Accounting Fundamentals

The Purpose of Accounting

• Answers key questions about a business's financial status:

  • How much profit or loss has the business made?

  • How much money does the business owe?

  • Will the business have sufficient funds to meet its commitments?

Stakeholders/Users of Accounting Information

• Internal Users:

  • Management (Board of Directors)

  • Owners

  • Employees

• External Users:

  • Equity investors (shareholders)

  • Loan creditors (bankers and other lenders)

  • Analysts/advisers

  • Business contacts (creditors and debtors)

  • The government

  • The public

Financial Accounting Stages

• Book-keeping:

  • Recording day-to-day business transactions.

• Preparation of Financial Statements:

  • Preparing statements from bookkeeping records.

  • Summarizing business performance, usually over one year.

  • Includes:

  • Trading, profit and loss account (Income Statement)

  • Statement of financial position (Balance Sheet)

  • Cash flow statement

  • Funds Flow Statement

Five Distinct Accounting Groups

• Revenue

• Expenses

• Capital

• Assets

• Liabilities

Revenue

• Major revenue: sales

• Other revenue: discount received, interest received, rent received

• Increases the company’s net profit

Expenses

• Major expenses: purchases for resale

• Other expenses: wages, light and heat, rent, petrol, office expenses

• Reduces the company’s net profit

Capital

• Owner’s personal investment in the business.

• Anything the owner injects is considered capital.

• Anything the owner withdraws is considered drawings.

Assets

• A present economic resource controlled by the entity as a result of past events.

  • An economic resource is a right that has the potential to produce future economic benefits.

• Fixed assets: more than one year use and not for resale.

  • E.g., premises, vehicles, furniture.

• Current assets: use for trading purposes and constantly circulate.

  • E.g., cash, bank, debtors, stock.

Liabilities

• A present obligation of the entity to transfer an economic resource as a result of a past event.

• Current liabilities: expected to be repaid within one year.

  • E.g., creditor from purchases, accrued electricity bill.

• Long-term liabilities: expected to be repaid over longer than one year.

  • E.g., bank loan, mortgage loan, debenture.

Dual Aspect

• Every transaction affects two items.

• Examples:

  1. Owner introduces capital in cash $5,000$: Increases cash and capital.

  2. Purchase of building in cash $3,000$: Increases building, decreases cash.

  3. Purchase of goods in cash $600$: Increases inventory, decreases cash.

  4. Purchase of goods on credit $500$: Increases inventory, increases liability (creditor).

  5. Sale of goods on credit $100$: Increases debtor.

  6. Sale of goods in cash $50$: Increases cash and inventory.

  7. Cash payment to Creditor $200$: decreases cash and creditor.

  8. Cash receipt from Debtor $100$: increases cash and decreases debtor.