Introduction to Accounting
Zoubida SAMLAL - MBA , CFA
Member, PHD candidate for HBS
program
1
PLAN
Module
chapter
Fondamentals
Introduction to accounting
Types of accounting and regulators
Accounting and financial systems
Midterm
Accounting and
business
transactions
Final
Task
Cases and exercies
1 h30 minutes
Recording transactions
Accounting for merchandising
Accounting for cash and principle of
internal control
ÉCases and exercies
2h30 minutes
Grading system
15%
participation
50%
Final exam
35%
midterm
Fundamental concepts
What is accounting?
• the language of business
• a process of identifying, recording, summarizing, and reporting
economic information to decision makers in the form of financial
statements
• a mean to communicate financial information.
• a way to convey information about a business to users.
4
Definitions of Accounting
• “The process of identifying, measuring, and communicating
economic information to permit informed judgements and
decisions by users of the information.”
—American Accounting Association (AAA)
•
“A service activity whose function is to provide quantitative
information, primarily financial in nature, about economic
entities that is intended to be useful in making economic
decisions.”
—American Institute of Certified Public Accountants
(AICPA)
5
Primary Functions of Accounting
• Recording data about business transactions- In the Egyptian
era they used a quill pen to record the data and stored it on
papyrus scrolls. Today we might use a bar code and scan data
into a computer system and store it on a magnetic disk.
• Summarizing results of business activity into useful reportThe balance sheet and income statement have been standard
reports for many years. More recently we added a statement
of cash flows. However, managers in today's environment
demand more detailed reports like sales by district or sales by
product type.
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Primary Functions of Accounting
•Providing assurances that the business is operating as intended
and that the assets of the organization are protected- All parties
to a business event have looked to accountants to provide
assurance that the transaction is properly handled, accurately
recorded, and accurately reported. Throughout most of this
century the assurance has been based on a system of internal
controls and an audit of the published financial statements.
7
Accounting as an Aid to Decision Making
• Accounting helps in decision making by showing where
and when money has been spent, by evaluating
performance, and by showing the implications of choosing
one plan instead of another.
• Fundamental relationships in the decision-making process:
Event
Accountant’s
analysis and
recording
Financial
statements
Users
Fundamental concepts
Who uses accounting information?
• Owners
• Managers
• Investors (including potential)
– Analysts on their behalf
• Creditors (including potential)
• Government (tax assessment)
• Regulators
• Customers
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Fundamental concepts
Accounting has two main divisions:
1- Financial accounting
Primarily prepared for users external to the company: Revenues,
earnings, assets, etc.
2- Management accounting
Primarily for internal purposes : Costing, budgeting, net present
value, etc.
– This COURSE will focus only on financial accounting.
10
Fundamental concepts
There are several ways that cash gets into a company:
• Investment by owners
• Investment by creditors (loans)
• Payments from customers
• Repayment of amounts loaned to other entities
• Return on investments (interest and dividend)
• Proceeds from selling assets
11
Fundamental concepts
These can be organized into three categories:
Operations
• Payments from customers
• Refunds from suppliers
Financing
• Investment by owners
• Investment by creditors (loans)
Investing
• Return on investments (interest and dividend)
• Proceeds from selling assets
• Repayment of amounts loaned to other entities
12
Fundamental concepts
Similarly, money going out of an entity can be categorized:
Operations
• Payments to suppliers
• Refunds to customers
Financing
• Payment of dividends or capital to owners
• Repayment of creditors
Investing
• Purchase of assets
• Amounts invested in other entities (debt or equity)
13
Fundamental concepts
Financial accounting categorizes all transactions and events based
on their substance.
– It is very important that the substance of a transaction be
accurately reflected by financial accounting because the users
of the information are using it with the assumption that these
categorizations are being made accurately.
• If money invested by owners was reported as revenue, this
would be counter to the fundamental definition of revenue (i.e.
that it results from the operations of the company).
– The separation of income and capital is a fundamental concept
of financial accounting.
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Standards and Regulatory bodies
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Securities and Exchange Commission
Established by federal government
Accounting and reporting for public companies
Securities Act
of 1933
Securities Act
of 1934
Encouraged private standard-setting body
SEC requires public companies to adhere to GAAP
SEC Oversight
Enforcement Authority
Financial Accounting Standards Board
Wheat Committee’s recommendations resulted in the creation of a the
Financial Accounting Standards Board (FASB) in 1973.
Financial
Accounting
Foundation
Selects members of the FASB
Funds their activities
Exercises general oversight.
Financial
Accounting
Standards Board
Mission to establish and improve
standards of financial accounting
and reporting.
Financial Accounting
Standards Advisory
Council
Consult on major policy issues.
Financial Accounting Standards Board
Missions is to establish and improve standards of financial accounting and
reporting. Differences between FASB and APB include:
Smaller Membership
Full-time, Remunerated Membership
Greater Autonomy
Increased Independence
Broader Representation
Standard-Setting Organizations
• Generally accepted accounting principles (GAAP) encompass the conventions,
rules, and procedures for determining acceptable accounting practices at a
particular time.
• Financial Accounting Standards Board (FASB) is primarily responsible for
evaluating, setting, or modifying GAAP in the U.S.
• Sarbanes-Oxley Act responded to cases of accounting fraud.
– Created the Public Accounting Oversight Board, which sets audit standards and
investigates and sanctions accounting firms that certify the books of publicly
traded firms.
– Senior executives must personally certify that the financial information reported by
the company is correct.
– Resulted in increase in demand for accountants.
Financial Accounting Standards Board
U.S. Generally Accepted Accounting Principles
Principles that have substantial authoritative support.
Major sources of GAAP:
FASB Standards, Interpretations, and Staff Positions
APB Opinions
AICPA Accounting Research Bulletins
When the Board approves a new standard, staff position, etc., the results are
included in the Codification through an Accounting Standards Update.
Standard-Setting Organizations
International Organization of Securities
Commissions (IOSCO)
 Does not set accounting standards.
 Dedicated to ensuring that global
markets can operate in an efficient
and effective basis.
http://www.iosco.org/
Financial Reporting Challenges
IFRS in a Political Environment
Financial Reporting Challenges
The Expectations Gap
What the public thinks accountants should do vs. what accountants think
they can do.
Significant Financial Reporting Issues
 Non-financial measurements
 Forward-looking information
 Sort assets
 Timeliness
Financial Reporting Challenges
Ethics in the Environment of Financial Accounting
Companies that concentrate on “maximizing the bottom
line,” “facing the challenges of competition,” and
“stressing short-term results” place accountants in an
environment of conflict and pressure.
IFRS does not always provide an answer.
Doing the right thing is not always easy or obvious.
Financial Reporting Challenges
International Convergence
In 2002 the IASB and the FASB formalized their commitment
to the convergence of U.S. GAAP and international
standards. The Boards agreed to:
1. Make their existing financial reporting standards fully
converged as soon as practicable, and
2. Coordinate their future work programs to ensure that
once achieved, convergence is maintained.
12 Fundamental concepts
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1) BUSINESS ENTITY CONCEPT
• Business is treated as separate & distinct from its members
• Separate set of books are prepared.
• Proprietor is treated as creditor of the business.
• For other business of proprietor different books are prepared.
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2) MONEY MEASUREMENT CONCEPT
• Transactions of monetary nature are recorded.
• Transactions of qualitative nature, even though of great
importance to business are not considered.
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3) GOING CONCERN CONCEPT
• Business will continue for a long period.
• As per this concept, fixed assets are recorded at their original
cost & depreciation is charged on these assets.
• Because of this concept, outside parties enter into long term
contracts with the enterprise.
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4) ACCOUNTING PERIOD CONCEPT
• Entire life of the firm is divided into time intervals for
ascertaining the profits/losses are known as accounting
periods.
• Accounting period is of two types- financial year(1st Apr
to 31st March) & calendar year(1st Jan to 31st Dec).
• For taxation purposes financial year is adopted as
prescribed by the Govt.
• Companies having their shares listed on stock exchange
publishes their quarterly results.
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5) HISTORICAL COST CONCEPT
• Assets are recorded at their original price.
• This cost serves the basis for further accounting treatment of
the asset.
• Acquisition cost relates to the past i.e. it is known as historical
cost.
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JUSTIFICATION FOR HISTORICAL COST
CONCEPT
• This cost is objectively verifiable.
• Justified by going concern concept.
• Current values are difficult to determine.
• Difficult to keep track of up down of the market price.
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DRAWBACKS OF HISTORICAL CONCEPT
• Assets for which nothing is paid will not be recorded like
reputation, brand value, etc.
• Information based on historical cost may not be useful to its
members.
34
6) DUAL ASPECT CONCEPT
• Every transaction recorded in books affects at least two
accounts.
• If one is debited then the other one is credited with same
amount.
• This system of recording is known as “DOUBLE ENTRY
SYSTEM”.
• ASSETS = LIABILITIES + CAPITAL
35
7) REVENUE RECOGNITION/REALISATION
CONCEPT
• Revenue means the addition to the capital as a result of
business operations.
•
1.
2.
3.
Revenue is realized on three basis-:
Basis of cash
Basis of sale
Basis of production
36
8) MATCHING CONCEPT
• All the revenue of a particular period will be matched with the
cost of that period for determining the net profits of that
period.
• Accordingly, for matching costs with revenue, first revenue
should be recognized & then costs incurred for generating that
revenue should be recognized.
37
Following points must be considered
while matching costs with revenue-:
• Outstanding expenses though not paid in cash are shown in the
P&L a/c.
• Prepaid expenses are not shown in the P&L a/c.
• Closing stock should be carried over to the next period as
opening stock.
• Income receivable should be added in the revenue & income
received in advance should be deducted from revenue.
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9) ACCRUAL CONCEPT
• In this concept revenue is recorded when sales are made or
services are rendered & it is immaterial whether cash is
received or not.
• Same with the expenses i.e. they are recorded in the
accounting period in which they assist in earning the revenues
whether the cash is paid for them or not.
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10) OBJECTIVITY CONCEPT
• Accounting transactions should be recorded in an objective
manner, free from the personal bias of either management or
the accountant who prepares the accounts. It is possible only
when each transaction is supported by verifiable documents &
vouchers such as cash memos, invoices.
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11) TIMELINESS
• This principle states that the information should be provided to
the users at right time for the purpose of decision making.
• Delay in providing accounts serves no usefulness for the users
for decision making.
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12) COST BENEFIT PRINCIPLE
• This principle states that the cost incurred in applying the
principles should be less than the profits derived from them.
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ACCOUNTING CONVENTIONS
ACCOUNTING CONVENTIONS
• An accounting convention may be defined as a custom or
generally accepted practice which is adopted either by general
agreement or common consent among accountants.
1) CONVENTION OF FULL DICLOSURE
• Information relating to the economic affairs of the enterprise
should be completely disclosed which are of material interest
to the users.
• Proforma & contents of balance sheet & P&L a/c are
prescribed by Companies Act.
• It does not mean that leaking out the secrets of the business.
2) CONVENTION OF CONSISTENCY
• Accounting method should remain consistent year by year.
• This facilitates comparison in both directions i.e. intra firm &
inter firm.
• This does not mean that a firm cannot change the accounting
methods according to the changed circumstances of the
business.
3) CONVENTION OF CONSERVATISM
• All anticipated losses should be recorded but all anticipated
gains should be ignored.
• It is a policy of playing safe.
• Provisions is made for all losses even though the amount
cannot be determined with certainity
4) CONVENTION OF MATERIALITY
• According to American Accounting Association, “An item
should be regarded as material if there is reason to believe that
knowledge of it would influence decision of informed
investor.”
• It is an exception to the convention of full disclosure.
• Items having an insignificant effect to the user need not to be
disclosed.
DIFFERENCE B/W CONCEPTS &
CONVENTIONS
BASIS
Established
Biasness
Uniformity
ACCOUNTING
CONCEPTS
By law
ACCOUNTING
CONVENTIONS
Guidelines based
upon customs or
usage
No space for
Biasness in adoption
personal biasness in
the adoption
Uniform adoption
No uniform adoption