ACCT 010: Introduction to Financial Accounting
Accounting definition
It is also defined as process of recording, classifying and summarizing in a significant manner
and in terms of money, transactions and event which are, in part at least, of a financial character
and interpreting the result thereof.
Accounting is defined as the analysis, classification and recording of financial transactions and
the ascertainment of how much transaction affect the performance and financial position of a
business.
Essential elements of an accounting definition are
i) Recording accounting data
Businesses will not keep all the details in their mind, so they have to keep records by recording
details relating to business transactions
ii) Classifying and Summarizing
Data recorded in the books need to be classified in various accounts such as assets, liabilities,
expenses, revenues and capital. Classifying and summarizing facilitates the determination of
profits or losses and financial position for the business.
iii) Communicating information
The results obtained from classifying and summarizing need to be communicated to the owners
of the businesses or to third parties allowed to receive this information.
Book Keeping Definition
Book- keeping is the art of recording business transactions in a systematic manner. It is the
process of recording in books of account all those business transactions that result in the transfer
of money or money’s worth”.
Accounting versus Book Keeping
Accounting has a wider scope than book keeping in every organization. While Accountants
record, classify and summarize business transactions while book keepers are involved merely in
the record transactions
Transaction Definition
A business transaction is business activity which takes place for a business reason and involves
the transfer of money or money’s worth. Examples of business transactions … it is important to
note that for transactions to be recorded in the books they have to be of financial nature.
Activities such as hiring a new employee or conducting a lecture do not involve the transfer of
money and thus are not recorded in accounting.
Functions of Accounting
(i) Ascertainment of profit and loss
Accurate and complete recording of all business transaction is essential in determination of
profits and losses
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(ii) To facilitate the credit transactions
Accounting records facilitate such credit transactions because these records will determine the
amounts due to creditors and done from debtors.
(iii) Assessment of tax
It facilitates accurate assessment of tax by availing records which show the profit or loss the
business has made or incurred.
(iv) Evaluation of assets and liabilities
Through a balance sheet, details relating to assets and liabilities are shown. This shows the
financial position of the enterprise and it can be used as a security to secure a loan.
(v) A tool for control
A proper and accurate accounting system will be helpful in controlling of unnecessary
expenditure and misappropriation of funds.
(vi) Base for further planning
Accounting records can provide sufficient data relating to sales, profits, investments to facilitate
making decisions about future programmes.
Users of Accounting Information:
1. Managers
2. Owners
3. Employees
4. Customers
5. Lenders
6. Suppliers
7. Government
8. General public
9. Investors
10. Financial analysts , stock brokers
The Accounting/book keeping/balance sheet Equation
The fundamental accounting equation is the equality between the resources of a business
(assets) and the (sources to the resources) liabilities and capital. It is expressed as below:
Assets = Liabilities and Capital
Resources = Sources to Resources
A business owns resources. These resources are called assets and they are funded by people who
put finance into the business.
The funds, including assets that the owner may put into the business are called capital. Other
persons who are not owners of the firm may also fund the assets of the business. Funds from
other persons are called liabilities.
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The total assets must be equal to the total funding i.e. both from owners and non-owners. This is
expressed inform of accounting equation which is stated as follows:
ASSETS = LIABILITIES + CAPITAL
Each item in this equation is briefly explained below:
Assets:
An asset is a resource controlled by a business entity/firm as a result of past events for which
economic benefits are expected to flow to the firm.
Classification of assets:
i)
Non current assets (fixed assets).
Non current assets are acquired by the business to assist in earning revenues and not for
resale. They are normally expected to be in business for a period of more than one year.
Examples land and buildings, motor vehicles, machinery, furniture and fittings, plant and
equipment
ii)
Current assets. (short term assets)
Current assets are not expected to last for more than one year or are expected to be converted
into cash within a year of the balance sheet date. . Examples …. Cash at hand, cash at bank,
debtors, prepaid expenses, stock, incomes outstanding etc
Liabilities
These are obligations of a business as a result of past events and whose settlement is expected to
result to an outflow of funds from the firm.
Liabilities are also classified into two main classes.
i)
Non-current liabilities (or long term liabilities)
Non-current liabilities are expected to last or be paid after one year. Examples are long-term
loans
ii)
Current liabilities.
These last for a period of less than one year and therefore will be paid within one year.
Examples … creditors, bank overdraft, outstanding expenses, incomes received in advance
Capital:
This represents the owners’ claim/interest in the assets of the business
Example
Musyoka had the following assets and liabilities as on 31 April 2002:
Creditors
Equipment
Motor Vehicle
Sh.
15,800
46,000
25,160
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Stock
Debtors
Cash at bank
Cash in hand
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24,600
23,080
29,120
160
During the first week of May 2002 Moody:
a. Bought extra equipment on credit for Sh.5,520.
b. Bought extra stock by cheque Sh.2,280.
c. Paid creditors by cheque Sh.3,160.
d. Debtors paid Sh.3,360 by cheque and Sh.240 by cash.
e. Moody put in extra Sh.1,000 cash as capital.
Required:
a. Determine the capital as at 1st May 2002.
b. Draw up a balance sheet after the above transactions have been completed.
Solution:
(i) Using the accounting equation of Assets = Liabilities + Capital, then assets and liabilities can
be listed as follows.
Capital = Assets – Liabilities
= Sh.148,120 - Sh.15,800 = Sh.132,320
(ii) To draw up the balance sheet, we consider the effect of the above transactions on the relevant
balances:
This is also summarized as follows:
Opening
Balance
Adjustment
Closing
Increase/Decrease
Balance
Assets/Liabilities
Sh.
Sh.
Sh.
Equipment
46,000
+5,520
Motor Vehicle
25,160
Stock
24,600
+2,280
26,880
Debtors
23,080
-3,600
19,480
Cash at bank
29,120
-2,280 – 3,160 + 3,360
27,040
Cash in hand
160
+240 + 1000
Creditors
15,800
+5,520 – 3,160
18,160
Capital
132,320
+1,000
133,320
51,520
25,160
Activity
Prepare the balance sheet from the above illustration
1,400