he Purpose of Accounting :

 Definition of accounting

o Accounting is the process of classifying, summarizing, recording, interpreting and communicating

financial information.

 Identifying: Establishing the essential characteristics or features of.

 Classifying and summarizing: sorting out data in a useful order.

o To Classify - to arrange or place items into categories or groups.

o To Summarize – To create a short description that gives the main facts in a condensed form.

 Measuring: placing a value; assigning numbers; determining the size

 Recording: make an official note of in writing, printing, or such.

 Interpreting: explain the meaning of something in clear, understandable terms.

 Communicating / Reporting: Presenting data to stakeholders like internal management and

 The purpose of accounting

o The purpose of accounting is to provide information about financial situation of an organization, so

informed decisions can be made.

 Difference between accounting and bookkeeping

o Definition of Bookkeeping – Bookkeeping is the recording of the accounting of a business.

 Bookkeeping consists of entering transactions into the journals, making adjustments, maintaining
precise and

accurate records, and preparing reports that keep management up to date on the financial condition
of their

company.

 Bookkeeping is, therefore, a part of accounting, the part concerned with recording information and

preparing accounts. Accounting involves interpreting the information recorded by the bookkeeper,
and

preparing reports in a way that management can use for decision making.

o Accountants are responsible for the design and management of the financial systems that
bookkeepers use.

 They prepare monthly financial statements and tax returns at year end.

 Accountants may also prepare budgets for management and loan proposals for bankers;

 They may also perform cost analysis for the company’s products or services.
Users of Accounting :

 The Users of Accounting Information: need to know profitability & liquidity of business, resources
and liabilities

Internal Users

o Owners of the Business – need to know profitability & liquidity of business; money in and out;
financial resources

o Management: - need to know profitability & liquidity of business - decision-making

o Employees / Trade Unions – Collective bargaining…negotiations for better wages etc.

External Users

o Potential Investors – general public and financial institutions e.g. unit trust – risk and return of
investment

o The Bank and other financial institutions – need to know credit rating – risk of non-repayment of
loans

o Suppliers – credit sales

The Types of Business Organizations :

 The various forms of business organizations are:

 Sole Trader: 1 owner

 Partnership: 2 – 20 owners / partners

 Limited Liability Companies

o Private Limited Companies: 2 – 50 owners / shareholders

o Public Limited Companies: 7 – unlimited owners / shareholders

 Cooperative Societies (purpose is furthering the economic welfare of its members): open
membership

 Non-Profit Organizations

Accounting Concepts and Conventions

Accounting Concepts and Conventions are the accounting rules that are followed when recording

transactions in the books.

The Cost Concept

states that assets are valued and shown in the

accounts at their cost price (the amount asset is

purchased for).

The Money Measurement Concept states that only transactions that can be measured
in monetary terms should be recorded in the books.

The Going Concern Concept

states that the business is assumed to be in

operation in the foreseeable future.

The Business Entity Concept

states that the items recorded in the business’

books are transactions that affect the business

(business transactions).

The owner (s)’ private transactions are kept

separate from business transactions.

The Realization Concept

(Revenue Recognition Concept)

states that revenue is realized/recognized/earned

and recorded as revenue when the goods or

services are passed to the customers and a liability

is incurred.

It is NOT based on when cash has been received.

The Accrual Concept

(Matching Concept)

states that the expenses incurred or used up in an

accounting period must be matched to the revenues

earned in that period, and therefore, recorded in the

accounting period incurred.

ACCOUNTING CONCEPTS

The rules that state how transactions are to be recorded.

The Dual Aspect Concept

states that there are two aspects of accounting, and

both aspects are always equal to each other.

Assets must always equal Capital plus Liabilities

(Accounting Equation).

“Double entry” is the method of recording the

Materiality

states that only relevant information, which has the

ability to influence decisions, is reported. Small

amounts are not considered material and may either

not be reported, or do not have to follow accounting

concepts.

Prudence / Conservatism

states that, in times of uncertainty, the figure that

understates profit should be reported, rather than

the figure that overstates profit.

Expenses should be overstated rather than

understated, and revenue should be understated

rather than overstated.

ACCOUNTING CONVENTIONS

These are the rules that standardize the

accounting methods used to assure that

similar items are dealt with in similar ways.

Consistency

states that the same method should be used for the

accounting treatment of similar items, and the same

method should be used from year to year. If the

method is changed, the change should be

disclosed.

INTRODUCTION TO THE BALANCE SHEET

 ALICE: Assets, Liabilities, Income, Capital, and Expenses.

A – Assets

L – Liabilities

I – income / Revenues

C – Capital / Owner’s Equity

E – Expenses

• Assets

Assets are economic resources owned by a business that are used in its daily operations to

generate profit and benefit the business. Simply, they are a company’s resources i.e. things the

company owns.

• Liabilities

Liabilities are economic resources borrowed by a business from a person or organization. They are

the debts of the business i.e. amount the business owes.

• Income

Income / revenues are amounts earned during the accounting period from the daily operations of
the

business. Simply, they are what the business earns for providing goods and services.

• Capital / Owner’s Equity

Capital is the economic resources that were contributed by the owner(s) of the business to the

business, either to start the business or to continue its operations.

• Expenses

Expenses are the costs incurred by a business in its daily operations in earning income. In other
words,

they are the cost of assets used by the business to generate revenues.

A company’s financial position

The financial position of a company is measured by:

1. Assets (what it owns)

2. Liabilities (what it owes to others)

3. Capital / Owner’s Equity

N.B. Every business transaction will have an effect on a company’s financial position.
5

INTRODUCTION TO THE BALANCE SHEET

The Balance Sheet and its major components :

 Definition of Balance Sheet

• The Balance sheet is a financial statement that is produced in order to show the financial position
of

the enterprise shows

• It is produced in order to show the assets of a business in relation to its liabilities and capital at a

particular point in time.

 The major components of the Balance Sheet

The financial position of a company is measured by:

1. Assets (what it owns)

2. Liabilities (what it owes to others)

3. Capital / Owner’s Equity

Assets, Liabilities and Capital are, therefore, Balance Sheet accounts

• Assets

 Assets are economic resources owned by a business that are used in its daily operations to

generate profit and benefit the business.

 There are two types of assets:

o Fixed Assets: assets used to carry on the business and generate profit.

They are not purchased for resale but intended to be retained permanently for the purpose of

carrying on the business

e.g. Land and Buildings, Fixtures and Fillings, Machinery etc.

o Current Assets: assets consisting of cash and other assets that would be consumed or easily

converted into cash within one year.

• Liabilities

 Liabilities are economic resources borrowed by a business from a person or organization. They
are the debts of the business (the money owed by the business).

 There are two types of liabilities:

o Long Term Liabilities: These are any debts or obligations owed by the business that are

due more than one year from the current date e.g. Mortgages, Bank Loans etc.

o Current Liabilities: These are any debts or obligations owed by the business that are due

within one year from the current date e.g. Creditors (suppliers, short term loans), bank

overdrafts etc.

• Capital / Owner’s Equity

 Capital is the economic resources that were contributed by the owner(s) of the business to the

business, either to start the business or to continue its operations.

 Capital is considered a special kind of liability. It is a loan by the owner to the business and is,

therefore, money owed by the business to the owner.

N.B. For accounting purposes, a business is regarded as being a separate entity from its

owner(s).

(the business entity concept)

INTRODUCTION TO THE BALANCE SHEET

The Accounting Equation :

The Accounting Equation (also called the balance sheet equation.)

• The Accounting Equation is the basic equation of double entry accounting that reflects the
relationship

between a company's assets, liabilities, and equity.

• It shows how assets were financed: either by borrowing money from someone (liability) or by
paying your

own money (ownership equity).

• It is expressed as:

Assets = Liabilities + Capital

The double entry system is a method used to record each transaction twice in the books as every
transaction affects two items.

Additional Information

The Expanded Accounting Equation :

 Revenue – Expenses = the business’ Profit or Loss

 If Revenues > Expenses, there is a Profit

 If Revenues < Expenses, there is a loss

 The owner of the business also has the option to withdraw capital from the business for personal
use: Drawings

 The expanded accounting equation is, therefore:

Assets = Liabilities + Capital + Revenues – Expenses – Drawings

o Revenues increase Capital / Owner’s Equity

o Expenses decrease Capital / Owner’s Equity

o Drawings decrease Capital / Owner’s Equity

The Simple Balance Sheet :

o An elaborate form of the Accounting equation is presented in a Balance Sheet, which lists all
assets, liabilities, and

equity, as well as totals to ensure that it balances.

The Format of a simple Balance Sheet (Horizontal)

Balance Sheet as at

Assets

Capital

Liabilities

XX XX

Balance Sheet as at

Fixed Assets

Current Assets

X
X

Capital

Long Term Liabilities

Current Liabilities

XX XX

INTRODUCTION TO THE BALANCE SHEET

The Balance Sheet – Arrangement of Assets and Liabilities

The assets and liabilities should be arranged in balance sheet in some specific order. Arrangement of
assets and liabilities in

the balance sheet is called 'Marshalling of assets and liabilities'. There are two systems of
arrangement of assets and liabilities

in the balance sheet:

(a) Order of Liquidity.

(b) Order of Permanence.

The Balance Sheet – Order of Permanence:

PERMANENCE is the condition, quality or state of being lasting or fixed, primarily judged by
durability and useful life.

ORDER OF PERMANENCE is where fixed assets are entered in the balance sheet in descending order
of permanence (i.e.

land first, then buildings, then equipment etc).

Balance Sheet as at

Fixed Assets

Current Assets

Capital
Long Term Liabilities

Current Liabilities

XX XX

The Balance Sheet – Order of Liquidity:

LIQUIDITY refers to the ability to quickly and easily convert assets into cash without incurring a
significant loss

ORDER OF LIQUIDITY is when items on a balance sheet are listed in descending order of liquidity.
After cash, the other current

assets are listed in order of liquidity or nearness to cash (i.e. Accounts Receivable first, then
Inventory…).

Balance Sheet as at

Current Assets

Fixed Assets

Current Liabilities

Long Term Liabilities

Capital

XX XX

N.B. The most permanent assets are the least liquid.

Assets and Liabilities in Order of Permanence and Liquidity :

FIXED ASSETS CURRENT ASSETS LONG TERM LIAB. CURRENT LIAB.

Order of
Permanence

Order of

Liquidity

Order of

Permanence

Order of

Liquidity

Order of

Permanence

Order of

Liquidity

Order of

Permanence

Order of

Liquidity

Land

Buildings

Machinery

Equipment

Motor

Vehicles

Motor

Vehicles

Equipment

Machinery

Buildings

Land

Land

Buildings

Machinery

Equipment
Motor

Vehicles

Motor

Vehicles

Equipment

Machinery

Buildings

Land

Mortgage

Bank Loan

due in over

a year

Bank

Loan due

in over a

year

Mortgage

Creditors

Bank

Overdraft

Bank

Overdraft

Creditors