LESSON ONE

INTRODUCTION TO BOOK KEEPING AND ACCOUNTING

INTRODUCTION
In all activities (whether business activities or non-business activities) and in all
organizations (whether business organizations like a manufacturing entity or
trading entity or non-business organizations like schools, colleges, hospitals,
libraries, clubs, churches, political parties, etc) which require money and other
economic resources, accounting is required to account for these resources. In
other words, wherever money is involved, accounting is required to account for
it. Accounting is often called the language of business. The basic function of any
language is to serve as a means of communication. Accounting also serves this
function.

Meaning and Definition of Book- Keeping

Meaning
Book- keeping includes recording of journal, posting in ledgers and balancing of
accounts. All the records before the preparation of trail balance is the whole
subject matter of book- keeping. Thus, book- keeping many be defined as the
science and art of recording transactions in money or money’s worth so
accurately and systematically, in a certain set of books, regularly that the true
state of businessman’s affairs can be correctly ascertained. Here it is important to
note that only those transactions related to business are recorded which can be
expressed in terms of money.

Definitions

Definition by R.N.Carter
“Book- keeping is the science and art of correctly recording in books of account
all those business transactions that result in the transfer of money or money’s
worth”.

Definition by A.H.Rosenkamph
“Book- keeping is the art of recording business transactions in a systematic
manner”.

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Objectives of Book- keeping
(i) Book- keeping provides a permanent record of each transactions.
(ii) Soundness of a firm can be assessed from the records of assets and
liabilities on a particular date.
(iii) Entries related to incomes and expenditures of a concern facilitate to know
the profit and loss for a given period.
(iv) It enables to prepare a list of customers and suppliers to ascertain the
amount to be received or paid.
(v) It is a method that gives opportunities to review the business policies in
the light of the past records.
(vi) Amendment of business laws, provision of licenses, assessment of taxes
etc., are based on records.

ACCOUNTING

Meaning of Accounting
Accounting is the process of preparing and explaining financial statements.
Accounting, as an information system is the process of identifying, measuring
and communicating the economic information of an organization to its users
who need the information for decision making. It identifies transactions and
events of a specific entity. A transaction is an exchange in which each participant
receives or sacrifices value (e.g. purchase of stationery, office furniture, raw
material). An event (whether internal or external) is a happening of consequence
to an entity (e.g. use of raw material for production). An entity means an
economic unit that performs economic activities.

Definition (By American Accounting Association)

Accounting is defined as the process of identifying, measuring and

communicating economic information to permit informed judgments and
decisions by users of the information.

Accounting is an information system. It measures business activities, process

data into reports and communicates result to people. Accounting is ‘the
language of businesses.

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Accounting produces financial statements, which report information about an
entity. Financial statements measure performance and tell where a business
stands in financial terms.

KINDS OF ACCOUNTING
The study of accounting is traditionally divided into two parts according to the
types of users’ i.e. external users and internal users of accounting information.
There are two broad types of accounting information:

Financial accounting (FA):

Is primarily concerned with the needs of users outside the business (or other
organisation). Thus it provides information for the people outside the firm, such
as investors, bankers, government agencies and the public. The information
must meet standards of relevance and reliability.

* Relevant – means ‘able to affect a decision’

* Reliable – means verifiable and free from bias.

Therefore FA relates to the external control and management of resources (for

example, by shareholders of the company in which they have invested their
funds, or by banks lending loans). A key part of financial accounting is reporting
the performance and position of the business to these external users, via the
financial statements (this is known as Financial Reporting). The form and
content of financial statements is usually highly regulated.

In contrast, Management Accounting is concerned with the needs of users inside

the entity. Therefore it relates to the internal control and management of
resources (for example, by the directors, management or employees of a
company). Management accounting statements may be more detailed than those
prepared for external users, and do not normally need to meet any legal
requirements.
Management accounting does not have to meet external standards of reliability
because only company employees use these data.

Note:

Financial Accounting is:

A branch of accounting involving the preparation and publication of financial
statements, earnings reports, and other forms for disclosure
to shareholders, regulators, and any other stakeholders. Financial accounting is

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necessary for publicly-traded companies and some other corporations. It must be
accomplished in accordance with the Generally Accepted Accounting
Principles or the equivalent in different countries. The primary difference
between financial accounting and managerial accounting is the fact that financial
accounting involves explanation to outside parties, while managerial accounting
is primarily internal.

In preparing accounting information, care should be taken to ensure that the

information presents an accurate and true view of the business performance and
position. To impose some order on what is a subjective task, accounting has
adopted certain conventions and concepts which should be applied in preparing
accounts.

For financial accounts, the regulation or control of what kind of information is

prepared and presented goes much further. Companies are required to comply
with a wide range of Accounting Standards which define the way in which
business transactions are disclosed and reported. These are applied by
businesses through their Accounting Policies.

The main financial accounting statements

The purpose of financial accounting statements is mainly to show the financial

position of a business at a particular point in time and to show how that business
has performed over a specific period.

The three main financial accounting statements that help achieve this aim are:

(1) The profit and loss account for the reporting period

(2) A balance sheet for the business at the end of the reporting period

(3) A cash flow statement for the reporting period

A balance sheet shows at a particular point in time what resources are owned by
a business ("assets") and what it owes to other parties ("liabilities"). It also shows
how much has been invested in the business and what the sources of that
investment finance were.

It is often helpful to think of a balance sheet as a "snap-shot" of the business - a

picture of the financial position of the business at a specific point. Whilst this is a

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useful picture to have, every time an accounting transaction takes place, the
"snap-shot" picture will have changed.

By contrast, the profit and loss account provides a perspective on a longer time-
period. If the balance sheet is a "digital snap-shot" of the business, then think of
the profit and loss account as the "DVD" of the business' activities. The story of
what financial transactions took place in a particular period - and (most
importantly) what the overall result of those transactions was.

Not surprisingly, the profit and loss account measures "profit".

What is profit?

Profit is the amount by which sales revenue (also known as "turnover" or "income")
exceeds "expenses" (or "costs") for the period being measured.

Objective of Accounting
Objective of accounting may differ from business to business depending upon
their specific requirements. However, the following are the general objectives of
accounting.

i) To keeping systematic record:

It is very difficult to remember all the business transactions that take place.
Accounting serves this purpose of record keeping by promptly recording all
the business transactions in the books of account.

ii) To ascertain the results of the operation:

Accounting helps in ascertaining result i.e., profit earned or loss suffered in
business during a particular period. For this purpose, a business entity
prepares either a Trading and Profit and Loss account or an Income and
Expenditure account which shows the profit or loss of the business by
matching the items of revenue and expenditure of the same period.

iii) To ascertain the financial position of the business:

In addition to profit, a businessman must know his financial position i.e.,
availability of cash, position of assets and liabilities etc. This helps the
businessman to know his financial strength. Financial statements are
barometers of health of a business entity.

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 iv) To portray the liquidity position: Financial reporting should provide
information about how an enterprise obtains and spends cash, about its
borrowing and repayment of borrowings, about its capital transactions, cash
dividends and other distributions of resources by the enterprise to owners
and about other factors that may affect an enterprise’s liquidity and solvency.

iv) To protect business properties: Accounting provides upto date

information about the various assets that the firm possesses and the
liabilities the firm owes, so that nobody can claim a payment which is not
due to him.

v) Communication: accounting systems provide a means by which

information is transmitted to users. For example, to external users via the
financial statements, or to internal users via the budget-setting process.

vi)To facilitate rational decision – making: Accounting records and financial

statements provide financial information which help the business in making
rational decisions about the steps to be taken in respect of various aspects of
business.

vii) To satisfy the requirements of law: Entities such as companies, societies,

public trusts are compulsorily required to maintain accounts as per the law
governing their operations such as the Companies Act, Societies Act, and
Public Trust Act etc.

NEED FOR KEEPING ACCOUNTING RECORDS.

There are many reasons for keeping accounting records depending on whether
the business is operated by a sole traders, partnership or company.

These reasons include;

1. To prevent cash and other items owned by the business (e.g. vehicles,
stock, and property) from being improperly used and stolen.

2. To monitor the cash available to the business, checking whether the

amount available is sufficient to pay bills as they fall due.

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3. To keep checking whether the business is doing well i.e. whether is
sufficient reasons for continuing to carry on with the business.

4. To satisfy tax inspectors.

5. For partners to be confident that they are receiving their fair share of what
the business earns.

6. It is essential to maintain accurate accounts to avoid disputes and possible

litigation.

Many professionals carry on business as partnerships e.g. solicitors,

doctors, chiropodists and auditors.

7. Legal requirements that directors who manage companies to keep proper

accounting records and to report financial information to those who have
invested their cash in the company.

USERS OF ACCOUNTING INFORMATION/ Importance of Accounting

Decisions markers need information, as to satisfy some of their different needs of

information. These needs include the following:-

(i) Owners (or Investors)

Need financial information relating to the enterprise to assess how

effectively the managers are running it and to make judgments about
likely levels of risk and return in the future.

Shareholders need information to assess the ability of the enterprise to pay

them a return (dividend). This also applied to potential shareholders.

(ii) Employees and their Representative Groups.

Are interested in information about the stability and profitability of their

employers. They also need information to be able to assess the enterprise’s
ability to provide remuneration, retirement benefits and employment
opportunities.

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(iii) Lenders.

Need information about the enterprises in order to assess its ability to

meet its obligations, pay interest and to repay the amount borrowed.

(iv) Suppliers and other Trader Creditors.

Need information to enable them determine whether amounts owed to

them will be paid when due.

(v) Customers.

Have an interest about the continuance of an enterprise, especially when

they have a long term involvement with or are depend on the enterprise.

(vi) Government and its Agencies.

Need information in order to regulate the activities of an enterprise, to

assess whether they comply with agreed pricing policies, whether
financial support is needed, and how much tax they should pay. They
also need information in order to determine taxation policies and as the
basis for national income and statistics.

(i) Members of the Public.

Are affected by enterprises in a variety of ways e.g. enterprises may make

substantial contributions to the national economy in many was. Including
the number of people they employ or their patronage of local suppliers.
Financial statements may assist the public by providing information about
the trends and recent developments in the prosperity of the enterprise and
the range of its activities.

(ii) Investment Analysts.

Need financial information relating to an enterprise to assess the likely

risks and returns associated with the enterprise in order to determine its
investment potential and to advise clients accordingly.

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(ix) Competitors

Need financial information relating to an enterprise to assess the threat to

sales and profits posed by those businesses and to provide a benchmark
against which the competitor’s performance can be measured.

(x) Managers.

Need financial information relating to an enterprise to help make

decisions and plans for the business and to exercise control so that plans come to
fruitions.

SPECIFIC REASONS WHY MANAGERS WITHIN THE BUSINESS NEED

ACCOUNTING INFORMATION.

1. To ensure that business resources (including cash) are protected and applied
in best manner possible.

2. To plan the business activities within the available resources.

3. To establish targets such as how much they plan to earn and the amount of
expense they are likely to incur.

4. To control costs – which is an essential task for survival in a competitive

market.

5. To establish business strategies e.g. whether to buy or rent the business

premises; whether to invest in a different machine, whether to diversify the
products, whether to maintain competitive advantage.

ELEMENTS OF FINANCIAL STATEMENTS.

SFAC 6 (Statements of Financial Accounting Concepts) defines 10 elements of

financial statements. These elements are “the building blocks within which
financial statements are constructed – the classes of items that financial
statements comprise’. They focus directly on items measuring performance and

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on reporting financial position. The definitions of these elements operationalize
the resources, claims and changes identified in the third objective of financial
reporting in SFAC 1.

The accrual accounting model is actually embodied in the element definitions.

FASB recognized that accrual accounting produces information that is more

successful in predicting future cash flows than is cash flow accounting.

The 10 elements are:-

(i) Assets (ii) Liabilities (iii) Equity

(iv) Investments by owners (v) Distributions to owners (vi) Gains
(vii) Revenues (viii) Expenses (ix) Losses
(x) Comprehensive income

These 10 elements of financial statements describe financial position and periodic

performance.

1. Assets.

These are probable future economic benefits obtained or controlled by a

particular entity as a result of past transactions or events. A key
characteristic of this definition is that an asset represents probable future
economic benefit. Thus a receivable is an asset only if it is probable that
the benefit will result, that cash will be collected. They are controlled by
aspect of the definition is also important. This is because for example,
employees of a company represent future economic benefits to a company
but they are not owned or controlled by the company and thus don to
qualify as assets.

2. Liabilities.

These are probable future sacrifices of economic benefits arising from

present obligations of a particular entity to transfer assets or provide
services to other entities in the future as a result of past transactions or
events.

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 Most liabilities require the future payment of cash the amount and timing
of which are specified by a legally enforceable contract. However, a
liability need not be payable in cash. Instead, it may require the company
to transfer other assets or to provide services e.g. a warranty liability is
created for the seller when a product is sold and the seller guarantees to
fix or replace the product if it proves defective.

A liability also need not be represented by a written agreement, nor be

legally enforceable e.g. a company might choose to pay a terminated
employee’s salary for a period of time after termination even though not
legally required to do so. The commitment creates a liability at the date of
termination.

3. Equity or Net Assets (Shareholders / Stock Holder’s Equity)

This is the residual interest in the assets of an entity that remains after
deducting liabilities. Assets and liabilities are measured directly. Equity
is not. It’s a residual amount. The accounting equation illustrates this
position:

A–L = Equity
Net Assets
Equity arises from two sources:-

(i) Amounts invested by shareholders in a company (reported as paid-

in capital) and
(ii) Amounts earned by the company on behalf of its shareholders
(reported as retained earnings).

4. Investments by Owners.

These are increases in equity resulting from transfers of resources (usually

cash) to a company in exchange of ownership interest.

5. Distributions to Owners.

These are decreases in equity resulting from transfers to owners. The

most common distribution to owners is cash dividend.

6. Revenues

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 Are inflows or other enhancements of assets or settlements of liabilities
from delivering or producing goods, rendering services, or other activities
that constitute the entity’s ongoing major, or central, operations. A
business enterprise acquires something (inflow of revenue) in exchange
for providing goods and services to customers, which is also a major
operation to an enterprise.

On the other hand if selling an item is not central operation of an

enterprise but only an incidental result of those operations, the inflow of
assets would produce again rather than revenue.

7. Gains.

Are increases in equity from peripheral or incidental transactions of an

entity. Gains are net inflows, the difference between the amount received
and book value. Revenues are gross inflows, measured as the amount
received/receivable for the good/service without regard to the cost of
providing the good or services.

8. Expenses. (Outflows of resources incurred in generating revenues).

These are outflows or other using up of assets or incurrence or liabilities

during a period from delivering or producing goods, rendering services or
other activities that constitute the entity’s ongoing major or central
operations.

9. Losses.
Represent decrease in equity arising from peripheral or incidental
transactions of an entity. Revenues plus gains less expenses and losses for
a period equals net income or net loss.

10. Comprehensive Income.

Is the change in equity of a business enterprise during a period from

transactions and other events and circumstances from non owner
resources. It includes all changes in equity except those resulting from
investments by owners and distributions to owners.

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