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CHAPTER 1 - Introduction To Accounting Concepts

Accounting concepts

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Carl Seipato
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45 views3 pages

CHAPTER 1 - Introduction To Accounting Concepts

Accounting concepts

Uploaded by

Carl Seipato
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Chapter 1: Introduction to Accounting Concepts

Accountancy is the process of communicating financial information about a business entity to


users such as shareholders and managers (Elliot, Barry & Elliot, Jamie: Financial accounting and
reporting).

Accounting has been defined as:

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 financial character, and
interpreting the results thereof.

Objectives of Accounting

Accounting provides the basis for management decisions and accountability through the process
of recording, summarizing and presenting historical and prospective information.

Key objectives of accounting can be summarized as follows.

Recording

The most basic role of accounting is to record and summarize business transactions and balances.
This process is often referred to as 'book-keeping' and is fundamental in managing any business.

Business transactions and balances once recorded can be summarized in the form of financial
statements. Financial statements provide key information relating to a business such as:

• How much capital has been invested in the business


• How have the funds been utilized in the business
• The amount of profit or loss in a period
• How much the business owes to others (i.e. liabilities)
• The amount of cash, receivables, inventory and other assets

Such information is not only useful for managers (e.g. to keep track of the financial health and
profitability of the business) but is also important for other stakeholders as discussed in the
article: users of financial statements.

Planning

Organizations need to plan how they intend to allocate their limited resources (e.g. cash, labor,
materials, machinery and equipment) towards competing needs in the future. An effective way of
doing so is by using various forms of budgets.
Budgeting is a major component of managerial accounting. Budgets enable organizations to plan
for the future by anticipating business needs and resources. It also helps in coordinating the
different business segments of an organization.

Decision-Making

A key role of accounting is to provide information and analysis for management decision and
control.

Examples of such analysis include:

• Variance Analysis
• Investment Appraisal
• Disinvestment Decisions
• Make or Buy Decisions
• Limiting Factor Analysis
• Ratio Analysis

Accountability

Accounting provides a basis for analysis of the performance over a period of time which
promotes accountability across several tiers of an organization.

Shareholders can ultimately hold the directors responsible for the overall performance of their
company through performance appraisal on the basis of accounting information published in the
financial statements.

Users of Accounting Information

Accounting information helps users to make better financial decisions. Users of financial
information may be both internal and external to the organization.

Internal users (Primary Users) of accounting information include the following:

• Management: for analyzing the organization's performance and position and taking appropriate
measures to improve the company results.
• Employees: for assessing company's profitability and its consequence on their future
remuneration and job security.
• Owners: for analyzing the viability and profitability of their investment and determining any
future course of action.

Accounting information is presented to internal users usually in the form of management


accounts, budgets, forecasts and financial statements.

External users (Secondary Users) of accounting information include the following:

• Creditors: for determining the credit worthiness of the organization. Terms of credit are set by
creditors according to the assessment of their customers' financial health. Creditors include
suppliers as well as lenders of finance such as banks.
• Tax Authorities: for determining the credibility of the tax returns filed on behalf of the company.
• Investors: for 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 any financial resources
to the company.
• Customers: for assessing the financial position of its suppliers which is necessary for them to
maintain a stable source of supply in the long term.

Regulatory Authorities: for ensuring 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

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