to understand.
QUALITATIVE CHARACTERISTICS 2. Relevance – To be useful, information must be relevant to the decision making needs of users. – Information needs to be released on a timely basis. – Information should be capable of making a difference in the decisions made by users.
QUALITATIVE CHARACTERISTICS 3. Reliability • Information is reliable when it is free from errors and biases. • A faithful representation of transactions and events
QUALITATIVE CHARACTERISTICS 4. Comparability • Comparability of information allows users to evaluate and choose between alternatives. – Example: Selling or holding an investment. • Information is more useful if it can be compared with similar information about other entities and with similar information about the same entity for another period.
ACCOUNTING CONCEPTS • Accounting concepts are considered as the basic rules, assumptions or conventions adopted in preparing financial statements. • Accounting concepts are developed to ensure consistency and uniformity of accounting records.
ACCOUNTING CONCEPTS 1. Business Entity Concept • A business is considered as an independent entity separated from the owner of the business. • According to this concept, business transactions are entered in the records of the business, by looking at them from the point of view of the business and not from the point of view of the owner. • Therefore, any personal incomes and expenses of the owner should not be treated as incomes and expenses of the business.
ACCOUNTING CONCEPTS 2. Dual Aspects Concept • This concept states that every business transaction has two equal aspects (effects). – Example: – Purchased a stock worth Rs. 2,000 1 st Aspect (Effect) Rise in stock by Rs. 2,000 2 nd Aspect (Effect) Fall in cash by Rs. 2,000
ACCOUNTING CONCEPTS 3. Money Measurement Concept • Transactions and events that are capable of being measured in monetary terms only, are recognized in the financial statements. – Example: Skills and competence of employees cannot be measured in monetary terms, however salaries paid to them can be. • Typically, the currency of the respective country will be used to represent the accounting transactions.
ACCOUNTING CONCEPTS 4. Going Concern Concept • This implies that the business will continue to operate for the foreseeable future. • Financial Statements are prepared based on a going concern basis, and is assumed that the entity has neither the intention to liquidate or cease trading. – Example: Classification of Assets in to current and non-current assets.
ACCOUNTING CONCEPTS 5. Accounting Period Concept • This concept identifies the necessity of dividing the indefinite period of business life into shorter periods and prepare financial statements to represent each period. • To determine the profit or loss of an entity, and to ascertain its financial position, financial statements should be prepared at regular intervals of time, usually at the end of each year. This one-year cycle is known as the accounting period.
ACCOUNTING CONCEPTS 6. Accruals Concept • Accrual basis is a method of recording accounting transactions for revenue when earned and expenses when incurred. • Simply, revenues and expenses relevant to a particular accounting period must be taken into consideration, irrespective of the date of receipt or payment – Example: Electricity Bill payments • A key advantage of the accrual basis is that it matches revenues with related expenses, so that the complete impact of a business transaction can be seen within a single reporting period. • The alternative method for recording accounting transactions is the cash basis.
CLASS ACTIVITY • Identify the accounting concept/ principle for the following: – Drawings of the owner is accounted separately as a reduction in capital. – The financial statements need to be prepared at annual intervals. – The electricity expense of $4,000 has been accounted as an expense for the period even though it is not yet paid.
ELEMENTS OF ACCOUNTING Assets Liabilities Capital Income Expenses
ELEMENTS OF ACCOUNTING Assets • A resource which a business owns or controls to benefit from its use. • An Asset can be recognized when: – The firm owns or controls the right to use the item – It is probable that the future economic benefits embodied in the asset will flow to the entity – The asset cost can be measured reliably “ Asset is a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity “ • Assets may directly generate revenue for the organisation (e.g. inventory) or it may be something which supports the primary operations of the organisation (e.g. buildings).
ELEMENTS OF ACCOUNTING Assets • Non-current assets – Assets whose benefits are expected to last more than one year from the reporting date. – Examples: Long term investments/ Land/ Equipment/ Buildings • Current assets – Assets an organisation expects to use within one-year time from the reporting date – Assets which are held for the purpose of being traded – Examples: Inventory/ Cash and Cash equivalents/ Receivables/ Prepaid expenses
ELEMENTS OF ACCOUNTING Liabilities • An obligation of an organisation to transfer cash or other resources to another party. Examples- Bank loans/ Trade payables • A liability can be recognized when; – The entity has a present obligation – It is probable that an outflow of resources will be required to settle the obligation – A reliable estimate can be made of the amount of the obligation “ A liability is a present obligation of the enterprise arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits”
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