UNIT ONE

ACCOUNTING INFORMATION

The Basis for Business Decisions

Contents:
Definition of accounting
Accounting information
Accounting information system
Financial accounting information
Managerial accounting information
Financial and managerial accounting defintion
The concept of Recognition, valuation and classification in the
accounting cycle
Accruals and Deferral
Basic financial statements
 What is Accounting?
The systematic recording, reporting, and analysis of financial
transactions of a business.
• Which type of organisation need accounting?
– Sole trader. This means one person who runs a business on their own, or
perhaps with a few employees. The main aim is to make a profit.
– Partnership. This is two or more people who carry on a business in common,
intending to make a profit.
– Limited company. A limited company is a legal organisation set up under the
Companies. The owners are called the shareholders, and it is run by
directors, who are appointed by the shareholders.
– Public sector bodies. Traditionally, these bodies have not existed to make a
profit, but to provide a service.
– Clubs and societies. Again the intention club is not to make a profit, but to
provide services for members.
• All of these organisations require some form of accounting
 What are the reasons that Accounting is undertaken by these
organisations?

• To record what money has come into the organisation and

what has gone out.
• To tell other people about the activities and consequent
profit or loss of the organisation during the past year, or
other period.
• To tell other people about the present financial state of
the organisation.
• To provide a basis for taxation.
• To provide a basis for planning future activities etc.
• To help managers make decisions about how to run the
organisation.
 Accounting Information :
What is information?

– It is a stimuli that has meaning in some context for its

user.

– When it is entered into and stored in a computer, it is

generally referred to as data.

– The output data can again be perceived as information.

• Thus, the first objective of accounting is to provide

information that is useful for decision making purpose.
 ........
• To make economic decision based on accounting
information, we need to understand the following
points
A. The nature of economic activities that
accounting information describes.

B. The assumptions and measurement

techniques involved in developing accounting
information.

C. The information that is most relevant for

making various type of decisions.
The Accounting information system

1) Income
Inputs Process Outputs Statement
2) Balance Sheet
3) Cash Flow

1. Accounts
2. Journal
3. General
Ledger
4. Trial Balance
 Financial Accounting Information
• Financial accounting provides information
about the financial resources, obligations
and activities of an enterprises that is
intended for use primarily by external
decision makers.

• Users of accounting information can be divided into two

A. External and
B. Internal users
Management Accounting Information
• Management accounting is the preparation &
use of accounting information systems to
achieve the organization's objectives by
supporting decision makers inside the
organization.

• Internal decision makers are employed by the

organization
 Comparison of Financial and Managerial Accounting
Financial Accounting Managerial Accounting

It describes the performance It is used to help management

of the business over a specific record, plan and control the
period. This specific period activities of a business and to
referred to as “accounting assist in the decision making
period”. It has one year long. process. It can be prepared for any
period (for daily, quarterly or
annually).

It is required by law to There is no legal requirement to

prepare and publish financial prepare management reports.
statements.
 The format of published There is no pre-determined
financial statement is format for managerial
determined by several accounting. It can be as
different regulatory bodies: detailed or brief as
Company Law, Accounting management wish
standards, Stock exchange
etc.
Financial accounting focus Management Accounting
on the business as a whole can focus on specific areas
rather than analyzing the of a business activities.
component parts of the
business. For example, it can provide
For example, sales are insight into performance of
aggregated to provide a figure products, departments,
for total sales rather than markets etc.
published product wise.
Financial accounting Managerial accounting
includes information usually include a wide
that can only be variety of financial and
expressed in monetary non-financial information.
terms. Example:
Number and productivity
of employees, sales
volumes (units sold) etc.
Its focus is on Its focus is on reporting
reporting to external to internal users
users of accounting (Management).
information.
It provides financial It is not guided by
statements based on Generally Accepted
Generally Accepted Accounting Principles
(GAAP).
Accounting Principle
(GAAP)/IFRS.

Financial accounting Managerial accounting

presents a historic emphasis on the future
perspective on the
financial performance Example:
of the business. Sales budget
The concepts of Recognition,
Valuation and Classification under the
Accounting Cycle
 Explain how the concepts of recognition, valuation and
classification apply to business transactions

• Business transactions are economic events that affect a company’s

financial position.
• To measure a business transaction, we must decide

ECONOMIC EVENTS

RECOGNITION when the transaction occurred

(the recognition issue),
VALUATION what value to place on the transaction
(the valuation issue), and
CLASSIFICATION how the components of the
transaction should be categorized
(the classification issue).
BUSINESS TRANSACTIONS THAT AFFECT FINANCIAL POSITION
 Recognition
• The recognition issue refers to the decision when a business transaction
should be recorded.
• This issue is important because the date on which a transaction is recorded
affects amounts in the financial statements.
• To illustrate some of the factors involved in the recognition issue, suppose a
company wants to purchase an office desk. The following events take place:
1. An employee sends a purchase requisition for the desk to the purchasing
department.
2. The purchasing department sends a purchase order to the supplier.
3. The supplier ships the desk.
4. The company receives the desk.
5. The company receives the bill from the supplier.
6. The company pays the bill.
• According to accounting tradition, a transaction should be recorded when title
of merchandise passes from the supplier to the purchaser and creates an
obligation to pay.
• Thus, depending on the details of the shipping agreement for the desk, the
transaction should be recognized (recorded) at the time of either event 3 or 4.
 Valuation
• The valuation issue focuses on assigning a
monetary value to a business transaction.
• IFRS states that all business transactions should be
valued at fair value when they occur.
– Fair value is defined as the exchange price of an actual
or potential business transaction between market
participants.

• This practice of recording transactions at exchange

price at the point of recognition is commonly
referred to as the cost principle.
 Example: Determine the value of the following transaction.

• A company provides printing paper to a local weekly newspaper

printing press in exchange for an advertisement for 52 issues.

• Determining the value of a sale or purchase transaction isn’t difficult

when the value equals the amount of cash that changes hands. However,
barter transactions, in which exchanges are made but no cash changes
hands, can make valuation more complicated. Barter transactions are
quite common in business today.
 Classification
• The classification issue has to do with
assigning all the transactions in which a
business engages to appropriate categories
• Assets
• Liabilities
• Capital
• Revenue
• Expenses and costs
 The Realization Principle:
When To Record Revenue
Realization Principle
Revenue should be recognized at the time goods are sold and
services are rendered. At this point the business transaction has
completed its earning process.
Assume that ABC company has taken a contract on September
2016 to render service to Z company. ABC company
performed the service on October 2016 and will receive
$2000 from Z company on November 20, 2016.
In which month ABC company should recognize the revenue
earned?
 The Matching Principle:
When To Record Expenses
Matching Principle
 According to Matching principle, Expenses should
be recorded in the period in which they are used up
to generate revenue.
In measuring Net income for the period, revenue
should offset by all the expenses incurred in
producing that revenue.
This concept of offsetting expenses against revenue
on a basis of cause and effect is called Matching
principle.
 ...
• Example: On June 10, 2017 ABC company has paid $1000 salaries of
May 2017 for its employees. ABC company prepares financial
statements at the end of a month.

• In which month this salaries amount should record in the book of

ABC company?

• In deciding when to record an expense, the critical question is

– “ in which period does the cash expenditure help to produce
revenue?” not “when does the cash payment occur?”
Accruals and Deferrals
 What are deferral and accrual?
• Deferrals and accruals are helpful in properly matching revenues and
expenses.
• A deferral is a delays of the recognition of either an expense that has
been paid or a revenue that has been collected.
– Example
– Prepaid expenses represent the cost of goods and services purchased
that are not entirely used up at the end of the year
– When revenue is received before goods are delivered or services
performed, the revenue is said to be unearned
• An accrual is an expense that has not been paid or a revenue that has
not yet been received.
– Many expenses which accumulate on a daily basis are only recorded at
set intervals. At the end of an accounting period a portion of such
expenses (for instance, salaries) often remains unpaid.
– At the end of an accounting period, all revenues earned but not yet
collected are accrued revenues which require adjusting entries. .
 Accruals and Deferrals
• When should expenses and revenues be
recognized?
– When we are talking about the timing of revenue
or expense recognition; the applied basis of
accounting method must be identified.

– The two mostly used methods of accounting are

– cash basis accounting and

– accrual basis accounting

• When revenue and expenses are recognized Under the cash
basis accounting?

 Under the cash basis accounting, revenues are recognized

when cash is received, regardless of time services are
provided or products are sold; and expenses are recognized
when cash is paid, regardless of time costs are incurred
 When revenue and expenses are recognized Under the accrual
basis accounting?
 On the other hand, under the accrual basis accounting,
revenues and expenses are recorded when earned and
incurred, accordingly, regardless of the time cash is
exchanged (i.e. received or paid).
 The Adjustment Process
Why do we need adjusting entries?
Adjusting entries are needed whenever revenue or expenses
affect more than one accounting period.
Adjusting entry needed to
bring the accounting records up to date.
state properly assets, liabilities, and owners’ equity at the end
of the accounting period.
Every adjusting entry involves a change in either a revenue or
expense and an assets or a liability.
• Each adjusting entry affects at least one Balance Sheet account
and at least one Income Statement account.
– Adjusting entries DO NOT involve debits and credits to cash.
 Adjusting Entries
• The types of adjusting entries may be classified in to the
following groups

1. Allotment of recorded costs (converting assets to expenses)

2. Allotment of recorded revenue (Converting liabilities into revenue)

3. Recording Accrual of unrecorded expenses (Recording

unrecorded expenses) and

4. Recording Accrual of unrecorded revenue (Record

unrecorded revenues)
 Effects of the Adjusting Entries
Income Statement Balance Sheet
Net Owners'
Adjustment Revenue Expenses Income Assets Liabilities Equity
Type I
Converting Assets to Expenses No effect Increase Decrease Decrease No effect Decrease
Type II
Converting Liabilities to Revenue Increase No effect Increase No effect Decrease Increase
Type III
Accruing Unpaid Expenses No effect Increase Decrease No effect Increase Decrease
Type IV
Accruing Uncollected Revenue Increase No effect Increase Increase No effect Increase
 Adjusting and Closing Entries
• Adjusting entries are recorded in the journal at the
end of the accounting period.
• An adjusting entry is typically made just prior to
issuing a company's financial statements
• The main purpose of adjusting entries is to
update the accounts to conform with the accrual
concept.
• At the end of the accounting period, some
income and expenses may have not been
recorded, taken up or updated; hence, there is a
need to update the accounts
• Closing entries, also called closing journal entries,
are entries made at the end of an accounting period to
zero out all temporary accounts and transfer their
balances to permanent accounts.

• In other words, the temporary accounts are closed or reset

at the end of the year

• A closing entry is a journal entry made at the end of the

accounting period in which data is moved into the
permanent accounts on the balance sheet from temporary
accounts on the income statement
 Reversing Entries
 After the accounting records have been adjusted and closed at the
end of an accounting period, reversing entries may be made on the
first day of the next accounting period.
 The purpose of the reversing entries is to simplify the recording of
routine transactions by disposing of the accrued items (assets and
liabilities), which were entered in the balance sheet accounts
through adjusting entries.
General guidelines for reversing entries when requires
1. When adjusting entry create an assets or liability account which
normally is not used during the accounting period, reversing
entry is required.
2. When an adjusting entry adjusts an asset or liability account
which normally is used to record transactions during the period,
no reversing entry is required.