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INSTITUTE OF ACCOUNTANCY ARUSHA

(BBM I & BPLM I 2024/2025)

INTRODUCTORY ACCOUNTING (IA)

TOPIC: ACCOUNTING POLICIES, PROCESSES AND PRINCIPLES

Learning objectives

✓ Introduction to accounting
✓ Objectives of accounting
✓ Users of accounting information and their needs
✓ Accounting concepts, principles and conventions
✓ Accounting equation

Introduction to accounting

Accounting is the process of systematically recording, summarizing, analyzing, and reporting

financial transactions and information of an organization to permit informed judgements and
decisions to users of financial information. It helps businesses and individuals track their financial
activities, assess their financial health, make informed decisions, and comply with relevant
financial regulations. Accounting involves various aspects, including bookkeeping, financial
statements, auditing, and tax preparation, and it plays a crucial role in providing insights into
an entity's financial performance and position.

Studying accounting is essential for a multitude of reasons. Firstly, it provides a strong foundation
for a wide range of lucrative and in-demand career opportunities, from becoming a certified public
accountant to financial analyst or auditor. Secondly, it equips individuals with vital financial
literacy skills, enabling them to manage personal finances, investments, and make informed
financial decisions. Additionally, understanding accounting is crucial for effective business
management, helping track financial performance, make budgeting decisions, and assess project
and investment viability.
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The primary functions of accounting are:

✓ Recording – capturing all financial transactions accurately.

✓ Classifying – organizing data into categories (like assets, liabilities, income, and
expenses).
✓ Summarizing – creating summary reports such as financial statements.
✓ Analyzing – interpreting data to understand financial trends.
✓ Communicating – sharing information with stakeholders, including investors, regulators,
and management.
Why Did Accounting Start?

The need for accounting began with the earliest human transactions and evolved as societies
became more complex. The primary reasons accounting started include:

✓ Record-Keeping – Early humans needed to keep track of resources like grains, livestock,
and goods, especially in agrarian and trading societies.

✓ Trade and Commerce – As trade expanded, merchants and traders needed to record
transactions to avoid disputes and calculate profits. Accounting provided a way to
document agreements and exchanges, supporting trust and commerce.

✓ Public Works and Taxation – Governments needed accurate records to manage taxation
and fund public works. In ancient civilizations, accounting records were crucial for
managing government spending and ensuring accountability.

✓ Ownership and Property Rights – Accounting helped document ownership of property

and debts, which were crucial for the development of legal and economic systems.

✓ Business Management – As businesses grew, accounting became essential for tracking

expenses, assets, and revenue to assess profitability and make informed business decisions.

In essence, accounting started as a fundamental necessity for human societies to manage resources,
trade, and finances accurately. Over time, it evolved to meet the needs of growing economies and
remains an essential tool for business, government, and individual financial management today.
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Objectives of accounting
Accounting has many objectives, including letting individuals and organizations know:
➢ If they are making a profit or a loss,
➢ What transaction(s) was worth to them,
➢ How much cash they have,
➢ How wealthy they are,
➢ How much they are owed and owe to someone else.
Users of financial information and their needs

Investors: Existing investors are current shareholders who use financial information to assess the
performance and profitability of their investments, helping them make decisions about holding,
selling, or increasing their shares. Potential or external investors, who have not yet invested, rely
on financial data to evaluate the financial health, growth potential, and risk profile of a company
before making investment decisions. Both groups use financial statements to gauge a company's
ability to generate returns, manage debts, and maintain long-term viability.

Financial institutions: financial institutions, such as banks and bondholders, use financial
statements to evaluate an entity's creditworthiness and its ability to repay loans or honor debt
obligations. They are interested in solvency, liquidity, and the ability to service debt.

Management: Internal management relies on financial data for decision-making, including

budgeting, planning, and performance evaluation. They need accurate and timely information to
monitor the company's progress and make strategic choices.

Government agencies and regulators: Government agencies and regulatory bodies require
financial statements to ensure compliance with financial regulations and tax laws. They need
information to enforce legal and regulatory standards.

Employees: Employees may use financial information to assess the stability and financial health
of their employer. They are particularly interested in job security, potential for salary increases,
and the financial stability of the company's pension or retirement plans.

Suppliers: Suppliers assess a company's financial stability to determine whether they will extend
credit or provide goods and services on credit terms. They want to ensure they will be paid for
their products or services.
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Customers: Customers may be interested in a company's financial health as it can affect the
continuity of products or services they rely on. For instance, they may be concerned about warranty
support or long-term service contracts.

Competitors: Competitors may use publicly available financial data to gain insights into a rival
company's performance and financial strategies, helping them make informed decisions in the
market.

Financial Analysts: Financial analysts, such as equity and credit analysts, use financial data to
provide insights and recommendations to investors and other stakeholders. They rely on financial
statements to make informed investment and lending decisions.

Public: Researchers and academics use financial accounting data for academic studies, economic
research, and industry analysis. They may seek to understand trends, economic impacts, and
industry performance.

Accounting concepts, principles and conventions

Business Entity Concept: The business entity concept ensures that a business’s financial
transactions are kept separate from the personal finances of its owners or other businesses. This
principle is crucial for accurate record-keeping and reporting, as it means that any funds invested
by the owner are seen as a liability of the business rather than a personal expense or income. For
instance, if the business borrows money or receives payments, these are recorded as business
liabilities or revenues, not the owner’s personal transactions. This clarity helps maintain
transparency and accountability in financial reporting.

Going Concern: The going concern concept assumes that a business will continue to operate
indefinitely and does not anticipate liquidation or closure in the near future. This assumption
allows financial statements to present assets and liabilities at their ongoing operational value rather
than at a liquidation or sale value. For example, the costs of machinery are spread over its useful
life through depreciation, reflecting the assumption that the business will continue to use the
machinery rather than sell it immediately.
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Accrual Basis: The accrual basis of accounting records income and expenses when they are earned
or incurred, regardless of cash transactions. This approach provides a more accurate picture of a
company’s financial performance, as it aligns revenue and expenses with the periods in which they
actually apply. For instance, if a company performs a service in one month but doesn’t receive
payment until the next, the income is still recorded in the month the service was performed to
match the time period when the revenue was generated.

Historical Cost: Historical cost requires assets to be recorded at their original purchase price rather
than their current market value. This concept emphasizes objectivity and stability, as it relies on
verifiable amounts rather than fluctuating market prices. For instance, a company that bought land
several years ago records the land’s cost based on what it originally paid, regardless of any
increases or decreases in value. This prevents subjective inflation or deflation of asset values in
financial reports.

Consistency: Consistency in accounting methods ensures that financial statements are comparable
over time. This principle requires businesses to apply the same accounting practices across periods
unless there is a valid reason for change, which must be disclosed. For example, if a business uses
a specific method for calculating depreciation, it should continue to use that method year after
year. If a different method is needed, the change is documented to maintain transparency and allow
users to understand financial performance changes.

Materiality: The materiality concept ensures that only transactions significant enough to impact
financial decisions are individually reported. Small, immaterial transactions that would not affect
decision-making are either grouped together or omitted to maintain clarity and efficiency. For
example, small office supplies are typically expensed as general office expenses rather than
recorded separately, as their impact on the financial statement is minimal. Materiality keeps the
focus on important information, simplifying reports for users.

Duality (Dual Aspect): Duality or the dual aspect concept is the foundation of double-entry
bookkeeping, where every transaction has two corresponding entries – a debit and a credit. This
principle ensures that the accounting equation (Assets = Liabilities + Equity) remains balanced.
For example, when a business purchases goods on credit, one account (inventory) increases by the
purchase amount, while another account (accounts payable) reflects the corresponding liability.
This dual effect captures the complete impact of each transaction, ensuring accurate records.
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Monetary Measurement: The monetary measurement concept requires that only transactions that
can be quantified in monetary terms are recorded. This ensures a common denominator, as all
financial data is measured using currency, which serves as both a unit of account and a store of
value. For instance, a business records financial information like revenue, expenses, and asset
values, but it does not quantify or include qualitative factors like brand reputation or employee
satisfaction, as these cannot be expressed in monetary terms.

Substance over form: It states that transactions and other events should be accounted for and
presented in accordance with their substance and financial reality and not merely with their legal
form. For instance, if you buy a motor vehicle for your business on hire purchase, when you make
down payment, you can be given the vehicle to use as you continue making installment payments.
The registration book, which is the evidence of ownership, will not be released to you until you
make the last installment payment. The lawyers say that title passes on fully paying up. The
question then is, how do you account for such vehicle, should you make it off-balance sheet i.e.
not to be recorded in your statement of financial position? Substance over form gives the answer
as follows: the substance and reality is that you are using the vehicle in your business so it is the
business asset and should be recorded in its books and financial statements. You should stop
worrying about legalities of title passing after all you will complete installment payments and
documents of ownership will be surrendered to you.

Periodicity and disclosure: This concept makes financial reporting mandatory and is enshrined in
companies’ act of Tanzania and many other countries. At the end of the accounting period or
financial year (may not be a calendar year but twelve months); a company must prepare and
disclose financial statements. Publishing annual accounts is made an obligation by this concept.
Disclosure can be made more than once in a year if the accountant so wishes. If interim accounts
are to be published, it is not discouraged. Non-disclosure even once a year is illegal. All material
information must be disclosed, an accountant must not be seen to be hiding some vital information.
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Accounting equation

The accounting equation, also known as the balance sheet equation, is a fundamental concept in
accounting that represents the relationship between a company's assets, liabilities, and equity. It is
expressed as:

Assets = Equity + Liabilities

Assets represent everything of value that a company owns or controls, including cash in hand, cash
at bank, inventory, and accounts receivable.

Liabilities are the company's financial obligations, such as short-term and long-term loans,
accounts payable, and accrual expenses.

Equity represents the residual interest in the assets of the entity after deducting its liabilities. It
includes the owner's investment and retained earnings.

The accounting equation must always balance, meaning that the total value of assets must equal
the sum of liabilities and equity. This equation serves as the foundation for preparing financial
statements and helps ensure that the accounting records are accurate and complete.

Reading assignment
Choose one of the recommended accounting books provided to you via module guideline then read
carefully on the following issues;
✓ Accounting policies, principles and conventions.
✓ Double entry principle of accounting.
✓ Accounting equation.
✓ The effects of business transaction on accounting equation.
✓ Accounting cycle.