Introduction to Accounting

1.1 Nature and Purpose of Accounting

1.2 The objective of Financial Accounting
1.3 The Elements of Financial Statements
1.4 The Accounting Equation
1.5 The Users of Accounting Information

Accounting is defined as the process of identifying, measuring and reporting economic

information to the users of this information to permit informed judgment.
The definition
Identifying - this is the process of recognition or non-recognition of business activities
as accountable events. This is the process which determines if an event has accounting
relevance.
Measuring - this is the process of assigning monetary amounts to the accountable
events.
Communicating- Communicating accounting information is achieved by the
presentation of different financial statements.
Recording - The accounting term for recording is journalizing. All the accountable
events are recorded in a journal.
Classifying - The accounting term for recording is posting. All accountable events that
are recorded in the journal are then classified or posted to a ledger.
Summarizing - the items that are journalized and posted are summarized in the basic
financial statements.
BRANCHES OF ACCOUNTING
Accounting, in all its broadness, can be sub-divided into areas of specialization;
a. Financial accounting; concerns itself with the collection and processing of accounting
data and reporting to interested parties inside and outside the firm.
b. Tax accounting; deals with the determination of the firm’s tax liability which could be,
Value added tax (VAT), customs duty, Pay as you earn (PAYE), corporation tax etc.
c. Cost accounting; helps establish costs relating to the production of a good or service
and allocating it to the various factors that contributed to the cost of production.
d. Managerial accounting; deals with the generation of accounting information to be
used categorically by the firm’s internal management in their day-to-day decision
making.
e. Auditing; concerns itself with the vouching and verification of transactions from the
financial accounting to determine that they are a true representation of the business’
activity i.e. the true and fair view of the company’s state of affairs.
USERS OF ACCOUNTING INFORMATION
2 Users of financial statements and accounting information
The following people are likely to be interested in financial information about a large company with
listed shares.
(a) Managers of the company appointed by the company's owners to supervise the day-to-day activities
of the company. They need information about the company's financial situation as it is currently and as
it is expected to be in the future. This is to enable them to manage the business efficiently and to make
effective decisions.
(b) Shareholders of the company, ie the company's owners, want to assess how well the management
is performing. They want to know how profitable the company's operations are and how much profit
they can afford to withdraw from the business for their own use.
(c) Trade contacts include suppliers who provide goods to the company on credit and customers who
purchase the goods or services provided by the company. Suppliers want to know about the company's
ability to pay its debts; customers need to know that the company is a secure source of supply and is in
no danger of having to close down.
(d) Providers of finance to the company might include a bank which allows the company to operate an
overdraft, or provides longer-term finance by granting a loan. The bank wants to ensure that the
company is able to keep up interest payments, and eventually to repay the amounts advanced.
(e) The taxation authorities want to know about business profits in order to assess the tax payable by
the company, including sales taxes.
(f) Employees of the company should have a right to information about the company's financial
situation, because their future careers and the size of their wages and salaries depend on it.
(g) Financial analysts and advisers need information for their clients or audience. For example,
stockbrokers need information to advice investors; credit agencies want information to advise potential
suppliers of goods to the company; and journalists need information for their reading public.
(h) Government and their agencies are interested in the allocation of resources and therefore in the
activities of business entities. They also require information in order to provide a basis for national
statistics.
(i) The public. Entities affect members of the public in a variety of ways. For example, they may make a
substantial contribution to a local economy by providing employment and using local suppliers. Another
important factor is the effect of an entity on the environment, for example as regards pollution.

Accounting information is summarised in financial statements to satisfy the information needs of these
different groups. Not all will be equally satisfied.
Needs of different users Managers of a business need the most information, to help them make their
planning and control decisions. They obviously have 'special' access to information about the business,
because they are able to demand whatever internally produced statements they require. When
managers want a large amount of information about the costs and profitability of individual products, or
different parts of their business, they can obtain it through a system of cost and management
accounting.
OBJECTIVES OF ACCOUNTING
The objectives of accounting can be given as follows:
Systematic recording of transactions - Basic objective of accounting is to systematically
record the financial aspects of business transactions i.e. book-keeping.
Ascertainment of results of recorded transactions - Accountant prepares profit and loss
account to know the results of business operations for a particular period of time. If
revenue exceeds expenses then it is said that business is running profitably and vice
versa.
Ascertainment of the financial position of the business - Businessman is not only
interested in knowing the results of the business in terms of profits or loss for a
particular period but is also anxious to know that what he owes (liability) to the outsiders
and what he owns (assets) on a certain date. To know this, accountant prepares a
financial position statement popularly known as Balance Sheet. The balance sheet is a
statement of assets and liabilities of the business at a particular point of time and helps
in ascertaining the financial health of the business.
Providing information to the users for rational decision-making - Accounting like a
language of commerce communes the monetary results of a venture to a variety of
stakeholders by means of financial reports. To
know the solvency position: By preparing the balance sheet, management not only
reveals what is owned and owed by the enterprise, but also it gives the information
regarding concern's ability to meet its liabilities in the short run (liquidity position) and
also in the long run (solvency position) as and when they fall due
ACCOUNTING EQUATION AND ELEMENTS OF FINANCIAL STATEMENTS
The accounting equation, also called the basic accounting systems. In fact, the entire
double entry accounting concept is based this. This equation illustrates two facts about
a company: what it owns and what it owes.
The accounting equation equates a company's assets to its liabilities and equity.
ASSETS = LIABILITIES + CAPITAL
Elements of Financial Statements
The elements of financial statements are the general groupings of line items
contained within the statements. These groupings will vary, dependi ng on the
structure of the business. They include:
a)Assets
An asset is a resource controlled by a business entity/firm as a result of past events for
which economic benefits are expected to flow to the firm
Some assets are tangible like cash while others are theoretical or intangible like
goodwill or copyrights.
Assets are classified into two main types:
i) Non-current assets (formerly called fixed assets).
Non-current assets are acquired by the business to assist in earning revenues and not
for resale. They are normally expected to be in business for a period of more than one
year.
Features of Non-current assets
There are tangible and intangible
There depreciate and appreciate
There are not for sales
There assist in the operation of the business
There last longer in the business.
Major examples include:
Land and buildings
Plant and machinery
Fixtures, furniture, fittings and equipment
Motor vehicles
ii) Current assets.
Current assets are not expected to last for more than one year. They are in most cases
directly related to the trading activities of the firm.
Examples include:
Stock of goods – for purpose of selling.
Trade debtors/accounts
Cash at bank.
Cash in hand
b)Liabilities
These are obligations of a business as a result of past events settlement of which is
expected to result to an economic outflow of amounts from the firm.
Liabilities are also classified into two main classes
i) Non-current liabilities are expected to last or be paid after one year. This includes
long-term loans from banks or other financial institutions.
ii) Current liabilities last for a period of less than one year and therefore will be paid
within one year. Major examples:
Trade creditors/ or accounts payable.
Bank overdraft
c) Capital /equity:
This is the residual amount on the owner’s interest in the firm after deducting liabilities
from the assets. This is the amount invested in a business by its owners, plus any
remaining retained earnings.

d) Revenue. This is an increase in assets or decrease in liabilities caused by the

provision of services or products to customers. It is a quantification of the gross

activity generated by a business. Examples are product sales and service sales.

e) Expenses This is the reduction in value of an asset as it is used to generate

revenue.