ACCOUNTING UNIT 1

MODULE 1 OBJECTIVE 1 & 2

Prepared by Dyad Business Academy

 OBJECTIVE 1:
THE NATURE
AND SCOPE OF
FINANCIAL
ACCOUNTING
 QUESTION
Based on your
experience as an
accounting student,
what do you think
accounting is all about?
 WHAT IS ACCOUNTING?

Accounting is the process

of recording; classifying,
selecting, measuring,
interpreting and
communicating financial
data of an organization to
enable users make
decision.
 The purpose is to help people
who use this information to
make decisions that are more
informed. If the financial
information that is
communicated is not capable
PURPOSE OF of improving the quality of
ACCOUNTING decisions made, there would be
no point in producing it. The
ultimate purpose of
accountant’s work is to give
people better financial
information on which to base
their decisions.
 FINANCIAL ACCOUNTING
AND IT’S ROLE
Financial Accounting, often referred to as
‘external’ accounting, is concerned with
recording and preparing financial statements
and reporting the state of health of the
company’s business for a prescribed
accounting period. The main role of financial
accounting is to:

- Record financial transactions e.g. paying

utilities, salaries, etc.
- Provide other stakeholders with legal/ vital
information.
Accounting arguably began before the
use of abstract counting. Around 7,500
BC, the Mesopotamians were using small
clay objects as counters for keeping
account of goods. Each object
represented quantities of different types
of commodities, such as food, clothing, HISTORY OF
and even labor. They became
increasingly complex over centuries, ACCOUNTING
bearing intricate markings, and
eventually, imprints of these markings
onto parchment replaced the counters
themselves. According to many scholars,
accounting and writing evolved side-by-
side in this way.
 History of
Accounting
 The need to keep a record of both goods
and currency was accelerated by several
factors. One was the ability to accumulate
personal wealth. Affluent members of
society wanted to record what they had,
what they owed, and what was owed to
them.

HISTORY OF Another factor was the rise of ruling entities

ACCOUNTING such as royal families and governments. A
particular concern for these sections of
society was finding more consistent ways to
record and demand tax. The growth of
global trade meant commerce was
happening on a much larger scale. Trading
with vastly different societies for diverse
resources meant that traders could easily
lose track of their activity without detailed
records.
 In 1494, Luca Pacioli first properly
described the double entry
bookkeeping system we are
familiar with today. Referred to as
‘the father of bookkeeping and
accounting’, he defined much
modern day thinking about debits,
HISTORY OF credits, journals, and ledgers. He
ACCOUNTING set out a comprehensive
accounting cycle, which described
a clear process for those involved
with accounts to follow. Among
other things, he introduced ledgers
based on assets receivables and
inventories, liabilities, capital,
expenditure, and income accounts.
 QUESTION

Click the link below.

Watch the video and identify the

possible answers to the following.

1. What is the significance of

accounting information?
2. Explain TWO limitations of
accounting information?
Accounting information provides vital insight into a
company's current financial position and is a valuable
indicator into how a firm will perform in the future. With
accounting information, management can evaluate a
company's financial position, make appropriate use of
resources, and plan how to take the company forward
in the future. The main objective of financial
information is to decide on the amount and certainty of
cash for investment and for credit. In considering
economic activities in the form of transactions, it is
possible to plan ahead.

SIGNIFICANCE OF ACCOUNTING
INFORMATION
Financial information allows for
businesses to report to external
users a summary of past economic
events of the recently concluded
financial period, reflecting the
entity’s financial performance SIGNIFICANCE
(Statement of Comprehensive
Income) and financial position
OF
(Statement of Financial Position). ACCOUNTING
This should be done in a timely INFORMATION
manner to allow the users to make
effective economic decisions.
These reports are called general
purpose financial statements.
 The following are the main limitations of
accounting information:
1. Different accounting policies and frameworks

2. Accounting estimates
LIMITATIONS
3. Professional judgment
OF
ACCOUNTING 4. Verifiability
INFORMATION
5. Use of historical cost

6. Measurability

7. Limited predictive value

 DIFFERENT ACCOUNTING POLICIES AND
FRAMEWORKS

Accounting frameworks such as IFRS allow the preparers of

financial statements to use accounting policies that most
appropriately reflect the circumstances of their entities.

Whereas a degree of flexibility is important in order to

present reliable information of a particular entity, the use of
diverse set of accounting policies amongst different entities
impairs the level of comparability between financial
statements
Accounting requires the use of estimates in the
preparation of financial statements where precise
amounts cannot be established. Examples of estimates:
- Provision for depreciation
- Provision for doubtful debts

Estimates are inherently subjective and therefore lack

precision as they involve the use of management's
foresight in determining values included in the financial
statements. Where estimates are not based on objective
and verifiable information, they can reduce the
reliability of accounting information.

ACCOUNTING ESTIMATES
 PROFESSIONAL
JUDGEMENT
The use of professional judgment by the
preparers of financial statements is
important in applying accounting policies in a
manner that is consistent with the economic
reality of an entity's transactions. However,
differences in the interpretation of the
requirements of accounting standards and
their application to practical scenarios will
always be inevitable. The greater the use of
judgment involved, the more subjective
financial statements would tend to be.
 Audit is the main mechanism that
enables users to place trust on
financial statements. However,
audit only provides 'reasonable'
and not absolute assurance on
the truth and fairness of the
VERIFIABILIT financial statements which means
Y that despite carrying audit
according to acceptable
standards, certain material
misstatements in financial
statements may yet remain
undetected due to the inherent
limitations of the audit.
 Historical cost is the most widely
used basis of measurement of
assets. Use of historical cost
presents various problems for the
users of financial statements as it
USE OF fails to account for the change in
HISTORICAL price levels of assets over a period
of time. This not only reduces the
COST relevance of accounting information
by presenting assets at amounts
that may be far less than their
realizable value but also fails to
account for the opportunity cost of
utilizing those assets.
Accounting only considers transactions
that are capable of being measured in
monetary terms. Therefore, financial
statements do not account for those
resources and transactions whose
value cannot be reasonably assigned
such as the competence of workforce
or goodwill.

MEASURABILITY
 Financial statements present
an account of the past
performance of an entity.
LIMITED They offer limited insight into
PREDICTIV the future prospects of an
E VALUE enterprise and therefore lack
predictive value which is
essential from the point of
view of investors.
 THE USERS OF
ACCOUNTING
INFORMATION
AND THEIR NEEDS
 THE USERS OF ACCOUNTING
INFORMATION AND THEIR NEEDS

They can be divided

Users of accounting into two main
information usually have categories namely
direct economic interests in and external
the business enterprise. users internal
users .
Internal users are decision
makers like owners and
managers who are responsible
for the management of the
business enterprise. They use
accounting information to set INTERNAL
goals for the company, to USERS
evaluate progress towards the
goals set, and to take
corrective actions if necessary.
 INTERNAL USERS - OWNERS

The owners provide funds for the operations of a

business and they want to know whether their funds
are being properly used or not. They need accounting
information to know the profitability and the financial
position of the concern in which they have invested
their funds. The financial statements prepared from
time to time from accounting records depicts them
the profitability and the financial position.
 INTERNAL USERS -
MANAGEMENT

Accounting information is an
Management is the art aid in this respect because it Thus, accounting
of getting work done helps a manager in information provides
through others, the appraising the performance the eyes and ears to
management should of the subordinates. Actual
performance of the management.
ensure that the
subordinates are doing employees can be compared Managers use
work properly. with the budgeted accounting records to
performance they were operate organizations
expected to achieve and
remedial action can be taken efficiently, profitably
if the actual performance is and also to plan for the
not up to the mark. future.
 INTERNAL USERS - EMPLOYEES
Employees are interested in the financial position
of a business entity they serve particularly when
payment of bonus depends upon the size of the
profits earned.
Therefore, they are interested in the company's
profitability and its consequence on their future
remuneration and job security.
This category of user is therefore interested in
knowing whether their jobs are secure and that
they will be paid wages, salaries and other
benefits on time.
 These are parties who show
keen interest in the company
and want to make use of the
information to make
appropriate decisions about
EXTERNAL the company.
USERS External users include
government agencies,
creditors (including banks
and supplier), existing and
potential investors,
employees and unions, and
customers.
 EXTERNAL USERS - CREDITORS

These users are interested in determining the credit

worthiness of the organization. Creditors (i.e.
supplier of goods and services on credit, bankers
and other lenders of money) want to know the
financial position of a concern before giving loans or
granting credit. They want to be sure that the
concern will not have trouble in making their
payment in time i.e. liquid position of the concern is
satisfactory.
 EXTERNAL USERS –
GOVERNMENT/TAX AUTHORITIES
These users determine the
credibility of the tax returns
filed on behalf of the company.
Tax authorities are interested in
the accounting information
because they want to know
earnings or sales for a
particular period for purposes
of taxation.
 EXTERNAL USERS – INVESTORS
Those who are interested in investing
money in an organization are interested in
knowing the financial health of the
organization, thus analyzing the feasibility
of investing in the company. Investors want
to make sure they can earn a reasonable
return on their investment before they
commit to any financial resources to the
company. To know the financial health,
they need accounting information which
will help them in evaluating the past
performance and future prospects of the
organization
 These parties are interesting when
assessing the financial position of its
suppliers (the business) which is
necessary for them to maintain a stable
source of supply in the long term.
EXTERNAL
USERS
CUSTOMER
The customers to desire to be
comfortable knowing that they have
access to quality goods and services
 EXTERNAL USERS –
REGULATORY AUTHORITIES
This party needs to ensure
that the company's disclosure
of accounting information is
in accordance with the rules
and regulations set in order
to protect the interests of the
stakeholders who rely on
such information in forming
their decisions
 THE
ACCOUNTING
CYCLE
The accounting cycle
illustrates a clear, yet
systematic framework on
recording accounting
information. The accounting
cycle goes through stages of THE
systematic recording, ACCOUNTING
starting from the CYCLE
documentation of
transactions and ending
with preparation of post-
closing trial balance.
THE
ACCOUNTING
CYCLE
 The first step in the accounting
cycle is to gather all the
documents that are related to
financial transactions of the
STEP 1: organization. These documents
TRANSACTIONS are called source documents.
ARE ANALYZED Examples include sales and
BY EXAMINING purchases invoices, debit and
THE SOURCE credit notes for returns, receipts
for cash paid out and received
DOCUMENTS.
and bank pay- in- slips and
cheque counterfoils orders. They
are the items which describe each
transaction which has occurred
during the financial period.
The information acquired from the source
documents is then recorded in the Books of
Original Entry (Journals). They are also called
STEP 2:
prime entry, subsidiary books or day books. DETAILS OF THE
SOURCE
- Purchase daybook/ journal
- Sales daybook/ journal
DOCUMENTS
- Purchase returns/ Returns outward book
ARE RECORDED
- Sales returns/ Returns inwards book IN VARIOUS
- Cash book JOURNALS.
- Petty cash book
- General Journal
 A ledger is a book or an
electronic record of all the
STEP 3: accounts of a company.
JOURNAL There are three main
ENTRIES ARE Ledgers. These are: Sales,
POSTED TO Purchases and General
VARIOUS
Ledger. The appropriate
LEDGERS.
debits and credits from
the journal are posted to
the affected accounts in
the ledger.
After posting information to the
ledger, accounts are balanced,
and the arithmetical accuracy STEP 4: A
of the accounting records is TRIAL
checked. A trial balance is BALANCE IS
prepared for this reason and is PREPARED TO
a list of all the company's CHECK ANY
accounts and their balance at POSTING
the time it was prepared. The ERROR.
total debit balance and total
credit balance must be equal.
 Adjusting entries are journal
STEP 5: entries recorded at the end of
ADJUSTMENTS an accounting period to adjust
ARE MADE TO income and expense accounts
so that they comply with the
THE accrual concept of accounting.
ACCOUNTS Their main purpose is to match
TO COMPLY incomes and expenses to
WITH THE appropriate accounting periods.
ACCOUNTING Adjusting entries are made at
CONCEPTS. the end of the accounting
period, but not at the end of
the accounting cycle.
The adjusted trial STEP 6:
balance is prepared to PREPARATIO
prove the equality of the N OF THE
debits and credits after ADJUSTED
adjusting entries have TRIAL
been made. BALANCE.
 Financial statements include:

STEP 7: - Statement of Comprehensive

FINANCIAL Income - This statement measures
STATEMENTS how well a company is performing
financially during a specific time
ARE PREPARED period. If the company realized a
IN profit, it therefore made a net
ACCORDANCE profit. If it lost money, it means
WITH THE that the company made a net loss.
ACCOUNTING - Statement of Financial Position -
GUIDELINES. This statement shows what the
business owns (assets) and what
the business owes (liabilities and
capital) at a particular date.
 Financial statements include:

- Statement of Cash Flows – This

STEP 7: statement shows the inflows and
FINANCIAL outflows of cash during the
STATEMENTS financial period. The movement of
ARE PREPARED cash is categorized under
IN operating, investing and financing
activities.
ACCORDANCE
WITH THE - Notes to Financial Statements –
this allows for the disclosure of
ACCOUNTING facts that can assist the users of
GUIDELINES. accounting information
interpretation of the financial
statements.
 STEP 8: CLOSING ENTRIES

At the end of the accounting

period, the company makes the
accounts ready for the next period.
This is called closing the books. In In contrast, permanent accounts
closing the books, the company relate to one or more future
distinguishes between temporary accounting periods. Permanent
(nominal) and permanent (real) accounts are not closed from
accounts. Temporary accounts period to period. Instead, the
relate only to a given accounting company carries forward the
period. The company closes all balances of permanent accounts
temporary accounts at the end of into the next accounting period.
that period. The rationale for this is
to essentially “empty” or bring the
balances to zero.
 STEP 8: CLOSING ENTRIES

In contrast, permanent accounts relate to one or more future accounting

periods. Permanent accounts are not closed from period to period. Instead,
the company carries forward the balances of permanent accounts into the
next accounting period.
Temporary (Nominal) Accounts Permanent (Real) Accounts (Statement
(Statement of Comprehensive Income) of Financial Position)

All Revenue Accounts All Asset Accounts

All Expenses Accounts All Liability Accounts

Owner’s Drawings Account Owner’s Capital Account

 STEP 9:
PREPARATION The post-closing trial balance
OF THE POST- is prepared to prove the
CLOSING equality of the debits and
TRIAL credits after closing entries
BALANCE.
have been made.
OBJECTIVE 2
ACCOUNTING
METHODS
 OBJECTIVE 2
ACCOUNTING
METHODS

After viewing the video, in your own

words identify the two accounting
methods and explain the difference that
 CASH BASIS

Cash Basis -Marlon was hired

Cash basis accounting is a to cut Jaime’s lawn. Jaime
method in which revenue is was travelling and decided to
recorded when cash is pay him one week after he
received, and expenses are cut the lawn. Marlon will
recorded when cash ONLY record the transaction
payments are made. when he actually receives
the money from Jaime.
 Accrual basis accounting is a method in
which revenue is recorded when it is
earned, and expenses are recorded
when they are incurred rather than
when cash is received or disbursed.

Accrual basis accounting is required in

the preparation of general-purpose
ACCRUAL BASIS financial statements as it considers all
the economic activity of the entity that
has occurred during the financial period
under review.

This gives a true and fair view of the

entity’s performance, allowing for
greater ability to predict future cash
flows.
 ACCRUAL BASIS
Under the accrual basis Marlon
will record the money as
earned when he actually cuts
the lawn and not when he
receives the money. Therefore,
the day Marlon cuts Jaime’s
lawn he will make a record of
revenue earned and accrued
even though he has not
received payment. He will then
record the receipt of money
when Jaime pays him.