DEFINITION OF ACCOUNTING

Accounting is a service entity. Its function is to provide quantitative information, primarily financial in
nature, about economic entities that are intended to be useful in making economic decisions.
Accounting is an information system that measures, processes and communicates financial information
about an economic entity.
Accounting is the process of identifying, measuring and communicating economic information to permit
informed judgments and decisions by users of the information.
Accounting is the art of recording, classifying and summarizing in a significant manner and in terms of
money, transactions and events which are in part at least, of a financial character, and interpreting the re -
sults thereof.
Accounting is the language of business

FUNCTIONS OF ACCOUNTING
1 Main function – to provide quantitative information, primarily financial in nature, about eco-
nomic entities, that is intended to be useful in making economic decision.
2 Basic function – to record and report accurately the economic reality of the business.
3 Audit function – to test the truthfulness of the financial reports, to trace fraudulent transactions
and to locate and rectify accounting errors.

THE ACCOUNTING EQUATION

Financial statements tell us how a business is performing. They are the final products of the accounting
process. But how do we arrive at the items and amounts that make the financial statements? The most ba -
sic tool of accounting is the accounting equation. This equation presents the resources controlled by the
enterprise, the present obligations of the enterprise and the residual interest in the assets. It states that as -
sets must always equal liabilities and owner's equity. The basic accounting model is:
Assets = Liabilities + Owner's Equity

Note that the assets are on the left side of the equation opposite the liabilities and owner's equity. This ex-
plains why increases and decreases in assets are recorded in the opposite manner (“mirror image") as lia-
bilities and owner's equity are recorded. The equation also explains why liabilities and owner's equity fol -
low the same rules of debit and credit.

The logic of debiting and crediting is related to the accounting equation. Transactions may require addi -
tions to both sides (left and right sides), subtractions from both sides (left and right sides), or an addition
and subtraction on the same side (left or right side), but in all cases the equality must be maintained.
DEBITS AND CREDITS-THE DOUBLE-ENTRY SYSTEM
Accounting is based on a double-entry system which means that the dual effects of a business transaction
is recorded. A debit side entry must have a corresponding credit side entry. For every transaction, there
must be one or more accounts debited and one or more accounts credited. Each transaction affects at least
two accounts. The total debits for a transaction must always equal the total credits.

An account is debited when an amount is entered on the left side of the account and credited when an
amount is entered on the right side. The abbreviations for debit and credit are Dr. (from the Latin debere)
and Cr. (from the Latin credere), respectively.

The account type determines how increases or decreases in it are recorded. Increases in assets are
recorded as debits (on the left side of the account) while decreases in assets are recorded as credits (on the
right side). Conversely, increases in liabilities and owner's equity are recorded by credits and decreases
are entered as debits.

The rules of debit and credit for income and expense accounts are based on the relationship of these ac-
counts to owner's equity. Income increases owner's equity and expense decreases owner's equity. Hence,
increases in income are recorded as credits and decreases as debits. Increases in expenses are recorded as
debits and decreases as credits. These are the rules of debit and credit.

ACCOUNTING CYCLE
The accounting cycle refers to a series of sequential steps or procedures performed to accomplish the ac-
counting process. The steps in the cycle and their aims follow:
1 Identification of Events to be Recorded
Aim: To gather information about transactions or events generally through the source documents.
2 Transactions are Recorded in the Journal
Aim: To record the economic impact of transactions on the firm in a journal, which is a form that
facilitates transfer to the accounts.
3 Journal Entries are posted to the Ledger
Aim: To transfer the information from the journal to the ledger for classification.
4 Preparation of a Trial Balance
Aim: To provide a listing to verify the equality of debits and credits in the ledger.
5 Preparation of the Worksheet including Adjusting Entries
Aim: To aid in the preparation of financial statements.
6 Preparation of the Financial Statements
Aim: To provide useful information to decision-makers.
7 Adjusting Journal Entries are Journalized and Posted
Aim: To record the accruals, expiration of deferrals, estimations and other events from the work -
sheet.
8 Closing Journal Entries are Journalized and Posted
Aim: To close temporary accounts and transfer profit to owner's equity.
9 Preparation of a Post-Closing Trial Balance
Aim: To check the equality of debits and credits after the closing entries.
10 Reversing Journal Entries are Journalized and Posted
 Aim: To simplify the recording of certain regular transactions in the next accounting peri

ACCOUNTING CYCLE

2 3

Transactions Journal entries

5
1 14
7 8are recorded in are posted to
6 9 0
the journal the ledger
Preparation of
the trial balance
Identification of
events to be
recorded

Preparation of
the worksheet
including ad-
justing entries
Preparation of
the financial Reversing journal
statements entries are journal-
Adjusting journal en- ized and posted
tries are journalized
and posted

Closing journal
entries are Preparation of
journalized and the post-closing
posted trial balance

This cycle is repeated each accounting period. The first three steps in the accounting cycle are accom-
plished during the period. The fourth to the ninth steps generally occur at the end of the period. The last
step is optional and occurs at the beginning of the next period.
THE JOURNAL
The journal is a chronological record of the entity's transactions. A journal entry shows all the effects of a
business transaction in terms of debits and credits. Each transaction is initially recorded in a journal rather
than directly in the ledger. A journal is called “book of original entry”. The nature and volume of transac-
tions of the business determine the number and type of journals needed. The general journal is the sim-
plest journal.

EFFECTS OF TRANSACTIONS
1 Increase in Assets = Increase in Liabilities (SA)
2 Increase in Assets = Increase in Owner's Equity (SA)
3 Increase in one Asset = Decrease in another Asset (EA)
4 Decrease in Assets = Decrease in Liabilities (UA)
5 Decrease in Assets = Decrease in Owner's Equity (UA)
6 Increase in Liabilities = Decrease in Owner's Equity (EC)
7 Increase in Owner's Equity = Decrease in Liabilities (EC)
8 Increase in one Liability = Decrease in another Liability (EC)
9 Increase in one Owner's Equity = Decrease in another Owner's Equity (EC)

PERMANENT ACCOUNTS
Permanent accounts are accounts that are not closed at the end of the accounting period. Permanent ac -
counts maintain a cumulative balance that are carried over from one accounting period to another. The ac-
counts found in the Statement of Financial Position are permanent accounts.

TEMPORARY ACCOUNTS
Temporary accounts are the opposite of the permanent accounts. They are closed at the end of each ac-
counting period and do not maintain a cumulative balance. The accounts found in the Statement of Com-
prehensive Income are temporary accounts.