RBBM8113: FINANCIAL

ACCOUNTING
BY: GABRIEL KAMAU

[email protected]

0789286605
 Brief Outline
• Introduction
• Recording Transactions
• Source Documents and Books of Original Entry
• Accounting Errors
• Control Accounts
• Final Accounts
• Year-end Adjustments
 Introduction

1.1 Types of business

• Sole Proprietorship: owned and controlled by one
person
• Partnership: owned and operated by 2-20 people who
have to agree on their profit/loss sharing ratio.
• Corporate Organization: Owned by shareholders.
 1.2 Nature and Purpose of Accounting

• Accounting is the process of identifying, measuring, recording

and reporting financial transactions to the users of this
information to permit informed decision.
• The main purpose of Accounting is to provide financial
information about an organization.
• Financial Transaction is an event which involves the transfer
of money or money‘s worth of financial events
• Examples of financial transactions:
i) Acquisition of assets from owners and other creditors
ii) Investing resources in assets to produce goods or
services
iii) Using resources to produce goods and services
iv) Selling goods or services of the firm
v) Paying those to whom money is owned
vi) Returning assets to owners, etc
 1.3 Types of Accounting

i) Financial Accounting: Is externally oriented i.e. the users are mainly

outsiders e.g. shareholders and stakeholders.
ii) Management Accounting: Is mainly internally oriented i.e. the users
of the information generated are within the organization.
 Assignment 1: Group work

• Assignment 1: In groups of seven:

• Identify and discuss any 7 users of accounting
information
 1.4 Basic Accounting Concepts

1. Assets
2. Liabilities
3. Expenses
4. Income
5. Capital
 1.4.1 Assets

• Are valuable resources that are owned by a firm.

• An asset is a resource controlled by an entity as a result of past events and
from which future economic benefits are expected to flow to the entity.
• Classification of Assets:
i) Tangible or Intangible Assets
ii) Financial or Non-Financial Assets
iii) Current or Non-current Assets
iv) Operating or Non-Operating Assets
 1.4.2 Liabilities

• A Liability is a present obligation as a result of a past event, the

settlement of which will result into an outflow from the entity of
resources embodying economic benefits.
• Types of Liabilities:
i) Current liabilities
ii) Long-term liabilities
iii) Contingent liabilities
 1.4.3 Expenses

• Expenses are the cost of assets consumed or services

used in the process of earning revenue.
• Examples of expenses include utility expense, rent
expense, and supplies expense.
 1.4.4 Income
• Income is the increase in economic benefits during the accounting period
in the form of inflows, enhancement of assets or reduction in liabilities
resulting to increase in equity other than those relating to the contribution
by the members.
• Income can be classified into two:
i) Revenue
• Increase in economic benefits from the ordinary activities of the business
which qualify to be an income. E.g. sales, fees, dividends, interests,
royalties etc.
ii) Gains
• Other items that meet the definition of an income but do not relate to the
ordinary activities of the business. E.g. sales of NCA.
 1.4.5 Capital

• Capital is the amount invested in a business by the

owner.
• Equity is the residual interest of the assets of the entity
after deducting all its liabilities.
• Owners may make a direct investment in the business
or operate at a profit and leave the profit in the
business.
• Note: Recognition means incorporating in the SoFP(Statement
of Financial Position) and IS(Income Statement) an item that
meets the definition and satisfies the criteria for recognition.
i) It’s probable that future economic benefits is going to flow
to or from the entity
ii) The cost or value can be measured reliably
 1.5 Basic Accounting Principles

1.5.1 Going Concern Assumption/Principle

• It’s the assumption that the business will be in operation for the
foreseeable future. That is, the business entity has no intention
or necessity to liquidate or limit the major operations of the
business
• If the business entity has that intention or necessity to liquidate,
financial statements should be prepared on realization method
and the method should be disclosed in the notes to the financial
statements.
 1.5.2 Cash vs Accrual Basis of Accounting

• The Cash Basis Accounting:

The cash basis of accounting records revenue
when cash is received.
This basis also records expenses when cash is
paid.
• Accrual basis of accounting:
The accrual basis of accounting records revenues when
goods have been delivered or services have been
performed, regardless of when cash is received
Revenue earned in the period should be matched with
costs incurred in earning it, not as money is received or
paid
This basis also records expenses when resources are
consumed, regardless of when payment is made.
Note: The accrual basis of accounting is the preferred method
because iy obeys the matching principle.
 1.5.3 Matching Principle

• The matching principle states that revenue must be

matched with their efforts.
• Expenses in one period are matched to revenues
recognized in the same period.
• There should be a logical and rational association of
revenues and expenses.
 1.5.4 Accounting (Balance sheet) Equation

• Financial accounting is based upon the accounting

equation which holds that
• Assets=Capital+ Liabilities
• This equation must balance.
 1.5.5 Double Entry System

• This is a method of recording transactions which states

that for every debit entry, there must be a
corresponding credit entry.
• The amounts recorded as debits must be equal to the
amounts recorded as credits.
 1.5.6 Historical Cost Principle

• Assets and liabilities are recorded at acquisition price

• Users of financial statements may find current fair
value information to be useful as well
 1.5.7 Consistency Concept

• The consistency concept states that in preparing accounts

consistency should be observed in two respects.
a) Similar items within a single set of accounts should be
treated the same way.
b) The same treatment should be applied from one period to
another in accounting for similar items. This enables valid
comparisons to be made from one period to the next.
 1.5.8 Money measurement concept

• The money measurement concept states that accounts

will only deal with those items to which a monetary
value can be attributed.
 1.5.9 Revenue Recognition Principle

• Revenue is recognized when it is earned and the amount

can be objectively determined.
• Revenue is earned when goods or services are delivered
and not necessary when cash is involved.
 1.5.10 Full Disclosure Principle

• Financial statements must report any information that could

reasonably be seen to affect the judgement or decision of an
informed user
• Disclosure may be made:
• within the main body of the financial statements
• as notes to those statements
• as supplementary information
• Disclosed information should:
• provide sufficient detail of the occurrence
• be sufficiently brief enough to remain understandable
 1.6 Characteristics of financial information

i) Relevance: Information is relevant if it has the ability to influence

economic decisions of users and provided in time to influence those
decisions.
ii) Reliability: Information is free from biasness, errors and must be
complete.
iii) Understandability: Presented in a way that is easy to understand
iv) Comparability: The financial statements should be compared through
time and should be compared with different business entities within the
same industry.
• To enhance comparability, the business entity must adopt the same
accounting policies in each year they are reporting.